Fixed income exchange offers third option

The introduction of the fixed income market offers a third option for the domestic financial system, according to a respected economist and consultant.

The two other options are the loans market and the equities market.

Increase in options for the financial system and the public allows for diversification to source funds in the three markets depending on what they are willing to commit to i.e., interest payments, coupons, or dividends, which in turn will influence their choice of the instruments.

"For investors, they certainly will have the option to use their excess funds either by implicitly creating loans from deposits or being stockholders outright or investing in liquid tradable instruments," Dr. Johnny Noe E. Ravalo, chief economist of the prestigious Bankers Association of the Philippines (BAP) said.

Ravalo explained that the fixed income market or the Philippine Fixed Income Exchange (PFIX) cannot really develop unless market participants have agreed on several critical conventions such as valuation benchmarks, accounting treatments, risk identification and regular audits. This is unlike in loans and equities whose respective markets arise literally from the issuance of licenses from regulatory bodies.

"In this sense, the form and substance of the system upgrade will depend a great deal on the second stage issue of market conventions," he added. The conventions on the other hand rise from the process of globalization wherein players set certain standards of practice.

In a report made to a regional assembly recently, the BAP economist said that the PFIX can provide the effect of diversifying industrial financial methods, a means for market agents to contribute and access long-term funds, insulate against the price risk in the loans market, and offer new product lines outside of equities and bank loans.

"The diversification impact really comes from its ability to source funds using a distinctly different set of professional core competence, product price discovery features, valuation and risk management methods," Ravalo said. "From the standpoint of the policymakers, fixed income differs from loans market and the equities market insofar as supervision and dynamics."

The PFIX is a post-1997 Asian financial crisis creation and it was formalized in early 2000. Its principal proponents are the Investment House Association of the Philippines (IHAP) and the BAP. The Bangko Sentral ng Pilipinas (BSP), the highest monetary authority and the country’s central bank has been closely monitoring the formation of the said exchange.

The beauty of the PFIX is that the Philippine government will not infuse any finds into the system except in the areas of reforms in monetary regulations and the taxation system.

It is presently at the stage of capital solicitation or infusion to raise the P500-million paid-up capital. The proponents have also put in a place a number of reforms to guide the practice of the exchange. These are:

• the creations of a risk reference manual, which binds commercial banks into minimum standards on different facets of the risk management process;

• best practice manuals for (a) origination and underwriting (b) sales and distribution (c) trading and marketing making plus (d) a product manual for foreign exchange;

• provisions for regulatory accounting and audit;

• creation of a daily yield curve based on electronically-captured "done" or actual trades of government securities in the secondary market for tenors from one month to 25 years;

• continuing education programs for market professionals through required accreditation exams.

The establishment of the fixed income market is a result of the globalization direction and the various stages that must be taken by countries to slowly blend in the environment.

Ravalo said that the first stage is the acceptance of globalization as the paradigm of choice while the second stage is the restructing and concerted cooperation between countries.

The third phase will basically involve rebuilding the domestic markets to meet the challenge of a financial liberalized environment.

"This stage is characterized by developing the local market as a system upgrade rather than a crisis response. It is not a vacuum state and must in fact evolve in parallel to and interactively with the second phase," the economist said.

Critical among the restructuring of the local financial markets, is the resolution of non-performing assets on the books of the banks. "Unless a write-off-cum-bank-recapitalization program is a convenient and viable option, liquefying state assets is really a task that is more complicated than most people give it credit for."

He added that good corporate government including transparency and audit issues will also be a significant recurrent them and "will likely do so for some time."