OVERVIEW OF CAPITAL MARKET DEVELOPMENT IN THE LAC REGION Carolin A. Crabbe Infrastructure and Financial Markets Division INTER-AMERICAN DEVELOPMENT BANK June 2, 2004 Washington, D.C

INTRODUCTION Capital markets a powerful force in the development of many countries: Finance corporate growth Promote the mobilization and allocation savings Enable development of institutional investors such as pension funds, insurance companies, and mutual funds Provide the framework for growth of a mortgage market Facilitate government debt management The conduct of monetary policy and Above all create wealth

Over the past decade, the IDB has taken an active role in the Reform and Development of Capital Markets 38 Sector Reform operations covering capital market reform 28 sector reform operations covering the insurance industry 17 sector operations covering pension reform Countless operations indirectly affecting the investment environment Promote dialogue/Disseminate best practices: e.g., Workshop on Government Bond Markets, Capital Markets Conference, etc. Source: Financial Market Development, February 2003

First Generation Reforms Supported by IDB and others, These reforms have supported efforts to improve the Capital Markets in LAC region: Enhanced supervision and regulation, focus on risk based supervision for pension and insurance industries Focus on market infrastructure: exchanges, clearing and settlement, broker training Pension reform. Creation of funded pillar creates powerful institutional investors in many countries (Argentina, Bolivia, Chile) Privatization of financial institutions Liberalization of interest rates

Despite First generation Reforms and financial support from local, foreign and international agencies, LAC capital markets are still underdeveloped The size of the LAC market in US Dollars is only a fraction of the European Union, the US, Japan or even Asia In LAC region capital markets have not yet played an important role

Size of Capital Markets Selected Indicators ( Billions of US Dollars)

Equity Capitalization in the World LAC 1.9% World 5.5% Emerging countries Trillions of US dollars

STOCK MARKET CAPITALIZATION OVER GDP IS LOW LAC region ranking behind the developed countries, the Middle East and North Africa, and South and East Asia

Developing Capital Markets

Some reasons why LAC markets have not flourished Macroeconomic instability of region Lack of Corporate Governance  Unwillingness to open company  Accounting and auditing do not follow international best practices  Lack of sound and transparent governance (officers and Board members) Inability to enforce and perfect contracts guarantees and other commercial instruments Judicial complexity and lack of clarity Absence of tax incentive vs. issues of tax burden

WHAT IS THE IDB DOING? Traditional projects Non-traditional projects Strategy and policy: In process of consolidating and updating Dissemination of best practices (conferences, seminars, publications)

Ingredients for Capital Market Development Continue with traditional areas of reforms begun in the 1980 and 1990s: Building Effective Legal and Regulatory Framework Institutional and Regulatory Infrastructure Enhanced supervision and move toward risk based supervision Harmonization of Regulatory Framework Enforcement

Ingredients for Capital Market Development Strengthening Capital Market Infrastructure Clearing and settlement Depositories Training of broker dealers

Non-traditional areas: Corporate Governance - Issuers and Investors Participated in development of OECD Guidelines Improve disclosure requirements for private sector Protect rights of shareholders (minority), bondholders and creditors Expand investor education Bankruptcy Codes, administrative and juridical procedures, contract enforcement Ingredients for Capital Market Development The Bank has also increased work in

Development of Institutional Investors and the Mobilization of Domestic Savings Support the development of Pension Funds Facilitate the growth of Insurance Markets, which are generally underdeveloped Support the expanding importance of the Mutual Funds industry Transition to Global Accounting and Auditing Standards Participated in development of accounting standards (IFAD) Focus on standards at the firm level: Issuers and Non- issuers

Enhanced Information Environments Investor information (pension affiliates and insurance clients) Innovation and Capital Market Instruments Foster development of long-term government securities markets Strengthen mortgage market. Securitization for mortgages, bank loans, physical inventories and cash flows Development of Rating Agencies and Credit Bureau Strengthen debt markets