Samuel George on the integration of the Colombian, Peruvian, Chilean and (eventually) Mexican stock markets
A common refrain around Washington these days is that the Pacific Alliance—a free trade and cooperation pact led by Mexico, Colombia, Peru and Chile—is the “most exciting thing happening in Latin America.”
But some other folks that follow the region (not to mention many in the region) remain skeptical.
To the seasoned Latin Americanist, perhaps numbed by the steady diet of short-circuited regional pacts, the excitement over the Pacific Alliance can seem disproportionate.
For one, the Pumas do not exactly have compatible export portfolios. Chile will not get far trying to export copper to Peru. Secondly, poor coastal infrastructure and sheer distance do not portend smooth, cost effective supply chains. Given these issues, and the fact that the Pumas all shared bilateral trade agreements prior to the Pacific Alliance, some consider the bloc little more than a publicity stunt.
Brazilian Foreign Minister Antonio Patriota recently referred to the pact as a “marketing success.”
I am currently writing a paper that debates this argument, but I wanted to share an excerpt in advance, and call attention to MILA, a Pacific Alliance project that is integrating the stock markets of Bogotá, Lima and Santiago, and is expected to include that of Mexico City in the near future.
MILA is an example of why the Pacific Alliance can be substantial, and why the Pacific Pumas can become regional leaders.
Why MILA Matters
The Pacific Pumas may be growing, but prior to MILA, their bourses remained largely overlooked. Outside of São Paulo and Mexico City, Latin American equity markets lack depth and breadth, with few companies listing publicly and transactions infrequent.
The World Economic Forum’s 2012 Financial Development Index of 62 major markets found Colombia, Peru and Chile to be in bottom quintile in terms of stock market turnover rate. Meanwhile, Mexico, Peru and Colombia ranked in the bottom quarter of stock market value to GDP.
Not only small and illiquid, these markets can appear one dimensional: Chile in retail and services (32 percent of capitalization), Colombia in financials and energy (78 percent of capitalization) and Peru in mining (53 percent of capitalization).
Such specialization may attract boutique investment, but it flies under the radar of the global heard seeking the “next Brazil.”
MILA could change this.
Even without Mexico, MILA’s US$700bn capitalization places the burse second only to Brazil in terms of market size in South America. With 544 firms, MILA offers the largest portfolio in Latin America. The expected eventual integration of the Mexican burse would render a market of global relevance.
The Mexican stock exchange has openly revealed its desire to join the integrated market with the Bolsa Mexicana de Valores signing a letter of intent to join MILA only months after its introduction in 2011. For Mexican brokers, MILA would provide preference access to the Andean listings, even if BMV already has the liquidity and size the other Pumas lack.
In September of 2012, BMV concluded technical feasibility study, and proposed a (potentially unrealistic ) entry date of early-2014. If it did, a Pacific Puma bourse would rival the size of BOVESPA, with the key caveat that, while Brazil appears increasingly inclined towards protectionism, the Pumas have expressed a committment to deconstruct barriers to capital flows.
With this scale comes cheaper transactions, as well as diversified risk—two factors that encourage an active market. Increased access improves resource allocation, hopefully funneling investment to worthy firms.
Moreover, whereas Puma markets may have been individually one-dimensional, combined, they offer a complimentary mix. Finally, international investors will likely be tantalized by this new, large block which will stand out in a way that, say, La Bolsa de Valores de Lima, could not.
Early Harvest Agreements
MILA attests to the efficacy of the Pacific Alliance “early-harvest” negotiations. Rather than quixotically pursuing an immediate integration of the three bourses, the parties sought a step-by-step model that allowed negotiations to methodically overcome knee-jerk opposition.
By moving slowly and building linkages, proponents convinced regulators and brokerages of the three markets that, while they would loss complete autonomy, the end results would be a larger piece of a much larger pie.
Phase I of MILA (completed in August, 2011) built a foundation for future integration. The phase implemented a communications system between Chilean, Peruvian, and Colombian brokerages that encouraged cross-border access to the three bourses.
MILA created the technical infrastructure for, say, a Peruvian broker to partner with a Chilean broker who could intermediate Peruvian transaction on the Bolsa de Santiago. The first phase of MILA also ensured soliciting rights across the three stock markets, allowing a given country to advertise domestic stock listing in participating foreign countries.
Securing Phase I reforms was not easy—Peruvian reluctance to accept a flat capital gains tax of 5 percent delayed implementation for months—but by keeping expectations reasonable, Colombia, Peru and Chile established momentum for the project.
Phase II negotiations, currently under way, will attempt to eliminate inefficiencies baked into Phase I reforms. For example, Peruvian brokerages currently pay the intermediary Chilean firms for their services. The resultant markup eats into already thin margins.
Direct access to the Chilean bourse would be preferable. Furthermore, settlement costs remain expensive. Sticking with the Peruvian – Chilean example, brokers execute the exchange by selling Peruvian soles to New York financial institutions for Chilean pesos that are then moved to Santiago. The transfer fees can equal up to 20 percent of the transaction.
Successful MILA II negotiations would lead to substantial increases in trade volume while costs would decrease. Suddenly, the proverbial pie would be far bigger still. From this point, it is but a short jump to MILA III: Full integration, in which brokers could follow screens in Lima and immediately place an order for a listing in Santiago.
This would be a level of integration that, to this point, Latin America has struggled to meet.
Samuel George in a Latin America specialist working in Washington DC
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