To build an equity market
Equity has never been a significant part of business in Central America, but now, with the emergence of an ambitious new model for regional securities exchange, all that may change
By Peter Krupa
San José
The term “stock market” might conjure up an image of a trading floor scattered with papers, of men shouting into their cell phones and of last-minute deals. But this Hollywood version of high finance couldn’t be further from the sleepy reality of Central America’s securities exchanges.
By any reasonable measure, the equities market in Central America is both tiny and highly fragmented. On a recent day this May, for example, the exchanges in Costa Rica, Panama, and El Salvador combined traded the shares of only seven companies for a total volume of about $650,000. And other securities aren’t much better: The volume of debt traded on the secondary market that day, for example, was a little more than $12 million collectively. It doesn’t even come close to the volume of even a single day’s trading in neighboring Colombia, where individual transactions often reach into the millions.
“The region’s equity markets at this point are basically vestigial,” said Matthew Sullivan, Director of the MAPA (Alternative Shares Market or Mercadeo Alternativo para Acciones) Initiative at the National Stock Exchange in Costa Rica (BNV). As a program of BNV, MAPA was designed to encourage small and medium companies to seek equity by coaching them through a process that allows them to take on equity investors without participating in the open market. The idea of the program is that the companies expand to the point where they eventually see value in going public.
What’s worse, the small volume handled by Central America’s securities exchanges is further hampered by the market’s fragmentation. Each exchange operates solely within its own national context of regulation and investment—that is, locally, in isolation, with no cross-border trading. Each country has its own securities regulator with its own regulations, which effectively prevent securities from being issued in another country or purchasing shares of foreign corporations through national brokers.
Because the exchanges are so small, illiquid and isolated, Central America’s equity market has not attracted much attention from local businesses that need to raise capital, nor has it inspired people with capital, whether local players and foreign investors, when looking for emerging market opportunities. “It’s a very illiquid market, the trading volumes are very small, and really that’s what needs to be changed,” said Andres Víquez, CEO of Costa Rican securities broker Aldesa Valores.
But the Central American market is now taking a step in that direction. A plan to create an association among three of the region’s seven securities exchanges is currently in the works. Called the Alianza de Mercados Centroamericanos (Alliance of Central American Markets, or AMERCA), the association seeks to create the equivalent of a unified regional securities market that will allow investors in any Central American member country to purchase instruments listed on any member exchange. The idea is to pool together the market’s supply and demand, creating an economy of scale that will tighten spreads while increasing volume and liquidity. “The markets (will be) put together in a way that from the outside, they look like a more or less seamless union of markets,” said Sullivan, who is heading up the plan for the three exchanges. “It’s like a jigsaw puzzle with perfectly fitting pieces.”
The idea is that AMERCA’s larger size will attract local businesses looking to raise capital, which in turn will attract investors— locally and possibly also internationally—creating something of a snowball effect. Over the last decade and a half, there have been several attempts to create a regional securities market, though all have failed. AMERCA itself still has several important barriers to overcome; even then, it is not clear if the region’s flexibility and size (equivalent to Colombia) will be sufficient to attract significant new investment. The region’s increasingly globalized profile means that companies that could benefit from the plan are either too small or large enough for acquisition by multinationals already listed elsewhere.
Still, AMERCA has progressed further than other efforts undertaken in the past. Having learned from their mistakes, AMERCA offers a radically different model that avoids most of the entanglements with local regulation and cultural factors that tripped up previous attempts. Representatives of the exchanges of El Salvador, Costa Rica, and Panama have signed a letter of understanding and are on track to form a jointly held subsidiary this November that will handle the technical aspects of the common trading platform. More importantly, the three countries’ securities regulators have taken an active role in the negotiations, allowing participants to head off regulatory hang-ups before they happen. As a result, the first crossborder securities trade could take place as soon as the end of next year.
The organization of the market
TAlthough there are companies currently listed on Central American securities exchanges, there are only a few offerings, and most of the trading does not involve equity but rather short-term corporate debt, sovereign debt, and money market transactions, particularly in Costa Rica and El Salvador.
In 2007, for example, Costa Rica’s exchange saw a secondary market trading volume of $43.14 billion. Of that, debt transactions accounted for $5.12 billion and closed fund trades accounted for a few hundred million.
Repos—sophisticated, relatively obscure money-market transactions involving shortterm borrowing backed by a security, historically made more attractive by low interest rates—accounted for 85.7 percent, or $36.97 billion, of the secondary market. Meanwhile, equity accounted for only 5 percent, or $2.19 billion, of the secondary market volume, with trades in shares of a single company making up almost half of all equity trades.
In El Salvador’s smaller securities exchange, called Bolsa de Valores de El Salvador, the total trading volume for 2007 was $6.77 billion. Of that, $1.14 billion was in debt transactions, with only 9.1 percent, or $617.74 million, in equity trades, and a whopping $3.94 billion in repos. Likewise for Panama’s exchange, where of the $2.28 billion traded in 2007, only 9 percent was made up of equity transactions.
The lack of equity trading in the three markets becomes even clearer when looking at market capitalization—the total value of listed shares—as a percentage of GDP, a standard measure of the health of a country’s equity market. According to the World Bank, developed markets in the U.S. and Europe often exceed 100 percent, while an average ratio for developing markets is about 36 percent of market capitalization as a percentage of GDP. For example, Colombia’s exchange in Bogotá has an equity market capitalization worth more than 40 percent of GDP, while in Costa Rica’s 2007 exchange, equity market capitalization was only 8.95 percent—an extremely low percentage even in a developing economy. Panama and El Salvador showed similarly low ratios. According to Sullivan, Central American has “equity markets the sizes of which are well below that of a healthy market.”
There are a number of reasons for Central America’s small market capitalization, ranging from deepseated cultural norms to recent market conditions that are shifting companies away from equity markets. For example, many major local companies in Central America are still family-owned and resist the idea of opening the door to strangers buying equity, said Carlos Mora de la Orden, owner of the Central American finance Web portal Capitales.com. So far, they haven’t had the need. Companies large enough to take on the complicated and time-consuming process of going public often have sufficient access to bank credit already, or else prefer to raise credit through issuing commercial paper or bonds. Finally, companies that are both big enough, or sophisticated enough, to go public on a local exchange aren’t likely to stay there for long. Though foreign investors haven’t paid much attention to the region’s securities market, they have become interested in acquiring successful listed companies in Central America, at which point the companies are swiftly unlisted. This has been the case with a number of companies in Costa Rica, including a bank (Interfin, purchased by Scotiabank), an appliance manufacturer (Atlas, purchased by Mabe), and a construction materials company (Durman Esquivel, purchased by Aliaxis Latinoamérica).
As a result, partly, of the above trend, the Costa Rican exchange has been actively moving away from equity. Equity trading in 2007 was down 34 percent, and capitalization as a percentage of GDP has dropped from the 13 percent registered in 2002. Few listings and thin trading on the markets also discourage investors. Light trading on an exchange means that it can be difficult to estimate the value of a particular company’s shares, as they are traded so rarely. Spreads are wider, and liquidity is so low that investors have no guarantee of being able to move in and out of a position quickly.
“At the end of the day, the depth and the liquidity of this market is not enough” to make it attractive, said Ariel Vishnia, CEO of securities broker BCT Valores. Vishnia and others say that the limitations of the Central American exchanges could be partially corrected by increasing its size. This could be done, for example, by tripling the number of both investors and participating companies, which would increase trading, narrow spreads, and make the market more liquid.
This is not a new concept; the quick way to carry it out would be for several exchanges to join forces and share listings, traders, or both. Central America’s exchanges have been trying to collaborate, through associations and business alliances that allow them to share listings and increase the pool of available investments, ever since they formed the Association of Central American and Caribbean Securities Exchanges [Asociación de Bolsas de Comercio de Centroamérica y el Caribe (BOLCEN)] in 1994, said Javier Mayora, CEO of El Salvador’s securities exchange. “Looking at the El Salvador market individually, it’s not as attractive,” he said.
The different attempts to establish bilateral and multilateral associations in the last few years have failed for two basic reasons. According to observers, the first reason was cultural. Combining national exchanges tweaked each country’s feelings of national pride and seemed as if it were creating winners and losers, Sullivan said. “Until now, all the exchanges had the attitude of being king of the hill,” said Mora de la Orden, a long-time observer of the region’s market.
The other problem was structural. The exchanges traditionally approached market unification by “cross-listing,” or sharing listings of securities. That model got quickly tied down with red tape. A system of cross-listing meant that countries would have had to make legal changes in each respective securities market regulation to allow foreign companies to list on the local securities exchange, something that proved prohibitive both in terms of time and complexity. “The proposals that we’ve always seen have been of a unified exchange,” said Juan Manuel Martans, president of Panama’s National Securities Commission. Those proposals, he said, were “very, very complicated.”
In the end, the companies that were supposed to be the beneficiaries would have had to go through the arduous process of listing themselves on several different exchanges at once. Besides being both time-consuming and expensive, this system would have fragmented the market. According to Mayora, however, there was important progress made during the process. For one, Central American securities regulators had a chance to work with each other and, in the end, to approve measures that officially recognized each others’ regulations as equal to, or better than, their own. The failed attempts also set the stage for cooperation that would lead to the current AMERCA plan.
A different model
AMERCA uses a different model: it’s designed to sidestep both the cultural and structural pitfalls of the previous attempts. Rather than cross-listing or merging the exchanges, the new plan is based on something called “remote membership” for foreign brokers.
A Costa Rican broker, for example, would be able to register in El Salvador as a “remote broker” and get access to securities listed on the Salvadoran exchange for his or her Costa Rican customers. The advantage of this system is that the regulatory structure in each individual country remains virtually unchanged, while the market itself is unified for all intents and purposes. This is the ingeniousness of the new system: it regionalizes access without having to regionalize regulation.
This method of creating a regional market is not a new invention, but rather modeled after NOREX, a joint Nordic securities market composed of eight Nordic and Baltic exchanges. Under the remote membership model, the various exchanges saw 30 percent collective annual growth after only three years into the alliance. Seven of the exchanges eventually merged into the OMX Nordic Exchange, which was purchased in May 2007 by the NASDAQ exchange. Today the NOREX members’ combined equity market capitalization is equal to $1.79 trillion, or 112 percent of the countries’ GDP, according to a recent report from the International Monetary Fund. “It seemed like an interesting example for us because it was a situation similar to ours,” said El Salvador security exchange CEO Mayora.
When it became clear that an association between the exchanges in Panama, El Salvador, and Costa Rica was a possibility, the three exchanges sought funding from the Inter- American Development bank, which granted them $150,000 to 18 Central hire the consulting services of OMX. Over the course of four monthly workshops starting in December, the heads of the three exchanges met for intensive talks, with representatives of the Nicaraguan exchange participating as observers and representatives of OMX presiding. Also present at the workshops were representatives of each country’s securities regulators, who are working closely with the exchanges as they hammer out the details of an association.
Talks continued on schedule, and at the conclusion of March’s workshop, the CEOs of the exchanges, along with market regulators and the OMX advisors, held a joint press conference in Costa Rica to announce that they were prepared to present a letter of agreement to their boards. The letter that the three exchanges signed on June 10 includes the creation of a jointly held corporation to carry out the marketing of the new association and oversee the technical platform used by the exchanges. At the announcement in March, the heads of the exchange said they expected the platform to be ready in two years’ time.
Hurdles remain
But while the association agreement has been proceeding on schedule, some significant obstacles remain. For example, despite the fact that regulators are looking over the shoulders of the exchanges as they form their association, it is not yet certain how each country’s regulatory regime will deal with the alliance in the end. The biggest question mark is the “remote membership” part of the scheme. “The idea is that, working with the regulators, we will create a new type of stock brokering firm,” Sullivan said.
But each country will have to create that regulation based on their regulatory framework. An eleventh-hour discovery that regulatory laws need to be changed through an act of the legislature would hurt the process badly.
According to Martans, Panamanian and other regulators have kept a sharp eye out for possible conflicts as the talks proceeded. He also sees the potential for complications in the process of information sharing among regulators. A mechanism for quick communication in the event of a crossborder complaint, he said, will be crucial for the system to function properly. “It’s very important that people share information,” he said.
No conflicts have yet come to light, said Martans, but it will be important for regulators to modify, sooner than later, any legislative rules or regulations that might obstruct the fluid exchange of information. Here too, the notion that the legislative branch might need to get involved could prove disastrous, as it would bring politics and other not necessarily helpful ingredients into the mix.
Finally, the exchanges have yet to agree on some of the more delicate matters for the association to come into being. Though the agreement largely manages to skirt national pride by leaving each exchange untouched in its local market, the plan still requires the incorporation of a joint subsidiary to carry out the technical and marketing logistics for unifying the market, as well as the decision where to locate actual operations. As a result, compromises may have to be made. Sullivan said the exchanges might agree to put different parts of the subsidiary in different countries, while Mayora said that locating the exchange in a third-party country—say, a Caribbean island with an advantageous tax structure—is also a possibility.
The new market
What will actually happen once Panama, Costa Rica, and El Salvador unify trading is still a matter of speculation. Even with the current move toward regionalized securities, a healthy equity market is still some ways off. Since the securities market in Central America so heavily favors debt instruments, its effect will likely be seen there first. Investors will have access to tools previously unavailable in their own markets—for example, Colón-denominated debt in Costa Rica, available in the dollarized Panamanian and Salvadoran economies for the very first time.
Víquez expects commercial paper to get a boost as companies take advantage of a larger pool of investors to raise cheaper money. Also, recent reforms in pension regimes throughout the region are paving the way toward a “critical mass of institutional investors that we didn’t have before,” Víquez said. These investors are likely to move to take advantage of the new system, starting with debt instruments.
Equity, however, is a different matter entirely. Even with the union of three exchanges, the equity market only has a dozen or so listed companies whose shares are liquid enough to trade on a regular basis. “I think it’s going to be a much slower process,” Víquez said. The problem is that the market will have to attract more listings in order to mature, but the fundamental set-up of the Central American market will make that difficult. Medium and large companies in the region are usually either family-owned, owned by a multinational, or big enough to take advantage of bank or other credit. The ones that don’t fit any of those categories either have nowhere to grow, given the small size of their home countries—making equity an unattractive option—or are likely targets for acquisition by foreign companies, said Capitales.com owner Mora de la Orden.
Instead, analysts think that the future of the region’s equity market is in small and medium companies with room to grow and limited access to bank financing. In this regard, there is one market trend that will encourage business owners to consider equity: the international tightening of credit markets. Small and medium companies with limited access to bank instruments from the beginning will now increasingly find their access even more restricted, thus turning to securities markets—and possibly equity—as better options for raising growth capital.
Another move that might drive businesses towards equity is MAPA, the program recently put in place by the Costa Rican exchange, and watched with interest by other exchanges in the region. “We’re looking at it as a greenhouse for potential issuers in the market,” said Mayora, the CEO of El Salvador’s exchange.
AMERCA will also be the first step towards further integration of the market. The association is currently being designed to allow other exchanges to join as well. The Nicaraguan exchange, for one, which has participated as an observer throughout the process, has expressed interest. According to Mayora, AMERCA will target other BOLCEN members in the short term, which would include Guatemala, Nicaragua, Honduras, and the Dominican Republic. In the long term, however, Mexico and South America might also join the alliance. Yet another feasible long-term possibility for AMERCA is the merger of member exchanges, similar to what happened in the case of NOREX. “If this works, there is an awfully large number of things that can be done to improve it even further,” said Sullivan. “Let’s hope that we find ourselves in that position as soon as possible.
Tomado de Central America Today, Edición de Junio/Julio
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