Integrated solutions: The marriage of three markets offers new opportunities for the region

The culmination of a two-year process in May 2011 to integrate the stock markets of Colombia, Chile and Peru was aimed at increasing business between the three capital markets and offering investors a more diverse and liquid range of alternative investments. Greater liquidity was expected to bring in more investors and encourage additional companies to list, thus further boosting liquidity and trading volumes. By coming together, the three economies were aiming to deepen their capital markets and drive economic growth by creating a new stock exchange to rival Bovespa in Brazil. The result is the Integrated Latin American Market (Mercado Integrado Latinoamericano, MILA), the second-largest market in the region by market capitalisation and by number of quoted stocks after Bovespa.

BY NUMBER: The average daily traded volume of MILA is about $100m. Taken together, the Colombian, Chilean and Peruvian exchanges that made up MILA had a total market capitalisation of $678bn, 515 issuers, 84 intermediaries and an annual trading volume of $84bn at end-2012. By comparison, Bovespa had a $1.23trn market capitalisation, 353 issuers, 90 intermediaries and $875bn in annual traded volume.

Several months after MILA’s launch in 2011, Standard & Poor’s (S&P) began tracking the top-40 quoted stocks, selected by size and liquidity, on its S&P MILA 40 Index. In June 2012, S&P stipulated that no member country could have fewer than five companies on the index, thereby ensuring regional diversity irrespective of market developments. At year-end 2012 Chile accounted for 22; Colombia, 12; and Peru, six; respectively. Colombia’s Ecopetrol is the biggest constituent by market capitalisation, while the two largest sectors, financials and materials, together account for roughly half of the index weighting. At least one exchangetraded fund linked to the index is envisaged for launch during 2013. The S&P MILA 40 rose in value by around 17.3% over the course of 2012.

FLEXIBLE: MILA gives non-regional investors a single access point, requiring a single account opening, to trade stocks in the region. They can transact in local currencies – Colombian pesos, Peruvian soles and Chilean pesos, respectively – while diversifying their exposure to three markets at once.

Regional integration of financial markets comes at an opportune time for firms and investors looking for growth and investment opportunities beyond their home markets. Leading Colombian banks including Bancolombia, Banco de Bogotá and Davivienda have been expanding their footprint in Central America.

Chilean financial groups (Banco Falabella and LarrainVial) are pushing into both Colombia and Peru, while its retailers (SAGA Falabella and Ripley) have built a significant presence in Peru. Banco de Crédito Perú has acquired majority takes in brokerage houses in both Chile (IM Trust) and Colombia (Correval), ostensibly to create a regional investment bank capable of reaping the benefits of developments such as MILA.

FURTHER INTEGRATION: While Brazil’s stock exchange, Bovespa, the regional leader, was rumoured to be in talks about joining MILA in late 2012, this looks unlikely in the near term. Much more likely, however, is the accession of Mexico, a move which could see MILA rival Bovespa for regional dominance. The Mexican Stock Exchange signed a letter of intent with the existing MILA members in December 2012. Due diligence is progressing and preparation is under way for amendments to the Mexican securities market regulation, and the Mexican Congress approved the stock’s integration in June 2013. The accession of Mexico, or even Brazil, in the future, would signal a new phase in the development of MILA, offering greater liquidity and diversity of investments to participants, including leading regional corporates like Carlos Slim’s América Móvil.

TEETHING PROBLEMS: Although MILA has not yet lived up to expectations in terms of traded volumes, mostly as its 2011 debut came at an inauspicious time for risk appetite in global financial markets, it is making steady progress. This development should be underpinned by continued strong growth in the economies of its constituent members and their widening and deepening capital markets. There is an expectation among the authorities that activity will pick up over the coming three to five years as problems are ironed out and rules harmonised. Eventually, it is hoped that initial public offerings (IPOs) can be coordinated in all member countries simultaneously on equal terms to open up the largest possible investor pool to issuers, and the most diverse range of offerings for investors. Luc Gerard, founder and CEO of Tribeca Asset Management, a private equity firm, told OBG, “The main exit strategy for private equity investors has been through a sale to a strategic partner. While the bulk of the activity that is happening in the market is too small for a flotation, by 2015 we will see transaction sizes ripe for IPO.”

There are currently several constraints on MILA achieving its full potential. If an integrated regional equity market characterised by high liquidity is the ultimate aim, then formally integrating stock markets can be considered a necessary but insufficient step. Firstly, investors must be well informed about potential investments, whether domestic or international. Where investors rely on their brokers for advice, this requires that brokers themselves have sufficient research capacity to offer informed advice. As Jose Manuel Vélez Londoño, president of Serfinco, told OBG, “The increasing integration of the three stock markets, Colombian, Peruvian and Chilean, has led to an integration of their players and brokers, with several partnerships, mergers and acquisitions taking place.” Although some larger financial groups have begun to establish such a regional presence, underpinned by a “MILA strategy”, this is far from universally the case. There is much work to be done regarding harmonising taxation, regulatory and operational regimes such that investors in all MILA member countries are operating on a level playing field.

A concrete example of such operational challenges is the use of so-called omnibus trading accounts in Peru and Chile whereby a broker can purchase a large volume of stocks in a single trade and later split them between clients as required. In Colombia, by contrast, this is not possible. To ward off potential money laundering, the Colombian authorities require the unique identifier of each final beneficiary of a trade to be registered on the trading platform, similar to the procedure in Brazil. Prohibiting the use of omnibus accounts also reduces the potential for counterparty risk on the part of the broker. This lack of synchronisation does, however, complicate the execution of trades.

TAX: Differential tax treatment also remains an issue. Dividends on Colombian shares attract no tax for either residents or non-residents so long as the appropriate taxes have been paid by the issuer. Dividends on Peruvian shares attract a tax of 4.1% for non-residents, whereas dividends on Chilean shares are taxed at a rate of 35%, less the relevant tax credit. Capital gains attract no tax in the case of Chile and Colombia (except if in the case of the latter the amount does not exceed 10% of the issuer’s shares outstanding in any given fiscal year), while Peru charges 5% on net capital gains.

GLOBAL: MILA, however, is not the sole regional integration initiative to which Colombia’s capital markets have been party. Cross-listings on US stock exchanges have long been key for the continent’s capital markets. Colombia has been no stranger to this trend, and the traffic has become increasingly two-way in recent years.

In 1995, Bancolombia became the first Colombian firm to secure a full listing on the New York Stock Exchange (NYSE). It was followed in 2008 by Ecopetrol, soon after its own domestic IPO. A listing on the NYSE not only offers access to new sources of capital but a stamp of approval as a global player. There has been much speculation in recent years that other Colombian firms would follow, notably Banco Davivienda and Grupo de Energía de Bogotá, although these have not yet materialised. With interest rates at record lows, the relative attractiveness of an international IPO is somewhat diminished. Colombia’s three leading banking groups (Bancolombia, Grupo Aval and Banco Davivienda), in particular, were very active in 2012 in international debt markets to fund both strong lending growth and aggressive regional expansion efforts.

Following reforms to allow dual listings on the Colombian Stock Exchange (Bolsa de Valores de Colombia, BVC), six foreign firms with strong business links to Colombia have secured listings on the BVC, led in late 2009 by Pacific Rubiales, the Canadian-based energy company which is also Colombia’s second-largest oil producer, after Ecopetrol. It was soon followed by other Canadian firms with energy interests: Canacol and Petrominerales. Given the wide shareholder base of Ecopetrol in Colombia, the BVC offers these firms the opportunity to expand their own investor pool.

To leverage the overall scope for Colombian-Canadian capital markets partnerships, the BVC and the Toronto Stock Exchange (TSX) signed a memorandum of understanding in June 2012 to facilitate informationsharing, mutual development and dual listings. With some 19 TSX-listed firms currently operating in Colombia, and an additional 43 on the TSX Venture Exchange, there is space for further dual listings going forward.