Foreign capital struggles for relevance in the Philippines

The Philippines needs investment from offshore if it wants to grow, but abundant local liquidity is making it tough for foreign capital to make in-roads.

When engaging in conversation with members of Manila’s finance community, it doesn’t take long for the topic of the country’s vast capital reserves to arise.

“The central bank has over Ps1.7 trillion ($40 billion) in special deposit accounts held by local financial institutions, and another Ps200 billion in repos,” explains Eduardo Francisco, president of BDO Capital, and a promoter of the country’s financial self-sufficiency. “These deposits roll over every 90 days, so there is no shortage of peso liquidity in the market.”

There is also a healthy store of US dollars, with banks reportedly sitting on $25 billion in reserves generated from overseas worker remittances and income earned from the boom in business process outsourcing.

The plentiful environment is ideal for companies in need of growth capital and access to the local markets is wide open.

At the time of writing this story, San Miguel was in the process of selling a multi-tranche peso bond in tenors of five, seven and 10-years. The targeted deal size was Ps20 billion, but well before the books had opened to retail investors, institutional orders had reached Ps46 billion. Deal tables show there have been 13 sizeable peso bond issues since October last year, with issuers raising a total of Ps78 billion.

Over in the equity markets there is further evidence that liquidity is robust.

Average daily volumes on the Philippine Stock Exchange (PSE) have gone up by 50% since the exchange added an afternoon trading session in January this year — a far greater jump than was anticipated. What’s more surprising, however, is that the trading is being dominated by local accounts.

“In 2007, foreign buying represented about 50% of the overall market, a level which had been fairly consistent for several years,” said Hans Sicat, chief executive of the PSE. “This year, however, foreign buying has dropped to 38% of the overall market as local institutions and private clients have stepped up their activity.”

Dangerous rhetoric
On the back of such evidence, it might be easy to assume that the Philippines is reaching a level of financial independence where there is enough cash in the local capital markets to meet the needs of issuers. It’s a high-minded idea that is gaining traction in certain business circles in Manila.

But not everyone is engaging in the rhetoric. Manuel Tordesillas, regional head of investment banking and advisory at Maybank Kim Eng in Manila, said foreign capital is essential to boosting the size and integrity of the markets — if not the peso debt markets, then certainly in equities, M&A and direct investments in infrastructure.

“The government has a very ambitious infrastructure development programme, and I can’t see this being achieved purely with local money,” said Tordesillas.

Eduardo Olbes, head of corporate and investment banking at Security Bank, agreed. “Foreign participation is important for creating price tension, particularly on the larger equity deals,” he said. “Sure, local buyers are accounting for the majority of secondary trading volumes on the stock exchange, but it’s the foreign and domestic institutional investors that underpin the primary markets.” Olbes believes the Philippines’ weighting in global portfolios will remain constrained while the overall size of the market is limited.

After all, the local equity markets aren’t particularly deep. Even with a 50% surge in volumes, the average daily turnover is still only $180 million compared to $450 million in Indonesia and $1.1 billion in Thailand. Last year, corporations raised a total of just Ps107 billion in new equity.

Sicat at the PSE is doing what he can to elevate the exchange and make it conducive to greater foreign participation. Aside from extending the trading hours, he has implemented a new electronic trading system purchased from the NYSE and has issued a set of best practice guidelines for corporate governance that include suggestions on appointing independent directors and separating audit committees. He is also working with the securities regulator to introduce exchange-traded funds and a framework for securities lending.

Though, to really boost the exchange, Sicat needs more companies to list, and this isn’t a simple task. “Finding new IPO candidates is a real challenge and requires encouraging companies to choose an alternative to bank financing that has historically supported their growth,” he said. “We need issuers to view the IPO process as not simply a single fundraising exercise, but as an important step in their graduation to mature companies.”

Roberto Dispo, president of First Metro Investment Corporation, reckons there are plenty of mid-tier companies that could be brought to market. “I have visited the provincial capitals and identified several large local businesses in each city that would make ideal IPO candidates, but they are reluctant to get their accounts in order and prepare the necessary listing documentation,” he said. A process that would also require coming clean with the tax department.

Due to the limited size of some of these companies, it is unlikely that they would hit the radar of foreign investors, even if they were to list.

They may, however, be more interested in a wave of secondary placements that is expected this year as companies move to comply with the PSE’s free-float requirements by issuing more shares. “As many as 44 companies are still below the threshold of 10% and the authorities have now shortened the deadline for them to fall into line, after which penalty taxes will apply,” said Francisco at BDO.

Debt markets stitched up
Finding space for foreigners to participate in the debt markets isn’t a straightforward exercise. The appetite for dollar funding has decreased significantly since the Asian financial crisis of the late 1990s a trend mirrored across Southeast Asia. The only regular issuers in the dollar bond markets are the large domestic banks that have dollar lending activities or a handful of Philippine conglomerates that have subsidiaries overseas.

In the first two months of this year, a total of four issuers tapped the dollar markets --RCBC Bank, BDO Bank, ICTSI and Carmen Copper — with deals in the $100 million to $300 million range. But not all of this dollar paper was placed offshore. Olbes at Security Bank Capital estimates at least 50% of each dollar bond deal is now bought by local accounts. “This figure is probably higher if you consider that the foreign order book probably includes local high-net-worth money sitting in offshore bank accounts,” he said, adding that the strong local bid is having the effect of “tightening the pricing relative to offshore benchmarks”.

The lack of a steady flow of deals makes it tricky for foreign investment banks to commit significant resources to the Philippines. Most operate on a fly-in/fly-out basis, where deal originators are brought in when they are needed. Some complement this strategy by having a permanent relationship manager on the ground.

Banks like HSBC, Standard Chartered and Citi operate slightly differently. Their ability to collect local deposits means that they can compete with domestic arrangers in the peso markets, and recent league table statistics show an increase in activity in this area. They are also keen to grab a greater share of the loan syndication market and to offer banking services to local conglomerates as they expand their businesses offshore.

It may only be a matter of time before the Philippines begins to attract more attention from foreign sell-side and buy-side firms. It is widely expected that within the next 12 months the global rating agencies will raise the country’s credit rating to investment grade, a move that will lead to a reweighting in the MSCI indices.

“A jump from half a percent in the MSCI to, say, one percent will bring a lot more money into the market,” said Tordesillas at Maybank Kim Eng.

“That will be a big fillip by any measure.”


This article first appeared in the April issue of FinanceAsia magazine.

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