UNIVERSITY OF SANTO TOMAS

España, Manila
COLLEGE OF COMMERCE AND BUSINESS
ADMINISTRATION

Chapter 2

An Evaluation on the Impact of Regulations and Policies on Bonds in

the Performance of the Philippine Bond Market

4FM1

Submitted to:

Assoc. Prof. Anthony DC. Altarejos, CB, CSS, DBA

By:
Sia, Camille
Singh, Manjit Kaur
Tayag, Renee
Te, Sophia

October 2019
 Review of Related Literature and Studies

The literature and studies cited in this chapter tackle the different concept,
understanding, and ideas, generalization or conclusions and different development related to
study of the enrollment from the past up to the present and which serves as the researchers
guide in developing the project. Those that were also included in this chapter helps in
familiarizing information that are relevant and similar to the present study.

I. Local Studies
The Philippines financial sector is underdeveloped compared to other countries in the
region. Establishing the long-term viability of the financial system requires recognizing
nonperforming assets at financial institutions. In most countries, more-effective resolution
tools are required to preserve financial stability in an increasingly complex and interconnected
global system. Progress is being made at national levels, but many challenges remain, also
at the international level. These include the design of infrastructures to wind down nonbank
financial institutions that are of systemic importance and banking organizations that operate
across borders. (Southeast Asian Central Bank Training and Research Centre (SEACEN),
2010) initiated an international research project on the “Relative Effectiveness of Policy
Choices During the Global Financial Crisis”. It focuses mainly on crisis management tools and
techniques. It explains why those choices varied, and assesses the current state of financial
and operational restructuring and institutional reform.

In the topic of Performance Evaluation of Bond and Money Market Mutual Funds, (F.
Modigliani and L. Modigliani, 1997) mentioned that Sharpe ratio and M2 measure are used as
a tool for evaluating the performance of Peso-denominated bond and money market mutual
funds. M2 measure is known as Modigliani risk-adjusted performance. It measure of the risk-
adjusted returns of some investment portfolio returns of the portfolio, adjusted for the risk of
the portfolio relative to that of some benchmark or market. They also used Treasury bill to
represent the risk-free security and the S&P 500 Index as the benchmark. According to
(Badillo et al. 2003) Sharpe ratios of different fund types were statistically equal. Sharpe
Ratios was actually developed by ( W. Sharpe, 1966).It is used to help investors understand
the return of an investment compared to its risk. (Reilly & Brown, 2012) defined Sharpe ratios
as “It seeks to measure the total risk of the portfolio by using the standard deviation of returns
rather than considering only the systematic risk summarized by beta”.

(Reilly & Brown 2012) studied mutual funds using the Treynor ratio, Sharpe ratio,
information ratio. It resulted to the hypotheses of (Tehrani, et al. 2011) which tells that “There
was a significant correlation between the Treynor and Sharpe ratios, the Treynor and
information ratios, and the Sharpe and information ratios of equity funds based in Philippine
Pesos.”

Bangko Sentral ng Pilipinas (BSP) currently conducts monetary policy. It highlights the
BSP's shift to inflation targeting as its monetary policy framework and the issues it must
 confront to achieve success.The BSP’s role in public debt management has been to examine
the effect of public debt issuance on the key macroeconomic variables under its purview.
Under Philippine law, all government borrowing, whether peso- or foreign currency-
denominated, requires the approval of the Monetary Board. On a more direct basis,
representatives of the BSP occupy two of the five seats in the Bureau of the Treasury’s auction
committee.

II. Local Literature

The Philippine bond market consists of short-term and long-term bonds. Government
bonds, such as Treasury Bills and Treasury Bonds, are more commonly issued in the country as
compared to corporate bonds. Even though corporate bond issuances are still small relative to
the size of government bonds - the former Deputy Governor of the Bangko Sentral ng Pilipinas,
Nestor Espenilla, Jr., described the corporate bond market as “Expanding, but still nascent”, as it
has been growing at a steady pace over the years.

Furthermore, it is necessary to establish measures to ensure that appropriate regulation

is in place to safeguard these activities (Asian Development Bank, 2017). Such issuances or
transactions require harmonized regulatory oversight to allow the domestic bond market to
flourish or expand its reach as it builds a stable and sustainable market environment.

In relation to that, the Philippine bond market is governed by the regulations, rules and
guidelines issued, maintained and enforced by the Securities and Exchange Commission (SEC),
Bangko Sentral ng Pilipinas (BSP), and Philippine Dealing & Exchange Corp. (PDEx) (Asian
Development Bank, 2017). The SEC and the Bureau of Treasury (BTr) are the two major
government agencies tasked with the management and regulation of debt instrument in the
country (NTRC Tax Research Journal, 2018). The SEC is in charge of the formulation of policies
and recommendations on issues with regards to the securities market while BTr monitors daily
activities in the government securities market. BSP on the other hand, enforces rules on bonds
or notes issuances depending on their currency, and whether the issuer is resident or nonresident.
PDEx is a centralized and efficient infrastructure that operates the electronic trading platform for
the fixed income market which ensures price discovery, transparency and investor protection.

Moreover, a series of market reforms is underway in the Philippine capital market, aimed
at addressing the financing mismatches of private enterprises. Specifically, the initiatives are
intended to foster an environment in which there is a link between investors willing to place funds
on one hand, and corporates in need of longer-term financing on the other (Espenilla, 2006). Few
of which were already launched - Financial Sector Forum and the Capital market reform agenda.
Both primarily aims to ensure that initiatives are conceptualized and implemented using a
common framework. In addition, the ASEAN+3 Bond Market Forum (ABMF) released the first
ASEAN+3 Bond Market Guide in 2012. This was the first officially recognized publication of bond
market regulations and settlement procedures of the respective ASEAN+3 economies. The
market guide helped narrow information gaps and increase market transparency, which was often
regarded as the biggest barrier to entry (Asian Development Bank, 2017).

III. Foreign Studies

Bonds refer to fixed income securities that have principal and interest payments returned
according to a predefined schedule. A bond market serves diverse functions and roles for issuers,
investors, intermediaries, and market infrastructure. (UN Economic and Social Commission for
Asia and the Pacific Dialogue Paper, 2009 p.13). For issuers, bonds enable them to raise large-
scale, long-term capital via capital markets. Bond issuers such as a nation state, municipalities,
state enterprises, financial institutions, and businesses can issue and sell bonds to investors in
the capital markets for large-scale financing in a longer term. Especially, issuers with high credit
ratings can tap into a bond market for financing at relatively low costs. Issuers with relatively lower
credit ratings can also raise capital in larger amount if they are willing to pay premiums (Seiwoon
Hwang, 2016). Investor bases vary depending on a stage that a nation’s bond market
development is placed. In a well-developed bond market, a wide array of institutional and ordinary
investors invests in bonds. Such market enables bond investors to sell and liquidate their bonds
immediately if necessary. But bond redeem-ability in that high level is achievable only with a
developed secondary market and investor pools with diversity (Hans J. Blommestein, Financial
Regulation and Compliance Special Issue, 2017).

The corporate bond market accounts for only very small portion of GDP in many local
economies. Corporate bonds are often issued through private placement and sold to banks. The
corporate bond market also lacks in transparency. (Satoshi Shimizu, Public Policy Review, Vol.14,
No.5, 2018). The local corporate bond markets in Asia and the Pacific lack in legal, institutional
and regulatory frameworks for issuance and trading. Although laws and acts provide the legal
basis for corporate bond issuance, it is not applied rigorously and a comprehensive regulatory
regime or mechanism does not exist for both primary and secondary markets for corporate bonds.
The efficient issuance and trading of corporate bonds are constrained by dominance of private
placements in the corporate finance (Rowter, K. 2001). In Asia and the pacific, corporate bonds
are used as a substitute for bank loans for companies with insufficient collateral. Bonds issued by
those companies based on their creditworthiness are sold to or underwritten by banks. Heavy
reliance on banks and lack of diversity among investors impede expansion of the investor base
for corporate bonds. Corporate bond investors are primarily banks and insurance companies. The
dominance of private placements is the main obstacle to widening the investor base (Adrian,
Tobias, Michael Fleming, Or Shachar, Daniel Stackman, and Erik Vogt, 2015)

According to a study conducted by the Asian Development Bank, the Philippines’ bond
market has been dominated by the government sector since 1997 to finance fiscal deficits that
have averaged around 5% of GDP per year. This may be one of the causes for the
underdevelopment of the corporate bond market, which accounts for about 7% of the bond
market. There are only two bond issues listed on the Philippine Stock Exchange (Ismail Dalla,
2003). The government securities market in the Philippines is regulated by the Department of
Finance and the implementation is carried out through the Treasurer of the Philippines. The
Bureau of Treasury implements the regulations on a day-to-day basis. Corporate debt markets,
both primary and secondary, are the responsibility of the Securities and Exchange Commission
(SEC). Thus far, there have been few bond issues listed on the Philippines Stock Exchange
because of the withholding tax on corporate bonds. (Asian Development Bank Outlook, 2002).

The absence of market infrastructure, such as credit rating function or system and bond
market statistics, impedes the development of the public placement market. Since there are few
reliable credit rating agencies in many local economies, investors have to rely on their own
assessment of issuer credit quality when making investments in corporate bonds and investors
find it difficult to sell the corporate bonds they purchased, unless the bond issuer is a high-profile
company in the market (Kim Yun-Hwan, and M. Suleik. 2001). Moreover, it is hard to obtain data
on the size of aggregate bond issue volume because the majority of corporate bonds issued are
privately placed. Credit rating system for corporate bonds and a well-functioning secondary
market do not exist so that bond prices are determined arbitrarily. (Fabella, Raul, and Madhur,
Srinivasa, 2003. Bond Market Development in East Asia: Issues and Challenges. EDR Working
Paper Series No. 35)

Fundamental improvements are required for the legal and regulatory framework for
corporate bonds. Appropriate laws and regulations on corporate bond issuance and trading
should be introduced. Relevant disclosure regime must be put in place as well. The corporate
issuance procedure should be revamped, and a responsible body needs to be designated for
overall regulation of corporate bonds. These moves would underpin the aggressive
implementation of policies to foster the bond market. Moreover, incumbent laws pertinent to
corporate bonds should be amended to establish comprehensive legal grounds for the corporate
bond market (Deutsche Bank. 2002. Global Market Research).

It is necessary to enhance the primary market’s transparency and promote public

placements. Investor confidence is a very critical ingredient in bond market development.
Furthermore, a policy measure should be formulated to encourage investment in corporate bonds
by ensuring the wider circulation of corporate bond data across the market and thus enabling
investors to make decisions using such data. Most imperative is the transformation of the primary
market into the one dominated by public placements. Public placement bonds are expected to
diversify the investor base and bring greater market transparency, thereby invigorating the
secondary market (Turner, Philip Basel: Bank of International Settlements, 2002). A new issuance
regime should be introduced to ensure that corporate bonds are issued in electronic book-entry
form. Issuance by physical printing is an impediment to market development in terms of costs and
trading efficiency. Another impediment is related to information collection on corporate bonds. In
this regard, adoption of the new regime for bond issuance via electronic book-entry would reduce
bond issuing costs and increase efficiency in issuance and trading. The electronic book-entry
system would facilitate the circulation of corporate bonds and raise efficiency in bond issuance
(World Bank. 2003. Global Economic Prospects and the Developing Countries).
 In many countries in the Southeast Asian region, there is no mechanism and information
disclosure system for corporate bond during and after issuance. And most of the corporate bonds
are not deposited nor settled through central settlement and depository institutions. Corporate
bonds can be traded through stock exchange but this has not been utilized for corporate bonds
in many economies due to underdeveloped infrastructure. Well defined disclosure regime and
infrastructure development would be essential for the further development of corporate bond
market (International Organization of Securities Commissions (IOSCO). 2002. Objectives and
Principles of Securities Regulation).

Perceptions on corporate bond need to be improved. Efforts should be made to help

companies perceive bonds as a useful source of long-term massive financing. For example, some
countries may push for pilot deals in which selected financially healthy companies raise long-term
funding at low costs by issuing bonds (Asia Pacific Economic Cooperation (APEC). 1999.
Compendium of Sound Practices). A disclosure regime for corporate bonds should be improved,
and a transparent statistics system should be introduced. Information on corporate bonds needs
to be delivered to stakeholders in a fast and transparent manner for creating an active and efficient
corporate bond market. Use of a data collection center is one option to consider. If a data
collection center collects and publicly discloses bond issuance and trading data, it would increase
transparency in corporate bonds, in addition to efficient centralized collection and disclosure of
bond market data (Allan, Matthew and Felix Suntheim, 2017).

IV. Foreign Literature

Ever since the Asian Crisis had occurred the Asian policymakers had taken note of what
had happened and decided to act for it to be avoided. According to Eschweiler (2006), one of the
actions they had done was to focus more on the development of the local bond market. The
market itself had grown in terms of size, however it is still considered as “underdeveloped” One
of the reasons that the bond market could underdeveloped is due the high restrictions in certain
parts of Asia.

Based on the result of the research of Eschweiler (2006) he put Hong Kong SAR and
Singapore as up to par to global standards. In terms of Foreign Access, they are very open to
open to investor access, issuer access, intermediary access, foreign exchange/ capital controls.
With the liberating access the foreigners, they became an enticing country to invest on. On the
other hand, the Philippines has a very limited to limited features on their Foreign Access. With the
limited access to the foreigners the Philippines is only opening its doors to a peep, giving the
foreigners only a glimpse. When a foreigner investor would be presented with two choices,
chances are the they would go where they are welcomed to invest in and where it is more hassle
free and convenient.

For their Issuance Restrictions that would affect not only the foreign investors, but as well
as the local investors. According to Eschweiler (2006) there are two types of issuance models:
 In the disclosure-based model, which is increasingly becoming the global standard,
the issuer is required to disclose all relevant information, but investors have to decide
themselves whether the bond is fairly valued.

In the merit-based model, a regulator decides whether an issuer is fit to launch a

bond. The regulator’s decision may be based on pure discretion, but more typically is
based on a number of criteria, like the issuer’s past financial performance, capitalization,
size of the issue, rating and so on. Eschweiler (2006), page 5, paragraph 2.

The Asian countries that have implemented the disclosure-based model are Hong Kong
SAR, Singapore and Malaysia. With their very open to open foreigner access it goes well that this
is their issuance restriction. Giving the local and foreign investors the power to decide if the bond
is “fairly valued.” Meanwhile the Philippines has gone with implementing the merit-based model
where the one who hold the power are the regulators. Giving the local and foreign investors less
power. This would take more ample amount of time as well because they are looking into “…
financial performance, capitalization, size of the issue, rating and so on.” Yes, in the disclosure-
based model they are going to require an ample amount of time as well as to value the bond, but
they are more encouraged to do this since it is their money that is being invested.

According to Eschweiler (2006) there is a growing trend that countries often do not tax or
tax little the foreign investors. The investors would want to avoid those countries that do not give
them the same privilege as the other countries does. Having tax treaties are still effective however
it is still far much more laborious to do compared to not being taxed when investing.

Countries who do not tax their foreign investors are Hong Kong SAR and Singapore. The
Philippines has a 20%-32% withholding tax and no capital gains tax. With the mentality that 20%-
32% of your earnings would be taken away from you is very discouraging especially when you
have the option to receive that amount in full.

However, the Philippines could be implementing a highly regulated system for a reason.
Customers at the end of the day would want to be ensured that what they are investing into is of
high quality. According to Luengnaruemitchai, P., and Ong, L. (July 2005). The Philippines has
an agency called the “Investment Ombudsman Team (IOT) this is a team that would “protect
investors against unscrupulous and power-tripping Philippine government officials and who delay
the natural flow of the investment process, particularly in providing the requisites approval from
state agencies.” Philippine Daily Inquirer (2014). The Philippines seems to be well aware of them
being a highly regulated country, but if the exchange for this high regulation is the safety of the
investment then this could be used as a marketing tool to entice more investors, this will especially
attract the risk averse investors. According to the International Organization of Securities
Commissions (IOSCO) Journal, (June 2019). The Corporate Bond Market are never the ones
who start financial crisis or “generated severe systematic adverse effects on other parts of the
financial system and [disrupt] financial stability”
 V. Assessment of Literature and Studies

Corporate bond markets exhibit different characteristics because of their country-specific

economic and market conditions. Therefore, it is impossible to improve the bond market structure
overnight. Hence, each country needs to implement policies for bond market development by
gradually improving the relevant market infrastructure in the short run and enhancing the market
structure in the long run through consensus and cooperation among market participants. The
government’s role would be an essential element in the effort to improve the market structure.
Securities registration scheme need to be introduced with respect to the issuance process. These
institutional arrangements are expected to make the corporate bond market more transparent and
enhance investor confidence in the market.

In many countries in Asia and the Pacific, corporate bond markets are dominated by
private placements which are very similar to bank lending. This implies that these markets remain
in their nascent stage, given their regulatory aspects, investor base, issuers’ market perception,
and market infrastructure. However, the Asian Development Bank market survey suggests that
the regional corporate bond markets have strong growth potential. Corporate bond market can be
an important source of financing for SMEs. Recently, non-banking financial companies such as
asset management companies and insurance companies are increasingly interested in the
corporate bond market. It is important to highlight the need for gradually revamp the market
infrastructure, and undertake policies for reshaping the market structure, based on consensus
and cooperation among market participants, from the long-term perspective.

The Philippine corporate bond market needs to be overseen by one comprehensive

regulatory body. Unified regulatory framework would enable the responsible regulator to control
and supervise the overall corporate bond market and proactively execute policies for market
development. In order to put a disclosure regime in place, the following actions need to be taken:
setting up a platform for filing bond registration statements with the relevant regulatory body; and
building a platform for primary market disclosure (securities registration) and secondary market
disclosure (post-issuance periodic disclosure). In addition, transparency in the corporate bond
market should be enhanced by establishing mandatory disclosure requirements for corporate
bonds. The introduction of such mandatory disclosure regime would help strengthen investor
confidence in corporate bonds. It is also useful to build an electronic registration platform to
ensure bond issuance under standardized framework. Specifically, it may be considered to have
financial authorities set up a platform for issuers to file in bond registration statements via website.
Thus, most of bonds can be issued immediately after registration statement is filed electronically.
For post-issued reports, continuous and event-based disclosures have to be made by issuers
throughout bond’s lifetime.

Strict separation of markets between public and private placements is needed for creating
an active public placement market. Regulations for the private placement market may need to put
restrictions on transactions and investors. On the other hand, incentives for public issuance need
to be provided for the public placement market. That is because it is important to encourage a
wide range of investors to buy publicly offered bonds and make public placements attractive to
issuers by highlighting the reduction in issuing costs. Large firms need to be encouraged to issue
bonds via public placement whereas smaller firms induced to issue bonds via private placement
and sell them to banks.

Laying the legal groundwork for bond issuance and adopting registration and depository
systems are preconditions for corporate bond market development. Local economies need to
strengthen legal grounds for bond issuance, registration and others while improving regulatory
underpinnings for corporate bonds by introducing a clear, well-defined registration process.
Countries like the Philippines need to overhaul the scope of eligible corporate bond issuers, the
issuance process and the registration system. These institutional arrangements are intended to
enhance the credibility of corporate bonds and ensure greater market transparency, thereby
bolstering the stability of the bond market. When it comes to issuing and holding bonds, it is
necessary that bonds be issued and held in book-entry or electronic form (a long-term goal). The
depository system would reduce the costs of administering securities, ensure the reliable transfer
of securities, and enhance transparency in securities information. Moreover, the bond market
could be managed more efficiently by linking the listing regime to the depository system.

Corporate bond market serves as a substitute for bank lending. In the Philippines, the
bond markets have been driven by banking sector because of the underdeveloped investment
fund market or other investment segments specializing in corporate bonds. Bank loans and
corporate bonds are not clearly distinguished. Private placement is the dominant method of bond
underwriting. It is important to expand the base of specialized corporate bond investors. Banks
need to change their perception of corporate bonds and thus treat corporate bonds as a different
investment instrument from bank loans. It is also necessary to develop a financial business
segment specializing in bond underwriting. This calls for improvement in the underwriting function
of securities firms.

It is also very important to introduce credit rating system because it helps accurately
assess the creditworthiness of bond issues, thereby making the corporate bond market more
active. If individuals invest in corporate bonds based on their own analysis of bond credit quality,
it would be difficult to build the secondary market. Besides, information inefficiency would impede
the expansion of the investor base. Thus, greater access to information on the bond market
requires the introduction of credit rating systems that evaluate the creditworthiness of corporate
bonds. On top of this, efforts are needed to enhance the reliability of credit rating agencies in the
long run, which would result in the wider investor base.
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