Latin American IFCs take advantage of global economic stagnation

Latin American financial centres are finding golden opportunities in the current financial crisis. The global investment trend has tilted towards emerging markets, and the large number of companies from developed economies looking to diversify their businesses into high-growth markets is breathing life into the major financial centres in the region.

“Traditionally each Latin [American] centre related individually to New York and London, and that sapped energy across the region. The integration of Latin America will boost the opportunities for trade and arbitrage with New York and London,” says Paulo Oliveira, head of BRAiN – Brazil Investments & Business, an initiative aimed at attracting businesses to Brazil. 

Enviable growth

Over the past 10 years São Paulo has been replacing Miami as the preferred domicile for many companies' Latin American operations. The rise of São Paulo to its current dominant position looks unlikely to be derailed.

“As a financial market, São Paulo [surpasses] all others in the region on a wide range of indicators from bank assets through stock market capitalisation. That makes for a much larger profit pool and attracts new businesses,” says Paul Gruppo, head of financial services advisory practice at Ernst & Young Terco in São Paulo. Brazil represents 40% of Latin America’s gross domestic product; 80% of its equity market volume (compared to just 10% in Mexico); and 90% of exchange-traded derivatives, adds BRAiN's Mr Oliveira.

Even non-Brazilians are impressed by the market’s growth and prowess. “I have to praise Brazilians; they have done a wonderful job at institution building and co-operation. São Paulo deserves to be the largest and dominant financial centre of the region,” says Guillermo Larraín, chairman at the Center for Regulation and Macrofinancial Stability in the department of economics at the University of Chile.

There are, however, concerns about the Brazilian government's recent meddling in the financial markets. Mr Gruppo says that there is reasonable confidence from investors in the long-term direction of Brazil, even if recent and abrupt increases in tax on foreign investments in the equity market – such as a 6% financial operations tax – have revived fears of a return to an unstable regulatory regime. This could hamper growth. “Taxation, shutting down whole markets and managing foreign exchange rates could move business offshore. [Brazil's] government has to be careful that in the heat of the moment, it does not make decisions that are to the detriment of long-term interests,” says Mr Gruppo.

Beyond Brazil

If the growth of São Paulo as a financial centre is well under way, smaller centres too are becoming pro-active in building capital markets.

Over the past three years, a frenzied period of growth in Colombia's capital Bogotá has driven very rapid development of the capital markets. The country’s public debt market is the fifth largest electronically traded market in the world, and the country is fast developing a corporate bond market with $7bn of local currency and long-term issuance in 2009-10, says Juan Pablo Cordoba, president of the Colombian stock exchange, Bolsa de Valores de Colombia.

This has created a pool of financial professionals who are branching out into new fields such as private equity and asset management. A promising, if still small, derivatives market, with trading of some $250m in nominal value per day, is also a sign of growing sophistication and confidence. Colombian corporates are spreading their wings as banks are in an optimistic mood.

Bogotá threatens to eclipse the more sophisticated and established Chilean capital of Santiago as the Spanish-speaking South American financial centre. Mr Larraín senses that his home city is losing ground. “Chile would like to become a financial centre for Latin America but has never had as clear a strategy as Brazil, and particular efforts to create an offshore segment have been hampered by poorly defined tax incentives,” he says.

Nevertheless, the depth of Santiago’s markets and its talent pool are still the best in Spanish-speaking Latin America and the city is likely to remain dominant in key niche sectors. A well-regulated fund management industry and rich base of pension funds means that the city is becoming a Latin American centre for asset management. 

Markets gulfed in Mexico

Surprisingly Mexico City’s markets are not enjoying the same success. Banks and capital markets continue to puzzle over this, given the size of the country’s economy, its well-developed industrial base and close links to the US.

Mr Larraín says that when this subject was highlighted at a recent conference, delegates were at a loss to pinpoint specific reasons for the slow growth. The conservative stance taken by many companies in Mexico and their reluctance to raise capital via the exchange were two possible explanations put forward, but it was widely perceived that while Mexican regulators have modernised the country’s financial framework, they have failed to keep pace with São Paulo and Santiago.

Mexico’s loss is São Paulo’s gain and it is likely that the city will continue to affirm itself as the predominant Latin hub. Other centres will become dominant in specialist areas; in addition to Santiago’s reputation for wealth management, Panama City has proved highly successful in the building of an offshore banking industry.

Integrating exchanges 

Over the past 10 years, Latin American exchanges have modernised their infrastructure, and stakeholders – from owners to managers – have successfully co-opted governments to develop markets. These exchanges are now fighting to bring back liquidity drained out to New York, whose American Depository Receipt programmes have attracted blue-chip companies from across the region. But just how far will that process go?

São Paulo’s BM&FBovespa is already the fifth largest exchange by market capitalisation and has daily trading volumes of $3.5bn. It is looking at opportunities to cooperate with other markets in the region.

A new exchange is rising that should help further stem the flow of liquidity to the US. The Integrated Latin American Market (MILA) connects the stock exchanges of Bogotá, Lima and Santiago. Mr Cordoba at the Bolsa de Valores de Colombia believes the virtually integrated exchange will create critical mass and liquidity, promote trading between markets, and encourage more companies to launch an initial public offering, knowing they can tap investors in three countries.

MILA got off to a rocky start with low volumes of trading in its first three months through August and a spat over tax harmonisation between the three countries involved. Mr Cordoba admits that volumes were low but says that this was expected and believes that as investors and intermediaries obtain more information on the other two markets, volumes will rise. Already, asset managers are creating MILA funds. Increasingly, companies will raise funds across the three markets, Mr Cordoba predicts. 

If MILA is successful, it could encourage further co-operation between Latin American exchanges. Juan Antonio Ketterer, financial markets specialist at the Inter-American Development Bank in Washington, DC, points to the Nordic model where exchanges provide equal access to each others’ markets.

Mr Oliveira is pushing hard for such a model to be implemented in Latin America. BRAiN has been working on a detailed study, which it will finish at the end of 2011, mapping out capital markets in the region. It plans to push an agenda of fast-track access for investors to other markets, so that Brazilian investors can get access to Colombian stocks, for example, without having to resort to the US. “We want to see coordinated and harmonised models where Latin exchanges and brokers work together. This is win-win situation for us all,” says Mr Oliveira.

Cooperate or compete?

Is this just another doomed and over-ambitious attempt at Latin integration? The University of Chile's Mr Larraín thinks not. He points out that for the first time it is the private sector and not the government that is pushing for integration. Multilatinas – Latin American companies that are active on other continents – have been blazing the trail and capital market organisations are now following.

If co-operation does come, the extra liquidity will allow larger companies to raise funds locally and allow Latin financial centres to challenge New York. Mr Ketterer believes an alternative scenario should be considered. “There are two schools of thought. There may be co-operation with a Nordic-style model of open access. Or there may be rivalry between centres as there is between Frankfurt, London and Paris. It’s just too early to say which,” he says.

One area where regional links are less obviously taking root is in the banking sector. This is partly because Latin America remains so dominated by banks from outside the region with Brazil being the only exception.

Brazilian banks have been focusing on the booming and highly lucrative domestic market, where high interest rates generate fat spreads. This domestic focus is changing, says Mr Gruppo. Today, Brazilian banks are evaluating prospects globally, and while the crisis makes caution necessary, some are already expanding overseas. BTG Pactual, Itaú and Banco do Brasil, for example, have all been pushing into foreign and Latin markets. Another strategy may be using their deep skills in specific product lines for developing monoline companies, such as those offering credit cards, consumer finance or auto finance to move into other Latin countries, says Mr Gruppo.

Already, foreigners are taking note of Latin America’s capital market strengths. US asset managers used to stay in New York, arguing that markets are more influenced by global flows and that the bulk of Latin trading takes place in the US. Today, the need for local knowledge and the transferal of liquidity to Latin America is forcing them to reassess. “Many are now questioning whether they can still be credible if they do not have presence in key markets such as Brazil,” says Mr Gruppo. That surely is a sign of the times.