Suits the C-Suite

02 December 2019

Narciso T. Torres, Jr.

Cars, not horses: Creating a sustainable growth advantage

Realizing growth is a challenge for all entrepreneurs who dream of creating and scaling their startups into tomorrow’s multinational corporations. However, early successes in the fast-paced initial phase of development do not necessarily guarantee an enduring competitive advantage and business sustainability. What then sets apart market-leading entrepreneurs from those who failed? In Daring to Compete, a new EY book exploring studies based on interactions with winning entrepreneurs of the EY Entrepreneur of the Year program, it was established that despite their differences in size and industry, leading entrepreneurs share a disciplined framework for growth. Such a framework helps companies align their capabilities with their growth strategies and find gaps by focusing on the seven drivers of growth: customer, people, behavior and culture, technology, operations, transactions and alliances, finance and funding, and risk. This framework, which the book identified as the EY 7 Drivers of Growth, discovers what all businesses will need to manage and evolve as they progress through their various stages of development. PRIORITIZING CUSTOMER-FOCUSED DIGITAL TRANSFORMATION Most companies service their customers directly in the early stages of business, equipping them with the ability to build direct relationships. However, competing operational priorities can easily cause a business to lose focus on its customers. Successful entrepreneurs know that to become market leaders, they must not only meet their customers’ expectations – they must exceed them. It should be noted, however, that this does not always mean giving the customer what they want, such as the case with Henry Ford. The father of the automobile industry famously said that if he’d asked what his customers wanted, they would have asked for faster horses. By finding an alternative perspective of the customer’s needs and wants, a company can disrupt the market, and create a truly sustainable advantage. Moreover, by challenging traditional business models and continuously raising the bar, today’s companies are bound to seek digital innovation. Evolving businesses do not initiate digital transformation out of a simple interest in technology; they do so to focus on customer agility and business change. Digital technologies such as data analytics allow them to make faster, smarter decisions to improve business performance, manage risk, and enhance operations. While this potential value is recognized, businesses still find it difficult to successfully utilize information technology to deliver business change. This means business leaders need to ask themselves the question of how to adapt their business model to create new opportunities, roles, and skills in light of new technologies, and effectively integrate these new technologies into the relevant aspects of their business. BALANCING SPEED AND SUSTAINABILITY A modernized workforce is key to leveraging new technologies, but companies, particularly those in their nascent stages, face their own challenges in attracting and retaining skilled individuals. For this reason, market-leading entrepreneurs prioritize attitude over skills when recruiting talent and make it a point to invest in training their workforce to meet the evolving demands of their business. As businesses scale from start-ups into multinational corporations, they also face the need to adapt their performance and reward structures to recognize behaviors that contribute to their long-term growth. Investing in both people and technology requires the right amount of funding at the right time. Leading entrepreneurs time their capital needs by planning their cash flow, setting key milestones, and sourcing for appropriate types of financing. Both human and financial capital can only grow at a certain rate, requiring a consistency that produces the highest likelihood of sustainable progress by strategically planning ahead instead of being opportunistic when it comes to growth. This poses the question to entrepreneurs of how to balance sustainability and speed in their businesses. EMBRACING CALCULATED RISKS New technologies and business processes lead to new risks. But while stereotypical entrepreneurship introduces the idea of risking everything, it is neither a useful nor healthy mindset in terms of effective risk management. It is true that market-leading entrepreneurs embrace the positive forces of risk, but they also employ a discipline that leads to taking only calculated risks. This involves weighing any potential disadvantages and assessing their ability to absorb the potentially negative impact of their decisions. Leadership plays the role of gatekeeping risks in the early stages of a company’s growth, but as the business grows, company leaders will need to formalize or refresh procedures and internal controls. Business risk increases and diversifies with growth and can come from both inorganic and organic expansions. Entrepreneurs can mitigate the risks from accessing product segments and new markets through strategic acquisitions, alliances, and partnerships. Evaluating these risks and performing thorough assessments are key components of the structuring and deal negotiation process. Circumstances may evolve at any point through this development, resulting in adjustments in price, revisions of terms and conditions, or the decision to simply let it go and walk away. Even as the customer remains the focus of growth strategies, entrepreneurs must effectively pace the growth of their business by balancing their investments and attention across the seven growth drivers. This not only provides an increased potential for sustainable growth, but an enduring advantage in the competitive businesses landscape. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Narciso T. Torres, Jr. is a Partner and a Market Group Leader of SGV & Co.

25 November 2019

Benjamin N. Villacorte

Are sustainability reports a fad?

Wider corporate reporting is being promoted as a means to improve corporate governance, as stated by International Accounting Standards Board (IASB) Chairman Hans Hoogervorst in his speech in Tokyo on Aug. 29, 2018. The IASB chair admitted that financial reporting has its limitations and cannot adequately capture certain elements that might be important to stakeholders, such as the intangibles that are vital to the company’s business model and its strategy for long-term value creation. Financial statements are essentially backward-looking reports that contain limited forward-looking information, which means that in their current state, financial statements do not address emerging sustainability issues that might impact a company’s future cash flow. However, the IASB Chair made it clear that the Board is not equipped to enter the field of sustainability reporting directly. He recognizes in a speech about sustainability reporting in April at Cambridge University that the Board does not have the expertise required to set sustainability reporting standards. Additionally, he notes that there are already several standard setters in this space. Mr. Hoogervorst also pointed out that regulators and stakeholders should not have exaggerated expectations that sustainability reporting will act as an agent of change and will be effective in forcing companies to “prioritize planet over profit.” That being said, clear public policies can certainly help effect change, and financial incentives are crucial to swaying companies to address material sustainability issues. The rise of sustainability reporting that focuses on stakeholders and provides information about the impact of sustainability issues on the future returns of the company is the most promising development in this space, according to the IASB Chair. While the IASB will not directly participate in sustainability reporting, it is addressing the limitations of financial reporting through its “Better Communication in Financial Reporting” project. This initiative aims to improve financial communication not by creating new standards, but by providing guidelines on how to better present information that has already been collected. The project contains several strands of work, one of which is revising and updating the Management Commentary (Practice Statement) to include a report on how material sustainability issues may impact the business. The IASB is expected to publish an Exposure Draft of the Practice Statement in the second half of 2020. On the local front, the Securities and Exchange Commission (SEC) has released a memorandum requiring publicly-listed companies (PLCs) to submit their Sustainability Report together with the 2019 Annual Report (SEC Form 17-A) in 2020. The memorandum issued early this year stated that the guidelines are to be adopted on a “comply or explain” approach for the first three years upon implementation. This means that “companies will be required to attach the template to their Annual Reports but they can provide explanations for items where they still have no available data. However, by 2023, PLCs will need to comply with the Sustainability Reporting Guidelines specified in the memo, or be subjected to the penalty for Incomplete Annual Report (under SEC Memorandum Circular No. 6, Series of 2005). Like traditional financial reporting, rigorous climate-related financial disclosures do not happen overnight. The path from start to finish can involve twists and turns, as well as the coordination of many moving parts, thereby requiring the collaboration and expertise of a variety of corporate functions to achieve an organization’s ultimate reporting objectives. The following are key action steps companies can take now to prepare themselves for reporting non-financial information. 1. Secure the support of your board of directors and executive leadership team. 2. Integrate climate change into key governance processes, enhancing board-level oversight through audit and risk committees. 3. Bring together sustainability, governance, finance, and compliance colleagues to agree on roles. 4. Look specifically at the financial impacts of climate risk and how it relates to revenues, expenditures, assets, liabilities, and financial capital. 5. Assess your business against at least two scenarios. 6. Adapt existing enterprise-level and other risk management processes to take account of climate risk. 7. Solicit feedback from engaged investors about what information they need to know about climate-related financial risks and opportunities. 8. Look at existing tools you may already use to help you collect and report climate-related financial information. 9. Plan to use the same quality assurance and compliance approaches for climate-related financial information as for finance, management, and governance disclosures. 10. Prepare the information you report as if it were going to be assured, even if you decide not to do so right now. 11. Look at the existing structure of your annual report and think about how you can incorporate the information into your discussion of risks, management’s discussion and analysis (MD&A), and the governance section. The recent pronouncements of the IASB and SEC on the need for reliable and accurate sustainability reporting underlines the necessity for companies to assess and manage its non-financial performance towards achieving the universal target of improved sustainability. However, for sustainability reporting to be effective and useful, companies should not only view it as an exercise in compliance, but actually a responsibility of every corporate citizen to measure and document their best practices towards achieving the goals of sustainable development to meet the needs of the present without compromising the ability of future generations to meet their own needs. It would seem then that need for sustainability reporting is here for good. In which case, companies are encouraged not to wait for sustainability reporting standards, or a regulatory requirement, to be mandatory. The time to act for the greater good is now. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Benjamin N. Villacorte is a Partner of SGV & Co.

19 November 2019

Wilson P. Tan

Suits The C-Suite By Wilson P. Tan

With the dizzying speed of digital disruption occurring in the global business environment, small and medium enterprises (SMEs) are increasingly realizing the urgent need to explore digitalization. Incorporating digitalization in their business will help expand and create new sources of value for their enterprises to remain competitive and relevant to their markets. In my recent article, I wrote about the findings of a recent EY study, Redesigning for the digital economy: A study of SMEs in Southeast Asia. In the report, almost 370 SME executives expressed as their top priorities leveraging digital technology and prioritizing the improvement of their customer service. However, to properly implement digitally-enabled operations and meet the consumer’s increasing demand for personalization and convenience, businesses will need the support of a modernized workforce to actualize their strategies. The function of modernized talent is critical to a company’s digital transformation. This increasing demand for appropriate digital services gives rise to new digital roles, such as digital marketers, data scientists, and automation engineers. At the same time, current employees will, by necessity, be disrupted by digital solutions that replace repetitive tasks, such as intelligent automation technologies and robotics process automation (RPA). While the use of intelligent and automated platforms to enhance efficiency will require the traditional workforce to adapt, these new and enhanced roles present the opportunity for companies to reboot their people programs and help employees focus on strategic, more value-added tasks. THE CHALLENGES OF WORKFORCE ADAPTATION The same study on SMEs had identified two main constraints that enterprises face in adapting their workforce to enhanced, digital roles. First is capacity and second is resources. SMEs specifically lack access to digital talent and face challenges in upgrading the skills of their employees, which understandably creates a gap between smaller enterprises and their multinational counterparts. Many SMEs also have the disadvantage of looking less attractive to potential candidates with the right digital skills compared to larger companies with more established names and deeper pockets. In addition, they face the struggle of prioritizing effective development programs to upskill their current workforce in light of other competing business priorities. REDESIGNING THE MODERNIZED WORKFORCE Challenges aside, SMEs will need to go beyond identifying the roles and skills required to achieve their digital transformation. They are expected to also dedicate employees to specific digital roles instead of merely assigning these roles to existing employees as secondary positions. For example, the role of social media manager can often be a full-time job, yet some companies simply assign this task to existing sales or marketing personnel who may not have the experience and exposure to maximize and manage social media assets. SMEs will have to consciously take active steps to evolve their current workforce into one that can maximize digital investment insights and productivity gains. One means to achieve this is by developing a clear view of critical digital roles, functions and skills instead of falling into the trap of blindly following hiring trends. SMEs need to assess and identify what roles are specifically designed to support their own digital transformation strategy. These roles and skills should then be adapted to form the career pathways of an organization, allowing management to conduct effective strategic workforce planning for the company’s future needs. A clear overview of their talent needs also allows management to further maximize their limited pool of human resources by deploying them into strategic roles. Furthermore, this allows management to address capability gaps through targeted employee skill development initiatives and talent attraction. For companies to effectively redesign job functions and business processes, they must leverage insights from the analysis of people data to support changes and decisions. SMEs also need to consider how to best incorporate digital solutions into any redesigned roles to improve efficiency as well as employee and customer satisfaction. This alleviates the pressure on talent shortages by expanding the workforce’s capacity to take on enhanced roles. PRIORITIZING THE ROLE OF DIGITAL Over and beyond considering technological or digital solutions, what is more essential is for SMEs to adopt a digital mindset and develop a digital work culture. This mindset and culture will effectively develop agility and further drive innovation. Attaining this end-goals will entail an assessment and the transformation of traditional policies, processes and platforms to better adopt and support digital thinking. As an organization undergoes digital transformation, SMEs will benefit from engaging their employees by working together with them to minimize resistance and drive the necessary behaviors to integrate digitalization into the company. They can achieve this through effective change management and positive reinforcement through rewards linked to performance and employee recognition, both of which can go a long way in nurturing a digital work culture. The leveraging of transformative technologies should serve as an enabler for SMEs instead of a complete replacement of their human workforce. Disruptive forces will continue to challenge SMEs in the digital age, making it increasingly apparent that digitalization cannot be relegated to a one-off project — it is by necessity a continuous and evolving journey with great impact on the entire workforce. SMEs that prioritize digital roles and fully embrace a digital mindset will, in all likelihood, achieve a competitive edge that leads to success in the digital economy. The question now for individual SMEs is, is it better for you to reboot your digital people strategy or invest in robotic processes? Or find a solution that combines both? This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Wilson P. Tan is the Vice Chairman and Deputy Managing Partner of SGV & Co.

11 November 2019

Faith Mariel N. Reoyan

Seven lessons from IFRS 17 live engagements

The financial statements of companies issuing insurance contracts are bound to change dramatically beginning Jan. 1, 2022, as the date marks the global adoption of International Financial Reporting Standard (IFRS) 17. IFRS 17 introduces the concept of deferring profit and recognizing this profit over the duration of the contract. This significantly changes the way companies measure and account for long-term insurance contracts. This poses the question of whether current financial metrics will remain relevant (such as gross premiums as a basis for ranking) and even if so, new metrics will surely be introduced (such as the future profits for new business) upon adoption of IFRS 17. Along with this key change, several requirements of IFRS 17 will force companies to implement changes to their data, systems and processes. While local companies are given an additional one-year reprieve at this time, companies should ideally be either in the last stage of their impact assessment or in the early phase of their implementation. Though the implementation experience varies from one company to another, several unique insights and lessons can be gained from each company’s IFRS 17 journey. We present seven important lessons learned from our own live IFRS 17 engagements which are bound to benefit the insurance industry. 1. DO IT NOW It is essential for companies that have not started any IFRS 17 activity to begin with a comprehensive data gap analysis. This will provide a view of the extent of work needed to implement IFRS 17. While 2023 might seem far away, it will easily take an average of 12-15 months to change systems and processes that conform with the new rules. Extra time will be better spent on parallel runs rather than on impact assessment. A detailed timeline including milestones and key dates should be clearly in place, with leeway for potential setbacks, whether these are caused internally or externally. Several key decision points that can affect the overall implementation journey also need to be addressed early on. The most critical of these is deciding whether the ambition level for change is for minimal compliance, smarter reporting, or a full finance transformation. 2. THE OPPORTUNITY TO UNLOCK THE POTENTIAL OF CROSS-FUNCTIONAL TEAMS Implementing IFRS 17 is more than just an accounting and compliance task; it should encompass a team that consists, at a minimum, of the following competencies: a. Accountants b. Actuaries c. Finance Subject Matter Experts d. Technology Subject Matter Experts e. Project and Change Managers Currently, there is a scarcity of talent equipped with IFRS 17 knowledge and experience to lead and drive the implementation. A reasonable assessment of a company’s internal resources should be performed to match each employee’s skills and availability to identified workstreams. Accountants and actuarial resources for most insurers are already stretched with business-as-usual (BAU) activities and other ongoing conflicting internal initiatives. This resulting gap must then be properly addressed with IFRS 17 content owners and drivers, whether to hire new employees or contract external advisors. The team should also have a strong and effective project manager with IFRS 17 content knowledge to ensure everyone is on the same boat and that key stakeholders are well-briefed and engaged. To plan for a sustainable future, companies need to adapt to an evolving relevant mix of resources, skills and capabilities to properly implement expected changes in the business under the new standard. A clear governance structure should also be in place to enable the timely alignment of key decision points. 3. LEARN TO MANAGE THE DETAILS IN THE DATA IFRS 17 has extensive requirements for data quality, calculation, transfer and storage. Experience suggests that data cleansing should be initiated, considering both accounting and actuarial perspectives, before embarking on any data transformation. Though it may vary from one company to another, securing the availability of clean and controlled source data to be extracted can take longer than expected. Significant time in the project plan must be invested to determine how information would feed smoothly into the IFRS 17 Information Technology solution. The vast data requirements will then need to be managed continually and effectively. This can be particularly useful for decision-making factors such as real-time data driven pricing models, “what if” scenarios, determining the most critical key performance indicators, and identifying high-risk transactions or customers. 4. EMBRACE TECHNOLOGY AS A KEY ENABLER For large multinational companies, it is apparent that one of the significant line items in the IFRS 17 budget will be the cost of acquiring a new system or changing an existing one. Most companies expect to change existing systems to operationalize and further centralize their modelling systems. While certain life companies have decided on a software vendor, most are still in the process of vendor evaluation and selection. One of the challenges encountered is the current assessment of system architecture. This pertains, but is not limited, to the complexity of system architecture, data granularity to support required reporting in the future, current functionality uses and existing model updates, the number of reporting basis and ledgers, and the alignment of various processes under one workflow software, whether this is built in-house or purchased. There is no magic “one size fits all” solution available but companies in the midst of designing or upgrading their systems, need to revisit their programs to consider the potential impact of the proposed IFRS 17 amendments. In addition, a big consideration is to have an integrated data model covering both actuarial and finance systems, ensuring that the technology and data are aligned and not just the workstreams. 5. THE NEED FOR KNOWLEDGE TRANSFER AND STAKEHOLDER AWARENESS IFRS 17 training should be provided to core team members to keep them abreast of current developments and proposed amendments. Collaborative awareness and education sessions must be continually adopted with a phased rollout approach not only for key team members but also for other relevant internal and external stakeholders. Moreover, members of the core team should be expanded to include members of BAU processes to facilitate a smooth transition. 6. TALK TO THE RIGHT PEOPLE EARLY ON Participating in industry working groups, advocacy initiatives with local regulatory bodies, and submitting comments and feedback to the International Accounting Standards Board will enable companies to raise peculiarities or transactions requiring special handling. The earlier the concerns and challenges are heard and addressed, the easier it will be for companies to incorporate necessary action required in their implementation activities. Proactiveness in reaching out to national standard-setting bodies and regional groups has a vital role in ensuring that the interests of the company are heard. These groups undertake relevant research, conduct surveys and identify emerging issues, thus providing further opportunities for companies to benchmark against the experiences and best practices of one another. 7. FORM A CHANGE MANAGEMENT TEAM Consideration to turnover, the language, and communication methods for employees to manage resistance and change fatigue, should be in put in place. External stakeholders must also be included in the plan, as many will be interested to know the projected changes to key performance indicators and revenue-driven metrics that will serve as the new language when presenting business results. A WAITING OPPORTUNITY As the timeline shortens with the approaching deadline, the key to a successful and relatively smooth adoption generally rests on management ensuring that the collaboration of the several moving pieces is closely monitored. Companies can take this as an opportunity to adapt and emerge from the change to further drive growth and agility. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Faith Mariel N. Reoyan is an Advisory Senior Manager of SGV & Co.

04 November 2019

Clairma T. Mangangey

Digital audits: the advantages add up

The rules of business have changed. Gone are the days when business leaders had the luxury of time to ponder significant business decisions and make momentous changes to their organizations or processes. Now, businesses are transacting and making decisions practically in real time, which also necessitates that businesses manage risks and leverage opportunities with speed, accuracy and efficiency. As auditors, we have an unparalleled view of all the aspects of a business — both up-close from an operational standpoint, as well as from a larger perspective in the global business environment. This combination of macro and micro views allows auditors to be well-placed to advise businesses on possible risks. But given the changes in the business environment, it is not enough to simply have a deep understanding of business, accounting principles and regulatory requirements — auditors in today’s digital age also need to adopt a digital-first mindset in order to elevate traditional audits with more digital dimensions. MANAGING AUDIT DATA We operate in an age where connectivity is becoming ever more seamless, making the sharing of data among businesses, customers and even governments a standard practice. As connectivity increases, we move into a time where operational, transactional and financial data will eventually reside on shared networks instead of physically with companies. Auditors who can connect to these networks directly and issue audit instructions instantaneously through a secure and dedicated online platform can greatly streamline the audit process. No longer will clients have to manually transfer massive data files and communicate via e-mails — all parties involved in an audit can now manage and view their data on one shared platform or client portal. In fact, SGV, as a member firm of EY Global, leverages such a proprietary global tool called EY Canvas. The client portal linked to EY Canvas provides live, real-time reporting on the actual status of audit requirements and issues alerts to all parties on any concerns as they occur. This means that everyone from the audit engagement team to a client’s management team are always on the same page in the audit, increasing efficiency, flexibility and transparency. This is particularly useful for companies with a large global footprint since the superior connectivity effectively removes physical boundaries and enables operations to be digitally enabled across locations. Even as a business spreads out globally, auditors can have the flexibility and scalability to conduct an audit regardless of size, complexity or location. Understandably, such data-sharing platforms also necessitate a greater focus on data security and privacy. The greater challenge and opportunity, however, is in mining the data for valuable insights and information. ANALYZING AUDIT DATA The sheer volume of data generated through data sharing platforms can make identifying risks more challenging. Auditors have to develop new approaches to process data and document information, which thankfully, rules-based automation can now handle with ease and accuracy. The advent of technology now allows auditors to focus on areas that require judgment, which makes the case for data analytics-driven audits. By today’s evolving standards, a high-quality audit is one that can both process and interpret data in meaningful and consistent ways, helping businesses identify anomalies, operational, financial and non-financial risks. This requires a suite of powerful data analytics technologies, such as the array of data analyzers we have with our EY Helix platform. Why is data analytics so important? First, the high processing speed and capabilities of data processing technologies can cover the entire data population loaded into EY Canvas, rather than the traditional method of random sampling. This complete coverage provides even greater assurance to the people who oversee governance and compliance. Second, by applying data analyzers to comprehensive and granular data, auditors are able to do deeper analysis to uncover new perspectives and improvement areas. Third, data analytics technologies are able to conduct a “continuous audit,” allowing audit efforts to be spread out across the year instead of only during peak periods. This allows an audit that is more efficient and productive, and where clients and auditors can focus on issues rather than processes. MAXIMIZING AUDIT DATA With the insights gleaned through thorough data analytics across a seamlessly connected audit data management platform, robotic process automation (RPA) and artificial intelligence (AI) technologies are now applied to further digitize the audit. By using RPA and AI, tedious mundane processes such as bank and accounts receivable audit confirmations can be done without human error. At the same time, digitizing these transactions open the possibility of data analytics providing even more insights and alerts to audit teams for necessary actions. Intelligent automation and AI in the audit process can help filter data or deliver initial findings, which allows auditors to focus on higher value analysis and raise audit quality. CROSSING THE DIGITAL DIVIDE At its core, the idea of a digital audit, however, implies more than just using digital tools and technologies in the audit process. A digital audit requires adopting a truly digital mindset, one that embodies seamless project management and drives global audit coordination. Having a digital mindset means developing new attitudes and behaviors that allow auditors — and clients — to foresee possibilities while being increasingly resourceful, innovative, adaptable and open to leveraging emerging technologies to change traditional processes. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Clairma T. Mangangey is a Partner and the Quality Enablement Leader of SGV & Co.

29 October 2019

Fahkriemar H. Limpasan

Is there a sweet spot in the new tax laws? Part 2

(Second of two parts) In the previous article, we discussed the salient points of the excise tax on Sweetened Beverages (SBs), the costs associated with its implementation, compliance with applicable regulations, and the applicability of the Prior Disclosure Program (PDP) to importers of SBs. In this second part of the article, we will examine some business considerations which importers as well as producers in the SB industry should consider, including possible opportunities brought about by the new excise tax law. IMMEDIATE IMPACT Given the law’s health objective, its impact was immediately felt upon implementation. According to Nielsen Retail Index, the sales of SBs weakened in the first few months due to the implementation of the excise tax. This was expected considering price increases normally push away consumers. An importer should consider ways to manage the immediate short–term impact of the new tax while waiting for the market to adapt and adjust to the increase in prices. There should be initiatives to address additional costs, while at the same time, maintain market share. For instance, sales efforts may become more targeted, such as towards SB consumers who are not price sensitive, or for whom promotional activities may be effective. At the same time, companies may wish to consider making price increases more gradual to ease the price impact on existing consumers and better manage their expectations. An importer of SBs may also consider sourcing goods from suppliers in countries that have Free Trade Agreements with the Philippines to avail of lower or preferential tariff rates, if any. This would help manage the cost that would have to be incurred by the business and passed on to customers. TAX SAVINGS VS IMPORTATION COSTS Based on the letter of the law, the only way for an SB importer to be exempt from the tax is to use purely coconut sap sugar and purely steviol glycosides. Otherwise, the importation becomes subject to the excise tax. Some companies have already gone this route and changed their formulations to use purely coconut sap sugar and steviol glycosides as sweeteners. Previously, this was considered a more expensive option, but with the imposition of the excise tax, these companies opted to reconstitute their imported products. However, the importers should consider the actual costs of the sweeteners exempt from excise tax. For instance, stevia is more expensive compared to the sweeteners subject to excise tax. Importers will need to conduct proper cost-benefit studies specific to their processes and operations to weigh the benefits of a change in sweetener used. Moreover, the importers should also consider the possibility of losing market share if there is a change in the sweetener used in the SBs, particularly if their market is taste-sensitive. While a change in the sweetening ingredient of the SB may result in possible tax savings, an importer should also factor in the preferences of the target market. OPPORTUNITY TO TARGET A HEALTH-CONSCIOUS MARKET The reality is that the Philippines is not the only country to implement a tax on SBs. Other countries have implemented or will implement similar taxes. The underlying factor among all these is the objective of improving the overall health of a country’s population. Given this general direction among different jurisdictions, there is an opportunity for players in the SB industry to cater to a specific market, i.e. those who look for healthy alternatives to SBs. In fact, developing “healthier” SB brands or formulations may even present new market possibilities abroad, with local producers eventually exporting SBs to health-conscious consumers outside the Philippines. In the Philippines, according to the National Tax Research Center, citing data from the Philippine Statistics Authority in 2015, the annual family expenditure on soft drinks reached as high as 20%. On the assumption that only half of this number would look for healthy alternatives, such number may constitute a good enough market size for an industry player to target. Companies should also take notice of the change in the consumption behavior of Filipinos. In a recent study, Filipinos are slowly becoming more health conscious in their food and beverage choices, opting for “light” variants or those with more nutritional benefits. While the increase in product cost is solely attributable to the excise tax, the decline in sales, however, may not be solely attributed to the same as changes in consumer behavior may also be a substantial factor. Resourceful companies can take this business gap as an opportunity to cater to the change in consumption behavior as well as meet the legislative intent to promote better health and address the alarming rates of diabetes and obesity in the country. In this way, perhaps a new “sweet spot” can be found that balances business gain with innovative product development and socially responsive market strategies. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Fahkriemar Limpasan is a Tax Senior Director of SGV & Co.

07 October 2019

Cyril Jasmin B. Valencia

Will REITs soon be within reach?

Real Estate Investment Trusts (REITs) had been gaining propulsion globally for many years. Locally however, since the introduction of REITs a decade ago, industry players have yet to launch the first such offering to the public. Recently, there have been positive regulatory developments that are expected to provide an attractive landscape for potential players to proceed. While it is true that there are many opportunities in this field, players must find ways to operate within the regulatory framework, allocate the asset portfolio effectively, comply with governance requirements, and adapt to continuing industry disruption. THE SPONSOR The big players in the real estate industry see REITs as an alternative venue for capital raising. It is a platform where Sponsors can unlock the value of their existing properties and receive upfront cash proceeds which can be redeployed to future growth projects. These big players act as Sponsors, who own the assets. They will need to weigh options as to the type of assets, among their portfolio, that can be contributed to the REIT company (REIT Co.), which will in turn operate the asset. A key point for the Sponsor in deciding on which asset to contribute is the asset’s ability to generate steady income since the law requires annual dividend declarations by the REIT Co. It is also equally important for the Sponsor to determine the proper valuation of the asset transferred, to ensure that shares received from the REIT Co. are commensurate to the value of the assets given up. The Sponsor will have to be prepared for how the transaction will impact its financial reporting, for both the separate and consolidated financial statements given the continuing need for transparency to its stakeholders and compliance with governance requirements. Before the actual transaction, it is important for the Sponsor to simulate the accounting implications in its books, particularly for the transfer of property to the REIT Co. in exchange for cash/shares or other considerations, and the treatment of its investment in REIT Co., on a continuing basis. It should be noted that in the separate financial statements, if the asset contributed by the Sponsor is other than cash, there is a need to assess how the value of the investment in REIT Co. will be booked, which may result in a gain or loss. Assuming the REIT Co. is controlled by the Sponsor at initial contribution, the transfer is a non-event transaction in the consolidated financial statements reporting. Under the legal framework, the REIT Co. is required to sell its shares during the initial public offering (IPO) and this will continue in the subsequent three-year period to meet the Minimum Public Ownership (MPO) requirement of 33% to 67%. Given the MPO requirement, there should be a continuing assessment if the Sponsor still has control over the REIT Co., or if such control has been reduced to joint control or significant influence or a simple investment in a financial asset. The accounting for the type of relationship will impact the income reported and balance sheet of the Sponsor. THE REIT CO. Given the MPO requirement, the REIT Co. should have a clear plan on the timing of the share offering and the continuing ability to price the shares commensurate to their underlying value. Another strategic decision for the REIT Co. is to determine the composition of a Fund Manager, who will implement investment strategies, and a Property Manager, who will manage the real estate assets considering the need to sustain the annual earnings. As contained in the law, such earnings will be tax-free to the extent of income that is distributed, but the savings from taxes will have to be escrowed in the meantime with the Bureau of Internal Revenue (BIR) until the MPO requirement is met. There is a need for a strong backbone to ensure continuing transparency and above-par governance. The REIT Co. will have to consider the financial reporting implications of the accounting for the asset received from the Sponsor; the classification of shares issued; the treatment of dividends; and the treatment of cash escrowed by tax authorities in relation to the MPO requirement. Furthermore, the relationships of the REIT Co. and the Sponsor with each of the Property Manager and Fund Managers will have to be studied carefully to determine the existence of control, joint control or significant influence, or possible treatment as a financial asset investment. Any tax implications from the perspective of all parties involved will have to be studied as well in order to ensure that the structure and the contracts are designed in a most tax efficient way. THE NEED TO BE AGILE The potential players will have to be cognizant of the continuing disruptive influences that are happening in the REITs space in other parts of the world. REIT assets today can just be in the form of malls, office space and industrial buildings. In the future, they can be assets in alternative sectors, such as data centers, wireline, communication towers, electronic vehicle charging zones, solar canopies, or battery storage, among others. In fact, several REIT jurisdictions have granted REIT status to these alternative property types. These influences may come from changing customer behaviors among space occupants, continuing demand for work and play balance, technological advancements and easing regulatory frameworks. Given these, it is of the utmost for the management to keep an open mind to these changes and be able shift the gears as quickly as needed. Regulators on the other hand will have to continue paving the way for business-friendly legislation, which can translate to strong job growth, high occupancy and additional tax collections. There are many moving parts in the REITs web. Hopefully, once the above fundamentals and preparations are put in place, the once blurry and far off horizon for REITs can soon be within reach. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Cyril Jasmin B. Valencia is the Real Estate Sector Leader and Partner of SGV & Co.

30 September 2019

Reynante M. Marcelo

Transfer pricing audit issues requiring attention Part 2

(Second of two parts) In the previous article, we discussed the salient points of RAMO No. 1-2019, the Transfer Pricing (TP) Audit Guidelines and the urgent need to have a TP documentation to prepare for the TP audits. These guidelines also provide the audit procedures to be applied to specific TP issues that are quite common to groups of companies today. These issues relate to intra-group services, intangible assets and interest payment transactions. Under the RAMO, intra-group services are activities undertaken within a group that provide benefits for one or more other members in the group. Intra-group services may take the form of management, administration, technical, support, purchasing, marketing, distribution and other commercial services provided in connection with the group’s business. Of the above forms of intra-group services, the most common are the management services for which a parent company or another company within the group charges a management fee, and the “shared services,” which include non-core or other support services that are centralized into and provided by a shared service center within the group. Under the guidelines, it is not enough that an arm’s-length fee is charged for these services. It is equally important to prove that the other party receiving the service has derived economic benefit from the service. Such benefit is derived by considering whether an independent party in similar circumstances would be willing to pay another independent party for the service or would just perform the services itself. There are also certain kinds of services that cannot be considered intra-group services because there is no economic benefit to the service recipient. These services include shareholder activities, duplicative services, those that provide incidental benefit, and on-call services. In such a case, such services do not justify a charge to the service recipient. Thus, the possible risk is a total disallowance or the downward adjustment of the service charge to the service recipient, insofar as it pertains to the excluded services, resulting in deficiency income tax from the additional income arising from a disallowed or lowered service fee. Given all these considerations, it is, therefore, important to revisit management and shared services agreements and the TP documentation itself. These agreements must be closely examined to ensure that the services described in the agreements fall within the category of intra-group services and not under the exclusions. The RAMO also provides procedures for identifying intangible assets in the conduct of functions, asset and risk (FAR) analysis of the parties to the related party transaction (RPT). Intangible assets are those that are neither physical nor financial assets. A higher profitability level than the average for the industry is a factor that may establish the existence of an intangible asset. It is not necessary that such intangibles be recorded as an asset in the balance sheet or registered with the Intellectual Property Office. Even costs or expenses incurred in connection with research and development and the marketing of a product may indicate the existence of an intangible asset. In transfer pricing, the existence of an intangible asset is an indication that the owner is engaged in high-value functions in its transaction with affiliates. In such a case, the owner of such an intangible asset should be compensated with more than a mere routine return for its functions. The owner must be remunerated at a higher return that will allow it to recover the costs incurred for the development of such an intangible asset. In addition, a company that owns an intangible asset cannot, in most cases, be selected as a comparable for a company that performs routine manufacturing or distribution functions. Thus, as part of the TP documentation, an analysis has to be made on whether a company, by the nature of its functions, owns such intangible assets. Finally, the RAMO also prescribes audit procedures on intra-group loan transactions. The two areas of focus are the arm’s-length nature of the debt-to-equity ratio and the reasonableness of the interest rate and other expenses for the intra-group loan transaction. In testing the interest payments, an analysis must be made of the need for the debt and the market conditions at the time the loan is extended. In determining the need for the debt, the level of debt held by the borrower of the affiliate should be considered. The debt-to-equity ratio of the borrower is also benchmarked against the debt and equity of similar companies, although the purpose for determining such ratio is unclear in the regulations. In other countries or jurisdictions, the debt-to-equity ratio is a factor that is taken into account in determining if a company is thinly capitalized, that is, whether the higher level of related-party debt than equity is intended to take advantage of the interest deductions that comes with financing with debt rather than with equity. Where a company is thinly capitalized, its interest deduction attributable to the higher debt-to-equity ratio may be disallowed. In the TP documentation covering the interest payments on intra-group loans, it is, therefore, important to establish what is an acceptable debt-to-equity ratio within the industry and to ensure that related-party debt is within the benchmarked ratio. Given the complexity of TP audits and the preparations being undertaken by the Bureau of Internal Revenue, it is now more vital than ever that companies consider the factors we presented when establishing a pricing policy for intra-group services, intangible assets and interest payment transactions. Companies with foresight will make advance work, prepare TP documentation or revisit an existing one, to be better positioned in managing risks brought on by a TP audit. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co. Reynante M. Marcelo is a Partner for International Tax and Transaction Services of SGV & Co.

20 September 2019

Janice Joy M. Agati and Redgienald G. Radam

Preparing for the IBOR Transition part 1

(First of two parts) Financial markets globally are preparing the shift from referring to Interbank offered rates (IBORs) as a benchmark for financial products and services to alternative reference rates (ARRs). For decades now, IBORs have been the reference rates for variable-rate financial instruments with the London Inter-bank Offered Rate (Libor), the most widely used IBOR, underpinning trillions of dollars’ worth of financial contracts. Libor is referred to worldwide for many financial products — bonds, loans, derivatives, mortgage-backed securities, and others. It represents the average rate at which internationally active banks obtain funding from wholesale and unsecured markets. Libor is also used to gauge market expectations on central bank interest rates, liquidity premiums in the money markets, and even on the state of a banking system during periods of stress. In 2012, however, a group of banks was accused of manipulating their IBOR submissions during the financial crisis and a series of scandals ensued. In 2017, UK and US regulators simultaneously declared the uncertainty of the use of IBOR as a benchmark rate after 2021. Initiatives to reform the benchmark were made but actual transactions supporting Libor rates continued to dwindle and markets further questioned the integrity of the rates as a benchmark. Regulators proposed the solution to develop and adopt instead ARRs. These ARRs are believed to be more appropriate as reference rates as they are “near-risk free” and are based on actual transaction volumes. Regulators worldwide began laying down concrete policy steps for the transition. Relevant ARRs have been selected for major currencies with strategic transition plans to minimize market disruptions. The US Alternative Reference Rates Committee (ARRC), for example, has issued a 4-year timeline starting in 2018 for the transition from the US Libor to the Secured Overnight Financing Rate (SOFR). ARRs for other major currencies include the Reformed Sterling Overnight Index Average (SONIA) for GBP Libor, the Swiss Average Rate Overnight (SARON) for CHF Libor, and the Tokyo Overnight Average Rate (TONAR) for JPY Libor and JPY Tibor. As ARRs are selected and regulators provide for a transition procedure, financial institutions must assess early on the potential impact of the change of benchmark in order to re-assess their business strategies and make the uncertain, certain. As discussed in a recent EY publication titled End of an IBOR era, the top 10 challenges that banking, capital markets organizations, and other financial market participants will face in transition to the ARRs include: 1. Client outreach, repapering and negotiating contracts. Institutions should consider the necessity to re-negotiate existing contracts that will mature past 2021 based on the new reference rates. 2. High litigation, reputation and conduct risk. Spreads should be re-assessed based on the differences between the IBOR and the ARRs. 3. Market adoption and liquidity in ARR derivatives. The market must account for a transition in the adoption of ARR derivatives, thus affecting the liquidity in the market. 4. Absence of ARR term rates. As most ARRs will initially be an overnight rate, defining term rates for ARRs needs to be accelerated to facilitate the timely and smooth transition of cash products. 5. Differences in ARR and transition timelines across G5 currencies. There is also the need to harmonize the timing of the transition and publication of daily ARRs across the G5 currencies (dollar, euro, pound, Swiss Franc and yen) to address the impact on the FX swap markets. 6. Regulatory uncertainty. There is a need for regulatory guidance to be issued early on if only to allow markets to plan and work on their transition plans. 7. Operations and technology changes. As IBOR has already been embedded deeply in operational procedures and technological infrastructures, changes to systems may have to be planned early. 8. Valuation, model and risk management. A wide range of financial and risk models will have to be developed, recalibrated, and tested in order to incorporate the new reference rates. This poses a challenge given the lack of available historical time series data. 9. Accounting considerations. Financial institutions will need to review changes against accounting standards. 10. Libor may yet survive. The Financial Conduct Authority recently hinted at the potential use of synthetic Libor for existing contracts that may go beyond 2021. Additionally, the ICE Benchmark Administration also indicated the possibility that Libor may still be used for selected currencies and tenors. The lack of clarity and firm decision pose a challenge for institutions given the huge amount of “To Dos” needed to prepare the onset of year 2021. The Philippines should keep up with, if not be ahead of, these changes and prepare early as well. The domestic financial industry can see this as an opportunity to accelerate the Philippine Capital Market Agenda by establishing local reference rates. Regulatory guidance will play a crucial role at this point. Institutions also need to understand the structural differences between the IBOR and the ARRs and re-assess the impact to ensure their business models are abreast with the industry developments. In the next article, we will continue the discussion on expected IBOR transition, looking at some of the other business areas that institutions should start re-assessing, such as operations, risk management and regulatory frameworks, accounting and procedures that companies can adopt to ensure an efficient and effective transition. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Janice Joy M. Agati and Redgienald G. Radam are Senior Directors from SGV & Co.’s Financial Service Organization service line.

18 September 2019

Janice Joy M. Agati and Redgienald G. Radam

Preparing for the IBOR Part 2

(Second of two parts) In the first part of this article, we highlighted the current state of Interbank Offered Rates (IBORs), the factors behind the shift from IBORs to Alternate Reference Rates (ARRs), and the top 10 challenges to be faced in transitioning to the ARRs. In this second part, we will delve into the key operational, financial and accounting considerations that come along with the imminent discontinuation of IBORs. It is expected that the broad impact of transitioning to ARRs will be felt not just by banking and capital market organizations, but also by corporates with significant exposures to IBOR-linked instruments. This impact will cut across various functions within an organization, including treasury, legal, finance and risk. Given this, it is imperative for market participants to quickly assess the cross-functional implications of the transition to their businesses and clients. Having an awareness of these implications early on will help an organization plan for an efficient transition. Here are some of the key considerations for organizations before the IBOR reform is implemented: Determining your exposure to IBOR — Developing a detailed inventory of IBOR-linked products and contracts will be cumbersome for many organizations with existing financial contracts that are not digitized. The organization will have to ensure that relevant contract terms, including any fallback provision, are captured so that all legal and financial risks are determined. Contract renegotiations — IBOR-linked products and contracts may need to be modified and renegotiated. While the International Swaps and Derivates Association provides protocols to facilitate amendments to contracts between counterparties, having a huge number of derivative contracts to be amended can be a tedious task. For cash products, the renegotiation may be more burdensome due to the non-standard nature of most of the contracts. Multilateral negotiations will also be required for bonds, syndicated loans and other securitized products. It will also be necessary to establish governance processes and controls to avoid any financial, legal and operational risks. Impact on IT systems and infrastructure — The shift to ARRs will require changes to various platforms (e.g., valuation, trading and risk management systems) within the organization’s IT systems. Recalibration or redevelopment of models — Organizations need to build an inventory of all its pricing, valuation and risk models that use IBORs as an input and assess the need for recalibration or redevelopment. Any change in the models will also impact the front (in terms of pricing strategy and new product offerings) and back-office processes of the treasury function and will warrant an update of the organization’s risk management strategy. Accounting and hedging — The transition to IBOR will have a significant impact on various aspects of accounting, more notably on the application of hedge accounting and derecognition assessment for any contract modification due to changes in reference rates. Although amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 9 Financial Instruments are underway to address some problematic hedge accounting issues pre-IBOR transition, financial reporting issues post-IBOR transition are still to be dealt with by the International Accounting Standards Board (IASB). The pre-IBOR transition issues covered by the proposed amendments to IAS 39 and IFRS 9 relate to the assessment of the probability of the hedged forecasted IBOR cash flows occurring, assessment of effectiveness of hedging relationships and the immediate release of any amount lodged in equity to profit or loss if hedged IBOR cash flows will no longer occur. WHAT ORGANIZATIONS SHOULD START DOING NOW Given the various considerations discussed above and the impending completion of the IBOR reform by local jurisdictions, there is a need for organizations to plan and prepare for a smooth transition to ARRs. As discussed in a recent EY publication titled How will you respond to IBOR transition (https://www.ey.com/Publication/vwLUAssets/EY-end-of-an-ibor-era/$FILE/EY-end-of-an-ibor-era.pdf), organizations must establish an IBOR transition program as a necessary foundation upon which they can plan their transition strategy and implementation programs. Here are recommended steps in establishing an IBOR transition program according to the EY report: Assemble a broad-based IBOR transition team — Mobilize a formal IBOR transition program team with a strong governance framework and senior leadership appointed to oversee and report progress to relevant executive committees and the board. This program team should be cross-functional in nature, with business leaders represented from inception. Conduct a comprehensive impact assessment — The impact assessment should cover all areas of the business that are exposed to IBOR. This would include: (1) product assessment — categorize and quantify financial IBOR exposure by various parameters, including maturity, optionality, counterparty, client segment, business and jurisdiction; (2) legal contract assessment — extract and analyze the contractual language of the impacted products with a priority on positions that are due to mature beyond 2021; (3) risk assessment — analyze the potential impacts of transitioning to ARRs on the risk profile and financial resources of your organization; (4) operational assessment — identify impacted areas, including systems, models and processes that are linked to current IBORs; and (5) inventory management — establish and maintain an inventory of products and contracts linked to IBORs across jurisdictions. Develop a transition roadmap — A comprehensive implementation roadmap is needed for prioritized initiatives, including key workstreams, projects, milestones and ownership. A strategy for educating and communicating with both internal and external stakeholders should also be addressed, including clients, technology vendors, regulators and industry bodies. Launch the formal IBOR transition program — Publish a multi-year enterprise-wide transition program, including a program charter, a stakeholder map and resourcing requirements. As the pace of IBOR transition picks up, complacency will be detrimental to organizations with significant exposure to IBORs. Considering the complexity and wide-ranging scope of the transition, these organizations should initiate steps to prepare and make the most out of this exercise. A “wait and see” approach to implementation will not work with the overwhelming challenges that are expected to emerge when the IBOR is discontinued. At this point, an organization that can get ahead of the curve will have the advantage of identifying early market opportunities with the new ARRs. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Janice Joy M. Agati and Redgienald G. Radam are Senior Directors from SGV & Co.’s Financial Service Organization service line.

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