## FINANCIAL INTEGRATION IN LATIN AMERICA (_030416) ## Source details **Canonical URL:** [FINANCIAL INTEGRATION IN LATIN AMERICA (_030416)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2016/_030416.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2016/_030416.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2016/_030416.pdf.json) --- ### EXECUTIVE SUMMARY — Overview, rationale and recent shocks - Recent performance and shocks: - Many Latin American economies experienced significant reductions in growth owing to the end of the commodity super-cycle and the rebalancing of China’s growth; a number of global banks have been leaving the region. - Since 2008 there has been a withdrawal of global banks from the region, potentially worsening access to credit or reducing competition in the financial sector. - The region continues to suffer from protracted sluggish growth in advanced economies; the GFC showed extreme volatility can originate outside the region. - Rationale for regional financial integration: - Timing: propitious now for greater regional financial integration. - Complement to global integration: not a substitute; some LA economies active globally. - Pathway benefits: - Facilitate adoption of best practices in supervision and accounting. - Facilitate inward investment. - Enable markets to achieve minimum viable size. - Add diversification across domestic, regional and global exposures. - Ongoing initiatives and private-sector developments: - Pacific Alliance (PA): Presidents of Chile, Colombia, Mexico and Peru meet regularly since 2011; Paracas Declaration (July 2, 2015) reaffirmed market integration commitment. - Mercosur: longer-standing organization with potential to revive financial integration agenda. - Private banks: regional expansion notably by banks from Brazil and Colombia. - Capital markets: MILA initiative; Brazilian stock exchange bought 8% of the Santiago exchange. ### Major policy recommendations (Box 1 — Key recommendations) - Core regulatory and market measures: - Take opportunities for regional integration when identifying potential purchasers in the event of global bank withdrawal. - Develop explicit, open, objective and non-discriminatory statutory and regulatory framework for cross-border entry. - Ensure level playing fields (access to credit bureaus, deposit insurance). - Develop stable and transparent tax rules; agreements for avoidance of double taxation. - Harmonize accounting and regulatory frameworks: consistent IFRS, consistent capital definitions as articulated by Basel 3 and Solvency II-type regimes; explore mutual recognition of licensing. - Enhance consolidated and conglomerate supervision; expand supervisory and resolution colleges and MoUs for regional banks with significant cross-border activity. - Harmonize legal frameworks for bank resolution and non-bank insolvency regimes. - Institutional investor and market measures: - Gradually increase maximum ratio for pension funds and insurance companies to invest cross-border within the region up to 50% (or higher) where current limits are below this, with safeguards for risk management. - Examine relaxation of limits for pension funds and insurance companies to invest in regional infrastructure projects. - Ensure infrastructure procurement bids open to institutions from the region. - Explore prospects for revitalizing regional currency settlement and for CCP recognition conditional on CPSS-IOSCO PFMI compliance. - Work towards full compliance with FATF standards to avoid loss of correspondent banking relationships. - Consider sequenced relaxation of exchange controls, including permitting individuals to hold foreign exchange accounts onshore. ### Preserved key facts, provenance and IMF lending table (executive-statistics) - GDP growth comparison: - GDP in 2014 in the seven LA countries covered in this report is estimated to have been 52 percent higher in real terms than in 2002, compared with 25 percent for the United States and 16 percent for the countries of the European Union. - Timeline and provenance: - March 30, 2016; Approved by Alejandro Werner; Prepared by a WHD team led by Charles Enoch with named contributors. - IMF lending (as presented in Table 1 of the source): - Brazil 641.3 - Chile 31.4 - Colombia 30.0 - Mexico 517.9 - Panama 70.4 - Peru 91.1 - Uruguay 102.8 - Al l I MF p rogra ms371314.5 --- ### BANKING SYSTEMS — Concentration, spreads, cross-border expansion and regulations - Concentration and ownership: - In Peru and Uruguay the three largest banks account for about 70 percent of banking system assets. - In Brazil, Chile, Colombia and Mexico the three largest banks hold 50 percent of banking system assets. - Uruguay: 40 percent of banking system assets controlled by one government-owned bank. - Foreign banks hold important market shares in some LA-7: 27 percent of LA-7 GDP. - Bank spreads, costs and profitability: - Brazil spreads: over 15 percent (non-financial corporations 10 percent; households 26 percent). - ROE around 20 percent for largest Brazilian banks. - Operating costs: three time higher in Brazil than average OECD, and 40 percent above the average in Latin America. - Spreads lower and falling in Colombia, Chile, Mexico, Panama; Peru has high spreads but low operating expenses. - Cross-border claims and regional integration momentum: - Foreign claims by Chilean banks on the region are 50 percent of total claims. - Brazilian banks’ foreign claims on other LA-7 about 13 percent of total claims—US$18 billion (of which 12 percent are on Chile). - Mexican banks’ foreign claims on other LA-7 are about 3 percent of total claims. - Assets of Colombian banks’ subsidiaries abroad reached US$50 billion, accounting for 24 percent of the total assets of the Colombian banking system. - Large regional players: - Bank Itaú (São Paulo) assets size close to the entire Mexican banking system (US$420 billion). - Itaú cross-border business share post-Corpbanca acquisition rising to 13 percent from 7 percent in 2011. - Barriers to regional integration and competition: - High equity prices in Chile, Mexico, Peru deter acquisitions. - Brazil: foreign bank entry requires Presidential approval; restrictions on Brazilians holding foreign currency domestically; only 10% of pension fund assets may be invested abroad. - Legal and operational impediments, pricing of centralized functions oversight, ring-fencing practices and local asset maintenance requirements can restrict cross-border business. - Regulatory heterogeneity: - Brazil and Mexico lead in Basel III implementation; Chile and Colombia more gradual. - Heterogeneous adoption timing complicates establishing a level playing field during transitions. ### Bank-related policy recommendations (selected) - Harmonize regulatory frameworks and legal frameworks for bank resolution and restructuring. - Strengthen consolidated supervision and supervisory/safety-net cooperation (MoUs; supervisory and resolution colleges). - Increase transparency of foreign bank entry processes; reduce discretionary licensing features (e.g., presidential approval in Brazil). - In dollarized economies: strengthen prudential requirements on dollar lending; support de-dollarization via deepening local-currency markets and FX derivatives. --- ### NON-BANK FINANCIAL SECTORS — Pension funds, insurance, mutual funds, infrastructure financing - Pension funds — size, limits and dynamics: - LA-7 pension fund assets have reached US$700 billion. - LA-7 pension fund assets amounted to about 17% of LA-7 GDP at end-2014 (except Chile much higher; OECD average 37%). - Between 2008 and 2014 LA-7 pension assets grew 50–100 percent. - Typical statutory limits on foreign assets (percent of total pension fund assets): Brazil (10%); Mexico (20%); Colombia (40-70%); Chile (80%); Peru (50%; operational limit 42% from Jan 1, 2015); Uruguay (15%); Panama (45%). - Peru: regulatory limit 50% established by Law; Central Bank set operational limit at 42 percent from January 1, 2015. - Uruguay’s low foreign asset cap: 15% and further restricted to multilateral institution securities. - Pension fund market and policy implications: - Rapid pension fund growth outpaces domestic capital markets, creating demand pressures, potential crowding out, and illiquidity; recommended increase of foreign/regional limits progressively (suggested about 50% where currently lower). - Proposal: treat regional (MILA/PA) securities as domestic for pension funds under safeguards; consider a special regional bond category initially exempting about 5% from foreign asset limits. - Portability: recommend pension fund portability across LA-7 to facilitate labor mobility and encourage harmonization. - Insurance sector: - Insurance penetration low: 1–4 percentage points of GDP in LA-7; insurance premia quadrupled between 2003 and 2013, reaching almost US$160 billion by 2013 (regionally). - Regulators moving toward Solvency II-type regimes: Brazil and Mexico leading; Chile expected to adopt similar frameworks. - Market concentration: Uruguay state-owned insurer controls 80% of market; other countries have top-10 shares ranging 60–80%. - Asset-liability mismatches common: up to 3- to 5-year maturity mismatches; shortage of long-term local-currency assets for life insurers/annuities. - Mutual funds: - Mutual funds and banks interlinked via repo operations and holdings of deposits and bank-issued bonds. - Infrastructure financing (Box 2): - Pension funds and insurance companies are natural long-term investors for infrastructure but face prudential caps (typical caps for “alternate” investments 5–10% of assets). - Solutions include project sponsors absorbing currency risk, hedging as markets deepen, syndicated bank loans, PPP risk frameworks, and collaboration to build regional risk assessment teams. ### Non-bank policy recommendations (selected) - Relax foreign asset limits for pension funds and insurance companies with safeguards and sequencing. - Enable pension funds to count cross-border PA investment as domestic after supervisory arrangements. - Create frameworks to permit pension funds to invest in regional infrastructure; open infrastructure procurement to regional institutions. - Harmonize operational practices, data quality and cross-border regulatory cooperation; use CPSS-IOSCO PFMI peer reviews for CCP recognition. --- ### CAPITAL MARKETS, EXCHANGES, OTC MARKETS, AND MILA - Capital market size and liquidity (end-2014): - Capitalization of LA-7 equity markets was 47% of regional GDP. - Value of domestically traded bonds outstanding about 61% of GDP. - Chile: stock 91.6% of GDP; bonds 51.0% of GDP. - Liquidity and trading issues: - Low trading volumes and declining liquidity due to high transaction costs and buy-and-hold institutional investors. - Equity depth impeded by concentrated ownership, limited free float and corporate governance issues. - Domestic bond markets often have higher rates, shorter maturities, smaller volumes; sovereign and highly rated corporates access international markets on better terms. - MILA and exchange cross-ownership: - MILA: merger initiative among Chile, Colombia, Peru; Mexico joined in December 2014. - Market capitalization (Dec 2014, US$ millions): Chile 233.0; Colombia 153.1; Peru 120.8; Mexico 481.0. - BM&FBovespa purchased an 8% stake in the Santiago exchange; BMV bought 6.7% of Lima exchange. - Cross-border trades limited: first trade of Falabella executed on Dec 2, 2014; total trades since MILA start less than Mexico’s weekly volume. - Post-trade and CCP issues: - Cross-border trades currently free-of-payment; cash and securities do not move together on settlement date; local broker-dealers bear counterparty risk. - Recommendation: multilateral DvP settlement solution (regional clearinghouse or interoperable local CSDs/ custodians) and CPSS-IOSCO PFMI compliance and mutual recognition of CCPs. - OTC derivatives and FX markets: - Interest rate derivatives in LA-6 currencies ~1.2% of global derivative turnover; BRL and MXN constitute 60% of that market, largely swaps. - Mexican peso OTC single currency interest rate derivatives turnover USD 12.3 bn in April 2013 (about 0.4% of global OTC single currency interest rate derivatives market); domestic clearing only USD 2.4 billion (18%). - MXN offshore trading dominance: MXN accounted for about 65 percent of offshore turnover of LA currencies; MXN turnover US$135 billion in 2013; MXN global FX market share 2.5% in 2013 (up from 1.3% in 2010). - Regulatory changes: Mexico scheduled phased implementation requiring standardized OTC trades on exchanges with mandatory clearing through CCPs (April 2016 domestic entities; November 2016 foreign financial institutions). - Policy recommendations for capital markets: - Harmonize financial infrastructure and operational practices (IFRS adoption, IOSCO MOUs, double taxation treaties). - Permit broker-dealers to operate cross-country (subject to home and host supervision) and “passport” broker-dealers in MILA. - Harmonize trading hours, tax treatments, listing requirements, and post-trade interoperability. --- ### LEGAL AND REGULATORY BARRIERS — Cross-border establishments, acquisitions and treaties - Entry regimes and practical constraints: - De jure open regimes for subsidiaries and branches: Chile, Colombia, Panama, Peru. - Restrictive regimes and conditions: - Mexico: prohibits branches of foreign banks; subsidiaries only under specified treaty conditions; residency requirements for board/executive board (Articles 45-A, 45-K, 45-L of Banking Law). - Brazil: Constitution formally prohibits opening of new branches/subsidiaries but waivers exist via Presidential approval; foreign entry requires presidential approval in practice. - Broad supervisory discretion and “best interests” tests can block market access (e.g., Panama’s Art. 48.3 and 48.5 Banking Law). - Cross-border acquisition of financial services: - Panama and Mexico: residents precluded from acquiring certain insurance contracts abroad (Panama Insurance Law Art. 153; Mexico Insurance Law Art. 21). - Restrictions on pension funds outsourcing asset management abroad exist; only allowed in Chile. - Brazil requires retail/professional investors to invest abroad only through Brazilian asset management vehicles. - Domestic-law reform recommendations: - Move entry regimes into primary legislation; avoid overly broad discretionary licensing; allow both subsidiaries and branches. - Recalibrate LAMR and ring-fencing: require LAMR to apply to a significant percentage of local liabilities (deposits), not just endowment capital. - Remove discriminatory ring-fencing; reconsider nationality/residence requirements for directors/managers. - Review rules prohibiting residents acquiring foreign financial services (Chile, Colombia and Peru explicitly authorize residents to acquire insurance abroad). - Role for soft and hard law: - Regional harmonization (soft law) can facilitate market access and cross-border supervisory cooperation; sequencing important. - Hard-law international treaties (FTAs/BITs) with specific financial services chapters can support integration (NAFTA, TPP, some FTAs include financial services chapters and prudential carve-outs). - Detailed treaty provisions (e.g., financial services committee, dispute settlement) can be helpful but need complementary domestic measures. --- ### QUANTIFYING INTEGRATION — Econometric results and macro implications - Measurement approach: - Composite indices combining financial openness (gross external assets and liabilities to GDP) and market convergence (regional dispersion of stock returns) via principal component analysis; alternative indices adding depth and regional openness. - Controls: GDP per capita (PPP), trade openness, past financial crises, public debt-to-GDP, institutional quality (ICRG investment profile). - Main econometric findings: - LA-7 countries are under-integrated as a whole after controlling for fundamentals, with Panama a notable exception (well integrated in many specifications). - Using composite indexes (openness + convergence + depth + regional openness variants), most LA-7 countries show under-integration relative to a global sample. - Growth dividend estimates: - Closing the integration gap in LA-7 countries may raise GDP growth by 0.25–0.75 percentage point. - Integration elasticities reported around 0.01–0.02; LA-7 gaps average 0.3–0.4 implying a potential 0.3–0.8 percentage point growth effect if fully closed (results treated with caution given endogeneity). - Market-implied spillover analysis: - Market-based contagion measures (vulnerability index; contribution to systemic risk) show contagion risks among LA large financial institutions remain contained relative to GFC levels. - Brazil’s public banks at times drive domestic market-implied contagion but actual cross-border spillovers are limited given low balance-sheet exposures across LA banks. - Bank contagion module (BIS-based): - LA banking systems have tighter links with advanced economy banking systems (Canada, Spain, UK, US); shocks to advanced-economy banking systems could materially affect foreign credit availability to LA. - Shocks originating within a LA banking system likely have small direct spillovers onto other LA countries due to limited intraregional cross-border banking exposures. --- ### RISKS, MITIGATION AND PRECONDITIONS FOR SAFE INTEGRATION - Risks identified: - Withdrawal of global banks increased consolidation among local banks, undermining competitiveness and liquidity. - Advanced-economy regulatory reforms (capital surcharges, Key Attributes, OTC reforms, ring-fencing) influence global bank behavior in the region and may induce further retrenchment. - Loss of correspondent banking relationships due to AML/CFT and enforcement actions reducing provision of correspondent services by some large international banks; e.g., JPMorgan withdrawing correspondent services for small/medium Mexican banks; Bank of America remaining for some local banks. - Increased integration raises potential for contagion spillovers in crises; needs monitoring and mitigation. - Mitigation measures: - Analytical work on spillover risks and market-implied linkages. - Strengthen regulatory oversight: forward-looking Basel 3 adoption, consolidated and conglomerate supervision, supervisory colleges and MoUs, cross-border resolution frameworks. - Macroprudential coordination and reciprocity to avoid regulatory arbitrage and leakage. - Careful sequencing of market-opening conditional on harmonization of supervision and safeguards. --- ### MODELS, TIMING AND COUNTRY-SPECIFIC NOTES (LA-7 coverage) - Strategic models: - Pacific Alliance (PA) + MILA seen as promising due to political momentum and market enthusiasm — recommend small secretariat to coordinate sequencing, reciprocity, passporting and pension/insurance treatment. - Mercosur: Financial Mercosur (SGT-4) exists; current dormancy may present opportunity for revival. - MILA: expansion beyond equities to sovereign and corporate bonds, harmonize listing and operational procedures, passport broker-dealers subject to home and host supervision, resolve post-trade settlement (DvP). - Country snapshots and select exact figures: - Brazil: - Nominal GDP ~US$2.35 trillion (2014). - Total financial sector assets close to US$2.4 trillion. - Banking sector ~117 percent of GDP. - Public banks represent about half of the banking system. - Foreign financial claims on Brazil ~US$442 billion (roughly 18 percent of GDP). - Chile: - Banking assets ~125 percent of GDP. - Pension funds ~75 percent of GDP. - AFPs foreign aggregate limit up to 80 percent; actual average foreign share 45 percent (up from 35 percent end-2011). - Colombia: - Banking system assets about US$200 billion, or 55 percent of GDP (end-2014). - Ten large domestic conglomerates hold about 80 percent of total financial sector assets. - Foreign claims (ultimate risk) on Colombia US$45 billion (11% of GDP); Spanish banks account for US$18 billion of that. - Mexico: - Financial system assets about 83% of GDP (2014); system growth average 2.5 percentage points of GDP annually (2010–14). - Banking sector foreign ownership about 70% of total assets (Spain 37%, USA 18%, UK 9%). - Mexican peso OTC interest rate derivatives turnover US$12.3 bn in April 2013 (0.4% of global OTC single currency IRD); domestic clearing USD 2.4 billion (18%). - Pension funds assets under management about 14% of GDP. - FX turnover US$135 billion in 2013; MXN global FX market share 2.5% in 2013 (up from 1.3% in 2010). - About 31 percent of government debt bonds held by foreigners (May 2015). - Peru: - Broad financial system grew from US$52.3 billion (58.1% of GDP) in 2006 to US$175.8 billion (90.8% of GDP) in 2014. - Equity market capitalization nearly 60% of GDP (2014) with 180 listed firms. - Pension fund statutory foreign limit 50%; operational cap set at 42 percent (since Jan 1, 2015). - Panama: - Pension funds foreign investment limit 15% (note country specifics vary by legal instrument). - Uruguay: - Pension fund managers collective assets US$11 billion (20 percent of GDP). - Public AFAP holds almost two-thirds of pension assets (US$6.2 billion). - Insurance assets US$3.2 billion at end-2014 (5 percent of GDP); state-owned BSE controls 82 percent market share. - Empirical assessment summary: - Econometric evidence suggests closing the integration gap could raise GDP growth by 0.25–0.75 percentage point in LA-7. - Integration elasticities typically 0.01–0.02 with LA-7 under-integration averaging 0.3–0.4. ### CONCLUSION — Path forward - MILA and regional securities-market integration are important staging posts to deepen intermediation and resilience through larger, more liquid markets. - Preconditions for safe, deeper integration: - Strengthened regional supervisory and regulatory oversight, consolidated and conglomerate supervision, robust macroprudential toolkits, harmonized legal frameworks for cross-border entry and resolution, post-trade DvP settlement, and adherence to international standards (Basel 3, PFMI, FATF). - Current low measured spillover risks provide room to advance integration provided regulatory and supervisory safeguards are strengthened and sequencing is respected. *Italic: Source: International Monetary Fund — Financial Integration in Latin America (excerpt, _030416, March 30, 2016).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Overview: recent performance and shocks - Many Latin American economies have experienced significant reductions in growth recently, as a result of the end of the commodity super-cycle and the rebalancing of China’s growth, and a number of global banks have been leaving the region. - Although Latin American countries were generally less affected by the global financial crisis (GFC) than other regions, the region continues also to suffer from the protracted sluggish growth in advanced economies. - Since 2008 there has been a withdrawal of global banks from the region, thus potentially worsening access to credit or reducing competition in the financial sector. - The GFC demonstrated that extreme economic volatility can originate from outside the region, rather than internally, as was the experience of the 1980s and 1990s. ### Rationale for regional financial integration - Timing: The timing may now be propitious for Latin American economies to work towards greater regional financial integration. - Complement to global integration: Regional financial integration would not be a substitute for wider integration in the world economy; some Latin American economies are amongst the most active in global initiatives. - Pathway benefits: - Facilitate adoption of best practices in supervision and accounting as steps towards wider integration later. - Facilitate inward investment. - Enable markets to achieve minimum viable size. - Add a dimension of diversification, reducing reliance solely on domestic or global developments and allowing countries to reap benefits from the economic stability of other countries in the region. ### Ongoing initiatives and private-sector developments - Pacific Alliance (PA): - Since 2011 the Presidents of Chile, Colombia, Mexico and Peru have met regularly to take forward the agenda of the Pacific Alliance. - Most recently, on July 2, 2015 they issued the Paracas Declaration reaffirming their commitment to foster market integration between their countries. - Mercosur: A more long-standing organization that may also revive the momentum of its financial integration agenda. - Private banks: Private sector banks, particularly from Brazil and Colombia, are moving across the region, establishing themselves as regional institutions. - Capital markets: - Stock exchanges are establishing regional presence: the Integrated Latin America Market (MILA) initiative aims to foster equity and bond market integration across the PA countries. - The Brazilian stock exchange has bought 8% of the Santiago exchange. ### Policy measures, pre-conditions and barriers to advance integration - The paper suggests a number of measures to advance regional financial integration in Latin America. - Pre-conditions identified that would enable integration to proceed safely (high level): - Regulatory and supervisory harmonization and adoption of best practices. - Legal frameworks to facilitate cross-border establishments and acquisitions of financial institutions. - Risk-mitigation frameworks and analytical work on spillover risks. - Barriers identified that could be progressively reduced and eliminated: - Limits on cross-border investments by pension funds and other large institutional investors. - Legal and regulatory impediments to cross-border establishment and acquisition of financial services. - Domestic prudential or ring-fencing measures introduced post-GFC that may inhibit regional market entry or cross-border flows. - Political economy facilitation: - Proceeding on a regional basis may make it more palatable for a country to relax limits to which its pension funds may invest cross-border. - Opening domestic economies in this way could increase competition and favorably position Latin American countries for further global integration in the future. ### Risks and mitigation (high-level) - Withdrawal of global banks has led to increased consolidation among leading local banks (for instance in Brazil), potentially undermining competitiveness of banking systems and liquidity in local markets. - Ongoing regulatory reforms in advanced-economy home jurisdictions (e.g., systemic banks’ capital surcharge, Key Attributes of Effective Resolution Regimes, OTC reforms, ring-fencing) influence the presence and behavior of global banks in the region. - The paper emphasizes the need for: - Analytical work on spillover risks. - Strengthened regulatory oversight and cross-border cooperation. - Mitigation strategies when deepening regional integration. ### Key statistics and factual points preserved from the source - GDP growth comparison: GDP in 2014 in the seven LA countries covered in this report is estimated to have been 52 percent higher in real terms than in 2002, compared with 25 percent for the United States and 16 percent for the countries of the European Union. - Timeline and provenance: - March 30, 2016 - Approved by Alejandro Werner - Prepared by a WHD team led by Charles Enoch, and including Carlos Caceres, Luc Eyraud, Alla Myrvoda, Anayochukwu Osueke, Diva Singh, Ben Sutton, Iulia Teodoru (all WHD), with contributions of LEG (Jefferson Alvares, Wouter Bossu, Barend Jansen, Laura Lorenzo), MCM (Marco Pinon, Mohamed Norat), and RES (Camelia Minoiu and Paola Ganum) on the basis of work at headquarters and on missions to Brazil, Panama and Colombia (June 2015) and Mexico, Peru, Chile and Uruguay (July 2015). - IMF lending (as presented in Table 1 of the source): - Brazil 641.3 - Chile 31.4 - Colombia 30.0 - Mexico 517.9 - Panama 70.4 - Peru 91.1 - Uruguay 102.8 - Al l I MF p rogra ms371314.5 *Source: EXECUTIVE SUMMARY (March 30, 2016), Financial Integration in Latin America — International Monetary Fund.* ### 4. The nonbank financial sector is also challenged. Volumes and liquidity in a number of ### _030416 - 4. The nonbank financial sector is also challenged. Volumes and liquidity in a number of ### Nonbank sector challenges and regulatory constraints - Volumes and liquidity in a number of exchanges are declining as US regulations for derivatives trading have increased the cost of doing business in emerging markets. - Pension funds and insurance companies face regulatory restrictions constraining the bulk of their activities to their domestic markets, causing increasing friction, especially in smaller markets. - Many countries’ pension and insurance funds remain heavily constrained in how much they can invest outside the home country (examples detailed below). ### Regional market integration trends and initiatives - Private sector regional expansion: - Banks from Brazil and Colombia are moving across the region, regarding themselves as regional institutions. - Cross-border participation in stock exchanges: the Brazilian stock exchange purchased 8% of the Santiago exchange. - Nonfinancial corporates are expanding across the region, notably retail institutions from Chile and conglomerates from Brazil and Mexico. - Official/regional initiatives: - Since 2011 the Presidents of Chile, Colombia, Mexico and Peru have been meeting regularly to take forward the Pacific Alliance (PA). - On July 2, 2015, they issued the Paracas Declaration, reaffirming their commitment to foster market integration. - In September 2015 the Presidents of the PA conducted a joint roadshow around major global financial markets. - The PA was invited as observer to the ASEAN meetings in the Philippines in November 2015. - Mercosur has brought together six LA economies3 with the objective of integration; although the Mercosur process has stalled recently, conditions may be favorable for a revitalization. ### Integration with the global economy and risks from retrenchment - Regional initiatives are not substitutes for further integration with the rest of the global economy. - The ongoing retrenchment of global institutions from the region could leave countries underfinanced, or with less competitive systems, unless they attract new institutions. - Global agreements on financial integration are slow; regional progress could raise financial standards and facilitate wider future integration. - Withdrawal of global institutions could hinder product development, increase costs and reduce access to finance for second-tier institutions, and transfer intermediation fees outside the region. ### Extent of regional financial integration and its economic importance - Latin American financial markets are less integrated than a global average, after controlling for fundamentals. - Integration can help foster depth; deeper financial markets have been shown to positively impact growth. - As prospects for growth in a number of LA countries hinge on large infrastructure investment projects financed through public-private partnerships (PPPs), deep and strong financial markets are increasingly important. ### Legacy and structural impediments to integration - Prudential measures adopted after crises of the 1980s and 1990s, and some pre-existing restrictions, limit integration: - Brazil: regulations restrict Brazilians from holding foreign currency domestically, permit foreign banks to enter the country only upon Presidential approval, and allow only 10% of pension fund assets to be invested abroad. - Mexico: regulatory framework provides a schedule of restriction on investment by type of instrument, limiting foreign asset holdings to 20%. - Restrictions hamper synergies between rapidly growing pension and insurance funds and countries’ needs for long-term financing. - Domestic capital markets are insufficient to provide efficient investment opportunities for large domestic initiatives if funds are constrained to invest mostly domestically. ### Conjunctural and structural strains on LA economies - Conjunctural: end of the commodity super-cycle boom and the slowdown in China reduced export-driven growth for many South American countries; effect on Mexico remains limited. - Structural: restrictions on cross-border investment limit financing for new industries and large projects; domestic funds constrained by concentration limits may be insufficient for financing large indivisible projects. ### Enumerated impacts and policy-relevant observations - Global bank retrenchment since the GFC and increased prudential requirements raise domestic banking concentration and may undermine efficiency (example: purchase of HSBC’s retail operations in Brazil by Bradesco announced in July 2015; Deutsche Bank announced withdrawal from investment banking activity in ten Latin American countries). - Increasing cross-border establishment of LA corporates (Brazil, Chile, Mexico) changes linkages across the region. - International regulatory reforms intended to reduce overall risks have had unintended consequences for emerging markets by increasing costs of cross-border activities and centralizing business in advanced-economy exchanges. - Size economies matter for financial infrastructures (IT, legal representation); smaller national markets may be unable to sustain competitive infrastructures without regional integration. - Rapid growth of pension and insurance funds in some LA economies threatens to overwhelm domestic capital markets, depress liquidity, and limit investment opportunities for smaller retail investors. - Financing large infrastructure projects solely through domestic markets will be challenging; permitting increased cross-border investments by pension and insurance funds would enable diversification and facilitate financing large indivisible projects, subject to appropriate risk management. - Regulatory reforms since past crises (tighter bank capital, liquidity, disclosure requirements) and consolidated supervision, conglomerate supervision, upgraded MoUs, and colleges of supervisors for banks with significant cross-border activity are complementary routes for protection. - Differences in the speed of application of global regulations and continuing restrictions on activities generate costs and anomalies, potentially disadvantaging banks from countries with more advanced regulations. ### Case for regional integration and recommended modalities - Benefits of regional integration: - Creates a larger internal market, enhances competition, fosters economies of scale, reduces costs associated with withdrawal of global institutions, diversifies risk exposures, makes economies less vulnerable to global market volatility. - Capital market integration would enable pension and insurance funds to diversify investments and enable large projects to access a wider range of potential investors. - Deeper markets likely to be more liquid, reducing costs and increasing access generally. - Increasing access for regional banks to operate cross-border would enhance competition and spread best practices. - “Passporting” broker-dealers recognized in one country could help establish a unified capital market, provided passported firms are subject to full supervision in both home and host jurisdictions. - Retaining intermediation within the region would help develop new products, facilitate access for second-tier companies, and generate income from financial market activity. - Harmonizing tax, regulatory and accounting frameworks would provide a level playing field and likely stimulate investment from overseas into the region. - Risk mitigation measures for increased cross-border activity: - Enhanced cross-border consolidated and conglomerate supervision to monitor complex cross-border activities. - Careful monitoring of intra-group transfers and ring-fencing capital to dampen spillovers from parent institutions’ home countries. - Higher quantity and quality of capital and liquidity requirements. - Supervisory and resolution colleges together with signing MoUs to provide early warnings and assist in problem resolution. - Macroprudential measures to address systemic risk concerns and limit spillover risks from global market volatility. ### Models, timing, and strategy for advancing integration - The Pacific Alliance (PA) offers a potentially more successful model, combining political and market enthusiasm; diversity among Mexico, Chile, Colombia and Peru could bring synergies. - MILA (Latin American Integrated Market) seeks to establish a unified capital market; initial measures have been limited and activity minimal, suggesting impediments may require a comprehensive removal rather than step-by-step approaches. - A coordinated push for financial integration among PA countries, based on reciprocity, could yield significant early results and sustain momentum. - Mercosur’s recent dormancy may present a propitious moment for revival given changes in external economic policies in Argentina. ### Scope and purpose of the paper - Aim: identify barriers to financial integration in the region that are legacy effects or unintended consequences of other measures, whose removal could pave the way for regional financial integration and support growth. - Coverage: seven LA economies (LA-7): Brazil, Chile, Colombia, Mexico, Panama, Peru and Uruguay. - Brazil represents almost half of the entire LA economy and is somewhat separated by geography, language, and regulatory regime. - Chile, Colombia, Mexico and Peru are actively engaged in an integration strategy through the PA and MILA. - Panama and Uruguay are smaller but have large financial systems and are closely related to regional neighbors. *Source: Excerpt from the IMF chapter “FINANCIAL INTEGRATION IN LATIN AMERICA” (LA-7 coverage and policy analysis).* ### 18. The report first looks at possible benefits of regional integration. It then covers the various ### 18. The report first looks at possible benefits of regional integration. It then covers the various ### Box 1. Key Recommendations to Facilitate Regional Financial Integration - Take opportunities for regional integration, in the event of global bank withdrawal/downsizing, when identifying potential purchasers. - Develop an explicit, open, objective and non-discriminatory statutory and regulatory framework for entry of cross-border financial institutions. - Ensure level playing fields within countries for domestic and cross-border banks, including by ensuring all banks have access to credit bureaus and deposit insurance. - Develop stable and transparent tax rules for domestic and cross-border financial activities, where appropriate buttressed by agreements for avoidance of double taxation. - Harmonize accounting and regulatory frameworks, through consistent implementation of IFRS, timely adoption of a consistent capital definitions as articulated by Basel 3 and Solvency II-type regimes, and explore opportunities for mutual recognition of licensing. - Introduce and/or enhance consolidated supervision of all banking groups; expand supervisory and resolution colleges to cover all regional banks with significant cross-border activity. - Introduce and/or enhance conglomerate supervision, and establish regulatory limits for intra-group exposures within banking groups, and between bank and non-bank parts of conglomerates. - Harmonize legal frameworks for bank resolution and restructuring, as well as non-bank insolvency regimes. - Increase gradually (avoiding disruption to markets) the maximum ratio for pension funds and insurance companies to invest cross-border within the region up to 50% (or higher) when the present limit is below this. Ensure that this occurs when there are sufficient safeguards for management of risks of these investments abroad. - Examine scope for relaxation of limits for pension funds and insurance companies to invest in regional infrastructure projects. - Ensure infrastructure procurement bids are open to institutions from the region (if not wider). - Explore prospects for revitalizing regional currency settlement. - Assess the compliance of regulatory frameworks Central Counterperties (CCPs) using the CPSS-IOSCO Principles for Financial Market Infrastructures (PFMI), through peer reviews. Upon compliance, LA-7 countries may recognize each other’s CCPs and/or regulatory frameworks. - Work towards full compliance with FATF standards so as to avoid loss of correspondent banking relationships; integrate efforts, including on plans to mitigate corresponding banking issue, across the region. - Consider, where relevant, relaxation of exchange controls in a timed and sequenced manner taking into account other macroeconomic and financial sector prudential policies. This could include permitting individuals to hold foreign exchange accounts onshore. Brazil - Permit sales of LA bonds in Brazil. - Reduce fragmentation of Brazilian public bond market by eliminating practice of separate legislation for each issuance. - Remove requirements for institutional investors to invest abroad only through Brazilian asset management vehicles. - Encourage revitalization of financial Mercosur. - Enhance cooperation with PA, bilaterally and through Mercosur, to examine possibilities for further integration, for instance through increasing cross-holdings of stock exchanges and harmonizing capital market practices. Pacific Alliance countries (Chile, Colombia, Mexico, Peru) - Establish a small secretariat in one of the countries to prepare and disseminate a comprehensive framework for integration, including timelines and sequencing to maintain integration momentum, ensure consistency, and gain the benefits of proceeding through reciprocity. - Permit pension funds and insurance companies to count cross-border PA investment as domestic Once appropriate supervisory arrangements have been put in place. - Replace remaining ratings-based country limitations for pension fund investments across PA countries with specific foreign exchange and corporate limitations. - Complete MILA expansion beyond equities (primary and secondary markets) to include sovereign and corporate bonds. - Harmonize operational procedures, including all aspects of listing requirements, for capital markets. - Ensure all countries have signed IOSCO Multilateral MOUs. - “Passport” broker-dealers in MILA countries, while ensuring broker-dealers are subject to regulatory oversight in both home and host countries. - Seek to harmonize safety nets, for instance as regards bank deposit insurance and investor protection, and consider establishment of a common fund. - Enhance contacts amongst national regulators and supervisors, including through exchanges of staff and secondments to the secretariat. - Examine potential for expanding geographic scope. Panama, Uruguay - Panama to refocus its efforts to be a regional hub including by ensuring that capital, disclosure and other requirements are at least as strong as those of other countries in the region. - Panama to examine the benefits of joining PA, and to adopt PA measures for regional integration. - Uruguay to consider raising its pension funds foreign asset cap, and to end the restriction that purchases be entirely with securities from multilateral institutions. - Uruguay to support revitalization of financial Mercosur, and to examine possibility of integration more broadly, including for instance to establish partnerships for the Uruguayan stock exchange. ### A. Definition of Financial Integration - Financial integration is the process through which the financial markets of two or more countries or regions become more connected to each other. - Forms of integration include cross-border capital flows, foreign participation in domestic markets, sharing of information and practices among financial institutions, and unification of market infrastructures. - Financial integration can have a regional or global dimension depending on whether a country’s financial market is more closely connected to neighboring countries or to global financial centers/institutions. - Two main criteria used here to define financial integration: - The degree of cross-border financial activity: concept close to IMF (2007) “financial globalization” proxied by the sum of countries’ gross external assets and liabilities relative to GDP. Any barrier to exchange or market access impedes free movement of capital and limits integration. - The degree of convergence and consolidation across markets: financial openness and free access are not sufficient; market participants should “face a single set of rules when they decide to deal with financial instruments and/or services.” A single (common and fully harmonized) market is the ultimate form of financial integration. - The two criteria are interconnected: convergence of market structures facilitates cross-border capital flows, while financial openness offers opportunities to import financial institutions, paving the way for harmonization. - Financial integration is always imperfect due to segmentation from capital flow restrictions, technical constraints, insufficient harmonization of regulations, cultural barriers, and country-specific risks. ### B. Is There a Deficit of Financial Integration in Latin America? - Since the 1990s, most countries in Latin America have embarked on a process of financial liberalization characterized by: - Reduction of impediments to cross-border financial transactions. - Increased participation of foreign banks in local banking systems. - Greater cross-border capital market activity. - Today most LA countries have fewer de jure restrictions on capital flows than Asian economies (Galindo and others, 2010). - De facto integration of LA with the rest of the world remains low: - Indicator 1: International investment positions (IIP) — the dollar value of international assets and liabilities among all LA countries has grown over the last decade, but the region has not increased its international exposure (assets plus liabilities in percent of regional GDP). - Indicator 1 (continued): The region’s relative importance as a partner in international finance has not improved, unlike allocation of foreign positions vis-à-vis emerging Asia, which doubled between 2004 and 2013 (figure 1). - Indicator 2: Cross-border claims held by BIS banks — the broad group of all LA countries has garnered a relatively low 3-5 percent of BIS claims over the last 10 years (figure 2, left). - Indicator 3: Bilateral portfolio and FDI stocks (CPIS and CDIS) — reiterates relatively low (and potentially declining) participation of the LA region, while highlighting the importance of FDI flows over portfolio investments (figure 2, right). - Econometric analysis in the accompanying background paper shows LA-7 countries are under-integrated even after controlling for macroeconomic fundamentals such as the level of development, trade openness, or the quality of the institutional framework. - Regional integration in LA seems less advanced than in other EM regions: - Figure 3 shows greater intra-regional investment (FDI and portfolio) among ASEAN countries. - For portfolio assets, intra-regional share in Latin America has fallen from over 10 to under 5 percent since 2008 (figure 4, left). - For FDIs (data available since 2009), data suggest a declining trend. - Indicators of cross-border bank lending point to some momentum in LA; Table 3 highlights expanding positions that Latin BIS banks are taking in their neighbors. The share of claims on other LA-7 countries has risen dramatically since 2005 (BIS consolidated statistics caveat discussed). - Cross-border mergers and acquisitions illustrate both global fragmentation and regional integration after the GFC: - 2013: Grupo Aval acquired BBVA activities in Panama; Bancolombia purchased HSBC’s holdings. - 2013: BBVA sold its Chilean, Colombian, Mexican and Peruvian pension funds to regional and local buyers. - Santander issued IPOs in Mexico and Brazil. - More recently: Ficohsa group from Panama nearly completed the purchase of Citibank’s operations in Honduras and Nicaragua. - HSBC announced intention to sell its Brazilian holdings to Bradesco. - Gradual merger of MILA stock exchanges (Chile, Colombia, Mexico, and Peru) began in 2011; once complete domestic investors will more easily buy and sell equities from other MILA countries. ### C. Benefits of Further Integration in Latin America - (Section heading present; substantive content begins after this point in the source and is not included in the supplied excerpt.) *International Monetary Fund — Financial Integration in Latin America (excerpt).* ### 26. By expanding possible financing options and vehicles for savings in a country, financial ### _030416 - 26. By expanding possible financing options and vehicles for savings in a country, financial ### Macroeconomic effects of financial integration - Financial integration can enhance financial development and is linked to higher economic growth (Sahay and others, 2015). - Channels for growth: - Stimulates capital accumulation by bringing capital from outside, enhancing competition among financial institutions, exploiting economies of scale, and improving the monetary transmission mechanism. - Improves resource allocation and imports technology and knowledge, creating productivity gains. - Promotes growth indirectly by exposing policymaker decisions and corporate actions to greater financial market scrutiny. - Quantitative assessment (background paper) for LA-7 countries: - Growth dividend estimated in the 0.25–0.75 percent range from closing the “integration gap.” ### Integration and economic resilience - Financial integration may reduce output volatility via: - Increased depth and liquidity of financial markets, expanding possibilities to sell and buy securities. - Greater opportunities for risk-sharing and inter-temporal consumption smoothing through portfolio diversification across asset classes, sectors and countries. - Stabilization effects are particularly beneficial in countries with concentrated production bases and dependence on agricultural or natural resource extraction (IMF, 2015). - Caveat: increased integration can also transmit shocks across countries in certain situations. ### Regional integration — potential additional benefits - Cross-border financial activity can follow and foster cross-border trade, supporting wider regional economic integration and creating growth opportunities amid lower commodity prices and tighter global financial conditions. - Regional banks and markets may have: - Better understanding of regional needs versus global institutions. - Ability to provide expertise suited to the host country, including improving financial inclusion and transplanting expertise in trade and industrial credit for commodity-exporting countries. - Capital market integration at the regional level creates scope for economies of scale when individual markets are relatively small, potentially reducing costs and expanding product ranges. - Larger and more liquid regional markets may attract larger inflows of foreign capital from international investors. - Regional banks can fill gaps left by retrenching global banks, mitigating credit squeezes if North-American and European banks reduce presence without onselling business. - This could lead to large regional banks, increasing competition and diversification of risks within domestic markets, though posing concentration risks at regional level. - Diversifying external market exposure through regional integration could mitigate foreign spillovers; regional banks from non-US/Europe regions were less affected in past crises, suggesting geographic diversification can buffer global volatility. ### Risks, preconditions, and empirical evidence - Advantages are not assured without accompanying measures, including enhanced supervision and sufficient official oversight capacity. - Historical crises cited as critiques of integration include Mexico (1994), East Asia (1997), and Russia (1998) following capital account liberalizations. - Empirical literature nuances: - Positive results often specific to forms of integration (FDI and equity favored over debt instruments) and dependent on conditions such as levels of economic development, institutional quality, and financial development. - Rancière and others (2006, 2008): direct effects of financial liberalization on growth outweigh negative indirect effects of higher crisis propensity. - Kose and others (2006): empirical literature “lends some qualified support to the view that developing countries can benefit from financial globalization, but with many nuances,” and finds little systematic evidence that financial globalization by itself leads to deeper and more costly developing-country growth crises. ### Box 2 — Can regional financial integration facilitate infrastructure project financing? - Infrastructure gaps exist in energy, transportation, telecommunications, and water/sanitation across Latin America; shrinking fiscal space has increased use of PPPs. - Pension funds and insurance companies are natural long-term investors for infrastructure but face constraints: - Prudential caps limit large investments in individual projects and cross-border financing. - Alternate investment caps for “alternate” investments—which include infrastructure—remain low and compete with real estate, energy, and private equity. - Cross-border investments must respect foreign currency and alternative asset caps. - Typical prudential caps for pension funds: 5–10% of assets under management for “alternate” investments. - Solutions to attract regional institutional financing: - Project sponsors absorbing currency risk in liabilities, or hedging as financial markets deepen. - Developing expertise in risk assessment for regional projects (expensive); syndication of bank loans helps distribute risk. - PPPs have developed risk frameworks and project financing that pair risks with participants best able to manage them. - Collaboration among banks, equity funds, insurance companies and pension funds to develop joint regional risk assessment teams can amass intellectual capital more quickly and at lower cost, making projects more financeable as mitigation strategies spread. ### The financial sector in Latin America and barriers to integration — LA-7 banking overview - Banking systems are the largest financial intermediaries in the LA-7, amounting to about 100 percent of LA-7 GDP. - Bank asset composition and ownership: - Most assets in the LA-7 are now with private banks (about 60 percent of LA-7 GDP). - Public bank assets remain high as a share of GDP only in Brazil and Uruguay. - Foreign banks hold important market shares in some of the LA-7: 27 percent of LA-7 GDP. - Regional banking integration remains low; banking systems are often highly concentrated with in some cases high bank interest rate spreads. - Financial intermediation and credit: - Chile: credit to the private sector rose from 50 to over 100 percent of GDP between 1995 and 2014. - Mexico, Peru, and Uruguay: credit to the private sector about 35 percent of GDP, with little rise over two decades. - Chile is the only LA country with credit to the private sector comparable to Emerging Asia and G7 economies. - Brazil’s credit-to-GDP remains relatively low compared to Emerging Asia and G7. - Deposits: - Brazil and Panama lead in deposit ratios (with ratios of 60 percent of GDP), though these are much lower than in Emerging Asia; Peru’s ratio is the lowest. - Financial access: - Number of branches per 100,000 adults is lowest in Uruguay and Mexico. - Credit growth patterns (2010s): - Uruguay: high credit growth from low levels, supported by economic growth and official efforts to increase financial access. - Brazil: credit growth decelerated to 11 percent y/y in 2014 from 30 percent y/y in 2010. - Peru: monthly credit growth rates still average around 15 percent (y/y); slowing since 2011 due to macroprudential measures. - Mexico: credit growth moderated to below 10 percent y/y in 2014 (from 17 percent y/y in 2011); lending by publicly-owned development banks is growing rapidly. - Colombia: credit buoyant and expected to outpace nominal GDP growth, aligned with financial inclusion policies. - Dollarization: - De-dollarization progressed after policy initiatives (inflation targeting; macroprudential measures; development of local currency capital markets). - Peru: FX corporate loans decelerated sharply after de-dollarization measures at end-2014 (new domestic-currency repos, higher reserve requirements on foreign currency deposits, and reserve requirements tied to de-dollarization targets). - Uruguay: highly dollarized financial sector with FX loans accounting for 60 percent of total loans and FX liabilities at close to 80 percent of total liabilities. - Brazil, Chile, Colombia: much lower FX lending and liabilities ratios; dollarization in Brazil has been increasing in the last year. *Source: _030416 - 26. By expanding possible financing options and vehicles for savings in a country, financial (IMF).* ### 33. Most banking systems in the LA-7 are characterized by high concentration, which may ### _030416 - 33. Most banking systems in the LA-7 are characterized by high concentration, which may ### Bank concentration and its effects on loan rates and spreads - In Peru and Uruguay, the three largest banks account for about 70 percent of banking system assets. - In Uruguay, 40 percent of banking system assets are controlled by one government-owned bank. - In Brazil, Chile, Colombia and Mexico the three largest banks hold 50 percent of banking system assets. - Brazil: 45 percent of banking system assets are controlled by public banks, with a high degree of earmarked and subsidized lending. - High concentration may have a significant impact on loan rates and spreads. ### Bank spreads, costs, and profitability - Brazil has the highest spreads at over 15 percent. - The rate for Brazil averages spreads for non-financial corporations (10 percent) and households (26 percent). - Return on equity (ROE) is reported to be around 20 percent for the largest Brazilian banks. - Brazilian banks exhibit high operating expenses due to entrenched inefficiencies, especially in state-owned banks with a high share of directed lending and social projects. - OECD and other sources: operating costs are three time higher in Brazil than in the average OECD countries, and 40 percent above the average in Latin America. - Uruguay has high interest rate spreads and operating expenses. - Peru has high spreads but one of the lowest operating expenses. - Spreads in Colombia, Chile, Mexico, Panama are lower than in Brazil and Peru, and they have been coming down in Colombia, Mexico, and Panama, hinting at increased competition. ### Ownership structure, foreign participation, and market openness - Panama is an exception in regional cross-border presence: regional banks hold 33 percent of bank assets in Panama, of which 22 percent are held by Colombian banks. - Foreign ownership of banks is highest in Mexico: 70 percent of bank assets are foreign-owned, of which 18 percent are owned by U.S. banks and 37 percent by Spanish banks. - Mexican banks have limited cross-border regional presence (example: Banco Azteca has a small presence regionally). - Brazil and Colombia: bank assets are predominantly held by domestic banks (Brazil: large part government-owned banks; Colombia: private banks). ### Cross-border claims and regional integration trends - Foreign claims by Chilean banks on the region are 50 percent of total claims, the highest among the BIS reporting banks from Latin America. - Panama’s foreign claims on the region are 30 percent of total claims. - Foreign claims by Brazilian banks on the other LA-7 are about 13 percent of total claims—US$18 billion (of which 12 percent are on Chile). - Foreign claims by Mexican banks on other LA-7 are tiny, at 3 percent of total claims. - Assets of Colombian banks’ subsidiaries abroad reached US$50 billion, accounting for 24 percent of the total assets of the Colombian banking system. - Colombian banks have significant market positions in Central America (22 percent of assets on average); share of Colombian bank assets in Panama reached 23 percent and over 50 percent in El Salvador. - Mergers and acquisitions by LA banks of international banks withdrawing from the region suggest a trend towards greater regional integration (notably Colombian bank acquisitions of HSBC, Santander, BBVA, Citibank operations in parts of the region). ### Large regional players and their cross-border expansion - Bank Itaú (São Paulo) has size close to that of the entire Mexican banking system (US$420 billion in assets). - Following acquisition of Chilean Corpbanca (and merger with Corpbanca Colombia), Itaú’s cross-border business share will reach 13 percent, up from 7 percent in 2011. - Investment bank BTG Pactual aspires to be the investment bank of the region and expanded following the GFC, but experienced market pressure after the arrest of its CEO in November 2015, which may hinder near-term regional expansion. ### Barriers to regional integration and competition - High equity prices in Chile, Mexico, and Peru act as a deterrent to acquisitions by regional banks. - High bank concentration and the size of domestic markets (e.g., Brazil) are potential barriers to regional bank entry. Examples: - Consolidation in Brazil: Bradesco increasing retail market share from 11 to 14 percent through acquisition of HSBC retail business. - Growth of three large government-owned banks since the GFC in Brazil; BNDES lends to large conglomerates at subsidized rates. - Legal regime for entry by foreign banks in Brazil is relatively opaque and requires presidential approval. - In Uruguay, BROU’s legal monopoly on public employee accounts has given the public bank a majority share of the peso deposit market; only regional bank present is Bank Itaú after Banco do Brasil’s exit in 2005. - Uruguayan banks consolidated from 20 private banks in 2002 to nine private banks, aiming for scale economies. - Ease of doing business constraints (getting credit, protecting investors, enforcing contracts), limited access to full-depth credit information in some countries (e.g., Brazil), and high operating costs contribute to higher spreads and deter entry. - Differences in bank competition, taxation and reserve requirements, creditor rights, availability of borrower information, and macro stability help explain diverging interest rate spreads across the LA-7 despite similar concentration levels. ### Regulatory heterogeneity and implications for safer cross-border integration - Countries are moving at different speeds in adopting enhanced supervisory and regulatory frameworks (e.g., consistent capital definition under Basel III and adoption of IFRS). - Brazil and Mexico lead regional implementation of Basel III, following closely the international timeline, followed by Peru. - Chile and Colombia have taken a more gradual approach; Colombia has enhanced its capital measure, bringing it closer to the Basel III definition. - Policy and regulatory implications noted: - Regional integration trends can spur enhancements to supervisory, resolution and tax system frameworks. - A level playing field across countries is harder to establish during protracted transition periods when jurisdictions adopt regulatory agendas at different speeds. *Source: IMF chapter/section content provided.* ### 45. A bank’s ownership structure could also be an impediment for regional acquisitions. When ### _030416 - 45. A bank’s ownership structure could also be an impediment for regional acquisitions. When ### Ownership structure as an impediment for regional acquisitions - HSBC’s attempted sale of its operations to GNB Sudameris (Colombian) in Uruguay fell apart reportedly because the banks owned by the owner of GNB Sudameris do not have the same holding structure in different jurisdictions, a situation considered inappropriate by the Uruguayan supervisor. - The SFC affirmed to the Uruguayan supervisor that it performs supervision on a consolidated basis over its supervised entities, and therefore requires GNB Sudameris to fulfill prudential regulations such as capital requirements, but this was deemed not sufficient. ### Global financial de-integration and effects on regional markets - Regulations in home countries of global banks aimed at strengthening banks’ resilience have reduced the profitability of subsidiaries. These measures have discouraged bank subsidiaries from playing an active role in markets as intermediaries or liquidity providers. - Liquidity in sovereign debt markets has fallen as certain big banks (mainly from the U.S. and U.K.) have substantially reduced their presence in regional markets. - Consolidation rules applied globally by parent banks on their subsidiaries appear in some cases to have come into conflict with the legal regulations in LA host countries, raising the costs of doing business in those countries relative to prior requirements and relative to local banks. - Vigorous application of these regulations could further the “de-globalization” trend, with costs and benefits of subsidiaries operating in emerging markets likely to shift, possibly initiating further downsizing or withdrawal from these markets. - April 2015 Global Financial Stability Report, Chapter 2 documents the decline in cross-border lending and finds it can be explained by a combination of regulatory changes, weaknesses in bank balance sheets, and macroeconomic factors. ### Loss of correspondent banking relationships - Bilateral and multilateral initiatives to increase transparency of the international financial system have contributed to a loss of correspondent banks in LA. - U.S. agencies’ enforcement actions against breaches of compliance with domestic regulations on trade and economic sanctions, tax evasion and AML/CFT have led international banks operating under U.S. regulations to withdraw from activities seen as “high risk”, with particular impact on correspondent banking relationships. - A small number of large international banks dominate the provision of correspondent banking services for banks in the region; some have been ending or reducing these services for local banks. - In Mexico, JPMorgan is maintaining its wholesale business, but is withdrawing from providing correspondent bank services to small and medium sized banks. - Bank of America is for some local banks the only major U.S. bank still offering correspondent banking facilities. - Authorities report withdrawal of lines to medium-sized banks that cater to SMEs, raising the cost of finance for these enterprises, and in some cases causing firms loss of access to credit from US exporters. ### Recommendations (from source) - Move forward in harmonizing regulatory frameworks across the region, as well as the legal framework for bank restructuring and resolution, towards international standards and best practices, with a view to promoting financial stability and establishing a level playing field across countries as well as across banks operating cross-border in the region. - Strengthen consolidated supervision. Supervisory agencies should have adequate powers over non-bank holding companies of banks, both domestically and cross-border. - Increase transparency regarding entry of foreign banks. To increase competition and lower the cost of financing, foreign banks should be allowed to enter the banking system through an explicit, open, objective and non-discriminatory statutory and regulatory framework. At this point regional banks seem to be more likely than global banks to respond to such opening. - In dollarized economies: - Strengthen prudential requirements on dollar lending and encourage the private sector to hedge its foreign currency exposures. - Further support the de-dollarization process whilst deepening financial and capital markets. - Deepening financial markets has proven to be an effective way to achieve de-dollarization, including through an active policy of de-dollarizing public debt, deepening local-currency bond markets, and promoting the development of markets for FX derivatives along with FX flexibility. - In Brazil and Colombia, when market conditions and financial stability considerations permit, relaxing the constraints on foreign exchange activities and adjusting net open FX position limits for settlements in other currencies, where present limits are low could be considered. - Continue to promote best efforts to ensure strong direct home and cross-border supervision, including measures to ensure that effective customer due diligence measures are in place. - Countries should work with key international financial centers’ regulators and international bodies, such as the FSB and the FATF, to ensure a clear understanding of regulations and policies relevant for their financial institutions. - Authorities should be encouraged to assess the need of adapting their financial system to the new regulatory environment and to consider public sector support in case of market failure. - Example: The process for meeting the requirement of a presidential approval for a foreign bank to enter the Brazilian market could be made fully transparent. ### Pension funds: size, growth, and cross-border integration - Pension funds are increasingly important in LA-7 financial markets, with size surpassing 17 percent of GDP in assets under management, largely driven by growing participation following legal changes in most of the region. - LA-7 pension fund assets have reached US$700 billion. - Between 2008 and 2014 LA-7 pension assets have experienced growth rates that ranged between 50 and 100 percent. - LA-7 pension fund assets amounted to about 17% of LA-7 GDP at end-2014, well below the OECD average of 37% of GDP, for every country, except Chile. - Brazil dominates LA-7 pension fund assets in value terms; Chile remains the largest in relation to country size. - Pension funds’ share of sovereign debt markets has increased significantly (example: Peru tripled its share; Colombia almost doubled). - Pension funds have contributed to development of domestic debt securities markets but have played a limited role in expansion of equity markets. - Cross-border management of pension funds’ assets has picked up due to consolidation and withdrawal of global institutions; regional asset managers are beginning to assert themselves. - International investments of pension funds predominantly allocated to advanced economies (Euro Area, United States, Japan); regional (LA) exposure is small (example: Peruvian pension managers reported LA-7 investments of just 3.7% of assets, 9.3% of foreign allocations). - Regulatory constraints limiting foreign holdings: - Uruguay’s low foreign asset cap of just 15% is further hindered by rules limiting external investments to securities from multilateral institutions. - In Chile, foreign asset holdings are effectively constrained by additional caps on risk tolerance, as measured by sovereign ratings. - Brazilian pension funds are required to collaborate with at least three other asset managers through a dedicated fund if they wish to invest abroad. ### Pension industry structure and competition effects - Consolidation in pension management has reduced scope for regional firms to enter neighboring markets, restraining competition and prompting higher pension fund fees. - Regulatory treatment of foreign and domestic companies is largely equivalent in most cases, but de facto barriers arise from high market concentrations with incumbent power that impede new entrants. - Dominant, established asset managers hold competitive advantages deemed too great for institutional investors to set up greenfield operations and grow organically. - Consolidation has pushed up corporate valuations beyond what foreigners are willing to pay to enter a market. - Examples of consolidation/withdrawal: - Withdrawal of several foreign institutional investment groups from the pension fund industry in the region, such as BBVA, ING, and HSBC, partially replaced by Principal Financial Group and MetLife. - Latin American financial groups, such as Grupo Suramericana de Inversiones (Colombia), have acquired controlling positions in Chile, Mexico, Colombia, Peru, and Uruguay through M&A. - Number of pension fund administrators fell in Mexico from 21 at end-2007 to 11 at end-2014. - Number of pension fund administrators in Colombia fell from 6 in 2012 to 4 in 2014. *Source: IMF chapter/section content provided in the input.* ### 56. As assets under management continue to grow, ### _030416 - 56. As assets under management continue to grow, ### Internationalization and asset allocation pressures - Pension systems in most countries of the region will have to increase their international exposures as assets under management continue to grow. - Fund inflows continue to grow faster than net government borrowing, putting strain on asset allocation strategies. - Excess allocations into bank deposits threaten to drag down returns. - Issuance of corporate debt and equity can meet some pension fund demand for local currency investments, but concerns remain about volume, liquidity, maturity, and corporate risks. - Most funds have invested in highly liquid segments of advanced country markets where currency hedging is less expensive. ### Regulatory limits and constraints on asset classes - Regulatory limits and restrictions vary by country and span categories such as foreign securities, equity, foreign currency, commodities, derivatives, single issuance holdings, and debt securities of lower ratings. - On average, limits on variable rate instruments tend to be more restrictive. - Countries with multi-fund systems (Chile, Colombia, Mexico, and Peru) have over time been able to ease regulatory restrictions allowing larger shares of investments in variable rate instruments. - Examples of statutory limits on foreign assets (in percent of total pension fund assets): Brazil (10%); Mexico (20%); Colombia (40-70%); Chile (80%); Peru (50%); Uruguay (15%); Panama (45%). - Chilean pension funds may hold no more than 20% of assets in securities of countries with sovereign risk ratings lower than Chile (AA). - In Peru, while the regulatory limit established by law is 50, the pension fund supervisor slowly continues to increase it; currently set at 42 percent. ### Market impacts of pension fund growth and minimum return requirements - Pension funds have outpaced the growth of domestic capital markets, complicating optimal portfolio diversification and making a case for expansion of investment opportunities through financial integration. - Consequences of pension fund asset growth include: - More difficult achievement of optimal portfolio diversification. - Equity markets may become more prone to asset price bubbles as pension funds pursue a limited number of securities. - Herd behavior as asset managers chase the same types of securities. - Reduced financial market liquidity due to large buy-and-hold positions by pension funds. - Crowding out of other financial intermediaries, such as insurance companies, from domestic financial markets. - Minimum return requirements (industry average typically serves as the minimum) compel pension funds to disclose asset composition and portfolio returns, and require asset managers to top up returns when deviations exceed generally more than 2-4 percentage points below the minimum over an extended period, usually about 36 months. - Minimum return requirements can incentivize herd mentality among asset managers and reduce diversification into new foreign markets; initial cross-border activity by market leaders would likely be followed quickly by other market participants if sufficient cross-border opportunities are available. ### Infrastructure and alternative assets - Alternative assets like private equity and infrastructure have garnered more attention, especially in Brazil, Peru and Uruguay, but prudential limits are low and the class is generally considered too risky to expect caps to rise quickly. - Investments in infrastructure to date are in the range of 3-5 percent of pension fund investments, well below regulatory limits. - Barriers to higher infrastructure investments include lack of expertise in the infrastructure sector, problems of scale of pension funds, lack of transparency in the infrastructure sector, shortage of data on performance of infrastructure projects, and lack of a benchmark. - Investments in infrastructure require significant time to complete due diligence and establish appropriate investment and risk management frameworks. - Some global pension funds (e.g., some Canadian and Australian pension funds) register about 10% investment in infrastructure where necessary knowledge and resources exist. ### Operating costs, fee structure, and competition - Pension fund fees directly affect the size of retirement income; retirement benefits depend on contributions, investment returns, and the amount of fees levied by pension fund providers. - Comparison indicates LA-7 pension fund fees are higher than the level suggested by their operating costs and higher than OECD country average when taken in percent of total assets under management. - Operating expenses as a share of assets under management in LA-7 largely remain comparable to OECD-country average, implying fees in LA-7 exceed those levied by OECD counterparts for a given level of operating costs. - Fees levied on contributors by LA-7 are almost double the size needed to cover operating expenses in some countries; in Panamá and México operating costs constitute less than half of income collected from fees. - Fee structures and examples: - Colombia levies a fee on contributions of 16 percent. - Peru and Chile have a 10 percent fee on contributions in place. - Salary-based fees vary from about 1.2 percent in Peru to 3 percent in Uruguay. - Mexican pension funds rely on fees imposed on asset balances. - Common fee types and considerations: - Contribution fees generate revenues at the start but may not align with changing fund managers’ cost structures. - Asset management fees on balances respond to costs but do not generate initial revenues. - Performance fees tend to distort long-term goals. - A suggested more optimal structure: annual flat fees combined with asset management fees. - Greater regional financial integration would prompt higher competition within the pension fund industry and could relieve high pension fund fees levied on contributors by allowing regional companies greater access to domestic markets and increasing competition. ### Recommendations - Higher regulatory limits on foreign security investments would ease demand pressures in domestic financial markets. - The growth of Latin American pension funds relative to domestic securities supports an argument for increasing regulatory limits on foreign securities, perhaps to about 50% percent in countries where they are currently set lower. - Relaxing limits on foreign, particularly regional, investments—subject to risk safeguards around investments abroad and availability of hedging instruments, plus enhancements to transparency and improvements in data—would: - Allow pension funds to invest more cross-border. - Ease pension fund demand for domestic securities. - Allow other financial intermediaries, such as insurance companies, greater access to financial instruments. *Source: _030416 - 56. As assets under management continue to grow, (excerpt).* ### 63. Given regional labor mobility among the LA-7 countries, authorities should seek to ### _030416 - 63. Given regional labor mobility among the LA-7 countries, authorities should seek to ### Pension fund portability and regional infrastructure access - Recommendation: Institute pension fund portability across the LA-7 region to facilitate transfer of balances accumulated in individual accounts and encourage adoption of best standards and harmonization of asset management processes. - Current bilateral example: Chile and Peru have a signed bilateral agreement allowing citizens to transfer balances accumulated in their individual accounts voluntarily from one country to another. - Recommendation: Simplify the process of creating infrastructure products and allow pension funds to access these instruments in other LA countries. - Rationale: Unrestricted access to regional infrastructure projects would boost the development of regional infrastructure products, contribute to securities market development, and allow pension funds to better diversify portfolios. - Rationale: Infrastructure projects are long-term investments that could match the long-term duration of pension liabilities and facilitate infrastructure financing overall. ### Pension funds — limits on foreign investments (selected country limits and operational notes) - Brazil - Legal instrument: Banco Central do Brasil- Resolução No. 3792 - Foreign investments allowed: Assets issued abroad belonging to the portfolios of the funds constituted in Brazil; Shares of investment funds and shares of investment funds in shares of investment funds classified as external debt; Shares of foreign index funds admitted to trading on the stock exchange in Brazil; Brazilian Depositary Receipts; Shares issued by foreign companies based in MERCOSUR. - Foreign Investment Limit: 10% - Chile - Legal instrument: Decreto Ley No. 3500 de 1980; Banco Central de Chile Acuerdo No. 1680-03-120517- Circular No. 3013-699 - Foreign investments allowed: Credit instruments or negotiable securities issued or guaranteed by foreign governments, central banks and banks; Stocks and bonds issued by foreign companies; Participation shares usually traded on international markets issued by mutual funds and investment funds. - Debt instruments must have at least two risk ratings by international rating agencies above BBB and N-3. - The Law sets the maximum limits range for all the funds combined (30%-80%), and the maximum limit range for each type of fund: - Fund A 45%-100% - Fund B 40%-90% - Fund C 30% -75% - Fund D 20%- 45% - Fund E 15% - 35% - The Central Bank set the limits within the above range as follows: - Maximum limits for the funds combined cannot exceed 80% of their value. - Fund A 100% - Fund B 90% - Fund C 75% - Fund D 45% - Fund E 35% - Colombia* - Legal instrument: Ministerio de Hacienda y Crédito Público- Decreto No 857/2011 - Foreign investments allowed: Debt securities issued or guaranteed by foreign governments or foreign central banks; Debt securities issued, guaranteed, or originated by foreign commercial or investment banks; or by foreign non-bank entities; Debt securities issued or guaranteed by multilateral lending institutions; ETFs, foreign mutual or investment funds; Equity securities; ADRs and GDRs; Private equity funds established abroad. - Foreign Investment Limits: - Conservative Fund: 40% - Moderate Fund: 60% - Riskier Fund: 70% - México - Foreign investments allowed: Foreign debt securities and foreign equity securities; Real estate investment vehicles; Bank demand deposits in foreign financial institutions; Derivatives with foreign equity as underlying assets. - Foreign Investment Limits: Funds 1-4: up to 20% for foreign debt securities. - Additional: Law establishes limits per type of investment – equity, structured investments for each type of Fund. - Panama - Legal instrument: Comisión Nacional de Valores Acuerdo No 11-2005 - Foreign investments allowed: Shares issued by foreign companies; Debt securities issued by governments, central banks, foreign financial institutions and companies that at least 50% are investment grade by the country of origin or by a recognized international rating agency. - Foreign Investment Limit: Foreign investments cannot exceed 50% per type of asset. - Perú - Legal instrument: Texto Único Ordenado de la Ley del Sistema Privado de Administración de Fondos de Pensiones; Banco Central de Reserva del Perú Circular No. 032-2014-BCRP - Foreign investments allowed: Financial instruments issued or guaranteed by foreign governments or central banks; shares and securities representing rights to shares registered in stock exchanges; debt securities, participation in mutual funds and hedge operations issued by foreign institutions. - Foreign Investment Limit: 50% established by Law. - Operational limit: The Central bank set the operational limit at 42% starting on January 1, 2015. - Additional: Limits are also added per category of instrument, depending on the type of fund. - Uruguay - Legal instrument: Ley 16.713 - Foreign investments allowed: Debt securities issued by international credit organizations or foreign governments with a very high credit rating. - Foreign Investment Limit: 15% - Note: In addition to the global investment limits specified above, some countries also set limits per issuer and per issuance. Example: Colombia sets a limit of 10% of the value of each fund per issuer, and a 30% limit per issuance. Mexico adds a 5% limit of the total assets of the fund per issuer and a 35% per issuance. ### Regional harmonization and a special regional bond category - Recommendation: Countries should demonstrate commitment to integration by agreeing to treat each other’s securities as domestic, conditional on: - adoption of the highest standards in pension and financial system regulation and regulatory collaboration; - harmonization of accounting standards through adopting the IFRS; - signing the multilateral memorandum of observance of international principles and practices relating to governance, monitoring, mitigating financial and operational risk. - Policy proposal: Establish a special category for the holding of bonds issued in the region that would not count against foreign asset limits. - Initial suggested level: lower levels of about 5%. - Future option: relaxation of these limits could be envisaged should asset holdings reach them and they become binding. ### Insurance sector — size, growth, market structure, and challenges - Penetration and growth - Insurance penetration in LA-7 markets remains low, ranging from 1 to 4 percentage points of GDP. - The sector expanded at a significant rate over the past decade, reaching almost 10 percent of the regional GDP in 2014. - Insurance premia of the Latin American market quadrupled between 2003 and 2013, reaching almost 160 billion of USD by 2013. - Drivers of growth - Resilient economic performance, strong employment growth, foreign direct investment, regulatory reform implementation, and improvements to the business environment. - Robust vehicle sales contributed to non-life insurance expansion; pension-related products fueled life insurance segments. - Economic formalization, increased occurrences of natural disasters, and rising purchases of life and retirement products expected to further boost growth. - Market maturity and regulatory frameworks - Market maturity varies; Chile and Brazil have the longest maturities (larger contributions of life premia). - Some countries are setting the stage for risk-based capital model implementation; Brazil and Mexico are at the forefront meeting Solvency II equivalent standards. Chile is expected to adopt frameworks similar to Solvency II in the coming years. - Other countries continue to operate under regimes similar to Solvency I; Colombia and Peru are considering comprehensive regulatory reforms and implementing risk capital requirements. - Distribution channels and barriers - Main distribution channels: agents, brokers, and banks; life insurers often use proprietary agent networks, which are costly. - Barriers to entry: high market concentration, costly distribution setup, relative product complexity (bundled products), lack of trust and product awareness, unaffordability of insurance for large population segments. - Market concentration and ownership - Examples of concentration: - Uruguay: large state-owned insurance company controls 80% of the market. - Peru: two largest companies manage about 60% of total premia. - Colombia: ten largest companies account for almost 80% of the market share. - Brazil: largest 10 companies account for around 65% of the sector premia (while there are over 110 companies). - Chile: largest 10 companies account for about 60% of the market share. - Cross-border integration has been observed mainly through cross-border company ownership and reinsurance growth rather than investments in foreign assets. - Regional shift in ownership: market share of regional companies among the largest groups increased from 32 to 54 percent since 2003; in the life segment regional share rose from 32 to 68 percent. - Reinsurance and cross-border activity - Reinsurance important for property and casualty segment due to natural disaster exposure, but reinsurance in LA remains relatively small; proportion of ceded premia is low and most reinsurance activity is carried out by foreign, primarily European, companies. - Asset-liability management and market frictions - Shortages of domestic securities have forced some companies to face maturity and currency mismatches. - Resulting mismatches can be up to 3- to 5-year maturity mismatches. - Causes: weak supply of domestic securities, scarcity of foreign exchange derivatives of sufficiently long duration, shortage of long-term assets in domestic markets. - Example: Chilean life insurers with annuity liabilities show a systematic maturity mismatch of assets and liabilities due to the shortage of assets with similar durations as liabilities. *Source: FINANCIAL INTEGRATION IN LATIN AMERICA — INTERNATIONAL MONETARY FUND (excerpts from the provided content).* ### 75. Due to the growing need for domestic instruments, holdings of foreign securities are ### _030416 - 75. Due to the growing need for domestic instruments, holdings of foreign securities are ### Insurance sector asset allocation and market behavior - Holdings of foreign securities are reported to remain well below regulatory limits in many countries. - In Mexico, the share of foreign securities remains below 3%, while the regulatory limit is currently 10%. - Mexican companies which offer insurance products in foreign currency tend to have slightly higher shares of foreign securities holdings. - Life insurers in the LA-7 largely choose to invest in debt securities: - In Colombia, Mexico, Peru, and Uruguay, about ¾ of investment portfolio allocations of life insurers are held in bonds. - In Panama, only about a quarter of portfolio is allocated toward bonds. - Companies in Mexico and Uruguay tend to hold mostly government bonds. - In Chile, Colombia, Panama and Peru companies appear to favor private debt securities. - Remaining portfolio allocations typically include equity shares, real estate investments, and other instruments. - Real estate investments are typically small, with the largest share around 10%, observed for Chile. - Equity shares are relatively low, except in the case of Panama, where the majority of portfolio is invested in equities. ### Insurance regulatory reform (Box 4): direction and implications - Regional trend: significant regulatory reforms to strengthen stability, improve transparency, generate efficiency, and align with worldwide trend of more rigorous rules. - Mexico, Brazil, and Chile are leading the way in the introduction of Solvency II-type frameworks in Latin America, as regulations are set to be implemented in the next three years. - Expected regulatory effects: - More advanced/risk-based frameworks will likely generate higher overall capital requirements, in particular under Solvency II-type regimes. - May encourage insurers to diversify business and product portfolios. - Efforts to decrease capital requirements may translate into higher demand for reinsurance, strengthening linkages with foreign countries, including the EU. - New regulations will impose tougher rules on risk identification and monitoring and set strict disclosure standards. - Market structure impacts: - Stricter frameworks may generate M&A as smaller companies may face difficulties complying with tougher guidelines, potentially leading to higher industry concentration. - Convergence with European regulation will even the playing field for foreign subsidiaries and empower Latin American insurers to access EU markets. - Domestic insurers in Latin America without EU operations could retain some competitive advantage during phased implementation; once implemented, Solvency II-type frameworks will even the playing field and make some Latin American markets—particularly in Brazil, Mexico, and Chile—more attractive to foreign entities. ### Policy recommendations (paragraphs 76–79) - 76. Harmonize financial infrastructure and operational practices across the countries. This may require legal changes in a number of countries. - 77. Relaxing regulatory foreign asset limits for pension funds would ease the burden of optimal portfolio allocation for insurance companies. - Limited domestic investment opportunities and a shortage of supply of domestic securities are magnified by the overwhelming presence of pension funds, which increasingly hold securities to maturity and crowd out investment opportunities for the insurance sector. - Relaxing foreign investment limits for pension funds would both ease optimal pension fund portfolio allocation and provide additional investment opportunities for the insurance sector. - 78. Simplifying new product development policies would foster capital market expansion and increase investment opportunities. - Authorities should review regulatory requirements to ease the process of creating new products in domestic capital markets. - Infrastructure product development could provide a valuable instrument for portfolio diversification for pension funds and insurance companies alike. - 79. Improve data quality and provisions to support industry monitoring and diagnosis of vulnerabilities. - Data quality and availability on insurance companies vary by country; heterogeneity of publicly available information often prevents proper comparison across countries. - Data harmonization, improved quality, and availability would support authorities’ monitoring and increase sector transparency. ### Capital market integration in the LA-7: size, depth, and constraints - Market size and liquidity (as of end-2014 and related measures): - Capitalization of LA-7 equity markets was 47% of regional GDP. - Value of domestically traded bonds outstanding was about 61% of GDP. - Largest bond and equity markets in dollar terms are in Brazil and Mexico. - Chilean markets stand out for relation to economy size: 91.6% stock and 51.0% for bonds. - Liquidity concerns: - Despite solid market capitalization, low trading volumes are an emerging concern. - Declining liquidity attributed to high transaction costs and significant “buy and hold” positions of institutional investors. - Equity market depth impediments: - Reluctance toward equity financing partly due to family and conglomerate owners maintaining strong controlling interests, preferring debt to equity financing. - Perception of limited “free floats” and corporate governance less responsive to minority shareholders. - Domestic bond market characteristics: - Generally livelier, especially for sovereign paper, but often second-best to international bond markets. - Sovereigns and highly rated corporates find better terms in international markets (lower rates, longer maturities, larger borrowing amounts). - Domestic bond markets typically have higher and often variable interest rates, shorter maturities, and smaller volumes. - Corporates obtain significant shares of financing from bank loans and supplier credit, especially SMEs. ### Regional integration: stocks, flows, and impediments - Measures of integration: - Coordinated Portfolio Investment Survey (CPIS) reports bilateral international portfolio asset positions and can be used to measure cross-holdings. - Trends 2003–2013: - Regional cross-holdings of securities increased in most LA-7 economies over 2003–2013. - Only Chile and Uruguay witnessed declines of regional assets as a share of total assets. - Uruguay comprises over half the region’s cross-border assets; rebalancing translated into a decline in the share of LA-7 asset cross-holdings. - On the liability side, Chile, Mexico, Panama and Peru increased their share of regional financing. - Linkages with advanced country markets grew even more: now 91.4% of external assets and 93.9% of liabilities are held vis‑à‑vis advanced economies. - Key impediments to regional capital market integration: - Cross-currency transaction costs: investors without internal foreign currency access must sell local currency for dollars (usually through New York), buy the foreign currency, then incur charges again when repatriating — raising transaction costs. - Capital controls in Brazil further raise costs for investors entering the largest regional market. - Higher operational costs in local markets: higher transaction costs and larger bid/ask spreads in smaller, less liquid markets dampen regional investor appetite. - Poor sector diversity in some markets: largest issuers in Chile, Colombia and Peru tend to be natural resource/mining firms with correlated business cycles. - Variance in tax rates/rules and administrative procedures; scope exists for standardizing and coordinating clearing and depository practices across the region. ### Analysis and operational integration efforts (paragraphs 86–87) - Operational integration pathways: - Collaborative agreements among securities exchanges on mutual access, post-trade clearing procedures, and adopting the same electronic trading platform. - Harmonizing trading hours, tax treatments, and supervisory practices. - Broker/dealers purchasing or establishing operations abroad to facilitate foreign trading activity of clients. - Enhanced infrastructure for payment and settlement across borders. - Use of CPSS-IOSCO PFMI peer reviews to assess compliance of regulatory frameworks of CCPs and safety/soundness of individual CCPs; upon compliance, LA-7 countries may recognize each other’s CCPs and/or regulatory frameworks. - Exchange modernization in the LA-7: - BMF&Bovespa and Bolsa Mexicana have fully demutualized in the last decade; Chile is developing plans to demutualize. - Bolsa de Lima and Bolsa de Colombia have publicly traded floats and must comply with financial reporting requirements. - Major exchanges have adopted electronic trading platforms facilitating more cost-effective back-office support. - Exchanges in Brazil, Chile and Mexico have independent central counterparty (CCP) entities that settle and clear trades in all markets (stocks, bonds, foreign exchange and derivatives) and maintain broker collateral against default. - On Colombian, Peruvian, Panamanian, and Uruguayan bolsas, stock and bond trades clear through the exchange itself. - Bolsa de Colombia operates a CCP for derivative and foreign exchange trades. *Source: IMF staff analysis and calculations as presented in the provided content unit.* ### 88. The trend for stock exchanges to build strategic alliances through ownership stakes in ### _030416 - 88. The trend for stock exchanges to build strategic alliances through ownership stakes in ### Cross-ownership and strategic alliances among exchanges - Trend: Stock exchanges in Latin America building strategic alliances through ownership stakes to facilitate cross-border trades, mobilize larger pools of savings, increase market size and trading activity, and cut costs via scale and back-office synergies. - Examples: - In early 2015, BM&FBovespa purchased an 8% stake in the Santiago exchange and is working with it to set up an electronic derivatives market in Chile. - BM&FBovespa was said to be interested in acquiring stakes in the other MILA exchanges as well as the Bolsa de Buenos Aires. - The 2013 acquisition that earned the Bolsa Mexicana an 8% stake in the Lima exchange made it the largest independent shareholder of the Peruvian Bolsa and signaled Mexico’s growing interest in the MILA initiative. ### International and regional brokerage networks - Expansion of internationally affiliated brokerages reduces cross-border trade costs and promotes greater integration. - Several international brokerages have obtained seats or licenses to be broker/dealers in many LA-7 markets. - Likely benefits listed: - Reducing transaction costs for regional trades (compared to similar trades with correspondent brokers). - Broadening client bases and transaction volumes, which could drive down average back-office support costs. - Regional brokerage presence: - BTG Pactual: brokerages in Brazil, Chile, Colombia, Mexico, and Peru. - Other intra-regional investment bank/brokerages: Itau (Brazil), Sura (Colombia), Credicorp (Peru), GNB Sudameris (Colombia), LarrainVial (Chile). ### Potential gains from greater regional capital market integration - Potential outcomes: - Increase market depth, liquidity, and scale of operations for exchanges and market participants. - Support development of LA-specific financial products, preserve regional financial expertise and innovation, and preserve regulatory expertise and surveillance. - Larger regional markets likely to attract greater extra-regional flows, promoting regional and global integration. - Strategic need: LA capital markets need greater scale to be competitive with US and European markets and to overcome regulatory bias drawing transactions onto those domestic exchanges. ### Policy recommendations (as presented) - Harmonize financial infrastructure, including through adoption of IFRS; countries that have not yet done so should: - Adopt the multilateral memorandum of observance of principles and practices as set out by the BIS and IOSCO related to governance, monitoring, mitigating financial and operational risk, and to exchanging information; - Sign double taxation avoidance treaties where not yet done; - Over time seek convergence in tax rates. - Encourage inter-operability of trading and settlement platforms across the region to lower trading costs by reducing reliance on correspondent brokerage services. - Harmonize trading and extended trading hours. - Permit broker-dealers to operate cross-country, subject to supervision from both home and host supervisors, and receive the same regulatory treatment as domestic firms. ### Box 5 — Mexico: Interest Rate Derivatives Market (key facts) - OTC market dominance: - The bulk of interest rate derivatives denominated in Mexican peso continue to be traded predominantly in the offshore markets, mainly in the US. - OTC turnover of single currency interest rate derivatives denominated in the Mexican peso stood at USD 12.3 bn in April 2013, representing about 0.4% of the global OTC single currency interest rate derivatives market. - Less than a fifth (USD 2.4 billion) of Mexican peso turnover is cleared in Mexico; the remaining 82 percent clear through offshore markets, mainly in the US. - Drivers of offshore activity: close ties with the US, delay in establishing a well-functioning trading platform, and lower costs of OTC transactions. - Domestic platforms and clearing: - MexDer (Mercado Mexicano de derivados) became an important player only a few years prior to the report. - Higher fees associated with technological and technical costs of the trading platform have contributed to preference for OTC. - Regulatory changes and timelines: - New Mexican regulation scheduled for gradual implementation will require OTC derivative trades to take place on exchanges or through inter-dealer brokers, and calls for mandatory clearing of standardized derivatives through a CCP—Mexican (established in Mexico and authorized by the SHCP) or foreign (if recognized by Banco de Mexico). - In April 2016, compliance with the new regulation will be required for transactions between Mexican entities. - November 2016 is the start date for transactions involving foreign financial institutions. - Expected effects and competition: - Regulation is expected to increase contracts traded through MexDer and cleared through Asigna. - Asigna likely to face strong competition from offshore CCPs such as CME and LHC, as foreign institutions are expected to continue clearing offshore. - Multinational entities clearing through a CCP in the parent country can consolidate operations via netting, decreasing capital requirements. - Expansion of MexDer and Asigna likely driven by Mexican institutional investors, such as pension funds. - Further technical and technological improvements are required to boost Asigna’s and MexDer’s competitiveness. ### Box 6 — Latin American OTC Interest Rate Derivatives (key statistics and patterns) - Aggregate share and composition: - Interest rate derivatives in LA-6 currencies represent about 1.2% of global derivative turnover, with Brazilian real and Mexican peso constituting 60% of the market, largely in swaps. - Majority of interest rate derivative transactions in Latin America are conducted with other financial institutions; instruments are frequently denominated in Mexican and Colombian currencies. - Interest rate swaps constitute the larger portion of instruments in LAC-6 currencies, with a larger portion of cross-border activity. - Trading location: - Most interest rate derivatives in LA-6 currencies are traded in the US; only about 16% is traded domestically. - Heterogeneity: - USD is the primary currency used in CHL and PER, while Brazil, Mexico, Argentina, and Colombia have IRS markets primarily dominated by domestic currencies. ### Box 7 — Foreign Exchange Turnover of Latin American Currencies (key findings) - Offshore dominance: - Offshore trading continues to dominate turnover rates of LA currencies, with the majority of transactions taking place in the US and the UK. - Latin America has the largest share of offshore currency trading among emerging markets. - Mexican peso prominence: - The Mexican peso accounts for about 65 percent of offshore turnover of LA currencies. - In 2013, Mexican peso turnover reached US$135 billion, raising its market share in global FX trading to 2.5%, from 1.3% in 2010. - At 80 percent, the share of offshore trading of Mexican peso is among the highest among emerging markets. - Drivers of MXN turnover: - Fully convertible, free-floating currency without exchange controls; unrestricted access trading globally 24 hours a day. - High liquidity of Mexican assets and inclusion of Mexican peso-denominated debt in Citigroup’s World Government Bond Index in late 2010 boosted popularity. - Aggregate offshore trading pattern: - Nearly 70 percent of OTC FX turnover occurs offshore, mostly in the US and the UK. - Global turnover of LA currencies dominated by MXN, followed by BRL. *International Monetary Fund — FINANCIAL INTEGRATION IN LATIN AMERICA (excerpts from the supplied content).* ### 91. This section will discuss legal barriers to the cross-border integration of financial systems, ### _030416 - 91. This section will discuss legal barriers to the cross-border integration of financial systems, ### Overview - Staff’s analysis focuses on legal issues that hinder cross-border integration directly or indirectly: the opening of cross-border establishments by banks and insurance firms, and the cross-border acquisition of financial services. - Countries in the LA-7 have removed most legal barriers on the cross-border provision of financial services, but actual or potential legal barriers remain in some countries. - The section suggests avenues for removing remaining barriers and measures to strengthen legal underpinnings for financial stability in the context of cross-border integration. ### A. Cross-border Establishments of Financial Institutions — Findings - Legislative regimes differ across the LA-7 in allowing foreign establishments in their jurisdictions. - Countries with de iure open regimes (explicitly allowing subsidiaries and branches of foreign banks and insurance firms): Chile, Colombia, Panama, Peru. - Examples of restrictive regimes: - Mexico: prohibits branches of foreign banks explicitly, authorizes subsidiaries only under specified conditions; only a foreign financial institution established in a country with which Mexico has a treaty or agreement allowing establishment of subsidiaries can establish a subsidiary in Mexican territory (Article 45-A Banking Law). Mexico requires a majority of board members and all members of the executive board to reside in Mexico: Art. 45-K and L of the Banking Law. - Brazil: Constitution formally prohibits opening of new branches and subsidiaries, but provides waivers through a complex legal framework requiring approval by the President. - Even where entry regimes are de iure open, practical constraints exist: - Identical capital adequacy requirements applied to branches and locally incorporated banks can be costly for branches because the parent remains legally liable for branch obligations. - Discriminatory “ring-fencing” rules can subordinate claims of foreign or non-resident creditors to local creditors upon branch liquidation, discouraging use of foreign branches. - Broad statutory or supervisory discretion can inhibit market access in practice: - Example: Panama’s Banking Law authorizes the supervisor to make the license subject to “any criterion it deems pertinent.” (Art. 48.5 Banking Law) - Broad “best interests of the economy” tests can condition licensing (Panama: license can be refused if “the bank does not contribute to Panama’s economy” (Art. 48.3 Banking Law); Mexico: Rule Fourth II. in fine requires description of benefits to Mexican economy). ### B. Barriers to Cross-border Acquisition of Financial Services — Findings - Several countries prohibit residents from acquiring certain financial services abroad: - Panama and Mexico: local residents precluded from acquiring certain types of insurance contracts abroad (Article 153 of the Panama Insurance Law and Article 21 of the Mexican Insurance Law). - Restrictions on pension funds outsourcing asset management to foreign asset managers exist; only allowed in Chile. - Requirement that retail and professional investors invest abroad only through a locally registered investment fund exists in Brazil. ### C. Removal of Barriers — Domestic Law (Policy recommendations and design considerations) - Objective and comprehensive entry regimes for foreign financial firms should be in primary legislation; regimes should provide for entry in the form of both subsidiaries and branches. - Avoid overly broad “best interests” tests and discretionary licensing criteria; primary legislation provides more transparent and stable legal regimes and limits excessive discretionary supervisory powers. - Review and recalibrate conditions imposed on foreign establishments that do not contribute to financial stability: - Some measures (limits to intra-group exposures for subsidiaries, local asset maintenance requirements for branches, nondiscriminatory ring-fencing powers) can be appropriate for stability. - Modify measures that are excessive or discriminatory and hinder cross-border integration without stability benefits. - Remove discriminatory features of “ring-fencing” mechanisms for foreign branches (already done by Chile and Panama). - Reconsider nationality or residence requirements for directors and senior managers where appropriate. - Strengthen certain legal requirements to enhance cross-border integration: - Local asset maintenance requirements (LAMR) for branches should apply to a significant percentage of local liabilities, particularly deposits, to be effective safeguards. - Colombia and Peru apply LAMR only on the endowment capital of the branch, which is a small part of liabilities and insufficient to protect depositors (Article 2.36.12.2.2 of Colombian Decree 2555/2010 and Art. 42 of the Peruvian Banking Law). These rules should be reviewed to require a higher amount of assets to be held locally. - Combine well-designed LAMR with non-discriminatory ring-fencing to give host countries comfort in managing branch risk. - Review rules prohibiting access of local residents to foreign financial services; Chile, Colombia and Peru explicitly authorize residents to acquire abroad foreign insurance coverage (Art. 4 Decree-Law 251 in Chile, Art. 38.2 of the Colombian banking law, and Art. 10 of the Peruvian Banking Law). ### D. A Role for “Soft Law” Regional Harmonization - Regional harmonization of legislative and regulatory frameworks can be a precondition for opening financial markets and for cross-border supervisory cooperation. - Global regulatory fora and standards (FSB, BCBS, IFRS) have achieved some, uneven, harmonization in the region; more is needed at a regional level, especially to harmonize supervisory rules at a granular level. - LA-7 countries differ considerably in designing key banking supervisory instruments in banking legislation; significant disparities exist in legislative approaches to minimum capital, corporate governance requirements, limits on large and bank-related party exposures, and early intervention tools. - Some harmonization of legislative approaches to these key supervisory tools is likely to increase comfort with market access, but sequencing is important: restrictions on market access should be removed only when sufficient harmonization is in place. - Inter-governmental processes could achieve greater regional harmonization, potentially as a precursor to regional “mutual recognition” mechanisms under which host countries grant market access to market participants from home countries that have adopted regionally harmonized rules and practices. ### Table-based legislative comparisons — selected exact figures and provisions (as presented) - Minimum Capital (USD) (as determined in national legislation reviewed): - Brazil: Determined by National Monetary Council. +/- $28, 9 million. - Chile: +/- $25, 2 million. - Colombia: +/- $26, 3 million. - Mexico: $10 million. - Panama: +/- $4, 2 million. - Peru: Determined by the CB. - Corporate Governance — Size of Board: - Colombia: Between 5-10 directors. - Mexico: Between 5-15 directors. - Peru: Minimum 5 directors. - Corporate Governance — Independent Director: - Colombia: Yes. - Mexico: At least 25%. - Large Exposures: - Chile: Individual limit: 10% limit for non-collateralized credit. 30% limit for collateralized credit. - Mexico: 25% global limit for credit facilities, obligations. 10% individual limit for non-collateralized credit and investments. 30% individual limit for collateralized credit and investments. - Panama: 25% global limit for credit facilities, obligations (noted as "To be determined by supervisor" for some entries). - Bank-related party lending (selected entries): - Chile: No related party lending. - Colombia: Bank related party: 10% shares. Includes arm’s length provision. - Mexico: 100% Global limit. Individual limit: 5% non-collateralized credit- 25% collateralized credit. - Panama: Bank related party: more than 1% of shares. Includes arm’s length provision. - Peru: Bank related party: 5% of shares. Includes arm’s length provision. - Uruguay: Bank related party: 4% of shares or “significant influence”. - Early Intervention (selected entries): - Mexico: Yes. - Panama: General provision (broad powers). - Peru: Yes. - Uruguay: Yes. ### E. A Role for “Hard Law” International Treaties - Few FTAs and BITs among Latin American countries incorporate detailed chapters on financial services; where they exist they tend to contain standard provisions: national treatment, most favored nation, fair and equitable treatment and a “prudential carve-out.” - More detailed treaty provisions can support regional integration; Mexico has used treaties with more detailed provisions governing foreign entry (NAFTA, FTA with the EU) which include provisions on: - Allowing residents of other signatories to provide cross-border financial services and to open establishments and expand geographically over time. - Establishing a Financial Services Committee to oversee application. - Specific dispute settlement procedures. - The Trans-Pacific Partnership contains similar provisions and applies to Mexico, Chile and Peru (in addition to nine non-LA7 countries). - The BIT of Peru and Colombia prohibits nationality and residency requirements for management positions in establishments of foreign financial institutions. - Detailed treaty provisions can help but are not a panacea: effectiveness depends on scope of treaty obligations and whether treaties catalyze broader domestic measures to remove barriers. - Example of another useful treaty type: Chile’s network of double taxation avoidance agreements to mitigate or eliminate double taxation of cross-border capital movements. *Prepared by the Legal Department. Content extracted from the source PDF section provided.* ### 103. Mercosur was established in 1991 through the ### _030416 - 103. Mercosur was established in 1991 through the ### Mercosur: origin, trade liberalization, and reversal - Mercosur was established in 1991 through the signing of the Treaty of Asuncion by the presidents of Argentina, Brazil, Paraguay, and Uruguay. - Venezuela joined in 2012, and Bolivia in 2015. - Progressive preferential trade liberalization among members took place from 1991 to 1994. - The common external tariff was established in 1995; by then tariffs among members had been reduced in most part. - Trade among Mercosur countries increased throughout most of the 1990s. - The period 1996 to 1999 saw a reversal in trade liberalization due to: - external shocks such as the Brazilian financial crisis in 1999, and - unilateral changes in the common external tariff by Brazil and Argentina. - New non-tariff barriers (import licensing requirements and anti-dumping measures) were introduced by both Brazil and Argentina. - Since 2000, trade among Mercosur countries has declined. ### Services liberalization and the Montevideo Protocol - The Montevideo Protocol (1997) included commitments to liberalization of services, including financial services. - Principles guiding the liberalization process paralleled GATS (1995) modes of provision and rules of market access and national treatment. - Complete liberalization under the Protocol was envisaged over a ten-year period. - The list of initial commitments under the Montevideo Protocol was marginally more extensive than the list negotiated in the GATS. - Country-specific commitments relative to GATS: - Argentina maintained the liberalization levels committed in the GATS but maintained some protection in cross-border supply of financial services and presence of natural persons. - Brazil maintained GATS-committed levels, made no commitments to liberalize cross-border supply and consumption abroad, and kept some restrictions in commercial presence and presence of natural persons. - Paraguay committed less than the amount negotiated in GATS and had the most restrictions across modes of supply. - Uruguay increased its commitments relative to GATS, particularly regarding presence of corporates and of natural persons, but still had some restrictions across all modes of supply. - Mercosur established a technical forum for financial issues—Financial Mercosur (SGT-4)—mandated with advancing the financial integration agenda. - SGT-4’s ultimate objective is to create a single regional market for financial services, whilst maintaining monetary and financial system stability. ### Financial liberalization in the 1990s and foreign bank entry - Unilateral liberalization in the 1990s increased the presence of global foreign banks. - Argentina’s “Convertibility” plan and subsequent deregulation, privatizations, trade liberalization, elimination of capital controls, and stable macroeconomic environment attracted foreign investment. - Brazil’s “Real” plan (introduced in 1994) led to restructuring of banks, privatizations, and liberalization of the financial sector. - To facilitate foreign bank entry, the restriction that the minimum capital for a foreign bank had to be twice as large as that required for a national bank was eliminated. ### Foreign claims, bank ownership, and regional integration indicators - Foreign claims of Brazil on Mercosur countries: - Rose from an average of 4 percent of total foreign claims over 2002-08 to a peak of 11 percent in 2011-12, after which they declined due to a reduction in foreign claims on Argentina. - Current market shares of Mercosur-origin foreign banks in selected countries: - In Uruguay: foreign banks from Mercosur countries hold 10 percent of assets. - In Paraguay: foreign banks from Mercosur countries hold 20 percent of assets. - Mercosur foreign banks do not have important market shares in Brazil and Argentina. - Brazilian Itau’s operations: - 17 percent of Brazilian Itau’s operations in LA are in Mercosur countries. - Itau has important market shares in the Paraguayan and Uruguayan banking systems of 18 percent and 11 percent, respectively. - Other indicators and restrictions: - Indices suggest restrictions to market access across modes of supply (cross-border supply, consumption abroad, commercial presence, presence of natural persons). - Additional restrictions reported include licensing for foreign banks (Brazil and Uruguay), foreign bank entry (Brazil), and movement of people (Argentina, Brazil, Uruguay). - Some indices (Barth et al (2007)) suggest an increase in restrictions to foreign bank entry and permitted banking activities in Argentina, while restrictions on banking activities were lowered in Brazil from 2000 to 2006. ### Financial Mercosur (SGT-4) progress and potential - Despite problems in Political and Commercial Mercosur, Financial Mercosur is making progress, especially on convergence toward best practices. - SGT-4 comprises financial sector regulators (banking, securities markets, insurance) of all Mercosur member countries to oversee integration. - The ultimate goal is a regional common market in financial services. - The current juncture may be propitious for taking further steps to achieve this goal. ### Pacific Alliance (PA) and capital market integration (MILA) - The Lima Agreement (April 28, 2011) created the Pacific Alliance (PA) with Chile, Colombia, Mexico, and Peru: - Immediate abolition of tariffs on 92% of merchandise trade, with the remainder to be abolished by 2020. - The PA countries represent 36% of Latin American GDP and are the largest exporters from the region. - PA governance and outreach: - Six-monthly Presidential summits maintain high-level political commitment. - The framework agreement for the PA came into force on July 20, 2015. - 34 countries are observers at PA meetings; several smaller countries are progressing through membership processes. - ASEAN is an observer to the PA; the PA met with ASEAN in May 2015 and was observer at the ASEAN summit in November 2015. - MILA (integrated stock exchange initiative): - Stock exchanges of Chile, Colombia, and Peru agreed to merge under MILA; Mexico joined in December 2014. - Initial cross-border trade example: first trade on 2 December 2014 of shares in Chilean retailer Falabella executed in the Mexican stock exchange. - The Mexican stock exchange bought 6.7% of the Lima stock exchange. - Together the joint exchange is the second largest in Latin America, slightly smaller than Saõ Paõlo. - Empirical outcomes and limitations: - Total trades in the three years since MILA was established are less than the volume traded in Mexico alone in a week. - Explanations proposed: - MILA may be redundant because capital market needs can be serviced domestically or outside the region (particularly in the United States). - The integration process has been insufficiently ambitious; a more comprehensive set of integration policies may enable “lift-off”. - Operational and policy limitations to MILA: - Trades must still be placed with a broker-dealer in the investor’s country, who must contact a broker-dealer in the investment’s country. - Initiative currently covers only equities; expansion to government and corporate bonds is in process. - No harmonization of operating hours and procedures, nor harmonization of tax systems to avoid double taxation. - Pension and insurance funds face strict limits on cross-border portfolio shares, constraining capital market integration. - Recommended measures to accelerate PA/MILA integration (expanded below in Recommendations). ### Boxed figures: MILA market capitalization (as of December 2014) - Market Capitalization of MILA Markets as of December 2014 ($US in millions): - Chile: $233.0 - Colombia: $153.1 - Peru: $120.8 - Mexico: $481.0 ### Post-trade settlement, counterparty risk, and back-office challenges in MILA - MILA has focused on trade-driven integration with limited attention to back-office settlement issues. - Cross-border trades are conducted on a free of payment basis: cash and securities do not move together on settlement date (cash moves ahead of securities). - Counterparty risk is presently carried by local broker-dealers when settling cross-border trades; this creates contagion and systemic risk concerns. - A multilateral process for settling cross-border trades on a Delivery-versus-Payment (DvP) basis is required; options (regional clearinghouse, use of local custodians, central securities depositories) have not materialized. ### Policy recommendations (from the source) - Mercosur: - Mercosur to revisit its plans for financial integration and to consider how to take them forward at the present time. - Pacific Alliance (PA) and MILA — establishment of a small secretariat in one of the PA countries to: - Permit pension funds and insurance companies to count cross-border PA investment as domestic. - Replace remaining ratings-based country limitations for pension funds investments across MILA countries with specific foreign exchange and corporate limitations. - Complete MILA expansion beyond equities (primary and secondary markets) to include sovereign and corporate bonds. - Harmonize operational procedures, including all aspects of listing requirements, for capital markets. - Ensure all countries have signed IOSCO MOUs. - “Passport” the licensing of broker dealers, while keeping them subject to host as well as home regulation. - Enhance contacts amongst national regulators and supervisors, including through exchanges of staff and secondments to the secretariat. - Examine the potential for expanding geographic scope. *Source: IMF, "FINANCIAL INTEGRATION IN LATIN AMERICA" (section covering Mercosur, Montevideo Protocol, Financial Mercosur, and Pacific Alliance / MILA).* ### Conclusion ### Conclusion ### MILA and integration benefits - MILA represents an important staging post for further securities markets integration in Latin America, opening up benefits for economic growth in the region through enhanced financial intermediation and financial resilience arising out of deeper and more liquid securities markets. - Further integration of securities markets should involve harmonization towards best practice regulatory standards, and should address important post-trade settlement issues for cross-border trades. - DvP is a securities settlement mechanism that links a securities transfer and a funds transfer in such a way as to ensure that delivery occurs if and only if the corresponding payment occurs. ### Risks and mitigation — Current conjuncture (A) - Notwithstanding the growth and cross-border dimension of LA-7 financial activity, there are currently low levels of contagion spillover risks in the LA-7. - Growing cross-border activity and financial integration increase the potential for contagion spillovers in a crisis, but preliminary quantitative analysis suggests that spillover risks among Latin American financial systems are currently contained (see Background Paper - Appendix III). - Conglomerates operating in LA-7 jurisdictions and wider LA can act as pathways for increased regional banking and financial sector connectivity through their network of subsidiaries, inter-group and other counterparty exposures. - Country authorities have started to be more focused on these risks, limiting cross-border activity in some cases by formal or informal restrictions imposed on cross-border activities. - Current low levels of spillover risk provide space for further financial integration if: - regional supervisory and regulatory oversight is strengthened, and - any country-specific weaknesses in supervisory frameworks are addressed to avoid regulatory arbitrage. - While contagion risks currently remain low, they would naturally rise with greater integration and/or under adverse crisis situations. This requires that such cross-border activity and exposures be monitored in a regionally coordinated manner. ### Analytical work on spillover risks (B) - Market-based spillover analysis (based on estimated default linkages) suggests that contagion risks among large financial institutions in Latin America remain contained. - The quantitative analysis looks at the existence of market-based interlinkages of large financial institutions in the countries included in the sample, using data on traded securities, and quantifies potential spillovers across institutions through the financial markets (see Background Paper - Appendix III). - In the case of banks in the six-country sample: - Argentinean banks (and Banorte in Mexico) appear to be the most “vulnerable to contagion” during the GFC, and also over the period from end-2010 to mid-2012. However, these spillover risks are mostly among themselves. - Over the past year or so, publicly-owned Brazilian banks (Banco do Brazil) appear to be driving most of the market-implied contagion among the banks in the sample, but the actual spillovers (outside Brazil) appear to be rather small. - Brazilian public banks might be very important for the domestic market (in Brazil), but not really for the region, likely reflecting the lack of significant balance sheet exposures among Latin American banks. ### Regulatory oversight (C) - A key pre-condition for substantial cross-border financial integration is to also have a robust and forward-looking best-practice regulatory and supervisory framework in place. - Since the GFC there has been an important need both domestically and internationally to enhance regulatory standards and develop macroprudential tools to reduce risks in the financial system, including cross-border risks. - As regards LA cross-border financial activity, risks may be mitigated by: - having a suitable entry, operating and resolution framework for cross-border institutions; - having sound national regulatory frameworks in place (Basel 3) reflecting appropriate timelines and banking system complexity; - having a full picture of the entire financial institution (need for cross-border consolidated and conglomerate supervision); - using the macroprudential toolkit to protect the national, and regional, financial systems from systemic financial stability risks. - Note: So far the assessment of EMs in Latin America on the basis of the Key Attributes of Effective Resolution for Financial Institutions is limited and will require further work. Colombia has recently undergone a pilot assessment which will provide useful inputs for the FSB from an EM perspective regarding the Key Attributes. ### I. Cross-border establishments - Legal and regulatory frameworks for subsidiaries and branches of foreign firms have been enhanced, but could be further strengthened. - Surveyed countries generally require that branches/subsidiaries follow all regulations and practices of the host countries. - All countries require endowment capital of branches, and most authorities have the powers to restrict issuing of dividends of subsidiaries (including cross-border), as well as of capital of subsidiaries. - Pricing of centralized functions such as IT and treasury is subject to oversight, thereby avoiding that restrictions on dividend or capital transfers are circumvented. - Further room for improvement: - Review local asset maintenance requirements for branches and limits on intra-group exposures for subsidiaries. - In the context of a broader update of bank resolution frameworks, strengthen powers to deal with cross-border coordination, including by removing the automaticity and discriminatory features of ring-fencing mechanisms. ### II. Basel 3: capital, liquidity and leverage requirements - Progress is marked but not yet complete amongst the LA-7 in adopting the Basel standards. - The Basel Committee’s Eighth Progress Report on the adoption of the Basel regulatory agenda shows rapid recent progress in many EMs. - Brazil and Mexico are fully compliant as regards the Basel 3 capital standard, the liquidity standard, and the leverage ratio. - Others are implementing at a pace they consider in line with the nature of their banking systems, though a move to the Basel III capital definition across the LA-7 would further enhance financial stability (Background Paper – Box 1). ### III. Consolidated and conglomerate supervision - Recent FSAPs for countries in the region show that for all countries there is some way to go in improving their supervisory framework and, in particular, implementing consolidated and conglomerate supervision, with legal restrictions in some countries preventing full achievement of best practices, in particular in the handling of the non-financial components of conglomerates. - Although subsidiarization, and regulatory and resolution ring fencing, can dampen cross-border spillovers, cross-border safety requires that the institution be supervised on a consolidated basis. - International best practices for consolidated supervision call for establishing robust supervisory regimes, cross-border supervisory processes, joint monitoring programs, and coordinated corrective/supervisory actions amongst all parts of a cross-border financial institution or conglomerate. - The structure of Latin American financial institutions makes consolidated supervision particularly important, given that many are parts of conglomerates, and that the non-financial parts of such conglomerates have in a number of cases already expanded cross-border to a much greater extent than the banks. - Even where there are no direct financial flows between the bank and non-bank parts of a conglomerate, problems in the non-bank can have major knock-on effects on the bank (example: problems in the retail arm of the group with the first Chilean bank to move cross-border led to financial pressures and ultimate sale to another regional bank, although the Chilean bank itself had faced no difficulties and was making substantial profits). - Increasing awareness of the importance of consolidated supervision: - Uruguayan regulators declined to give a license to a regional bank seeking to acquire a bank being sold in Uruguay on the grounds that the regional bank’s supervisor was not conducting consolidated supervision. - Chile received IMF technical assistance on this subject in 2014–15. - Conglomerate supervision complements individual sector supervision by adding a layer to solo and consolidated sectoral supervision, addressing: - double gearing of capital, - conflicts of interest, - risks of contagion, - concentration, - other specific group risks. - Internationally agreed documents provide national authorities a set of principles that support consistent and effective supervision of financial conglomerates: - The main references are the “Basel core principle for effective banking supervision” and the Joint Forum’s “Principles for supervision of financial conglomerates.” - Colombia is currently seeking parliamentary approval for a bill on providing supervisors with powers over the holding company of financial and mixed conglomerates in line with the Principles. - The Principles are flexible and non-prescriptive to cover a wide range of structures, emphasizing recognition of structural complexity and risks arising from all entities—unregulated or regulated—that affect the financial conglomerate’s overall risk profile. - Beyond consolidated supervision there is also need for increased cooperation amongst supervisors to tackle conglomerate and cross-border risks more broadly. - Supervisory colleges have been established for major banks in the region. - Colombia has gone further in Central America through a multilateral MoU, a Regional Council of Finance Ministers, a Regional Monetary Council, and a joint Council of Supervisors. ### IV. Macroprudential toolkit - Since the GFC there has been considerable progress in much of the world in designing and implementing a macroprudential toolkit. - Macroprudential authorities have the power to impose additional capital charges if they consider that cyclical conditions so warrant. - Specific instruments such as limits on loan-to-value and debt-to-income are also being studied. - Such instruments are likely to be designed and implemented at a national level, given the different risk exposures of each country. - Where there is cross-border financial activity, there is a clear need for coordination, and reciprocity, to avoid arbitrage and “macroprudential leakage” across countries. ### Recommendations - Latin American countries may be assisted by taking a regional approach as they come to implement remaining elements of the global regulatory agenda and develop and implement their emerging macroprudential toolkits: - Seek to align timelines while reflecting international commitments and local circumstances as national authorities move forward with implementing the regulatory agenda. - Introduce, and/or strengthen consolidated supervision, if necessary with technical assistance from IMF or other sources, in line with recommendations from IMF FSAPs and the Joint Forum’s Principles. - Continue the development of macroprudential tools through regional conferences, and possibly a more formal regional arrangement, so that tools can be designed and implemented on a regional basis to avoid cross-country regulatory arbitrage and coordinate eventual spillovers. - Note: Brazil and Mexico as members of the Basel Committee and the FSB have to abide closely with the international timeline for implementation. *Source: _030416 - Conclusion* ### 22. International Bank Claims on Colombia ______________________________________________________ 50 ### 22. International Bank Claims on Colombia ### Cross-border expansion and drivers - Colombia’s three largest banks—Bancolombia (based in Medellin), Banco de Bogotá, and Davivienda (based in Bogotá)—expanded aggressively to Central America. - The assets of Colombian banks’ subsidiaries abroad reached US$50 billion, accounting for 24 percent of the total assets of the Colombian banking system. - Colombian banks have attained a significant market position in Central America (on average: 22 percent). - The expansion strategy aimed first to follow Colombian clients abroad and then to diversify portfolios to serve other clients, exploiting acquisition opportunities arising from the withdrawal of foreign banks from Central America and the high capitalization of Colombian banks. - Banco de Bogotá’s subsidiary (BAC) in Central America/Panama has a much more important consumer credit and mortgage lending portfolio compared with its corporate-led loan portfolio in Colombia, generating cross-complementarities (for example, bringing credit card technology from Panama to Colombia and exporting corporate lending knowhow from Colombia to Panama). - Bancolombia’s portfolio in Central America/Panama includes all core banking products (corporate lending, as well as consumer credit and mortgage lending), while its home market activity is mostly corporate banking. - Davivienda’s portfolio in Central America/Panama is increasingly focusing on consumer lending while withdrawing from corporate lending; in Colombia Davivienda has a high share of corporate lending and smaller shares of consumer and mortgage lending. ### Funding, business model and regional implications - Expansion motives and constraints noted in the region: - Follow clients abroad and diversify portfolios. - Take advantage of acquisition opportunities from withdrawing foreign banks. - Colombian banks’ high capitalization supported outward expansion. - Business-model differences affect cross-border strategy and risk: - Retail banking abroad requires funding and is more challenging to develop; corporate and investment banking are easier to follow across borders. - Wholesale-funded banks face liquidity swings and funding risk when expanding regionally. - Examples of regional private-bank dynamics (contextual, illustrating cross-border behavior): - With its most recent acquisition of Chilean Corpbanca (and merger with Corpbanca Colombia), one Brazilian bank’s cross-border business share rose to 13 percent from 7 percent in 2011 (illustrates cross-border shares can change materially with M&A). - For investment banks (e.g., BTG Pactual), being 100 percent wholesale funded incentivizes regional expansion to diversify wholesale funding, but wholesale funding reliance translates into noticeable swings in liquidity and vulnerability to funding stress. ### Capitalization, regulatory context, and market-based measures - Regulatory capital requirements differ across Latin American countries; examples cited: - Brazil (11 percent), Peru (10 percent), Guatemala (10 percent), Uruguay (10 percent), Chile (8 percent), Argentina (8 percent), Mexico (10.5 percent), Colombia (9 percent). - Some systemic Colombian banks have lower levels of capital in excess of the regulatory minimum than some regional peers. - Total capital ratios in excess of the regulatory minimum requirement stood at 2.9 percent for the largest Colombian banks, characterized as the lower end of regional peer comparisons. - Capital definitions and comparability caveats: - Cross-country differences in capital computation include treatment of revaluation of fixed assets; accounting of profits from current or past periods; treatment of investments in capital instruments; deductions from capital (goodwill, intangibles, deferred tax assets); grandfathering of some capital (debt) components. - Capital can differ depending on consolidation level: individual (solo) bank, banking group, or financial conglomerate. - Differences in regulatory risk weights, national definitions of capital, the Basel framework in use, and accounting standards imply that direct comparisons of total regulatory capitalization should be interpreted with caution. ### Key statistics (as reported) - Assets of Colombian banks’ subsidiaries abroad: US$50 billion. - Share of those subsidiary assets in total Colombian banking system assets: 24 percent. - Average market position of Colombian banks in Central America: 22 percent. - Cross-border business share example (post-acquisition for a Brazilian bank): 13 percent, up from 7 percent in 2011. - Colombia’s regulatory capital requirement: 9 percent. - Total capital ratios in excess of regulatory minimum (Colombian largest banks): 2.9 percent. ### Observations relevant for policy and supervision (drawn from source analysis) - Regional expansion can diversify banks’ portfolios but introduces funding and liquidity considerations—retail expansion abroad is more funding intensive than corporate/investment banking expansion. - Supervisors should account for differences in capital definitions and consolidation practices when assessing cross-border exposures and capital adequacy. - High capitalization at home can facilitate outward expansion, but home-country regulatory requirements and differences in ring-fencing or information-sharing rules in host countries can constrain group-level support and cross-border operations. - Cross-complementarities between home and host-country operations (e.g., technology transfer, product mix diversification) can strengthen franchise value but may also change risk profiles across jurisdictions. *International Monetary Fund — Financial Integration in Latin America (selected excerpts).* ### Box 1: Capital Definitions and Capital Ratios Across Latin America (Concluded) ### Box 1: Capital Definitions and Capital Ratios Across Latin America (Concluded) ### Capital measures and cross-country comparisons - Rating-agency measures produce differing assessments of quantity and quality of capital across countries. - Standard and Poor’s risk-adjusted capital (RAC) measure: - Deducts all goodwill on the balance sheet from banks’ respective total adjusted capital. - Under RAC, Colombian banks have lower levels of capital—reflecting large amounts of goodwill from mergers and acquisitions after the late 1990s crisis and recent geographic expansion. - Fitch Core Capital (FCC) measure: - Brazil, Chile and Colombia show much lower capital under FCC. - Drivers: higher leverage of the system, sizeable investments in insurance companies, high levels of goodwill and deferred tax assets (all deducted from equity to reach FCC levels). ### Additional loss absorbency in the region - Market-based capital ratios may appear low in some countries, but banking systems often have additional loss-absorbing elements: - Many banks hold high levels of provisions (Brazil, Colombia). - Lower NPLs (Colombia). - More conservative risk weights (Colombia, Chile). ### Basel III adoption and implications - Many Latin American countries are adopting Basel III standards at different paces. - Expected benefits: - Help address inconsistency of capital definitions. - Recent Basel Committee work should ensure harmonization of risk weights. - Implementation heterogeneity: - Differentiation of capital may persist due to differences in adoption of above-minimum capital measures (Pillar 2 and conservation, countercyclical and D-SIB buffers). - Heterogeneous adoption may reflect: - Need to address supervisory failings. - Desire to tailor capital to bank risks across Latin America. - Some countries may set capital requirements above Basel III voluntary minimums. ### Conclusion on capital and stability - Greater consistency in capital frameworks across Latin America will: - Help ensure financial stability. - Sustain bank lending during economic downturns. - Regional challenges requiring more conservative long-term capital planning: - Moderating economic growth. - Low yield environment. - Volatility around US monetary policy normalization. - Cross-border risks and conglomerate expansion. - Feasibility: - Moving to Basel III should help and is attainable for most Latin American banking systems as current capital is sufficient to support transition and additional loss absorbency exists beyond capital. ### Basel implementation progress (summary) - Basel 2: - Brazil, Mexico most advanced in terms of implementation. - For others: implementation progressing but further work needed on legal enhancements, development of risk-based supervision, and supervisory capacity and guidelines. - Basel 2.5: - Brazil, Mexico most advanced in terms of implementation. - For others: no regulation for implementation or regulator decided it is not currently applicable given the state of development of financial markets and institutions’ business models. - Basel 3: - Brazil, Mexico most advanced in terms of implementation. - For others: implementation is on a slower track, especially regarding liquidity, leverage and capital buffer implementation. - Risks of slower progress: - Inadequate identification of cross-border and interconnected risks. - Insufficient holding of capital against such risks. - Inconsistent regulatory and supervisory oversight, with potential gaps in consolidated and conglomerate supervision. ### Quantifying financial integration: measurement approach - Objective: quantify extent to which Latin American (LA) markets are “under-integrated” given economic fundamentals. - Controls used to filter exogenous factors: - Level of economic development (proxied by GDP per capita in PPP dollars). - Trade openness (exports plus imports divided by GDP). - Past history of financial crises (Reinhart and Rogoff indicators). - Public debt-to-GDP ratio. - Quality of institutional framework (investment profile subcomponent of the International Country Risk Guide Index). - Exclusions: - Variables directly affected by policy (e.g., extent of capital controls) are excluded to focus on exogenous factors. - Econometric strategy: - Regress a measure of financial integration (baseline or alternative composite indices from Box 2 or subcomponents) on macro determinants and fixed effects. - Degree of under- or over-integration = difference between estimated country (or region) fixed effect and sample average of fixed effects. - Sample: 67 countries between the mid-1980s and 2014. - Model notation provided: FI_{i,t} = X_{i,t} β + α_i (where FI_{i,t} denotes the financial integration indicator, X_{i,t} are control variables, and α_i is the fixed effect). ### Box 2: Building a synthetic index of financial integration (key design points) - Baseline composite index combines: - De facto openness of the financial account = sum of stocks of foreign assets and liabilities as a share of GDP. - Regional dispersion of stock market returns = standard deviation of returns of MSCI indices across countries of the same region (lower standard deviations imply greater convergence). - Combination method: - Principal component analysis (PCA) on standardized variables; weights are squared factor loadings. - First component explains more than 50 percent of the total variance for the three indices constructed. - Three alternative indices: - Alternate 1: - Replaces stock of external assets plus liabilities/GDP with external liabilities-to-GDP ratio. - Alternate 2: - Adds a third component: private sector credit by banks to GDP (financial system depth). - Alternate 3 (regional focus): - Adds a measure of relative regional openness (ratio of regional assets and liabilities to total foreign assets and liabilities). - Variants for defining region: - 8-region world (advanced economies; Africa; Asia; emerging Europe; Latin America and the Caribbean; Middle East and North Africa; Commonwealth of Independent States; other small states). - 4-region world (Asia, Europe, Western Hemisphere, rest of the world). - Distance-based weights: bilateral financial positions weighted by geographic proximity; regional openness increases when countries are more financially open to neighbors. - Rationale for including global openness alongside regional openness: - Ensures “regional integration” captures both scale and direction of financial flows; avoids labeling a de facto closed economy with small neighbor linkages as highly regionally integrated. *Source: IMF (Box 1 and Box 2 content as provided).* ### 11. The econometric results confirm that the LA-7 countries are under-integrated as a ### 11. The econometric results confirm that the LA-7 countries are under-integrated as a ### Main findings on financial integration levels and cross-country differences - Overall conclusion: LA-7 countries are under-integrated as a whole once broader measures of integration are used through composite integration indexes, even after controlling for fundamentals. - Exception: Panama is the notable exception, being well-integrated across most specifications and often showing integration in line with or above the sample average. - Openness-only perspective: - Using financial openness measured as the ratio of gross external assets and liabilities to GDP or as the liability ratio (Table 2), LA-7 countries appear relatively well integrated from an openness perspective compared to the sample average. - This openness result is partly driven by Panama and Chile, which clearly show a greater degree of openness than the others. - Composite indexes combining openness and convergence (baseline, Table 3): - After combining dimensions of financial openness and financial convergence, the LA-7 countries (except Panama) are under-integrated relative to the sample average after controlling for fundamentals. - The relatively high openness of Chile and Peru (Table 2) is dominated by a lack of regional convergence in their financial markets. - Alternative openness measure using external liabilities-to-GDP (Table 4): - Using this narrower openness measure corroborates baseline findings: with the exception of Panama, LA-7 countries show under-integration virtually identical to the baseline results. - Panama stands out as the one LA-7 country whose level of integration is above the sample average in this specification. - Three-component index adding depth (Table 5): - Results confirm that, excluding Panama, LA-7 countries are under-integrated relative to the sample average after controlling for fundamentals. - After adding depth, integration outcomes worsened for all LA-7 countries except for Panama and Chile. - Panama’s result became not only above the sample average but significantly stronger than its outcomes using two-component indexes. - Chile’s magnitude of under-integration was halved relative to the two-component indexes, suggesting a relatively deep market; Chile’s under-integration stems largely from lack of convergence with the region. - For the remaining five LA-7 countries, under-integration primarily reflects lack of convergence and depth in their financial markets. - Three-component index including regional openness (Table 6): - Including a measure for relative regional openness (in addition to global openness and regional convergence) changes outcomes: all LA-7 countries, including Panama, exhibit under-integration relative to the sample average. - Panama still shows the lowest degree of under-integration among LA-7 countries, suggesting Panama’s previous high integration reflected extra- rather than intra-regional integration. - Using this index, Brazil, Colombia, Peru and Uruguay are less under-integrated relative to the sample than Chile and Mexico. - Mexico’s result may reflect its higher degree of integration with the U.S.A. (not included in Mexico’s regional grouping). - Chile’s interconnections appear to stem principally from outside the region despite its relatively deep markets. ### Econometric approach and data details - Sample and period: - Panel for financial openness regressions: 67 countries from 1986-2011. - Composite-index exercises and alternative specifications use panels of up to 172 countries from 1986-2011 (Table 6) and 76 countries between the mid-1980s and 2014 for the growth–integration exercise. - Regression methods: - OLS regressions with standard errors adjusted for clustering at the country level. - Fixed effects (FE) regressions estimating country fixed effects (reported LA-7 results in tables). - Instrumental variable (IV) panel estimator used for growth regressions to address endogeneity of integration. - Dynamic Arellano–Bond GMM and first-differenced GMM (Arellano Bond (2001)) used as robustness checks for dynamic and endogeneity concerns. - Instruments used for IV estimation: - First lag of the integration variable. - The capital controls indicator by Fernández and others (2015). - Occurrence of a banking crisis 10 years earlier (Reinhart and Rogoff indicator). - A subcomponent of the ICRG political risk index describing profit repatriation rules. - Instruments assumed to impact integration directly but affect growth indirectly. - Notes on GMM and robustness: - IV estimates indicate a clearly positive elasticity of financial integration with growth across specifications and dependent-variable choices. - Results are robust to removing the banking crisis instrument (which reduces sample size). - Arellano–Bond GMM dynamic estimates broadly unchanged for the financial integration coefficient; however, GMM results are sensitive to the number of lags used for instruments. - Excluding the lagged GDP-per-capita level (to address its endogeneity) leaves the integration coefficient broadly unchanged. - Non-linear specifications (interaction terms and quadratic form of the integration indicator) did not produce robust results. ### Macroeconomic implication: integration and growth - Model linking financial integration to economic growth: - Specification follows Beck and Levine (2004) and Sahay and others (2015), including controls: initial income per capita, trade openness, inflation, government expenditure-to-GDP ratio, investment-to-GDP ratio, population growth, and ICRG institutional-quality measures. - Sample for growth estimation includes 76 countries between the mid-1980s and 2014. - Main result: - Instrumental variables indicate financial integration is positively correlated with growth; IV estimates show a clearly positive elasticity regardless of control variables, inclusion of time dummies, and whether real growth or real growth per capita is used. - Alternative integration measures (two-component index with external liabilities-to-GDP; three-component index adding financial depth; three-component variants including regional openness measured in several ways) all yield a positive and significant effect of integration on growth (Table 8, columns 1–6). ### Key methodological and interpretative points - Time dummies are incorporated in all specifications where noted. - Demeaned estimates reported for country dummies: fixed effect estimates minus a sample average of fixed effects. - Institutional quality proxied by the investment profile subcomponent of the International Country Risk Guide political risk index. - Robust T-statistics reported in italics in tables. Significance flags: *** p<0.01, ** p<0.05, * p<0.1. - Caveats: - Finding fully exogenous instruments in macro settings is difficult; instruments here are assumed exogenous because they are slow-moving. - GMM estimators are sensitive to instrument lag choices; some GMM regressions suffer from traditional shortcomings. - Non-linearities in the integration–growth relationship were tested but did not yield robust evidence. *Source: IMF chapter section on econometric results and macroeconomic gains from regional integration in Latin America (tables and discussion as presented in the supplied content).* ### 16. Using the measure of under-integration calculated in the previous section, the ### _030416 - 16. Using the measure of under-integration calculated in the previous section, the ### Growth effects of closing the financial integration gap - Closing the integration gap in LA-7 countries may raise GDP growth by 0.25 to 0.75 percentage point. - The various specifications return integration elasticities of 0.01-0.02. - Using the fixed effects estimates, the gap in LA7 countries averages 0.3-0.4; with an elasticity of 0.01–0.02, the implied growth effect is therefore 0.3-0.8 percentage points if the gap were fully closed. - Caveat: results should be treated with caution because most variables in growth regressions are endogenous, creating potential estimation biases that IV and GMM estimators cannot always correct. ### Baseline econometric findings (selected) - Financial integration (FI) baseline coefficients reported around 0.01–0.02 across specifications (Table 7). - Trade openness: log of trade openness coefficients reported in Table 7 around 0.03–0.05 (for example, 0.04***, 0.03**, 0.05*** in different specifications). - Investment: log of investment to GDP ratio coefficients around 0.07–0.14 in various specifications (for example, 0.14***, 0.08***, 0.09***). - Fiscal expenditures: log of public expenditures to GDP ratio coefficients reported as negative in several specifications (for example, -0.08***, -0.05**, -0.06***). - Other notable coefficients: Log of PPP GDP per capita (t-1) often negative and significant (examples include -0.05***, -0.02*, -0.11***). - Estimation methods: most specifications estimated with panel IV estimator; specifications 7 and 9 in Table 7 use GMM. Table 8 reports alternative FI indicators with FI coefficients including 0.02**, 0.01***, 0.03*, 0.02*, 0.09*, 0.06** in different specifications. ### Market-implied interlinkages: methodology and sample - Direct vs. indirect linkages: - Direct linkages: explicit balance-sheet positions of one financial institution vis-à-vis another (assets or liabilities). - Indirect linkages: co-movement/synchronicity of market indicators (e.g., stock prices) absent explicit balance-sheet links; may reflect similar business models, common exposures, or common perceptions of vulnerability. - Objective: quantify both direct and indirect linkages among financial institutions in Latin America using market-implied measures. - Sample and data: largest listed banks from Argentina, Brazil, Chile, Colombia, Mexico, and Peru over the period 2005–2015; relies on publicly available daily time series of financial variables (e.g., stock prices, CDS spreads). - Key synthetic measures (CIMDO-based): - Vulnerability index (VI): measures the susceptibility of an institution to fall into distress given distress in other financial institutions (institution’s “vulnerability to contagion from other financial institutions”). - Contribution to systemic risk: percent share that a given institution represents in the changes in the vulnerability index of all other institutions (its role as a “source of contagion”). - Data sources for marginal probabilities of distress: Moody’s KMV’s Expected Default Frequencies (EDFs) database. ### Market-implied findings for Brazil and the regional sample - Two samples analyzed: five large Brazilian banks (Brazil sample) and 15 banks from the six LA countries (regional sample). - Brazil (Figure 6 findings): - In the Global Financial Crisis (“Period I”) foreign banks such as Santander (SAN) were perceived by the markets to be relatively safe compared to domestic banks. - In the recent period of falling economic activity, lower commodity prices, and heightened political tensions in Brazil (“Period III”), public banks (BDB, RSU) are perceived to be a larger source of risk for the banking system compared to privately owned banks such as Itau (ITA) and Bradesco (BRA). - Interpretation: public banks in Brazil are an important part of the banking system; co-movement of their market indicators may reflect wider economic concerns for Brazil and thus they are a significant source of risk for the domestic banking system. - Regional 15-bank sample (Figure 7 findings): - During the GFC (“Period I”), Argentinean banks and Banorte (Mexico) appear to be the most “vulnerable to contagion.” - In “Period III,” Banco do Brazil (BDOBR) appears to be driving most of the market-implied contagion. - However, actual spillovers outside Brazil appear to be rather small when comparing vulnerability index levels to those observed during the GFC. - Conclusion: large domestic public banks in Brazil may be very important domestically but are not necessarily central for cross-border contagion in the rest of the region; market-based measures align with limited actual cross-border balance-sheet exposures of LA banking sectors. ### Bank contagion module and simulated cross-border spillovers - RES’ Bank Contagion Module objective: analyze potential spillover effects arising from international lending operations of global banks; simulates propagation of financial shocks across borders through bank losses and deleveraging. - Data: utilizes BIS bilateral banking statistics (claims of banking systems in BIS reporting countries vis-à-vis residents in reporting and non-reporting countries). - BIS reporting countries in Latin America: Brazil, Chile, Mexico, and Panama. - Main result: Latin American banking systems are not strongly integrated among themselves but have tight links with advanced economy banking systems. - Key creditor advanced economies with important links to LA: Canada, Spain, UK, and the United States. - An asset-side shock to these advanced economies’ banking systems could have a sizeable impact on the availability of foreign credit to Latin American countries (Table 10). - A shock to any Latin American banking system would likely have small direct spillovers onto other LA countries due to limited intraregional cross-border banking exposures. ### Brazil: key financial system facts (LA country profile) - Brazil’s nominal GDP amounted to about US$2.35 trillion in 2014. - Total financial sector assets are close to US$2.4 trillion. - The banking sector represents close to 117 percent (of GDP). - Publicly owned banks represent about half of the banking system. - The banking sector is concentrated: the 8 largest banks account for about 85 percent of the banking sector. - Characterizing features: high degree of conglomeration; high interest margins and high profitability for large banks; a “high interest rate and short duration” equilibrium that limits capital market development and potential growth. *Source: IMF staff report text (excerpts as provided).* ### 30. Regarding non-banks, the insurance sector is performing well. Profitability in the ### _030416 - 30. Regarding non-banks, the insurance sector is performing well. Profitability in the ### Non-bank financial sectors: insurance, mutual funds, and pension funds - Insurance sector: - Profitability in the insurance sector has been relatively high over the past few years, likely benefiting from high interest rates. - This has translated into solid solvency ratios. - Mutual funds: - Mutual funds and banks are highly interconnected through repo operations and the holding of deposits and bank-issued bonds by the funds. - Pension funds (Brazil): - Pension funds are sizeable in Brazil, with assets under management close to US$280 billion. - Essentially all these assets are invested domestically (Figure 12). ### Brazilian banks: regional presence and structure - Regional presence: - Itau is the only universal Brazilian bank with a significant presence across the region. - Itau represents almost 10 percent of the banks’ total assets in the region. - Itau is present in Argentina, Chile, Colombia, Mexico, Paraguay, and Uruguay. - BTG Pactual is attempting to position itself as a regional investment bank. - Bank type implications: - Investment banks can operate with smaller balance sheets and potentially be profitable without large scale, which is reflected in their capital costs. - Foreign claims concentration: - Brazilian foreign claims remain concentrated in a few advanced economies. - Brazilian claims on countries such as the U.S. and the U.K. dwarf those on other LA countries (Figure 13). - The only exception is Chile, where Itau has a significant presence. - Cayman Islands has a notable share of Brazilian foreign claims; most Brazilian banks establish operations there to offer investments denominated in foreign currencies. ### Foreign financial claims on Brazil and external funding reliance - Growth and scale: - Foreign financial claims on Brazil have more than quadrupled since 2005 (Figure 13). - Foreign claims stand at about US$442 billion (roughly 18 percent of GDP). - Country composition: - Spain has the highest foreign claims, representing close to 7.5 percent of GDP, reflecting the significant presence of Spanish banks, most notably Santander. - Recent trends and resilience: - In the last couple of years, the total amount of foreign claims has stabilized, consistent with the slowdown in the domestic economy. - Brazilian financial institutions have a relatively low ratio of foreign liabilities to credit to the economy (around 10 percent). - This suggests a relatively low reliance on foreign funds as a source of funding, limiting the effects of any potential global liquidity squeeze. ### Cross-border flows, trade linkages, and securities issuance - Geographic relation to real sector: - Banking sector flows appear geographically related to real sector activity. - There is evidence that cross-border banking sector flows in Brazil tend to be associated with trade linkages as well as FDI (Figure 15). - Issuance abroad: - There has been a noticeable increase in bank as well as non-bank issuance abroad by Brazilian corporations through 2014 (Figure 16). - Issuance abroad has contracted as risk appetite for Brazilian securities has subsided. ### Regulatory framework and barriers (Brazil) - Adequacy: - Brazil’s regulatory framework is broadly adequate. - The 2012 FSAP characterized financial sector oversight as strong, but noted efforts were needed to stay abreast of a rapidly evolving system. - Compliance of banking supervision vis-à-vis Basel Core Principles (BCP) is one of the highest in the region: 100 percent of principles were found to be “Compliant” or “Largely Compliant”. - Significant regulatory barriers: - Foreign banks need special presidential approval in order to operate in the country, even under the subsidiary model. - Brazilian banks are not allowed any significant position in their balance sheet (loans or deposits) denominated in foreign currencies. - This minimizes potential FX-associated risks (both market and credit risks), though most countries tend to allow some small open FX position on banks’ balance sheets. - Other barriers include Brazil’s large size and the degree of market concentration, which reportedly represent hurdles for regional players to enter the domestic market. ### Chile: financial system structure and cross-border linkages (selected findings) - System size and institutional investors: - Assets of the banking system amount to about 125 percent of GDP. - Pension funds account for about 75 percent of GDP. - Mutual funds and insurance companies are significantly smaller (20–25 percent of GDP). - All institutions combined, the financial sector is close to 250 percent of GDP. - Openness and external positions: - Chile’s net external position has hovered around -15 percent of GDP since 2008. - FDI inflows increased from an annual average of 6 percent of GDP in the early 2000s to 8½ percent in recent years. - Portfolio investment amounted to 30 percent of GDP in 2014 (based on IIP stock data). - U.S. residents hold nearly half of total portfolio investment assets vis-à-vis Chile, followed by Luxembourg and the United Kingdom (each 10 percent). - Non-residents hold about 5 percent of Chile’s sovereign bonds. - Supervision and institutional arrangements: - The Ministry of Finance (MoF), the Central Bank of Chile (BCCh), and three supervisory agencies (SBIF, SVS, SP) are responsible for financial regulation and supervision. - BCCh conducts twice-a-year top down stress tests focusing on credit and market risk for the banking sector and shares results with supervisory agencies. - Coordination improved through creation of a Financial Stability Council in 2011. - Banking sector characteristics: - Foreign banks account for 35 percent of total banking sector assets in Chile. - Domestic deposits are the main funding source; banks’ reliance on external funding is relatively moderate at 12¼ percent of their total funding needs (up from about 9½ in August 2012). - Bank capitalization and profitability: capitalization is adequate; profitability remained strong in 2014 but declined in 2015 mainly due to a smaller positive impact of inflation. - Pension funds: - Pension funds in Chile have total assets above 70 percent of GDP. - Mandatory contribution is 10 percent of wage or salary to an individual account. - AFPs: today, four are foreign-owned and two are Chilean; assets are managed by international and domestic fund managers with strong focus on EMs. - AFPs have been restructuring portfolios toward riskier, foreign, and/or less liquid assets in response to a low-yield environment. - AFP investment limits: - For each portfolio (A–E) there are limits on “restricted instruments” (non-investment grade fixed income and stocks in markets rated lower than AA). For portfolio A, limit is 20 percent of assets under management. - AFPs cannot invest directly in alternative assets (private equity, real estate) but must invest through a mutual fund. - Two types of foreign investment limits: portfolio-specific limits (e.g., 90 percent of portfolio B can be invested in foreign assets) and an aggregate limit of up to 80 percent of total assets under management abroad. - Actual average foreign share is 45 percent, up from 35 percent at end-2011. *Italic: International Monetary Fund, "FINANCIAL INTEGRATION IN LATIN AMERICA" (selected pages).* ### 47. The insurance sector is the largest sector after banks and pension funds. This ### The insurance sector is the largest sector after banks and pension funds. This ### Insurance sector structure and market features (Chile) - Competitive market with "60 companies". - Life insurance companies represent "90 percent of assets". - Growth has been spurred by the pension system. - In life insurance "about a third of the market share is held by foreign companies". - International companies must be based in Chile to operate domestically, and their risk rating needs to be equal to or above "BBB". - Most insurance companies are part of conglomerates. - At retirement, a retiree chooses either buying an annuity from an assurance company or leaving the money in the pension fund and drawing it monthly; "in most cases, retirees chose the first option and pension funds are converted into annuities." ### Investment constraints, regulation, and portfolio shifts (Chile) - Insurance companies increased allocations in real estate and lower rating domestic and foreign corporate bonds due to the low yield environment. - Foreign investment limits: - Insurance companies cannot invest more than "20 percent of their assets abroad". - Limit of "5 percent for foreign high-yield bonds". - The "20 percent limit" has recently become binding for several life insurers and constrains portfolio management. - A new regulation introduced in "2015" requires insurance companies to define their risk appetite and introduces "own risk and solvency assessment". - A draft law introducing risk-based supervision and risk-based capital requirements for insurance companies is still in Congress. ### Mutual funds and stock market (Chile) - Mutual fund sector share of GDP has "tripled since the early 2000s". - Mutual funds are often affiliates of banks such as Banco de Chile, Santander or BCI. - Investment abroad is relatively low: "about 10 percent of assets under management are foreign (mostly in the US)". - Mutual funds invest mostly in money market funds; the share of bonds is increasing. - Mutual funds are not subject to standardized liquidity requirements but face restrictions on foreign investment depending on the quality of the foreign market’s supervision and regulation. - Market capitalization is around "90 percent of GDP" (as measured by the World Federation of Exchanges). - The 2010 MK III law provisions included: - Exemption of capital gains obtained by foreign institutional investors on the sale or transfer of some securities. - Authorization for representative offices of foreign banks to advertise products or credit services offered by the parent company. - Promotion of local trading of registered foreign securities by allowing denomination in Chilean pesos (payable in an authorized foreign currency or in Chilean pesos). - Stock market liquidity has declined and is relatively low compared to other economies; Chile’s market moved from one of the most liquid to one of the least liquid among EMs since the GFC. - Factors reducing market liquidity include: pension funds as buy-and-hold investors, large conglomerates reducing float, tax incentives favoring debt issuance, and poor corporate governance with informational asymmetries. ### Financial conglomerates (Chile) - Conglomerates comprise "16 systemically important domestic institutions" with assets totaling "125 percent of GDP" as of end-December 2011. - Conglomerates held more than "one-third" of the assets of local pension funds and life insurers, which total some "60 percent of GDP" at end-December 2011. - Sectoral focus among the 16 conglomerates: - Five focus on banking activities. - Four concentrate in the insurance and pension sectors. - Four focus on both banking and insurance sectors. - International integration: out of the 16 conglomerates, two are led by major international banks and four by major international insurance companies. - Four local mixed conglomerates have significant operations in neighboring countries’ financial and non-financial sectors. - Supervision developments: - Supervision currently relies on a sector/silo approach with separate superintendencies for banks, pension funds, and insurance companies. - The Financial Stability Council law strengthened consolidated supervision by: - Removing barriers to information-sharing among supervisors. - Expanding power to request information from final owners of financial institutions within the conglomerate. - Establishing solvency requirements for controlling shareholders of banks and insurance companies. - Supervisors still lack powers to conduct comprehensive group-wide supervision (including setting risk-based minimum prudential standards and monitoring conglomerates’ compliance with exposure limits). - The 2011 FSAP recommended stronger coordination among supervisors and the identification of a group-level supervisor with enhanced powers. ### Colombia: financial system structure and integration - Banking system assets are about "US$200 billion, or 55 percent of GDP" at end-2014. - Nonbank financial intermediaries (largely private pension funds, trust companies and insurance companies) account for another "60 percent of GDP". - Ten large domestic complex conglomerates hold about "80 percent of total financial sector assets". - Banking concentration: - Top 3 banks (Bancolombia, Banco de Bogota, and Davivienda) hold about "50 percent of banking system assets". - Banks extend "90 percent of their commercial loans to 7 percent of borrowers". - Foreign banks hold "24 percent of banking system assets"; regional banks hold "8 percent". - Capital markets: - Capitalization reached "45 percent of GDP" at end-2014. - Non-government fixed income is "4 percent of GDP". - Investor base for government debt comprises mainly domestic investors—banks ("20 percent of GDP"), pension funds ("20 percent of GDP"), insurance companies ("6 percent of GDP") and mutual funds ("5 percent of GDP"). - Foreign investors’ ownership of government debt rose to "14 percent of the total" at end-2014, up from "3 percent" at end-2012. - Authorities intend to raise foreign investors’ participation in the government debt market to "15–20 percent". - Pension and insurance sectors: - Since 2008, assets under pension funds’ management increased by "about half". - The two largest private pension funds, Porvenir and Proteccion, manage "more than 70 percent of industry assets". - Pension funds’ share of foreign assets is still less than half of that in Chile and Peru, but comparable to Mexico, and has been picking up. - Investments abroad by pension funds are about "30 percent of total assets", close to the "40 percent statutory limit for the Conservative Fund". - Insurance sector: premium growth was "24 percent for the life segment, and 4 percent for the non-life segment" in 2012-13. - Premiums per capita are "US$200" and premiums amount to "about 3 percent of GDP". - Insurance sector concentration: the ten largest companies account for "almost 80 percent of the market"; foreign insurance companies are virtually non-existent. - International bank claims on Colombia: - Foreign claims (ultimate risk basis) on Colombia are "US$45 billion (11% of GDP)". - These originate mostly from European banks ("US$21 billion or 46 percent of the total"—of which "US$18 billion are from Spanish banks"), U.S. banks ("US$10 billion or 22 percent of the total"), and Japanese banks. - Most foreign claims are on the non-bank private sector. - Market entry and regional expansion: - High bank concentration (50 percent of assets held by the three largest banks; concentration rises to 65 percent if the largest conglomerate of four banks is included) and conglomerate linkages hinder entry of big foreign players. - Examples of consolidation and acquisitions: GNB Sudameris acquired HSBC’s assets in 2014; Chilean Corpbanca acquired Banco Santander’s business and Helm Bank in 2012–13; Bank Itau is merging with Corpbanca (which will place it 5th in market share). - Colombian financial institutions have significant presence in Central America; assets of Colombian banks’ subsidiaries abroad account for "2 percent of the total assets of the Colombian banking system". - Colombian banks’ market position in Central America is on average "22 percent". - Bank soundness and performance (Colombia): - Regulatory Tier 1 capital to risk-weighted assets: "12.4 percent" (simple average). - Systemic Colombian banks Tier 1 capital: Bancolombia "8.9 percent", Banco de Bogota "7.4 percent", Davivienda "7.1 percent" in 2014. - NPLs by portfolio: consumer "4.8 percent", microfinance "4.5 percent", commercial "1.8 percent", housing "2.5 percent". - Provisions cover "163 percent of total NPLs" (one fifth of provisions come from the countercyclical loan loss provisioning system adopted in 2007). - Return on assets is "3.5 percent". - Return on equity has stayed near "24 percent". - Standard and Poor’s RAC measure indicates Colombian banks have lower capital levels compared to other banks in the LA-7. *International Monetary Fund — FINANCIAL INTEGRATION IN LATIN AMERICA (excerpts).* ### 68. Mexico’s financial system remains ### Mexico’s financial system remains ### Overview - The Mexican financial system remains small relative to its size and the level of economic development, but it continues to expand robustly. - Over the period 2010–14, the Mexican financial system increased on average by 2.5 percentage points of GDP annually, with total assets accounting for about 83% of GDP in 2014. - Much of the growth appears to have been generated by the non-bank financial sector, owing largely to the sustained rise of mutual funds and private pension funds, as non-bank asset accumulation continues to outperform the banking industry. ### Banking Sector: ownership and structure - The banking sector has the highest share of foreign ownership: about 70% of total assets. - Foreign bank ownership by country of origin: - Spain: 37% - USA: 18% - Great Britain (UK): 9% - Canada: 4% - Mexico (domestic ownership share): 31% - Germany: 1% - Switzerland: 0.4% - Japan: 0.3% - Peru: 0.01% - Major banks and market shares: - BBVA Bancomer: about 22 percent of the banking system assets - Santander: about 14 percent of the banking system assets - Citibank’s subsidiary Banamex: 15% market share (component of US banks’ share) - HSBC (UK banks’ majority share): about 8% market share - Total assets of top 10 banks = 86% of total - Banco Azteca is the only Mexican banking entity with subsidiaries in other LA countries, including Panama, Guatemala, Peru, and Brazil. - Operational and funding model: - Foreign banks’ subsidiaries in Mexico largely operate as autonomous financial institutions, mostly funding themselves through the domestic customer base. - Foreign banks historically have maintained operational autonomy from headquarters and have followed a largely domestically financed credit model. - Foreign and domestic banks report sufficient levels of profitability and capitalization, despite Mexican lending and deposit interest spreads being the lowest within LA-7. ### Banking Sector: concentration, entry barriers, and regulatory impacts - Concentration and entry: - Of the 47 commercial banks, the largest 10 account for 86% of the market share; 5 of those 10 are foreign subsidiaries, representing about three quarters of that subgroup’s assets. - High banking sector concentration and high equity prices are often cited as major barriers to entry; reaching a reported minimum market share of 7–10 percent through greenfield investment would be difficult. - Cross-border entry of foreign banks, including regional entrants, is often discouraged by high equity prices. - Expansion of domestic banks into other countries has been limited; few domestic banks possess the necessary size for substantial acquisitions abroad. - Regulatory environment and effects since the GFC: - Changes in regulatory environments of advanced economies, precipitated by the GFC, have led to withdrawal from, or downsizing of, global banks from EMs including Mexico. - Higher capital and other regulatory requirements have increased the cost of doing business and encouraged some global banks to retrench to core/domestic operations. - US authorities’ enhanced enforcement, including exemplary fines for AML/CFT and other US regulations, has contributed to global banks rethinking strategies. - Additional regulatory costs—such as requirements that systemic banks establish minimum loss absorption capacity—may continue this retrenchment. - Specific cross-jurisdictional regulatory frictions: - Mexican deposit insurance is not recognized by US regulators for LCR calculation purposes in the same manner as FDIC insurance, which calls for more liquidity when foreign subsidiaries consolidate with parent jurisdictions. - Basel Standardized approach (used in Mexico) allows zero-risk weight for domestic-currency sovereign debt; the advanced approach (IRB) used in the US requires estimation of risk parameters that lead to positive capital charges on those exposures when global banks consolidate, potentially increasing capital requirements on Mexican government debt. - Higher capital requirements on Mexican government debt may have deeper implications for the Mexican sovereign bond market. ### Pension Funds - Size and growth: - Mexican pension funds represent the second largest segment of the financial system. - Assets under management have more than doubled in size since 2008. - Assets under afores management now constitute about 14% of GDP, and have continued to climb rapidly over the last decade. - Industry structure and concentration: - Number of administrators peaked at 21 at end-2007 and declined to 11 as of mid-2015 due to M&A activity, including foreign acquisitions. - The acquisition of ING Afore in 2012 by Grupo Sura (Colombian) signified the entrance of a regional player; as of mid-2015, Sura Afore held 15% of industry assets and ranked as the third largest pension fund in Mexico. - The three afores managed by US entities constituted about 26% of market share; the remaining 60% of assets were managed by domestic pension funds. - Investment regime and limits: - CONSAR has gradually liberalized the investment regime since 1997, allowing investments in currencies, equities, Mexican private equity funds and real estate trusts, structured assets, swaptions and REITS, and foreign securities. - Regulatory limits on certain types of investments—originally to stimulate financial market deepening and protect contributors—have become binding in some cases, particularly limits on foreign securities. - The tiered-risk model (SB funds) varies limits by contributor’s age, allowing greater risk diversification for younger cohorts (SB4). - Foreign security holdings have long reached the allowed limit; pension funds have outpaced domestic capital market supply, leading to calls to increase the foreign security holding limit, a process complicated by required Congressional approval. - Foreign holdings and diversification: - Foreign asset holdings are largely concentrated in equities, invested mainly in advanced economies and emerging markets outside of LA. - Current shares of debt instrument holdings remain significantly larger than in other OECD countries; domestic holdings of equity remain relatively low. - Holdings of securities from other Latin American markets are reported to be limited (investments in Brazil stalled; Chile, Colombia, Peru limited by market size). - Anticipated increase in foreign security holding limit is expected to be largely used for equity diversification. - Infrastructure and other products: - The investment regime allows afores to invest in infrastructure, housing, and private equity through various vehicles, but supply of infrastructure products has been limited to date. - The anticipated energy reform is likely to promote energy product development in the market. ### Insurance Companies - Market structure and size: - About 200 insurance companies operate in the market, jointly capturing about 2.1 percent of GDP in premia and holding nearly 6 percent of GDP in assets (End-2014 CNSF data). - Insurance penetration remains well below OECD averages and among the lowest in LA. - Product mix: - Life insurance: about 40 percent of the market - Damages insurance: about 19 percent of premia - Auto insurance: 19% of premia (depressed by absence of mandatory third-party motor insurance requirement in many states) - Competition and foreign presence: - Commercial and trade agreements liberalized the industry, allowing foreign subsidiary ownership and resulting in considerable foreign presence. - The insurance market is very open; among the largest 10 institutions (about 70% of the market), 60 percent of premia are captured by foreign-owned entities. - Five largest institutions capturing nearly half of direct premia: MetLife Mexico (US), Grupo Nacional Provincial (domestic), AXA Seguros (France), Seguros Banames (US), and Seguros Banorte Generali (domestic). - Expansion of Mexican insurance companies abroad has been limited due to sizable unrealized domestic potential and elevated market concentration in LA-7 countries. - Investment behavior and regulation: - Financial integration through foreign investment remains limited; investment strategies are largely dictated by product structure rather than regulatory limits. - Insurance companies invest the majority of assets in domestic government securities; domestic equity access is limited by small size and low turnover/liquidity of domestic equity market. - The absence of a mandatory limit on holdings of government securities incentivizes heavy reliance on that sector. - Solvency II-type regulation was implemented in April 2015; Solvency II-type regulation is expected to increase the foreign asset holding limit to 20%, anticipating more foreign asset investments going forward and the rising popularity of non-life insurance products denominated in foreign currency. - Asset-liability and maturity considerations: - Growing importance of life and pension insurance products shifts demand toward longer-term financial assets denominated in local currency (up to 30 years maturity). - The local market can only offer much shorter-duration instruments, creating a maturity mismatch; to avoid currency mismatch, insurers seek Mexican peso-denominated assets, resulting in foreign investments well below regulatory limits. ### Capital Markets and FX - Heterogeneity of development: - Foreign exchange and debt markets have gained volumes and liquidity in recent years; the domestic equity market has stalled due to family-based ownership and informality. - Largest banks and pension funds are the most important domestic institutional investors in sovereign and corporate debt markets. - Mexican peso and FX market activity: - The Mexican peso has been among the ten most traded currencies since 2013, largely against the US dollar and in the form of foreign exchange swaps and spot transactions. - Turnover reached US$135 billion in 2013, raising its market share in global FX trading to 2.5%, from 1.3% in 2010. - The US dollar–Mexican peso currency pair comprises the majority of Mexican peso trading and constitutes about 2.4% of the global FX market transactions. - Since the vast majority of these transactions take place offshore, the Mexican domestic market manages about 0.5% of global foreign exchange market turnover. ### Key statistics and figures (preserved exactly as reported) - Financial system growth: average increase of 2.5 percentage points of GDP annually (2010–14). - Total assets: about 83% of GDP in 2014. - Banking sector foreign ownership: about 70% of total assets. - Foreign bank share by country: Spain (37%), USA (18%), Great Britain (9%), Canada (4%), Mexico (31%), Germany (1%), Switzerland (0.4%), Japan (0.3%), Peru (0.01%). - BBVA Bancomer market share: about 22 percent. - Santander market share: about 14 percent. - Banamex (Citibank subsidiary) market share: 15%. - Top 10 banks’ share: 86% of market; 47 commercial banks in total. - Pension funds assets: about 14% of GDP (assets under afores management). - Number of pension administrators: peak 21 at end-2007; 11 as of mid-2015. - Sura Afore market share as of mid-2015: 15%. - US-managed afores’ share: about 26% of market; domestic pension funds manage 60% of assets. - Insurance sector: about 200 companies; premia capture about 2.1 percent of GDP; assets nearly 6 percent of GDP (End-2014 CNSF data). - Insurance product shares: Life insurance ~40% of market; damages insurance ~19% of premia; auto insurance 19% of premia. - FX turnover: US$135 billion in 2013. - Mexican peso global FX market share: 2.5% in 2013 (up from 1.3% in 2010); US dollar–Mexican peso pair ~2.4% of global FX market transactions; Mexican domestic market manages ~0.5% of global FX turnover. *Source: IMF staff analysis as presented in the chapter.* ### 88. Mexican sovereign debt securities are largely held by institutional investors. ### _030416 - 88. Mexican sovereign debt securities are largely held by institutional investors. ### Sovereign and corporate debt holdings - About 31 percent of government debt bonds were held by foreigners as of May 2015. - Foreign ownership of Mexican government debt: - 31 percent (Mexico, as of May 2015) - 40% (Peru) — Mexico trails Peru but exceeds Brazil and Colombia. - Major foreign institutional investors: US and European funds, and Japanese pension funds. - Corporate debt market: - Foreign currency corporate bond issuances remain an important source of funding for the Mexican corporate sector. - Estimates suggest that Mexico and Brazil jointly accounted for more than half of Latin American issuance of corporate debt in foreign currency in 2014. ### Equity market structure and constraints - La Bolsa Mexicana de Valores (BMV) is shareholder-owned and is the second largest stock exchange in LA, trailing only Brazilian BM&F Bovespa. - Key constraints on equity market development: - Family-owned structure of many Mexican firms. - Level of economic informality. - Alternative sources of funding, particularly in the United States. - Market indicators: - Number of listed companies at end-2014: 147 companies. - The number of listed companies has been stagnant over the last decade and has slowly declined. - Only a few stocks dominate the IPC (Indice de Precios y Cotizaciones), a capitalization weighted index of leading stocks on the Mexican Stock Exchange. ### Interest rate derivatives market activity and structure - Market composition: - Majority of transactions take place through the over-the-counter (OTC) market. - Exchange-traded derivatives share remains limited; traded on MexDer and cleared through CCP ASIGNA (both subsidiaries of BMV). - MexDer’s turnover remains small, with a reported market share in the low single digits. - Reasons OTC remains dominant: - OTC market is more competitive than MexDer, which charges considerable fees. - High foreign presence in Mexican markets and close US ties push derivatives trading to the US, UK, and Europe. - Product mix: - Interest rate swaps, largely TIIE swaps (Tasa de Interes Interbancaria de Equilibrio), represent the majority of trading. - Volume of forward rate agreements, options, and other products remains limited. - Market size and location of trading: - OTC single currency interest rate derivatives turnover in Mexico stood at US$2.4 billion as of April 2013. - This represented about 0.1% of the global interest rate derivatives market. - Mexico is the second largest market in Latin America for OTC single currency interest rate derivatives, trailing only Brazil. - Most OTC single currency interest rate derivatives trading denominated in Mexican pesos occurs in the US markets; only 18% executed domestically. ### Regulatory changes and implementation timeline - Post-GFC regulatory context: - Changes aligned with G-20 frameworks, the Dodd-Frank law (US), EMIR (EU), and Basel III standards aimed to increase transparency and reduce counterparty risk. - New regulations call for standardized OTC derivative contracts to be traded on exchanges or electronic trading platforms and cleared through CCPs; non-centrally cleared contracts face higher capital requirements. - Mexican regulatory implementation: - A new Mexican regulation was introduced with gradual implementation: - April 2016: compliance required for transactions between Mexican entities. - November 2016: start date for transactions involving foreign financial institutions. - The regulation requires derivative trades to take place on exchanges or through inter-dealer brokers and mandates clearance of standardized derivatives through a CCP—Mexican (established in Mexico and authorized by the SHCP) or foreign (if recognized by Banco de Mexico). ### Expected market impact and CCP competition - Anticipated benefits: - More transparency and reduced counterparty risk. - Competition dynamics: - Higher CCP clearance volumes will increase competition between ASIGNA and foreign CCPs (e.g., CME). - ASIGNA’s volume is expected to be driven largely by Mexican pension funds. - Clearance through CME is likely to remain significant given large share of transactions involving multinational institutions headquartered in the US. - Operational considerations for multinationals: - Many counterparties are subsidiaries of foreign entities; clearing through a CCP in the parent country enables consolidation and netting of derivative positions, decreasing capital requirements. - Market segmentation outlook: - ASIGNA may maintain domestic and regional market share (including regional trading through MILA). - Foreign CCPs, such as CME, would largely handle business involving global multinationals. *Italic: Source: _030416 - 88. Mexican sovereign debt securities are largely held by institutional investors.* ### 104. The financial system in Peru is relatively small, ### The financial system in Peru is relatively small, but growing solidly ### Overview and size - Between 2006 and 2014 the broad financial system including insurance and pension funds grew from US$52.3 billion (58.1% of GDP) to US$175.8 billion (90.8% of GDP). - In 2014, the insurance industry collected about US$3.4 billion in premiums and held $11.1 billion in assets (1.8% and 5.8% of GDP respectively). - In 2014, equity markets had a market capitalization of nearly 60% of GDP and 180 listed firms. - Aggregate value of stocks and bonds traded in 2014 was about US$5.8 billion or 3.7 times annual net contributions to pension funds. ### Market structure and foreign participation - Most of the financial system (except for the stock exchange) is under the consolidated purview of the superintendent for banks, insurance and pensions (SBS). - The banking system is assessed to be largely Basel II compliant; SBS reports that Basel III compliance is expected in the next few years. Some larger, particularly foreign owned, banks have already adopted many Basel III principles. - All firms traded on the Bolsa de Lima must file IFRS compliant annual reports to the securities regulator. - Despite a high level of dollar deposits: - Banking system maintains relatively low non-resident asset exposure. - Share of foreign liabilities is rising but is still less than 10% of the system’s balance sheet. - Insurance and pension funds deposits in the banking system still account for 11 percent of total deposits (having declined markedly). - No legal impediments to foreign financial institutions entering, operating or exiting Peru; legal regime provides equal treatment of foreign and domestic entities. Foreign institutions may operate as branches or subsidiaries; currently there are no branch operations of foreign banks. - Within the four largest banks (about 85% of total assets and credit): - Two (Banco del Credito and Interbank) are controlled by domestic conglomerates. - Two are foreign owned institutions. - Historical acquisitions: - BBVA purchased half the controlling interest in Continental bank in 1995 to become the second largest bank by assets. - Scotiabank purchased the operations of two smaller banks in 2006 and is now the fourth largest bank. - SBS reports strong interest from many foreign financial firms to obtain operating licenses; insurance sector has seen many new applications and entrants from abroad. - Potential impediments for foreign investors: - Highly concentrated market structures (dominance of a few firms in banking, brokerage, pension management). - SBS exhaustive documentation of ownership to enforce prohibition against multiple licenses to subsidiaries of same parent may lengthen licensing. - 30% tax on dividend repatriation may weaken foreign incentive to operate in Peru. ### Domestic bank expansion and cross-border opportunities - Divestiture of regional operations by global banks and skills developed by Peruvian banks may present expansionary opportunities: - Banco del Credito del Peru (BCP) already owns the fourth largest private bank in Bolivia and an asset management/insurance company in Chile. - Interbank (fourth largest bank) and parent Intercorp focus on organic growth domestically; Interbank’s retail strength could be leveraged in other countries with high informality. ### Private pension funds (AFPs) - About 5 million adults (out of nearly 20 million aged 15–64) are enrolled in Peru’s private pension fund system. - Formal sector employees are required to contribute 10% of their salaries to funds administered by one of 4 fund managers (AFPs).19 - Under each administrator there are 3 age-determined, risk-tolerant funds: - Funds for youngest workers have highest risk tolerance; funds for those closer to retirement are less aggressive. - Younger participants may elect conservative pools; older subscribers are prohibited from moving into riskier funds. - Upon retirement, AFPs provide a stream of income rather than a lump sum; AFPs have fiduciary responsibility for retirement income proportionate to accumulated savings. - Contributions growth: - Contributions now grow by over US$230 `million each month (US$130 million net of fees and paid benefits). - Supervisory mechanisms and competition: - Supervisors penalize funds that do not yield a minimum level of returns. - Minimum financial returns are determined as the average systemic return less 2% over the previous 36 months. - Fund managers must “top up” returns from their own capital if they fail to meet minimum returns. - AFPs mimic each other’s asset class holdings; competition to attract clients is more marketing-based than returns-based. - All new subscribers are enrolled with the same AFP; every two years SBS solicits proposals where the winner is the lowest proposed management fee. If lower than current rate, the new lower rate is applied to all its subscribers. After initial two years, subscribers are free to move AFPs. ### Investment limitations and regional integration proposals - Rapid growth of assets under management exceeds capacity of domestic capital markets to provide sufficient portfolio securities: - About 180 shares and over 350 bonds listed on the Lima exchange. - Universe of investable domestic securities for pension funds constrained by small cap and infrequently traded listings. - Supervisor has increased limit on foreign asset holdings several times; it now stands at 50 percent20, with regulator currently limiting holdings to 42 percent as effective cap is raised slowly to stem large capital outflows and volatility in on-shore FX market. Limits are effectively binding on nearly all funds. - Calls exist for higher foreign asset limits if implemented gradually to avoid abrupt sales of nuevo soles. - Proposals: - Treat MILA country assets as domestic securities (not count towards foreign asset limit) or create special category for pension fund holdings of MILA country assets. Expected benefits: - Ease demand for domestic assets while promoting regional integration. - Lower cost of access to regional securities, provided costs for hedging cross rates and market risk also come down. ### Insurance market and matching issues - Insurance market characteristics: - In 2014, premiums US$3.4 billion; assets $11.1 billion (1.8% and 5.8% of GDP). - Sector concentrated: 6 of 18 firms account for about 75% of premiums and 72% of assets. - Several foreign firms active through local subsidiaries (Mapfre and Sura among largest foreign subsidiaries), but most insurers domestically owned. - Premiums split roughly evenly: life insurance and property/casualty about US$1.7 billion each. - Most policies are written in nuevo soles; firms generally have fewer foreign holdings than statutory limit of 40% of assets for currency matching reasons. - Challenges: - Insurers reportedly face difficulties finding sufficient long term local currency assets in domestic capital markets to match long term liabilities in life policy segment. - Macroeconomic development leading to higher incomes and greater employment formality expected to drive deeper insurance penetration going forward. ### Capital markets: equities and bonds - Equity markets: - Market capitalization near 60% of GDP in 2014; 180 listed firms. - About 40% of market capitalization tied to firms that primarily trade in New York. - Liquidity concerns: low frequency of IPO issuance, muted share trading volumes, many infrequently traded firms. - 2015 measures: exemptions on capital gains and reforms related to short selling, automated trading, and market makers to encourage higher trading volumes. - Debt markets: - Domestic bond markets significantly smaller than LA-7 counterparts (except Panama and Uruguay) and have low liquidity. - Limited number of long term bonds; money market trading is quite active, especially for corporate issuers. - Only a small number of securitized instruments listed on the BVL; derivative products are not traded domestically. - Table indicators (2014, Lima Exchange): - Equities that trade more than 4 times a day, on average: 33 firms; 132,548 trades; $2,505.1 Mil USD value traded; $62,922 Mil USD market capitalization; 31.0 (% of GDP). - Equities that trade 1 to 4 times a day, on average: 189 firms; 9,602 trades; $380.8 Mil USD value traded; $39,068 Mil USD market capitalization; 19.3 (% of GDP). - Equities that trade once a day or less, on average: 295 firms; 7,733 trades; $961.8 Mil USD value traded; $18,773 Mil USD market capitalization; 9.3 (% of GDP). - BVL total equity market: 180 firms; 147,883 trades; $3,847.7 Mil USD value traded; $120,763 Mil USD market capitalization; 59.6 (% of GDP). - Debt securities outstanding (Total Mil USD): $1,051.3 (Local currency $76.3; Foreign currency $23.7); Number of trades total 3,299 (Local currency 27.5; Foreign currency 127.5). - Continuous market (Mil USD): $343.6 total ($28.9 local; $3.8 foreign); Number of trades 241 (Local 3.3; Foreign 28.0). - Money market (Mil USD): $707.7 total ($47.4 local; $20.0 foreign); Number of trades 2,575 (Local 26.3; Foreign 99.5). ### Regional integration and exchange cooperation - There is scope for the Lima (BVL) and Mexican (BMV) exchanges to lead capital market integration within MILA and the region. - 2013 agreement between the exchanges included BMV attaining an 8 percent ownership stake and a board seat on the BVL and envisioned cooperation on technology and best practices: BVL to share experiences in junior mining and alternative markets; BMV to help BVL establish derivatives and commodities markets. - At end 2014 a new cooperation was signed between the stock market regulators in the two countries.21 - Level of cooperation by exchanges and regulators could be a model for greater harmonization within MILA countries and beyond. *Source: _030416 - 104. The financial system in Peru is relatively small,* ### 119. The absence of private domestic banks in Uruguay, and the lack of focus of the ### _030416 - 119. The absence of private domestic banks in Uruguay, and the lack of focus of the ### Banking structure and regional integration - Scotiabank entered Uruguay in 2011 by acquiring Banco Comercial, the last private domestic bank operating in Uruguay. - Following the 2011 acquisition, Uruguay was left with only foreign private banks, which: - Must abide by parent country regulations and compliance standards that are becoming ever more stringent. - Often operate subsidiaries in various countries in the region as independent entities and are not allowed to pool their capital for projects. - Consequences for cross-border/regional activity: - Foreign assets of the banking system have reduced considerably in the past decade. - Non-resident deposits have shrunk to just 15 percent of total deposits, from 50 percent during the 2002 crisis. - Historically, Banco Comercial and other private domestic banks maintained significant cross-border ties with Brazil and Argentina and non-negligible investments in regional banks; those ties were severed after the Scotiabank acquisition. ### Financial soundness and profitability - Resilience and soundness indicators: - NPL ratios at less than 2 percent of total loans. - Loan-loss provisions on average three times larger than NPLs. - Net foreign exchange positions below 1 percent of capital. - Latest data, as of March, 2015. - Emerging weaknesses and risk factors: - Foreign currency lending to un-hedged borrowers rose from 26 percent of total private sector loans in 2010 to 31 percent in 2014. - Profitability: - Overall banking profitability is low compared to the region, attributed to high levels of deposit dollarization and dollar liquidity, low interest rates on U.S. dollar assets, and high operating costs. - Significant heterogeneity exists between BROU and private banks; BROU enjoys higher profitability aided by its predominant position in the peso market. ### Pension funds and institutional investment - Market structure and size: - Four pension fund managers with collective assets under management amounting to US$11 billion (20 percent of GDP). - The defined-contribution pension system is characterized by two funds (an accumulation fund and a retirement fund). - Ownership and asset distribution: - Republica AFAP (publicly-owned) holds almost two-thirds of pension assets (US$6.2 billion). - Three private AFAPs are regionally-owned: - AFAP SURA from Colombia: US$1.99 billion. - Union Capital, owned by Itau: US$1.82 billion. - AFAP Integracion, owned by the Venezuelan Banco Bandes: US$998 million. - Nearly 80 percent of the pension system’s assets are invested in government bonds and held to maturity due to the small size of Uruguay’s private capital markets. - Regulation and recommendations: - Investment regulations currently permit only 15 percent of assets under management to be invested abroad. - Expanding this limit could diversify portfolios and mitigate crowding of retail investors in domestic market opportunities. - Enhancing regional integration and possibly including a separate investment limit for regional investments could leverage the regional ownership and expertise of the three private AFAPs. ### Insurance market - Size and structure: - Total assets of insurance companies in Uruguay amounted to US$3.2 billion at end-December 2014 (6 percent of total financial system assets, or 5 percent of GDP). - There are 15 insurance companies operating. - The sector is dominated by the state-owned Banco de Seguros del Estado (BSE), which controls 82 percent of the insurance market. ### Capital markets and informal market activity - Market depth and formality: - Total risk capital managed by brokers in Uruguay is projected at about US$5 billion (10 percent of GDP). - Only 5 percent of this goes through the formal Bolsa de Valores. - There is a large informal market with a significant volume of direct placements between securities issuers and the pension funds. - Factors limiting formal market activity: - High brokerage fees make private placements through banks less costly than going through brokers. - Withdrawal of brokerage activities by global banks has dampened formal capital market activity. - Policy implication: - Becoming an integrated member of a regional capital market initiative could be beneficial given the relatively small size of the domestic market, the need for scale, and scope for deepening. *Source: Excerpt from IMF chapter on Uruguay (pages 78–80 of the provided content).* ### 60.459 regulating Decreto-Lei N ### 60.459 regulating Decreto-Lei N ### B. Rules on Cross-Border Investment/Lending/Borrowing (Brazil) - Banks - local asset maintenance requirements: see para. 9. - Domestic banks: counterparty exposure limits do not discriminate against nonresidents. - Single client or group exposure limit: 25% of capital (Resolution 2844/2011, articles 1 and 4). - Total combined large exposure limit: less than 600% of capital. - Exposure limit on exchange rate fluctuations: 30% of capital on a consolidated basis; the central bank is authorized to amend this limit. - Domestic banks may: - Borrow overseas and freely use the proceeds in domestic operations (Resolution 3844/2010, Annex I, article 10). - Take deposits from nonresidents in local or foreign currency; local currency deposits owned by nonresidents must be registered with the central bank and are subject to foreign exchange transaction rules (Resolution 3568/2008, articles 24 and 25). - Only foreigners in transit in Brazil and Brazilians residing overseas are allowed to hold foreign currency deposits (id., article 34). - Insurance firms and pension funds: - In principle not allowed to invest resources abroad, with exceptions including branches/subsidiaries abroad; equity stakes in insurance companies, reinsurers, or pension funds previously authorized by SUSEP; and investments expressly provided by CMN or CVM regulation. - CVM regulations Instrução 554 and 555 (mid- and end-2014; in place since mid-2015) classify insurance firms and open entities as ‘professional investors’ and set foreign investment limits: - unlimited: for funds intended exclusively for professional investors that include the suffix ‘investment abroad’; and for funds intended exclusively for professional investors that establish in their bylaws that a minimum 67% of the liquid capital is to be invested in financial assets abroad. - 40% of liquid assets: for funds intended exclusively for professional investors to which the unlimited exception does not apply. - CVM regulations include limits per issuer and per issuance. - Rules governing/authorizing cross-border provision of banking and financial services: - Foreign banks may lend to resident persons or companies, subject to transaction registration with the central bank (Resolution 3844/2010, Annex II, article 1). Costs and terms must follow those usually observed in international markets (id., article 3). - Foreign banks may invest in instruments and securities negotiated in domestic markets; investors and investments must be registered with the securities commission and the central bank (Resolution 4373/2014, articles 3 and 4). - Foreign banks may take deposits from resident persons or companies provided rules on international money transfers are observed (Resolution 3.568/2008, article 8(1)). - Insurance firms: law permits purchasing insurance policies offered by Brazilian companies (Lei Complementar No 126, de 15 de Janeiro de 2007 Art. 19). - Brazilian residents may buy insurance from foreign firms only under exceptional circumstances (id. Art. 20). Brazilian residents can acquire foreign insurance to cover risks taking place outside of Brazil. ### C. Trade Liberalization and Bilateral Investment Treaties (Brazil) - Multilateral: - Brazil is a member of the Southern Common Market (Mercosul/Mercosur) and a party to the financial services annex to the Montevideo Protocol on Trade in Services. - Annex provides for mutual recognition of prudential measures to protect investors, depositors, policyholders, or ensure solvency and liquidity; recognition may be unilateral, via harmonization, or memoranda of understanding; member states undertake to pursue harmonization in prudential regulation, consolidated supervision, and information exchange. - Brazil’s schedule of commitments includes reservations on market access and national treatment for new branches and subsidiaries of foreign banks. - Bilateral: - As part of Mercosul/Mercosur, Brazil has bilateral FTAs in force with Chile, Bolivia, Peru and Israel, and preferential trade agreements with Uruguay, Argentina, Guyana, Mexico, India, Colombia, Ecuador, Venezuela and Suriname; none make provision for trade in financial services. ### CHILE — A. Prudential Rules on Establishments (Inward and Outward) - Inward: foreign banks may establish branches, subsidiaries, and representative offices upon SBIF authorization (GBL, articles 27-33). Chilean operations of foreign banks enjoy same rights as domestic banks (article 34). - Branches: - Dotation capital and reserves must be paid up in local currency and held in the country. - Resident creditors have priority claim on bank’s assets in the country. - Transfer of liquidity abroad requires SBIF authorization. - Subsidiaries: allowed and subject to same licensing regime as new banks (articles 27-31). - Representative offices: may not engage in banking; only advertise products/services (article 33). - Equity stakes: holding more than 10% in a new or existing Chilean bank requires prior authorization from home supervisor and the home country must permit Chilean supervisor adequate monitoring; an exchange-of-information agreement must be in place (GBL article 29). - Insurance firms - subsidiaries: law organizes insurance firms as “sociedades anónimas”; nothing prevents foreign nationals holding equity stakes (Decreto con fuerza de ley 251 Art. 4). - Pension funds - subsidiaries and equity stakes: pension fund managers must be corporations under national law (Decreto Ley No 3500 de 1980, Art. 23); nothing prevents nonresidents holding shares. - Outward: - Chilean banks may open branches and representative offices abroad with SBIF authorization; may hold participations in foreign banks/corporations upon joint authorization of SBIF and the Central Bank (article 76). - To open abroad, banks must comply with minimum capital requirements, high supervisory rating, demonstrate financial and economic viability; target country must conduct satisfactory supervision; shareholders owning 10%+ must comply with solvency and integrity requirement (GBL, article 77). - Capital of a branch abroad must be no less than 3% of the bank’s total assets (article 81 No2, Chapter 11-7, III, 3,a) of SBIF Instructions RAN). - A bank may invest up to 40% of its capital in authorized companies in any one country (article 80). - Total investments in foreign companies plus other authorized investments may not exceed paid-up capital plus reserves (article 69). - Domestic bank required to ensure subsidiaries/branches abroad and companies it invests in observe related party exposure limits and limits on loans to residents of Chile (article 80). - Banks — limits and permissible operations: - Related-party exposure: total claims against a related foreign bank and subsidiaries may not exceed 25% of the foreign bank’s capital (GBL, article 80). - Permissible investments: only assets classified by Central Bank of Chile as financial instruments, including foreign government/central bank bonds, bonds by foreign companies, structured notes (art. 83, Chapter 12-15 RAN, Chapter III.B.5 Central Bank’s Rules “Compendio de Normas Financieras”). - Sovereign and third-party exposure: up to 30% or 50% of capital, respectively, in foreign bank deposits or government bonds (id.). - Permissible lending operations: credit operations for trade purposes with foreign subsidiaries/branches of domestic companies, or individuals/companies domiciled abroad (art. 83, Chapter 12-15 RAN, Chapter III.B.5). - Insurance firms: - Cross-border provision: Chile restricts foreign insurers to offer policies related to trade and satellites; Chilean residents may acquire any kind of insurance policy abroad (Decreto con fuerza de ley 251 Art. 4). - Investments in financial assets abroad: admissible instruments include debt securities; deposits, bonds, promissory notes issued by foreign financial institutions, companies or corporations; shares of foreign companies; shares in foreign mutual/investment funds; shares in Chilean mutual/investment funds with investments abroad; real estate abroad (id, Art. 21 3). - Global limit for foreign investments: 20%. - 5% limit for debt securities, deposits, bonds, promissory notes and other debt securities issued by foreign financial institutions with rating under BBB or N-3. - 10% limit for shares of foreign companies, shares in foreign mutual/investment funds and shares in Chilean mutual/investment funds with investments abroad. - 3% limit for real estate located abroad. - Superintendence of Securities and Insurance may establish limits per issuance (id. Art 24). - Pension funds: - Pension fund managers may delegate asset management to corporations organized under Chilean law exclusively for pension resource management (Decreto Ley No 3500 de 1980, Art. 23bis); no limitation for nonresidents to establish or participate as shareholders. - Admissible foreign instruments include debt securities issued/guaranteed by foreign states, banks, foreign central/international banks; municipal/regional negotiable securities; negotiable securities issued by foreign banks; debt securities secured by foreign banks; bonds and commercial paper by foreign companies; short-term deposits in foreign banks; shares of companies and foreign banks; shares of foreign mutual and investment funds (Decreto Ley No 3500, Art. 45 j). - Central Bank set an 80% global limit for investments in foreign assets and fund-specific limits ranging from 90% for the riskier fund to 35% for the most conservative fund (Acuerdo N° 1680-03-120517 - Circular N° 3013-699 B.2). - Trade liberalization: - Multilateral: Chile is party to Pacific Alliance, MERCOSUR, FTAs with Central America, EFTA, EU, and the TPP (includes financial services chapter). Pacific Alliance and EU agreements include chapters on financial services with prudential recognition and carve-outs. - Pacific Alliance reservation: only foreign banks allowed to establish branches; other foreign financial institutions restricted to subsidiaries or acquisition of equity stakes. - Bilateral: numerous FTAs; only those with Hong Kong, Australia, Japan and the United States include chapters on financial services. TPP contains provisions on cross-border trade of financial services permitting residents to purchase financial services from cross-border suppliers located in another Party. ### COLOMBIA — A. Prudential Rules on Establishments (Inward and Outward) - Inward: - Banks and insurance firms: subsidiaries and branches explicitly authorized; banks and reinsurance firms may establish representative offices. - Subsidiaries: establishment may be conditioned on consolidated supervision on the foreign parent and consent of the home supervisor (Art. 53.3.f EOSF). - Branches: - Licensing focuses on branch circumstances; no specific Colombia-style legal form imposed (Art. 53.1 in fine EOSF). - Full payment of dotation capital required, converted into pesos and held in Colombia (Art. 45A, third para. EOSF). - Dotation capital guarantees creditors of the branch; creditors residing in Colombia preferred (Art. 45B.2 EOSF). - Governance: fit and proper requirements apply (Art. 45B.3 EOSF); no nationality requirement. - Opening of branches governed by Commercial Code (Art. 469 et seq.); nationality requirement in Commercial Code applies to public service/national security sectors, not financial sector. - Representative offices: approval required; activities limited to liaison, administrative promotion, promoting parent activities, and collection agency functions (Art. 94 EOSF; Decree 2555 of 2010 Art. 4.1.1.1.6 et seq). - Acquisition of equity stakes: acquisition by foreign banks/insurers of equity in Colombian banks/insurers is authorized (Art. 91 EOSF); acquisition >10% requires Supervisor approval and assessment of investor suitability (Art. 88 EOSF; Art. 91.1). - ECF and registration: acquisitions subject to ECF and must be registered with Central Bank (Decree Nr. 1068 Art. 2.17.2.3.1.1., 1st para.). - Pension funds: - Management by trusts (sociedades fiduciarias) and insurance companies (Art. 168 EOSF); pension fund management companies must be corporations ‘sociedades anónimas’ or cooperatives (Decree 656/94 Art. 1); credit institutions and insurance companies can participate in any proportion (Decree 656/94 Art.3). - Outward: - Colombian banks and insurers may invest in branches and agencies abroad (Art. 92, 3rd para. EOSF); may open branches/subsidiaries abroad subject to host-country laws and Supervisor approval (Art. 2.17.2.4.4.1 Decree 1068 of 2015). - Domestic banks and insurance companies can invest in foreign branches with Supervisor’s prior authorization and in compliance with exchange regulations (Instrucciones Aplicables a las Entidades Vigiladas Chapter V and Title II Part I). ### B. Rules on Cross-Border Investment/Lending/Borrowing (Colombia) - Banks: - Banks can buy, own or sell bonds or other interest-bearing liabilities issued by national government, foreign governments or railway and industrial companies. - Global large exposure limit for foreign or company-issued instruments: 10% of commercial banks’ paid up capital and reserves (Art. 9 b EOSF). - Capital investments in foreign financial, securities and insurance sectors permitted subject to Superintendence approval (Art. 326 2) EOSF; Art. 2.17.2.4.4.1 Decree 1068/2015). - Insurance companies: - Minimum technical reserves requirement: 40% must be backed by securities issued/guaranteed by Colombian Government or Central Bank, or other high liquidity/security/profitability securities. - Remaining 60% admissible investments mainly national assets; government may authorize other investments (art. 187 EOSF). - Decree 2555/2010 establishes investment criteria and limits; a 40% global investment limit to the value of the portfolio backing technical provisions on foreign financial assets and demand deposits in foreign banks (Article 2.31.3.1.2 and Decree 2555/2010). - Pension funds: - Decree 2555/2010 defines Conservative, Moderate and High Yield funds (Article 2.6.12.1.1). - Foreign financial assets and demand deposits in foreign banks are admissible (Article 2.6.12.1.2). - Global investment limits on foreign financial assets by fund type: - 40% for the Conservative fund and the Special Scheduled Retirement Fund. - 60% for the Moderate fund. - 70% for the High Yield fund. - Concentration limits: - Exposure to the same entity/issuer cannot exceed 10% of the value of each type of mandatory pension funds (Article 2.6.12.1.12). - Acquisition of more than 30% of total value of all mandatory pension funds in a given issuance is not allowed, except for debt securities issued/guaranteed by Colombian government or Central Bank. - Local asset maintenance requirements: - Foreign banks and insurance companies established in Colombia must have allocated capital permanently backed by assets located in Colombia (Article 2.36.12.2.2 Decree 2555/2010). - Cross-border provision rules: - EOSF allows domestic banks to borrow within the country and abroad (EOSF Art. 7.1.i). - Colombian residents may borrow from and lend in foreign currency to non-residents; loans from non-residents cannot be granted by individuals (R.E. 8/2000 Article 24). - Disbursement of loans in foreign currency obtained by residents requires a deposit with the Central Bank as determined by Board of Directors (currently 0% - R.E. 8/2000 Article 83); exemptions include loans to finance Colombian investments abroad, personal expenses via international credit cards, concessional loans with aid components, etc. - Colombian residents lending foreign currency to non-residents are exempt from deposit requirement but must inform the Central Bank (R.E. 8/2000 Article 26). - EOSF authorizes any natural/legal person residing in Colombia to acquire abroad any type of insurance, with exceptions for social security, mandatory insurance, insurance requiring prior mandatory insurance, and insurance where policyholder/insured/beneficiary is a State entity (EOSF Art. 39 Par. 2). ### C. Trade Liberalization and Bilateral Investment Treaties (Colombia) - Multilateral: - Colombia has signed FTAs: Northern Triangle, EFTA, EU, Pacific Alliance. All but the Northern Triangle include sections/chapters on financial services: EFTA (Annex XVI), EU (chapter 5, section 5), PA (Chapter 11). - Financial services chapters typically include prudential recognition, carve-out provisions, national treatment, right of establishment, and rules for cross-border trade in financial services. - FTAs provided for opening of branches of foreign banks and insurance companies as an exception to pre-2009 prohibition on branching. - FTAs contain reservations, including on dotation capital for banking and insurance branches. - Bilateral: - Bilateral FTAs with Mexico, Chile, Canada, U.S., Panamá (signed not in force), Israel (signed not in force), Costa Rica (signed not in force) and Korea (signed not in force). All include financial services chapters except Korea; financial services chapter with Chile under negotiation. - Colombia has one BIT in force with a Latin American country: Peru (entered into force 2010) containing standard provisions including national treatment and most favored nation. - Salient elements: - Prudential carve-out provision allowing reasonable measures for prudential purposes to protect depositors, investors, participants, policy holders; maintain solvency, financial integrity and responsibility of financial institutions; guarantee financial integrity and stability. - Provision removing barriers related to nationality or residency requirements for management positions. ### MEXICO — A. Prudential Rules on Establishments (Inward) - Inward: - Mexican law explicitly authorizes establishment of subsidiaries and representative offices in Mexico of foreign financial institutions. - Mexican legal framework does not allow establishment of branches of foreign banks. *Source: 60.459 regulating Decreto-Lei N o 73; Decreto No. 81.402 — FINANCIAL INTEGRATION IN LATIN AMERICA, INTERNATIONAL MONETARY FUND* ### Annex 1 establishes that national treatment will not apply and Colombia can grant exclusive rights or preferential ### _030416 - Annex 1 establishes that national treatment will not apply and Colombia can grant exclusive rights or preferential ### Colombia — Annex 1 key provision - Annex 1 establishes that national treatment will not apply and Colombia can grant exclusive rights or preferential treatment to public entities including the National Guarantee Fund, the Fund for Financing the Agricultural Sector (Finagro); Trade Bank (BANCOLDEX). - Such advantages/preferential treatment will include: - tax exemption, - purchase of securities issued by the Colombian Government, - exemptions to registry and periodic reporting requirements related to issuance of securities. ### Mexico — Establishment and corporate forms - Subsidiaries - Foreign financial institutions can establish banks and insurance firms as subsidiaries in Mexico, subject to specified conditions, in accordance to the Law of Credit Institutions (LCI) and the Law of Insurance Institutions (LII). - Only a foreign financial institution established in a country with which Mexico has entered into a treaty or agreement allowing for the establishment of subsidiaries can establish one in Mexican territory (Article 45-A of the LCI). - Subsidiaries are subject to the treaties/agreements allowing their establishment, the LCI, and rules set by the Ministry of Finance in consultation with the Central Bank and the National Banking and Securities Commission (Articles 45-B and 45-N). - To establish a subsidiary, authorization from the Mexican supervisor is required after obtaining an opinion from the Central Bank (Article 45-C). - The law requires that the foreign financial institution must at least own 51% of the capital stock of the subsidiary (Article 45-G). - Capital of subsidiaries is integrated by shares of series “F”. Series “F” shares can only be acquired directly or indirectly by a foreign financial institution and will represent no less than 51% of the capital. The remaining 49% can be acquired by either or both series “F” and “B”. “B” Series are treated like ordinary shares and can be freely subscribed. - Subsidiaries must conduct the same type of operations in the home country as those the subsidiary is authorized to perform in Mexico, with an exclusion for subsidiaries integrated in a financial conglomerate controlled through a holding company authorized in Mexico (Article 45-E). - Subsidiaries are allowed to conduct the same operations as domestic banking institutions unless the applicable agreement or treaty establishes otherwise (Article 45-D). - No nationality requirements for executive board and directors, but the majority of executive board members and all general directors must reside in Mexico (Articles 45-K and L). - Rules for establishment (DOF 31/12/2014) require license applications to describe home-country activities, contributions to economic development, and benefits to the Mexican economy. - Insurance companies - Same rules apply as for banks (See LII Articles 74-85). - Pension funds - Law on Retirement Savings Systems (Article 20) requires pension fund management companies to be incorporated as ‘corporations’. - In establishing subsidiaries by foreign financial institutions, the Law refers to applicable international agreements (Article 21). - Foreign financial firms must at least own 51% of the capital of the subsidiary. - Representative offices - With supervisor approval, representative offices can be opened in Mexico; activities are limited to providing clients information regarding operations in the home country (Article 7). - Equity stakes - Mexican law authorizes acquisition by foreign banks of equity stakes in Mexican banks and the establishment of a de novo bank wholly owned by foreign investors (Article 8 of the LCI in relation with article 17). - Capital of domestic banks is represented by two classes of shares which can be freely subscribed. - If acquisition/transfer of ordinary shares exceeds 2% of paid capital, notice to the National Banking and Securities Commission is required (Article 14). - Acquisition of paid capital above 5% requires authorization from the Commission after hearing the Central Bank’s favorable opinion; same for acquisition/transfer of 20% of ordinary shares or to obtain control (Article 17). - Outward activities - Mexican banks can open branches and subsidiaries abroad with supervisor authorization. - Foreign branches can, with Ministry of Finance authorization, carry out operations not provided for in Mexican legislation to adapt to host country conditions (Article 87 of the LCI). - Credit institutions can invest directly or indirectly in foreign financial entities with prior supervisor authorization. - When a Mexican credit institution owns more than 51% of paid capital or controls a foreign credit institution, it must ensure the latter complies with applicable foreign law and Mexican financial authorities’ regulations (Article 89). - Mexican insurance companies can open branches or offices abroad with supervisor authorization (Article 194 of the LII); no specific provision on establishment of subsidiaries abroad. ### Mexico — Cross-border investment, lending, borrowing - Banks - For Liquidity Coverage Ratio calculations, Mexican regulations include among eligible assets bonds issued by foreign governments and foreign non-financial firms subject to credit rating requirements (Disposiciones... DOF 31/12/2014). - Insurance companies - Under the LII, insurance companies can invest in financial assets abroad subject to legal framework guidelines and companies’ investment commissions (Article 247). - Pension funds - Recent regulation (DOF 29/05/2014) identifies fund types based on workers’ age and sets global limits: pension funds can invest up to 20% of their assets in foreign securities. - Annexes establish credit rating requirements and limits per issuer and per issuance for risk diversification. - Cross-border provision rules - Mexican rules allow domestic institutions to borrow from and lend money to foreign residents. - Mexican law prohibits residents acquiring abroad certain types of insurance (Article 21 LII), with exceptions where the National Insurance Commission might authorize contracts with foreign insurers for specific cases (risks occurring only abroad; lack of domestic coverage). ### Mexico — Trade liberalization and BITs - Mexico has entered into multilateral and bilateral FTAs with Bolivia, Central America, Chile, Colombia, EFTA, EU, Japan, NAFTA, Pacific Alliance, Panama, Peru and Uruguay. - Many agreements (EU, NAFTA, Pacific Alliance, Colombia, Guatemala, Honduras, El Salvador, Nicaragua, Peru and Panama) include a financial services chapter with a “right of establishment” clause. - Mexico has signed numerous Bilateral Investment Treaties (BITs) covering all types of investments; these do not include explicit provisions related to financial services but financial services sector has been interpreted as covered. ### Panama — Prudential rules on establishments (Inward) - General - Panama law explicitly authorizes establishment of subsidiaries, branches and representative offices of foreign banks; specific licensing procedure exists (Art. 10 and 12 Regulation No. 3-2001). - Consent (or no objection) of the home supervisor is required for subsidiaries, branches, and representative offices (Art. 43 Banking Law). - Subsidiaries and branches are subject to local asset maintenance requirements (Art. 78 BL). - Licenses for subsidiaries and branches whose capital is represented by bearer shares are prohibited (Art. 6 Regulation No. 3-2001). - Subsidiaries - Foreign banks can establish subsidiaries conditioned on existence of consolidated supervision on the foreign parent (Art. 62 BL). - Capital of the subsidiary must be additional to the capital of the foreign parent; it may not be part of it (Art. 10.i in fine Regulation No. 3-2001). - A “general interest” test exists: license can be refused if “the bank does not contribute to Panama’s economy” (Art. 48.3 BL). - Supervisor can make licensing subject to “any criterion it deems pertinent” (Art. 48.5 BL). - Third parties can object to granting the license based on “circumstances that make it inconvenient to establish a new bank in Panama” (Art. 51, 2nd BL). - Branches - Branches require the same dotation capital as the minimum capital for local banks (Art. 10.i Regulation No. 3-2001). - Dotation capital guarantees local creditors in case of insolvency; creditors of the Panama branch are preferred over creditors of the foreign parent (Art. 221 BL). - CAR is not applied separately on the branch; the parent must certify yearly the compliance of the parent’s consolidated CAR with the home country’s requirements (Art. 18 Regulation no. 001-2015). - Supervisor can rely on the parent complying with sound corporate governance principles; in absence, Panama’s framework can be applied (Regulation No. 005-2011). - Representative offices - With supervisor approval, representative offices can be opened but they cannot exercise banking business in Panama or from Panama (Art. 13 Regulation No. 3-2001). - Equity stakes - Law authorizes and regulates acquisition by foreign banks of equity stakes in Panamanian banks (Art. 16.I.7 BL and Regulation No. 1-2004). - Acquisition of more than 25% in a bank requires supervisor approval, which will assess investor suitability; the regulation contemplates foreign acquirers and requires home supervisor approval (Art. 7.22). - Supervisory approval can be withheld when the “Supervisor determines this is not useful for the banking center” (Art. 14.10). - Outward - Panama’s regulation includes framework for Panamanian banks acquiring/opening foreign subsidiaries and branches (Regulation No. 4-2002). - Subsidiaries of Panamanian banks must comply with Panamanian capital adequacy rules (Art. 2). - Panamanian banks require supervisor authorization before acquiring any amount of shares in any foreign financial institution. ### Panama — Cross-border investment, lending, borrowing and local asset maintenance - Local asset maintenance - Banking law (Art. 78) requires banks to maintain assets in the country equivalent to a percentage of local deposits determined by supervisors; percentage cannot exceed 100% of local deposits. - Local financial firms’ investments abroad - Banks - No general rule for admissible investments, but law covers investments for liquidity ratio compliance. - Banks, subsidiaries, and domestic branches must maintain at all times a minimum net balance of liquid assets equivalent to the percentage of gross total deposits established by the supervisor; percentage cannot exceed 35% (Article 73). - Supervisor’s Regulation 004-2008 established such percentage at 30%. - Banking Law explicitly excludes deposits of a foreign parent bank, foreign subsidiary, foreign branch, and foreign affiliate from the calculation. - Liquid assets include securities issued by foreign countries authorized by the supervisor; securities of foreign private companies authorized by the supervisor; net balances in banks abroad payable on demand or term with maturity not exceeding 186 days and authorized by the supervisor. - Supervisor’s Regulation 004-2008 establishes rating requirements for these instruments. - Supervisor may authorize other assets (Article 75 BL). Regulation (“Acuerdo”) 002-2011 defines other authorized assets and requirements, including securities from foreign private companies if they comply with international rating requirements, payable in US dollars or a freely convertible and transferable currency, and subject to periodic quotes in an organized securities market. Up to 50% of the minimum liquidity index can consist of these securities. - Foreign banks will be considered acceptable if they have a long-term international rating of not less than BBB-/Baa3; or a short-term international rating of not less than A-3/P-3. - Supervisor establishes maximum acceptable percentages of securities issued by a foreign government according to risk: AAA+- BBB-, 100%; BB+, 50%; BB, 40%; BB-, 20%; B+ 10%; and B 5%. - Regulation includes minimum rating requirements for securities issued by foreign private and governmental agencies. - Insurance companies - Insurance law (Ley 12 de 3 de abril de 2012) requires insurance companies to build and maintain in Panama a reserve fund of 20% of the company’s net profits to establish a fund of two million balboas, and thereafter of 10% to reach 50% of the paid capital (Article 213 IL). - Admitted assets must be composed of easily realizable investments (Article 214 IL). - Law requires that a minimum of 50% be invested in local assets (credit instruments guaranteed by the national government; credit instruments issued by banks with a general license; or legal entities registered by the securities market supervisor). - Supervisor has discretion to approve other investments based on a technical study showing financial health and observance of diversification and risk management. - Pension funds - Legal framework (Ley 10 de 1993) requires pension fund managers to have at least a basic fund complying with law rules. - Maximum of 15% of fund resources can be invested in credit instruments issued or guaranteed by foreign states, provided they have a credit rating similar or higher than Panama’s. - Pension funds may invest up to a maximum of 15% in credit or capital instruments issued by foreign legal entities authorized for public offering by foreign supervisors recognized by the securities market superintendence; or bank deposits in banks from jurisdictions recognized by the securities market superintendence (Article 8). - Pension fund managers can create funds different from the basic fund with different risk profiles; these funds must invest in assets mandated by law but are not subject to limits for the basic fund (Article 8-A). ### Panama — Cross-border provision of services and trade liberalization - Cross-border provision rules - Banks - Regime does not differentiate between foreign residents and citizens for borrowing/lending. - Insurance companies - IL generally requires residents to purchase insurance policies for assets and persons located in Panama only from companies authorized to operate in Panama. - Superintendency can authorize contracts with foreign companies when authorized by international treaty; when policies offered do not exist in Panama; and when impossible to obtain coverage in Panama. - Residents obtaining such authorizations must register them with the Superintendence (Article 153 IL). - Pension funds - Law does not contain provisions related to the cross-border activities of pension funds. - Trade liberalization - Panama has subscribed multilateral FTAs with EFTA and the EU. *Source: _030416 - Annex 1 establishes that national treatment will not apply and Colombia can grant exclusive rights or preferential* ### annex on financial services ### annex on financial services ### Trade agreements, FTAs, and BITs — general findings - Many FTAs include chapters on financial services containing standard provisions such as national treatment, most favored nation, prudential carve-out and prudential recognition, and provisions for the expeditious treatment of license application procedures. - Most FTAs create a Financial Services Committee in charge of the application of the agreement. - Panama BITs: Argentina, Canada, Chile, Czech Republic, Dominican Republic, Germany, France, Korea, Mexico, Netherlands, Spain, Switzerland, Ukraine, U.K., U.S. and Uruguay. Only the BIT with Canada has a section covering investments in financial services that includes a prudential carve-out provision. - From Peru’s FTAs: Pacific Alliance, the EU, Japan, EFTA, Costa Rica, Mexico, Panama, Canada, Chile, the U.S., MERCOSUR, Thailand, South Korea, China, and Singapore. With the exception of EFTA, MERCOSUR, Chile, Thailand, China and Singapore, these agreements include a chapter on financial services. - From Peru’s BITs: only two BITs include provisions related to the financial sector. The BIT with Canada contains provisions related to prudential measures by financial authorities. The BIT with Colombia includes provisions related to financial services. - Salient BIT elements (Peru): - Prudential carve-out provision to allow reasonable measures for prudential purposes to protect depositors, investors, participants in the financial markets, and policy holders; to maintain solvency, financial integrity and responsibility of financial institutions; and to guarantee financial integrity and stability. - Provision removing barriers related to nationality or residency requirements for management positions. ### PERU — A. Prudential rules on establishments (Inward / Outward) - Inward — Banks and Insurance Firms: - Peruvian law authorizes the establishment of subsidiaries, branches and representative offices in Peru of foreign banks and insurance firms; foreign investment in financial firms receives same treatment as domestic investment (Article 5 Banking and Insurance Law). - Subsidiaries—Foreign financial firms can establish subsidiaries in Peru (Article 34-37). - Branches—Prior authorization of the Superintendency of Banks, Insurance and Pension Funds required for establishment of branches of banks and insurance companies. For financial companies, the supervisor must request the opinion of the Central Bank (Article 39 BIL). - Dotation capital: Peruvian law requires full (i.e., same amount of minimum capital of Peruvian banks) payment of dotation capital, which must be held in Peru (Article 42 BIL). Dotation capital guarantees creditors in case of insolvency; creditors of the branch residing in Peru are preferred over other creditors (Article 39 in fine of BIL). - Governance: No nationality requirement for branch representatives in Peru (article 39a of BIL). - Representative Offices—With Supervisor approval, representative offices can be opened; activities limited to promote services with purpose mainly to facilitate trade and provide external financing (article 45-46 of BIL). - Equity Stakes—Acquisition by foreign banks and insurers of equity stakes in Peruvian banks and insurers is authorized and subject to same limitations as Peruvian banks and insurers. Acquisition of more than 10% in a supervised entity requires Supervisor approval (article 57 BIL). - Pension Funds (Inward): - Establishment of pension funds management companies under national law as corporations – sociedades anónimas (Texto Único Ordenado de la Ley del SPP, Art. 13). - Acquisition by foreign legal persons of equity stakes in Peruvian pension funds requires the pension fund management company to notify the Superintendency whenever there is change in ownership involving a foreign legal person; notification must include names of individual shareholders of the foreign legal person (Texto Único Ordenado de la Ley del SPP, Art.13 A). - Outward — Banks and Insurance Firms: - Peruvian banks and insurers can open branches and subsidiaries abroad subject to formal and prior approval by the Supervisor (article 30 BIL). - They can acquire equity stakes in foreign banks and other foreign institutions. If such acquisition is of more than 3% of the assets of the acquired entity, supervisor’s approval required (article 221.13 BIL). - Outward — Pension Funds: - No provision in the legal framework regarding establishment of subsidiaries of Peruvian pension fund management companies abroad. ### PERU — B. Rules on cross-border investment/lending/borrowing - Local asset maintenance requirements of foreign firms: - Branches of banks and insurance companies are subject to asset maintenance requirements in Peru: amount of assets to be held is the same as the minimum capital required for domestic banks (article 42 BIL). - Local financial firms investment in financial assets abroad: - Permitted operations: derivatives; purchasing, selling and maintaining foreign debt securities; purchasing, selling and maintaining bonds issued by multilateral credit institutions (article 221 BIL). - Global investment limits exist and the Superintendency can set additional global limits for prudential reasons (article 200 BIL). - Individual limits guidelines based on risk diversification (article 203 BIL). - Investments in legal persons abroad (excluding other financial entities) limited to up to 5% of the Peruvian financial entity’s assets (Article 211 BIL). The law allows such limit to be increased to up to 30% under certain conditions, such as granting of guarantees. - Pension Funds: - Permitted foreign instruments include financial instruments issued or guaranteed by foreign governments and central banks; shares and securities representing rights to shares; debt instruments; participation shares in mutual funds and hedge operations issued by foreign institutions (Id. Art 25). - Global investment limit of 50% of the value of the pension fund for these instruments, but the Central Bank of Peru can set a different operational limit (Id. Art 25 D). - Rules governing/authorizing cross-border provision of banking and financial services: - Domestic institutions can establish branches abroad and borrow/lend money to foreign residents. - Domestic banks may lend and borrow within the country and abroad (BIL article 221). - BIL authorizes domestic financial institutions to provide credit to financial institutions abroad but subject to limits related to similarity of supervisory regimes (BIL article 205). - BIL authorizes any person residing in Peru to acquire abroad any type of insurance/reinsurance (BIL article 10). - Insurance companies or insurance services suppliers domiciled in a territory of a Party that has an international agreement signed with Peru which allows the cross-border supply of, or trade in, financial services (30th Final and Complementary Disposition BIL) may supply in Peru certain services as provided for in the BIL. These services are: - (a) insurance of risks related to: - (i) maritime shipping and commercial aviation and space launching and freight (including satellites), covering goods being transported, the vehicle transporting the goods, and any liability arising therefrom; - (ii) goods in international transit; - (b) reinsurance and retrocession; - (c) consultancy, actuarial, risk assessment, and claim settlement services; - (d) insurance intermediation, such as agency and brokerage, as referred in (i) and (ii). ### PERU — C. Trade liberalization and bilateral investment treaties (summary) - FTAs typically include prudential recognition and carve-out provisions allowing parties to adopt or maintain measures for prudential reasons to protect investors, depositors, policy-holders; or to ensure integrity and stability of the financial system; and provide for effective and transparent regulation. - Many FTAs contain reservations on market access and national treatment. - A recurring non-conforming measure: preferential treatment of Peruvian residents regarding assets located in Peru of a branch of a foreign financial services supplier in case of liquidation; limitations on assignation of capital located in Peru. ### URUGUAY — A. Prudential rules on establishments (Inward / Outward) - Inward — Banks: - Foreign banks allowed to set up subsidiaries and branches provided by-laws or policies do not bar Uruguayan citizens from serving as directors, managers or employees (Decree-Law 15322/1982, article 8). - Banks must be established as corporations; branches of foreign banks are exempt from such requirement (id., article 17). - Dotation capital required for branches; amount assigned to branches must be indicated in license application (RNRCSF, article 18). Amount of dotation capital identical to minimum capital requirement for local banks (articles 21 and 159 RNRCSF). - In case of insolvency or liquidation of a branch, Uruguayan banking does not impose “ring-fencing” of local assets to satisfy local liabilities. - Foreign banks may open representative offices to promote business (id., article 113); representative offices cannot carry out financial activities. Foreign banks must comply with minimum risk rating requirements to open a representative office, except Mercosur countries (id., article 115). - Inward — Insurance Companies: - Foreign insurance companies underwriting risks arising in Uruguay must establish locally as corporations and secure government authorization (Law 16426/1993, article 2). Exception: issuance of policies against risks from international transportation and trade. - Foreign residents, including financial institutions, allowed to hold equity stakes in or control insurance companies in Uruguay (RNSR, articles 4 and 6). - Foreign nationals and residents authorized to serve as directors or managers of insurance companies (id., article 4). - Inward — Pension Funds: - Foreign residents, including financial institutions, effectively permitted to hold equity stakes in or control pension fund managers. Permission found in provisions requiring home country of foreign controlling institutions be FATF member and home supervisors exercise consolidated supervision (RNCFP, article 1). License applicants must provide information on foreign shareholders (id., article 3). - Foreign nationals and residents allowed to serve as directors or managers of pension fund managers; submission of information on candidates from third countries required (id., article 4). - Outward — Banks: - Domestic banks must request authorization from the supervisor to open branches abroad (RNRCSF, article 29) and demonstrate branch viability. - Legal framework does not provide explicit regime for local banks to set up subsidiaries or representative offices abroad. - Outward — Pension Fund Managers, Insurance Companies and Securities Firms: - No explicit regime for these entities to set up subsidiaries, branches or representative offices abroad. ### URUGUAY — B. Rules on cross-border investment/lending/borrowing - Inward: - No explicit regime governing local operations of foreign banks, pension fund managers, insurance companies, and securities firms, except requirement that foreign insurance companies establish locally to underwrite policies for risks arising in Uruguay (Law 16426/1993, article 2). - Outward — Banks: - Deposits: Local banks may open savings accounts for nonresidents (RNRCSF, article 311.1). - External financial institution (EFI): A deposit-taking institution allowed to transact exclusively with nonresidents and carry out operations involving securities and money located abroad (id., article 12). - Other liabilities: Banks may issue certificates of deposit, negotiable instruments and mortgage-backed securities to nonresidents (id., articles 289.1 to 298.20). - Assets: Banks may not invest in shares, bonds and other financial instruments issued by private companies (Decree-Law 15322/1982, article 18). Exception: banks may invest in shares of foreign financial institutions upon authorization; may hold shares in pension and mutual funds and acquire publicly offered securities (Law 16713/1995, article 92; Law 16774/1996, article 5; Law 18627/2009, article 47). - Regulation allows banks to invest in negotiable instruments and mortgage-backed securities issued by nonresidents (RNRCSF, article 286), as well as in shares of banks established abroad and EFIs (id., article 252). - Local asset maintenance requirement: Banks must hold assets located in Uruguay or claims against residents in an amount at least equal to their minimum capital requirements (id., article 199). - EFIs must hold at least US$ 500,000 in local assets, deposited at the Central Bank (id., article 221). - Exposure limits: - A bank may hold investments in foreign countries in amounts varying from one time to 10 times its capital (id., article 214). - In general, it may not hold or issue foreign-exchange denominated assets or liabilities worth more than twice the amount of its minimum capital requirement (id., article 200). - Maximum credit exposure to a foreign sovereign may be as low as 15% of a bank’s capital to 5 times as much, depending on the sovereign’s credit rating (id., article 209). - Credit exposure to foreign banks may range from 70% to 150% of a bank’s capital depending on the credit rating of the foreign bank (id., article 211). - Pension Funds: - May invest up to 15% of their assets in fixed income instruments issued by international financial institutions or highly rated foreign governments (Law 16713/1995, article 123). - Such instruments must be traded on securities exchanges under supervision by Banco Central del Uruguay (Decree 399/1995, article 69). - Investment in securities issued by foreign companies not allowed, except if the foreign company is a bank operating in Uruguay (Law 16713/1995, article 124). - Deposits may be held at banks established in Uruguay only (RNCFP, article 62). - Insurance Companies: - Insurance companies established in Uruguay permitted to underwrite insurance with respect to risks and persons abroad (Decree 354/1994, article 24). - May seek reinsurance from companies established abroad (id., article 22). - Investment limits: Up to 30% of an insurance company’s capital and non-provisional obligations may be covered by investments in: - (a) securities issued or guaranteed by foreign governments; - (b) securities issued by international financial organizations; - (c) foreign bank deposits; - (d) bonds and shares issued by foreign companies, including financial institutions; - (e) other authorized instruments (RNSR, articles 49 and 51). - Up to 15% of the provisional obligations may be covered by investment in high quality fixed-income instruments issued by international financial institutions or foreign governments (id., articles 53 and 55). ### URUGUAY — C. Trade liberalization and bilateral investment treaties (summary) - Uruguay is a Mercosur member and party to the financial services annex to the Montevideo Protocol on Trade in Services. The annex: - Provides for mutual recognition of prudential measures taken by member states to protect investors, depositors or policyholders, or to ensure solvency and liquidity of the financial sector. - Allows such recognition unilaterally, through harmonization, or pursuant to memoranda of understanding. - Sets that member states undertake to pursue harmonization in prudential regulation, consolidated supervision, and information exchange on financial sector matters. - Uruguay / Mercosur FTAs: bilateral FTAs in force with Bolivia, Chile, Peru and Israel; framework agreements with Mexico and Morocco; preferential trade agreements with Colombia, Ecuador, India and Mexico. None make provision for trade in financial services. - Bilateral investment treaties generally allow foreign investors to make investments and carry out business under conditions no less favorable than domestic investors or other foreign investors, though parties may restrict certain investments in accordance with domestic law. The treaty with the United States allows for imposition of restrictions only in pursuit of financial stability or as warranted by monetary policy. *Source: annex on financial services, _030416 - annex on financial services* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2016/_030416.pdf_