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LESSONS:

Capital Market Development Program

sector: Finance | country: Philippines

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.

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.

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.

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 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.

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.

Lessons from Project Evaluation

Capital Market Development Program (Loan 1363-PHI)

Development of a new market structure and associated institutions is time consuming and the program loan modality though used for this purpose should not have a quick-disbursing nature when applied to an overall sector development agenda. Instead, multitranche loans spread over a longer time horizon associated with key components of the program or a cluster program approach is preferable.

Given that institutional development is a continuing process that needs continuing monitoring, short-term technical assistance (TA) modality that enables international consultants to only provide recommendations may not be the most suitable way to address this continuing capacity building. Instead of TA grants, which are limited to short-term small infusion of funds from ADB, longer term TA loans, sector development programs, or cofinancing arrangements with other institutions may be more appropriate for such capacity-building initiatives. These TAs should be geared to clearly identifying capacity-building needs and should include sufficient funds and duration, not only to derive recommendations but also to implement them.

In undertaking financial reforms, the need for interaction between the component submarkets must be recognized. Therefore, an explicit overall holistic capital market reform agenda has to be formulated carefully and painstakingly considering the unique features of the economy and issues confronting it.

The creation of new laws does not guarantee meaningful reforms and the desired development. To achieve the desired development, many other conditions have to be fulfilled. First, the intended legislation needs to correspond with the final form of the law, and this is not always true especially if the passage of the law is delayed over many years. In addition, the relevant institutions must also have the capacity to enforce the new provisions of law, and finally private sector participants should be willing to abide by the new legal framework. Therefore, it is important that prior to the enactment of legislation, a new set of dynamics is set in motion in the form of administrative measures and memoranda of understanding through a participatory dialogue. By doing so, in effect, the implied actions of the proposed law can be put into place at the same time the law is passed.

The legislative process is designed to take time to ensure that all concerns from various stakeholders can be raised and to prevent the possible abuse of dominant institutional parties. The long delays associated with passage of law have been evident in implementing many of the approved program loans. Therefore, the passage of a law could be a program condition in a cluster program loan approach where its passage may be a precondition for the next phase of the program. This could be a useful way of promoting legislative reforms without undermining the ongoing program to the prolonged and unpredictable process. In addition, if improvements to regulations are required, alternatives to legislation through rules and administrative orders should be explored prior to formulating legislative action as program conditions.

The overall capital market agenda works best if it is designed through the collective voice of stakeholders. Not only should there be active and formal discussion among stakeholders, but the means for reform must emanate from a visible high-level entity that is seen as representing the spectrum of interests in the capital market. This is not only an issue of participation but also that of transparency in the ownership of ideas and delegating responsibility for specific endeavors. In the Philippines, this was attempted through the Capital Market Development Council (CMDC), which helped in crafting a reform agenda agreed by consensus between the regulators and the regulated, speaking in a collective voice while trying to dissipate both political sensitivities and potentially conflicting interests among stakeholders. Based on the positive impetus created by CMDC, a lesson could be learned about establishing and finding a means to sustain such forums during the development of capital markets in any country. While the establishment of such markets could initially be funded by grants for demonstrative effect, it may be possible to generate a long-term fund through a levy imposed on the members of CMDC when the importance and the usefulness of the forum become evident.

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