Following the recent decision by the Supreme Court of the Philippines in Roy III v. Chairperson Teresita Herbosa (Roy) we take the opportunity to review the foreign investment landscape in the Philippines, the implications of this decision for investors and the foreign investment outlook for 2017.
Historically the Philippines has struggled to keep up with the other large economies in the Association of Southeast Asian Nations (ASEAN) when it comes to foreign direct investment (FDI). According to ASEAN statistics, in 2015 FDI in the Philippines was around US$5.7 billion whereas Indonesia, Thailand and Vietnam attracted FDI of US$16.9 billion, US$8.0 billion and US$11.8 billion respectively in the same period. FDI in the Philippines has also been waning in recent years following an all-time high in 2014. To compound matters, in common with other larger ASEAN nations, the Philippines has also been losing out to the CMLV countries (Cambodia, Myanmar, Laos and Vietnam), whose aggregate share of the reduced ASEAN FDI pie grew 38 per cent in 2015 (albeit from a much lower base).
With the Philippine Government targeting GDP growth of between 6.5 per cent and 7.5 per cent in 2017 compared with around 6.1 per cent in 2016 (and the 5.6 per cent forecast by UBS in its 2017 Regional Economic Outlook), this is a situation that Manila clearly needs to address. Moreover, in a response to the generally accepted view that under-investment in the infrastructure sector has become the number one impediment to economic growth in the Philippines, the Duterte administration has made bold commitments to infrastructure spending which can only realistically be met if significant foreign capital can be attracted into the proposed projects.
On the plus side, however, there have been two notable developments over the last 18 months which suggest that the Government may be up to the challenge.
Early in 2016, the National Competitiveness Council of the Philippines launched Project Repeal: The Philippine Red Tape Challenge. Aimed at streamlining the regulatory environment, this scheme seeks to overhaul the legal and regulatory framework with a particular focus on the repeal of unnecessary, redundant and burdensome laws which stifle entrepreneurial activity and inhibit growth in the wider economy. While Project Repeal is still in its infancy, there are encouraging signs that it is gathering momentum, with over 60 laws identified for review according to reported statistics. Although this initiative is not specifically aimed at encouraging FDI, if successful, it can only be seen as a positive move and is to be welcomed by foreign investors generally. Project Repeal has certainly been well received domestically. For example, in a recent press interview Perry Pe, president of the Management Association of the Philippines – who criticised the Philippines for putting up too many barriers to foreign investment while simultaneously sending out a message of welcome – applauded the scheme.
Pivot to China
There has been much press coverage of President Duterte’s so-called ‘pivot to China’ – a shift in Philippine foreign policy with an emphasis on rebalancing the Philippines’ dependency on the US versus China (and Russia). It is still too early to gauge how far down this road Duterte intends to go but, in an early example of his apparent intentions, Manila recently announced that the Beijing-based Asian Infrastructure Investment Bank (AIIB) would participate in two new infrastructure projects in the Philippines. Launched in January 2016, the AIIB is a multi-lateral funder primarily financed by China and is seen as a rival to the World Bank and the Asian Development Bank. The projects concerned are both in the Manila area and involve flood control and mass rapid transport.
A further signal of Beijing’s new-found favour with Manila came during President Duterte’s state visit to China in October 2016, when it emerged that Hong Kong- and Shanghai-listed China Railway Engineering Corporation (CREC) was considering investments of over US$400 million in the Philippines. CREC, which is majority owned by China Railway Group Ltd (a state-owned infrastructure firm), has been linked with the 2,000km Mindanao railway project, among others.
In common with a number of other ASEAN countries, foreign investment in the Philippines is subject to a suite of regulatory measures driven in part by the social, economic and other policy considerations of the incumbent Government. The principal legislation governing such foreign investment in the Philippines is the Foreign Investment Act of 1991 (FIA). The FIA provides foreign investors with basic rights including the right to repatriation of investment, the right to remittance of earnings and freedom from expropriation (subject to certain exceptions). The FIA expressly states that the Philippines wishes to attract and promote foreign investment for the purposes of, inter alia, furthering industrialisation and socio-economic development subject only to the limitations of the Philippine Constitution and other relevant laws. The other relevant laws referred to in the FIA are typically industry-specific laws that deal with sensitive industries such as banking, telecommunications and power generation.
The FIA is supplemented by the Foreign Investment Negative List (Negative List), which comprises a list of economic activities – essentially industry sectors and sub-sectors – where foreign equity participation is either prohibited or limited to certain percentage levels. The Negative List itself comprises two lists – List A and List B. List A deals with areas where foreign equity is prohibited or limited by mandate of the Philippine Constitution or other specific laws. List B deals with areas where foreign equity is limited for security, defence, health or moral reasons, or to protect small and medium-sized enterprises. In effect, List A is a summary of the relevant limitations as mandated by the Constitution or the specific law concerned, whereas List B represents the limits determined by the Government from time to time pursuant to presidential order.
The Negative List is updated and re-issued periodically subject to the proviso that those items in List A are updated as and when there are changes to the relevant provisions of the Constitution or the specific law, whereas List B may not be re-issued more than once every two years. The current version of the Negative List was issued in May 2015 and was largely perceived as underwhelming by the business community, with little or no movement in the permitted levels of foreign investment across most sectors. However, for List A items, effecting a change to the limitations requires considerable legal reform given that the limitations are set by the Constitution or primary legislation, whereas the limitations applicable to those items in List B can be amended more readily.
So, with a Government that is committed to driving significant foreign investment and economic growth targets that are dependent on it succeeding, what is the relevance of the Roy case to the FDI landscape?
Roy was preceded by the 2011 case of Gamboa v. Teves (Gamboa). In Gamboa the petitioner contended that the respondent, publicly listed telecoms utility the Philippine Long Distance Telephone Company (PLDT), had violated a constitutional provision which limits foreign ownership of the capital of a public utility to not more than 40 per cent. In its decision in Gamboa, handed down in 2012, the Philippine Supreme Court was required to determine the definition of ‘capital’ for such purposes and in particular, where a company (such as PLDT) has multiple classes of shares with different economic and voting rights, which classes of shares form part of such capital. In reaching its decision the Supreme Court determined that the ownership test should be made by reference to those shares having the right to vote on the election of directors.
Following Gamboa, the Philippine Securities and Exchange Commission (SEC) issued a set of guidelines in 2013 for the purposes of assisting companies and other market participants in determining compliance with the foreign ownership limitations applicable to companies (such as PLDT) operating in nationalised or partly nationalised industries (Guidelines).
Notwithstanding the decision in Gamboa and the issue of the Guidelines by the SEC, some residual uncertainty remained as a result of further comments made by the Supreme Court when it dismissed a motion for reconsideration filed by the petitioner in Gamboa. In dismissing the motion the Supreme Court observed that the foreign ownership test should be applied to all classes of shares and not just those entitled to vote on the election of directors. The uncertainty centred around whether this requirement applied to each class of shares separately – such that a failure to meet the test in respect of any single class of shares would be fatal – or whether it applied to all shares in aggregate irrespective of their class. The former interpretation was reflected in the Guidelines.
In Roy the Supreme Court found that the Guidelines were valid but that the provisions which required the foreign ownership test to be extended to all classes of shares separately (and not in the aggregate) were based on obiter dicta in Gamboa and, as such, were not binding. In giving its decision the Supreme Court notably observed that the flexibility of corporations to create different classes of shares in order to raise much needed capital was an important one and that the Constitution made no reference to any intention to limit such flexibility.
In Roy the Supreme Court also looked at the question of beneficial ownership in the context of determining the level of foreign ownership of companies operating public utilities. It determined that in order for shares to be owned by a Filipino for such purposes, both the legal and beneficial ownership must be held by a Filipino. Accordingly, where a Filipino is the registered holder of a share one must also look at the beneficial ownership, which is to be determined by an analysis of who has the right to exercise the voting and investment powers attaching to the share. If a foreign party has the right to exercise either voting power or investment power over such share (i.e., the decision whether to hold or sell the share), then the share is not to be regarded as being held by the Filipino for the purposes of determining the level of Filipino ownership under the Constitution. Given that the Philippines has an Anti-Dummy Law, which imposes civil and criminal sanctions on those who violate the foreign ownership limitations, it is suggested that this should not be seen as surprising and merely recognises the need to look at substance over form.
The Supreme Court’s decision in Roy is to be welcomed as it signals a reluctance on the part of the judiciary to apply an overly restrictive interpretation of the Constitution in the area of foreign investment. That the Supreme Court also expressly referenced the need for corporations to be afforded flexibility when it comes to their capital structure is also a positive development, particularly in light of the ever-increasing complexity of financial instruments and the related blurring of the line between debt and equity.
It is anticipated that the Negative List will be re-issued at some point in 2017. Given the Government’s commitment to foreign investment generally and infrastructure spending in particular, it is hoped that revisions to the Negative List will be more progressive than was the case in 2015. However, even following Roy, since the FIA and the Negative List are subject to certain restrictions which are hard-wired into the Constitution or primary legislation, unless President Duterte is prepared to push through constitutional reform or amendments to significant primary legislation in the area of foreign investment then, in some sectors of the economy, there is only so much that can be done by tinkering with the Negative List.