SC decision on foreign ownership

Introspective -- By Raul V. Fabella

SC decision on foreign ownership

June 28, 2011, is a sad day for the Philippines. Once again the Filipinos’ considerable capacity for self-laceration reared its ugly head. The Philippine Supreme Court, sitting en banc, decided by a majority decision to interpret the constitutional foreign ownership limit as applying to 40% of common shares of a company and not to total shares (preferred and common shares). It has directed the regulatory watchdog, the Securities and Exchange Commission (SEC), to see to it that the new rule is enforced in the case of PLDT but it clearly spills over to the whole regulatory landscape.

Preferred shares do not have voting rights while common shares have voting rights. As the exercise of the voting rights determines the membership of the company’s board of directors, it determines the effective control of the company. The interpretation of the constitutional limit on foreign ownership as a policy instrument for Filipino control of key industries and voting as the exercise of that control is a plausible reading of original intent. The Supreme Court is well within its constitutional compass to make the decision. This dispels the possible ambiguity in the constitutional provision but does not constitute an endorsement of the sanity of the constitutional provision of foreign ownership limits. As a pun on a legal principle goes, Stulta lex sed lex (“Stupid law but law”). This interesting topic deserves a separate future rumination, however.
The problem at hand is that the Supreme Court is not writing a rule on a tabula rasa. The SEC had adopted and applied the second interpretation (40% ownership of total shares) as its operating ownership limit rule and has sanctioned petitions and transactions compliant with this rule. The Philippines has, in effect, been telling the world that that is part of the “rules of the game” in the Philippines that investors must comply with. If you comply and enter, there is an implied fiduciary covenant that you will be accorded the usual decencies: you will be protected from or properly compensated for arbitrary future changes in the rules, effectively, protection from arbitrary expropriation.

This is where the Supreme Court fell short as a serious deliberative body: it failed to take cognizance of history and thus failed to provide for a proper and just treatment of underlying implicit contracts.

Let me illustrate the point with a case I consider a just treatment of implicit covenants. The University of the Philippines -- under the stewardship of then
President Emerlinda Roman -- decided in 2006 to adjust the UP tuition fee upward. This was not only to preserve its real value since the last adjustment in 1996 but also to craft a structure more in keeping with ability to pay. The problem was that there were students in the pipeline who entered under the old tuition rule. The tuition adjustment can cause havoc in their ranks and can cause some to fall by the wayside. The Tuition Proposal committee -- headed by Professor Emmanuel de Dios -- recommended that the UP honor the implicit contract with these students and exempt them from the increase until they graduate (Section 8, Tuition Proposal). Only incoming freshmen and transferees became subject to the new fee structure. That was a King Solomon moment and, with that added feature of fairness backward and forward, it hurdled the obstacles.

The Philippines has a gaping problem: it has the lowest ratio of capital formation to GDP in our region. This has also been falling despite the country being now a net lender to the world. While there is a great need for investment, investors are not taking the plunge. Regulatory uncertainty is an aspect of governance quality that greatly affects investor decision. Changes in the rules of the game midstream can mean bankruptcy for some projects, especially those with long payback periods. De Dios (2010) has empirically shown how governance problems (corruption and instability) pull down the investment ratio, in general, and direct foreign investment, in particular.

Domestic and foreign investments are largely complementary and co-determined. It is naîve to believe that only foreign investors hate increased regulatory uncertainty. Domestic investors are just as savvy. The result is that our banks currently hold P-trillion in Special Deposit Accounts (SDA) in the Bangko Sentral ng Pilipinas (BSP). Too few people will wager on the future under such a cloud.

The SEC has been tasked to enforce this new interpretation. It can either implement it blindly or it can temper it with understanding and delicacy. If it chooses to wield it blindly, it will further the demolition job that the Supreme Court let loose on our regulatory landscape, perhaps un-intendedly.

If the intention was to blindside the current Malacañang resident, it could not have found a more mordant stinger. Without some regulatory relief from this ill wind, the P-trillion that banks hold as SDAs in the BSP may begin to migrate and create jobs in Vietnam and Indonesia. That’s sado-masochism in any language but that would be only the latest among many in history. Pity the poor and unemployed Juan de la Cruz. Would that the SEC will act more responsibly.


Raul V. Fabella is the vice-chairman of the Institute for Development and Econometric Analysis, a professor at the UP School of Economics and a member of the National Academy of Science and Technology.

For comments and inquiries, please e-mail us at idea.introspective@gmail.com.

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