Philippine short-selling move paves way for listed derivatives

Philippine Stock Exchange waits for tie-up with fixed-income exchange before allowing short-selling

Manila-based PSE gained the go-ahead from the SEC this year

The Philippine Stock Exchange (PSE) is gearing up to allow the short-selling of stocks in a move that will pave the way for the development of more complex derivatives products.

The exchange has been looking at the possibility of allowing short-selling for more than 12 months, but it had to wait for the Securities and Exchange Commission (SEC) to give the formal go-ahead, which it did earlier this year.

The Insurance Commission has also endorsed short-selling, stating in a circular last year that it would allow insurance companies to participate in the PSE's securities borrowing and lending programme (SBL).

"The initial lenders to this programme will be insurance companies, which have a longer-term outlook for asset ownership. It's a win-win situation. Insurers will be able to generate extra income by lending out their stock, and borrowers get access to this elusive supply of stock from these parties for settlement or strategic reasons," says Hans Sicat, chief executive officer of the exchange.

The original plan had been to roll out the SBL programme by the end of this year, but Sicat says it is unlikely to happen until sometime in 2016.

The PSE is waiting for the SEC to approve its purchase of a majority 28.91% stake in the country's fixed-income exchange, the Philippine Dealing Systems (PDS), before it allows short-selling. Final approval is expected to be given "in the next few weeks", adds Sicat.

Robust and safer environment

While the PSE could have introduced short-selling without this exchange tie-up, Sicat says a vertically integrated platform would create a more robust and safer environment for such transactions.

"Although our clearing house communicates with the depository, having a depository within the same group will allow us to respond [in] more real time in certain specific situations or when there are issues to tell whether or not the securities are available before they get cleared. This is better from a risk management perspective," he says.

A vertically integrated platform also offers greater possibilities for product development beyond equities, Sicat continues: "Clearly, there are a lot of synergies and a lot of product development flexibility to be gained by being able to control the depository and, in this case, knowing what's happening in the corporate and government bond markets. You're empowered because you have a slightly larger toolkit."

In preparation for the tie-up, the PSE has replaced its former trading platform with technology from Nasdaq, which Sicat says is robust enough to handle the changes taking place at the exchange.

Short-selling is one of the basic building blocks for more complex financial products, and Sicat hopes its introduction in the Philippines will give a much-needed boost to one of Asia's least developed derivatives markets.

SGX offshore deal

It is not the first time the Manila-based exchange has attempted to energise the country's derivatives market, with limited results. In 2013, PSE teamed up with the Singapore Exchange (SGX) to develop an offshore equity futures product, based on the MSCI Philippines index.

The decision was taken to launch the product offshore because the local regulatory environment was not perceived to be conducive to the development of new financial products. The hope was that listed derivatives would eventually come onshore, but this has not happened.

Although volumes have been lower than expected, Sicat says participating in this initiative has been worthwhile: "It's a lot better to have a product being traded where we can benefit from the expertise and the economics with SGX, rather than finding ourselves in a situation where somebody else creates the product in various other markets without the PSE being involved at all. The product launch has also shown to our own regulator that, even if they are not willing to approve or see the value in products traded locally, the world is a much larger capital market. We still hope this will be the catalyst to bring indexed futures products to the Philippines."

Initial lenders to this programme will be insurance companies, which have a longer-term outlook for asset ownership. It's a win-win situation

But this could still take time, as regulators struggle to become comfortable with bringing derivatives onshore. "There are a lot of regulatory impediments [to offering new products] and the speed of regulatory bureaucracy is much slower than we would like, which means the pace of our plans often has to be slowed down," says Sicat.

A case in point has been the tie-up with PDS, which he had hoped would happen a year-and-a-half ago. "The economic managers of the country, whether it be the central bank or the department of finance, seem to be in agreement with what we're trying to do, but, when it comes to the execution, bureaucratic processes get in the way," he says.

One of the problems, notes Sicat, is the Philippines regulatory environment is weighed down by legacy rules, which make it harder to get new products approved.

"What we are trying to do is work with the regulators in a constructive way and push forward regulatory measures that we see as common sense fixes. Many of the rules on the statute books don't need to be there in this day and age, or don't make sense given current considerations," says Sicat.