Alternative arrangements: The government aims for diversification and expansion of the market

In comparison to neighbouring bourses in Chile and Colombia, the Lima Stock Exchange (Bolsa de Valores de Lima, BVL) is a minor player in terms of both market capitalisation and volume traded. Despite top performing stocks in retail and finance, the BVL remains highly concentrated in mining, which accounts for 41.5% of total market capitalisation. The government is seeking to address these shortcomings by implementing a series of reforms aimed at expanding and diversifying the BVL.

The first of these is the Securities Market Promotion Act, led by the Ministry of Economy and Finance (Ministerio de Economía y Finanzas, MEF) and leaders from the banking and finance sectors. This reform, passed in June 2013, is aimed at boosting participation in the BVL by reducing costs for companies and investors, and improving corporate governance of small and medium-sized enterprises (SMEs). A primary goal is to encourage more SMEs to list on the exchange. The law also introduces rules to make the market more flexible, increase the number of listings, draw investors and diversify financing structures.

Meanwhile, the creation of the Alternative Stock Exchange (Mercado Alternativo de Valores, MAV) by the Superintendency of the Securities Market ( Superintendencia del Mercado de Valores, SMV) is a complementary initiative to capital market reform. The MAV will act as an intermediate platform for SME entrance into the debt and equity markets.

Reform

The capital market reform has been long awaited. It is the first of its kind since the early 1990s. The MEF along with participants from regulatory bodies and the private sector hope to use the reform to address a wide variety of concerns which fit within three broad categories: attracting more SMEs to use debt and equity finance, improving corporate governance and diversifying the market in general.

Miguel Castilla, the minister of economy and finance, told local press that the reform commission will look to make the requirements for companies that want to list on the stock exchange more flexible, and reduce the cost of listing for SMEs. By doing so, the commission hopes more companies will consider bond and equity issuances as financing options.

Knowledge Gap

Another hurdle that may prevent some SMEs from listing on the exchange or issuing debt is a lack of knowledge of the corporate governance practices that must be in place for a company to go public. Jose Luis Sarrio, partner at audit and advisory firm GrantThornton, told OBG, “There are family companies that are looking to list, but they don’t know how to do it or whether it is a good thing. This goes back to a lack of understanding surrounding corporate governance.”

Influencing better corporate governance has been a major initiative of the BVL over the past couple of years. The exchange has an Index of Good Corporate Governance and hosts an annual ceremony to honour the best-governed Peruvian companies. The SMV conducts workshops, inviting business owners to learn about corporate governance practices and the potential long-term benefits of going public.

Finally, the reform seeks to expand and diversify Peru’s capital markets by means including encouraging the listing of public companies, allowing investment funds and mutual funds greater access to the market and promoting internationalisation of the BVL via the Integrated Latin American Exchange (Mercado Integrado Latinoamericano, MILA).

Daniel Garcia, principal analyst at the SMV, told OBG that the reform is likely to address capital gains taxes. At present, BVL investors are required to pay a 5% tax on all earnings. Castilla has said that there is a need to re-evaluate this tax, especially in light of regional competition. Chile, for example, does not charge its stock market investors a similar tax.

According to Christian Laub, president of the BVL and CEO of Credicorp Capital, for the BVL to attract more investors and compete on a regional level, the reforms need to lower the rate of capital gains tax, and also all costs associated with BVL investment. “You need to increase trading volume by cutting costs throughout the process, including placing an order, executing a trade and taxes. The 5% tax on exchange earnings affects liquidity and the MILA.”

MAV

While the reform aims to reduce costs for BVL investors, regulators are focused on lowering the costs and regulatory burdens for SMEs that want to access capital market financing. In August 2012 the BVL introduced the MAV. Similar to the BVL’s junior mining exchange, the MAV is intended to serve a specific niche – SMEs that are new to capital market finance. SMEs with less than PEN200m ($75m) in sales on average over the past three years are eligible to participate. They can use the MAV to list equity shares, short-term instruments and bonds in the primary and secondary markets.

The MAV distinguishes itself from the BVL through a variety of reductions in the costs and regulatory requirements to participate in the stock exchange. Under normal circumstances, a company that would like to list on the BVL would need to have two risk assessments, with each costing around $15,000. The MAV reduces the requirement to one risk evaluation, thereby saving companies $15,000.

Further, instead of having to publish quarterly financial reports, which the BVL would normally require, companies on the MAV must provide financial reports only twice a year, barring any serious changes in the business which could affect its share value. These are mandated to be publicly announced in a timely fashion. Finally, the SMV has developed a separate set of standardised forms for interested companies to fill out should they want to participate in the MAV. These help to cut down on legal costs associated with preparing contracts.

The MAV is based on the model used to launch the Alternative Investment Market (AIM) in London in 1995. According to the AIM’s 15-year report of 2010, the exchange has grown from 10 companies in 1995 to 1200 in 2010. Similar to the MAV, the AIM provides participants with much greater flexibility than the London Stock Exchange. It has no minimum free float requirement, for example. The AIM is considered a success not only due to its dramatic growth but also its diversity. As of 2010 it had participants from more than 40 different sectors, with no major concentrations in any individual one.

Concerns

While achieving a level of success similar to the AIM in terms of growth in market capitalisation and sector diversity is a laudable goal, some have voiced concerns about the MAV project. Alejandro Rabanal, the head of equity research for Peru at Credicorp Capital, told OBG that the MAV has parallels with a former programme launched by the BVL known as Avanza BVL. Avanza BVL was primarily an educational programme created to inform participating businesses with sales of between $5m and $100m of the benefits of listing on the BVL and prepare them to eventually go public.

However, according to Rabanal, just as some of the companies were preparing to go public they were acquired by other firms. For example, Bembos, a fast food chain and participant in Avanza BVL, was purchased by retail giant Interbank. Logically the risk exists that as SMEs prepare to enter the capital markets by improving their corporate governance this process also makes the companies more desirable in the eyes of potential buyers. There is little that can be done to address this concern.

Others in the finance sector believe that the MAV is a good measure, but that it does not go far enough to address the shortcomings of Peru’s capital markets. According to Laub, if the BVL would like to see a large increase in liquidity there should be some effort to think about how the exchange can “manage to have large Peruvian companies issue their debt in the country as opposed to abroad”. Large Peruvian companies have tended towards the latter, especially over the past year as international markets have witnessed strong growth in issuances of Peruvian corporate bonds. It is not clear if and how the MAV would address this challenge.

Luis Quispe, general manager of Grupo Coril, also told OBG that the widely reported higher issuance of corporate bonds is misleading and not necessarily indicative of a wide increase in the number of companies listing. “It is only the large companies, the same companies that are already listed, simply looking to take advantage of cheaper debt abroad,” he said.

Potential

In April 2013 the MAV saw its first listing, though as of September no others had listed. However, many potential participants are reported to have already expressed an interest in the exchange. Overall, SMEs account for 70% of employment and 40% of GDP in Peru, while only 20% of business finance comes from the capital markets. These figures indicate that the MAV holds great growth and development potential. If implemented effectively, the capital market reform could significantly boost the MAV, as well as the domestic market in general.