Hundreds of companies are already listed on the Philippine Stock Exchange. The next challenge is making their shares easier to trade.
Having a stock listed on an exchange does not necessarily mean investors can easily buy or sell it.
For many Philippine stocks, the problem is familiar. Trading can be thin. Buyers and sellers can be far apart. A relatively small order can move the price considerably.
This is why Securities and Exchange Commission Chairman Francis Lim believes market structure deserves attention as part of efforts to strengthen the Philippine capital market.
Lim discussed market making and margin financing during an interview after his speech as guest speaker at the Financial Executives Institute of the Philippines’ 9th General Membership Meeting on Sept. 16 at Fairmont Makati.
Both mechanisms are being considered as part of efforts to deepen trading activity in the market. But they also introduce risks that regulators need to manage.
Why liquidity matters
Liquidity sounds technical, but its importance is easy to understand.
Suppose an investor owns shares worth P1 million based on the last traded price. If there are few buyers in the market, selling the entire position at that price may be impossible.
The investor may have to accept progressively lower prices to find buyers.
The reverse happens when someone wants to accumulate shares in an illiquid stock. A large purchase can push the price sharply higher because there are not enough sellers near the prevailing market price. This makes the quoted stock price less useful.
A stock may be worth P20 based on the last transaction, but if only a small number of shares changed hands at that price, P20 may not represent the price at which a meaningful position can actually be bought or sold.
This is why Lim emphasized the importance of “deeper liquidity” and “credible price discovery” in his discussion of what a successful public market should provide.
Enter the market maker
This is where market making comes in. Instead of waiting for a natural buyer and seller to appear at exactly the same time, a market maker continuously provides prices at which it is prepared to buy and sell a security.
In simple terms, it helps keep both sides of the market available.
Imagine a stock where the highest buyer is willing to pay P9.50 while the lowest seller wants P10.50. That P1 difference is the bid-ask spread.
A market maker willing to buy at P9.90 and sell at P10.10 could narrow the gap considerably. Investors would have a better chance of executing transactions without moving the price as much.
Market makers earn from the spread between their buying and selling prices, but in doing so they also assume risk.
If a market maker buys shares and the stock suddenly falls before those shares can be sold, it can suffer losses. Likewise, heavy selling can leave it holding an unwanted position.
This is one reason capitalization matters.
Should brokers have more capital?
During his interview, Lim said the SEC is reviewing broker capitalization requirements.
He recalled that broker capitalization requirements were established years ago and said many brokers today remain relatively small.
“Yes, we are reviewing the capitalization,” Lim said.
His comments become particularly relevant when brokers engage in activities that expose them to additional market risk.
Lim identified market making and margin financing as two such activities.
“What we want to do,” he explained, is require higher capital for brokers that want to participate in them.
A traditional broker primarily facilitates transactions between investors. A market maker may have to commit its own balance sheet and hold securities in inventory.
The greater the risk a broker assumes, the more financial capacity it may need to absorb losses during periods of market stress.
Lim said the objective is also to encourage brokers to build more meaningful capitalization.
Margin financing adds another layer
Margin financing addresses liquidity from another direction. It allows investors to purchase securities partly with borrowed money, subject to collateral and regulatory requirements.
This can increase the amount of capital available for trading.
For example, an investor who would otherwise be able to purchase P100,000 worth of shares may be able to take a larger position if part of the purchase is financed through margin.
More buying capacity can contribute to market activity, but leverage works both ways.
If the stock rises, the investor earns a return on a position larger than the cash originally committed. If the stock falls, losses are also magnified.
A sufficiently large decline can trigger a margin call, which requires the investor to provide additional collateral or reduce the position.
If many leveraged investors are forced to sell at the same time, margin financing can actually amplify market declines.
This explains why Lim grouped margin financing with market making when discussing higher capital requirements for brokers. Both can support a more active market, but both introduce risks that ordinary brokerage activity may not carry to the same degree.
Liquidity can improve price discovery
The potential benefit goes beyond higher trading volume. A liquid market can produce better information.
Every transaction represents a buyer and seller reaching agreement on price. When thousands of investors continuously trade a security, new information can be incorporated into its price more quickly.
When almost nobody trades it, the last quoted price can become stale. This matters particularly for valuation.
Investors often compare companies based on price-to-earnings ratios, price-to-book ratios, dividend yields and other market measures. But all of these ratios depend on the market price.
If the price comes from very thin trading, investors should be more cautious about treating the resulting valuation multiple as an accurate reflection of market consensus.
Liquidity therefore affects not only whether investors can get into and out of a stock. It can also affect the quality of the price itself.
But liquidity cannot be manufactured indefinitely
Market making, however, should not be confused with creating genuine investor demand.
A market maker can narrow spreads and provide continuous quotations. Margin financing can give investors additional purchasing capacity.
Neither can make investors want to own a company they consider unattractive.
If a stock has weak fundamentals, poor disclosure or little investor following, adding a market maker does not change the underlying business.
There is also an important difference between liquidity and volume. High trading volume can sometimes come from short-term speculation. A genuinely liquid market is one where investors can transact meaningful amounts without causing excessive changes in price.
Making the stocks we already have work better
Much of the discussion about reviving the Philippine stock market revolves around attracting more investors or bringing more companies to the exchange.
But there is another issue. The companies already listed need a secondary market that works efficiently.
Investors need reasonable confidence that when they decide to buy, there will be sellers. When they decide to sell, there will be buyers. And the quoted price should represent something close to where meaningful transactions can actually take place.
This is where market making, margin financing and stronger intermediaries could play a role.
The reforms will not solve every weakness of the Philippine stock market. They cannot replace good companies, credible financial information or genuine investor demand.
But they can improve the machinery through which investors and capital meet.
Lim described the objective in simpler terms: a market needs “deeper liquidity” and “credible price discovery.”
For Philippine investors, that may ultimately be the test of these reforms. It is not simply whether trading volume increases.
It is whether the stocks they already own become easier to buy, easier to sell and harder for a small amount of trading to push far away from their underlying value.
