Cross-border move holds promise of new landscape

After years of discussions, Latin America’s Federación Iberoamericana de Bolsas (FIAB – federation of stock exchanges), with support from the Washington-based Inter-American Development Bank (IDB), is due to launch a regional stock market initiative in the next few months. This will, for the first time, allow brokers in Mexico to offer investors a sample of Brazilian stock, in addition to shares listed on Mexico City’s exchange; and likewise, give brokers at Bovespa, Brazil’s main stock exchange in Sao Paulo, the opportunity to sell Mexican stock alongside Brazilian offerings.

Small fry? Decidedly, when compared to the consolidations and outright mergers now occurring between European and US bourses.

Bigger picture

However, Elvira Maria Schamann, secretary general of the FIAB, says that the initiative is starting with a demonstration of the operational links of only two Latin American stock exchanges, Mexico’s and Brazil’s (which also happen to be the area’s largest by capitalisation). It will follow agreements reached between the two bourses’ regulators, clearing and depository corporations, and brokerage firms on issues like the information that the listed companies must make publicly available and the average minimum trading value of the stock. But the project’s aim is that these links (and agreements) will eventually be duplicated by several, if not all, the stock markets in Latin America, including Colombia’s (which has already announced that it wants to join the initiative), Chile’s, Peru’s, Argentina’s and Venezuela’s.

Similarly, in the demonstration, the cross-border trading will be limited to about 25 Brazilian and about 15 Mexican stocks, many of them blue chip. As a result, many of the shares in the sample already have American depository receipts (ADRs), which means that they have a minimum free-float cap of $100m, meet stricter US disclosure rules and can trade on US stock exchanges. But the project’s objective is that eventually medium-scale Latin American companies, which currently cannot trade on the New York Stock Exchange (NYSE) because they do not have sufficient capital, will benefit from the region’s new listing integration – not least because they constitute the majority of businesses in Latin America and currently rely almost entirely on banks to raise their capital.

However, Clemente del Valle, a senior financial analyst at the World Bank’s International Finance Corporation (IFC), says that Latin American banks tend to be conservative in their lending policies; and there is also a dearth of private equity and venture capital funds in the region. “[As a result] there is a bottleneck in the cycle of a company’s growth. It is much, much harder for a medium-sized company to grow in Latin America than it is in the US,” says Mr del Valle, who previously worked at Colombia’s Securities Commission.

Although the ultimate aim of the FIAB’s initiative is to increase the liquidity of Latin America’s stock exchanges so that medium-size companies can raise more capital, that still leaves the question of why the region’s bourses are so underdeveloped despite some recent improvements. Coinciding with globalisation and Latin America’s capital market reforms in the 1990s, and more recently with a considerably improved macro-economic situation in the region, the capitalisation of the region’s main stock exchanges (in Brazil, Mexico, Chile, Argentina, Venezuela, Peru and Colombia) has increased. But so too has the share of listing, capital raised and value traded by Latin America’s biggest companies, principally in the form of ADRs on US exchanges.

Consider: seven Latin American companies were listed on the NYSE as ADRs in 1992; in 2006, 88 Latin American companies were listed in this way. Meanwhile, the amount of capital raised by Latin American ADRs in the first nine months of 2006, according to Citigroup’s depository receipt department, was $2.1bn, with $1.9bn of this raised through initial public offerings (IPOs). And in the first half of 2006, the US share of trading in stocks from Latin America – including Brazil, Mexico, Chile and Argentina – was 67%, according to the NYSE. In other words, 67% of the moves in these Latin American countries’ stock can be explained by moves in the Standard & Poor’s Index.

“I always say the Latin American countries are leading the globalisation. Latin America is the region that is most advanced in the world in terms of the migration of companies from domestic to international stock markets,” says Pietro Masci, head of the IDB’s infrastructure and financial market division.

Mr Masci, who helped to design the FIAB project, continues: “This is good news from the perspective of the large companies because they can raise a lot of money on international markets. But it is bad news for Latin American countries and for the liquidity of their stock exchanges. The evidence shows that when a company emigrates, domestic investors who can afford to invest in stock follow.”

Structural hindrances

The development of the region’s stock market has also been affected by structural problems, such as too few companies listed and a small turnover value – despite the considerable growth in pension funds in the 1990s as Mexico, Argentina and other countries imitated the Chile-style private pension fund reform, and despite privatisations of telecommunications and other state-owned enterprises in several countries, which also boosted activity.

Notwithstanding this, according to a World Bank report published last March (Capital Market Development: Whither Latin America?), the number of companies listed on Latin America’s main stock exchanges declined in the past 10 years. And, despite the recent increases, the average capitalisation of Latin America’s main stock exchanges, in terms of gross domestic product (GDP) ratios, is much lower than in other regions, such as east Asia.

Regional differences are even more striking when it comes to turnover. The value of turnover averages a mere 6.1% of GDP on Latin America’s main bourses, compared to 104% of GDP in east Asia, the World Bank report says.

“In Latin America, there’s not much trading going on, due to the ownership structure of the stocks. Much of the stock is held by insiders and insider entities that do not have an incentive to buy or sell,” says Eliot Kalter, assistant director of the new monetary and capital markets department of the IMF.

“Most of the companies listed on Latin American stock exchanges are family-owned. So they only float a few shares in order not to lose control,” says the IDB’s Mr Masci.

High concentration

Latin American bond markets have developed more rapidly than stock markets recently, which has also affected liquidity.

“It is a sign of the professionalism and sophistication of the Treasury departments of Brazil, Colombia, Chile and Peru that public-sector debt issues, with up to 20-year tenors and in local currencies [which avoids exchange rate risks], have been so successful in reducing these four countries’ public debt,” says Mr Masci.

However, he adds: “Latin American governments also need to show restraint because the public debt issues are now so big that, rather than setting a benchmark for the rest of the market, which is usually the case, they are now absorbing between 60% and 70% of the market’s available funding and liquidity. As a result, the costs and risks of floating private sector stocks and bonds increase, and private companies are reluctant to list on the markets in these circumstances.”

Listed companies also bear part of the blame for their lack of investor support. “They need to become much more professional. There needs to be much more willingness to disclose information. There is not enough pressure yet on medium-sized companies to reform. But as a result of globalisation, that will come,” Mr del Valle predicts.

Coinciding with the FIAB’s initiative (which could eventually lead to regional IPOs, according to the federation’s Ms Schamman), Mexico, Brazil and Colombia have recently approved new securities reforms which “all broadly seek to: ease the rules on medium-size companies and ordinary investors that prevent them from entering the market; improve the transparency of issuing companies and their corporate-governance practices; and strengthen the rights of minority shareholders”, says Mr Kalter.

For example, in Mexico, following the approval of a securities law in June, the minimum amount needed for an individual investor to enter the market will be lowered, and medium-sized companies will soon be allowed to trade shares in the market with less of the listing requirements of conventional companies, for three years, says Mr Prieto.

In Brazil, the authorities split Bovespa into several trading tiers, with the highest, Novo Mercado, applying the strictest disclosure rules and corporate-governance standards. These standards include the disclosure of insider trading by controlling shareholders and senior managers, and full voting rights for all shareholders. Since then, Novo Mercado has expanded from just two companies in 2004 to 35 now, and practically all of the 25 IPOs in Brazil in the past two years occurred there, says Geraldo Soares, head of investor relations at Banco Itaú, Brazil’s second biggest bank, which manages $6bn in equity investments domestically and $3bn abroad.

Nevertheless, Mr Masci says: “Much more needs to be done by Latin America’s governments to develop the stock markets and to develop them from a regional perspective. There are now far too many stock exchanges in the region [13 of which belong to the FIAB] in terms of the size of the countries’ economies. Only two or three are needed”.

FIAB MEMBERS:The 13 Latin American stock exchanges that belong to FIAB are: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Mexico, Panama, Peru, Uruguay, Venezuela.