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Friday, October 7, 2011

Revisiting the PEACe Bonds

What are the PEACe Bonds?

The Poverty Eradication and Alleviation Certificates Bonds (PEACe Bonds) are Treasury Noted designed by the Caucus of Development NGO Networks (CODE-NGO) and its financial advisers1 to raise funds for poverty alleviation programs.

What is the exact nature of the securities that make up the PEACe Bonds?

In technical terms, the PEACe Bonds are 10-year zero coupon bonds (zeroes) issued by the Bureau of Treasury (BTr) of the Republic of the Philippines. A zero-coupon bond is a debt paper usually sold at a deep discount from its face value, or the amount the issuer pays when the bond matures. The issuer, in this case the government, will not make periodic or coupon payments to bondholders. It will instead pay a large premium to the bondholders when the debt paper matures.

The bonds were offered to the public through a Dutch Auction2 held by the Bureau of Treasury on October 16, 2001. The Bureau of Treasury was authorized by the Monetary Board to issue up to PHP 50.0 billion. However, only PHP 35.0 billion worth of zero-coupon bonds were sold, yielding the Treasury a cash flow of PHP 10.169 billion due to the discounted rate of the debt paper. The discount rate arrived at through the Dutch Auction was a yield-to-maturity (YTM) of 12.75%.

Why is this considered innovative?

The bonds are the first ever zero-coupon bonds issued by the Bureau of Treasury. In other countries, zeroes are used regularly and often. Because the interest rate in the zeroes is fixed and the interest capitalized, they are highly versatile. Since all the interest and principal is paid at the end of the term of the bond, insurance companies, pension plans, and retirement funds buy them and use them to fund their obligations that mature in lump sum over the years, such as life insurance policies, pensions, and retirement plans. They can also be used to ease up the cash flow requirements of projects that become profitable only after some time.

What are the other attractive features of the bond issue?

Tax Exemption

The bonds are tax-exempt: both capital gains tax and final withholding tax: Since the bonds have a maturity of over five years, they are exempt from the capital gains tax pursuant to Section (32)(B)(7)(g) of the 1997 Tax Code. Since the bonds were sold to less than 20 investors, gains from the sale, exchange, or retirement of the bonds are not subject to the 20% final withholding tax imposed under Section (27)(D)(1) of the 1997 Tax Code.


The bonds are endowed with reserve and capital eligibility that would make them attractive to institutional investors, particularly banks and insurance companies.

Secondary Reserves

The bonds could be used for the compliance of liquidity reserves of banks. Since the central bank pays only 8.5% for the liquidity reserves, a higher yielding debt instrument such as the zeroes that qualifies as a liquidity reserve is always a much more attractive investment.

Capital and Reserve Investments of Insurance Companies

The bonds are eligible as capital and reserve investments of insurance companies under Sections 203 and 204 of the Insurance Code. Similarly to the liquidity reserve eligibility, the bonds are higher yielding instruments than ordinary capital and reserve investments of insurance companies.

What will the funds raised be used for?

The funds raised or “gross issue proceeds” of PHP 10.169 billion will go to the National Government's General Fund. These will be used to finance ordinary government expenditures as well as government's deficit.

So why are they called PEACe Bonds?

It is not the bonds themselves that will help alleviate poverty. Rather, it is the PHP 1.338 billion profit that CODE-NGO made from selling the bonds that will go to fund projects to alleviate poverty. The name PEACe Bonds is not the official name given by the government to the bond issue. Instead, it is a nickname given by the bond designer (CODE-NGO and its financial advisers) to this bond issue because they were instrumental in the bond's design, implementation, and purchase.

How did CODE-NGO earn this profit?

CODE-NGO bought the bonds in the auction and turned around and sold them to final investors in the secondary market at a profit. The profits from the reselling of the securities - PHP 1.338 billion in all - were used to fund the permanent endowment and capital fund of the Peace, Equity, and Access for Community Empowerment Foundation (Peace and Equity Foundation). The foundation is a non-stock, non-profit entity created by CODE-NGO to “provide non-governmental organizations (NGOs), cooperatives and public organizations (POs) with new opportunities to expand, strengthen, and deepen, their anti-poverty programs.” CODE-NGO also kept PHP 140 million or 10% of the profit for itself, “for initiating this innovative fund raising project and working for its successful completion.

You mean to say CODE-NGO had PHP 10 billion to purchase these bonds and resell them?

No, it didn't. CODE-NGO acted through the Rizal Commercial Banking Corporation (RCBC) and its investment house subsidiary, RCBC Capital. The bank had the money to bid for the bonds and also found the companies, banks and other institutions to which CODE-NGO resold the bonds.3

Wouldn't this be seen as using government funds or at least profits from the sale of government debt papers to fund and “favor” a purely private concern, even if that private concern was a foundation dedicated to poverty alleviation?

Yes, That's why Danilo Songco, Managing Director of CODE-NGO, said that the deal was initially structured as a negotiated sale of the bonds by the government to CODE-NGO. However, the public would not know about this until the sale was concluded, which would render highly questionable any profits CODE-NGO earned from this transaction.

This explains why, just a little over two weeks before the October 16 auction, the Department of Finance shot down CODE-NGO's proposal to exclusively buy the entire 10-year Zero-Coupon Treasury bond issue through a negotiated sale.4 As reported in a local daily, CODE-NGO's exclusive purchase offer would have raised the local financial community's fears of a crony deal in the making. This is primarily because the approval for such an offer lies within the Department of Finance headed by Secretary Jose Isidro Camacho, a brother of CODE-NGO chairperson, Maria Socorro Camacho-Reyes. As a result, Secretary Camacho directed National Treasurer Sergio Edeza to ensure transparency in any dealings with CODE-NGO by changing the sale mechanism from negotiated sale to public auction. Secretary Camacho also said that he would inhibit himself from the auction process.5

So CODE-NGO had to compete in the open market to buy the bonds at a price that would yield them a good enough profit to fund their foundation?

Yes, Red Mayo said that RCBC was mandated to “purchase the Bonds at a price that will enable CODE-NGO to raise the desired endowment for the PEACe Foundation. If other GSEDs bidded more aggressively, and captured all or substantially all of the Bonds, there would be no endowment to speak of.”

Wouldn't the competition be tough?

Yes. CODE-NGO/RCBC competed against other GSEDs, many of whom are sophisticated financial players. Some of the major banks, particularly the foreign ones, are routinely exposed to and compete for such zero-coupon bond transactions abroad. They probably even have personnel who were stationed abroad, who trained in and worked on such transactions, and are now locally-based.

So how successful was CODE-NGO/RCBC in the auction.

Extremely successful. They won the entire zero-coupon issue that was bidded out on October 16, 2001.

According to RCBC, they placed four bids in the auction and all four bids won. The bids were “expertly positioned over a range of yields up to a high of 13% of which only those below or equal to 12.75% were accepted by the Bureau of Treasury.” RCBC captured PHP 35.00 billion in face value or PHP 10.17 billion in gross issue proceeds. The government raised PHP 10.17 billion in pesos through the bond flotation. All of it came from CODE-NGO/RCBC.

You mean no other GSED/bidder won?

Yes. CODE-NGO/RCBC won 100% of the auction despite the fact that the issue was oversubscribed by at least five times. The Bureau of Treasury saw PHP 137.08 billion worth of bids (in face value) chasing after PHP 35.00 billion in bonds (in face value). Theoretically, with this amount of competition, some other GSED/bidder should have been able to snag a significant portion of the bond issue. This is not the case with the PEACe Bonds.

Is it unusual for a GSED to capture the entire amount bidded out in a Treasury auction?

In most cases no, but in this case, yes. The Bureau of Treasury bids out PHP 249.0 billion6 worth of Treasury Bills and Treasury Bonds a year. Around 60% of it or PHP 150.0 billion consists of short-term Treasury Bills with maturities of 91 days, 182 days, and 364 days. These are bidded out on a weekly basis in tranches of PHP 3.0 billion to PHP 4.0 billion each. It is not unusual for a single GSED to bid aggressively and capture the entire auction issue. A GSED that completely lost out in the weekly Treasury Bill auction can easily buy from the secondary market or wait for the next week's auction. Supply is not a problem. At PHP 10.0 billion, the Zero-Coupon Treasury Bond Float represents just 6.7% of the entire annual Treasury Bill issue.

However, when compared to the annual Treasury Bond issue, the 10-Year Zeroes become too big to ignore. At PHP 10.0 billion, the Zeroes represent more than 10% of the amount of Treasury Bonds raised annually. These Treasury Bonds are of varying maturities: 2 years, 5 years, 7 years, 10 years, and 20 years. The ten-year Treasury Bonds amounted to PHP 25.0 billion or 25% of the total annual Treasury Bonds issue of PHP 100.0 billion. When matched against Treasury Bond issues of 10-year maturity, the Zeroes amount to 40% of the total 10-year Treasury Bonds issued annually.

In other words, CODE-NGO/RCBC snagged a very significant chunk (40%) of the total annual supply of 10-year Treasury Bonds. Why would other GSEDs ignore the auction of a financial instrument whose supply comes intermittently and few and far between?

Why didn't any of the other bidders win?

This is not clear. There were 45 bids from over 15 GSEDs. The bidding range was very wide, from as low as 12.248% to as high as 18.000%. The cut-off was at 12.750%. Obviously, all of the non-RCBC bids were above the cut-off of 12.750%.

The bid differential of 5.752% between the top winning bid and the bottom losing bid stands out as one of the highest ever in the history of 10 year Philippine Treasury Bond auctions (65 auctions since 1998 to 2011). No other auction prior to the PEACe Bond auction on October 16, 2001 or after the PEACe Bond auction has ever come close.

In fact, the high low differential in auctions of 10 year Philippine Treasury Bonds from 1998 to 2001 (prior to the PEACe Bond auction on October 16, 2001) was a marginal 0.422%. In other words, the PEACe Bonds differential was over ten times the historical average. Had the PEACe Bond offering maintained this differential of 0.422% during the PEACe Bond auction, the bottom losing bid would only have a yield-to-maturity of only 12.670%. The resulting bond values would differ by only PHP 11,863.08 from top winning bid to bottom losing bid or  an acceptable bond value differential of 4.05%.

The bid differential of the PEACe bond auction was such an outlier in the history of 10 Year Treasury Bond auctions from 1998 to 2011, that it upwardly skewed the average high-low bid differential by as much as 22%. With the PEACe Bonds, the bid differential of the 10 year Treasury Bond auction averaged at 0.460% from 1998 to 2011. Without the PEACe Bonds, the bid differential average was only 0.377%.

The Bureau of Treasury has held no less than 8 auctions of zero-coupon bonds since the PEACe Bond offering in 2001. None of the bonds offered were as big in size (maximum of PHP 10.0 billion vs. PHP 35.0 billion for the PEACe Bonds) or had as long a tenor (maximum of 7 yrs. vs. 10 yrs. for the PEACe Bonds). However, based on the data available, the bid differentials were much lower than that of the PEACe Bonds. The bid differentials for these subsequent zero coupon bond auctions from 2004 to 2006 averaged 0.601% and ranged from as low as 0.250% to as high as 1.480%.

Why did RCBC bid so low?

The presence of RCBC's bids at the bottom of the range seems to indicate that they were confident that the bonds' extra features would make the instruments attractive to others, particularly institutional investors such as banks and insurance companies, despite their low bid. (These extra features are the tax exemptions and reserve and investment eligibility for banks and insurance companies.) In other words, they knew that the yield that the banks and insurance companies receive on their funds placed in reserve is low. Therefore, any instrument that promised to pay a higher yield yet also qualified as a reserve would always be attractive. Moreover, such instruments are scarce and not readily available.

National Treasurer Sergio Edeza downplayed this factor and said pricing in the liquidity reserve would only reduce the yield to maturity by 0.5% (half a percent).

He “added that a bank treasurer always prices the liquidity reserve feature mindful of the fact that this value could easily be eroded by the actions of the monetary authorities. The BSP, for instance, has already cut the liquidity reserve requirement twice, bringing down to the current ratio of 7 percent of deposits and deposit substitutes. At the time of the zero coupon bonds auction, the requirement for secondary reserves was as high as 11 percent.”

However, Edeza's view was contradicted by that of RCBC Treasurer Jaime Panganiban, who said that the 11 percent yield-to-maturity of the PEACe Bonds (when RCBC purchased the PEACe Bonds from CODE-NGO) was still very attractive over the current yields for liquidity reserves. Mr. Panganiban confirmed that the RCBC Group did not buy the PEACe bonds at a loss7. He said that they had “a fallback” in the form of bank reserves.

Hindi palugi iyan because at that time, if you remember, the reserve requirement (yields of reserve eligible securities) was, I think about seven percent, which means a four percentage point difference (11 percent minus 7 percent),” he says.

In other words, even if we didn't touch the issue and placed it in our reserves, we already have a 4-percent carry.”

Weren't the other banks informed about these extra features?

This is not clear. According to RCBC, conventional practice was followed: the Bureau of Treasury announced the terms of the auction the week prior to the auction through the three major international information services, namely Reuters, Bloomberg, and Bridge. Red Mayo of Capex promised to furnish a copy of the announcement done through the international information services but has not done so to date. Instead, RCBC/Capex furnished copies of the following documents:

  1. A letter from the Bureau of Treasury to all GSEDs dated October 9, 2001, announcing a public auction of PHP 30.0 billion worth of 10-year Zero-Coupon Bonds to be held one week later, October 16, 2001. The letter did not describe any other feature of the bond other than the fact that the issue was limited to the 19-lender rule and was therefore not subject to the 20% final withholding tax. The letter also said that the GSEDs were to submit their bids by fax8 and disclose the name of the buyer. The letter was signed by Eduardo Sergio G. Edeza, Treasurer of the Philippines.
  1. A memorandum from the Bureau of Treasury to all GSEDs dated October 15, 2001, describing the auction guidelines for the 10-Year Zero-Coupon Bonds to be issued on the next day, held October 16, 2001. The memorandum acts as a term sheet to the GSEDs and detailed the nature of the offering, its size, minimum bid amount (PHP 500.0  million face value or PHP 150.0 million in cash value), terms, and extra features. The bidding was no longer manual but electronic. Although the memorandum disclosed that the bonds were eligible as liquidity reserves, it did not disclose that the bond had a pending eligibility with the Insurance Commission as a capital and reserve investment for insurance companies. The memorandum was signed by Eduardo Sergio G. Edeza, Treasurer of the Philippines.
So, based on the documents furnished by CODE-NGO, the GSEDs knew:
  1. Only one week in advance that the auction of the zero-coupon bond issue was pushing through; and
  1. Only one day before the auction date, the issue's terms, conditions, and eligibilities that would define its marketability, price, and target market, as well as the bidding procedure to be used.
In short, the GSEDs had only one day to understand this very new and innovative financial instrument. They had only one day to test its marketability with potential buyers who have the means to place a minimum bid of at least PHP 500.0 million face value or PHP 150.0 million cash value. They had only one day to price it and submit a winning bid.

Moreover, at 9:30 a.m. on the day of the bidding - after they bidding had opened at 8:00 a.m., the Bureau of Treasury issued a clarificatory memorandum to all GSEDs, citing excerpts of BIR ruling and Monetary Board Resolution on tax exemption and reserve eligibility, respectively, of the PEACe Bonds. National Treasurer Edeza claimed that this was not an issue because he said that each GSED had the technical ability to price the zero coupon bonds in under an hour. Despite this, the bids came in a wide range and did not improve and get competitive over time. The winning bids, CODE-NGO/RCBC's bids, came in early at bids 9 to 12, out of the 45 bids submitted.

On the other hand, CODE-NGO and RCBC, because they had been working on this flotation since March 2001, knew all the details surrounding the auction even before it was announced to the other bidders. They were extremely prepared and fully armed information-wise. No wonder that CODE-NGO/RCBC won the entire auction.

So CODE-NGO had an informational advantage over other bidders at the time of the auction. Did it have any other advantages?

First, it obtained official confirmation of the bond's eligibility with insurance companies after the auction.

Based on the documents provided by CODE-NGO, it appears that having won all of the PEACe Bonds issue, CODE-NGO then obtained a decision from the Insurance Commission to enhance the PEACe Bonds' attractiveness in the secondary market. The documents provided show a letter from the Insurance Commission to Mrs. Maria Soccorro Camacho-Reyes, Chair of CODE-NGO, advising her that the PEACe Bonds were eligible as capital and reserve investments of insurance companies. This letter, however, was dated November 16, 2001 - a full month after the auction date.

Second, CODE-NGO knew the contents of confidential Monetary Board resolutions governing the secondary reserve eligibility before the auction.

Another document provided shows BSP Circular No. 307 in relation to the secondary liquidity reserve eligibility of the PEACe Bonds. This circular was in effect on October 18, 2001, two days after the auction date, and is dated November 12, 2001. It cites Monetary Board Resolution No. 1679 dated October 25, 2001, over a week after the auction.

The same circular also cites three earlier Monetary Board Resolutions: No. 878 (June 7, 2001), No. 1261 (August 9, 2001) and No. 1545 (September 27, 2001) - which were amended and superseded by Circular 307. All three resolutions appear to be in relation to the secondary reserve eligibility of these bonds. But these resolutions are not available to the public. According to the BSP, they are only for the internal use of the Monetary Board and the BSP, and cannot be released to the public unless authorized by the BSP governor or required by the courts. CODE-NGO, however, knew what these resolutions contained. Among the documents it distributed at a forum for NGOs on the PEACe Bonds held on December 12, 2001, were as follows:
  • A letter to CODE-NGO Chairperson Mrs. Camacho-Reyes, dated June 14, 2001, from BSP Deputy Governor Alberto V. Reyes, citing Monetary Board Resolution No. 878 dated June 7, 2001; and
  • A letter to Finance Secretary Undersecretary Cornelio C. Gison, dated October 8, 2001, from BSP Deputy Governor Amando M. Tetangco, Jr., citing Monetary Board Resolution No. 1545 dated September 27, 2001 and the amendments to earlier Resolution Nos. 878 and 1261 dated June 7, 2001 and August 9, 2001, respectively.
This informational asymmetry seems to be confirmed by the wide range of values that the bidders assigned to the bonds.

There was a huge gap in bond values assigned by the bidders. The top winning bid of 12.248% YTM valued a PHP 1 M Face Amount PEACe Bond at PHP 304,598.51, which is PHP 126,167.62 or 71% higher than the value of PHP 178,430.89 assigned by the bottom losing bid of (18.000% YTM).

Would this information make the bonds more attractive?

Definitely, for various reasons.

First, insurance companies, and not banks, are the primary market for fixed rate long-term securities such as the zeroes.

Banks are generally floating rate investors. In other words, they use their treasury operations to park the excess funds from their lending operations in short-term floating rate securities like T-bills. This gives them the flexibility to pull out the excess funds when the market conditions for lending improve and reduces the risk of lower market values for the bonds when interest rates rise. Banks usually invests in fixed rate long-term securities for trading purposes - in other words, they buy the bonds for resale at a profit later.

Insurance companies are generally fixed rate investors. They invest in fixed rate long-term securities like Treasury bonds and long-term corporate bonds to fund their long-term obligations: insurance policies. The fixed rate bonds allow the insurance companies to fund and match their long-term obligations with long-term investments and, moreover, “lock-in” the return on their investment for the long-term.

Second, the 19-lender rule (for tax-exemption) implies that the investor in the zeroes must have a buy and hold strategy.

To maintain its tax-exempt status, the bonds must have no more than 19 “owners” or bondholders at any one time. This means that the bonds can only be bought and sold in large chunks - more specifically, chunks of PHP 1.842 billion in face value or over PHP 535.2 million in cash value. Any investor who bought the bonds for resale at a later date will have to find another investor with the cash to buy PHP 535.2 million worth of PEACe bonds in one transaction. That investor, in turn, must have the willingness to hold the bonds until maturity (10 years later) or have the capability to find another buyer just like him. This “19-lender” rule severely limits the universe of potential bond buyers to very large institutional buyers of which there are very few. The limited market means that anyone who buys the bonds had better be prepared to tie up a very large amount of cash (PHP 535.2 million) until maturity (when the bonds are paid 10 years later) if he is unable to resell the bonds. This invariably boils down to two types of investors:
  • Insurance Companies or other financial companies with similar long term obligations; or
  • Banks that need to fund the more “permanent” core of their liquidity reserve requirements with higher yielding instruments
Third, the bonds' eligibility as a capital and reserve investment for insurance companies is by no means automatic.

Technically, under Sections 203 and 204 of the Insurance Code, all government securities (treasury bills and treasury bonds) are eligible as capital and reserve investments of domestic insurance companies. However, eligibility is by no means automatic. The securities have to be proven satisfactory to the Insurance Commission. The PEACe Bonds are no exception. They are the first and only zero-coupon bonds issued by the Bureau of Treasury. Hence, the need for CODE-NGO for confirmation on their eligibility from the Insurance Commission. CODE-NGO itself acknowledges this when it wrote:

the merits on whether to grant these requests for eligibilities are deliberated upon by these agencies (BIR, BSP, Insurance Commission) on a case-to-case basis in their regular meetings as a matter of course.”

This is obviously a sensitive issue because in its FAQ on the PEACe Bonds, CODE-NGO explains that many companies do what it did, that is, apply with the Insurance Commission for capital and reserve investment eligibility after the auction.

Fourth, the Zeroes offer a respectable alternative to the other eligible capital and reserve investments for insurance companies.

Normally, capital and reserve investments for insurance companies are limited to short-term and low-yielding treasury bills (average of 9% pre-tax) which are plentiful and longer-term and high yielding treasury bonds which are scarce. So any investment in a Zero would be higher or at least match the current investment alternatives. If the yield on the usual capital and reserve investments for insurance companies is substantially lower than the 8% the central bank pays to banks on their liquidity reserves, it could explain why RCBC bid much lower than everyone else.

Fifth, Ten-year Treasury Bond instruments are scarce.

Ten-year Treasury Bond issues total just PHP 25 billion annually - 10% of the total annual Government Securities issued by the Bureau of Treasury (Treasury Bills and Treasury Bonds) and 25% of the total annual Treasury Bond issue. In the 10-Year Maturity category, the 10-year Zeroes represent 40% of that supply. Again, this is a significant chunk of a sufficiently rare and attractive financial instrument that is too big for other GSEDs and other financial institutions to ignore.

Sixth, the lack of an official eligibility advisory and confirmation from the Insurance Commission is a major deal breaker for private sector bond issues.

The eligibility of the bonds as a capital and reserve investment for insurance companies is so paramount that very few, if any, prospective bondholders are willing to commit to a private sector bond issue if the official confirmation of its eligibility from the Insurance Commission is not in place. In fact, whole bond issues of private sector companies like PLDT and Globe have been postponed and delayed because of the lack of that confirmation document. The underwriter of the bond issue has to request, obtain,and fax the approval to the various prospective bondholders before he even attempts to float the bonds. Therefore, the lack of an official eligibility confirmation or even an indication of its pending application with the Insurance Commission in the term sheet before the auction is highly irregular.

The above listed materialities show that the BSP Circular No. 307, which took effect two days after the auction, as well as the decision of the Insurance Commission, which was dated a month after the auction are not “mere formalities”9 as CODE-NGO and its financial advisers would like us to believe. Rather, they are important and material documents that trigger the prospective investors' investment perceptions and judgement on the true market value of the PEACe Bonds.

Was a prospectus10 about the issue released?

No. According to Red Mayo, the financial adviser who designed the PEACe Bonds for CODE-NGO, there was no need for a prospectus because the zeroes are issued by the National Government and as such are risk free, particularly if they are peso-denominated. Moreover, he said that a prospectus is designed as a selling instrument, particularly for unsophisticated financial players. Since all the participants in the auction are other GSEDs, all possess the financial sophistication to understand the issue, its terms and pricing implications. Hence, an ordinary Bureau of Treasury term sheet would suffice. CODE-NGO Managing Director Danilo Songco also explained that there was no prospectus because initially the PEACe Bonds were intended to be issued through a negotiated “exclusive” sale.

But wasn't this a maiden issue of a zero in the Bureau of Treasury? And, didn't it have all these extra features that made the PEACe bond zeroes more complex to price than a plain vanilla zero?

Yes. In fact, to insure that everybody was familiar with the nuances of the Zeroes, the Bureau of Treasury conducted a mock auction a couple of weeks earlier wherein all interested GSEDs were asked to submit bids. This enabled the Bureau of Treasury to test their existing system and make the necessary adjustments in time for the actual auction on October 16, 2001.

So despite the practice they received in the mock auction, all the GSEDs - with the exception of RCBC - failed to price their bids to win?


Since CODE-NGO bidded so aggressively that they captured all the bonds available for sale, were they able to sell the bonds down to other investors and make a good profit?

Yes. CODE-NGO made money, lots of it. CODE-NGO realized a net gain of PHP 1.338 billion on the turnaround sale of the zeroes to institutional investors in the secondary market. The gains were then used to fund the endowment of the PEACe Foundation and the 10% fee of CODE-NGO. According to RCBC, all the trading gains went to the PEACe Foundation, and the bank received none of it except for a 2% underwriting fee of PHP 239 million for RCBC Capital, RCBC's investment house subsidiary. This is extremely magnanimous of the bank, especially since it projected a net profit of only PHP 444 million in 2001.

So RCBC Treasury passed up the opportunity to earn PHP 1.338 billion for itself in one transaction when the entire bank is set to earn only PHP 444 million for the year?

Yes. The amount of profits the RCBC Treasury passed on to CODE-NGO is over three times what the entire bank is projected to earn for the year 2001.

Can RCBC really afford to be that magnanimous?

No, and many a banker would say that no bank in its right mind would walk away from such a huge trading gain. But if RCBC was not acting magnanimously, then more questions surface. Was there an under the table deal between the issuer - the Arroyo Government - and the buyer - CODE-NGO, with RCBC facilitating the deal? Was RCBC acting on instructions from the government to pass on to CODE-NGO a discount that the government was willing to forgo in favor of CODE-NGO? These questions beg to be answered!

Capital Raising Efforts

RCBC's generosity becomes even more curious after taking into account the expensive PHP 2.0 billion that the bank had to raise in a stock rights offering its shareholders approved in November 200111. The first tranche of the stock right issue offered 167.35 million shares in exchange for PHP 1.761 billion. The second tranche involved 32.964 million shares. The new shares, priced at PHP 10.0 per share, were sold to existing shareholders at a 50% discount to market price.

At the time of the stock rights offering, the bank was also mulling a PHP 2.0 billion debt issue within the first half of the year as part of a Tier 2 capital raising scheme to support the bank's growth.

High Ratio of Non-Performing Assets

The bank also needed to raise capital to cushion itself against further loan losses. At the time of the PEACe Bonds offering, its Non-Performing Loans comprised 16.72% of its Total Loan Portfolio. The bank was sitting on PHP 20.823 billion of illiquid non-earning assets consisting of NPLs (PHP 14.184 billion) and Acquired Real Estate Assets (PHP 6.639 billion). These illiquid assets amounted to 1.56 times its capital base of PHP 13.339 billion. Any significant deterioration of the values of these illiquid assets will markedly reduce the bank's capital base. Moreover, RCBC was one of the weakest banks among the large private commercial banks in terms of the ratio of its distressed assets to bank capital in 2001.  Only Government or semi-government owned banks such as UCPB, PNB, and Land Bank had higher ratios.

Further Illiquidity

Adding PHP 10.796 billion of unsold and relatively illiquid PEACe Bonds to its portfolio would have increased its illiquid assets to PHP 31.619 billion or 2.37 times its capital. Since the zero-coupon bonds, by nature, pay out only at maturity, they will not produce any cash flow during the entire 10-year holding period.

Massive Interest Rate Risk

For RCBC, warehousing 90% of the PEACe Bonds within the bank exposes it to massive interest rate risk. So, undertaking the transaction for the sake of earning an underwriting commission of PHP 240 million does not make financial sense and is an unsafe and unsound banking practice that could imperil the whole bank. Given that the interest rate on the 10 Year Treasury Bonds fluctuated 4.574% from a low of 13.772% (April 2000) to a high of 18.346% (May 1998), the average interest rate fluctuation was 1.330%. If interest rates had fluctuated upwards by the historical average of 1.330% to reach 12.330%, the bank would have lost PHP 1.275 billion. A loss of PHP 1.275 billion would have made the bank, already burdened by high non-performing assets, even weaker. In other words, they would have risked PHP 1.275 billion or almost 10% of their capital base of PHP 13.4 billion as of the 4th Qtr of 2001 to make PHP 240 million. Its risk was over five times the reward. These are not prudent trading odds by any standard. To even up the odds, the bank had to expect to make money from a fall in interest rates12 that will drive up the value of the bonds or buy reselling the bonds to other institutional investors at fat profit margins.

Fortunately for RCBC, interest rates declined substantially since October 2001.

If RCBC made so much money for CODE-NGO (PHP 1.338 billion), didn't it buy any of the bonds for its own account and profit?

No. According to Jaime “Jimmy” Panganiban, Treasury Head of RCBC, in a forum for NGOs, the bank passed on all the profits to CODE-NGO because RCBC wanted to be known as trailblazers for zero-coupon bond transactions. It wanted to let its clients make all the money before it makes money for itself. It is significant to note that Mr. Panganiban never raised the conflict of interest issue of its underwriter relationship with CODE-NGO: that if the bank had pursued the bonds for its own account, it would have been competing with its own client for the same bonds the client contracted it to by for the client's behalf.

Mr. Panganiban issued other statements that contradicted his claim that the bank acted out of charity.

RCBC deigns to call the profits that accrued to CODE-NGO a donation. 'We are not a charitable institution,' Panganiban asserts. Moreover, treating the transaction as such, sources say, would make it liable to its stockholders and open to minority suits.”13

However, in a news conference14, Jaime Panganiban admitted that the bank had sold some of its PEACe Bonds at a profit.

We have a contracted sale for PHP 1.2 billion [out of the PHP 35 billion worth of PEACe Bonds, which is the issue's face value upon maturity], Panganiban said. But given the publicity about the PEACe Bonds, we're not aggressively [selling them in the secondary market]. He admitted that there is demand or keen interest in the bond.

The bonds were sold to RCBC's corporate clients outside the Yuchengco group of companies.15 Mr. Panganiban said that RCBC has been selling the bonds, which RCBC acquired at an effective cost of 34 centavos per bond unit (PHP 1.00 at maturity in 10 years), for 40 to 45 centavos to undisclosed corporate buyers.16 This translates to an effective yield to maturity rate of 8.170% to 9.370%. In terms of profit, this means that RCBC, by selling PHP 1.2 billion or 10% of the PEACe bonds it acquired from CODE-NGO for PHP 11.996 billion, realized a trading gain anywhere from PHP 201.32 million to PHP 374.94 million from this one transaction alone. If it continued to sell the rest of its holdings at this price, it would reap an additional trading gain ranging from PHP 1.812 billion to PHP 3.374 billion, bringing its total potential profit on the entire PEACe to PHP 2.013 billion to PHP 3.749 billion. Therefore, it is RCBC, and not CODE-NGO, that stands to make the lion's share of profits from the PEACe Bonds deal: PHP 3.749 billion in gross profits for RCBC vs. PHP 1.827 billion for CODE-NGO. In other words, had the Bureau of Treasury been able to sell the PEACe Bonds directly to Institutional Investors, it would have gotten an additional PHP 5.575 billion in Treasury bond proceeds.

If RCBC priced the bonds, won the bid, fronted the purchase money, and found the buyers, what was CODE-NGO's value-added on the transactions?

On paper, CODE-NGO was the initiator and designer of the bond issue and as such would readily know the features that made the bond issue attractive. On paper, it was also the underwriter that sought out and contracted RCBC to buy the bonds on its behalf. However, the most significant contribution CODE-NGO made towards the purchase and resale of the PEACe Bonds was to employ its best efforts - including connections - to ensure that the regulatory authorities and National Government would agree to the PEACe Bond float, cooperate with them regarding the auction, and to enhance the debt papers.

In an interview with the Philippine Daily Inquirer17, Jaime Panganiban, RCBC's Treasurer and Executive Vice President,

admitted that he specifically requested CODE-NGO to 'supply the bond's special features,' which he claimed would be valuable to the bank's portfolio.

RCBC officials essentially told the organization's financial advisers that they will leave it to their client to fulfill all the bureacratic requirements, mainly to seek approval of the national treasurer over the bond issuance, request eligibilities from the Monetary Board/Bangko Sentral ng Pilipinas (such as for liquidity reserves and Agri-agra law compliance) and obtain rulings from the Bureau of Internal Revenue (BIR) regarding exemptions from withholding and capital gains taxes stipulated by law.

'They (CODE-NGO's advisers) came to use with the bond already structured and we told them, 'okay we will buy them (PEACe bonds) at this price (about 11 percent), but these are our conditions (the eligibilities). You do all the legwork. We will just sit here and wait,' Panganiban said.”

RCBC Treasurer Jaime Panganiban later backtracked from this position in an interview with Businessworld18. He said that:

'The reserve eligibility and the tax exempt ruling, for RCBC, is just a fallback position for us. What is in it for RCBC is that we bought the zero coupons for product lines. We can create different products out of the zero coupons,' Mr. Panganiban said. But he did not disclose the products RCBC would develop, due to proprietary considerations. He also noted that while RCBC is still to launch the new products, it is holding an instrument that is reserve eligible and tax exempt.

'We are not buying it (zero coupons) for reserves or tax exemptions. That's why we are keeping 90% of it. Because we have a very good product line for which we can turn around and make more money,' Mr. Panganiban said.

What else can RCBC do with the PEACe Bonds?


According to RCBC Treasurer Jaime Panganiban, RCBC has thought of creating “principal protected products”19 not found locally.

I can create from these bonds a fund with a principal-protected product where your upside potential is unlimited and your worse return is 100 percent of your principal, because it's guaranteed by government, though we're not saying we have advanced product knowledge because these products you can easily find abroad,” he says.

Window Dressing losses from Bank NPLs

In June 2002, newspapers issued reports that RCBC was planning to use the PEACe Bonds to clean the non-performing loans and assets of other banks and the BSP is said to be amenable to the plan20. Under the plan, buyers of the PEACe Bonds may use the bonds to acquire foreclosed assets of banks at a substantial discount to their book value. Banks that accept these bonds as payment for the foreclosed assets, if allowed by the BSP, will not have to book the sale of the foreclosed assets at a loss because it can record the receipts based on the bond's face value instead of their discounted or present value. The bank selling the foreclosed assets, however, will not be allowed to book an income from the bonds.

Asset Management Companies

According to BSP Deputy Governor Alberto Reyes, asset management companies can use the zero-coupon bonds to buy bank NPLs. The PEACe bonds are risk-free because they are guaranteed by the government. For instance, a PEACe bond with one billion pesos in face value could, depending on prevailing interest rates, only have a value of PHP 500.0 million pesos and this bond could then be used to buy an acquired asset of another bank, valued on the selling bank's books at one billion pesos, for only PHP 500.0 million. The selling bank will then not have to recognize a loss on the sale unless the asset's book value is more than one billion pesos, the face value of the PEACe Bond.

Using the method described above, banks can also use the PEACe Bonds with its own asset management companies to warehouse its own NPLs.

Cesar E. A. Virata, RCBC director and Banker's Association of the Philippines (BAP) President said that the zero-coupon bonds could be used as an alternative mode of settlement because both the buyer of the foreclosed assets and the selling bank can both take advantage of the discounted nature of the zero-coupon PEACe bonds21. He cautioned, however, that, aside from the BSP's go signal, the industry would also have to consider the accounting standards used in transactions involving the acquisition of a bank's acquired assets with the use of zero-coupon bonds.

Washing NPLs from a bank's own books

The banks can also use the PEACe Bonds in cashless debit-credit accounting transactions to hide the NPLs on its own books.22

For instance, an NPL that is on the bank's books for PHP 1.0 billion may only have a recoverable value of PHP 500.0 million (Step 1). The bank can sell a PHP 1.0 billion Face Value PEACe Bond (with a discounted value of PHP 500.0 million) to the delinquent borrower (Step 2). But on the books of both the bank and the delinquent borrower, the amount owed to the bank is recorded at the face value of the PEACe Bond, which is PHP 1.0 billion (Step 3). The bank then simultaneously buys back the PEACe bond from the delinquent borrower (Step 4). The repurchase of the PEACe Bond creates a payable on the right side of the bank's balance sheet and puts the bank in a situation where its has itself a shadow indebtedness to the borrower in the same exact amount as the NPL. The bank then offsets its account payable to the borrower against the NPL (of the same amount) of the delinquent borrower on the asset side (Step 5). This way, the indebtedness of the borrower remains on the accounts receivable portion of the asset side of the bank's balance sheet but it is no longer an NPL and is not connected to a loan. Thus the bank's balance sheet is laundered in a way by simply removing the stain of non-collectibility or ageing. The new receivable derived from the sale and repurchase of the PEACe Bond is after all exactly that - new.

According to Dean de la Paz, a bank used approximately PHP 3.0 billion of the zeroes to clean out some non-performing loans23. The zeroes provided a cleansing mechanism that virtually transformed non-performing assets. Both payer and payee banks enjoyed booking the benefits where zeroes were not recorded at market values. This changed when the accounting protocols under Philippine Financial Reporting Standards were revised to conform to International Financial Reporting Standards.

Could RCBC have done the transaction without CODE-NGO?

Theoretically, yes. In practice, no. RCBC claims that all GSEDs had received sufficient disclosure and time to study the relevant and material features of the bond issue prior to the auction. The bonds were then bidded out in a competitive auction wherein any GSED could have won had they been sufficiently aggressive in pricing the bids. This is theory. In practice, there are numerous gaps in the process and timing of the disclosure. The documents provided by CODE-NGO/RCBC show that official confirmation of the actual auction date came only a week before the auction day itself. They also show that the official Bureau of Treasury term sheet detailing the terms, conditions, and features of the offering came only a day prior to the auction date itself. Also, the Monetary Board memos discussing the features and eligibilities of the issue were only for internal use and not meant for public consumption. Moreover, CODE-NGO's ability to speed up the process of securing these eligibilities (the legwork) was a major factor in enabling the transaction to push through.  And lastly, they also show that a major dealbreaker - the official confirmation from the Insurance Commission of the bonds' eligibility as a capital and reserve investment for insurance companies - only came out a full month after the auction date.

Can other NGOs/Foundations design and implement their own PEACe Bonds?

No. It was a one-shot deal. The words of Red Mayo, financial adviser to CODE-NGO sum it up best:

As Financial Advisors to CODE-NGO, we have received inquiries from other NGOs interested in replicating what we did with the Bonds to advise and represent them in talks with the Bureau of Treasury for the subsequent auctioning of up to PHP 15.0 billion unissued 10-year, zero-coupon T-Notes that comprised part of the original PHP 50.0 billion PEACe Bonds tranche, of which only PHP 35.0 billion was awarded during the previous auction at a yield-to-maturity acceptable to the Bureau of Treasury.

Our thinking on the matter is that while it is certainly possible to do a PEACe Bonds II, the market is also that much the wiser. Having learned from the lessons learned in the first auction, bids will be more finely calibrated, and the realizable gains are not likely to be as interesting. Once a deal becomes commoditized, arbitrage earnings virtually disappear.

Our honest-to-goodness advise is to consign the PEACe Bonds to the dustbin of history, and come up with a better mousetrap design that is not simply a clone of the original issue structure. As a matter of course, we custom-design deal structures to suit the particular circumstances of the client in the light of prevailing circumstances and market conditions. Since financial concepts are not patentable, we have to constantly break new ground through a process of continuous innovation.”

What constitutes the behest/fraudulent nature of the PEACe Bonds deal?

The PEACe Bonds controversy can be summed up in the following points. These points illustrate the “coincidences” behind the deal and there are many. And, as the saying goes, “too many coincidences is usually no coincidence.”

  1. CODE-NGO initiated and designed the PEACe Bond issue as an exclusive and negotiated sale of the 10-Year Zeroes between the government and CODE-NGO. CODE-NGO planned to buy the bonds through RCBC and resell it to RCBC Capital to reap a profit of at least PHP 1.0 billion.
  2. The sale mechanism was changed to a competitive auction only after transparency issues were raised.
  3. The timing and process of disclosure of the bond issue's salient features to all GSEDs participating in the auction seem to be, at best, inadequate and, at worst, improper.
  • The GSEDs were made aware that the auction of the 10-Year Zero-Coupon Treasury Bonds was actually pushing through only a week prior to the actual auction date.
  • The GSEDs received official notice of the terms, conditions, and features of the offering only a day prior to the auction date.
  • The form of the auction was changed from manual (by fax) to electronic only a day prior to the auction date.
  • The BSP Circular 307 establishing the eligibility of the bond issue as a secondary reserve instrument was dated October 18, 2001 - two days after the auction date.
  • The Monetary Board Resolutions cited in BSP Circular 307 are for internal Monetary Board and BSP use only and were not published.
  • The eligibility of the Bond issue as capital and reserve investments for insurance companies was confirmed by the Insurance Commission only on November 16, 2001 - a full month after the auction date itself. Moreover, this eligibility was not disclosed as pending in the Bureau of Treasury Memo/Term Sheet

  1. As initiator and designer of the PEACe Bond issue, CODE-NGO/Capex/RCBC had intimate and detailed knowledge of the confirmed and pending features of the bond issue. Moreover, they had months ahead of every other auction participant to canvas for and line up buyers, develop pricing strategies, and place the bonds with third party investors.
  2. CODE-NGO/RCBC won, in what was touted as a competitive bidding situation, all of the PEACe Bond issue. This was achieved despite the fact that the bond issue represented a significant chunk of a scarce financial instrument whose eligibilities make it very attractive to banks and insurance companies.
  3. CODE-NGO/RCBC turned around and sold these bonds to RCBC Capital for a staggering gross profit of PHP 1.827 billion and a net profit of PHP 1.338 billion. The profits were achieved by selling the bonds to these buyers at an interest rate at least 1.75% or 175 basis points lower than the 12.75% yield-to-maturity interest rate the Bureau of Treasury received for the Zeroes. This pricing gap was achieved despite the fact that the bond auction was five times oversubscribed.
  4. RCBC itself turned around and sold 10% of the bonds to institutional investors outside the Yuchengco Group for a gross profit ranging from PHP 201.32 million to PHP 374.94 million from this one transaction alone and demonstrating the potential for RCBC to make an even more staggering gross profit of up to PHP 3.749 billion on the PEACe Bonds issue.  Had the Bureau of Treasury been able to sell the PEACe Bonds directly to RCBC's institutional investors, it would have gotten an additional PHP 5.575 billion in Treasury Bond proceeds.

  1. Althought the government saved money in the transaction - it saved 0.4% in interest rates or PHP 367 million in gross issue proceeds - it could have saved much much more. It could have saved 1.75% in yield-to-maturity interest rates or the PHP 1.827 billion in gross profits that CODE-NGO made had the bidding become even more competitive. In other words, had the auction been even more competitive, CODE-NGO's profits would have been whittled down substantially and those profits would have gone directly to the government coffers.  It could have also saved an additional 2.83% or 283 basis points in yield-to-maturity interest rates had the government been able to sell directly to RCBC's institutional investors.

  1. The profits were achieved with the help of RCBC who priced the bonds, won the bids, put up the funds for their purchase, and found the buyers in the secondary market. By doing this, RCBC Treasury, obtained the potential to earn PHP 3.749 billion in one transaction or roughly nine times the bank's entire bank's projected net income of PHP 444 million for the year 2001.
  2. The PEACe bond issue had a “hushed” quality to it:

  • No prospectus was released prior to the auction.
  • No public roadshow was held for prospective financial investors
  • No public forum was held for the benefit of civil society before the auction
  • There was no tombstone24 in the press regarding the first long-term zero-coupon Treasury Bond
  • For a government known for trumpeting its achievements in the press, there was little or almost no news regarding the maiden issue of the zero-coupon bond in the Philippine Treasury. Only a single article appeared in the business press the day after the auction was held. All other major dailies, which had several articles on the issue prior to the auction, had none after the auction.
  • A public forum for civil society was held only after several articles and editorials critical of the bond issue appeared in the opposition press.

  1. Finance Secretary Jose Isidro Camacho may have inhibited himself from all negotiations and discussions relating to the PEACe Bonds. But it is clear he did not officially object to it. By not objecting to the deal, Secretary Camacho allowed it to happen. By not objecting to the deal, Secretary Camacho sent a signal to the market that everything was aboveboard as far as this flotation was concerned. Moreover, by inhibiting himself, Secretary Camacho made President Gloria Macapagal-Arroyo directly accountable to the local and foreign business community and to the wider public, regarding this deal.
  2. Maria Soccorro Camacho-Reyes refused to resign as chair of CODE-NGO when her brother, Jose Isidro Camacho, was appointed Secretary of Finance or when transparency concerns regarding the negotiated sale broke out and the sale mechanism was changed to a competitive auction. Although both she and her brother reportedly inhibited themselves from the auction, the presence of numerous inconsistencies and coincidences regarding the PEACe Bonds issue gives strong reason to believe that CODE-NGO:
  • Had undue access to information regarding the bond issue;
  • Had hugely improbable rate of success in obtaining all the necessary government and regulatory decisions to enable it to corner the auction and to generate a billion peso profit; and
  • could not have exercised their informational advantage without the cooperation of regulatory authorities and the National Government, in terms of disclosure of information and breaches in standard practices that ensure a level playing field.

A lot of the issues concerning the bond issue could have been laid to rest completely had Maria Soccorro Camacho Reyes resigned her position as chairwoman of CODE-NGO out of delicadeza the moment her brother became Finance Secretary. So why didn't she? We will never know for sure but Danilo Songco, Managing Director of CODE-NGO, states it very well:

[W]e were on the verge of making PHP 1.3 billion and we would give up the opportunity out of delicadeza? Sobra naman yata yan. Kung personal kaming makikinabang pwede pa but it was potentially all of civil society that would gain from the fund... I will ask those who raise it: if you were in our shoes, would you have quit at that point out of delicadeza?

We just couldn't turn back because of delicadeza. There was too much to lose in exchange for virtues which we would have foolishly imposed on ourselves when no one else in government bothers to do the same.”

Why should ordinary citizens view insider advantage and influence as improper and unacceptable?

Insider trading occurs when a financial trade has been influenced by the privileged possession of corporate information that has not yet been made public. Because the information is not available to other investors, a person using such knowledge is trying to gain an unfair advantage over the rest of the market.

Using nonpublic information for making a financial trade violates transparency, which is the basis of a well-functioning capital market. Information in a transparent market is disseminated in a manner by which all market participants receive it at more or less the same time. Under these conditions, one investor can gain an advantage over another only through acquiring skill in analyzing and interpreting available information. This skill is based on individual merit and awareness. If one person trades with nonpublic information, he or she gains an advantage that is impossible for the rest of the public. This is not only unfair but disruptive to a properly functioning market: if insider trading were allowed, investors would lose confidence in their disadvantaged position (in comparison to insiders) and would no longer invest, leading to a long term decline in the whole capital market.

In the end, isn't the deal a worthy one since the Peace and Equity Foundation will support poverty alleviation and poverty reduction efforts of civil society?

That is like saying it's ok to be a crony favored by the government if what you are doing is going to help the poor, and especially because you belong to civil society. The minute we begin to apply a different set of standards on ourselves from the ones we impose on cronies, politicians, public servants and leaders, then we are in trouble.

What are the implications of this deal?

The implications of this deal are many and profound.

First, the seeming lack of transparency in the timing and process of disclosure by the financial and regulatory players in this deal casts doubt on the government's seriousness in undertaking or even enforcing reforms that will improve the integrity and credibility of the Philippine capital markets.

Second, the behest nature of the deal is yet another indication that the Philippine government is very much a “soft” state. Rules exist only to govern those outside the so-called “circle of power.” Those within that circle can bend, subvert, or openly break these rules to favor a select few.

Third, for a foreign investor, this demonstration of a lack of an uncompromising rule of law especially with regards to basic financial instruments such as Treasury Bills and Treasury Bonds, introduces yet again an added element of investment risk. Adherence to the rule of law will enhance out credit rating with international credit rating agencies like Moody's and Standard and Poors. Foreign investors will demand and get higher returns of their Philippine investments resulting in higher interest rates, lower stock market valuations, and an even weaker exchange rate.

Fourth, it gives even more ammunition to the political opposition in their claim that the Arroyo administration is no different in substance and may even be worse than the administration it deposed.

And lastly, it shows that the Filipino's greatest enemy is himself. For when he is thrust into a position of power and influence, he abandons the virtues he previously upheld and embraces the vices he previously despised.

PEACe Bonds - A Chronology

02/20/01 Start of brainstorming between CODE-NGO and its investment bankers
03/01/01 Jose Isidro Camacho becomes the Secretary of Energy
03/03/01 CODE-NGO presents a request for issuance of zero-coupon treasury notes to then Finance Secretary Alberto Romulo
03/06/01 CODE-NGO presents the project to a “Monetary Board member”
03/09/01 CODE-NGO sends letter-request to Bangko Sentral ng Pilipinas (BSP) Governor Rafael Buenaventura
03/10/01 CODE-NGO sends a follow-up letter to BSP
03/12/01 CODE-NGO sends another follow-up letter to BSP
03/13/01 CODE-NGO presents the project to National Treasurer Sergio Edeza
03/23/01 CODE-NGO sends a letter-request to Finance Secretary Alberto Romulo
03/30/01 CODE-NGO sends a letter-request to BSP Governor Rafael Buenaventura
04/17/01 CODE-NGO formally appoints RCBC Capital as exclusive issue manager, arranger, and lead underwriter for resale of Treasury Notes to be acquired by CODE-NGO from the Bureau of Treasury
05/05/01 CODE-NGO requests Bureau of Internal Revenue (BIR)'s confirmation regarding exemption of PEACe Bonds from capital gains tax
05/10/01 CODE-NGO sends another follow-up letter to the BIR
05/25/01 CODE-NGO sends another follow-up letter to the BIR
05/31/01 BIR Commissioner Rene Banez issues BIR Ruling No. 020-2001 stipulating that the PEACe Bonds are tax-exempt certificates of indebtedness
06/04/01 Commission on Audit (COA) Chairman Guillermo Carague gives verbal opinion to CODE-NGO
06/07/01 Monetary Board issues Resolution No. 878 approving CODE-NGO's request for reserve eligibility
06/11/01 Jose Isidro Camacho becomes the Secretary of Finance
06/13/01 Treasurer Edeza requests COA in a letter for assistance in formulating the necessary book entries for the proposed zero-coupon Treasury Bonds
06/14/01 BSP Deputy Governor Alberto Reyes notifies CODE-NGO in a letter of Monetary Board Resolution No. 878
06/20/01 COA issues written reply to Treasurer Edeza
07/12/01 Treasurer Edeza writes a memo to Secretary Camacho questioning legal personality of CODE-NGO to enter into negotiated purchase/sale of Treasury Notes, as well as some aspects of BIR/Banez Ruling of May 31
07/17/01 RCBC offers to buy PHP 15 billion of 10-year, zero-coupon Treasury Notes from the Bureau of Treasury for about PHP 4.7 billion. The Treasury Notes will be resold as PEACe Bonds the earnings from which will be used to finance anti-poverty projects and programs of NGOs. This will be the centerpiece of the President's State of the Nation Address on July 23, 2001
July/Aug 2001 Secretary Camacho hosts a meeting between CODE-NGO and the Bureau of Treasury. He and his sister are present at the meeting
08/08/01 Treasurer Edeza writes BIR Commissioner Banez for further clarification on his ruling of May 31
08/09/01 CODE-NGO writes BSP Governor Buenaventura asking for an expansion of reserve eligibility from PHP 15 billion worth of PEACe Bonds to PHP 35 billion
08/09/01 Monetary Board Resolution No. 1261 granting CODE-NGO's request. The resolution quotes directly from CODE-NGO's letter
08/10/01 Bureau of Treasury recommends to the DOF that the government issue zero-coupon bonds as part of its regular financing program. Secretary Camacho approved this in his marginal note
08/16/01 BIR Commissioner Banez issues Ruling No. 035-2001 reaffirming his ruling of May 31 (No. 020-2001). Banez further defines “at any one time” to cover “only the origination or original issuance of the bonds regardless of whether sale or trading is made in the secondary market
09/03/01 Presidential full powers granted for zeroes subject to 20% final withholding tax
09/04/01 The BSP receives a letter from Secretary Camacho informing them that CODE-NGO no longer wishes to make the PEACe Bonds eligible as alternative compliance under the Agri-Agra Law
09/05/01 Secretary Camacho writes to the President requesting for permission to inhibit himself from having to make any decision, approve or sign the proposed debt issue of PEACe Bonds
09/17/01 Monetary Board issues opinion on zeroes subject to 20% final withholding tax
09/26/01 Treasury announces an auction for October 2, 2001, of PHP 3.5 billion worth of 10-year zero-coupon bonds, subject to 20% final withholding tax
09/27/01 Monetary Board issues Resolution No. 1545 raising the face value of the PEACe Bonds to PHP 50 billion from PHP 3.5 billion
09/28/01 Bureau of Treasury postpones auction of 10-year zero-coupon bonds to October 11, 2001
09/28/01 Presidential full powers granted to zeros not subject to 20% final withholding tax (transmitted to Department of Finance on October 1, 2001)
10/02/01 Bureau of Treasury announces trial auction for zeroes subject to 20% final withholding tax
10/03/01 Bureau of Treasury had a general meeting with government securities eligible dealers (GSEDs) where tax treatment of zeroes was discussed. GSEDs request a postponement of October 11, 2001 auction. Bureau of Treasury agrees
10/05/01 Bureau of Treasury holds trial auction for zeroes subject to 20% final withholding tax. Revised electronic bidding system (to accomodate zeros) is tested at this trial auction
October 1 to 7 Bureau of Treasury asks its service provider to modify electronic bidding system to allow for exemption from 20% final withholding tax. Service provider says it needs two to three weeks in order to make the necessary adjustments
10/08/01 BSP Deputy Governor Amando Tetangco Jr. writes Finance Undersecretary Cornelio Gison notifying him of Monetary Board Resolution No. 1545 dated September 27, 2001
10/09/01 Bureau of Treasury announces a zero-coupon offering to GSEDs scheduled for October 16, 2001. A 19-lender rule is announced as a requirement for exemption from 20% final withholding tax
10/12/01 Bureau of Treasury issues memo to GSEDs announcing the formula for determining purchase price and settlement amount of zeroes to be auctioned on October 16, 2001
10/12/01 Bureau of Treasury discusses the tax feature with the Bankers Association of the Philippines Government Securities Reform Committee
10/15/01 Bureau of Treasury issues additional memo notifying GSEDs of liquidity reserve eligibility
10/15/01 Monetary Board issues Resolution No. 1679 consolidating earlier Resolution Nos. 878 (June 7, 2001), 1261 (August 9, 2001), and 1545 (September 27, 2001) to take effect on October 18, 2001
10/16/01 At 8 a.m., Bureau of Treasury begins accepting bids for 10-year zero-coupon
10/16/01 At 9:30 a.m., Bureau of Treasury issues a clarificatory memorandum to GSEDs, citing excerpts of BIR ruling and Monetary Board Resolution on tax exemption and reserve eligibility, respectively, of PEACe Bonds
10/23/01 A week after the auction, CODE-NGO tells its members it has the billion-plus peso endowment firmly in its possession
11/05/01 CODE-NGO applies to the Insurance Commission for eligibility of the PEACe Bonds as security/statutory deposits of insurance companies, and as admitted assets for insurance company purposes
11/16/01 Insurance Commission grants CODE-NGO its request
November 2001 Bureau of Treasury instructs its service provider to modify electronic bidding system to enable zero-coupons not subject to 20% withholding tax

1Red Mayo of Capital Advisors for Private Enterprise Expansion (Capex), Inc. designed the bond. He, together with Bobby Guevarra of SEED Capital Ventures, served as the financial advisers to CODE-NGO on the issue structure.
2A Dutch Auction or uniform price auction, within the context of debt papers, is a method of pegging the coupon rate or yield of a fixed rate debt instrument at the minimum level that would realize the issuer the desired proceeds at some cut-off yield. Simply put, the bid amounts and their corresponding yields are ordered from the lowest yield rat tendered to the highest. The uniform rate is set at the yield at which the level of the bid amount equals the total issue size. All those who bid at or below the uniform rate are awarded their bid amounts at the same rate.
3CODE-NGO requested the parent bank, RCBC, a government securities eligible dealer or GSED, to purchase the bonds from the Bureau of Treasury on its behalf. CODE-NGO also engaged RCBC's investment house subsidiary, RCBC Capital, as its underwriter. In its role as underwriter, RCBC Capital would have to repurchase the bonds from CODE-NGO that its parent, RCBC, purchased on behalf of CODE-NGO and resell the bonds to other investors. As underwriter, it would have to absorb the bond purchase for its own account at a firm price even if it could not find any buyers for the bonds after the auction.
4“DOF junks NGO plan to buy bonds,” by Elena R. Torrijos of Inquirer News Service, Philippine Daily Inquirer, September 30, 2001.
5Ibid. According to Danilo Songco of CODE-NGO, Secretary Camacho, upon inhibiting himself, assigned Finance Undersecretary Cornelio Gison to attend to all matters concerning the PEACe Bonds. However, Secretary Camacho only officially inhibited himself from the PEACe Bonds transaction in a letter to the President dated September 5, 2001 when he had assumed the Finance portfolio on June 11, 2001 and CODE-NGO had been in discussions with the Department of Finance since March 3, 2001. Prior to his official notice of inhibition, Secretary Camacho, in a letter dated September 4, 2001, informed the BSP that CODE-NGO “no longer” planned to apply for the bonds to have eligibility as alternative compliance to the Agri-Agra Law, noting the secondary reserve eligibility granted by the Monetary Board was sufficient. A July 9 letter written by CODE-NGO to BSP Governor Rafael Buenaventura mentioned a meeting at the Finance Department “hosted” by Secretary Camacho and attended by Danilo Songco of CODE-NGO, RCBC Executive Vice President Jaime Panganiban, National Treasurer Sergio Edeza, as well as Secretary Camacho.
6Bureau of Treasury figures for the year 2000
7“CODE-NGO under pressure to use P1.4-B gain well,” by Margarita H. Debuque, Philippine Daily Inquirer
8In other words, this was not an electronic bidding system but a manual one.
9Statement of Red Mayo when he was questioned about the late dates of the documents CODE-NGO supplied in the CODE-NGO Forum on the PEACe Bonds, held for civil society last December 12, 2001, in Ateneo de Manila University, Quezon City.
10A prospectus is a formal legal document that provides details about an investment offering for sale to the public. A prospectus should contain the facts that an investor needs to make an informed investment decision. It is a way of disclosing information to the market so that prospective buyers can decide whether or not to invest in, as in the case of the PEACe Bonds, a bond flotation, how much to purchase of the bond, and what price to bid for the bond issue.
11“RCBC expects PHP 4.0 billion additional capital this year”, by Cecille E. Yap, Businessworld, January 29, 2002
12“Code-NGO under pressure to use P1.4-B gain as well,” by Margarita H. Debuque, February 22, 2002, Philippine Daily Inquirer
13“Code-NGO under pressure to use P1.4-B gain well,” by Margarita H. Debuque, February 22, 2002, Philippine Daily Inquirer
14“Raid on the Treasury - JPE on the PEACe Bonds Scandal, by Butch Fernandez and Erik de la Cruz, Reporters, February 13, 2002, Today Newspaper.
15“Internal Revenue bureau defends tax break for PEACe bonds,” by L.M. Gallardo with C.E. Yap, February 13, 2002, Businessworld
16“Enrile sees wholesale ruse in CODE-NGO deal,” by Angie M. Rosales and Jun Vallacera, February 13, 2002, Daily Tribune
17“Peace bonds stir political, financial storm,” by Margarita H. Debuque, February 19, 2002, Philippine Daily Inquirer
18“PEACe bonds: 'chilling' private transactions,” by Leotes Marie T. Lugo, Leilani M. Gallardo, February 21, 2002, Businessworld
19“Code-NGO under pressure to use P1.4-B gain well,” by Margarita H. Debuque, February 22, 2002, Philippine Daily Inquirer
20“RCBC urges using PEACe Bonds to clean banks' idle assets,” by Elena M. Torrijos, Philippine Daily Inquirer
21“BAP to revive talks on using zeroes to clean banks' books,” by Catherine C. Junia, June 28-29, 2002, Businessworld
22“Laundering out losing loans,” by Dean de la Paz, March 7, 2002, Businessworld
23“Zeroing-in on Zeros,” by Dean de la Paz, October 20, 2010, Filipino Voices,
24In the language of finance, a tombstone is an advertisement appearing in a major publication announcing an issue of an investment instrument such as shares, bonds, or syndicated loans. It is paid for generally by the one issuing the instrument. It is meant to announce to the public that a financial transaction has been completed, particularly for the maiden issue of investment instruments such as Zero-Coupon Bonds. It is called a tombstone because the announcement is usually framed in the shape of a tombstone.

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