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Market criticizes SEC rules on OTC trading

May 5, 2006 10:52am
Market players have rejected the draft rules on over-the-counter (OTC) trading of government securities issued by the Securities and Exchange Commission (SEC) for being too restrictive.

The rules limit the practice of over-the-counter trading and detail how trading should be done.

Over-the-counter trading basically refers to the system where bond dealers and brokers negotiate directly with one another over computer networks, such as the system run by Bloomberg used by dealers today, and by phone.

The present OTC market is not directly regulated. Over the years, market participants through the Bankers Association of the Philippines (BAP) and the Money Market Association of the Philippines (MART) have developed policies and procedures for trading government securities in the OTC market.

"The guidelines should allow for more mobility for dealers and investors to move between markets, between exchanges and the OTC and vice versa," said Narciso L. Erana, president of voice brokerage firm ICAP Philippines, Inc.

"Only this way can real competition and a free market exist. Without a free market, the public investor will ultimately suffer," Mr. Erana said.

The draft rules outline very strict procedures for an existing member of a self-regulatory organization (SRO) to trade in the OTC market.

At present, the fixed income exchange is seeking its own SRO status to allow it to regulate trading on the exchange.

Market players noted that if the exchange is given an SRO status, it would be difficult for them to trade in the OTC since most of them also subscribe to the bourse.

Section 6b of the draft rules only allows a member of an existing SRO to trade in the OTC market if the broker or dealer has obtained permission from his group to do so.

Moreover, the self-regulatory group must show that it can regulate and supervise its members as far as their activities in the OTC market are concerned.

"Right now there is still no SRO with respect to the government securities market. But if the fixed income exchange gets an SRO, that means we would have to ask its permission before we can trade in the OTC market," said a bank treasurer, who declined to be named.

"The rules are going to kill the market. They are counterproductive," Rizal Commercial Banking Corporation (RCBC) Treasurer Eduardo Sergio G. Edeza said.

Mr. Edeza, a former National Treasurer, said the rules are cumbersome and some provisions are redundant. He gave as an example the rules that qualify eligible investors in an OTC market.

"Why do you need to qualify an investor? If you deprive someone of his right to invest, it will no longer be a free market," he told BusinessWorld.

Based on the draft rules, the corporate regulator wants to categorize investors in the OTC market either as qualified or non-qualified.

Qualified investors are financial institutions such as banks and investment houses, while non-qualified investors include corporate and individual investors.

A qualified investor can directly buy or sell securities in the OTC market. A nonqualified investor, on the other hand, must go through either a broker, an investment house, a bank, an investment company, a nondirectional trust fund or a pension fund.

Mr. Edeza also criticized the requirement that existing licensed market players get a separate approval before they could trade in the OTC market.

"The registration process is a very tedious exercise," he pointed out. Presently, banks and other institutions that want to trade government securities have to be accredited by the Bureau of the Treasury (BtR). They must also get a license from the SEC. Banks are also given another license by the central bank.

"There is nothing wrong with the market. Individually, these banks are already licensed as government securities dealers, unless you’re saying there is something wrong with the licensing process," Mr. Edeza pointed out.

Section 4a of the draft rules state that "a broker or dealer with current registration... shall amend its registration to specifically reflect its intention of conducting the activities of a broker or dealer in an OTC market."

Moreover, the proposed rules require market players to form a group and seek approval from the SEC to become an SRO before they can participate in the OTC market.

They also require the electronic integration of the various quotation systems for the buying and selling prices for securities.

Some banks said the MART, which represents the country’s fixed income securities dealers, should be the one to register with the SEC as an SRO.

"If the rules go [ahead], the MART should get an SRO status. That is what the market has actually been doing. We are self-regulating already," another dealer who wished to remain unnamed said in an interview. BusinessWorld contacted MART but officials said they were still studying the proposal.

Market participants also want the SEC to conduct a public hearing to clarify the proposed rules.

"A layman’s interpretation could lead him to believe that the OTC market is in fact being restricted," said Philippine National Bank Treasurer Asterio L. Favis, Jr.

Mr. Favis said the rules are unclear on the difference between trading among banks and trading with the public.

"There should be a clear differentiation between an OTC market among professionals and the OTC market for retail investors. Because of that unclear distinction, even the professional market is forced to deal in the rigid structure described in the rules," he pointed out.

The PNB treasurer also said the present OTC system is transparent enough and can safeguard the interest of public investors.

Mr. Edeza said there should be a dialogue between regulators and market participants since this is a significant capital market issue.

"Over the years, we have developed rules, we have strengthend the market. The market itself has learned to police its ranks by professionalizing the traders through training. It is a very transparent market," Mr. Edeza said.

Banks and other market participants were asked by the SEC to submit their feedback by April 28 but the deadline was later moved to May 12 to give banks more time to prepare their position. -KARL LESTER M. YAP, Business World Reporter
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