The Philippine government will facilitate unified trading between tax-paying and tax-exempt institutions, two halves of the peso bond market that have previously been separate. This will take place after a buyback of government securities at the end of this year, and is one of the key steps necessary to improving liquidity in the market.
As it stands, for regular government securities, separate instruments for a single tenor are issued for tax-withheld and tax-exempt investors, and trading is only allowed among holders of the same tax-category, according to the Asian Development Bank (ADB)’s latest bond market guide. This limits access to liquidity across the board.
This problem has been recognised by the government, and unification was supposed to take place in April, but was postponed as details of the new bond issue format could not be finalised. Last week, the Bureau of the Treasury decided that the change will be implemented at the end of this year.
“There was a meeting last week and the time frame is November or December. The government is first planning to do a major bond swap with the existing debt for benchmark tenors of three, five, seven, ten, twenty and twenty-five years. They’re going to swap it out to these major benchmarks and that’s when we’re going to see an implementation of a single price for bonds, so everything starts again at par,” said one bond trader in Manila.
“This is part of the liability management efforts of the government to extend the duration profile of its liabilities. Eligible bonds will be from as short as less than a year to just below the duration of the new issue. For example if the government is issuing 10-year bonds you can swap anything from less than one year to close to 10 years,” added a bond trader at a Philippine bank.
After this swap at the end of the year, the option to swap government securities will be made constantly available to bondholders.
“All of the tenors are covered right now but some are liquid and some are illiquid. The plan is for them to have a constant swap so that there is always a benchmark tenor and it doesn’t run down like is happening now when some of the bonds become illiquid,” said the Manila-based trader.
The new bonds issued will be tax neutral and non-restricted. According to bankers with knowledge of the matter, tax-exempt institutions will be reimbursed by the Bureau of the Treasury for the tax component of the bond.
“This will either be right away or they will have to declare it and be reimbursed at a later date, but I would like to think it will be an immediate reimbursement,” said the bond trader in Manila.
Improving liquidity
At the moment, there are two different catagories of bond investors in the Philippines. Tax-exempt investors are allowed to participate in the weekly sovereign auctions, but tend not to participate actively in the markets. Tax-exempt institutions make up a reasonable percentage of the Philippine bond market, according to bankers.
“In a broad definition the tax exempt are mainly government institutions like the GOCCs [government owned and controlled corporations] and also some educational institutions as well as the church - sometimes they also have investments in the government bonds. Mostly the players will be government institutions like the SSS [Social Security System] and GSIS [Government Service Insurance System],” said the trader at the Philippine bank.
Allowing these institutions, including all the major government-owned retirement and pension funds, to participate in the market will provide a major liquidity boost.
“This will make a lot of difference, right now about a third of outstanding issues is held by tax exempt institutions. When they participate in the primary markets they hold it for a long time because they don’t have any exit. The only exit is amongst themselves and most of them do not actively trade,” said the Manila banker.
Sabyasachi Mitra, principal economist of the office of regional economic integration at the ADB agrees: “The varying tax laws between investors do impact secondary market turnover due to settlement and security transfer issues. Harmonised or unified tax laws between investors would help to dismantle investor segmentation, encourage foreign investors and further improve secondary trading and liquidity.”
“[This] would create a level playing field, [and] also broaden investor diversity through direct participation of insurance and trust companies in secondary markets.”
Further measures
Unification of the bond market will improve liquidity ahead of the planned 2015 Asean bond market integration scheme, which is part of the Association of Southeast Asian Nations Free Trade Agreement. Commentators agree that this is one of the key changes that need to be made.
Another is the market maker programme which is currently being discussed by the Philippine Bureau of the Treasury and the government.
“They will select certain market makers which will have access to the prices for the illiquid securities and they will be able to swap them with a benchmark,” said the Manila bond trader.
“At the moment they only have a swap once or twice a year. Some government issues have as little as four billion outstanding, and clients who hold these try and find an exit but banks will not give a good competitive rate because they know if they get it they will have to hold it until maturity,” he added.
He believes the change will also be implemented by January, though no details of the scheme have been announced yet.
Another bugbear that some commentators believe is a hindrance to local currency market liquidity is the 20% withholding tax.
“The real issue in my view is how you deal with the withholding tax of 20% which may not be in line with the debate or the plan to unify bond market trading. It is still a big issue facing a lot of investors, especially offshore ones who would like to get into the market, particularly on the peso side where there is a lot of liquidity support,” said a Philippines analyst at a global bank.
However, on the whole he is positive about the developments.
“The government has done a lot and the plan is that it will continue to liquefy and deepen and improve benchmark liquidity, particularly in the long end of the curve,” he said.