Highly liquid banks hinder capital markets

Excess liquidity among domestic banks has become a limiting factor for the growth of the local capital markets, making them seem small and obscure compared to the country’s neighbors, the Oxford Business Group (OBG) said in its recent report on the Philippines.

Banco de Oro Capital and Investment Corp. President Eduardo Francisco, who is also co-chairman of the Capital Market Development Council, told OBG that, while the local capital market seems small based on funds raised, it is understated.

“There is an abundance of domestic liquidity and some clients opt not to go via capital markets, utilizing other options, instead. For example, in many cases when a client would normally want to issue a bond, banks will instead offer a loan of up to P10 billion or $225 million,” he said.

Francisco said that as a result, the banking system is competing with capital markets by making financing easier, which creates the impression that the local capital markets are weak.

The OBG report said 2014 was a breakthrough year when the market appeared to have found its leg and grew into a major fundraising venue.

Gross issuance through the Philippine Dealing and Exchange Corp. (Pdex) fixed-income exchange came to P192 billion last year, up 130 percent, from the P83.5 billion issued in 2013, the report noted.

It quoted Pdex figures that showed outstanding issuance grew from 59 bonds issued by 21 companies worth P345 billion at the end of 2013 to 88 bonds issued by 31 companies worth P470 billion last year.

“Remarkably, this happened during a year when interest rates were expected to and did, in fact, rise, which reduced the market prices of bonds,” the report said.

Francisco said once liquidity is reduced, capital market activity is expected to become normal and show higher numbers.

“Since banks are currently exceptionally strong, they dominate the fixed-income market,” he added.

Francisco said from the perspective of issuers, many clients are large enough to hit the capital markets and be attractive to not just local investors, but also regional ones.

“Thus, effort is going toward building awareness among private firms, educating them about the benefits of having new investors and the additional transparency requirements,” he said.

He added that while the benefits of listing a local firm are significant, challenges remain, like changing the business culture and increasing disclosures.

“Consider the bond market: year-on-year issuance growth has increased and the Philippines is working to encourage smaller companies to tap the bond market, while also pursuing cross-border listing opportunities,” he said.

Francisco said to be considered by local firms in the integration of regional markets are the kinds of products and services that would be offered in the equities and fixed-income market, and the simplification of tax structures.

“These go in tandem with the ongoing deployment of infrastructure and the development of a regulatory framework that makes the country more competitive,” he said.

The government should also address existing regulatory issues, particularly related to the Bureau of Internal Revenue, like the taxability of foreign investors, he said.

Pdex is currently seeking to unify and simplify existing tax structures, as there are currently tax-exempt and non-tax exempt Philippine institutions that cannot trade among themselves.

“These issues confuse local firms and would prove difficult for foreigners,” Francisco added.

“On the securities side, integration creates a situation where the countries’ national priorities may conflict, thereby creating the potential for smaller players to be marginalized,” he added.

“When the Philippines is linked to other countries in the region, if it does not exhibit the variety of investment products of its regional peers, Asean neighbors may not invest in the country, while at the same time, the country’s $40 billion in liquidity could be invested abroad. As a result, it is imperative to first fix the domestic market, or else integration would see our funds exit and we may not receive any in return,” he added.

He said educating local firms before pushing for securities is also needed because they are not yet sophisticated enough to buy equity, as they are accustomed to fixed income.

“To protect customers, it would, for example, be unwise to tell them to buy Malaysian-issued equities or Islamic bonds, because they are not financially adept. The investor base will grow quickly from its current 0.5 percent of the population, and this expansion must be complemented with educational support,” Francisco said. Luis Leoncio