Philippines
23 January 2024
Nearly three decades after short selling was initially proposed, Sophie Downes explores the impact of the new guidelines on the Philippines stock market and why the time is finally right
Image: stock.adobe/fazon
“Short selling is integral for securities lending,” says Hannah Nunez, head of financing and securities services for the Philippines at Standard Chartered.
Be that as it may, the introduction of short selling has been a protracted process for the Philippines Stock Exchange (PSE). First proposed in 1996, the move has been beset by regulatory changes, Covid-19 and multiple revisions from market participants. As a result, the immediate implementation of short selling on 6 November 2023 marked an eagerly anticipated development in the Philippine market. Nunez believes revisions between the local market and policymakers were necessary for improving the current equities landscape. In contrast to previous iterations, the short selling guidelines include enhancements such as allowing offshore collateral, and a lending agency service through the depository.
The guidelines, published by the PSE and subject to the advice of the Securities and Exchange Commission (SEC), the securities market regulator, demonstrate the conservative manner in which the PSE is adopting short selling. These allow short selling for 52 stocks and one exchange-traded fund, along with select equities from the PSE MidCap and PSE Dividend Yield Index constituents. The guidelines also include further stipulations to ensure fair practice, including the application of the uptick rule and conditions about who can trade.
Under the uptick rule, the last trade price of a stock has to be higher than its previous trade price to be shorted. This prevents the price of a declining stock being driven down even further. Moreover, in a bid to prohibit ‘naked’ short selling, the SEC has set out clear guidelines about the format and wording used to record securities borrowing and lending (SBL) in legislation. A depository participant that transfers shares to another depository participant shall indicate ‘SBL Borrow – Short Selling’ or, for buyback transactions, ‘SBL Return – Short Selling’ in the depository’s system in a bid to increase transparency around transactions.
Similarly, trading participants must enter the short selling on behalf of their client, even if this client already has direct market access (DMA). The DMA client is allowed to trade on its own behalf if the trading participant verifies that they have borrowed the subject securities prior to the entry of any short selling order, and upon compliance with possible further requirements imposed by the SEC. Failure to comply with the new guidelines will result in penalties sanctioned by the PSE and, according to trading rules, may risk “restrict(ing) or prohibit(ing) short selling indefinitely or for such period as it may deem necessary or advisable for the protection of investors”.
The time is right
Timing was key in shaping the introduction of short selling to the Philippine markets. “There is never not a right time, but there are times that are going to be more optimal than others”, observes Stephen Howard, CEO of the Pan Asian Securities Lending Association (PASLA).
Against a backdrop of low volumes and valuations in equities in the Philippine market, there have been various discussions on necessary reforms, spanning foreign investments, taxation and a lack of robust facilities for stock borrows and shorting, among others. Nunez describes how “there was resounding support from policymakers to push reforms, and those that have been underway, such as SBL and short-selling, were prioritised and addressed”.
For Nunez, the question of timing comes down to the numerous revisions the PSE were subject to and she suggests that the guidelines were implemented as early as they could have been. “Efforts to improve and simplify guidelines took longer and had to be queued for regulatory approvals, which in some areas were subject to changes in existing laws,” she explains. These include approval for offshore collaterals for SBL transactions and the agency lending licence of the equities depository, which were only granted in 2023. The PSE also needed to ensure the operational readiness of the central depository, the Philippine Depository and Trust Corporation (PDTC), to participate in the short selling programme as a central lending agent.
For Howard, it was also crucial that the wider market was prepared. “When you look at the arc of progression of a capital market and equity capital market and its structure, there are certain component pieces that need to be in place.
“Looking at that arc of travel, now could be the opportunity for the Philippines to test that water and see how short selling it can be applied, with the aim of growing the market structure further.”
Market impact
So what impact can we expect on the market? For Howard, “it can only be constructive”.
Indeed, a significant benefit of short selling is that it opens up new opportunities for hedge funds and traders. “By providing that market structure change, you are inviting different market participants to enter the Philippines market,” says Howard.
Standard Chartered is one bank that has already seen increased interest from various participants. According to Nunez, the firm has been fielding queries from foreign market players on securities borrowing and lending, demonstrating a foreign interest both to borrow and to lend. She explains that “domestic real-money players such as insurance companies and asset managers have interest to lend stocks. SBL is primarily eyed to support facilitation of settlements and for hedging”.
Howard is confident that the “sensible” approach that the PSE has adopted to the introduction of short selling is likely to protect against a proliferation of short-bias funds destabilising equities prices. “If you look at the range of investment strategies that can be conducted that use short selling as a part of their investment thesis, [this] is just one component piece of the portfolio,” he says.
This may mitigate commonly held criticisms of short selling by those who believe it encourages opportunistic behaviour at the expense of the general market. APAC markets saw this play out in real time in November 2023, when South Korea reinstated a short-selling ban due to illicit trading practices by foreign firms. The framework issued by the PSE, particularly the application of the uptick rule, aims to mitigate potential market volatility in response to short selling.
While the new guidelines may precipitate greater activity, it will take some time to see a definitive impact on the market. Howard comments: “I do not expect a sudden surge in volume and activity, but what I would expect to see is a gradual progression of business activity, calibrated based on the underlying market liquidity.”
With current market conditions reporting multi-year lows and a lack of liquidity, opportunities for short selling are not immediately available. Currently, there are no volumes reported on both facilities, except for the occasional stock borrow — mainly for the management of trade settlement fails. Instead, Howard argues that the region can expect a “gradual growth (in market liquidity) as it attracts new capital, new investors and supply is then brought into the market by other participants”.
Looking forward
Both Nunez and Howard agree that the new guidelines are a source of optimism for the future of the Philippine stock market. While Nunez concedes that the current market conditions may not readily present opportunities for short selling, “the advantage is that the facility is now available to assist investors’ trading strategies, and local discussions are ongoing to continue fine-tuning the mechanisms and guidelines and to ensure wider participation”.
Standard Chartered believes that educating market participants may be a step in the right direction. “We are seeing ongoing discussions and seminars to help more local participants to be aware of the opportunities and requirements to engage in short selling and SBL transactions since their re-launch in late 2023,” says Nunez.
For the PSE, short selling is only the beginning of further expansion in the Philippine market. Commenting on its plans for the future, PSE president and CEO Ramon Monzon says: “The exchange will continue to introduce new products and push for new laws and regulatory reforms that will promote and encourage wider stock market participation and entice foreign investors back into our market. We will likewise continue to pursue our various initiatives to help and attract companies to list their shares in the exchange.”
Be that as it may, the introduction of short selling has been a protracted process for the Philippines Stock Exchange (PSE). First proposed in 1996, the move has been beset by regulatory changes, Covid-19 and multiple revisions from market participants. As a result, the immediate implementation of short selling on 6 November 2023 marked an eagerly anticipated development in the Philippine market. Nunez believes revisions between the local market and policymakers were necessary for improving the current equities landscape. In contrast to previous iterations, the short selling guidelines include enhancements such as allowing offshore collateral, and a lending agency service through the depository.
The guidelines, published by the PSE and subject to the advice of the Securities and Exchange Commission (SEC), the securities market regulator, demonstrate the conservative manner in which the PSE is adopting short selling. These allow short selling for 52 stocks and one exchange-traded fund, along with select equities from the PSE MidCap and PSE Dividend Yield Index constituents. The guidelines also include further stipulations to ensure fair practice, including the application of the uptick rule and conditions about who can trade.
Under the uptick rule, the last trade price of a stock has to be higher than its previous trade price to be shorted. This prevents the price of a declining stock being driven down even further. Moreover, in a bid to prohibit ‘naked’ short selling, the SEC has set out clear guidelines about the format and wording used to record securities borrowing and lending (SBL) in legislation. A depository participant that transfers shares to another depository participant shall indicate ‘SBL Borrow – Short Selling’ or, for buyback transactions, ‘SBL Return – Short Selling’ in the depository’s system in a bid to increase transparency around transactions.
Similarly, trading participants must enter the short selling on behalf of their client, even if this client already has direct market access (DMA). The DMA client is allowed to trade on its own behalf if the trading participant verifies that they have borrowed the subject securities prior to the entry of any short selling order, and upon compliance with possible further requirements imposed by the SEC. Failure to comply with the new guidelines will result in penalties sanctioned by the PSE and, according to trading rules, may risk “restrict(ing) or prohibit(ing) short selling indefinitely or for such period as it may deem necessary or advisable for the protection of investors”.
The time is right
Timing was key in shaping the introduction of short selling to the Philippine markets. “There is never not a right time, but there are times that are going to be more optimal than others”, observes Stephen Howard, CEO of the Pan Asian Securities Lending Association (PASLA).
Against a backdrop of low volumes and valuations in equities in the Philippine market, there have been various discussions on necessary reforms, spanning foreign investments, taxation and a lack of robust facilities for stock borrows and shorting, among others. Nunez describes how “there was resounding support from policymakers to push reforms, and those that have been underway, such as SBL and short-selling, were prioritised and addressed”.
For Nunez, the question of timing comes down to the numerous revisions the PSE were subject to and she suggests that the guidelines were implemented as early as they could have been. “Efforts to improve and simplify guidelines took longer and had to be queued for regulatory approvals, which in some areas were subject to changes in existing laws,” she explains. These include approval for offshore collaterals for SBL transactions and the agency lending licence of the equities depository, which were only granted in 2023. The PSE also needed to ensure the operational readiness of the central depository, the Philippine Depository and Trust Corporation (PDTC), to participate in the short selling programme as a central lending agent.
For Howard, it was also crucial that the wider market was prepared. “When you look at the arc of progression of a capital market and equity capital market and its structure, there are certain component pieces that need to be in place.
“Looking at that arc of travel, now could be the opportunity for the Philippines to test that water and see how short selling it can be applied, with the aim of growing the market structure further.”
Market impact
So what impact can we expect on the market? For Howard, “it can only be constructive”.
Indeed, a significant benefit of short selling is that it opens up new opportunities for hedge funds and traders. “By providing that market structure change, you are inviting different market participants to enter the Philippines market,” says Howard.
Standard Chartered is one bank that has already seen increased interest from various participants. According to Nunez, the firm has been fielding queries from foreign market players on securities borrowing and lending, demonstrating a foreign interest both to borrow and to lend. She explains that “domestic real-money players such as insurance companies and asset managers have interest to lend stocks. SBL is primarily eyed to support facilitation of settlements and for hedging”.
Howard is confident that the “sensible” approach that the PSE has adopted to the introduction of short selling is likely to protect against a proliferation of short-bias funds destabilising equities prices. “If you look at the range of investment strategies that can be conducted that use short selling as a part of their investment thesis, [this] is just one component piece of the portfolio,” he says.
This may mitigate commonly held criticisms of short selling by those who believe it encourages opportunistic behaviour at the expense of the general market. APAC markets saw this play out in real time in November 2023, when South Korea reinstated a short-selling ban due to illicit trading practices by foreign firms. The framework issued by the PSE, particularly the application of the uptick rule, aims to mitigate potential market volatility in response to short selling.
While the new guidelines may precipitate greater activity, it will take some time to see a definitive impact on the market. Howard comments: “I do not expect a sudden surge in volume and activity, but what I would expect to see is a gradual progression of business activity, calibrated based on the underlying market liquidity.”
With current market conditions reporting multi-year lows and a lack of liquidity, opportunities for short selling are not immediately available. Currently, there are no volumes reported on both facilities, except for the occasional stock borrow — mainly for the management of trade settlement fails. Instead, Howard argues that the region can expect a “gradual growth (in market liquidity) as it attracts new capital, new investors and supply is then brought into the market by other participants”.
Looking forward
Both Nunez and Howard agree that the new guidelines are a source of optimism for the future of the Philippine stock market. While Nunez concedes that the current market conditions may not readily present opportunities for short selling, “the advantage is that the facility is now available to assist investors’ trading strategies, and local discussions are ongoing to continue fine-tuning the mechanisms and guidelines and to ensure wider participation”.
Standard Chartered believes that educating market participants may be a step in the right direction. “We are seeing ongoing discussions and seminars to help more local participants to be aware of the opportunities and requirements to engage in short selling and SBL transactions since their re-launch in late 2023,” says Nunez.
For the PSE, short selling is only the beginning of further expansion in the Philippine market. Commenting on its plans for the future, PSE president and CEO Ramon Monzon says: “The exchange will continue to introduce new products and push for new laws and regulatory reforms that will promote and encourage wider stock market participation and entice foreign investors back into our market. We will likewise continue to pursue our various initiatives to help and attract companies to list their shares in the exchange.”
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