Wednesday, December 29, 2010

Chile`s Capital Markets: A brief overview

GLG News Analysis

Chile`s Capital Markets: A brief overview
November 01, 2010


 Analysis realized from Exhibition given by Vittorio Corbo, Central Bank former President of the Central bank in Chile, in Third International Conference organized by the Chilean Issuers Chilean Issuers Committee (CIC) of Amcham Chile.


 The recent turbulence that occurred in international financial markets responded to a standardization process for recovery of credit risk premiums of various assets. In fact, both the Global Financial Stability Report published by the IMF, including reports from the Global Stability Forum and Reports Financial Stability and Monetary Policy which regularly publishes the Central Bank realized a while ago of a necessary correction price and therefore is likely to increase market volatility. However, the deterioration of U.S. subprime mortgage market problems made evident asset valuation and monitoring and credit risk management of financial institutions. Taking excessive credit risk of financial institutions questioned the financial stability of financial markets developed. The reaction of the Federal Reserve Bank of U.S. and European central banks, injecting liquidity to ensure the functioning of the interbank market, emphasized again the importance of central banks in times of financial stress. Despite the timely intervention of these agencies was inevitable increased preference for liquidity in the markets.

For the temporary relief that central banks can provide, is the interest of maintaining the operation of the banking system and, of course, the capital market. The literature gives us three important results:

i) A positive correlation between financial development and economic development
ii) Financial crises are costly and therefore it is beneficial to prevent
outbreak and limit its impact on economies, and
iii) The banking system and capital markets will complement and enhance the growth potential of an economy.

These results show that there is, then, a close relationship between financial stability and capital market development. On the other hand, concern for financial stability has been the mandate of central banks since its inception. Consequently, the relationship between the development of capital markets and the role of central banks is unquestionable. Recent events reveal serious challenges for regulators and supervisors in the international markets in relation to improving their understanding and ability to detect risks that are incubated in modern financial systems. In our country we have closely followed these developments, assessing the potential impacts of short-term financial conditions and prospects for economic growth, but also in order to draw conclusions about the implications for financial stability of the economy national long-term.

The development of capital markets in Chile, in recent years in our country have implemented a set of economic policies that constitute a strong first line of defense against financial turmoil as those experienced recently in the international markets and, no doubt have contributed to the sustained growth of the capital market. First, at the macroeconomic level features a monetary policy geared to price stability under a floating exchange rate with fiscal policy, where spending is determined by the central government's permanent income. This combination of macroeconomic policies helps to stabilize the business cycle and increase the capacity of our economy to absorb shocks. This macro stability also facilitates the development of a deeper capital market. In the financial sphere, the Ministry of Finance in collaboration with the superintendents that regulate financial service providers and the Central Bank launched several reforms to the functioning of capital markets designed to promote integration and financial market development under a framework greater flexibility, transparency and self-management agents. Thus, Chile is in a very favorable position compared to other emerging economies and at the same time, their situation resembles that of most developed countries in terms of market development of private issuers of debt.
The Central Bank's Role in the development of capital market, the bank's constitutional mandate is to ensure currency stability and the normal functioning of the internal and external payments. So granted, the mandate is a cornerstone of the financial stability of our economy. However, unlike the objective of monetary policy, financial stability is not an exclusive objective of the central bank, being shared with other agencies and supervisory regulations. However, the central bank's contribution to the development of capital markets has covered several areas of the financial system, which are summarized below: Payment infrastructure, the year 2000, the Central Bank Council resolved to adopt a program aimed to modernize payment systems in our country to converge with international standards in this area. Our main objective was to increase efficiency and safety of payment systems, high value, operating in the country. One of the most important milestones of this program was the implementation of the RTGS system in April 2004. The RTGS is an electronic system for interbank payments and gross settlement in real time, operated by the Central Bank and which are available to all banks established in Chile. Without prejudice to the operation of the RTGS system, and recognizing the value netting schemes or compensation payment settlement, the Central Bank in late 2005 authorized the operation of "Clearing House Payments High Value” National Currency, a company that is operated by an enterprise of banking support, Combanc SA Payments made through this Chamber are final and irrevocable and once completed their business daily, the result of the clearing process finally be settled through the RTGS system. The development of these systems has been held: i) the number of operations conducted between the two has more than doubled since its inception; ii) the increased use of the system is largely explained by the increase in operations conducted by third parties.

To this, the Central Bank has joined other initiatives to modernize payment systems help to minimize operational risks and improve access to financing from commercial banks. First, it reflects the mode of delivery versus payment of securities traded in the money market and, secondly, the availability of a permanent facility Liquidity in domestic currency (FLI), implemented in January 2005. There are still many aspects to modernize our payment system and the Central Bank is actively evaluating and participating in such initiatives. In the first case, pending the challenge of increasing the security of settlements and compensation for foreign currency transactions. In the second case, the Central Bank has been involved in the development of a Clearing and Settlement System for Securities that will result in the creation of a Central Counterparty House. This project led by Treasury and is in the early stages of legal proceedings, will operate with greater legal certainty of transactions and improve the safety of operations of the stock market. Structure of bank debt, Central Bank, during the nineties was the largest issuer of long-term debt situation has changed somewhat in recent years with the emissions on behalf of the Treasury. In any case, the market for long-term instruments and had an interesting stage of development since the mid-eighties, proceeds from the issuance of letters of credit mortgage used to finance the purchase of real estate assets. This development was made possible largely by demand for investment instruments term created by the steady accumulation of savings funds from the pension fund industry, the Central Bank's efforts to control inflation and the existence of an indexing unit widely accepted in the economy.
Traditionally, our long-term papers, known as PRCs were denominated in Unidades de Fomento (
NYSE:FMX) (UF) and structured to be paid in equal semi-annual coupon form, i.e. including the amortization of capital. This structure extremely difficult to estimate the yield curve and the creation of deep markets in different parts of the curve. Proceeds of the foregoing, the Central Bank in August 2002 decided to restructure the composition of its debt, leading to type bullet bond issue, which only consider payment of interest coupons during the life of the bond, while the capital cancel the expiration of the last coupon. Thus, bonds issued in dollars, known as BCP, 2 and 5 years and UF bonds, called BCU, 5 and 10 years respectively. Instruments were also issued dollar denominated and payable in pesos, BCD, and denominated and payable in that currency, BCX, with maturities of 2 to 5 years. Later, in 2004 the first BCP was issued a longer period, 10 years.
The objectives of this initiative were:

i) Modify the composition of long-term debt of the Central Bank to increase the share of debt in pesos and the average time of it;
ii) Adopting international standards for the issuance of Central Bank debt,
iii) Strengthening the benchmark bond issues, with a minimum issue size by the use of reopening, buybacks and exchange of instruments.
This modernization also allowed the Council's decision to strengthen the Central Bank of nominalized the conduct of monetary policy adopted in August 2001 when he replaced the TPM indexed to the UF for a nominal TPM. In turn, the nominalization of monetary policy ended a monetary regime that lasted 16 years, conducting monetary assimilating the practice adopted by other central banks around the world who lead an active monetary policy. In practice, the nominalization of monetary policy and the restructuring of the Central Bank debt, in aggregate, provided the pricing and comparison with similar instruments developed capital markets, allowing also the determination of spreads and the placement of instruments private debt in the local market.

Financial and market risks, On another level, regulation of the banking system was modernized and made in line with international best practices with the approval of the Central Bank of new regulations on liquidity risk management and risk management market, which considers the exchange rate risks, interest rate and inflation. Market growth of bank deposits has been very important in recent years, highlighting the increasing share of deposits denominated in pesos, development consistent with the nominalization.
Among the innovations in regulation emphasizes, first, and after a period of collaboration with the Superintendence of Banks and Financial Institutions (SBIF) and in consultation with the banking industry, the publication in October 2003 of the new regulations liquidity. These regulations remained the structure of this maturity mismatch in the previous regulation, but introduced substantial changes in the explicit requirements of a policy of liquidity management of banks and greater transparency of information available to the market. It also introduced the distinction between debtors and creditors and between wholesale and retail contract terms and deadlines, in order to bring the regulation to the specific conditions faced by various banks participating in our market. Later, during the second half of 2004 and again in coordination with the SBIF and in collaboration with industry regulations replaced the existing market risk by legislation considered best practices and recommendations of the Committee on Banking Supervision, Bank for International, but adapted to the reality of our market. This policy held the line taken earlier in the liquidity rules requiring the existence of an explicit policy to deal with market risks of financial institutions. In a sense, this law introduced greater flexibility in the management of market risks as banks allowed to choose a risk profile more appropriate to their business strategy. A very important development that introduced this legislation is the possibility that some banks now have, with the authorization of the SBIF, to issue options on currencies and interest rates, which have helped to broaden the range of financial services, can be found in the local market. Also, both the rules of market risk and liquidity risk introducing the concepts of stress testing and back testing. Banks should carry out periodic stress tests on predetermined changes in interest rates and exchange rates, and view its impact on the solvency of institutions. These exercises can reveal potential vulnerabilities for banks in certain scenarios that involve a risk to financial stability. Other regulatory developments, Recently, a modified standard fundraising and financial intermediation by banks which, according to the laws of market risk and liquidity discussed previously, consider a more flexibility in banking operations as at rates, currencies and maturities. This legislation also simplified the rules for securities lending between institutions allowing their development by increasing liquidity in the money market. Recently, the Circle of ICARE Finance published a document containing proposals to modernize the capital market. These initiatives show the importance not only for regulatory and supervisory authorities continued promotion of a deep and robust market.

Challenges ahead, the Chilean capital market has experienced remarkable development in recent years, as reflected in the strong growth of corporate bond issues and mutual fund administrators. However, I think there is still room for further stimulated growth. In particular, it is necessary to increase the liquidity of money market and debt instruments in general in all parts of the curve and integration with international markets. Increased market liquidity would broaden the base of both domestic and foreign investors, and streamlining the implementation of monetary policy. It is important to continue to gradually expand the range of financial services available in our capital market as financial innovation help to complete the market, allowing domestic agents to cover various scenarios of internal and external risk. For example, international comparison suggests that the structure of derivatives transactions is still far from the levels observed in other countries:

In terms of market structure, Chile still exhibits characteristics of a highly indexed to UF, but we found a trend towards a greater number of transactions at a fixed rate, in line with other capital markets:

Chile is also seen in its structure characteristics of issuers with a significant importance to the Central Bank. However, the most notable is the growing presence of private issuers, companies basically on the overall structure of instruments.

However, this development must necessarily be accompanied by greater market discipline on the part of non-financial agents. This should result in greater transparency of financial statements and notes to the principal actors. The availability of a "map" of assets and liabilities by type of agent (business corporate, institutional, government, and homes) would allow investors, regulators and supervisors were able to identify clear and timely manner which would be incubating the credit risks, market and operational risks that could jeopardize the financial stability of the economy.
Bernardo Javalquinto
University of Maryland

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