ASIAN DEVELOPMENT BANK PCR: PHI 21223

PROGRAM COMPLETION REPORT

ON THE

CAPITAL MARKET DEVELOPMENT PROGRAM (Loan 1363-PHI)

TO THE

REPUBLIC OF THE PHILIPPINES

August 2000 CURRENCY EQUIVALENTS

Currency Unit – Peso (P)

At Appraisal At Program Completion 15 March 1995 15 June 2000 P1.00 = $0.04 $0.02 $1.00 = P25.86 P42.40

ABBREVIATIONS

ADB – Asian Development Bank BSP – Bangko Sentral ng Pilipinas CMDC – Capital Market Development Council CMDP – Capital Market Development Program DOF – Department of Finance ECC – Economic Coordinating Council FIBV – Federation Internationale des Bourses de Valeurs IOSCO – International Organization of Securities Commissions IPO – initial public offering PCDI – Philippine Central Depository Inc. PSE – Philippine Stock Exchange RICA – Revised Investment Company Act SCCP – Securities Clearing Corporation of the Philippines SEC – Securities and Exchange Commission SRC – Securities Regulation Code SRO – self-regulatory organization TA – technical assistance USAID – United States Agency for International Development

NOTES

(i) The fiscal year of the Government and its agencies ends on 31 December. (ii) In this report, "$" refers to US dollars. CONTENTS

Page

BASIC DATA ii

I. PROGRAM DESCRIPTION 1

II. EVALUATION OF IMPLEMENTATION 1

A. Program Components 1 B. Implementation Arrangements 6 C. Program Schedule 6 D. Conditions and Covenants 6 E. Disbursements 7 F. Project Performance Report Implementation Ratings 7 G. Performance of the Borrower and the Executing Agency 7 H. Performance of ADB 8

III. EVALUATION OF INITIAL PERFORMANCE AND BENEFITS IMPACT 8

A. Economic Performance 8 B. Attainment of Benefits 11

IV. CONCLUSIONS AND RECOMMENDATIONS 12

A. Conclusions 12 B. Lessons Learned 12 C. Recommendations 14

APPENDIXES 16 BASIC DATA

A. Loan Identification

1. Country Philippines 2. Loan Number 1363-PHI 3. Project Title Capital Market Development Program 4. Borrower Republic of the Philippines 5. Executing Agency Department of Finance 6. Amount of Loan $150 million 7. Project Completion Report Number PCR:PHI 580

B. Loan Data

1. Appraisal - Date Started 1 March 1995 - Date Completed 15 March 1995

2. Loan Negotiations - Date Started 24 July 1995 - Date Completed 26 July 1995

3. Date of Board Approval 22 August 1995

4. Date of Loan Agreement 2 May 1996

5. Date of Loan Effectiveness - In Loan Agreement 31 July 1996 - Actual 31 March 1997 - Number of Extensions 4

6. Closing Date - In Loan Agreement 31 December 1997 - Actual 31 December 1999 - Number of Extensions 2

7. Terms of Loan - Interest Rate variable - Maturity (number of years) 15 years - Grace Period (number of years) 3 years

8. Disbursements a. Dates

Initial Disbursement Final Disbursement Time Interval 21 April 1997 28 May 1997 1.25 months

Effective Date Original Closing Date Time Interval 31 March 1997 31 December 1997 9 months iii

b. Amount

Original Amount Amount Undisbursed Allocation Canceled Disbursed Balance

$150,000 $75,000 $75,000 0

C. Data on ADB Missions

No. of No. of Specialization of Members Name of Mission Date Persons Person-days Appraisal 1-15 Mar 95 5 80 Sr. Financial Analyst Sr. Counsel Investment Officer Project Economist Economist

Review Mission 1 3-4 Sep 97 2 4 Sr. Financial Analyst Capital Markets Specialist

Review Mission 2 13-14 Jul 98 2 4 Capital Markets Specialist Investment Officer

Policy Consultation 1 1-2, 5-6 Oct 98 2 8 Capital Markets Specialist Investment Officer

Policy Consultation 2 14 Jun 99 2 2 Financial Economist Capital Markets Specialist

Policy Consultation 3 17 Jun 99 4 4 Manager Financial Economist Capital Markets Specialist

Policy Consultation 4 27 Jul 99 4 4 Financial Economist Project Economist Investment Officer Economist

Policy Consultation 5 23 Oct 99 1 1 Manager

Policy Consultation 6 15 Nov 99 2 2 Manager Financial Economist

Policy Consultation 7 2 Dec 99 2 2 Manager Financial Economist

Policy Consultation 8 15 Dec 99 2 2 Financial Economist

Project Completion 19-22 Jun 00 3 7 Senior Financial Economist Review Young Professional Associate Economic Analyst I. PROGRAM DESCRIPTION

1. On 22 August 1995, the Asian Development Bank (ADB) approved the Capital Market Development Program (CMDP) loan for $150 million from its ordinary capital resources to the Government of the Philippines. The CMDP aimed to support the first phase of capital market reforms to mobilize long-term funds critical for the growing resource requirements of infrastructure and the recapitalization of banks. The objective of the CMDP was to promote diversified, competitive, and vibrant capital markets to enhance the allocative efficiency of domestic savings. The CMDP was designed to (i) merge the two stock exchanges, (ii) introduce awareness of the significance of good governance and investor protection by encouraging transparency and accountability through increased public disclosure of financial information, and (iii) build capacity and market confidence.

2. The CMDP was expected to facilitate recovery from the recession that characterized the Philippines economy from the late 1980s to the early 1990s. Although conceptualized in 1990, the CMDP structure was finalized after appraisal in March 1995. The timing of the CMDP coincided with the implementation of a macroeconomic stabilization and structural adjustment program supported by the Extended Fund Facility approved by the International Monetary Fund in 1992. This program supported new prudent management policies and the creation of a new independent central bank, Bangko Sentral ng Pilipinas (BSP). While BSP’s improved monetary management helped bring inflation under control, the Government’s solid macroeconomic policies helped revive economic growth in 1993 and the economy appeared set to turn around. The macroeconomic environment was conceived to be conducive for capital market development.

3. Given this context, the CMDP was timely and constituted the first comprehensive policy package aimed at promoting vibrant capital markets. To complement the CMDP, ADB provided a number of sequential technical assistance (TA)1 operations that helped (i) improve efficiency and transparency of stock market transactions, (ii) elevate the professionalism of the stock exchange staff, and (iii) improve the capacity of regulators in the Securities and Exchange Commission (SEC) and Insurance Commission.

4. This program completion report provides an overview and evaluation of CMDP implementation.

II. EVALUATION OF IMPLEMENTATION

A. Program Components

5. The capital market reforms were expected to mobilize long-term savings, improve supervision and prudential regulation of capital market institutions, and lead to adoption of internationally accepted standards and practices in the capital markets. The CMDP focused on (i) rationalizing the allocation of regulatory responsibilities, (ii) strengthening the capital market regulatory framework, (iii) developing the stock market, (iv) reforming collective investment schemes, and (v) increasing the supply of equity shares. This section provides an assessment of CMDP implementation relative to program targets. Compliance with policy matrix conditionalities is described in Appendix 1. Some statistics on the country’s capital markets are given in Appendix 2.

1 TA 1640-PHI: Stock Market Development, for $585,000, approved on 2 January 1992; TA 1641-PHI: Institutional Strengthening of the Securities and Exchange Commission, for $589,000, approved on 2 January 1992; TA 2379- PHI: Capital Market Development, for $600,000, approved on 22 August 1995; and TA 3120-PHI: Institutional Strengthening of the Insurance Commission, for $600,000, approved on 15 December 1998. 2

6. The Government implemented the substance of the CMDP, albeit slowly, and complied with the seven core conditions for release of the second tranche (Appendix 3). Moreover, the recently enacted Securities Regulation Code2 (SRC) has resulted in all but one program condition being fulfilled. The one outstanding policy action, requiring increase of financial and other penalties specified under the Investment House Law to make them true deterrents, is still in committee under congressional review.

1. Allocation of Regulatory Responsibilities

7. This component of the CMDP focused on encouraging the Government to (i) prepare a strategy paper and action plan to rationalize the allocation of regulatory responsibilities among regulatory institutions; and (ii) examine the regulatory framework for different market participants, and recommend a more efficient allocation of capital market oversight responsibilities. Progress in this area has been largely satisfactory. SEC, with ADB TA,3 prepared a strategy paper clarifying SEC’s authority and jurisdiction. However, given the predominance of universal banking paired with a regulatory framework based on the United States model (where universal banking is not allowed), duplication and overlapping in regulation and monitoring of capital market activities by banks are unavoidable. The overlap of responsibility between SEC, BSP, and to a lesser extent, the Insurance Commission has contributed to confusion over jurisdiction and compliance with different regulations. This issue is being addressed under another recently approved ADB TA,4 which is supporting development of an efficient regulatory framework for all market participants.

8. Based on studies sponsored by the Government and aid agencies, SEC and other agencies have developed an understanding of the issues, overlaps, and gaps in the regulatory framework of different segments of the securities market. Efforts have also been made to realign regulatory responsibilities in selected areas. For instance, the Government has transferred the regulatory responsibility for investment bank houses and securities brokers and dealers that are not affiliated to banks, from BSP to SEC. At the same time, congressional discussions are under way to move the regulation of preneed plans5 from SEC to the Insurance Commission.

2. Strengthening the Capital Market Regulatory Framework and Improving Investor Confidence

9. The CMDP supported strengthening of the regulatory framework and developing investor confidence by (i) introducing a disclosure-based regulatory system, (ii) strengthening the antifraud provisions of the securities laws, (iii) amending the Corporation Code, (iv) amending the 1982 Revised Securities Act, and (v) amending rules governing the activities of investment bank houses.

10. Adoption of full disclosure rules. In line with the CMDP, SEC ceased merit regulation practices and is no longer involved in influencing share prices or promoting the investment merit of securities. In place of merit-based regulation practices, SEC adopted a full disclosure system in October 1996. These full disclosure rules established a new process for registration of financial

2 The SRC, Republic Act 8799, was enacted on 19 July 2000. Earlier versions of the bill were known as the Securities Act or the Securities Regulation and Enforcement Act.Earlier versions of the SRC were known as the Securities Act or the Securities Regulation and Enforcement Act. 3 TA 1641-PHI: Institutional Strengthening of the Securities and Exchange Commission, for $589,000, approved on 2 January 1992. 4 TA 3245-PHI: Nonbank Financial Sector Development, for $2 million, approved on 25 August 1999. 5 Preneed companies provide benefits relating to education, pension fund accumulation, interment, and death-related services. The preneed industry products are quasi-insurance products and as they have shorter maturities ranging from, usually one to five years. SEC currently supervises the preneed industry as because preneed plans are legally defined classified by law as securities. 3 statements and other reports to be filed with SEC and distributed to investors. Full disclosure policies have allowed SEC to match other regulators in the region by introducing rules to encourage greater transparency in the market.

11. Protection of minority shareholder rights. In line with the CMDP, the SRC includes provisions that (i) increase the protection of minority shareholders; and (ii) introduce disclosure and transparency into the market through changes in SEC requirements for issuer registration, security broker and dealer registration, and the registration and operation of a stock exchange.

12. Code of conduct. Consistent with the CMDP, SEC issued proxy rules enabling minority shareholders to vote. Minority shareholders would have access to the same offers as majority shareholders. The codes of conduct adopted by SEC and the Philippine Stock Exchange (PSE) specify that company directors must act in good faith, carry out fiduciary responsibilities, and prohibit interested parties from voting on resolutions when there may be a conflict of interest. The code for the operation of PSE, specifically, stipulates that failure to enforce rules designed to prevent fraud and market abuse will constitute grounds for revoking PSE’s license to operate.

13. The full disclosure rules. The CMDP called for SEC to establish minimum disclosure requirements for listed companies that require a prospectus containing full information for all new public offers and made available to all prospective purchasers. In 1996, SEC implemented comprehensive full disclosure rules that established a new process for the registration of financial statements and other reports filed at SEC. In addition, these rules require full disclosure of all information on prospectus forms, including fees and expenses relating to the prospectus. Beneficial owners are now required to disclose positions on tender offers.

14. The net capital rule. Introduced by SEC, this rule complies with the CMDP provision for the introduction of risk-based capital requirements for brokers and dealers. Better supervision has been achieved in compliance with the CMDP by eliminating the requirement that SEC provide at least five days prior notice for on-site examination of the books and records of brokers or dealers.

15. Enhancement of investment bank operations. Amendments proposed to the Revised Investment Company Act (RICA) to meet CMDP requirements include (i) allowing brokers to engage in underwriting, provided they meet the same net capital and other requirements as underwriters; and (ii) increasing the financial and other penalties specified under the Investment House Law to make them effective deterrents. Investment houses and universal banks currently carry out underwriting activity. In practice, requirement (i) has been complied with as brokers that meet the net capital and other requirements as underwriters have established underwriting affiliates. With respect to (ii), the proposed RICA legislation includes provisions to increase financial and other punitive penalties. RICA legislation is scheduled for hearings in Congress and Senate in 2001.

3. Stock Market Development and Regulation

16. The Government, in line with the CMDP, introduced modern regulation practices for PSE with the objective of improving transparency and accountability, and developed market trading infrastructure, particularly an efficient clearance and settlement system. PSE was accorded self- regulatory organization (SRO) status in 1998 following accreditation by the Federation Internationale des Bourses de Valeurs (FIBV)6 in 1996. SEC approved the SRO license for PSE

6 FIBV, or the International Federation of Stock Exchanges, is the trade organization for regulated securities and derivative markets worldwide. It promotes the professional business development of financial markets, at national and international levels. 4 based on its adoption of systems and procedures to ensure fairness, efficiency, and transparency in exchange transactions by member brokers and market participants.

17. PSE was empowered to regulate its members, and formulate and implement rules and regulations subject to the oversight authority of SEC. In 1999, SEC directed PSE to (i) improve its audit capability, (ii) increase the number of nonbrokers on its board of governors, (iii) strengthen the Market Watch Unit, and (iv) admit additional members in the Business Conduct and Ethics Committee from academic and nonboard member brokers. To improve governance, in 1997 PSE inducted three nonmembers to the board of governors, and eliminated the mandatory allocation of shares of initial public offerings (IPOs) to PSE members and the involvement of PSE management in setting the price of securities. PSE has also introduced codes of conduct for brokers and dealers.

18. In March 2000, SEC suspended PSE’s SRO license since PSE’s compliance and enforcement division was no longer operational. SEC now directly supervises PSE including monitoring brokers and dealers. Although this has been a step backward in developing a modern regulatory framework, it could not be avoided in the wake of a major stock market scandal (para. 45). Under the SRC, PSE is required to privatize its current mutual company structure and develop an adequate regulatory structure for itself.

19. In accord with the CMDP requirements, SEC established a listing committee and department in November 1997 to encourage additional listings, introduce fairness, eliminate mandatory share allocation, and establish transparent pricing procedures. The listing rule lowered the minimum public offer requirement for listing from 25 percent to 10 percent of paid-up capital. Setting the price of securities offerings is now the prerogative of the issuer and underwriter rather than SEC or PSE. Also, SEC established new distribution rules changing the allocation of IPO shares: qualified institutional investors are entitled to 30 percent, local small investors (applications up to P20,000) to 10 percent, and the public to 60 percent.

20. As envisaged under the CMDP, these reforms were reinforced by the introduction of a code of conduct and professional ethics for securities traders in April 1999. This code is in accordance with the standards recommended by FIBV and was enforced by PSE as long as it had the SRO status, and now SEC. The board of directors and management of listed companies are required to comply with this code of conduct.7

21. Consistent with the CMDP, the Philippine Central Depository Inc. (PCDI) was established and operationalized in 1996 in accordance with recommendations of the Group of Thirty8 (Appendix 4). Investors now can either hold stock certificates or leave their stock on deposit with PCDI. Investors who opt to keep their certificates in the depository deliver certificates via their broker to PCDI. The Securities Clearing Corporation of the Philippines (SCCP) handles clearing and settlement operations for listed securities. PSE is a fully automated auction market where buy and sell orders are prioritized by price and time. When entering an order, every broker, dealer, or licensed sales representative must indicate if the order is for the account of the firm or on behalf of a client, and whether it is a local or foreign investor. As a result of resistance from PSE’s smaller broker members, SCCP still operates with a temporary license that is periodically renewed. The main objection of the smaller brokers is the introduction of the delivery-versus-payment system with final payment and settlement due four days (T+4) following the execution of an order. The smaller brokers resisted the introduction of this system as it eliminates the “float” time between

7 The code of conduct stipulates general guiding principles, basic rules in trading one’s account, and penalties. 8 A private, nonprofit, international body composed of very senior representatives of the private and public sectors and academia established in 1978. 5 when a security is sold and when the security is delivered. Moreover, SCCP currently provides its services free of charge. PSE, the majority owner, is covering the cost of operations. When SCCP becomes permanent, its operational costs will be passed on to the users, the brokers and dealers.

4. Reforms for Collective Investment Schemes

22. In the Philippines, collective investment schemes include common trust funds, mutual funds, and preneed plans. BSP regulates common trust funds, while SEC regulates mutual funds and preneed plans. Under the CMDP, the rules and regulations governing the operation of mutual funds and preneed plans were to be evaluated and recommendations proposed to increase the efficiency and transparency of operations. It was envisaged that these recommendations would then be implemented under the CMDP. The Government is substantially in compliance with these conditions.

23. The Department of Finance (DOF), assisted by ADB and United States Agency for International Development (USAID), conducted studies examining the operations, rules, and regulations governing mutual funds and preneed plans. Some of the issues identified in these studies include high taxation, lack of clarity of investment guidelines, legal impediments to competitive distribution networks, and limitations on fund management. The CMDP underscored the need for technical advice to the preneed sector to improve the regulatory framework and upgrade accounting standards to improve the quality of disclosure.

24. Based on recommendations from the studies sponsored under the CMDP, the Government eliminated double taxation9 on mutual funds with the passage of the Comprehensive Tax Reform Law in January 1998. Provisions were also drafted into the RICA legislation (still in committee in Congress) requiring (i) prohibition of activities and relationships that could lead to conflict of interest, (ii) declaration of unlawful activities for the protection of investors, (iii) prudential guidelines on portfolio management and financial structure, (iv) full disclosure of information by companies, (v) reinforcement of SEC’s supervisory functions, and (vi) the ability to introduce self- regulation by an industry association.

5. Supply of Equity Shares

25. The CMDP called for augmenting the supply of equity shares to help attract long-term savings for the creation of long-term assets. This was envisaged to be achieved by divesting state- owned enterprises through public offerings, and encouraging commercial banks to issue equity by requiring 10 percent of paid-up capital for listing to obtain a universal bank license. The Government is in compliance with this condition although progress in this area is ongoing.

26. Implementation of the privatization program, has resulted in the divestment and privatization of several state-owned enterprises generating about P32 billion in revenue. In conjunction with privatization efforts, the Monetary Board issued a resolution in December 1997 requiring universal banks to list at least 10 percent of their paid-up capital. Although the financial crisis has limited progress on this CMDP component, six universal banks listed their shares during the program period.

9 Until December 1997, although funds paid transaction taxes on their listed stocks, shareholders upon redemption of their mutual funds were required to pay a capital gains tax on the first P100,000 net gain and 20 percent on the excess, a form of double taxation that inhibited the growth of the fund industry. 6

6. Technical Assistance

27. To bolster the efforts of DOF, SEC and PSE, four TA operations (footnote 1) were approved by ADB, since 1991, to support reforms under the CMDP. These TAs, totaling almost $2.4 million, covered (i) assistance to support unification of the two stock exchanges, (ii) a diagnostic study and creation of a development master plan for SEC development, (iii) institutional strengthening of the Insurance Commission, and (iv) a TA for capital market development.

28. The scope of the capital market development TA10 attached to the CMDP loan included assistance to (i) establish PCDI, (ii) develop reforms needed for the mutual fund industry, (iii) conduct a study of the preneed sector that would scrutinize industry practices, and (iv) support DOF in implementing the CMDP. In October 1996 the scope of the TA was changed and funds were shifted from components (ii) and (iii) to accommodate Government requests to sponsor a study on development of the peso bond market, and examine the feasibility of a private sector infrastructure facility.11 Drawing heavily on domestic expertise, the completion of these two studies resulted in TA savings. The remaining uncommitted funds from this TA are being used to assist PSE in developing a plan for its demutualization. This activity will commence in August 2000 and be completed within five months.

B. Implementation Arrangements

29. DOF was the Executing Agency for the CMDP, and had overall responsibility for the oversight of the administration, disbursement of loan proceeds, and maintenance of records. The SEC and PSE were the Implementing Agencies.

C. Program Schedule

30. Implementation of the CMDP initially proceeded as expected. The September 1996 Review Mission noted that policy actions were proceeding on schedule. However, by August 1997 this view had changed. In the first quarterly report on the reform agenda, staff noted that while certain reforms have been completed, the reform process was affected by continued delays in implementing policy actions, many of which were related to legislation. In response to these concerns, staff increased program monitoring with follow-up notes, faxes, and missions every month for the next six months. Despite extensive dialogue with the Government, DOF, SEC, and PSE throughout 1997, 1998, and 1999, the CMDP was not fully implemented due to delays in enacting securities legislation.

D. Conditions and Covenants

31. The CMDP was supported by a loan of $150 million from ADB’s ordinary capital resources. The loan carried the pool-based, variable lending rate applicable to ADB’s US dollar facility and had a maturity of 15 years, including a 3-year grace period. The loan was expected to be utilized over 2 years from the date of loan effectiveness.

32. The Government provided quarterly progress reports on the implementation of reforms under the CMDP in compliance with the loan covenant. The first quarterly report circulated in August 1997 was brief and more information would have been beneficial to staff in evaluating potential issues that might lead to implementation delays. Furthermore, the progress reports

10 TA 2379-PHI: Capital Market Development, for $600,000, approved on 22 August 1995. 11 Under a USAID grant (para. 23) consultants completed studies on the mutual fund industry and the preneed sector. 7 throughout the program period were more optimistic than the staff assessments (para. 30 notes the increased level of follow-up as staff realized the potential for delays).

E. Disbursements

33. The loan, which was to be disbursed in two tranches of $75 million each, became effective in March 1997, 18 months after Board approval. The delay in disbursement of the first tranche stemmed from new amendments to the Foreign Borrowings Act that limited Government’s ability to borrow external funds. Additional clarification was required for satisfactory evidence of the due execution and delivery of the loan agreement by a duly authorized Government representative.

34. The first tranche was released in two parts: $70 million was disbursed in April 1997 and $5 million in May 1997. Given the first tranche release delays, the second tranche release was rescheduled from its original date of the first quarter 1997 to December 1998. Delays enacting key legislation contributed to a further extension of the date for second tranche disbursement until December 1999. After an extension of the loan closing date on these two occasions, ADB and the Government mutually agreed on loan cancellation effective 31 December 1999.

F. Program Performance Report Implementation Ratings

35. The Program Performance Report Implementation Ratings introduced in 1998, require that programs experiencing delays in second tranche release of more than one year be automatically classified as unsatisfactory. Since release of the second tranche was delayed by over two years, the implementation rating of the CMDP was downgraded to unsatisfactory in March 1999. Notwithstanding the delayed implementation of some policy actions, the Government is now in compliance with all but one condition that is embodied in legislation pending in Congress (para. 6). In view of this, the Program is rated partially successful.

G. Performance of the Borrower and the Executing Agency

36. DOF exhibited its commitment to the CMDP through continuous dialogue with Congress during the program period. This dialogue was supported by USAID assistance due to human resource constraints at DOF. The impact of these efforts was limited because the legislature required more lead time to perform its due diligence on the amended laws which are technically complex and require a sound understanding of the capital market legal and regulatory framework. DOF met regularly with ADB staff and diligently followed CMDP implementation.

37. The performance of SEC and PSE was affected by their relationship with each other. The SRO status of the latter led to tensions between the two institutions over regulatory responsibility, jurisdiction, and authority. Furthermore, PSE’s ability to comply with covenants that would eventually improve the structure and quality of professionalism and management at PSE was limited because of resistance from vested interests. It appears that while the larger brokers welcomed and supported modernization and increased professionalism, the resistance of the smaller brokers proved stronger than expected making implementation of policy actions difficult.

38. Despite these issues, it must be noted that the Government took considerable prior action although the CMDP loan was not effective until March 1997. These actions included unification of the two stock exchanges, computerization of trading operations, and initiatives in drafting revisions for the RICA. The Government also encouraged a number of activities to implement capital market reform and enacted supporting rules and laws (Appendix 5). Government commitment to reform in past program loans has been consistent and satisfactory. In the four program loans provided by ADB to the Philippines prior to the CMDP, the project 8 completion reports and project preparatory audit reports of these loans found that the Government met the respective policy conditions (Appendix 6). All tranches of the four program loans were released.

H. Performance of ADB

39. ADB monitored the implementation of the CMDP regularly. This monitoring was conducted based on quarterly progress reports submitted by the Government and direct follow- up with DOF, SEC, and PSE. Loan review missions were fielded in September-October 1997 and July 1998. Subsequently, ADB held regular meetings at both staff and senior management levels with senior Government officials, PSE, the Capital Market Development Council (CMDC), and other market participants to underscore its concerns for the effective implementation of the CMDP. In addition to these meetings, ADB held policy dialogue throughout 1999, which continues to date, on issues relating to policy actions initiated under the CMDP. Substantial economic and sector work was launched in 1999 to identify the future course of capital market reforms.

III. EVALUATION OF INITIAL PERFORMANCE AND BENEFITS

A. Economic Performance

40. Prior to the onset of the economic crisis in mid-1997, real gross domestic product grew at an average of 5.0 percent from 1994 to 1996, while real gross national product grew at an average of 5.6 percent during the same period. The peso-dollar exchange rate was stable ranging from P24 to P27 to $1; the consolidated public sector financial position swung from a deficit of P8.4 billion in 1994 to a surplus of P7.3 billion in 1996; total net foreign investments increased from $1.6 billion to $3.5 billion during the same period, and unemployment declined from 9.5 percent in 1994 to 8.6 percent in 1996. These favorable developments contributed to the rapid growth of the capital market in the precrisis years.

41. Major changes occurred in the financial sector as a result of Government and market initiatives to strengthen financial sector management, while at the same time, liberalizing the sector’s operations. Significant policy measures having implications for the CMDP include the following:

(i) 1992: The CMDC was established, comprising both Government and private sector practitioners. Its task is to recommend proposals for capital market development in an integrated and consistent manner, and implement consequential changes in Government policy. The CMDC, along with the Capital Market Coordination Council composed of Government and representatives, set up in 1993, fully endorsed to the National Economic Development Authority and DOF the capital market reform agenda contained in the CMDP.

(ii) 1993: The central bank was restructured into BSP allowing for more focus on and improvement of monetary management. This led to lower inflation (18.7 percent in 1991 to around 9 percent average during 1994-1996 and lower interest rates).

(iii) 1994: Unification of the Manila and Makati stock exchanges into PSE. This led to a rapidly increasing stock market capitalization increased until the crisis (Table 1). 9

(iv) 1995: The banking system was opened to foreign competitors through legislation passed in 1994 and in 1995. Ten foreign banks were licensed to open full service branches.

(v) 1995: BSP raised minimum capital requirements for licensed commercial banks and adopted the Basle Committee norms on capital adequacy and income recognition.

(vi) 1995-1996: SEC shifted its regulatory philosophy from a merit-based approach to full disclosure and enforcement.

(vii) 1996: PCDI and SCCP were established. PCDI was fully operational by the end of 1996, and SCCP by the end of 1998.

(viii) 1995-1996: Amended laws and regulations governing financial, capital market and other related activities to liberalize the markets were presented to Congress (Securities Regulation and Enforcement Act, RICA, Corporation Code, Financing Company Act, and Investment Houses Law).

(ix) 1998: Regulatory responsibilities were realigned along more functional lines such as giving SEC jurisdiction over all investment houses and finance companies not affiliated to banks.

(x) 1998: SEC granted an SRO license to PSE after PSE met FIBV criteria and received accredited FIBV status.

(xi) 1999: BSP and SEC agreed to a memorandum of understanding to undertake information sharing in areas of overlapping jurisdiction.

(xii) 2000: The SRC was enacted providing the foundation for deeper changes in capital market regulation.

42. The implementation performance of the CMDP was less than satisfactory primarily due to delays in passing securities legislation. The reasons for these delays can be attributed to a few critical factors. The most striking feature of the CMDP is the number of reforms attached to one piece of legislation. The SRC contains conditions and amendments that were required to fulfill 21 of the 49 policy actions identified in the CMDP. The congressional elections in May 1998 further delayed the enactment of new legislation. Although both the SRC and RICA were at relatively advanced stages of consideration before the elections,12 the newly reconstituted Congress needed time to discuss the proposed legislation; this delayed program implementation. The potential for resistance to these reforms from vested interests was seen as a risk in the CMDP. These risks were to be mitigated by the growing acknowledgment by PSE members of the need for professional management and by the Government’s strong commitment to the CMDP.

43. Notwithstanding this issue, the Philippines capital market witnessed substantial growth prior to the crisis (Table 1).

12 The SRC was pending a second reading in both the House and Senate, and the RICA was approved by the House and was pending a second reading in the Senate. 10

Table 1: Key Stock Market Indicators

Year Market Capitalization Value of Trading Number of Listed $ billion P billion $ billion Companies 1990 6 161 1 153 1991 11 298 2 161 1992 15 391 3 170 1993 40 1,089 7 180 1994 56 1,386 14 189 1995 59 1,546 15 205 1996 81 2,122 26 216 1997 31 1,251 20 221 1998 35 1,374 10 221 1999 48 1,918 20 226 Source: International Finance Corporation. Various years, 1990-2000. Emerging Stock Market Factbook. Washington, D.C.

44. Since the onset of the regional economic crisis in mid-1997, the Philippines has experienced economic turmoil characterized by currency depreciation, a decline in the performance of banking, interest rate volatility, a significant decline in share prices, and a reduction of foreign currency reserves. These factors led to a slowdown in the growth of the economy in 1997 and 1998. The Philippines’ economic performance in 1998 was also adversely affected by the decline in agricultural production caused mainly by the effects of the drought related to the El Niño phenomenon and later the typhoons related to the La Niña phenomenon.

45. In addition to the setback resulting from the Asian crisis, capital reforms slowed because of the congressional, and later presidential, elections. Newly elected representatives needed time to familiarize themselves with the proposed legislative amendments envisaged under the CMDP. These delays created uncertainty among investors whose confidence was further eroded by the major stock market scandal reported in the press in the first quarter of 2000. This scandal involved allegations of stock price manipulation by a number of brokers, followed by allegations of political interference in investigations by SEC. In the meantime, investigations of the stock price manipulation have been completed, and the report has been submitted to the Department of Justice for action.

46. Publicity and public perception of capital market irregularities have adversely affected market confidence and led to increased pressure on Congress to pass the SRC. Provisions contained under the legislation force fiduciary responsibilities on company directors and impose punitive penalties for fraud. Moreover, as envisaged in the CMDP, these provisions enhance transparency and address some of the shortcomings in the market that have been identified in recent months.

47. Prices of shares of Philippines companies listed on PSE fell significantly in 1997. The falling stock market and resultant heavy selling of Philippines equity securities by foreign investors induced exchange rate pressures and affected the foreign currency positions of financial institutions in the Philippines. The PSE Composite Index declined 45.8 percent in peso terms from 3,448 on 3 February 1997 to 1,870 on 29 December 1997, and continued to fall during most of 1998, reaching a historic low of 1,082 on 11 September 1998. After a partial recovery in late 1999 and early 2000, the PSE Composite Index has continued to be quite volatile, declining to 1,534 on 30 June 2000. 11

48. Fragility and volatility in the capital markets have eroded investor confidence and disrupted capital flows, especially portfolio investment. Increased turbulence, political jitters, and deepening of financial stress have sent PSE capitalization to an all-time low of $28 billion as of June 2000.

49. To revive the economy and place it on sustainable footing and to systematically address structural issues, the Government has constituted a central economic council. In early January 2000, the President issued an executive order establishing the Economic Coordinating Council (ECC), consisting of the President as chair, the secretary of finance as vice-chair, and the following members: governor of BSP; the secretaries of trade and industry, budget and management, and agriculture; the executive secretary; the director-general of the National Economic Development Authority; and the chair of the Housing and Urban Development Coordinating Council. The ECC is tasked with overseeing the country’s economic recovery and has broad functions, including (i) coordination of implementation of economic programs and projects; (ii) promotion of deregulation, liberalization, and market competition; and (iii) promotion of private sector participation in the economy.

B. Attainment of Benefits

50. Despite the adverse effects of exogenous shocks such as the Asian crisis and exceptional political circumstances, the CMDP has facilitated the introduction of modern market concepts, tools, and institutions that are essential for future capital market development. These fundamentals were rightly embodied in the seven core conditions for the second trance release (Appendix 2), and look into consideration the requirements of the new financial architecture as outlined by the International Organization of Securities Commissions (IOSCO).

51. Foreshadowing the increased emphasis and prominence of financial disclosure, the CMDP supported the introduction of minimum disclosure requirements under SEC regulations. This was an integral part of the approach undertaken in the CMDP to shift from merit-based regulation to a full disclosure-based framework. Also in line with the requirements of new international financial architecture, the CMDP supported the introduction of new rules to improve the accuracy and adequacy of information needed to list companies on the PSE.

52. A major challenge has been how to ensure compliance with these new rules by enforcing creditable financial reporting by issuers. To date three IPOs have been registered under the full disclosure rules. SEC is no longer involved in setting or approving the initial offering price, although SEC does require the initial offering price to be stated in the registration statements. The underwriters, after sufficient analysis and appraisal, indicate the initial offering price to allow investors the opportunity to make a prudent investment decision (para. 19).

53. An additional impact of the CMDP was to introduce new standards of corporate governance and professionalism into PSE’s operation. Initial work in this area was started by requiring PSE to transform itself into an SRO. The SRO status of PSE was accorded as it introduced three nonmembers on the PSE board of directors and eliminated the mandatory allocation of shares for the IPO to PSE members. Further action is required to reinforce these initial steps toward improving corporate governance in PSE.

54. The CMDP helped sustain and strengthen capital market reforms by assisting in creating sound legal, regulatory, and supervisory frameworks that govern the capital market. The present market disruptions that are linked to allegations of market manipulation, abuse, and fraud do not necessarily reflect badly on the impact of the CMDP. In fact, it was the vigilance of the investigators within PSE that brought to light market irregularities. Well-publicized investigations 12 and prosecutions are to be expected and even encouraged as part of the responsibility of a securities regulator, thereby demonstrating market monitoring and vigilance in prosecution.

55. Moreover, the CMDP supported measures that have helped increase transparency and reduce risk in the financial sector by introducing processes like the delivery-versus-payment system for stock transactions and supporting the establishment of PCDI and SCCP.

IV. CONCLUSIONS AND RECOMMENDATIONS

A. Conclusions

56. The CMDP is rated partially successful because of the noncompliance with one policy action (embodied in the RICA legislation which is under consideration in Congress - para. 6) and the significant delays in the enactment of the SRC. As the implementing rules and regulations for the SRC are introduced and reforms implemented, irreversible changes in the processes that govern business culture and institutions in capital markets will occur.

57. The CMDP was well timed and coincided with the launching of a macroeconomic stabilization program and broad-ranging structural reform. Sequentially, capital market reforms followed the major overhauling of the banking system that included establishing an autonomous central bank, strengthening banking policies and regulations, and recapitalizing weaker banks. The CMDP laid a foundation for a vibrant securities market that helped in doubling the level of market capitalization between 1992 to 1996. The CMDP’s momentum was, however, blunted by the Asian financial crisis and delays in enacting key securities legislation as a result of a large number of newly elected representatives in the legislature.

58. To accommodate these delays, ADB extended the closing date of the CMDP loan first to December 1998 and then to December 1999. When the December 1999 deadline passed and the securities legislation was still being discussed in the House of Representatives, ADB and the Government agreed to cancel the second tranche.13 This cancellation notwithstanding the SRC was enacted on 19 July 2000.

59. ADB maintains a strong policy dialogue in the area of capital market development to ensure that an appropriate policy framework is adopted to deepen the reforms in the capital markets.14 In addition, efforts are under way at SEC and PSE to improve governance of the markets, and surveillance and supervision activities. This is evident in the incorporation of specific amendments to the SRC that address insider trading and indemnification of securities regulators. These and additional reforms are critical for the Philippines to meet the growing competition and emerging challenges of technology and globalization that have motivated other regional exchanges to swiftly modernize and transform themselves.

B. Lessons Learned

60. The experience with implementing the CMDP underscores the need for strong commitment in the legislature to enact the required new laws. To facilitate this process, policy dialogue on structural reforms need to be extended from the Government to capital market participants as well as politicians. A major impediment in the passage of securities legislation was been the complexity of the technical details that required deep understanding of the role of regulator and significance of its autonomy to enforce higher standards of market conduct. Beside

13 A Board Information paper on the cancellation of the second tranche was circulated in April 2000. 14 Under TA 3245 (footnote 4), ADB is assisting in the restructuring and reorganization of SEC, demutualization of PSE, and drafting of implementing rules and regulations for the SRC. 13 the pressures of vested groups, the legislature extensively debated the question of financial autonomy service rules that were to bring SEC out of the scope of public service regulation.

61. A discussion of more specific lessons follows:

(i) Program Design. The CMDP rightly placed emphasis on strengthening the regulatory reforms to improve transparency and disclosure, protect minority shareholders, and introduce modern regulatory practices. However, the CMDP placed excessive reliance on achieving these objectives through amendments to the legislation. Theoretically, there is nothing wrong with this approach, but in situations where the legislative process is complex and the issues require deep technical knowledge of financial markets, it may be prudent to explore other means of achieving the objectives. For example, rather than opting for new legislation, future operations may choose to focus on ensuring that current market regulations, if found satisfactory, are adequately enforced. This would include an increased emphasis on issues of compliance, and market monitoring and surveillance mechanisms. Better enforcement of market discipline improves the environment for greater acceptance of more stringent and elaborate laws.

(ii) Strong Independent Regulator. The success of financial sector reforms depends critically on the strengths and weaknesses of the regulator. While SEC has undergone some important initial changes, the organization is part of DOF. During the CMDP period, the oversight of SEC was transferred to the President’s office and then sent back to DOF. Being under Government authority and civil service rules, SEC lacks the desired level of independence and financing to properly perform its role and functions, to enforce its regulations, and to prosecute noncompliance, and market abuse. The notion of an independent securities regulator, although advocated in IOSCO Objectives and Principles of Securities Regulation, which are endorsed by virtually every country, has been difficult for many countries to implement. As a result of extensive dialogue over the last year between ADB, SEC, and the Government, a provision providing limited financial independence for SEC was included in the SRC. Continued policy dialogue is under way to look at options that would enhance SEC’s ability to effectively enforce and regulate the securities market.

(iii) Good Governance of Capital Markets. A governance structure was initially envisaged for the PSE board of directors that allowed for an equal number of nonmembers on the board. However, when the CMDP was finalized it was agreed by ADB, SEC, and DOF that the board of governors would have 3 nonmembers and 12 broker members. This proved to be a serious obstacle to reform and market transparency. As a result of continued problems, PSE lost its SRO status in March 2000 (paras. 16-18). Recent dialogue with the Government and continued public pressure have resulted in a provision in the SRC mandating a nonmember majority structure for the PSE board of directors. Maintaining good corporate governance standards among market participants should remain a top priority in program lending.

(iv) Resistance of Vested Interests. Given the pressure of market participants, prudential regulations have not been updated to reflect new understandings of market risk. This has resulted in a rapid growth of market participants who operate with low levels of capital. The CMDP supported the introduction of PCDI and SCCP. The smaller market participants resisted these changes and had a 14

disproportionately adverse impact on the pace of reform, almost stopping the creation of SCCP. Lack of adequate capital standards and weak enforcement of the current standards have impeded PSE’s ability to operate as a sound SRO.

(v) Need for Broader Consultative Process and Greater Accessibility of Policy Issues. Although extensive consultations were held during the Program with the CMDC; some reforms met with considerable resistance. This factor, coupled with the time needed for the new Congress to gain a thorough understanding of the complex securities legislation, contributed to delays in program implementation. Broader consultation at the program formulation stage would alert ADB missions to the acceptability of or resistance to anticipated reforms or policy actions. It could help identify advocates within the government and legislature. Expressions of resistance could also indicate a need to simplify reform programs. Documentation, including the policy matrix, should be couched in nontechnical language so that concerned parties can easily understand the proposed reforms.

C. Recommendations

1. Program-Related

62. Future Monitoring. The SRC has been enacted but the implementation of many provisions will depend upon SEC rulemaking. The total impact of the SRC cannot be measured until the necessary rules are adopted. Of specific significance are the implementing rules for the amendments that were included in the SRC prior to its enactment. A number of these amendments, such as provision for self-financing, are the result of dialogue between ADB and the Government, especially SEC, in the follow-up to the CMDP and under the new TA for strengthening nonbank financial sector (footnote 4). These additional amendments are the result of a realization by stakeholders that SEC must be strengthened to effectively regulate the securities market, and that transparency and corporate governance must be improved. Staff will also continue to monitor progress with the RICA legislation.

63. Covenants. The quarterly reporting instrument used by the Government to report program progress to ADB had a simple design and the Government complied with the reporting requirement. Although, the simplified reporting format allowed for a clear breakdown of the policy actions involved in a complex program, it did not provide adequate information to analyze the issues that were creating delays in program implementation. Nevertheless, the reporting format.

64. Further Action or Follow-Up. Follow-up is being undertaken through sustained dialogue in a number of areas to pursue broader nonbank financial sector reform.

65. Additional Assistance. The work started under the CMDP is part of a continuing effort by ADB to help develop vibrant, competitive, and well-functioning capital markets in the Philippines. This includes important reforms initiated under the CMDP, such as introducing more modern regulatory structures, increasing the efficiency and professionalism of PSE staff, and increasing market capitalization. Additional TA was approved in 1999 to strengthen the capacity of SEC staff, focusing on compliance and enforcement activities, and the introduction of IOSCO standards for securities market regulation (footnote 4). Further reforms of the nonbank financial sector are critical to consolidate the progress achieved under the CMDP. Following the enactment of the SRC (i) new governance structures should be introduced to support market regulation as PSE undertakes demutualization, (ii) the demand and supply conditions should be right for the development of a domestic debt market, and (iii) restructuring and market consolidation should be undertaken in the nonbank sector. These are all part of a second phase of reforms that will result 15 in a regionally competitive market that is able to fulfill its primary function of increasing domestic capital formation.

2. General

66. Project Design. To avoid excessive reliance on the enactment of legislation that may make the implementation of policy actions unpredictable, future operations should focus on ensuring that current market regulations, if found satisfactory, are adequately enforced. If improvements in regulations are required, alternatives to legislative action should be explored.

67. Consultation. Broader consultation at the program formulation stage involving both the executive and legislative branches of the government and other directly affected stakeholders will help alert staff to the acceptability of or resistance to the proposed reforms or policy actions. This consultation process should make certain that documentation, including the policy matrix, is couched in nontechnical language so that concerned parties can easily understand the proposed reforms. 16

APPENDIXES

Number Title Page Cited on (page, para.)

1 Status of Reforms 17 1, 5

2 Capital Market Statistics 22 1, 5

3 Summary of Compliance with the Seven Core 25 2, 6 Conditions

4 Recommendations of Group of Thirty – Securities 26 4, 21 Clearance and Settlement Study

5 Acts, Rules, and Regulations Relating to the Securities 28 7, 38 Markets Implemented during the Program

6 Previous Program Loans for the Philippines 29 8, 38 STATUS OF REFORMS CAPITAL MARKET DEVELOPMENT PROGRAM LOAN

Policy Action Status of Implementation

A. Assign Regulatory Responsibility for Effective Regulation Allocation of Regulatory Functions Department of Finance to prepare a strategy paper and propose Substantially complied with. With support of ADB TA, the Capital Market Development an action plan to rationalize and allocate regulatory Council and the Securities and Exchange Commission (SEC) have been examining ways to responsibilities among the appropriate Government agencies rationalize and allocate regulatory responsibilities of various capital market institutions. In taking into account the recommendations made under Asian line with this objective, the Bangko Sentral ng Pilipinas (BSP) has transferred regulation to Development Bank (ADB) technical assistance (TA) 1641-PHI SEC of investment houses that operate without quasi-banking and trust functions or for (i) money market instruments (commercial paper); (ii) investment management authority, and are not a subsidiary or affiliate of a bank. Regulation securitized assets; (iii) investment houses; (iv) standard rules of of securities dealers and brokers not affiliated with a bank was transferred from BSP to accounting; (v) common trust funds and mutual funds; (vi) SEC. Based on studies, discussion is under way on how best to regulate preneed preneed companies; and (vii) finance companies, pawnshops, companies. Department of Finance’s authority over the application and development of and lending investors. accounting rules has been removed. B. Strengthen the Regulatory Framework to Develop Investor Confidence 1. SEC Operations

SEC to cease applying rules and procedures that derive from a 17 merit-based regulatory approach and adopt a disclosure basis of regulation and supervision, including (i) establishing minimum disclosure requirements and requiring Complied with. In October 1996, SEC adopted comprehensive full disclosure rules that that a prospectus containing specified information be issued established a new process for the registration of financial statements and other reports to be for all new public offers and made available to all filed with SEC and distributed to investors. 1 prospective purchasers (core condition) Three issues (Armstrong Securities, Inc; Philippine Seven Corporation; and Euro-Med Laboratories Philippines, Inc.) have been registered under the full disclosure rules.

(ii) discontinuing SEC’s requirement that the initial offering price Complied with. SEC adopted a revised approach to initial public offering pricing in be specified in the registration statement (core condition) consultation with ADB. The purpose of the condition was to prevent SEC from influencing the determination of the initial offering price. With the shift from merit-based regulation to a full-disclosure based framework, SEC is no longer involved in setting or approving the initial offering price, even though it requires the initial offering price to be specified in the registration statement. Underwriters, subject to due diligence of companies, indicate the initial offering price to allow investors the opportunity to make a prudent investment decision. 2. The Corporation Code Appendix 1,page1 a. SEC to issue rules and regulations for publicly listed companies to: (i) strengthen the provisions of the Corporation Code Complied with. SEC has issued proxy rules to allow shareholders the opportunity to indicate relating to the protection of minority shareholders how they would like their shares to be voted and to issue a proxy, which is good only for one meeting. In addition, SEC has issued the “tender offer rules and reports” to be filed by certain beneficial owners. The Corporation Code is amended to ensure that when an offer is made to majority shareholders, the same offer must also be made to minority shareholders.

1 Compliance with the seven core conditions were viewed as critical for second tranche release. Policy Action Status of Implementation

(ii) require directors and officers to act in good faith to Complied with. This is addressed in amendments to the Securities Regulation Code (SRC)2. exercise reasonable business judgment and carry out Under proposed provisions, persons who have a controlling interest are liable where any fiduciary responsibilities to act in the best interest of the director or officer hinders or delays the filing of information that is required to be filed under corporation and its shareholders law. (iii) prohibit voting on resolutions on proposed transactions Complied with. SEC business conduct rules cover this requirement. by interested directors (iv) increase the notice period for shareholder meetings for Complied with. The SRC requires companies to issue and mail notices of meetings at least resolutions that have a material impact on a company 15 days before a meeting. to at least 10 business days b. Require a minimum number of outside nonexecutive Complied with. The SRC requires companies to have at least two independent directors or a directors for publicly listed companies sufficient number to represent at least 20 percent of the members of the board of directors. 3. The Revised Securities Act (1982) a. Registration of Statement and Prospectus (i) SEC to adopt rules imposing an expressed due Complied with. The rule took effect in September 1995. A work cell concept was adopted diligence on underwriters to certify the accuracy and whereby process management and centralized SEC receiving procedures are combined adequacy of information in the registration statement into a "one-stop shop" service for securities registration and monitoring, and the regulation and prospectus provided by the issuer (core condition) of various market participants.

(ii) SEC to require prominent disclosure of all fees and Complied with. Since October 1996, SEC has maintained a comprehensive system of full 18 expenses relating to an offering in the prospectus disclosure rules. (iii) SEC to exempt private placements of institutional Complied with. SRC allows private placement of securities to be exempt from normal investors from registration requirement registration requirements. (iv) SEC to eliminate the requirement to obtain a permit to Complied with. SRC allows (a) offers for the sales of securities to be made only upon the offer securities and instead provide that (a) offers may effectiveness of the registration statement, and (b) the registration statement to become be made only upon the effectiveness of the registration effective 45 days after filing unless delayed by the issuer or SEC brings proceedings to statement, and (b) the registration statement will reject the registration. become effective 45 days after filing unless delayed by the issuer or SEC brings proceedings to reject the registration (v) SEC to require an updated short form prospectus for Complied with. Since October 1996, SEC has maintained a comprehensive system of full rights issues disclosure rules. (vi) Amend the Revised Securities Act to Appendix 1,page2 (a) provide objective standards for registration and Complied with. SEC maintains proper standards for registration and disclosure as stipulated delete provision that enables SEC to reject a in the full disclosure rules. registration statement on the basis of merit judgements as long as there is full disclosure; (b) provide for exemptions from registration not Compliance pending enactment of legislation. Amendments in the SRC exempt sales to enumerated in the act by adopting rules, including qualified investors from registration requirements. sales to qualified investors; eliminate the need to apply for exemption;

2 The Securities Regulation Code, Republic Act 8799, was enacted on 19 July 2000. Earlier versions of the SRC were known as the Securities Act or the Securities Regulation and Enforcement Act. Policy Action Status of Implementation

(c) require registration of bank or bank-guaranteed Complied with. SRC requires registration of bank or bank-guaranteed offerings and merger- offerings and merger-related offerings; and related offerings. (d) reduce disclosure threshold for substantial Complied with. SRC allows the reduction of the disclosure threshold to 5 percent and notice acquisition or sale of shares from 10 percent to period is fixed by SEC. 5 percent, and the notice period from 10 days to 1 business day. b. Registration of Brokers and Dealers (i) Amend the Revised Securities Act to (a) add a registration category called an “associated Complied with. Amendments in the SRC insert a registration category called an “associated person" of a broker and dealer to be defined as an person” of a broker and dealer to be defined as an individual acting in a managerial or a individual acting in a managerial or a supervisory supervisory capacity including executive officers. capacity including executive officers; (b) delete the requirement that all broker and dealer, Complied with. Amendments in the SRC have deleted the requirement that all broker and investment house and vendor registrations dealer, investment house, and vendor registrations terminate at the end of each calendar terminate at the end of each calendar year; year. (c) provide only objective grounds to refuse or revoke Complied with. Amendments of the SRC provide for only objective grounds to refuse or registration of securities professionals; revoke registration of securities professionals.

(d) delete the requirement that SEC provide at least Complied with. SRC has deleted the requirement of at least five days’ prior notice to SEC 19 five days' prior notice of any on-site examination of for any on-site examination of the books and records of a broker or dealer. Currently this is the books and records of a broker or dealer; being implemented administratively by SEC under the books and records rules. (e) introduce civil liability provisions for fraud in Complied with. SRC provides civil liability provisions for fraud in secondary trading secondary trading transactions and for insider transactions and for insider trading. trading; and (f) amend the definition of securities brokers to include Complied with. SRC extends the provision for definition of securities brokers to banks. banks. (ii) SEC to add requirement, as a condition of registration Complied with. The requirement that applicants must pass an appropriate examination as a broker or dealer, that applicants must pass an demonstrating competence has been implemented since 1992. appropriate examination demonstrating competence (iii) SEC to provide a risk-based net capital requirement for Complied with. The Net Capital Rule, August 1996, has resulted in introduction of risk-based brokers and dealers, with specific capital items to be net capital requirement for brokers and dealers. defined explicitly in the rules Appendix 1,page3 c. Stock exchanges (i) SEC to require that all transactions by brokers in Compliance pending enactment of legislation. Amendments in the SRC require transactions unlisted securities be traded in a centralized market by brokers in unlisted securities to be traded in a centralized market under the supervision under the supervision of a registered SRO of a registered SRO. Policy Action Status of Implementation

(ii) SEC to expressly require a registered exchange to Complied with. SEC has requested the Philippine Stock Exchange (PSE) to introduce the enforce its rules, including rules designed to prevent Code of Conduct and Professional Ethics for Traders and Salesmen, in effect since 21 April fraudulent and manipulative acts and practices, 1999. promote just and equitable principles of trade, and protect investors and the public interest; provide that failure to enforce rules will constitute grounds to revoke registration of the exchange or imposition of other sanctions on the exchange or its officials (iii) SEC to require a registered exchange to submit Complied with. SRC requires a registered exchange to submit substantive amendments of substantive amendments to its rules to SEC for prior its rules to SEC for prior of its internal approval. approval (iv) Require that officers of a stock exchange need not be Complied with. SRC stipulates that officers of a stock exchange need not be directors. directors 4. Investment Houses a. Allow brokers to engage in guaranteed underwriting, Complied with. All brokers with the requisite net capital can have established subsidiaries to provided they meet the same net capital and other conduct guaranteed underwriting. requirements as underwriters, as specified by SEC. b. Increase the financial and other penalties specified under Compliance pending enactment of legislation. Provisions in the Revised Investment 20 the Investment Houses Law to make them true deterrents. Company Act provide that the financial and other penalties are increased to make them true deterrents. C. Institute Self-Regulatory Mechanisms at PSE for Efficient and Transparent Stock Allocation and Trading in Accordance with Sound Practices 1. Philippine Stock Exchange a. PSE to be recognized as an SRO in accordance with Complied with. PSE was accredited as an FIBV member on December 1996. PSE was International Organization of Securities Commission formally granted SRO status by SEC, giving it the power to regulate its own members and to (IOSCO) standards as evidenced by accreditation by formulate and implement its own rules and regulations, subject only to the oversight Federation Internationale des Bourses de Valeurs (FIBV) authority of SEC. (core condition) b. PSE to ensure that investor concerns are addressed Complied with. The first nonbroker governor was appointed on September 1993; the other through the appointment of at least three members from the two nonbrokers were appointed on March 1997. nonbroker community to the PSE Board of Governors (core

condition) Appendix 1,page4 c. PSE to eliminate the mandatory allocation of shares of initial Complied with. Until 1997, initial public offering distributions included a retained portion for public offers to PSE members (core condition) PSE members, giving them an advantage over genuine investors. In November 1997, an SEC memo, Circular No. 4 Series of 1997 set out new distribution rules: • qualified institutional investors 30% • local small investors (applications up to P20,000) 10% • general public 60% d. SEC to prohibit PSE management or listing committee from Complied with. Setting prices of securities offerings is now the prerogative of the issuer and involvement in setting prices of securities offerings underwriter. e. PSE to introduce a code of conduct of best practices for its Complied with, implemented since 1996 with the introduction of the Business Conduct members along the lines recommended by FIBV: Rules. Policy Action Status of Implementation

(i) Define and require adequate disclosure of conflicts of Complied with, under full disclosure rules. interests. (ii) Define and require adequate disclosure of all material Complied with, under full disclosure rules. information. (iii) Prevent insider trading. Complied with, under full disclosure rules. (iv) Impose a fiduciary duty to act in the client's best Complied with, under code of conduct. interest. (v) Ensure segregation of customer funds to protect Complied with, under code of conduct. customer savings from bankruptcy of intermediary. (vi) Set rules for maintenance of customer and trading Complied with, under code of conduct. records. 2. Central Depository System

Philippine Central Depository Inc. (PCDI) to establish a central Complied with. PCDI established a central depository system in December 1997 to help depository system substantially in accordance with standards set modernize brokers’ back-office systems resulting in significant efficiencies in the transfer of by the Group of Thirty (core condition) securities.

D. Provide a Sound Legal Framework for Collective Investment Vehicles to Raise Risk Capital from Retail Investors 21 Reform in Mutual Funds, Preneed Companies, and Related Accounting Standards 1. Department of Finance to conduct independent studies on the Substantially complied with, activity is ongoing. Studies on mutual fund and preneed issues operations of mutual funds and preneed companies, and the have already advanced into the stage where legislation has been proposed. For mutual rules, regulations, and policies governing them. funds, double taxation has been eliminated with the passage of the Comprehensive Tax Reform Law. 2. Implement the recommendations of the above studies, to improve Substantially complied with, activity is ongoing. Double taxation on mutual funds has been the efficiency and transparency of the operations of mutual funds eliminated with the passage of the Comprehensive Tax Reform Law; and Senate Bill 152 and preneed companies. entitled Revised Investment Company Act reflects major developments including (i) prohibition of activities and relationships that could lead to conflict of interest, (ii) declaration of unlawful acts for the protection of public interest, (iii) prudential restrictions of portfolio management and financial structure, (iv) full disclosure of information, (v) reinforced supervisory functions of SEC, and (vi) self-regulation of industry association. Action on this

reform measure has been satisfactorily initiated. Appendix 1,page5 E. Increase the Supply of Equity Shares to Widen the Retail Investor Population and Attract Long-Term Savings Supply of Equity Shares 1. The Government to divest its equity shares in state-owned Substantially complied with. Ongoing activity. About P32 billion has been generated by enterprises by public issues (if appropriate and if market public issues, i.e., the Philippine National Bank and Petron Corporation. Further privatization conditions permit) is expected as market conditions improve. 2. BSP to encourage commercial banks to raise equity by listing Substantially complied with. Ongoing activity. Board Resolution dated 27 December 1997 their shares and require a 10 percent listing to obtain a unibank requires expanded commercial banks to list at least 10 percent of their paid-up capital to license. broaden their ownership. To date, 15 of 21 universal banks have listed their shares. 22 Appendix 2, page 1

CAPITAL MARKET STATISTICS

Table A2.1: Financial Institutions in the Philippines Financial System

Institution 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98 Nonbank Financial Intermediaries Investment Houses 17 23 26 37 46 58 Financing Companies 124 124 128 137 145 153 Investment Companies 64 65 65 64 64 – Securities Dealers and Brokers 126 126 129 128 132 168 Lending Investors 1,148 1,436 854 1,829 2,017 2,420 Pawnshops 2,000 2,213 2,479 2,859 3,854 4,432 Government NBFIs 4 5 5 5 5 – Venture Capital Corp. 10 10 10 10 10 10

Nonbank Thrift Institutions Non-Stock SLAs 106 110 111 115 115 – Mutual BLAs 6 7 7 7 7 –

Banks Commercial Banks 32 32 33 45 49 – Thrift Banks 98 97 100 99 108 – Rural Banks 787 780 784 790 804 – – = not available, BLAs = building and loan associations, NBFIs = nonbank financial institutions, SLAs = saving and loan associations. Source: Bangko Sentral ng Pilipinas and Securities and Exchange Commission.

Table A2.2: Maturity Structure of Debt Securities Issued

Issuer Instrument Issuance Maturity Medium- to Long-Term Central Government (BTr, DOF) Fixed Rate Treasury Bond 2, 5, 7 years Central Government (BTr, DOF) Floating Rate Treasury Note 3 years Financial Institutions Certificate of Deposit 3-6 years Public and Private Sector Commercial Papers/Promissory Notes 3-5 years Corporates Corporates Corporate Bonds 3-5 years Corporates Convertible Bonds 5-7 years

Short-Term Central Government (BTr, DOF) T-bills 91, 182, 364 days BSP Central Bank Bills 30-91 days Corporates Commercial Papers/Promissory Notes Up to 1year Financial Institutions Certificate of Deposit Up to 1year BSP = Bangko Sentral ng Pilipinas, BTr = Bureau of Treasury, DOF = Department of Finance. Source: Standards Chartered Equitor. 23 Appendix 2, page 2

Table A2.3: Corporations Listed on PSE through IPOs 1995-1997

Name of Stock Par Value Offered Shares Total Listed Shares Date Listed

Alaska Milk Corporation 1.00 217,927,506 640,963,252 17 Jan 1995 Vitarich Corporation 1.00 104,562,738 409,969,764 8 Feb 1995 Waterfront Philippines, Inc. 1.00 112,500,000 450,000,000 17 Mar 1995 Bankar, Inc. 1.00 118,000,000 338,000,000 21 Mar 1995 La Tondena Distillers, Inc. 1.00 40,185,185 321,481,482 18 Apr 1995 William Lines, Inc. 1.00 235,714,285 785,714,285 15 May 1995 MRC Allied Industries, Inc. 1.00 168,000,000 500,000,000 18 May 1995 Security bank Corporation 10.00 34,483,000 135,495,350 8 Jun 1995 Pilipino Telephone Corporation 1.00 230,000,000 1,040,002,800 11 Jul 1995 Ionics Circuits, Inc. 1.00 42,969,000 171,875,000 18 Jul 1995 C & P Homes, Inc. 1.00 566,540,000 2,776,031,286 31 Jul 1995 Sinophil Corporation 0.01 25,000,000,000 100,000,000,000 28 Aug 1995 Filipino Fund, Inc. 1.00 600,000,000 850,000,000 27 Sep 1995 Fil-Estate Land, Inc. 1.00 200,000,000 1,012,397,455 23 Nov 1995 Primetown Property Group, Inc. 1.00 108,228,000 432,912,000 8 Dec 1995 DMCI Holdings, Inc. 1.00 383,434,000 1,127,747,000 18 Dec 1995 Asian Terminals, INC. 1.00 150,000,000 750,000,000 25 Jan 1996 Fortune Cement Corporation 1.00 140,000,000 923,187,200 4 Mar 1996 UrbancorpRealty Developers, Inc 1.00 351,000,000 701,000,000 19 Mar 1996 Alsona Cement Corporation 1.00 267,988,000 724,291,509 25 Mar 1996 Hi Cement Corporation 1.00 368,075,000 768,500,220 17 Jun 1996 Empire East Land Holdings, Inc. 1.00 425,000,000 1,700,000,000 28 Jun 1996 Lorenzo Shipping Corporation 1.00 100,751,880 300,751,880 22 Jul 1996 Central Azucarera de Don Pedro 1.00 174,400,000 577,750,000 8 Aug 1996 Unwind Holdings, Inc. 1.00 891,838,000 2,548,109,762 19 Aug 1996 Ever Gotesco Resources & Holdings 1.00 1,377,359,300 5,000,000,000 16 Sep 1996 Music Semiconductor Corporation 1.00 123,594,930 308,987,320 26 Sep 1996 Asiatrust Development Bank, Inc. 10.00 18,818,000 69,342,150 8 Oct 1996 Digital Telecommunication Phils., Inc. 1.00 1,271,395,000 6,356,976,310 27 Nov 1996 PCI Leasing & Finance, Inc. 121,220,000 606,100,000 6 Jan 1997 Mabuhay Vinyl Corporation 223,187,000 656,972,390 5 Feb 1997 Reynolds Philippine Corporation 238,000,000 700,000,000 27 Feb 1997 Equitable Banking Corporation 62,172,820 340,000,000 3 Apr 1997 Boulevard Property & Holdings, Inc. 500,000,000 1,000,000,000 28 Apr 1997 Premiere Entertainment Production Inc. 180,000,000 520,000,000 5 May 1997 Source: Philippine Stock Exchange. 24 Appendix 2, page 3

Table A2.4: Listed Universal Banks

Name of Bank Date Listed 1. Solid Bank 25 October 1963 2. PDCP Development Bank 29 July 1964 3. China Bank 1 December 1965 4. Bank of the Philippine Island 12 October 1971 5. Banco Pilipino 2 July 1973 6. Metro Bank 26 February 1981 7. Philbanking Bank 29 March 1983 8. Rizal Banking and Trust Company 6 November 1986 9. Prudential Bank 22 December 1987 10. Philtrust Bank 17 February 1988 11. PB Com Bank 2 May 1988 12. Philippine National Bank 21 June 1989 13. Union Bank 29 June 1992 14. PS Bank* 10 October 1994 15. Security Bank and Trust Company* 8 June 1995 16. Asiatrust Development Bank* 8 October 1996 17. Urban Bank* 28 January 1997 18. Equitable PCI Bank* 3 April 1997 19. Chinatrust Bank* 2 June 1999 * Universal banks listed during the program period. Source: Philippine Stock Exchange and Securities and Exchange Commission. 25 Appendix 3

SUMMARY OF COMPLIANCE WITH THE SEVEN CORE CONDITIONS

Second Tranche Conditions Status of Compliance

The Securities and Exchange Commission Complied with. In October 1996, SEC adopted comprehensive (SEC) to establish minimum disclosure full disclosure rules that established a new process for the requirements and require that a prospectus registration of financial statements and other reports to be filed containing specified information be issued for with SEC and distributed to investors. all new public offers and made available to all Three issues (Armstrong Securities, Inc; Philippine Seven prospective purchasers Corporation; and Euro-Med Laboratories Philippines, Inc.) have been registered under the full disclosure rules. SEC to discontinue the requirement that the Complied with. SEC adopted a revised approach to IPO initial public offering (IPO) price be specified pricing in consultation with the Asian Development Bank. The in the registration statement purpose of the condition was to prevent SEC from influencing the determination of the initial offering price. With the shift from merit-based regulation to a full disclosure-based framework, SEC is no longer involved in setting or approving the initial offering price, even though it requires the initial offering price to be specified in the registration statement. Underwriters, subject to due diligence of companies, indicate the initial offering price to allow investors the opportunity to make a prudent investment decision.

SEC to adopt rules imposing an expressed Complied with. The rule took effect in September 1995. due diligence on underwriters to certify the Process management and centralized SEC receiving accuracy and adequacy of information in the procedures are combined into a "one-stop shop" service for registration statement and prospectus securities registration and monitoring and the regulation of provided by the issuer various market players.

The Philippine Stock Exchange (PSE) to be Complied with. PSE was accredited as an FIBV member on recognized as a self-regulatory organization December 1996. PSE was formally granted SRO status by (SRO) in accordance with International SEC, giving it the power to regulate its own members and Organization of Securities Commission formulate and implement its own rules and regulations, subject (IOSCO) standards as evidenced by only to the oversight authority of SEC. accreditation by Federation Internationale des Bourses de Valeurs (FIBV)

PSE to ensure that investor concerns are Complied with. The first nonbroker governor was appointed on addressed through the appointment of at September 1993. The other two nonbrokers were appointed least three members from the nonbroker PSE governors on March 1997. community to the PSE Board of Governors

PSE to eliminate the mandatory allocation of Complied with. Until 1997, IPO distributions included a IPO shares to PSE members retained portion for the PSE members, giving them an advantage over genuine investors. In November 1997, a SEC memo Circular No. 4 Series of 1997, set out new distribution rules: • qualified institutional investors 30% • local small investors (applications up to P20,000) 10% • general public 60%

Philippine Central Depository Inc. (PCDI) to Complied with. PCDI established a central depository system establish a central depository system in December 1997 to help modernize brokers’ back-office substantially in accordance with standards systems resulting in significant efficiencies in the transfer of set by the Group of Thirty securities. 26 Appendix 4, page 1

RECOMMENDATIONS OF GROUP OF THIRTY – SECURITIES CLEARANCE AND SETTLEMENT STUDY

A. Recommendation #1: Trade Comparison on T+1

1. By 1990, all comparisons of trades between direct market participants (i.e., brokers, broker/dealers and other exchange members) should be accomplished by trade date plus 1.

B. Recommendation #2: Trade Comparison for Indirect Participants

2. Indirect market participants (such as institutional investors, or any trading counterparts that are not broker/dealers) should, by 1992, be members of a trade comparison system that achieves positive affirmation of trade details.

C. Recommendation #3: Central Depository

3. Each country should have an effective and fully developed central securities depository, organized and managed to encourage the broadcast possible industry participation (directly and indirectly), in place by 1992.

D. Recommendation #4: Netting

4. Each country should study its market volumes and participation to determine whether a trade netting system would be beneficial in terms of reducing risk and promoting efficiency. If a netting system would be appropriate, it should be implemented by 1992.

E. Recommendation #5: Delivery versus Payment

5. Delivery versus payment (DVP) should be employed as the method for setting all securities transactions. A DVP system should be in place by 1992.

F. Recommendation # 6: Same Day Funds

6. Payments associated with the settlement of securities transactions and the servicing of securities portfolios should be made consistent across all instruments and markets by adopting the “same day” funds convention.

G. Recommendation #7: T+3 Rolling Settlement

7. A rolling settlement system should be adopted by all markets. Final settlement should occur on T+3 by 1992. As an interim target, final settlement should occur on T+5 by 1990 at the latest, save only where it hinders the achievement of T+3 by 1992.

H. Recommendation #8: Securities lending

8. Securities lending and borrowing should be encouraged as a method of expediting the settlement of securities transactions. Existing regulatory and taxation barriers that inhibit the practice of lending securities should be removed by 1990. Appendix 4, page 2 27

I. Recommendation #9: Use of ISO Standards 7775 and 6166

9. Each country should adopt the standard for securities messages developed by the International Organization for Standardization (ISO Standard 7775). In particular, countries should adopt the ISIN numbering system for securities issues as defined in the ISO Standard 6166, at least for cross border transactions. These standards should be universally applied by 1992. 28 Appendix 5

ACTS, RULES, AND REGULATIONS RELATING TO THE SECURITIES MARKETS IMPLEMENTED DURING THE PROGRAM

No. Act/Rules/Regulations Date 1 SEC Amended Rules Governing Warrants Jun 94 2 SEC Rules on Suspension/Revocation of the Certificate of Registration of Corporations Jun 94 (SMD) Series of 1992 3 BSP Act Imposing a Tax on the Sale, Barter, or Exchange of Shares of Stock Listed and Traded May 94 Through the Local Stock Exchange or Through Initial Public Offering 4 SEC Amended Rules Governing the Distribution of Excess Profits of Corporation Sep 95 (distribution of Cash Declaration) 5 SEC Records Retention Policy and Archival Media Jun 96 6 SEC Business Conduct Rules Jun 96 7 SEC The Net Capital Rule, Books, and Record Rule and Other Related Rules Jun 96 8 SEC Full Disclosure Rules Oct 96 9 SEC Rules Amending the Rules and Regulations Prescribing Penalties for Issuance of Dec 96 Shares Without Prior Permit 10 SEC Amendment to the New Rules on the Registration and Scale of Pre-Need Plans Dec 96 and Similar Contracts and Investments (19 August 1996) 11 SEC Commission Release Announcing Adoption of Subordination Agreements Jun 97 and Margin Rules (22 January 1997) 12 SEC Rules to Govern the Dissemination of News on Security Issues Jun 97 13 SEC Rules to Govern Trading by Trader/Salesmen of Brokerage Firms for Their Own Personal Jun 97 Accounts 14 SEC Clearing and Settlement Rule Jun 97 15 SEC Rules of Procedure Governing the Issuance of temporary Restraining Orders Jun 98 16 SEC Commission Release Adopting Tender Offer Rules, Reports to be Filed by Dec 98 Certain Beneficial Owners and Issuance/Sale of Securities Abroad 17 SEC The Investment Company Rule (ICA Rule 35-1) Dec 98 18 PSE Code of Conduct Apr 99 19 SEC Rules and Regulations Implementing the Uniform Chart of Accounts for Pre-Need Jun 99 Plan Companies 20 SEC Rules and Regulations to Implement the Provisions of Republic Act No. 8556 Dec 99 (The Financing Company Act of 1998) 21 SEC New Rules and Regulations on Futures Trading Dec 99 Source: Securities and Exchange Commission and Bangko Sentral ng Pilipinas. 29 Appendix 6

PREVIOUS PROGRAM LOANS FOR THE PHILIPPINES

Loans 971/972-PHI: Fisheries Sector Program, for $50 million equivalent (SFR) and $30 million equivalent (OCR), approved on 26 September 1989. The Program was generally successful as per the program completion report (PCR). The implementation of the Program was effective, and the loan covenants were generally met.

Loan 680-PHI: Agricultural Inputs Program, for $15 million, approved on 27 March 1984. This Program loan included both an investment component (for importation of fertilizers) and important policy changes. The Program according to the PCR was substantively achieved and contributed significantly to the rationalization of policies in the fertilizer sector, including liberalization of fertilizer trade and better regulatory policies for pesticides.

Loans 889/890-PHI: Forestry Sector Program, for $60 million equivalent (SFR) and $60 million equivalent (OCR), approved on 28 June 1988. The Program consisted of an investment component and policy institutional reforms. The Government complied with all 12 second tranche conditions and 32 of 34 covenants, two covenants being partially complied with. Original investment targets were also generally met.

Loan 1047-PHI: Road and Road Transport Sector Program, for $50 million, approved on 8 November 1990. The Program was generally successful and met its policy conditionalities for tranche release. Both tranches were released.