Despite the Philippine Stock Exchange hitting historical highs, further reform is needed

Though smaller than some other capital markets in the region, the Philippine Stock Exchange (PSE) reached record highs in 2017 against a backdrop of robust macroeconomic expansion and the sweeping Tax Reform for Acceleration and Inclusion (TRAIN) programme, which should support the government’s sizeable infrastructure agenda, Build, Build, Build (BBB).

Benefitting from rising levels of trading and liquidity, and rapid growth in fixed income, the PSE is poised for a strong 2018. Efforts to finance the BBB agenda should see a near-term increase in the amount of foreign currency-denominated bonds, with a recent landmark Panda bond issuance – denominated in Chinese renminbi – attracting significant investor participation. Corporate bonds are set to stay on a strong upward trajectory as new public-private partnership (PPP) regulations allow infrastructure companies to access alternative funding via the capital markets.

While regulatory reforms addressing burdensome listing requirements and ownership concentration rules have yet to be finalised, the country’s strong macroeconomic fundamentals and ambitious reform agenda should support near- and mid-term growth, despite ongoing geopolitical worries.

Structure

One of the oldest exchanges in Asia, the Manila Stock Exchange was founded in August 1927 and followed by the establishment of the Makati Stock Exchange in May 1963. The two exchanges merged in December 1992 to become the PSE. In June 1998 the industry regulator, the Securities and Exchange Commission (SEC), named the PSE a “self-regulatory organisation”, and in 2001 the exchange was converted from a non-profit entity into a revenue-earning corporation overseen by a president and board of directors. In February 2018 the former exchanges’ trading floors were unified when the PSE opened its new headquarters in Bonifacio Global City.

The PSE comprises eight indices: the All Shares index; the PSE index (PSEi), which includes 30 of the exchange’s largest and most active common stocks; and six sector indices for financial services, holding firms, industry, property, mining and oil, and services.

Index Shuffle

In September 2017 the PSE announced it had removed nine companies from its sector indices and added an additional 11, following a performance review conducted between July 2016 and June 2017. The Philippine Business Bank was removed from the financial index and Medco Holdings was added, while the industrial index dropped Da Vinci Capital Holdings and welcomed CEMEX Holdings Philippines and Pilipinas Shell Petroleum. Filinvest Development Corporation and Prime Orion Philippines were pulled from the holding firms index, while ATN Holdings and Lodestar Investment Holdings joined.

On the property index, Arthaland Corporation, Crown Equities and MRC Allied Corporation were added, and the services index gained Apollo Global Capital, Golden Haven Memorial Park and Harbor Star Shipping Services. DFNN and ISM Communications were dropped from the services index. The mining and oil index, for its part, lost Abra Mining and Industrial Corporation, Manila Mining Corporation, and Atlas Consolidated Mining and Development.

The PSEi was left unchanged through the shuffle, as each of its firms had floated at least 12% of its shares publicly, and passed liquidity and market capitalisation tests. However, in February 2018 the PSE raised its free-float requirement for PSEi-listed firms to 15%.

Recent Performance

While the PSE recorded a historically strong performance in 2017, the previous year was relatively subdued when looking from start to finish. The PSEi ended trading on December 29, 2016 at 6840.64 points – just 7.22 points above the close of 6833.42 posted on the first day of trading that year. Although full-year growth for the PSE was largely flat in 2016, the year was characterised by significant volatility, with the standard deviation of the PSEi rising by nearly 30% compared to that of 2015.

In its 2016 annual report, the PSE stated that the global geopolitical landscape had a profound impact on market sentiment that year, with many investors surprised at both the UK’s vote to leave the EU and the victory of Donald Trump in the US presidential election. Capital outflows were also a concern in the third quarter of 2016, as the US Federal Reserve signalled its intention to raise interest rates. This resulted in P25.16bn ($497.1m) of net foreign selling over 22 consecutive days in late August and September.

According to a report in local media, investor uncertainty in 2016 was exacerbated by a moderating Chinese economy and President Rodrigo Duterte’s anti-Western statements. However, a number of domestic factors supported the market around the middle of the year. These included the announcement of stronger-than-anticipated GDP growth for 2015 and the introduction of a planned “golden age of infrastructure”, which pushed the PSEi to an annual high of 8102.3 on July 21. This was just short of the previous high of 8127.48, set in April 2015.

Record Rebound

The PSE surged in 2017, with trading, market capitalisation levels and the PSEi each reaching record highs. The index rose by 25.1% – or 1717.78 points – in 2017, and reached an all-time intraday high of 8640.04 on December 29. This was significantly more than the previous year’s intraday high of 8118.44, reached on July 22, 2016. The index closed at a record 8558.42 on December 29, 2017, the last day of market activity.

According to the PSE’s 2017 annual report, the market’s daily average turnover was P8.06bn ($159.2m) that year, up 3.2% over 2016, while net foreign buying hit P56.2bn ($1.1bn), compared to a mere P2.8bn ($55.3m) the year before. Market capitalisation reached a record high of P17.58trn ($347.3bn) during 2017, and property developer SM Prime Holdings reached a single-firm market capitalisation level of P1.01trn ($20bn) on June 9 – the first time a domestic company had surpassed the P1trn ($19.8bn) threshold. The PSE’s net income for 2017 came to P828.09m ($16.4m), 18% more than in 2016.

In late 2017 Jose Pardo, chairman of the PSE, told local media that he expects the market will continue on an upward trajectory. He projected the PSEi would surpass the 9000-point threshold in 2018 – this indeed occurred on January 29, when the index hit a new high of 9058.62 – and exceed 10,000 in 2019.

Bond Market

Consisting of short- and long-term instruments, the Philippine bond market is currently dominated by Treasury bills and Treasury bonds. Both government and corporate bond markets were active in the first quarter of 2018, supported by a robust local currency bond market, strong investor appetite for a recent Panda bond and promising projections for new corporate issuances. Perhaps more important, though, was regulators’ approval of new reforms to help developers tap the capital markets for infrastructure project financing (see analysis).

In March 2018 the Asian Development Bank (ADB) reported that the Philippine local currency bond market rose by 12.5% for the whole of 2017 and by 5.1% quarter-on-quarter (q-o-q) in the last three months of the year to end at P5.48trn ($108.3bn). This was the highest quarterly growth rate in the emerging East Asia region, after a slight 0.8% rise during the third quarter of 2017.

The government bond market grew by a comparable 12% in 2017 and by 5.8% q-o-q in the final months of the year. Driven by the issuance of P255.4bn ($5bn) worth of retail Treasury bonds in November, 2017 ended with a value of P4.46trn ($88.1bn). Although the Philippines remains one of the smallest bond markets in emerging East Asia, it recorded the largest increase in 10-year government bond yields. This rose 101 basis points between December 29, 2017 and February 15, 2018, driven by the first phase of the TRAIN programme. Corporate bonds, meanwhile, were up by 14.4% in 2017 and by 2.2% q-o-q to end the year at P1.02trn ($20.2bn), according to the ADB.

Forecasts

The government bond market is expected to maintain momentum in 2018, bolstered by the March offering of the country’s first Panda bond. Nearly P12bn ($237.1m) was raised from the issuance, and underwriter Standard Chartered stated that the landmark transaction should pave the way for private Philippine firms to tap China’s onshore bond market for financing. The bond was 6.32 times oversubscribed, with bids reaching RMB9.22bn ($1.4bn) against the government’s offering of RMB1.46bn ($218.9m). With a spread of just 35 basis points above benchmark, the three-year bonds offered a 5% coupon rate, lower than the originally forecast 5.6%.

Corporate bond issuance is also forecast to see continued activity, with a considerable portion of fixed-income issuances expected to be derived from listed firms participating in infrastructure projects, according to Philippine Dealing System Holdings Group (PDS Group). PDS Group is the holding firm for Philippine Dealing and Exchange Corporation, the fixed-income trading platform, and Philippine Depositary and Trust Corporation.

Cesar Crisol, CEO of PDS Group, told local media in March 2018 that corporate issuances for the year should match the P207bn ($4.1bn) seen in 2017. Conglomerate San Miguel Corporation issued five-, seven- and 10-year local retail bonds worth as much as P30bn ($592.7m) in March, while real estate firm Ayala Land listed a P7bn ($138.3m), fixed-rate bond in April to be due in 2022. China Banking Corporation also plans to raise P50bn ($987.8m) in 2018 with highyield time deposits, bonds and commercial papers.

State of Affairs

Although equity and bond markets recorded a record-breaking performance in 2017, Philippine capital markets remain shallower and less developed than those of many regional neighbours.

Capital market expansion has not kept pace with broader GDP growth in recent years. The World Federation of Exchanges reports that the market capitalisation-to-GDP ratio of domestic listed firms fell from a high of 92% in 2014 to 81.57% in 2015 and 78.63% in 2016. Furthermore, according to the April 2017 report “Deepening capital markets in emerging economies” by global consultancy McKinsey, the country’s capital markets remain insufficient to finance its sizeable infrastructure agenda. McKinsey noted that while equities, private and public bonds, and securitised products amounted to 130% of GDP in the Philippines – comparable to China at 136% and India at 118% – it lags behind Malaysia and Thailand, at 275% and 184%, respectively.

Issuance of private capital markets products and government bonds each amounted to an average of 4% of GDP between 2013 and 2015, slightly lower than in China, Malaysia and Thailand. Moreover, the cost of equity in the Philippines is more than 14% – higher than in many other emerging Asian economies – while the cost of debt ranges from 2% to 3%.

On a positive note, McKinsey writes that the Philippines’ largest asset class – equities – has offered investors high risk-adjusted returns, with the country’s Sharpe ratio averaging 1.4 between 2008 and 2015. The Sharpe ratio measures returns per unit of risk, with higher ratios indicating larger returns for a certain amount of risk. Most other Asian markets’ Sharpe ratios were below 1 in the same period.

However, the PSE continues to grapple with low liquidity, high trading costs and problematic hedging mechanisms. It also remains difficult for companies to tap into the equity market, with more than 40 documents required to list on the exchange.

IPO Activity

Persistent hurdles to accessibility have resulted in generally limited volumes and values of initial public offerings (IPOs), although reforms aimed at improving small business listings and supporting PPP implementation could reverse this trend (see analysis). According to local media reports from December 2017, Philippine corporations had raised over P1.7trn ($33.6bn) on the market since 2013.

The PSE’s 2016 annual report states that a total of P227.25bn ($4.5bn) was raised through four IPOs and follow-on share offerings that year, including P176.8bn ($3.5bn) via the offering of primary shares by listed companies gathering funds for expansion and new projects. This put the 2016 IPO total just P1bn ($19.8m) short of the record set in 2012. Two of the 2016 IPOs were notable for being among the 10-largest offerings in the exchange’s history. The July listing by CEMEX Holdings Philippines raised P25.1bn ($495.9m), while Pilipinas Shell Petroleum’s October IPO brought in P19.5bn ($385.2m). These helped boost total market capitalisation to P14.44trn ($285.3bn), 7.2% more than 2015, while domestic market capitalisation rose by 6.1% to P11.87trn ($234.5bn).

Another four IPOs occurred in 2017: Wilcon Depot at P7bn ($138.3m), Eagle Cement at P8.6bn ($169.9m), Cebu Landmaster at P3bn ($59.7m) and Chelsea Logistics Holding at P5.84bn ($115.4m). Two of these companies are based outside Metro Manila, which is hoped to set an example for other firms in those areas.

Market capitalisation levels in 2018 may benefit from what would be one of the largest share offerings in the country’s history. In April 2018 San Miguel Corporation, the biggest company in the Philippines, announced plans to raise up to $3.6bn in the fourth quarter of the year by offering shares of its recently merged food and drinks unit. Ramon S Ang, the company president and CEO, told media that San Miguel Food and Beverage is now worth around $12bn and could sell up to a 30% stake. The share value of the parent company rose by 21% in 2017, and by an additional 27% between January and April 2018 alone.

Listing Reforms

In a January 2018 interview with Dealstreet Asia, a regional business publication, Roel Refran, the senior vice-president and COO of the PSE, stated that P165bn ($3.3bn) was raised through capital offerings in 2017. He noted the exchange continues to fall below its annual target of P200bn ($4bn), but that rights offerings, private placements and follow-on offerings would be vital in supplementing IPOs.

Importantly, Refran said the PSE was open to reforming parts of its IPO regulatory framework. The last set of reforms, carried out in 2013, included new requirements for the listing of small- and medium-sized enterprises (SMEs). According to Refran, the stricter rules led to increased use of crowdfunding platforms and venture capital investment by startups that were unable to meet listing requirements. Potential new reforms could include incorporating benchmarking best practices for start-up listings and allowing start-ups backed by a larger company to list, as is the case with London’s Alternative Investors Market. The more established firms would help protect investors while enabling SMEs and start-ups to participate more fully in the capital markets.

SEC Regulations

Reforms backed by the SEC are also under way, after the commission strengthened its regulatory framework with the 2015 Securities Regulation Code (SRC). Since then, the SEC authorities have been increasingly active in implementing reforms aimed at improving transparency, accountability and stability. One of the most important reforms has significant ramifications for the PSE’s ownership structure. The SRC included a provision that states industry ownership of the exchange must be 20% or less and that individual ownership must be capped at 5%. This rule has proven troublesome for PSE officials as they work to reduce ownership concentration to move forward on a landmark acquisition of PDS Group.

In February 2018 the PSE announced a stock rights offering (SRO) to reduce its level of broker ownership from 23% to less than 20%. The exchange offered 11.5m shares to all existing shareholders except brokers, priced at P252 ($4.98) per share. The process was not without its challenges. After halting all trading on the PSE for a few hours in late February 2018, the SEC reported that the SRO alone would not be enough to reduce broker ownership to less than 20%.

The SRO was nevertheless carried out between March 12 and 16, 2018, with media later announcing that broker ownership had been reduced to 21.38% following the P2.9bn ($57.3m) offering. This has stalled the PSE’s plans to acquire PDS Group, which would consolidate ownership of the fixed-income and equities markets, and create a unified exchange for stock and bond trading. Authorities at the PSE argue that such a consolidation will result in a larger and more efficient capital markets ecosystem, yet the acquisition remained blocked as of April 2018. The situation has become further complicated with state lender Lank Bank of the Philippines also offering to buy a majority stake in PDS Group.

Outlook

Geopolitical uncertainty remains one of the largest threats to near-term capital markets growth, with the PSE sinking below 8000 in March 2018 on the back of fears over a US-China trade war and the US Federal Reserve’s decision to raise interest rates. The index dropped to 7909.07 on March 21, immediately following the US rate increase announcement, and remained below the 8000 mark through late April, with the exception of a handful of days.

More broadly, economic growth in 2018 should be enabled by long-awaited tax reform legislation, which will support the government’s major infrastructure agenda. The first phase of the TRAIN programme is expected to generate P130bn ($2.6bn) of new revenue, boosting the take-home pay of low- and middle-income workers, while increasing taxes on fuel, vehicles and sweetened beverages. It will also expand the value-added tax base (see Economy chapter). The TRAIN bill could negatively impact capital markets, however, as it includes a provision to raise the stock transaction tax from 0.5% of the gross selling price to 0.6%. According to Ramon Monzon, president and CEO of the PSE, the Philippines already has the highest stock transaction tax in the region. This could add to the pressure of competition with exchanges in Thailand, Malaysia, Indonesia and Vietnam.

Although the Philippines’ strong macroeconomic fundamentals have brightened the near-term outlook, business-friendly reforms to encourage IPOs and deepen the market will remain a critical focus.