ISBN: 1-931003-49-1
544 pp. 2003
English
$26.75

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Focus on Capital tackles various aspects of developing Latin American capital markets. Macroeconomic and structural policies, accounting practices and standards, bond market development, market infrastructure, derivatives markets, corporate governance, ethics, human capital, and regional integration all play a role. One of the shortcomings of many strategies for capital market development-more important than getting the sequencing wrong-is failing to understand the links between the various components and the need for an overall strategy as well as plans for each component.

Focus on Capital analyzes the status of the markets in Latin America and identifies the technical, political, and financial challenges to building vibrant capital markets and increasing the efficiency benefits of regional economic and financial integration.

Contents

Foreword
Acknowledgments
About the Authors
Overview

Part I. Introduction

Chapter 1
Developing a Strategy for Reforming Capital Markets
in Latin America and the Caribbean
Kenroy Dowers, Felipe Gomez-Acebo, and Pietro Masci

Part II. Factors Affecting the Development of Capital Markets

Chapter 2

Globalization, Technology, and Regulation in Capital Markets:
Strategies for Latin America and the Caribbean
Reena Aggarwal

Chapter 3
Internet Technology and the Development of Securities Markets
Georg Wittich, Ethiopis Tafara, and Robert J. Peterson

Chapter 4
The Impact of the Macroeconomic Environment on Capital Markets
in Emerging Latin American Economies
Valeriano F. Garcia and Luis Alberto Giorgio

Chapter 5
Institutional Investors and Capital Market Development
Karen Goldstein Rossotto

Part III. Issues in the Implementation of Capital Market Strategies

Chapter 6
Promoting Regional Capital Market Integration
Ruben Lee

Chapter 7
Accounting and Auditing Standards
Pietro Masci and Ivan Sotomayor

Chapter 8
Enhancing Market Infrastructure in Emerging Economies
Andrew Hook

Chapter 9
Demutualization of Exchanges as a Strategy
for Capital Market Regulatory Reform
Roberta S. Karmel

Chapter 10
Developing Bond Markets: A Comprehensive View
Clemente del Valle

Chapter 11
Designing a Derivatives Complement to Cash Markets
in Developing Countries
Andrea M. Corcoran, Ronald B. Hobson, Gregory J. Kuserk,
Karen K. Wuertz, and Derek West

Chapter 12
Access to Financing for Small and Medium Enterprises
Hannes Takacs and Kinga Korcsmaros

Chapter 13
Developing Capital Markets in Latin America and the Caribbean: Ethical Issues
Osvaldo R. Agatiello

Chapter 14
Corporate Governance and Capital Market Development:
Recent Experiences in Latin America
Mike Lubrano

Chapter 15
Human Capacity Development for Capital Market
Professionals in Latin America and the Caribbean
Catherine Chandler-Crichlow

Part IV. Conclusion

Chapter 16
Pragmatic Issues in Capital Market Development in Emerging Economies
Kenroy Dowers, Ruben Lee, and Antonio Vives

Index

Overview

Financial markets have a significant impact on economic growth and competitiveness. Experts, practitioners, and policymakers generally agree that the development of financial markets both precedes and facilitates economic performance. Thus, the relationship between financial development and economic growth is neither one-dimensional nor mechanical because developing financial markets without considering the real economy is not sufficient to ensure economic growth. For instance, U.S. financial and capital markets have grown because of the strong economy and companies' need for financing to grow and compete. The German economy grew despite the lack of a capital market because there was a solid banking system.

Although there is much to learn about the relationship between the financial and productive sectors, there is clear evidence that a well-functioning financial system positively influences growth and macroeconomic stability as well as encourages poverty reduction. However, a strong, export-oriented productive sector defines the scope of a financial system and requires that the financial sector become more sophisticated and complete. Furthermore, financial and capital markets, particularly in emerging market economies, constitute a "public good" that deserves the attention of policymakers and the expenditure of public resources. Policymakers need to find the right balance between allowing the real productive sector (which is typically outward oriented) to advance and devising a strategy for financial market development that facilitates the expansion of the real sector. Local capital market development is part of such a strategy.

Why is local capital market development important, especially now? It improves the efficient allocation of resources and reduces information asymmetries. The justifications for local capital market development refer to the need to reduce the risk of financial crises that result from an excessive reliance on external borrowing?for example, to avoid foreign exchange risk, reduce contagion, and decrease short-term external borrowing. In fact, as financial crises dwarf the role of financial intermediation, the problems of asymmetric information become even more severe, leading to greater public mistrust of financial institutions.

In addition, local capital market development allows emerging markets and particularly Latin American countries to use domestic resources for national fiscal evolution, avoiding the risk that globalization and information technology will deplete these countries' scarce savings by allowing them to be attracted to industrial countries. Thus, fostering local capital market development in Latin America and the Caribbean can be an important mechanism for completing financial sector development, facilitating economic growth, and reducing financial instability and crises.

Local capital markets embody market infrastructure, the legal and regulatory framework, and organizations and institutions. These markets function effectively through competition and enhanced information by using existing instruments, such as equity and bonds, and by creating new ones. The markets therefore ultimately permit economic growth and constitute a relevant development target.

Many Latin American and Caribbean countries can easily be included in the category of those that have not developed a fully functioning capital market and have suffered grave and recurrent crises. There is an extensive literature on capital market development in emerging markets in general and in Latin America and the Caribbean in particular. The literature provides analysis, insights, and recipes for building vibrant capital markets in the region.

Building on this literature and experience, the overarching goal of this book is to provide a forward-looking perspective on the issues that affect capital markets in emerging market economies. To this end, the book presents a set of critical issues that constitute the ingredients for a policy initiative to ensure local capital market development. The issues raised are addressed in a synergistic rather than isolated fashion, recognizing that the challenge for policymakers and regulators is to minimize interference with the functioning of markets but allow continuous oversight to detect problems and make appropriate interventions.

The Message of the Book

This book answers several questions: What is the status of market development in Latin America and the Caribbean? Which strategic initiatives foster market development? Who are the key players in the development of local capital markets? How are capital market institutions and organizations built? And how can trust and confidence be assembled and sustained to support the development of a capital market?

The book's authors assume that capital market development is a relevant initiative for policymakers to embrace. That is, ensuring the stability of the financial system and developing a capital market are worthy objectives of public policy. In pursuing these objectives, the political decision to reform the financial sector rests with the highest level of government, while the finance ministry has the day-by-day responsibility to build the necessary consensus among parties, design a long-term strategy, and monitor implementation.

In shaping the public policy interventions to develop capital markets, the governing authorities need to recognize that they must abstain from interfering with market functioning. Instead, their sphere of action must be limited to removing market imperfections and shortcomings-by providing vision and direction, ensuring good economic management, promoting the disclosure of information, avoiding monopolistic practices, and building institutions.

Thus, governments are not supposed to intervene to adjust asset price volatility but rather to eradicate the causes of excessive price swings that threaten the functioning of the financial and capital markets. Governments also can help market players realize that the rules are in place and that they are on their own to "play the game." The same right balance needs to be found between market functioning, regulation, and self-regulation-keeping in mind that the appropriate mix is constantly changing and thus needs to be monitored by interest groups that have the ultimate stake in the functioning of the market.

In accord with this balance, this book is both theoretically grounded and focused on operational issues in Latin America and the Caribbean. A combination of endogenous and exogenous factors has created a situation whereby the region's economies are hampering the export-oriented productive sector and directing insufficient resources to it. This makes the task of policymakers daunting and may create the wrong expectation that initiatives to reform the financial sector and local capital markets could entirely solve problems related to growth and resources directed to the productive sector. Policymakers need to find a balance between the two sectors. Moreover, the characteristics of Latin America and the Caribbean-such as the region's diversity-make the task of creating efficient capital markets more challenging than in other regions.

Latin America and the Caribbean faces a dire economic and financial situation in comparison with other regions, as is shown in table 1. The picture becomes even more distressing when the economic losses from the crisis in Argentina, which are not reflected in the table, are taken into account. Yet even though the average financial market development indicators for Latin America are well below worldwide averages, some countries in the region are at a level similar to that of industrial countries.

The regional integration of financial and other markets, which would be the long-term answer to many problems, constitutes the ultimate objective for the region's capital markets. However, for the time being, domestic interests still prevail and national and regional institutions continue to be feeble. The regional aspect of creating the critical mass to build a viable capital market requires leadership, a long-term view, and thinking beyond national borders.

The start-up role assigned to the public sector must be taken into consideration in the midst of these special circumstances and difficulties. The key challenge for public institutions is that the dynamics of capital markets are incredibly complex and the resources-human, financial, and institutional-are scarce. The challenges at hand include multiple and changing goals, and various and emerging topics, stakeholders, and decisionmakers. Government leadership is essential as markets evolve in response to new challenges and as institutions respond to new issues.

Investment in human capital and regional integration are the two key components of the public policy strategy for capital market development. The need for a skilled pool of professionals, experts, and practitioners to deal with capital market issues requires a forward-looking attitude, given the intricacy of the issues and their continuous evolution. Moreover, decisions about these issues (for example, the determination of financial standards) are made outside the substantive reach of emerging market countries. Governments in Latin America and the Caribbean thus face the intimidating challenge of building solid national institutions while markets become globalized and decisions are made beyond national boundaries. In this respect, the task requires hefty resources and the benefits will be realized far in the future.

The Structure of the Book

The book has four parts. Part I introduces the themes and topics. Part II describes the factors that affect the development of capital markets. Part III covers the issues in implementing capital market strategies. Part IV offers conclusions.

The introductory chapter that constitutes part I discusses the evolution of capital markets in Latin America and the Caribbean. It formulates the main components of a strategy for further development on the basis of three pillars: an enhanced regulatory framework, modernization of market institutions and actors, and support for regional efforts and activities. Assuming that an appropriate foundation for market activity is in place, the strategy focuses on increasing market activity and liquidity, broadening investor participation, and expanding the types of instruments traded.

The four chapters in part II review key factors underlying the development of capital markets. Chapter 2 examines the current status of emerging markets in relation to the progress that has been made during the past decade. It analyzes the key factors in the development of securities markets in both industrial and developing markets: globalization and regionalization of financial markets and increased competition; the role of technology in creating new types of trading platforms and the widespread use of the Internet in providing financial services; and the changing regulatory structure dealing with globalization, technological innovation, and the changing structure of securities markets. The chapter raises key policy questions and strategies for capital market development.

Chapter 3 looks at the impact of Internet technology on the development of securities markets. The chapter discusses the relevance for policymakers, regulators, and market participants of the early lessons many capital market regulators have learned regarding securities activities on the Internet. It centers on those areas that have seen the greatest growth and innovation and to which regulators have paid the most attention-that is, the use of the Internet by investors, exchanges, issuers, and market intermediaries; system capacity, resilience, and security; liability for hyperlinks and information contained on websites; the growth of day trading; and the unique enforcement concerns posed by Internet chat rooms and information stored by Internet service providers. Securities regulators have various options for using the Internet to better protect investors and promote market efficiency and transparency. The chapter states that the most significant lesson is that the fundamental principles of securities regulation do not change, regardless of the medium used to buy, sell, and market securities. The recommended focus is on the type of information made available to investors to protect them; enhance market fairness, efficiency, and transparency; and reduce systemic risk-rather than the manner in which that information is delivered.

Chapter 4 provides policymakers and financial experts with an overview of the most relevant issues related to the effect of macroeconomic policy, institutional arrangements, and other exogenous structural factors (such as market size) on the development of capital markets in emerging economies, with particular emphasis on Latin America. The chapter analyzes the constraints that the macroeconomic environment imposes, which are characterized by the impact of exogenous factors on the effectiveness of capital market performance. The chapter highlights the negative impact of financial regulations that give preferred status to banking over capital market investment and financing instruments.

Chapter 5 examines the relevance and role of institutional investors in fostering capital market development. On the basis of the experience of the United States and other countries that belong to the Organisation for Economic Co-operation and Development, the chapter provides policy guidance on how governments and policymakers can further encourage the growth of domestic institutional investors in Latin America and the Caribbean while capitalizing on the sector's potential benefits for the region's capital markets.

The chapters in part III review several important issues for developing strategies to implement capital market reform and offer guidance for building a capital market strategy. The issues addressed include regional integration, the bond and derivatives markets, international trends in clearance and settlement systems, and the role of corporate governance in fostering capital market development. Moreover, this part of the book goes considerably beyond many texts on financial sector reform by tackling the elusive topics of human capacity development and ethics.

Developing an approach to regional capital market integration is one of the most crucial topics in Latin America and the Caribbean. Chapter 6 examines the costs and benefits of and typical barriers to integration. It identifies the principles and methods that might be employed to promote integration, including regulatory standardization and harmonization, multiple listing, links and mergers between stock exchanges and other types of market institutions, technical interfaces, and information sharing. The chapter describes the success or failure of attempts to promote integration in different regions, identifies the elements of a strategy to promote integration, and discusses the optimal role and functions of policymakers, private sector entities, government agencies, regional bodies, and international financial institutions.

Chapter 7 emphasizes the role of information disclosure and accounting standards and practices in capital market development. It discusses accounting standards as an essential component of the global and regional public good. It identifies the peculiarities of accounting in emerging market countries, particularly in Latin America and the Caribbean; describes the debate between the two prevalent sets of accounting standards (the U.S. Generally Accepted Accounting Principles, or U.S. GAAP, and the International Accounting Standards, or IAS); and discusses the national standards of each country and reviews the progress of the process of convergence. The chapter describes the situation in Latin America and the Caribbean and makes public policy recommendations that point toward a long-term goal of accounting convergence between U.S. GAAP and IAS and the role of multilateral financial institutions.

Chapter 8 discusses the key risks in clearance and settlement systems and addresses the application of international standards in developing such systems. The chapter focuses on the challenges policymakers face in building market infrastructure in emerging economies. The underlying motive is that developing or upgrading capital market infrastructure is a responsibility of the public sector and part of the public policy agenda directed at developing capital markets. Designing and operating infrastructure that functions with a minimum of errors and delays and that can interact with other financial and information systems is a major challenge for policymakers in emerging economies, particularly in Latin America and the Caribbean. At the same time, policymakers need to regard this particular activity as part of the larger strategy of capital market development, providing the right incentives for the private sector to be part of this initiative, but at the same time not falling into the trap of thinking that infrastructure alone is sufficient for capital market development.

Demutualization is discussed in chapter 9, and this is somewhat of a departure because the focus is on the rationale for demutualization and the key issues developing countries must consider when thinking about the decision to demutualize. The chapter establishes that demutualization is fundamentally a strategic decision that Latin American and Caribbean countries are probably a few years behind in addressing. The chapter highlights some of the key trade-offs regulators must confront in developing a newly demutualized exchange, using lessons learned by established exchanges.