2021 Articles - Suits the C-Suite - Page 4 | SGV & Co. | EY

31 May 2021

Christian G. Lauron

Corporate Banking Circa 2030: 7 hypotheses (Second part)

Second of two partsPreviously, we discussed how banks can leverage ecosystems to organize integrated networks and how they can expand services beyond banking to help clients focus on their core activities. These are among the seven hypotheses on how banks will transform to build the next generation of businesses. The second part of our two-part article continues by discussing how banks can provide leadership on critical societal issues to strengthen trust with the next generation of clients.PROVIDING LEADERSHIP ON SUSTAINABILITY AND COVID-19 RECOVERYReduced trust in financial services poses a serious threat, pushing some banks to prioritize making a credible and high-profile commitment to helping businesses address their challenges and risks. This may be achieved through establishing and executing a clear social purpose and creating measurable non-financial value. These efforts extend beyond expanding environmental, social and governance (ESG) investments and enable the growth and development of profitable operations, benefiting stakeholders beyond a bank’s bottom line. This way, sustainability becomes more than a public relations or branding exercise — it becomes a cultural mindset.The mindset shift will require substance and depth in the banks’ sustainability agenda, which may currently revolve around the prioritization of ESG-minded business practices to ensure operational resilience, the development of forward-looking multi-year roadmaps with interim targets and intergenerational narratives, and the implementation of responsible banking targets, categorized mainly into climate action and provision of social equity. These roadmaps should include solutions for societal challenges, particularly to help restore socio-economic growth in the aftermath of the COVID-19 pandemic. On the climate action agenda, banks can prioritize investments in, and extend credit to, sustainable companies so that those ventures can scale. Banks can help provide direct incentives for clients that commit to and meet sustainability targets, and in the process offer robust and intuitive solutions for businesses to track and report on carbon consumption and other metrics while developing exchanges and marketplaces for the trading of carbon credits. Mark Carney, former head of Bank of England and now a UN Special Envoy, has suggested that “the transition to net zero is creating the greatest commercial opportunity of our age.”It is estimated by the International Energy Agency that $3.5 trillion of annual global investments would be needed to build the infrastructure of a green economy, requiring the coordinated management of finance and investments during the transition phase of climate change mitigation and sustainable development. During this phase where forests are replenished, oceans and supply chains cleaned up, clean technologies replacing dirty power plants, banks will have to face the financial risk and capital implications of stranded assets in their portfolios, particularly to clients exposed to fossil fuel reserves becoming stranded resources. The regulatory stress testing exercises and the launch this year of a sustainability standards board by the International Financial Reporting Standards Foundation are twin developments that are expected to accelerate the surfacing of these issues.Depth is a characteristic that banks will need to embrace on the other agenda of sustainability, which is the provision of social equity. While this can be a highly ideological issue, stakeholders often find common ground on jobs generation, a concrete manifestation of participation by individuals and communities in socio-economic growth and recovery post-COVID. Banks need not go far — they can look at the supply chain for instance, where banks can play a role in deepening the supply chains notably for the following sectors that face varying levels of distress or flourish — construction and real estate, industrials and manufacturing, semiconductor, energy and utilities, agriculture and technology. In these supply chains, there is often a high proportion of underserved suppliers with poor or opaque creditworthiness. At the current state, and as reconfigurations take place, supply chain participants have greater financing needs to enhance resilience, fund reshoring and diversification, and in the process, generate jobs. Banks have for some time been strategizing along supply chains, with capital allocation being driven into SMEs through direct credit enhancements of anchor buyers while employing advanced analytics to identify early warning (and conversely, recovery) indicators. Some of these involve spatial, sentiment and mobility indicators to supplant lagging financial indicators. The increasing visibility on movement of cash between and across tiers of companies in the supply chain correlate with an increase in penetration of underserved SME segments, with FinTechs upping the ante on competition with their adoption of emerging technologies across the value chain. The blurring of the line between the physical supply chain (e.g., sourcing, production, shipping and tracking) and financial supply chain (e.g., ordering, contracting, payment and settlement) is being accelerated especially with the rise of networks and platform solutions like the electronic invoicing utility. One can easily be swamped by these developments, and this is where the banks should discern their purpose, assessing which sectors and value chains to focus on and correspondingly, finance based on size, fit and feasibility, while distilling the value proposition and business case and contributing to whole-system transformation — whether in manufacturing, services or even housing. Banks are critical in the development of inclusive capitalism, and they can create clear market differentiation by expressing and maintaining a clear social purpose. The rising generation of small business owners and entrepreneurs, as well as consumers, prefer to do business with companies that share their values on sustainability, and banks can exert clear leadership by revisiting their social contract and acting upon societal issues, particularly climate action and reduced inequalities, to foster client loyalty.FUTUREPROOFING FOR WHAT’S NEXTThe way forward in a transformation journey, though unique for every bank, starts with a clear and client-focused strategy, strong vision and purpose, sophisticated technology, and a strong and flexible operating model. In many cases, this will require uprooting structures and processes built around a model largely unchanged for a century. While business case development and strategic planning are necessary, banks should not delay action. Securing future market leadership will require addressing the difficult questions in managing transformation; defining clear, long-term business strategies and innovative, client-centered solutions; and sustained execution. By recognizing the opportunities in the present and taking bold action, banks can better capitalize upon what the future holds for the banking industry and thrive in it.Much has been said about banking functions remaining necessary, but as to whether they will continue to be performed by banks is another story. Banking — notably corporate banking — will inevitably have to undergo transformation that goes beyond the technology dimensions. These functions will become not only commoditized — they are becoming complex, networked and distributed, to mirror the continuing need for relevance and utility to bank clientele. Banks may want to take a leaf from the etymology of corporation — corpuratus, to form into a body — why were these groups or bodies formed? They are bound by common aims and aspirations that resulted in a sense of being and action. Corporate banks who find a way to rediscover their purpose will find a wellspring of transformation from within and provide the energy to sustain their transformation journey.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Christian G. Lauron is a Financial Services Partner of SGV & Co. He also leads the Firm’s Government & Public Sector.

24 May 2021

Christian G. Lauron

Corporate Banking Circa 2030: 7 hypotheses (First part)

First of two partsDespite the disruption and challenges caused by the pandemic, the banking industry is more poised than ever for a fundamental transformation. The speed of technological advancements and the means by which banks harness emerging technologies such as artificial intelligence (AI), blockchain, intelligent automation and machine learning only accelerated over the past half-decade. However, though innovation has become more a common capability than an aspirational buzzword, there’s still much transformational work to be done. Banks in the past five years have only seen incremental investments in this direction, adopted emerging technology in a siloed fashion, and focused mostly on cost optimization.Organizations continue to become more global, with electronic marketplaces facilitating more international activity among SMEs and with multiple micro-sized supply chains spanning across different countries. Due to a combination of disruptive technologies, dynamic markets, and easily accessible capital, small and medium-sized firms find the path to becoming substantial commercial accounts — and in turn, huge corporate banking clients — significantly easier.An EY study released in November 2020, How will banks transform to build the next generation of businesses, shares seven hypotheses that reflect how the trends of today reshape the current market, and how they play out in the next 10 years. These hypotheses describe how corporate, commercial and small and medium-sized enterprise (CCSB) banks can rise above the challenges of 2020 and leverage opportunities for growth in 2030.These seven hypotheses discuss 1) how the expansion of banking services from large platforms and tech giants will shrink market share across CCSB segments, 2) how banks can redefine client-centricity in a segment-less world, 3) how they can evolve to become trusted advisors by leveraging data to shape client business strategies, 4) how the subscription model can revolutionize commercial banking, 5) how banks can leverage ecosystems to organize integrated networks, 6) how banks can expand services beyond banking to help clients focus on their core activities, and 7) how banks can provide leadership on critical societal issues to strengthen trust with the next generation of clients.This two-part article will focus on the last three hypotheses, highlighting the importance of transforming banks to better capitalize upon the future of the banking industry. In this first part, we discuss how banks can leverage ecosystems to organize integrated networks and how they can expand services beyond banking to help clients focus on their core activities.ORGANIZING INTEGRATED NETWORKS IN THE AGE OF ECOSYSTEMSToday’s businesses maintain relationships with different banking providers, because there are no single banks that offer a truly comprehensive range of services nor an integrated platform. The convenience of a single interface offering a unified experience for all banking needs will become a baseline in the future, with regulations such as open banking now nudging the development of ecosystems to serve clients better. Because multiple providers will drive this ecosystem for clients to access an expanded menu of products and ancillary services, tomorrow’s leading banks will be simultaneously integrated, open and secure.Top-performing banks will still own client relationships but will also create their own ecosystems curated with products and services from third party partners through integrated platforms. This gives them an edge by focusing and excelling at their core competencies, innovating through open banking technologies, application programming interfaces (API), and attracting preferred third-party partners through niche offerings. Banks can utilize this advantage by developing macro and micro ecosystems to cater to client demand and major geographical markets.Banks can take another path to market leadership in three ways: by capitalizing on their scale; providing profitable niche services to multiple ecosystems; or specializing in products and services for specific industries. Other banks may even capitalize on their technological capability, experience with complex payments services, risk management experience and scale to provide ecosystem connectivity. The services these ecosystems can provide could also include for instance real-time payments and instant lending to SMEs.Banks need to thoroughly assess their strengths and weaknesses and embrace design thinking and agile working strategies. Plans must be made to heavily invest in cybersecurity, vendor management and strategies to build trust across their own ecosystems. Ecosystems are just one of the many new models that open banking regulation has paved the way for. Integrated partnerships provide the means to move forward, as proven by collaborations between banks and third parties such as FinTechs — and even with other banks and organizations that cater to niche markets, such as microfinance. This would mean determining which partnerships will be necessary to develop and scale integrated ecosystems and operationalizing said relationships.ENABLING BUSINESSES BEYOND BANKINGWith company success driven by focusing on core activities, more companies will need help with non-core activities, particularly those relative to key growth milestones. Banking providers can further deliver value by allowing their clients — especially SMEs — to focus on their businesses, strengthening client relationships by bringing in advisory, risk management, legal and other financial management capabilities in an accessible manner.Harnessing the power of ecosystems allows banks to launch integrated services, such as Chief Financial Officer in a box, corporate treasurer, financial risk and asset-liability manager, on-demand tax and legal advisor, payment and electronic invoicing utility, and model platforms. These would be particularly useful for firms planning mergers or acquisitions, geographic and cross-border trade expansion, supply chain restructuring, IPOs or funding rounds, or even insolvency and liquidation. Ecosystems will also allow banks to carve out niches in specific areas such as healthcare, connectivity, and infrastructure project finance. Offerings will no longer be limited to banking services but can even include the entire financial operating system to manage the business. For example, healthcare providers can engage banks to manage insurance, liquidity, billing and payments, in addition to traditional financing services and investment advisory. A more complex example for banks would be on the emerging case of cities, companies and communities embarking on sustainable and smart city strategies that would require innovative financing and investment structures as well as development strategies aided by integrated and logical frameworks, citizen and community engagement and geo-spatial location intelligence.Banks must be capable of deep integration into client corporations, institutional clients, supply chains and value networks to survive and flourish, as large corporations and institutions with established service providers will expect an integrated experience and seamless collaboration among banks, suppliers and vendors.In the second part of this article, we discuss how banks can provide leadership on critical societal issues to strengthen trust with the next generation of clients.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Christian G. Lauron is a Financial Services Partner of SGV & Co. He also leads the Firm’s Government & Public Sector.

17 May 2021

Roderick M. Vega

Prioritizing the integrity agenda in times of uncertainty (Second part)

Second of two partsThe difficulties of dealing with the pandemic have aggravated current integrity issues while presenting new ones for emerging markets all over the world. The emerging markets perspective of the EY Global Integrity Report, which surveyed more than 1,700 employees across all levels of large organizations in 21 emerging market countries, reveals that corruption and fraud remain major threats to long-term success for businesses in the wake of remote working conditions and regulatory scrutiny following the New Normal.The Global Integrity Report, conducted by global market research agency Ipsos MORI, presented relevant insights into the ethical challenges the organizations faced. By considering how the respondents dealt with areas of risk, businesses may gain insights about how to overcome some of the challenges to post-pandemic recovery.In the first part of this two-part article, we discussed the first of four key areas identified by the Integrity Report: prioritizing corporate integrity and encouraging the use of whistleblower channels. In this second part of the article, we discuss the need for an increased focus on data protection and cybersecurity, and the need to address integrity issues in third party service providers.INCREASING FOCUS ON DATA PROTECTION AND CYBERSECURITYRemote working during the pandemic has heightened the risk of cyber breaches, with more cyber criminals exploiting weak networks and targeting unsuspecting employees. The year 2020 saw a spike in ransomware and cyberattacks, infecting networks with malware and even selling fake COVID-19 treatments through phishing e-mails.Data breaches can result in devastating financial and reputational consequences for an organization, making it imperative to prioritize data protection. The EY report encouragingly shares that 55% of emerging market companies address this by offering employee training on how to prevent security breaches, a higher value than the 45% of companies doing so in developed markets. Should a security breach occur, 42% have an incident response plan in place. Moreover, as much as 86% even share confidence that they are doing everything they can to protect the data of their customers.With such high stakes, organizations should consider building a data privacy and protection framework guided and supported by the board. The increasingly sophisticated nature of cyberthreats and strict regulations result in the need to implement industry-leading practices and raise the bar to protect sensitive data. Companies can improve vigilance and identify issues by utilizing the latest technology, strengthening their virtual infrastructure, and raising cybersecurity and digital risk awareness among stakeholders. In addition, companies must consider developing thorough diagnostics scans, strong monitoring frameworks and incident response strategies.ADDRESSING INTEGRITY ISSUES IN THIRD-PARTY SERVICE PROVIDERSThough it is no mean feat to uphold integrity within an organization, external factors such as third-party partners can undermine existing efforts. The reputation of a retailer, for instance, will suffer greatly if one of its suppliers engages in malpractice, exploits loopholes, pays bribes, or engages in other similarly unethical behavior. These acts tarnish the reputation of the partnered retailer and subjects them to the high likelihood of financial loss, heavy penalties, or legal ramifications.The integrity report reveals that emerging market companies are aware of this particular threat, but with only 35% showing confidence that their third-party partners operate with integrity. Businesses cannot afford to place just their supply chain partners under scrutiny — sources of third-party risk can be found in distributors, joint-venture partners, contractors and consultants. However, despite the added challenge of restricted operations, remote working and limited mobility, 31% of emerging market companies address this risk through training and processes that highlight third-party due diligence.These challenging times pose an increased possibility of lapses in conducting due diligence, impeding internal reference checks, physical site visits and informal discussions that help identify potential gaps in conduct. However, this also gives companies the opportunity to reframe how they assess third-party risk. Digital solutions can be leveraged to streamline the assessment process, such as using data analytics to automate risk scoring and using automated dashboards for more efficient monitoring.CHAMPIONING A CULTURE OF INTEGRITYRisks to integrity have existed before and will persist beyond the pandemic. Employees may be tempted to risk the easy path regardless of accountability, cyberthreats increase in complexity and potential to expose vital data, and third-party risk creates more points of vulnerability in growing ecosystems.The report proves that emerging market companies recognize these threats and are making progress in addressing them, but there is still much to do. Businesses must expand their scope of focus past traditional aspects of integrity such as fraud, corruption and bribery, and must include measures in environmental, social and governance (ESG) criteria. With more customers prioritizing businesses with ethically sound practices, it is more important than ever to champion a culture of integrity not just because it is the right thing to do, but to also create long-term value.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.Roderick M. Vega is a Partner and the Forensic and Integrity Services (FIS) Leader of SGV & Co., and Dennis F. Antonio is an FIS Senior Manager of SGV & Co.

10 May 2021

Roderick M. Vega

Prioritizing the integrity agenda in times of uncertainty (First part)

First of two partsPressure from the COVID-19 pandemic on emerging market economies continues to impede business growth. Economies and companies all over the world are seeing unprecedented challenges and difficulties, which have further exacerbated potential integrity issues. According to the emerging markets perspective of the EY Global Integrity Report, corruption and fraud still pose a major threat to long-term success for businesses. While regulatory regimes and activities designed to strengthen company integrity have increased during the recent months, the remote working conditions and regulatory scrutiny following the New Normal have only aggravated existing issues while presenting new ones.The Global Integrity Report, conducted by global market research agency, Ipsos MORI, surveyed more than 1,700 employees from across all levels of large organizations in 21 emerging market countries. It presents relevant insights into the ethical challenges the organizations faced. From board executives to staff members, nearly 63% of the respondents believe it is difficult to maintain standards of integrity during periods of uncertain market conditions or periods of accelerated change. However, the report also reveals that emerging market businesses push efforts to mitigate misconduct, with 44% sharing how much easier it has been to report misconduct in the past three years, and 55% saying their management regularly communicates the significance of operating with integrity.The report discusses four key areas — ranging from cybersecurity to raising corporate integrity higher in the management agenda — that organizations must focus on in their integrity agendas. By considering how the respondents dealt with these areas of risk, businesses may gain insights into how to overcome some of the challenges to post-pandemic recovery. The first part of this article will discuss prioritizing corporate integrity and encouraging the use of whistleblower channels.PRIORITIZING CORPORATE INTEGRITYThe reputational damage from corporate integrity scandals can heavily scar the reputations of both the companies in question and their stakeholders, damaging even executives who are clearly not involved in such scandals. Stakeholder relationships are also impacted, compromising the long-term value of the involved business.It is critical for organizations to build an integrity agenda from the top and clearly communicate the relevance of acting with integrity. Corporate integrity is not a mere act of compliance — to act with integrity is both the right thing to do and a means to differentiate the business.Though frequently highlighting the importance of integrity in company-wide communications is an important step, actual action plans are much more significant. Senior management must reinforce their integrity message with clear examples, institute key performance indicators (KPIs) and have clear and quantifiable metrics to gauge the impact of their integrity initiatives.Formal policies and programs will provide an avenue for top management to set an example, emphasizing that everyone will be held responsible for their actions regardless of rank or individual performance.ENCOURAGING THE USE OF WHISTLEBLOWER CHANNELSAll employees should be heard. To truly embed integrity into an organization, it is critical to foster a culture of speaking up and active listening. Developing the right reporting channels not only provides a clear indicator of how the organization truly embraces integrity — it also discourages individuals from reporting issues directly to regulators or the media. Whistleblowing about unethical behavior can result in high-risk situations that may affect the reporting individual’s safety or lead them to fear reprisal both personally and professionally. The report states that 37% of the respondents in emerging markets do not report concerns about integrity due to apprehensions about their careers, while a worrying 29% choose to keep their concerns private due to fear of their own personal safety.However, progress is still being made, particularly in emerging markets, with 44% of companies saying it is easier to report concerns in the past three years, and 31% sharing that their companies offer more protection to whistleblowers compared to before. This is driven in part by tighter regulations in emerging markets, but it is also in the best interest of the company to make the whistleblowing process as easy as possible. Employees who are unable to bring their issues to management may instead go directly to a regulator or to social media, leading to a much higher risk of reputational damage. On the other hand, fostering “psychological safety” among employees can help drive productivity, employee satisfaction, and even workplace innovation.As a key pillar of any organization’s corporate governance framework, whistleblower programs require board oversight to be successful. Employees need to feel safe to report misconduct and believe that it is both a practical solution and in the best interest of the organization. Companies should provide multiple channels to report concerns so employees can choose an option that is comfortable and advantageous to them.A minimum requirement to consider for a whistleblowing mechanism includes a formal system that efficiently normalizes the process, such as case management, resource allocation, and clarity regarding how to speak up. Protection is also imperative, and anonymous complaints must be addressed by stakeholders.In the second part of this article, we will discuss the need for an increased focus on data protection and cybersecurity, and the need to address integrity issues in third party providers.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.Roderick M. Vega is a Partner and the Forensic and Integrity Services (FIS) Leader of SGV & Co., and Dennis F. Antonio is an FIS Senior Manager of SGV & Co.

03 May 2021

Karen Mae L. Calam-Ibañez and Aiza P. Giltendez

Redefining Philippine Taxation: CREATE (Fourth part)

Fourth of four partsThe first-ever revenue-eroding tax reform package and the largest economic stimulus program in the country’s history, Republic Act No. 11534, or the Corporate Recovery and Tax Incentives for Enterprises Act (CREATE), provides for major amendments to our tax and incentives laws. These changes are enacted with the goal of helping businesses move into post-pandemic recovery while encouraging more foreign investment. The law took effect on April 11.The first and second parts of this four-part article discussed the passage and goals of the CREATE Act, as well as the exemption of foreign-sourced dividends, the repeal of improperly accumulated earnings tax, tax-free exchange, additional provisions to consider and provisions that were vetoed.In the third part last week, we covered the nature of incentives before CREATE, their centralization and administration, and how they become performance-based and targeted. In this fourth and final part, we cover the periods of availment and the kind of incentives registered enterprises may enjoy.PERIOD OF INCENTIVESWith the intention to make incentives time-bound to encourage growth, CREATE no longer accords registered business enterprises (RBEs) incentives in perpetuity.Qualified export enterprises may be eligible for a four to seven-year income tax holiday (ITH), followed by either 10 years of 5% special corporate income tax (SCIT) on gross income earned (GIE) or 10 years of enhanced deductions (ED).On the other hand, qualified domestic market enterprises (DMEs) may be eligible for a four to seven-year ITH followed by five years of ED.As for DMEs, the grant of 5% SCIT incentives was vetoed since the same, according to the President, is redundant, unnecessary, and weakens the fiscal incentives system. If the government is to grant 5% SCIT to registered DMEs, then homegrown firms that are not registered, and make up most of the country’s micro, small and medium enterprises (MSMEs), will have to pay more taxes than registered DMEs. In the process, registered DMEs will have more legroom to reduce prices and secure more contracts, ultimately taking over the market and potentially threatening to put MSMEs out of business.An additional two years of ITH will be given to projects or activities of RBEs located in areas recovering from armed conflict or a major disaster.An additional three years of ITH will also be given to projects or activities registered prior to the effectivity of the CREATE Act that will, in the duration of their incentives, completely relocate from the NCR.In the interest of national economic development and upon positive recommendation of the FIRB, the President can approve extraordinary incentives for up to 40 years, where the ITH does not exceed eight years, followed by a 5% SCIT.The modified set of incentives or financial support package favors projects with comprehensive sustainable development plans, complying with set minimum investment capital or minimum local employment generation, among other conditions.The flexibility and range of authority conferred to the President in granting incentives is not new. ASEAN neighbors like Malaysia, Indonesia, Thailand and Vietnam have been exercising a similar level of discretion in granting incentives to boost their attractiveness and achieve their economic objectives.KINDS OF INCENTIVESIn computing the taxes due, the 5% SCIT is based on GIE, in lieu of all national and local taxes, just like the old 5% GIT. Nevertheless, the allowable deductions for purposes of computing the GIE must be clarified in the IRR to be promulgated by the DoF after consultations with the IPAs and other government agencies.Pre-CREATE, the issue on whether the enumeration of direct costs for purposes of GIE computation is exclusive or not has been the subject of various cases brought before the BIR and the courts. For PEZA-registered entities, the issue has finally been settled by the Supreme Court (SC) in the case of Commissioner of Internal Revenue vs. East Asia Utilities Corp. (G.R. 225266, Nov. 16, 2020) wherein the SC confirmed the non-exclusivity of the list of allowable deductions for purposes of computing PEZA-registered enterprises’ 5% GIT. This pronouncement by the SC on the proper interpretation of the allowable deductions for GIE computation, when articulated in the IRR, will, it is hoped, provide clear direction for the guidance of the implementing agencies and taxpayers alike.Meanwhile, at the regular CIT rate, registered enterprises may claim enhanced deductions that are expected to cushion the income tax effect. These enhanced deductions are: additional depreciation allowance of 10% for buildings and 20% for machinery and equipment; additional 50% direct labor expense; additional 100% research and development cost; additional 100% training expense; additional 50% domestic inputs expense; additional 50% power expense; a deduction of a maximum of 50% of the reinvested undistributed profits or surplus (for those in the manufacturing industry); and an enhanced Net Operating Loss Carry Over (NOLCO) of five years following the year of loss (incurred during the first three years from the start of commercial operations). In addition to the above incentives, all registered enterprises may enjoy duty exemption on the importation of capital equipment, raw materials, spare parts, or accessories directly and exclusively used in the registered project or activity. Registered enterprises may also enjoy VAT exemption on importation and VAT zero-rating on local purchases of goods and services directly and exclusively used in the registered project or activities.INCENTIVES SUNSET PROVISIONTo give IPA-registered enterprises ample time to adjust to the new incentives, RBEs with incentives granted prior to the effectivity of the Act are given a transitory period.Existing registered activities granted only an ITH will be permitted to continue the remaining ITH period.On the other hand, existing registered activities granted either an ITH and 5% gross income tax (GIT), or are currently receiving the 5% GIT, will be able to enjoy a 10-year 5% GIT. After the expiration of such 10-year 5% GIT transition period, existing registered export enterprises may reapply and enjoy the SCIT for 10 years, subject to certain conditions and performance reviews, and without further extension.The provision allowing export enterprises to further extend the 10-year SCIT has been vetoed by the President.Notably, unlike in the CITIRA Bill where existing RBEs were given the option to shift to the new tax incentives regime by surrendering their Certificate of Registration instead of availing of the sunset period, such a provision is wanting in the CREATE Act.With the passage of CREATE, provisions of the prior laws to the extent inconsistent with CREATE are repealed or amended.While fiscal incentives are not the only determinant for the country to attract investment, adjusting corporate taxes and modernizing fiscal incentives serve as a means for the country to remain competitive with its ASEAN neighbors. Redefining our taxation puts it in a better position to compete for investments and CREATE a better economic future for the Philippines.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Karen Mae L. Calam-Ibañez and Aiza P. Giltendez are a Tax Senior Manager and Manager, respectively, of SGV & Co.

26 April 2021

Karen Mae L. Calam-Ibañez And Aiza P. Giltendez

Redefining Philippine Taxation: CREATE (Third part)

Third of four partsRepublic Act No. 11534, also known as the Corporate Recovery and Tax Incentives for Enterprises Act (CREATE), is said to be the first-ever revenue-eroding tax reform package. The largest economic stimulus program in the country’s history, it provides major amendments to our tax and incentives laws with the goal of helping businesses move into post-pandemic recovery while encouraging foreign investments into the country. The law took effect on April 11, 2021.The first and second parts of this four-part article discussed the passage and goals of the CREATE Act, as well as the exemption of foreign-sourced dividends, the repeal of improperly accumulated earnings tax, tax-free exchange, additional provisions to consider and provisions that were vetoed.We continue by discussing the second salient feature of the CREATE Act: the codification and rationalization of Fiscal Incentives. In this third part, we cover the nature of incentives before CREATE, their centralization and administration, and how they are now more performance-based and targeted.INCENTIVES BEFORE CREATEThe Department of Finance (DoF) had long since been pushing for tax reform and the rationalization of fiscal incentives to improve governance in the grant of incentives and promote a fair and accountable incentive system that is performance-based, targeted, time-bound and transparent.Before the passage of CREATE, the various Investment Promotion Agencies (IPAs), such as the Philippine Economic Zone Authority (PEZA), Board of Investments (BoI), Bases Conversion and Development Authority (BCDA), Clark Development Corp. (CDC), and Tourism Infrastructure and Enterprise Zone Authority (TIEZA), administered their own investment regimes to registered business enterprises (RBEs) within their purview. In granting incentives, these IPAs exercised wide discretion, which allegedly resulted in detrimental and economically damaging competition among the IPAs.As ASEAN integration progresses, a regional comparison of tax incentives becomes more relevant. Pre-CREATE, it was indisputable that the scope of tax incentives in the Philippines was far more generous than the rest of ASEAN. The Philippines appears to be the only ASEAN country that grants incentives in perpetuity. The perpetual grant of incentives, which is believed not to have attracted the commensurate new investments, expansion projects or measurable economic contributions, may have discouraged growth and resulted in tax leakages or foregone revenue (estimated at P441 billion in 2017).By adopting a uniform policy and offering a single menu of incentives, the government hopes to cut down on redundancy and lost revenue.CENTRALIZATION OF INCENTIVES IN THE FIRBThe consolidation of IPAs into one centralized agency has been long proposed in order to centralize the promotion and administration of incentives in a single agency, consistent with international best practice.In a nutshell, CREATE centralized the oversight of the grant of incentives in the Fiscal Incentives and Review Board (FIRB). The primary role of the FIRB is to exercise policymaking and oversight functions on all RBEs and IPAs. As such, under CREATE, it is the FIRB that will, among other expanded functions, have the power to approve or disapprove the grant of fiscal incentives upon the recommendation of the IPA. The FIRB shall meanwhile delegate the grant of tax incentives to the IPA for investment projects involving P1 billion and below, though the President has clarified that the power of the IPAs to grant incentives only stems from a delegated authority from the FIRB. The FIRB is authorized to check whether the incentives granted by the IPAs conform with the intent to modernize the incentive system. The threshold, nonetheless, may be increased by the FIRB in the future.Consistent with the declared policy to approve or disapprove applications on merit, the provision granting automatic approval of applications with complete documentary requirements within 20 days of submission was vetoed by the President, who said that there are other mechanisms to address inaction in the approval process.TARGETING OF INCENTIVESCodifying the longstanding intention to make incentives performance-based and targeted, CREATE categorized RBEs into export enterprises, which export at least 70% of their total production or output directly or indirectly; and domestic market enterprises (DMEs). The President vetoed provisions further categorizing DMEs into those that are engaged in activities classified as “critical” by the NEDA, and those with a minimum investment capital of P500 million.Determining the availment period for incentives will be based on both the location and industry of the registered project or activity. This also includes other relevant factors as may be defined in the Strategic Investment Priorities Plan (SIPP), which is currently being worked on by various government agencies in consultation with the private sector.Location is prioritized according to the level of development such that activities in areas outside or not adjacent to the National Capital Region (NCR) or other metropolitan areas can avail of longer incentive periods.Meanwhile, the industry tiering of the registered project or activity is prioritized according to the national industrial strategy specified in the SIPP. We should note that the President vetoed the enumeration of specific industries in the CREATE Act to keep the law flexible enough to meet changing needs. As such, the activities and projects that may qualify should not be hardwired in the law so that the government does not keep on incentivizing obsolete industries and close its doors to technological advances and industries of the future.With the targeted grant of incentives, the government hopes to attract the right kind of investors to do business in the country, particularly those that offer quality jobs and technology transfer, and can introduce new industries that would allow the economy to flourish.In the fourth and final part of this article, we cover the periods of availment and the kind of incentives registered enterprises may enjoy.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.Karen Mae L. Calam-Ibañez And Aiza P. Giltendez are a Tax Senior Manager and Manager, respectively, of SGV & Co.

19 April 2021

Karen Mae L. Calam And Aiza P. Giltendez

Redefining Philippine Taxation: CREATE (Second part)

Second of four partsSaid to be the first-ever revenue-eroding tax reform package and the largest economic stimulus program in the country’s history, Republic Act No. 11534 or the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act was signed by the President on March 26. It amends our tax and incentives laws with the goal of helping businesses move into their post-pandemic recovery while encouraging foreign investment.In the first part of this series, we discussed the passing and goals of the CREATE Act and how it reduces Corporate Income Tax. In this second part, we continue by discussing additional changes: the exemption of foreign-sourced dividends, the repeal of improperly accumulated earnings tax (IAET), tax-free exchange, additional provisions to consider and provisions that were vetoed.EXEMPTION OF FOREIGN-SOURCED DIVIDENDSTo better compete within ASEAN, the CREATE Act adds a new provision on foreign-sourced dividends for domestic corporations with outbound investment. Generally, dividends received by domestic corporations from their subsidiaries abroad are subject to tax. This new provision states that these dividends are now exempt from income tax, provided that the domestic corporation directly holds at least 20% of the outstanding capital stock of the foreign subsidiary for at least two years at the time of dividend distribution. The funds must also be reinvested in the working capital, capital expenditure, dividend payments, investment in domestic subsidiaries, and infrastructure projects of the domestic corporation within the next taxable year from the time when the dividends were received. All these conditions must be met, otherwise the foreign-sourced dividends are subject to Philippine tax.This falls within the objective of encouraging businesses — particularly domestic corporations — to reinvest in the Philippines all profits earned here and overseas to help our economy recover from the downturn caused by the pandemic.REPEAL OF IMPROPERLY ACCUMULATED EARNINGS TAXThere will be no more IAET from 2021 onwards, which is great news for corporations that accumulate earnings beyond the reasonable needs of their business or paid-up capital. The imposition of IAET, ironically, compels the distribution of profits to investors or shareholders, or to repatriate the foreign investor’s money out of the Philippines instead of reinvesting or spending it locally. To address this, the CREATE Act now encourages investors to keep their money in the Philippines and potentially reinvest it in business expansion and generate employment.Since the repeal does not provide any retroactivity, it will follow the general effectivity date of the CREATE Act. As such, any excess retained earnings in 2020 and prior years will still have to be dealt with by the taxpayers and be appropriated or declared as dividends. Otherwise, it will be penalized through the imposition of 10% IAET on excess retained earnings.TAX-FREE EXCHANGEThe CREATE Act now expressly provides that a prior Bureau of Internal Revenue (BIR) confirmatory ruling will not be required to avail of the tax exemption in the case of business reorganizations, including mergers or consolidations, further control, recapitalization, and reincorporation. It likewise reiterates the TRAIN Law provisions that the sale or exchanges of property used for business for shares of stock are exempt from VAT and any gain or loss may not be recognized for tax purposes. This, however, only defers the payment of taxes since any subsequent transfer/s will be subject to applicable taxes on a substituted-cost basis. This new provision will ultimately reduce the problematic and long-running backlog of the BIR.One notable wording added to the CREATE Act is on “further control” under Section 40 (c)(2). It has put to rest the further control issue, a gray area in the past, by expressly stating that an exchange is tax-free when the “transferor or transferors, collectively, gains or maintains at least 51% of the total voting power of all classes of stocks entitled to vote of the issuing corporation.”ADDITIONAL PROVISIONSThe CREATE Act includes more provisions surrounding exemption from VAT. Upon effectivity of the Act, the sale, importation, printing or publication of educational reading materials, including those in digital or electronic format not principally used for advertisements, are exempt from VAT. Additionally exempted beginning Jan. 1, 2021 are the sale of medicines for cancer, mental illness, tuberculosis, and kidney diseases. Moreover, the sale or importation of COVID-19 drugs, vaccines and medical devices, COVID-19 treatment drugs for use in clinical trials, and the capital equipment, spare parts and raw materials for the production of personal protective equipment components are exempt from Jan. 1, 2021 to Dec. 31, 2023.VETOED PROVISIONSThe President vetoed the increase of the VAT-exempt threshold for the sale of real property by real estate developers, the 90-day period for the processing of general tax refunds, the definition of investment capital and the special corporate income tax incentive for domestic enterprises. Also vetoed were new incentives for same activity of existing registered enterprises, limitations on the power of the Fiscal Incentives Review Board, specific industries under the activity tiers, the power to exempt any investment promotion agency from the reform, and the automatic approval of applications for incentives.With the veto of the VAT-exempt provision on sale of real property, the sale of house and lot and other residential dwellings with a selling price of more than P2 million, along with residential lots regardless of the selling price, shall continue to be subject to 12% VAT beginning Jan. 1, 2021 except those qualified as socialized housing (based on price ceilings set by the Housing and Urban Development Coordinating Council) which remain VAT-exempt, pursuant to the TRAIN Law.Originally, Congress proposed to increase VAT-exempt thresholds to P2.5 million for the sale of house and lot and other residential dwellings, and to P4.2 million for the sale of residential lots which could have benefitted those who can actually afford proper housing. However, the President vetoed it to avoid potential revenue losses of about P155.3 billion.REDEFINING PHILIPPINE TAXATION FOR RECOVERY AND INVESTMENTThe passage of CREATE is certainly welcome to aid businesses during these challenging times, while also serving as a sign to investors that the Philippines is a worthwhile investment destination. Government efforts to redefine Philippine taxation by developing more globally competitive tax incentives and improving the current corporate tax system through wider tax bases, lowered tax rates and reduced tax leakage will hopefully progress the economy further along the path of post-pandemic recovery.In the third and fourth parts of this series, we continue our discussion on the CREATE Act by covering the rationalization of incentives.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Karen Mae L. Calam And Aiza P. Giltendez are a Tax Senior Manager and Manager, respectively, of SGV & Co.

12 April 2021

Karen Mae L. Calam And Aiza P. Giltendez

Redefining Philippine Taxation: CREATE (First part)

First of four partsA long period of uncertainty was ended after President Rodrigo R. Duterte signed Republic Act No. 11534, known as the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act on March 26.The CREATE Act is said to be the first-ever revenue-eroding tax reform package and the largest economic stimulus program in the country’s history, with major amendments to our tax and incentives laws. With the pandemic continuing to negatively impact the business landscape, it is hoped that these changes will support post-pandemic recovery while attracting more foreign investment into the country.In the first part of this four-part series, we discuss the passage and goals of the CREATE Act and how it reduces Corporate Income Tax (CIT).IMPROVING THE EFFICIENCY OF THE TAX SYSTEMSet to take effect on April 11, this legislation is part of the Comprehensive Tax Reform Program rolled out by the Duterte administration in 2017. After the passage of TRAIN Law in December 2017, the House of Representatives passed the Tax Reform for Attracting Better and Higher Quality Opportunities (TRABAHO) bill in September 2018. A year after it was transmitted to the Senate, the Senate renamed its version to the proposed Corporate Income Tax and Incentives Rationalization Act (CITIRA) bill.Neither bill had seen the light of day when COVID-19 hit. To combat the pandemic, governments around the world imposed strict lockdown measures that led to the reduction of business operations or outright business closures. Extended lockdowns severely impacted the business community, leading the government to realign its priorities in response to the needs of the economy while simultaneously encouraging investor interest in the Philippines. With this in mind, CREATE was drafted to improve the equity and efficiency of the corporate tax system by lowering the tax rate, widening the tax base, reducing tax distortions and leakages, and developing a more responsive and globally-competitive tax incentives regime that is performance-based, targeted, time-bound, and transparent.The House of Representatives and the Senate approved and passed different versions of the CREATE bill before deliberations by the Bicameral Conference Committee. On the last day of the 30-day period to act on the enrolled CREATE bill, the President signed it into law but vetoed certain provisions. These include the VAT-exempt threshold on the sale of real properties by real estate developers and the special corporate income tax incentive for domestic enterprises, among others.REDUCTION IN CORPORATE INCOME TAXAs of 2020, the Philippines imposes the highest CIT rate at 30% in ASEAN, where the regional average is 23%. To address this, the CREATE Act lowers the CIT rate for domestic corporations (including one-person corporations) to 25% of the taxable income beginning July 1, 2020 while that for companies with total assets not exceeding P100 million and taxable income not exceeding P5 million is lowered to 20% of the taxable income. In valuing the P100 million threshold, we should note that the land on which the particular corporation’s office, plant and equipment are situated shall be excluded as the appreciation of its value may remove small businesses from the 20% bracket. This threshold shall be determined on a taxable year basis.For resident foreign corporations (including branch offices), the CIT rate is lowered from 30% to 25% of the taxable income beginning July 1, 2020 while the interest income from a depository bank under the expanded foreign currency deposit system and gains from sale of shares not traded in the stock exchange received by the resident foreign corporations shall be taxed at 15%.Regional operating headquarters are subject to 25% CIT beginning Jan. 1, 2022. However, they may apply for incentives under the CREATE Act. The CIT rate for non-resident foreign corporations is lowered from 30% to 25% of the gross income beginning Jan. 1, 2021.With the lowering of the CIT rate, the non-allowable deduction for interest expense is likewise reduced from 33% to 20% of the interest income subjected to final tax. However, if the interest income tax is adjusted in the future, possibly in the tax reform package 4 or the proposed Passive Income and Financial Intermediary Taxation Act, the interest expense reduction rate may likewise be adjusted.To compute the CIT due, corporations adopting calendar year ending Dec. 31, 2020 are to multiply the total annual taxable income by the effective rate of 27.5% (under the 25% CIT rate) or 25% (under the 20% CIT rate), whichever is applicable, for domestic corporations, and 27.5% for resident foreign corporations.For corporations adopting fiscal years, the multiplier shall vary depending on the year ending. One way to compute the CIT due for those using fiscal years is to divide the total annual taxable income by 12 and multiply it by the number of months covered by the new rate. For example, for corporations with fiscal year ending March 31, 2021, the total annual taxable income shall be divided by 12 and the aggregate income from April 1, 2020 to June 30, 2020 is to be taxed at 30%, while the aggregate income from July 1, 2020 to March 31, 2021 will be taxed at 25% or 20%, whichever is applicable.This was put in place to ensure that taxpayers do not resort to the allocation of income and expenses that will yield a lower tax due.Since the CIT rate is reduced, a reduction of Expanded or Creditable Withholding Tax (EWT) rate should also follow suit to avoid any tax leakage. This will avoid a situation where the EWT tax due will be much higher compared to the income tax due of certain suppliers and hence, creating tax leakage. As a measure, the CREATE Act directs the Department of Finance (DoF) to revisit or amend EWT rules and regulations, including the tax rates, every 3 years.An additional benefit in the form of a deduction from gross income is also provided under the CREATE Act wherein businesses are given an additional deduction of 50% of the value of labor training expenses incurred for skills gained by enterprise-based trainees enrolled in public senior high schools, public higher educational institutions, or public technical and vocational institutions covered by an Apprenticeship Agreement, provided they secure proper government certification and the additional 50% labor training expense deduction does not exceed 10% of the direct labor wage.The CREATE Act also provides additional temporary relief to taxpayers beginning July 1, 2020 to June 30, 2023 by reducing the minimum corporate income tax from 2% to 1%, the CIT rate for proprietary educational institutions and non-stock and non-profit hospitals from 10% to 1%, and percentage tax from 3% to 1%.The adjustments in CIT rates will not only support big businesses but will ultimately provide relief to micro, small and medium enterprises, which constitute 99.5% of the total business enterprises in the Philippines, employ 62.4% of the total labor force, and account for 35% of gross domestic product and 35.7% of economic value. While this tax reform package will reduce the government’s revenue, the DoF hopes that this will help revitalize businesses and consequently, create more jobs for workers who have been greatly affected by the pandemic.While known for its skilled labor and professionals and relatively lower operating costs, the Philippines has unfortunately been left behind as investors tend to lean towards the more attractive fiscal system of our ASEAN neighbors. This recent development in our tax laws may be a good pull for foreign investors looking for more opportunities.In the second part of this four-part series, we will discuss more effected changes: the exemption of foreign-sourced dividends, the repeal of improperly accumulated earnings tax, tax-free exchange, additional provisions to consider and provisions that were vetoed.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Karen Mae L. Calam And Aiza P. Giltendez are a Tax Senior Manager and Manager, respectively, of SGV & Co.

05 April 2021

Aris C. Malantic

Embracing a new operating reality for corporate reporting

In the face of COVID-19, finance leaders find themselves having to strike a difficult balance in delivering corporate reporting. On one hand, they must respond to the pandemic with resilience and transparency; on the other hand, they must also generate long-term, sustainable value for stakeholders that focuses not only on financial outcomes but also on environmental and social impact.With performance now measured across broader dimensions, pressure is mounting to meet the demands for non-financial information in addition to credible financial disclosures. Finance leaders need to rethink how finance and corporate reporting can play central roles to meet the changing expectations of stakeholders, such as investors and regulators, and ensure that reporting remains relevant.It becomes imperative for corporate reporting to evolve and fully embrace optimizing value, with the goals of meeting the increasingly wide insight requirements of stakeholders and making corporate reporting central in realizing long-term value ambitions. The pandemic accelerated the demand for richer insights during this period of uncertainty, and such demand is unlikely to decline even when the pandemic is over. Stakeholders will very likely continue to search for organizations with a focus on long-term value creation.For corporate reporting to play an important role, finance teams must transition to the new operating reality and virtual environment imposed by the pandemic and its ongoing implications.THE CHALLENGES OF TRANSFORMATIONRespondents to the 2020 EY Global Financial Accounting and Advisory Services (FAAS) corporate reporting survey, who are composed of a thousand Chief Financial Officers (CFOs), financial controllers and other senior finance leaders, say that they are satisfied with this new operating reality shift, though it is not without its challenges. While communication with existing colleagues is effective, building personal relationships with new colleagues gained through acquisition or investments can prove difficult. More than half the respondents (56%) have also shared resistance to some of the changes introduced in their transformation journey. Moreover, 51% shared that when they failed to adopt new processes, finance team members simply reverted to traditional methods.Returning to previous ways of working could prove disadvantageous and failing to focus on the future of reporting could have significant consequences. It could result in cumbersome operating models and in finance teams being less relevant and agile, hindering their ability to provide the forward-looking insights stakeholders look for.With the increasing demand for non-financial information such as environmental, social and governance (ESG) and sustainability reporting from both stakeholders and regulators, CFOs are tasked with growing value along with their previous mandate of protecting enterprise value.Another challenge lies in the potential obstacles that can obstruct the means of measuring and communicating long-term value. One such obstacle identified by one in five respondents from the EY survey was the lack of formal reporting frameworks showing how the connection between intangible and tangible assets contributes to long-term value creation.Finance leaders need to consider how best to challenge traditional ways of working while mapping out an innovative future for the function. They can step in the right direction by focusing on building trust in technology and transforming finance and corporate reporting operating models.ACCELERATING SMART TECHNOLOGIES TO TRANSFORM THE FINANCE MODELTrusting technology, artificial intelligence (AI) in particular, is difficult when controls, governance and ethical frameworks still need further development and refinement. From the EY survey, nearly half the respondents (47%) share that finance data produced by AI cannot be trusted in quality compared to the data produced by the usual finance systems. This lack of trust could be reflective of a lack of understanding in how these systems work. Both AI and machine learning arrive at conclusions based on a large number of data sets, instead of an individual examining a single set with the possibility of introducing their own biases. This is why smart machines can likely perform data-driven tasks with more consistency, accuracy and efficiency.The future finance function looks very different in the eyes of the survey respondents, specifically due to a major shift to a more open and intelligent finance operating model. The survey shares that 53% of finance leaders anticipate that half of the finance and reporting tasks performed by a human workforce will be done by machines over the next three years. It becomes important to define a partner or managed services strategy to achieve the organization’s transformational goals, where many reporting activities could be handled by accredited providers of managed services instead of handled in-house. A cloud-based solution also becomes a major priority in tandem with advanced analytics and AI, providing infrastructure for AI processing as well as space for vast amounts of data.REINVENTING LEADERSHIP ROLES AND FINANCE SKILLSWith the evolution of the finance function, CFOs and financial controllers are likely to see their roles evolve as well. As much as 67% of survey respondents agree that CFOs will focus more on driving enterprise-wide digital transformation and growth than traditional finance responsibilities.Finance leaders will need to reassess the skills of their teams, and ensure they have people with knowledge of both digital processes and digital accounting. Even though machine learning can perform certain tasks more efficiently, a finance team will always need people capable of reading and understanding International Financial Reporting Standards (IFRS) statements. Finance operations will need problem-solvers with holistic views, logic and critical thinking. Leaders must take an innovative approach to reskill their people and equip them with the capabilities required for the future finance function.EMBRACING THIS NEW REALITY FOR THE FUTUREThough the pandemic continues to pose a significant challenge for finance leaders to deliver corporate reporting, the new operating reality and its implications invite CFOs and finance teams to approach the finance function with a fresh perspective. The New Normal dictates that finance leaders consider the reporting needs Now, anticipate the challenges to come Next and find ways to take the finance function Beyond.Those with foresight will likely find opportunity in today’s uncertain environment to challenge traditional ways of reporting and reaffirm its relevance beyond the pandemic.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.Aris C. Malantic is the Financial Accounting Advisory Services (FAAS) Leader of SGV & Co. and EY ASEAN. He is also a Market Group Leader in SGV & Co.

29 March 2021

Benjamin N. Villacorte

Sustainability reporting in the Philippines: Year One review

Today, as markets become more unstable, companies are obligated to create a sustainable business model and implement environmental and social initiatives that will benefit future generations as well as create long-term value for stakeholders.Now more than ever, organizations need to recognize the value of transparency in reporting by disclosing non-financial information through sustainability reports. Sustainability reporting is no longer just a nice-to-have program but has been elevated as a requirement for publicly listed companies (PLCs).GOVERNMENT MANDATE FOR SUSTAINABILITY REPORTSOn Feb. 18, 2019, the Securities and Exchange Commission (SEC) released Memorandum Circular (MC) No. 4, series of 2019, under the title Sustainability Reporting Guidelines for Publicly-Listed Companies, specifying the procedure for sustainability reporting in the Philippines. They require all PLCs to submit a sustainability report as part of their annual report each year.The Commission said this requirement will help companies assess and manage their contributions towards the attainment of the 2030 United Nations Sustainable Development Goals (UN SDGs) and the Philippine Development Plan 2017-2022 or Ambisyon Natin 2040.The first report was scheduled for submission in 2020, attached to the company’s 2019 Annual Report. For companies already producing sustainability reports in accordance with internationally-recognized frameworks and standards, their reports were considered sufficient compliance with the reporting requirement.The guidelines also mandate a “comply or explain” approach for the first three years upon implementation. This means that companies need to disclose specific non-financial information using a suggested SEC template or a standalone report attached to their Annual Reports. They can also provide explanations for required data that companies are unable to provide. Companies failing to adhere to the guidelines are subject to the penalty for Incomplete Annual Report provided under SEC MC No. 6, Series of 2015, Consolidated Scale of Fines.With the new regulation emphasizing the growing importance of non-financial disclosures, SGV conducted a review of how PLCs responded to the SEC requirement to publish sustainability reports and shared our findings in a study, Beyond the Bottom Line: Sustainability Reporting in the Philippines.The report reviewed 73 PLCs that submitted sustainability reports for the financial year ending Dec. 31, 2019, with the demographic based on the number of PLCs within an industry, information from industry briefings, and changes to local industry regulations. It also included nine listed holding firms that had been reporting on sustainability and non-financial information before the SEC requirement. The study was limited to publicly available information, such as the SEC sustainability templates appended to SEC Form 17-A, standalone sustainability reports, integrated reports and annual reports.The report also leveraged EY sector trends, the World Economic Forum’s Global Risks Report 2020 and SGV’s experience in supporting businesses in sustainability and non-financial reporting.WIDELY USED SUSTAINABILITY REPORTING STANDARDS AND PRACTICESKey findings from the study suggest that 64% out of the 73 companies reviewed used the reporting template provided by the SEC to ensure compliance on the first year. However, more organizations will likely transition to stand-alone or integrated reports moving forward. Of the PLCs assessed, 40% released stand-alone sustainability reports, while 30% disclosed sustainability information as part of their Annual Reports. Moreover, only a small percentage released Integrated Reports, which included financial and non-financial disclosures. These reporting formats are not mutually exclusive, as some PLCs disclosed their non-financial information using more than one reporting format.Among the PLCs submitting stand-alone reports, the most widely referenced or adopted sustainability reporting standard was the Global Reporting Initiative (GRI) Standards. Companies also used other frameworks or standards, like Sustainability Accounting Standards Board (SASB), Integrated Reporting (IR) Framework and Task Force on Climate-related Financial Disclosures (TCFD), to address other topics like climate change or industry-specific material sustainability topics.Further, only 11% of the PLCs obtained independent external assurance, all of which had limited assurance. Notably, obtaining assurance on non-financial information, while not required, is considered a global best practice. In fact, according to the EY Climate Change and Sustainability Services (CCaSS) investor survey, 75% of investors see independent assurance of a company’s processes and controls over sustainability reporting as “valuable” or “very valuable,” in addition to the 70% who say the same for non-financial and environmental, social, and governance (ESG) performance measures.ADDITIONAL INSIGHTS ON SUSTAINABILITY REPORTING PRACTICESAnother significant outcome observed was the focus on the UN SDGs, with 77% of the sustainability disclosures linked to the SDGs, and 45 PLCs using the SDGs to inform about their sustainability strategy, materiality assessment process and/or material sustainability issues. Incorporating the SDGs in a company’s sustainability strategies ensures that their products, services and programs contribute to attaining the global sustainability goals.Moreover, 60% established the scope and boundary of their reports while only 52% disclosed their materiality assessment process, or the method used to determine the sustainability issues material to the company and their stakeholders. Material sustainability issues are the key focus areas addressed by a company and relevant information or plans in these areas are included in its sustainability report. Stakeholder engagement is an important part of the materiality assessment process to demonstrate that companies listen to their stakeholders and address their concerns.Meanwhile, only 32% disclosed having sustainability governance in place, which is not surprising since sustainability reporting is relatively new to the country. However, as sustainability issues continue to take center stage in developing business strategies, business leaders should consider having a member of management spearhead sustainability within the organization.On specific disclosures, Occupational Health and Safety (OHS) was the most disclosed topic by PLCs, while the least discussed were environmental topics. This presents an area for improvement for PLCs as they will not be able to fully address their ESG impacts, risks and opportunities without measuring or reporting on environmental topics.REITERATING THE SIGNIFICANCE OF NON-FINANCIAL REPORTINGThe report reveals that the first year of reporting focused more on compliance. However, it still met the objective of creating awareness and inclusion of sustainability on the board and management agenda. Due to the impact caused by the pandemic, it is very likely that the 2020 sustainability reports will heavily focus on health and safety, with pandemic response programs such as Department of Labor and Employment (DoLE)-mandated safety protocols, testing and vaccinations getting reported as part of ESG concerns. We also expect more robust disclosures on climate-related matters such as decarbonization, baselining energy consumption and air and greenhouse gas emissions.In addition, PLCs can improve their reporting on topics such as waste management to address pressing global concerns; resource management, specifically of materials and water, since unhampered consumption is not sustainable; and the protection and rehabilitation of biodiversity and ecosystems affected by operations to minimize negative environmental impact. Another area which may be improved further is social issues, particularly privacy and data security, after the pandemic rapidly shifted professional communications into the digital space.After the initial year of compliance with the new SEC requirement, PLCs will hopefully realize the significance of non-financial reporting and develop strategies that incorporate global and national development goals. By measuring and addressing their current sustainability impacts, risks and opportunities, they can help create long-term value for stakeholders, and at the same time, ensure a sustainable future for generations to come.This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.Benjamin N. Villacorte is a Partner and Yna Altea D. Antipala is a Senior Associate from the Climate Change and Sustainability Services team of SGV & Co.

2021