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Who ought to be regulator of trust funds?

(Article published in the July 19, 2006 issue of Manila Standard Today)

We live in the age of convergence.  Gone are the boyhood days of the King of Siam, as portrayed by Yul Bryner in The King and I, when “what was so was so and what was not was not.”

Today, not all the 10 fingers of both your hands are enough to count the functions that manufacturers have been able to put into your cellphone.  Your television set that was originally meant to provide visuals to the radio when connected to just a couple of externals also serves as a home entertainment center, if not a videoke.  The Internet, earlier known only as an information highway, is now a market place sprawled in virtual space.

As with products, so too with services.  One hardly enters a restaurant nowadays to have something to eat.  Instead, one goes for a dining experience.  A gym is not where you just pump iron; it is a wellness center where one picks up the latest on nutrition, spiritual wellness and personal hygiene. 

Financial intermediation is no exception.  Savings and investments are features of cash value insurance. Insurance is bundled with deposits accounts.  Some debts are “quasideposit substitutes”; some stocks are like IOUs.           

           It is tempting, in the face of all this convergence, to advocate a thorough revamp of the current regulatory regime to make it more able to cope up with the problems posed the proliferation of multifeatured products and services.  That, however, would probably require a cataclysmic cleansing of dimensions not known since the flood of Noah.  More within the realm of the possible is the thoughtful deliberation of all concerned, particularly the policy and decision makers, about how a particular product or service is to be regulated, and by whom.

Recently, that question, probably elicited by the events of May, was asked of the unit investment trust funds.  Specifically, the issue is which agency, the Bangko Sentral ng Pilipinas  or the Securities and Exchange Commission, ought to have the mandate to regulate and supervise trust funds?  I submit that the regulation and supervision of trust funds, for the purpose of seeing to it that public interest is served and the investing public is protected, ought to remain with the central bank.

There are four basic approaches provided by statute and employed by regulators over financial intermediaries to protect the public.  They are (a) requiring disclosure requirements; (b) mandating portfolio-shaping; (c) regulating institutional structure; and (d) imposing fiduciary standards of conduct.  Professor Howell Jackson of Harvard Law School identified these strategies in the United States, but it is easy to recognize them in the Philippine regulatory landscape.

Disclosure requirements have long ago been with the then Central Bank of the Philippines,  now the BSP.  The more obvious instances are its implementation of the Truth in Lending Act, in effect sinceoe

 1963 and, the whole slew of reports that the BSP asks banks to submit, some daily, under the authority of the General Banking Law of 2000 and the earlier New Central Bank Act passed in 1993.

Securities and Exchange Commission regulations are, of course, the epitome of disclosure requirements. The commissions’ entire regulatory posture is driven by the premise that an informed decision is the first line of defense against securities fraud.  Registration is thus its main tool of enforcing compliance.

Mandating portfolios, both the institutions’ own as well as those that they manage for others, is the forte of the central bank.  Rules in the General Banking Law that  impose the single borrower’s limit, that prescribe (almost proscribe) the way of handling of Dosri loans, that lay down the extent of collateral cover, that define the scope of major investments, that fix the profile of the banks’ balance sheet, and  Section 88 that, prescribes the asset composition of funds held in trust are portfolio-shaping regulations.

Nowhere in the Securities Regulation Code, which is the primary statute that can used as a platform for the SEC’s oversight over financial products, is there similar authorization for the regulator to intervene to that overt extent in the way the regulated entities utilize their powers and property.  As far as I know, the only time SEC essayed into portfolio shaping was in the case of listing the proper investment outlets for preneed companies.  That, however, did not prevent the crisis that the preneed industry is currently facing.

Similarly, the central bank appears to be the only financial regulator to have the specific authority to regulate, in a dynamic way, the capital structure of a financial institution.  As distinguished from portfolio shaping that focuses on the assets and liabilities devoted to a particular activity of the business enterprise, dynamic regulation of capital structure zeroes in on the sufficiency of the business enterprise’s net worth to absorb the adversities of the endeavor.

The central bank and SEC do this type of regulation when they require the banks and brokers/dealers, respectively, to adjust the amount of capital in the enterprise according to the risks that they face.  The enterprises as thus asked to maintain what is known as “risk-based capital.

However, the BSP, under Section 34 of the General Banking Law, has specific authority to require risk-based capital. SEC, on the other hand, has had to rely on its general regulatory powers under Section 5 of the SRC.

The imposition of fiduciary standards and seeing to it that the standards are met are traditional domains of the BSP.  Since the passage of the General Banking Act in 1948, the supervision of the business of fiduciary service has been lodged with the central monetary authority. Only lately, in the wake of the commoditization of a number of financial services and marketing thereof by entities which are not banks has SEC ventured into requiring the conduct of a fiduciary on its constituencies engaged in advisory and portfolio management activities.  But still, the description of “fiduciary” as the latters’ role is, at best, a loose rendition of the term’s meaning and since the brokers and investment managers under the aegis of the SEC are no more than agents, the fiduciary nature of their roles still falls short of the quality required of trustees who, per se, hold the legal title in their own names. 

Given these four basic regulatory strategies and the differing specialties of the BSP and the SEC, the question of which is the better choice as regulator of trust fund hinges, I submit, on the suitability of the protection offered to the needs of the publics of trust funds.  And since these funds are no more and no less than collective investment vehicles for the funds of trusts managed by trust banks, then the question resolves itself into which regulatory strategy or strategies are best suited to protection of trust beneficiaries. 

The universe of trust beneficiaries is evident from this description of what trusts do.  According to US Judge William Rhodes Harvey, in a case he decided in the 1920s, a trust “protects the living and serves the dead, befriends the widow and orphan, guides the aged, strengthens the weak, curbs the improvident, represents the incompetent, advises the hesitant, plans for the inexperienced, encourages the timid, administers to charities, gratifies whims of the eccentric and otherwise justifies its claim to be an ‘incorporate friend’.”

           Given the wide range of diversity among those who need or make use of trusts, it is obvious that the mandate to regulate institutional trustees, and their tools of trust administration and operation like the UITF, ought to be lodged on that regulator that has sufficient statutory authority, personnel experience and institutional memory to effectively employ any and all, as warranted, regulatory strategies described above. 

            As things now stand, that mission lies on the shoulders of the central bank and I see no compelling reason, at this time, to transfer it elsewhere.