On November 22, the stock exchanges of Lima, Peru (the BVL); Colombia (the BVC); and Santiago, Chile (the BCS) will make their shares available to investors in all three countries. The first stage in the integration will facilitate technological access to the local market for foreign intermediaries. The exchanges will remain separate legal entities that function and operate independently.

The idea is to provide investors with a broader supply of shares and share issuers with additional sources of financing. “In theory, the integration of stock markets enables the interchange of capital flows between the markets in a way that is much more expeditious,” says Jaime A. Retamal Smith, director of the MBA program of the Gabriela Mistral University in Chile. “This integration will enable any citizen in these countries to invest in a particular market as easily as he or she does in their own country of origin. In this context, one would expect that small investors, who previously were unable to find such diversification because of problems of scale, could now do so perfectly.”
Retamal says the initiative “is appropriate and will have a positive impact over the medium and long term.” Diana P. Piedrahita, coordinator of the financial laboratory at the EAFIT University in Colombia, calls the integration “an enormous step for deepening the markets of the region.”
A Giant in Latin America
According to its website (http://mercadointegrado.com), the unified market of Peru, Colombia and Chile will become the largest in Latin America, with 563 companies issuing shares.
The Integrated Latin American Market (MILA by its Spanish acronym) had market capitalization of nearly US$661 billion on November 9, 2010, according to Bloomberg. The percentages and dollar values of the market capitalization, by country, worked out as follows:
·         Chile, 50.6%, US$334.46 billion.
·         Colombia, 33.55%, US$221.76 billion.
·         Peru, 15.85%, US$104.75 billion.
Only Brazil, at US$1.747 trillion, had a higher market capitalization in the region. Mexico’s was lower, at US$457.99 billion.
By value of shares traded, MILA will be the third-largest market in Latin America, at US$57 billion annually, trailing Brazil (US$633 billion) and Mexico (US$87 billion). A recent Reuters survey of market participants suggested that the daily value of shares traded on MILA could reach US$300 million.

The integration provides investors with a route to diversification; the markets individually are heavy with issuers from particular industries. Mining companies represent more than half (53%) of the market capitalization of the Peruvian market, according to the Lima-based exchange. In Colombia, the industrial sector provides 78% of market capitalization. And in Santiago, the service sector weighs in with 32%.

Benefits for Investors, Share Issuers
Integration’s main advantage for local investors, Piedrahita notes, is the chance to invest in more financial instruments and, because of the distinct focuses in each of the markets, achieve greater diversification of investments. “Finally, there are all sorts of different products in the three markets (ETFs, mutual funds, derivatives) that would add to the possibilities for investing,” Piedrahita says. “In addition, one would expect that greater competition between these stock markets would lead to lower transaction costs, more options for choosing among them, and possible mergers and acquisitions.”

From the viewpoint of share issuers, Piedrahita says, integration “would make it easier to enter capital markets, which would translate into lower costs for financing, and better receptivity to public share offerings.”

According to Diego Agudelo, director of the graduate program in finance at Colombia’s EAFIT University, integration “would benefit those firms that are listed on the stock markets that integrate, and even foreign firms, since it would provide them with a broader selection of potential buyers of their new shares.” He says that “by increasing the availability of brokers who can potentially negotiate share trades, it must increase the trading volume of the various shares.” In his view, that was the case in other integration processes, such as the three European exchanges that formed Euronext in 2000; the three Colombian stock markets that formed BVC in 2001; and the Nordic stock markets.
“We can illustrate that last point with a simplified example. Let’s suppose that there are two independent stock markets, A and B. In each market each day there are potentially 10 buyers and 10 sellers. In each market, there will be 100 potential transactions, for a total of 200. If the two markets fully integrate, they will have 20 potential buyers and 20 potential sellers, for a total of 400 different potential transactions. In this simplified market, the integration process doubled the number of potential transactions,” Agudelo notes.
“There are benefits for the people who manage the exchanges and for the exchanges themselves: greater income for larger transaction volumes. They will also have a greater capacity to compete against the big Latin American stock markets like Bovespa (in Sao Paulo, Brazil) and BVM (in Mexico) for new share offerings and foreign investment.”

Robert Tornabell, professor of finance at the ESADE business school in Spain, also believes that integration will have advantages for publicly traded companies and investors. “The companies will have the opportunity to attract a greater volume of capital and compete among themselves with new issues of shares in the stock markets.” Meanwhile, “investors will be able to put their savings into different countries apart from their own, and they will be able to know and control them much better.”

Beyond that, Tornabell sees integration as the beginning of something more important for Latin America. “We can find ourselves at the first step that small countries take so they can level out the road toward the integration of much larger markets with the incorporation of giants such as Brazil. That country is also interested in integration because it will attract a greater volume of capital movements to the region, more liquidity, diversification of savings and, as a result, wealth for everyone.”
Not everything about the integration is positive, however. “A possible negative effect,” Piedrahita says, would be if the excessive appetite of investors for these emerging markets were not completely supported by the fundamental variables of the economies and the companies but, instead, by the great liquidity and lower interest rates in their countries of origin so that asset prices inflate to the point where they generate speculative bubbles.”
Two Stages of Integration
MILA says the integration will occur in two stages. In the first, the stock exchanges will facilitate foreign intermediaries’ technological access to the local market and address issues around settlement of transactions. In the second, intermediaries will access the market directly. Rules will be standardized and cross-border settlement procedures defined.
Retamal stresses the challenges involved in the process. “When it comes to building institutions among countries, this process obliges them to resolve all of the question marks created by the flow of capital between countries, such as operating systems, clearing houses, taxation and so forth. … Given the fact that the system would operate with ‘mirrors’ among the countries, the transaction itself would be viewed directly at the points where there are participants, independent of the market that is involved.”
Agudelo notes “certain differences in the level of sophistication” of the participating exchanges. “For example, in Chile it is possible to sell shares short, but not in Colombia and Peru. However, in Peru the ‘global market’ (for shares of foreign firms) is more developed than in Chile or Colombia.”
For Tornabell, “one of the greatest problems, if integration is to work, is the lack of a free market for capital flows among the three countries.” Another issue is “the significant imbalances of payments that these countries suffer and the absence of a common, stable currency.” In this way, MILA is “a very worthwhile effort” that is nevertheless “complicated” to achieve. “Integration of the stock markets of Mercosur would be much more feasible because Brazil has great monetary reserves, among other reasons,” he says. The Mercosur free-trade union comprises Argentina, Brazil, Paraguay and Uruguay. Bolivia and Venezuela are in the process of joining, and Chile, Colombia, Peru and Ecuador are associate members.
Tornabell believes that Peru, Colombia and Chile could find a good example in the integration process at Latibex, the Latin American share market in Madrid. That’s because the share prices of all companies traded there are quoted in the same currency, the euro. “I believe that the exchanges of Peru, Colombia and Chile should consider the possibility that all of their shares be traded in one currency; that would make things a lot easier.”
Piedrahita laments that during the first phase of integration “there won’t be a joint system of trading, but each stock market will maintain its own system and clear its transactions through a centralized system of deposits.” Regulatory differences also present a challenge. “The critical points of this combined regulation are the management of foreign exchange rates and taxation of share prices, although one hopes that this will be resolved in the second phase of integration.”

Still, integration can propel Latin America toward much more ambitious goals. “The big step that could be achieved is to go from integration of the stock markets to integration of these countries’ economies. For this to happen, the first step would be integration of trade among the three countries, through a much stronger free-trade agreement,” Piedrahita says.