Rule Model

Conservatism principle requires that losses are recognized when they are quantified and that gains are recorded when they are realized. But measuring impairment on financial instruments under the old financial reporting standards is not conservative enough to ensure the reliability of the financial reporting system. Impairment on financial instruments is recognized after rather than before the default, which overstates assets and earnings and understates liabilities and expenses. How unfortunate that this liberal recognition of impairment on financial instruments has been tolerated by the accounting profession to the detriment of the users of financial statements. But the days of overstated assets and earnings and understated liabilities and expenses are gone after the Bangko Sentral ng Pilipinas (BSP) approved the guidelines on the adoption of Philippine Financial Reporting Standards (PFRS 9) – Financial Instruments for BSP-supervised Financial Institutions (BSFIs). PFRS 9 is the local adoption of the International Financial Reporting Standards (IFRS 9) – Financial Instruments, which was issued by the International Accounting Standards Board as a replacement to the International Accounting Standards (IAS 39) – Financial Instruments: Recognition and Measurement. PFRS 9 requires BSFIs to incorporate material information in measuring impairment on financial instruments under the new financial reporting standards. BSFIs are required to assess the impact of PFRS 9 on business strategies and credit risk management systems to be able to adopt policies and procedures to ensure the reliability of the financial reporting system. Based on the guidelines on the adoption of PFRS 9, the BSP will evaluate the consistency of sales activities and metrics being used in monitoring the performance of financial instruments with the business model for holding the instrument. This will align the accounting treatment with the credit risk management systems to strengthen governance over the financial reporting system. PFRS 9 requires the adoption of an Expected Credit Loss (ECL) model in recognizing impairment on financial instruments to provide accurate information to the users of financial statements under the Guidelines on Sound Credit Risk Management. Under the ECL model, an allowance for credit losses at any balance sheet date is calculated by recognizing probable defaults within the next 12 months or for the entire remaining life of the financial instrument. The estimation of ECL will be a remarkable change in the financial reporting standards. Given the importance of BSFIs in the Philippine capital market, it is important for stakeholders to develop reasonable ECL estimates to ensure the accuracy of financial statement disclosures.

Cake News

Goldilocks Bakeshop scheduled Initial Public Offering (IPO) did not push through due to the elevated political and economic risks after the unexpected outcome of the 6 May 2016 general election. This made Goldilocks Bakeshop a legitimate Merger and Acquisition (M&A) candidate due to its remarkable economic moat. From a one-store bakeshop in Makati City in 15 May 1966, Goldilocks Bakeshop became a 579-store food retailing enterprise in the Philippines with branches in Canada, Thailand, and United States. When the political and economic storm calmed down, SM Retail and Goldilocks Bakeshop started negotiating for a proposed joint venture, equity investment or cooperation agreement. SM Retail is a subsidiary of SM Investments Corporation - a public conglomerate with business interest in retail, banking, property, and equity investments. SM Retail agreed to acquire a majority stake in Goldilocks Bakeshop for an undisclosed amount and the proposed equity investment was approved by the Philippine Competition Commission (PCC) on the condition that SM Retail will be subjected to random inspections by the PCC to ensure compliance in managing potential competition issues in the transaction. SM Retail must address any competition issues and any breach of the conditions will subject it to fines and other legal remedies. Under the Philippine Competition Act (PCA), the PCC is mandated to review M&A that breach the P1 billion threshold to ensure that these transactions will not abuse the merged business position by engaging in conduct that will prevent or reduce competition. PCA defines, prohibits, and penalizes undue dominant position, anti-competitive agreements, and anti-competitive M&A. But the proposed M&A went nowhere when SM Retail announced that it had abandoned its plan to acquire a majority stake in Goldilocks Bakeshop due to changes in the general business environment. We were taken aback when the proposed M&A was canceled and what confused us was the obscure reason for the cancelation. General business environment has been stable and favorable to M&A so it is bothersome to hear a lame excuse from a renowned retail conglomerate run by postgraduate-educated management team. Perhaps the PCC imposed unreasonable conditions to ensure free market system or the due diligence revealed the business shenanigans of Goldilocks Bakeshop. We do not know the reason why the proposed M&A was canceled but what we do know is that Goldilocks Bakeshop will remain a legitimate M&A candidate due to its remarkable economic moat.

Sold Down

Philippine Stock Exchange (PSE) had been condemned by the minority shareholders when it delisted Calata Corporation (CAL) due to violations of the disclosure rules under the Securities Regulation Code (SRC). Disclosure rules stated in SRC Rule 17.1 require a public company to file a current report to make an accurate disclosure to the public of every material fact or event that occurs which is expected to influence the investors decisions in relation to those securities. In the event a news report appears in the media involving an alleged material fact or event, a current report must be made within the prescribed period in order to clarify the news report that can create public speculation if not denied or clarified by the public company. PSE alleged that CAL had committed 55 violations of the disclosure rules from 6 October 2016 to 20 June 2017. First violation of the disclosure rules carries a fine of P50,000, second violation carries a fine of P75,000, third violation carries a one month trading suspension, and fourth violation will be a ground for delisting. CAL was fined a total of P300,000 and the PSE decided to start involuntary delisting proceedings. The imposition of monetary penalties and trading suspension are without prejudice to any regulatory action that can be undertaken by the regulators in connection with the violations. Despite the absolute violation of the disclosure rules, the minority shareholders are against the decision of the PSE to delist CAL due to the absence of an exit mechanism. To appease the minority shareholders, the PSE proposed voluntary rather than involuntary delisting on the condition that a tender offer will be conducted. CAL rejected the proposed voluntary delisting as it does not have enough retained earnings to buy back outstanding shares at book value per share. Although the tender offer price must be based on a fairness opinion valuation of the business, there are no rules under the SRC that pegs the tender offer price to the book value per share. PSE had bended the disclosure rules to accommodate an exit mechanism but CAL had chosen the road most traveled to enrich themselves at the expense of the minority shareholders. When corporate governance breaks down, minority shareholders must sell and never forget. Those who break the rules are scum but those who abandon those rules are worse than scum.

Market Watch

Philippine stock market performance as measured by the Philippine Stock Exchange Index (PSEi) has been considered as one of the most turbulent among the emerging markets. The term emerging market was coined by economists at the International Finance Corporation when they were promoting the maiden mutual fund investments in developing countries. An emerging market has the features but not the standards of a developed market so it can be upgraded to a developed market or downgraded to a frontier market at the discretion of the global index providers. The year that was had shown us that buy-and-hold strategy does not work in emerging markets unless we know the balance between the desire for the lowest possible risk and the highest possible return. Low levels of risk are associated with low potential returns while high levels of risk are associated with high potential returns. But high potential losses must be reckoned because there are no guarantees. We must not measure investment returns based on passive investment strategy where an investor buys and holds stocks even with observable market threats. But we must measure investment returns based on active investment strategy where an investor buys and sells stocks anchored on favorable market sentiment. Although the MSCI Emerging Markets Index opened at 794.14 points on 31 December 2015 and closed at 862.27 points on 30 December 2016 or an investment return of +8.58%, the PSEi opened at 6952.08 points on 29 December 2015 and closed at 6840.64 points on 29 December 2016 or an investment return of -1.60%. MSCI Emerging Markets Index is an index created by Morgan Stanley Capital International (MSCI) designed to measure stock market performance in emerging markets. Beyond reasonable doubt it was a bad year for passive investors but a good year for active investors. From the year low of 6084.28 points on 21 January 2016 to the year high of 8102.30 points on 21 July 2016, the PSEi made an investment return of +33.17%. But from the peak of 8102.30 points on 21 July 2016 to the trough of 6563.67 points on 23 December 2016, the PSEi made an investment return of -18.99%. PSEi had shown us that we must engage rather than evade market turbulence. But do not enter into uncharted territories unless the potential reward outweighs the potential risk. Before you jump on the bandwagon ponder that past performance does not guarantee future results.