## 1. Secondary Market

## Source details

**Canonical URL:** [1. Secondary Market](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06288.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06288.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06288.pdf.json)

---

### Introduction and background
- By the beginning of 2004 the mutual fund industry:
  - Investor population grew from 9,573 in 1998 to 67,327 in December 2003.
  - Assets under management increased from 1.35 percent GDP to 16.2 percent GDP, equivalent to roughly 60 percent of bank deposits.
- End‑March 2004 adjustment in emerging market bond prices triggered a crisis:
  - Mutual funds showed negative returns for the first time in their history.
  - A massive run followed; redemptions were honored promptly and orderly.
  - By June 2004, total assets held in mutual funds had declined to 8 percent GDP.
- Paper purpose: explore whether securities‑market regulatory weaknesses played a role and draw lessons for developing countries’ regulatory design.
- High‑level lessons emphasized:
  - Need for a multi‑pillar framework for securities regulation.
  - Importance of financial literacy and capacity building.
  - Importance of market conduct rules and challenges posed by mark‑to‑market implementation in developing markets.

### The mutual fund industry (structure and growth)
- Pre‑1997 and legal changes:
  - Prior to the Securities Act of 1997 collective investment used trusts and “carteras mancomunadas”; “carteras mancomunadas” were phased out by 2002 under the Act.
  - The Securities Market Act of 1997 (effective 1998) defined “mutual funds” regulated by the Superintendencia General de Valores (SUGEVAL) and required trusts to meet the same requirements as mutual funds.
- Industry size and composition (figures as of December 2003):
  - Total assets: 1,203,940 (millions of colones).
  - Number of investors: 67,327.
  - Number of funds: 144.
  - Fund categories (Assets / Investors / Funds):
    - Money market — Assets: 85,631; Investors: 7,750; Funds: 26
    - Short-term — Assets: 88,960; Investors: 4,555; Funds: 16
    - Income — Assets: 278,086; Investors: 12,326; Funds: 30
    - Growth — Assets: 651,085; Investors: 40,299; Funds: 58
    - Share — Assets: 1,839; Investors: 198; Funds: 3
    - Real Estate — Assets: 94,546; Investors: 2,134; Funds: 10
    - Mortgage securitization — Assets: 3,793; Investors: 65; Funds: 1
  - Dollar/colones split noted: Dollars: 901,307; Colones: 302,633 (1/ In millions of colones).
- Portfolio concentration (December 2003):
  - Financial funds investing in colones: 95 percent invested in Costa Rican sovereign debt, 3 percent in repos, and 3 percent in other debt issuances.
  - Financial funds investing in dollars: 77 percent invested in Costa Rican sovereign debt, 12 percent in repos, and 11 percent in other debt issuances.

### Regulatory framework for mutual funds and managers (authorization, disclosure, prudential rules)
- Authorization and disclosure requirements (minimum content based on IOSCO Principles):
  - a) Summary of the prospectus—and full prospectus if requested—at moment of placement.
  - b) Information on share price, net assets and commissions, provided daily to the regulator and available to market and investors.
  - c) Portfolio composition provided biweekly to the regulator and available to market and investors.
  - d) Personal statement accounts provided to each investor monthly.
  - e) Financial statements for both the mutual fund and the mutual fund manager provided quarterly and annually; annual statements required audit plus report on compliance with securities regulations and internal controls.
- Prudential rules:
  - Diversification limits, leverage limits and a liquidity coefficient.
  - Diversification limits exempted investments rated triple A by an international credit rating agency and Costa Rican sovereign paper.
  - Liquidity coefficient two stages:
    - First stage: percentage of assets under management — 15 percent for money market funds and 10 percent for all other open‑end funds.
    - Second stage: depended on average permanence of investors in the fund.
  - “Prudent man rule” obliging diligence in investment selection.
- Fund managers:
  - Required to be sociedades administradoras de fondos de inversion (mutual fund managers) structured as corporations; subject to capital requirements adjusted by assets under management and fit and proper requirements for investment committees.
- Gaps through March 2004:
  - Lack of detailed governance rules and market conduct obligations specific to fund managers.
  - SUGEVAL had released for consultation a regulatory framework including more detailed corporate governance and market conduct rules, not yet approved by March 2004.
  - New regulations for the mutual funds industry were enacted in 2006 addressing these issues.

### Mark‑to‑market valuation: implementation, methodology, and challenges
- Regulatory change and scope:
  - Mutual funds required to adopt mark‑to‑market valuation in August 2002.
  - SUGEF, SUGEVAL and SUPEN required all CIS, including pension funds, to be valued mark to market, except money market funds allowed cost‑based valuation.
- Practical implications:
  - Under cost‑based valuation asset prices remain at acquisition price; under mark‑to‑market subscription and redemption prices are affected daily by asset price changes.
  - Implementation challenged by limited depth and liquidity in the secondary market; secondary market trading was modest and concentrated in repos which cannot be used for price formation.
- Methodology development and contentious issues:
  - Debates included regulator’s role in methodology design, single versus multiple methodologies, authorization of price vendors, and discretion to deviate from methodology prices.
  - Final regulations allowed participants to develop their own methodologies based on guidelines; in practice Bolsa Nacional de Valores (BNV) became the de facto price vendor and developed a pricing vector based on the sovereign yield curve (SYC).
  - Key feature: use of prices from trades of specific sovereign issuances to estimate prices of other nontraded sovereign issuances (the “drag along” method), linking prices across issuances — this linkage proved a key factor in volatility during the crisis.
  - Final regulations significantly limited possibilities for operators to deviate from methodology‑derived prices.
- Communication and timing:
  - Implementation occurred during decreasing interest rates and rising security prices, so few CIS initially reflected losses from the change.
  - Superintendencias required CIS managers to send letters to each investor explaining mark‑to‑market impact; announcements and brochures in major newspapers reinforced communication.

### Secondary market trading statistics (2003 and 2004)
- Trading composition (percentages):
  - Repos: 74.79 (2003), 74.80 (2004)
  - Outright sales—Debt: 24.26 (2003), 24.9 (2004)
  - Forward trades: 0.53 (2003), 0.10 (2004)
  - Outright sales—equity: 0.14 (2003), 0.18 (2004)
  - Lending: 0.09 (2003), 0.03 (2004)
  - Total: 100 (2003), 100 (2004)
- Number of trades:
  - Repos: 95,642 (2003), 103,631 (2004)
  - Outright sales—Debt: 38,955 (2003), 37,664 (2004)
  - Forward trades: 261 (2003), 55 (2004)
  - Outright sales—equity: 2,136 (2003), 2,539 (2004)
  - Lending: 30 (2003), 36 (2004)
  - Total number of trades: 137,024 (2003), 143,925 (2004)
- Average volume (1/ In millions of colones):
  - Repos: 77.2 (2003), 80.4 (2004)
  - Outright sales—Debt: 62.0 (2003), 80.4 (2004)
  - Forward trades: 199 (2003), 73.6 (2004)
  - Outright sales—equity: 6.5 (2003), 195.0 (2004)
  - Lending: 283.3 (2003), 7.7 (2004)
- Total volume 1/: 9,867,997 (2003), 11,140,158.8 (2004)
- Daily average volume 1/: 39,630.5 (2003), 44,383.1 (2004)
- Source for table: SUGEVAL.

### Crisis dynamics, returns, and market adjustment (2002–2004)
- Bubble and drivers:
  - During 2002–2003 low U.S. interest rates and increased global liquidity pushed eurobond prices up; local government issuance policy reduced available short‑term colones paper for fund managers.
  - Beginning in March 2003 net subscriptions of mutual and pension funds exceeded net government placements. At their peak in September 2003 net subscriptions in mutual and pension funds amounted to roughly 340 million colones while net government placements amounted to roughly 40 million colones.
- Returns and industry expansion:
  - At their peak in June 2003 returns on income and growth funds invested in issuances in dollars were "approximately 10 percent"; return on a 30-day certificate of deposit of a state-owned bank was "around 2.5 percent."
  - During 2003 the industry showed a 65 percent growth compared with 2002, reaching US$4,000 million (63 percent of total claims on banks).
- Returns by fund type — Last 30 days (columns correspond to Dec-02, March, Jun, Sept, Dec-03, March preserved exactly):
  - Funds in colones:
    - Money market: 12.29; 14.72; 15.57; 11.56; 11.57; 10.99
    - Short-term: 14.35; 14.5; 14.28; 12.05; 11.44; 10.12
    - Income: 9.28; 14.13; 17.36; 12.51; 10.99; 12.13
    - Growth: 12.22; 15.13; 17.06; 12.40; 12.11; 11.95
    - Equity: 11.67; 6.92; 42.39; 18.51; (19.86); (27.29)
    - Real state: 10.3; 8.29; 8.79; 7.71; 8.88; 8.92
    - Securitization: 8.77; 8.61; 9.77; 8.52; 8.02; 9.14
  - Funds in dollars:
    - Money Market: 3.04; 2.95; 1.5; 1.24; 1.66; 1.75
    - Short-term: 4.46; 4.40; 3.61; 2.24; 2.84; 2.36
    - Income: 6.01; 6.46; 12.24; 6.45; 3.95; 4.49
    - Growth: 5.84; 7.32; 9.66; 5.70; 3.4; (1.55)
    - Equity: (52.77); 6.29; 30.45; (13.13); 32.49; (6.52)
- Spread behavior (basis points) — Costa Rica September 2003 / June 2004 (selected):
  - bde08 — 259 / 419
  - Bde09 — 272 / 427
  - Bde11 — 315 / 436
  - Bde12 — 314 / 428
  - Bde13 — 300 / 420
  - Bde14 — (June 2004) 407
  - Bde20 — 323 / 422
- Price variation for Costa Rican eurobonds (percentage columns preserved exactly: Oct-Dec 2002; Jan-June 2003; Jul-Dec 2003; Jan-Mar 2004; Mar-Apr 2004; Apr-May 2004; May-Jun 2004):
  - BDE08: n.a.; 6.4; 0.5; 1.1; -7.0; 0.6; -0.2
  - BDE09: -0.6; 8.7; 1.1; 0.9; -7.2; -1.5; -0.8
  - BDE11: -0.5; 7.1; 1.9; 2.8; -6.9; -2.0; -2..0
  - BDE12: -0.9; 7.4; 0.5; 3.8; -6.7; -2.6; -1.3
  - BDE13: n.a.; 5.0; 1.4; 3.8; -7.1; -3.1; -1.3
  - BDE14: n.a.; n.a.; n.a.; 0.5; -6.1; -3.8; -3.4
  - BDE20: -2.2; 6.3; 2.4; 4.7; -6.4; -6.6; 0.4
  - Source: Arce, Jose Luis.
- Adjustment and run (March–June 2004):
  - Negative returns during March–April 2004: average of 3 percent in dollars and 1 percent in colones.
  - A massive run of around US$1,500 million occurred in three weeks.
  - By June 2004:
    - Total assets declined by 52 percent for funds in dollars.
    - Total assets declined by 33 percent for funds in colones.
    - Number of investors declined from 67,327 (December 2003) to 39,573.
  - Growth funds were most severely affected, followed by income funds.

### Liquidity dynamics, trading shifts, and bank deposits during crisis
- Trading pattern shifts (March–June 2004 trimester):
  - Outright sales reached 32 percent of total volume of transactions (prior average 24 percent).
  - Repo operations represented 67 percent of total volume for the same trimester, down from an average of 75 percent in 2003.
  - Repo volumes diminished during the crisis because fund managers needed to unwind repo positions to have securities available for sale.
- Liquidity providers:
  - Local banks were buyers who provided liquidity; market participants indicated most buying was carried out by state‑owned banks.
- Bank deposits April–June 2004:
  - Deposits in state-owned banks increased by 389,680 million colones, a 77 percent increase from 2004.
  - Deposits in privately owned banks increased by 81,327 million colones (16 percent).
  - Deposits in the Banco Popular y de Desarrollo Comunal increased by 35,146 million colones (6.9 percent).

### Supervisory and market responses during the crisis
- Early warning and proposals:
  - SUGEVAL publicly warned about a price bubble in November 2003; the warning had no noticeable effect on manager or investor behavior.
  - Proposed regulatory measure to subject long‑term funds to early exit commissions was not approved by the Consejo Nacional which regarded it as "very interventionist."
- Coordination and preparedness:
  - SUGEVAL had off‑site supervisory mechanisms with real‑time information but had no emergency plan for a massive run.
  - The president of the central bank coordinated responses and communicated daily with the three superintendencias; constant multilateral meetings took place at the central bank.
- Liquidity and market‑stabilizing measures implemented:
  - Central bank buy back of issuances in colones (BEM) for C 25.000 million.
  - Reduction in outstanding BEMs by more than 155,000 million colones.
  - SUGEVAL authorized mutual funds to increase repo operations from 10 percent to 30 percent; initially refused but later authorized a temporary increase for the period "between April 30 and May 31."
  - SUGEVAL instructed managers of funds with significant redemptions to initiate winding‑up processes so that "all customers would be redeemed at the same time, once all assets were liquidated" to avoid unfair treatment.
  - SUGEVAL approved an amendment to the pricing vector to eliminate the "drag along" method and authorized BNV to carry out block trades in a separate market.
- Communications:
  - SUGEVAL increased resources to the Information Center; issued full page announcements in major newspapers encouraging investor information gathering.
  - SUGEVAL added a special web link with daily information on all mutual funds and a "Frequently Asked Questions" section; superintendent engaged with press urging responsible coverage.
- Post‑crisis review:
  - SUGEVAL carried out a review of market compliance to identify needed enforcement actions and regulatory changes.

### Industry impacts and post‑crisis structure
- Lasting effects:
  - The mutual fund industry has not returned to pre‑crisis levels.
  - Money market funds increased (valued at cost and shorter duration); income and growth funds contracted sharply.
- Mutual Fund Industry — selected figures (1/ In millions of colones. Source: SUGEVAL):
  - Totals:
    - Assets under Management: Dec 03 1,203,940; Dec 04 642,604; Dec05 660,117
    - Number of Investors: Dec 03 67,327; Dec 04 31,752; Dec05 31,003
    - Number of Funds: Dec 03 144; Dec 04 135; Dec 05 131
  - Category examples:
    - Money market — Assets under Management: Dec 03 85,631; Dec 04 172,338; Dec05 186,427; Number of Investors: Dec 03 7,750; Dec 04 9,413; Funds: Dec 03 26; Dec04 28
    - Growth — Assets under Management: Dec 03 651,085; Dec 04 127,388; Dec05 81,261; Number of Investors: Dec 03 40,299; Dec 04 10,095; Funds: Dec 03 58; Dec04 48
    - Real state — Assets under Management: Dec 03 94,546; Dec 04 130,630; Dec05 202,139; Number of Investors: Dec 03 2,134; Dec 04 2,719; Funds: Dec 03 10; Dec04 11

### Micro‑level regulatory lessons and market conduct failures
- Causes and diagnostic points:
  - Crisis resulted from an overappreciation of Costa Rican sovereign paper and concentrated exposures in mutual funds.
  - The report argues concentration limits on sovereign paper are conceptually inappropriate because asset allocation decisions should rest with investors.
- Disclosure shortcomings:
  - Prospectuses contained basic disclosures but lacked prominent warnings that funds were concentrated; new framework recently approved requires such warnings.
- Market conduct failings:
  - Placement and marketing practices were inadequate; many investors wrongly assumed principal protection comparable to bank products.
  - "Know your customer" and "suitability" obligations were widely neglected by placement agents.
  - Complaints for inadequate information and advice at placement were filed before SUGEVAL.
  - In some state‑owned bank–owned fund cases, investors were told the fund carried the full faith and credit of the government (true only for state‑owned bank liabilities).
- Conflicts of interest:
  - Banks investing in mutual funds reportedly redeemed participations early without informing the market or clients.
- Governance and risk management shortcomings:
  - Many fund managers lacked selection and training programs for sales personnel; sales staff often lacked professional or technical qualifications.
  - Most fund managers had not developed policies to cope with interest‑rate risk; many income and growth funds lacked early exit commissions.

### Valuation oversight and role clarity
- Valuation challenge:
  - Developing a methodology that yields fair value is difficult when secondary markets lack depth and liquidity; individual trade prices may not reflect market conditions.
  - Methodology set stricter parameters to determine trades usable for estimating security prices.
- Division of responsibilities:
  - Superintendencia emphasized valuation responsibility rests with CIS managers and chose not to join the “methodology committee” instituted by BNV, while maintaining active communication.
  - Many fund managers delegated valuation responsibility to BNV; report recommends clarifying roles and responsibilities of fund managers vis‑à‑vis the price vendor and strengthening supervisory mechanisms.

### Macro‑level regulatory lessons, financial literacy, and capacity building
- Regulatory architecture critique:
  - SUGEVAL’s “rules‑based” and “single pillar” approach — relying exclusively on the regulator to ensure compliance — is criticized for creating moral hazard and misplacing primary responsibility for compliance onto the regulator rather than market participants.
  - Recommendation to shift toward a multi‑pillar approach emphasizing:
    - Self‑discipline of financial institutions through sound corporate governance and risk management.
    - Use of market discipline and reserving the regulator’s role for monitoring, evaluating, and strengthening institutions’ risk management processes.
  - Cultural change recommended: place primary responsibility for regulatory compliance, policies, procedures, internal controls, and risk management with market participants.
- Financial literacy:
  - Low financial literacy exacerbated the crisis; many investors did not perceive differences between mutual funds and banking accounts.
  - Investor education prior to 2005 largely reached existing investors; since 2005 SUGEVAL shifted to activities attracting the average citizen (Investor Fair, periodic public presentations).
  - Mass media identified as effective for financial literacy programs.
- Capacity building:
  - Importance of building capacity across market participants and the regulator.
  - Reliance on international consultants is common, but sustainable development requires local staff training.
  - Recommendation: include training within terms of reference of external consultants to ensure local capacity for implementation and oversight.

### APPENDIX I — Structure of financial regulation in Costa Rica (summary)
- Three specialized regulators:
  - Superintendencia General de Entidades Financieras — banking sector.
  - Superintendencia General de Valores (SUGEVAL) — securities sector.
  - Superintendencia de Pensiones — pension sector.
- Superintendencias operationally independent though part of the central bank; central bank cannot direct them in areas under their competence.
- Common board: Consejo Nacional de Supervision del Sistema Financiero:
  - Roles: general guidance, approving regulations, decisions on suspension and liquidation (based on superintendent proposal), appeals review.
  - Composition: seven members — five private sector members appointed by the central bank board for five years (possible reelection, removable only for cause) and two ex officio members: the minister of finance and the president of the central bank.
- Funding: 20 percent of superintendencias’ actual expenses funded by fees on market participants; remaining 80 percent from central bank budget.
- Annual budget process: central bank sets maximum amount; Consejo Nacional approves individual superintendencia budgets based on superintendent proposals.

### APPENDIX II — The pricing vector developed by the Bolsa Nacional de Valores (BNV)
- Purpose:
  - Generates a unified price report for a selected group of securities based on trade observations; estimates prices when observations do not exist.
- Categories included (seven):
  - a) Issuances that comprise the sovereign yield curve (SYC)
  - b) Other public debt issuances
  - c) Private debt issuance
  - d) Foreign issuances
  - e) Equity issuances
  - f) Unit of close‑end funds
  - g) Premium for other debt issuances of public entities
- Data inclusion rules:
  - Only prices from outright sales settled in the same currency as the issuance are considered.
  - Only trades within volume thresholds are considered. Thresholds (as of the document):
    - For issuances in the SYC:
      - Colones: Inferior 30,000,000 Superior 350,000,000
      - Dollars: Inferior 100,000 Superior 2,000,000
    - For all other bonds:
      - Colones: Inferior 10,000,000 Superior 350,000,000
      - Dollars: Inferior 35,000 Superior 1,000,000
    - For equity:
      - Colones: Inferior 5,000,000 Superior 350,000,000
      - Dollars: Inferior 15,000 Superior 1,000,000
  - For issuances in the SYC the system requires at least three trades in a trading day to run calculations; for other issuances one trade suffices.
- Calculation formulas and conventions:
  - WAP (weighted average price) formula:
    - PPP =    ∑ P_i,j * FV_i,j   i,j 
              —————————————
              ∑ FV_i,j   i,j
    - Definitions: j: Issuance; P_i,j: Price observed in trade i for issuance j; FV_i,j: Face value observed in trade i for issuance j; WAP_j: Weighted Average Price for issuance j.
  - WAY (weighted average yield) formula:
    - WAY =  ∑ Y_i,j * FV_i,j   i,j
            —————————————
            ∑ FV_i,j   i,j
    - System conventions: uses clean prices (accrued interest excluded) and annual nominal yield.
- SYC methodology:
  - SYC built from issuer yields (minister of finance and central bank issuances only) selected by turnover and diffusion.
  - For issuances with fewer than three trades in a day the system calculates a “Mobile” WAP using prices from the last five trading sessions under certain circumstances; if no observations in the last five trading days the last observed price is used.
- Private debt and premiums:
  - When no observations for a private issuance exist, prices are calculated from the SYC plus an “individual premium” determined by comparing the issuance yield with the sovereign issuance yield of same maturity.
  - The premium is recalculated with information from the secondary market and updated if market observations for the issuance become available.

*Source: _wp06288 - 1. Secondary Market; Box 2. The Development of Mark-to-Market Regulations; APPENDIX I; APPENDIX II (IMF PDF).*

### 1.         Secondary         Market ....................................................................................

### 1.         Secondary         Market

### Introduction
- By the beginning of 2004 the mutual fund industry had reached the average Costa Rican household and was competing directly with savings accounts and other traditional banking products.
- Investor population: grew from 9,573 in 1998 to 67,327 in December 2003.
- Assets under management: increased from 1.35 percent GDP to 16.2 percent GDP, equivalent to roughly 60 percent of bank deposits.
- End‑March 2004 adjustment in emerging market bond prices triggered a crisis:
  - Mutual funds showed negative returns for the first time in their history.
  - Losses provoked a massive run; redemptions were honored promptly and orderly.
  - By June 2004, total assets held in mutual funds had declined to 8 percent GDP.
- Purpose of the paper: explore whether weaknesses in the regulatory framework for the securities market played a role in the crisis and draw lessons for developing countries’ regulatory design.
- Key high‑level lessons highlighted:
  - Need for a multi‑pillar framework for securities regulation.
  - Importance of financial literacy and capacity building.
  - Importance of market conduct rules and challenges posed by mark‑to‑market implementation in developing markets.

### The Mutual Fund Industry (pre- and post-1997 Securities Act)
- Prior to the Securities Act of 1997:
  - Collective investment conducted through trusts and “carteras mancomunadas.”
  - “Carteras mancomunadas” were off‑balance pools managed by brokerage houses with promised fixed returns; phased out by 2002 under the Act.
  - Trusts’ investor returns depended on portfolio performance but were not regulated; the Act required trusts to be subject to the same requirements as mutual funds.
- The Securities Market Act of 1997 (effective 1998):
  - Chose mutual funds as the vehicle for collective investment and defined regulation by the Superintendencia General de Valores (SUGEVAL).
  - Created a new legal category “mutual funds,” administered by a fund manager, with assets registered under ownership of the mutual fund (not the manager).
  - Eliminated incentive to use trusts for CIS by subjecting them to the same regulation.

### The Regulatory Framework for Mutual Funds and Fund Managers
- Authorization and disclosure:
  - Mutual fund authorization based on submission of a prospectus and periodic disclosure.
  - Disclosure obligations (minimum content based on IOSCO Principles), including:
    - a) Provision of a summary of the prospectus—and if requested, the complete prospectus—at the moment of placement.
    - b) Information on the share price, net assets and commissions, to be provided daily to the regulator and available to the market and investors.
    - c) Portfolio composition, to be provided biweekly to the regulator and available to the market and investors.
    - d) Personal statement accounts, to be provided to each investor on a monthly basis.
    - e) Financial statements for both the mutual fund and the mutual fund manager, to be provided quarterly as well as annually. Annual statements had to be audited and supplemented with an additional report on compliance with securities regulations and internal controls.
- Prudential rules for mutual funds:
  - Diversification limits, leverage limits and a liquidity coefficient.
  - Diversification limits applied to all investments except those rated triple A by one of the international credit rating agencies and Costa Rican sovereign paper.
  - Liquidity coefficient: two stages — first stage defined as a percentage of assets under management (15 percent for money market funds and 10 percent for all other open-end funds); second stage depended on average permanence of investors in the fund.
  - “Prudent man rule” obliging diligence in investment selection.
- Fund managers:
  - Required to be sociedades administradoras de fondos de inversion (mutual fund managers) structured as corporations; subject to capital requirements adjusted by assets under management and fit and proper requirements for investment committees.
- Gaps at the time (through March 2004):
  - Framework lacked detailed rules on governance issues and market conduct obligations specific to fund managers.
  - SUGEVAL had released for consultation a regulatory framework including more detailed corporate governance and market conduct rules, not yet approved by March 2004.
  - New regulations for the mutual funds industry were enacted in 2006 addressing these issues.

### Mark‑to‑Market Valuation: Implementation and Challenges
- Regulatory change:
  - Mutual funds required to adopt mark‑to‑market valuation in August 2002.
  - SUGEF, SUGEVAL and SUPEN required all CIS, including pension funds, to be valued mark to market, except money market funds allowed cost‑based valuation.
- Practical implications:
  - Under cost-based system, asset prices valued at acquisition price; under mark‑to‑market, subscription and redemption prices are affected daily by changes in asset prices.
  - Mark‑to‑market implementation posed a challenge due to limited depth and liquidity in the secondary market; secondary market trading modest and concentrated in repos, which cannot be used for price formation.
- Development of methodology:
  - Controversial issues: regulator’s role in methodology design, whether one or multiple methodologies should be allowed, authorization of price vendors, and discretion to deviate from methodology prices.
  - Final regulations allowed participants to develop their own methodologies based on guidelines; in practice, Bolsa Nacional de Valores (BNV) became the de facto price vendor and developed a pricing vector based on the yield curve for sovereign issuances.
  - A key feature: use of prices from trades of specific sovereign issuances to estimate prices of other nontraded sovereign issuances (the “drag along” method), linking prices across issuances — this proved a key factor in volatility during the crisis.
- Communication and implementation timing:
  - Implementation occurred during a period of decreasing interest rates and rising security prices, so few CIS initially reflected losses from the change in accounting methodology.
  - Superintendencias required CIS managers to send letters to each individual investor explaining mark‑to‑market impact, reinforced by announcements in major newspapers and brochures.

### Secondary Market Trading Statistics (2003 and 2004)
- Trading composition (percentages):
  - Repos: 74.79 (2003), 74.80 (2004)
  - Outright sales—Debt: 24.26 (2003), 24.9 (2004)
  - Forward trades: 0.53 (2003), 0.10 (2004)
  - Outright sales—equity: 0.14 (2003), 0.18 (2004)
  - Lending: 0.09 (2003), 0.03 (2004)
  - Total: 100 (2003), 100 (2004)
- Number of trades:
  - Repos: 95,642 (2003), 103,631 (2004)
  - Outright sales—Debt: 38,955 (2003), 37,664 (2004)
  - Forward trades: 261 (2003), 55 (2004)
  - Outright sales—equity: 2,136 (2003), 2,539 (2004)
  - Lending: 30 (2003), 36 (2004)
  - Total number of trades: 137,024 (2003), 143,925 (2004)
- Average volume (1/ In millions of colones):
  - Repos: 77.2 (2003), 80.4 (2004)
  - Outright sales—Debt: 62.0 (2003), 80.4 (2004)
  - Forward trades: 199 (2003), 73.6 (2004)
  - Outright sales—equity: 6.5 (2003), 195.0 (2004)
  - Lending: 283.3 (2003), 7.7 (2004)
- Total volume 1/: 9,867,997 (2003), 11,140,158.8 (2004)
- Daily average volume 1/: 39,630.5 (2003), 44,383.1 (2004)
- Source cited for table: SUGEVAL.

*Source: _wp06288 - 1.         Secondary         Market ..........................................................................................................7 (IMF PDF).*

### Box 2. The Development of Mark-to-Market Regulations

### Box 2. The Development of Mark-to-Market Regulations

### Development of mark-to-market regulations — key debates and outcomes
- The development of mark-to-market regulations was contentious; market participants opposed implementation while the superintendencias considered cost-based systems inadequate because they did not reflect the real price of assets used for subscription (buying) and redemption (selling) of units.
- Role of the regulator:
  - Debate over whether the superintendencias should design the valuation methodology.
  - Prevailing view: valuation of portfolios is the direct responsibility of CIS managers; regulations did not prescribe a specific methodology.
  - Regulations required use of observations from the market to calculate prices of traded securities and to estimate prices when no observations were available.
- One or multiple methodologies:
  - Debate over whether there should be a single methodology for the market.
  - Prevailing view: consistent use of the chosen methodology by the CIS manager was the key issue, not standardization.
  - Regulations allowed participants to develop their own methodologies, provided each financial group used the same methodology across different products.
  - In practice, the superintendencias fostered development of one methodology for the whole sector.
- Price vendors:
  - Debate on allowing third parties to develop methodologies and whether they should be authorized with fit and proper requirements.
  - Regulations allowed third parties to provide methodologies but did not create “price vending” as an authorized activity.
  - Responsibility for proper valuation of portfolios remained exclusively with CIS managers; disagreements between managers and price vendors had to be solved internally.
  - In practice, the Bolsa Nacional de Valores (BNV) became the first “de facto” vendor providing a pricing vector to most market participants.
- Discretion to deviate from the methodology:
  - Disagreement over whether operators could deviate from methodology-derived prices if they considered them not to reflect fair value.
  - Final regulations significantly limited possibilities for operators to deviate from their methodologies.

### Characteristics of the mutual fund industry (summary and key statistics)
- Industry growth (1998–2003):
  - Assets managed through mutual funds grew from 49,119 million colones to 1,203,940 million colones.
  - This represented around 17 percent GDP and 60 percent of total claims on banks.
- Number of investors:
  - Grew from 9,573 to 67,327 between 1998 and 2003.
  - SUGEVAL lacks investor-type data; market conversations indicate the majority were middle-class Costa Ricans. Corporations and banks also managed their own funds through mutual funds.
- Product breadth and composition:
  - Number of funds available for public offer grew from 59 to 144.
  - Fund types included money market, short-term, income, growth, share, real estate and mortgage funds.
  - Majority of assets under management were held in financial funds.
- Table 2. Mutual Fund Industry as of December 2003 (figures in millions of colones unless noted)
  - Money market — Assets: 85,631; Investors: 7,750; Funds: 26
  - Short-term — Assets: 88,960; Investors: 4,555; Funds: 16
  - Income — Assets: 278,086; Investors: 12,326; Funds: 30
  - Growth — Assets: 651,085; Investors: 40,299; Funds: 58
  - Share — Assets: 1,839; Investors: 198; Funds: 3
  - Real Estate — Assets: 94,546; Investors: 2,134; Funds: 10
  - Mortgage securitization — Assets: 3,793; Investors: 65; Funds: 1
  - Totals — Assets: 1,203,940; Investors: 67,327; Funds: 144
  - Dollars: 901,307
  - Colones: 302,633
  - 1/ In millions of colones. Source: SUGEVAL.
- Portfolio concentration:
  - Most financial funds’ portfolios were highly concentrated in Costa Rican sovereign issuances.
  - As of December 2003, for financial funds investing in issuances in colones: 95 percent invested in Costa Rican sovereign debt, 3 percent in repos, and 3 percent in other debt issuances.
  - For financial funds investing in issuances in dollars: 77 percent invested in Costa Rican sovereign debt, 12 percent in repos, and 11 percent in other debt issuances.
  - Note: Figures add up to 101 percent (taken from the SUGEVAL).

### The crisis (2002–2004): bubble, runs, and market dynamics
- During 2002–2003 internal and external factors created a bubble in the price of Costa Rican sovereign paper, producing very attractive returns for mutual funds and significant industry growth.
- The price adjustment in 2004 led to a massive run by investors that reduced the industry by half its size in less than a month; measures were devised to ensure orderly and timely redemptions.
- International and local drivers prior to the crisis:
  - Global driver: low U.S. interest rates and increased global liquidity were important determinants of the 2003 rally in emerging market debt.
  - Local driver: government issuance policy changes—incrementing external indebtedness, prolonging maturity of issuances, and preferring private placements over public auctions—reduced stock of short-term notes in colones and bonds in dollars available in the domestic market, leaving fund managers with fewer investment options.
  - Beginning in March 2003 net subscriptions of mutual and pension funds exceeded net government placements. At their peak in September 2003 net subscriptions in mutual and pension funds amounted to roughly 340 million colones while net government placements amounted to roughly 40 million colones.
- Spread behavior (Table 3: Basis points)
  - Costa Rica — September 2003 / June 2004
    - bde08 — 259 / 419
    - Bde09 — 272 / 427
    - Bde11 — 315 / 436
    - Bde12 — 314 / 428
    - Bde13 — 300 / 420
    - Bde14 — (June 2004) 407
    - Bde20 — 323 / 422
  - Panama — September 2003 / June 2004
    - 22/04/2008 — 330 / 241
    - 08/02/2011 — 373 / 335
    - 23/07/2012 — 361 / 328
    - 15/03/2015 — 390 / 399
    - 15/05/2020 — 372 / 388
    - 16/01/2023 — 359 / 378
    - 30/09/2027 — 237 / 304
    - 01/04/2029 — (June 2004) 383
- Empirical note:
  - As with other emerging markets, low U.S. interest rates were among the factors that pushed Costa Rica eurobond prices up; IMF’s GFSR (April 2004) found global liquidity from low U.S. interest rates became a more important determinant of emerging market spreads than country-specific fundamentals following September 2001.

*Source: _wp06288 - Box 2. The Development of Mark-to-Market Regulations*

### 119.18 to 124.87) from January to mid-April 2004.

### _wp06288 - 119.18 to 124.87) from January to mid-April 2004.

### Ministry of Finance placements by maturity (Table 4)
- Maturities and amounts (In millions of colones)
  - 0-90 days
    - Dec 02: Amount 28,597.1; Percentage 1.7
    - Dec 03: Amount 9,774.2; Percentage 0.5
    - Dec 04: Amount 352,349.1; Percentage 15.7
  - 91-180 days
    - Dec 02: Amount 115,499.8; Percentage 6.7
    - Dec 03: Amount 77,789.4; Percentage 4.1
    - Dec 04: Amount 165,354.5; Percentage 7.4
  - 181-360 days
    - Dec 02: Amount 316,552.7; Percentage 18.3
    - Dec 03: Amount 261,572.4; Percentage 13.9
    - Dec 04: Amount 135,047.5; Percentage 6.0
  - 361-720 days
    - Dec 02: Amount 33,099.3; Percentage 1.9
    - Dec 03: Amount 122,704.2; Percentage 6.5
    - Dec 04: Amount 416,756.7; Percentage 18.6
  - +720 days
    - Dec 02: Amount 1,239,222.1; Percentage 71.5
    - Dec 03: Amount 1,408.277.9; Percentage 74.9
    - Dec 04: Amount 1,170.966.6; Percentage 52.3
- Source: SUGEVAL.

### Mutual fund returns and industry expansion
- Market dynamics and returns
  - "The increase in the prices of Costa Rican bonds led to very attractive returns" which accelerated industry growth.
  - At their peak in June 2003 returns on income and growth funds invested in issuances in dollars were "approximately 10 percent", while the return on a 30-day certificate of deposit of a state-owned bank was "around 2.5 percent."
  - During 2003 the industry showed a 65 percent growth compared with 2002, reaching US$4,000 million (63 percent of total claims on banks).
- Returns by fund type (Table 5 — Last 30 days). Values correspond to columns Dec-02, March, Jun, Sept, Dec-03, March (preserved exactly).
  - Funds in colones
    - Money market: 12.29; 14.72; 15.57; 11.56; 11.57; 10.99
    - Short-term: 14.35; 14.5; 14.28; 12.05; 11.44; 10.12
    - Income: 9.28; 14.13; 17.36; 12.51; 10.99; 12.13
    - Growth: 12.22; 15.13; 17.06; 12.40; 12.11; 11.95
    - Equity: 11.67; 6.92; 42.39; 18.51; (19.86); (27.29)
    - Real state: 10.3; 8.29; 8.79; 7.71; 8.88; 8.92
    - Securitization: 8.77; 8.61; 9.77; 8.52; 8.02; 9.14
  - Funds in dollars
    - Money Market: 3.04; 2.95; 1.5; 1.24; 1.66; 1.75
    - Short-term: 4.46; 4.40; 3.61; 2.24; 2.84; 2.36
    - Income: 6.01; 6.46; 12.24; 6.45; 3.95; 4.49
    - Growth: 5.84; 7.32; 9.66; 5.70; 3.4; (1.55)
    - Equity: (52.77); 6.29; 30.45; (13.13); 32.49; (6.52)
- Fund design and investor behavior
  - Most growth concentrated in income and growth funds in dollars, which were long-term instruments in design but lacked incentives (e.g., early exit commissions) for investors to remain long-term; as a result, they were used like money market funds while benefiting from long-term paper returns.

### The adjustment (market shock) and price corrections
- Drivers
  - Indication that U.S. interest rates could increase (FOMC policy language changes in January and March, strong economic data, stronger employment) shifted interest rate expectations; U.S. Treasury yield curve moved upward (especially long end) while emerging market bonds experienced widening spreads.
  - Market participants unwound long-term positions to realize capital gains and to hold more liquid short-term positions.
- Costa Rica-specific adjustments
  - Adjustment began in the short part of the curve, notably with central bank certificates of deposit.
  - First important adjustment: March 17 cd$c5 issuance which "fell 273 basis points."
  - Correction extended to longer-term eurobonds by the Ministry of Finance and, by May, to paper issued in colones.
- Variation in prices of Costa Rican Eurobonds (Table 6 — in percentage). Columns: Oct-Dec 2002; Jan-June 2003; Jul-Dec 2003; Jan-Mar 2004; Mar-Apr 2004; Apr-May 2004; May-Jun 2004 (preserved exactly).
  - BDE08: n.a.; 6.4; 0.5; 1.1; -7.0; 0.6; -0.2
  - BDE09: -0.6; 8.7; 1.1; 0.9; -7.2; -1.5; -0.8
  - BDE11: -0.5; 7.1; 1.9; 2.8; -6.9; -2.0; -2..0
  - BDE12: -0.9; 7.4; 0.5; 3.8; -6.7; -2.6; -1.3
  - BDE13: n.a.; 5.0; 1.4; 3.8; -7.1; -3.1; -1.3
  - BDE14: n.a.; n.a.; n.a.; 0.5; -6.1; -3.8; -3.4
  - BDE20: -2.2; 6.3; 2.4; 4.7; -6.4; -6.6; 0.4
  - Source: Arce, Jose Luis.

### Impact: run on mutual funds and losses
- Performance and redemptions
  - During March–April 2004 most financial funds experienced negative returns for the first time in their history.
  - Negative returns during March–April 2004: average of 3 percent in dollars and 1 percent in colones.
  - A massive run of around US$1,500 million occurred in three weeks.
  - By June 2004:
    - Total assets declined by 52 percent for funds in dollars.
    - Total assets declined by 33 percent for funds in colones.
    - Number of investors declined from 67,327 (December 2003) to 39,573.
  - Growth funds were most severely affected, followed by income funds.

### Approach to the crisis: supervisory and market responses
- Early warning and regulatory proposals
  - SUGEVAL had warned about a price bubble (public warning in November 2003) but the warning had no noticeable effect on fund managers or investor behavior.
  - Proposed regulatory measure: subject long-term funds (such as growth funds) to early exit commissions to better match asset maturities and investor permanence; proposal was not approved by the Consejo Nacional, which viewed it as "very interventionist."
- Supervisory preparedness and coordination
  - SUGEVAL had off-site supervisory mechanisms that provided real-time information on secondary market trading and redemption levels, but had no emergency plan for a massive run.
  - The president of the central bank coordinated responses and communicated daily with the three superintendencias; constant multilateral meetings took place at the central bank.
- Liquidity and market-stabilizing measures (actions implemented)
  - Central bank buy back of issuances in colones (BEM) for C 25.000 million.
  - Reduction in outstanding BEMs for more than 155,000 million colones.
  - SUGEVAL authorized mutual funds to increase repo operations from 10 percent to 30 percent; initially refused but later authorized a temporary increase for the period "between April 30 and May 31" when eurobond prices reached sustainable levels.
  - SUGEVAL instructed managers of funds with significant redemptions to initiate winding-up processes so that "all customers would be redeemed at the same time, once all assets were liquidated" to avoid unfair treatment.
  - Pricing and market structure adjustments:
    - SUGEVAL approved an amendment to the pricing vector to eliminate the "drag along" method to price securities, helping to smooth price volatility.
    - SUGEVAL authorized the BNV to carry out block trades in a separate market.
- Communications
  - SUGEVAL deployed additional resources to the Information Center; full page announcements in major newspapers emphasized investor information-gathering rather than specific advice to redeem.
  - SUGEVAL added a special web link with daily information on all mutual funds and a "Frequently Asked Questions" section; the superintendent engaged with the press urging responsible coverage.
- Post-crisis review
  - After the crisis SUGEVAL carried out a review of market compliance to identify needed enforcement actions and regulatory framework changes.

### End of the crisis: market mechanics
- Liquidity generation and trading patterns
  - Fund managers used outright sales to obtain liquidity to honor redemptions.
  - Outright sales increased as a share of total transaction volume:
    - For the trimester March–June 2004 outright sales reached 32 percent of total volume of transactions.
    - Prior average was 24 percent of total volume.

*Source: _wp06288 - 119.18 to 124.87) from January to mid-April 2004.*

### 2003. Conversely repo volumes diminished during the crisis due to the fact that fund

### _wp06288 - 2003. Conversely repo volumes diminished during the crisis due to the fact that fund

### Liquidity dynamics and repo activity
- For the same trimester, repo operations represented 67 percent of the total volume of transactions, from an average of 75 percent in 2003.
- Repo volumes diminished during the crisis because fund managers needed to unwind repo positions in order to have securities available for sale.
- Local banks were the buyers who provided mutual funds with the liquidity necessary to honor redemptions; market participants indicated most buying was carried out by the state-owned banks.
- Some market participants believed state-owned banks found it easier to “help” their funds because of their diffuse ownership.

### Bank deposits and investor flows (April–June 2004)
- Deposits in state-owned banks increased by 389,680 million colones, a 77 percent increase from 2004.
- Deposits in privately owned banks increased by 81,327 million colones (16 percent).
- Deposits in the Banco Popular y de Desarrollo Comunal increased by 35,146 million colones (6.9 percent).

### Mutual fund industry impacts and structure
- The crisis had a lasting effect on the mutual fund industry, which has not reached pre-crisis levels again.
- Income and growth funds were the most affected due to larger concentrations in long-term Costa Rican issuances and greater sensitivity to variations in interest rates.
- Money market funds increased, mainly because portfolios are valued at cost and have shorter “duration.”

- Table 7. Mutual Fund Industry (1/ In millions of colones. Source: SUGEVAL.)
  - Money market
    - Assets under Management: Dec 03 85,631; Dec 04 172,338; Dec05 186,427
    - Number of Investors: Dec 03 7,750; Dec 04 9,413
    - Number of Funds: Dec 03 26; Dec04 28
  - Short-term
    - Assets under Management: Dec 03 88,960; Dec 04 104,828; Dec05 74,049
    - Number of Investors: Dec 03 4,555; Dec 04 4,082
    - Number of Funds: Dec 03 16; Dec04 16
  - Income
    - Assets under Management: Dec 03 278,086; Dec 04 102,018; Dec05 112,387
    - Number of Investors: Dec 03 12,326; Dec 04 5,219
    - Number of Funds: Dec 03 30; Dec04 28
  - Growth
    - Assets under Management: Dec 03 651,085; Dec 04 127,388; Dec05 81,261
    - Number of Investors: Dec 03 40,299; Dec 04 10,095
    - Number of Funds: Dec 03 58; Dec04 48
  - Equity
    - Assets under Management: Dec 03 1,839; Dec 04 1,262; Dec05 0,796
    - Number of Investors: Dec 03 198; Dec 04 147
    - Number of Funds: Dec 03 3; Dec04 3
  - Real state
    - Assets under Management: Dec 03 94,546; Dec 04 130,630; Dec05 202,139
    - Number of Investors: Dec 03 2,134; Dec 04 2,719
    - Number of Funds: Dec 03 10; Dec04 11
  - Securitization
    - Assets under Management: Dec 03 3,793; Dec 04 4,140; Dec05 3,055
    - Number of Investors: Dec 03 77; Dec 04 77
    - Number of Funds: Dec 03 1; Dec04 1
  - Total
    - Assets under Management: Dec 03 1,203,940; Dec 04 642,604; Dec05 660,117
    - Number of Investors: Dec 03 67,327; Dec 04 31,752; Dec05 31,003
    - Number of Funds: Dec 03 144; Dec 04 135; Dec 05 131

### Reputation and institutional consequences
- Public perception held that the SUGEVAL should have done more to avoid the crisis; the superintendent was summoned twice to the Legislative Assembly and announced he would step down in September 2004.

### IV. Lessons from a regulatory perspective — Micro level
- The crisis resulted from an adjustment in prices of Costa Rican sovereign paper that had been overappreciated.
- Concentration limits for Costa Rican sovereign paper were proposed by some market participants but the report argues such limits are conceptually inappropriate because asset allocation decisions should rest with investors; imposing local concentration limits would effectively compel exposure to foreign paper.
- Disclosure requirements (1999 SUGEVAL regulations) required a prospectus explaining investment policies, risks, and risk management mechanisms and required fund managers to provide the prospectus prior to investment; SUGEVAL review found these basic disclosures were present.
- Shortcomings in disclosure:
  - Lack of a prominent warning on prospectus covers stating funds were concentrated; the new framework recently approved does require such warnings.
- Market conduct failings:
  - Placement and marketing practices were inadequate; many investors wrongly assumed principal protection comparable to certificates of deposit or savings accounts.
  - Fund managers should be subject to financial intermediaries’ regulation including market conduct rules from subscription to redemption.
  - “Know your customer” and “suitability” obligations were widely neglected by placement agents.
  - Numerous complaints for inadequate information and advice at placement were filed before the SUGEVAL.
  - In some state-owned bank–owned fund cases, investors were told the fund carried the full faith and credit of the government (true only for state-owned bank liabilities).
- Conflict of interest concerns:
  - Banks invested in mutual funds reportedly redeemed participations early without informing the market or clients, likely reducing their losses relative to individual investors.
- Corporate governance and risk management:
  - Inspections showed many fund managers lacked selection and training programs for sales personnel; sales staff often lacked professional or technical qualifications.
  - Most fund managers had not developed policies to cope with interest-rate risk; many income and growth funds lacked early exit commissions that could have slowed runs.

### The challenge of mark-to-market and valuation oversight
- Developing a methodology that reasonably leads to fair value remains a key challenge while secondary markets lack sufficient depth and liquidity; individual trade prices may not reflect market conditions.
- The methodology attempted to establish stricter parameters to determine trades usable for estimating security prices.
- Regulatory division of responsibilities:
  - The superintendencia emphasized that asset valuation and development of methodologies are the responsibility of fund managers and chose not to be part of the “methodology committee” instituted by the BNV, though it kept active communication.
  - Many fund managers delegated valuation responsibility to the BNV; the report recommends clarifying roles and responsibilities of fund managers vis-à-vis the price vendor and strengthening supervisory mechanisms.

### IV. Lessons from a regulatory perspective — Macro level
- The SUGEVAL’s “rules-based” and “single pillar” approach relied exclusively on the regulator to ensure compliance; this approach is criticized for creating moral hazard and misplacing primary responsibility for compliance onto the regulator rather than market participants.
- Recommendation to shift toward a multi-pillar approach:
  - Emphasize self-discipline of financial institutions through sound corporate governance and risk management.
  - Use market discipline and reserve regulator’s role for monitoring, evaluating, and strengthening institutions’ risk management processes.
- Cultural change needed: place primary responsibility for regulatory compliance, policies, procedures, internal controls, and risk management with market participants.

### Financial literacy
- The general low level of financial literacy exacerbated the crisis; many investors had not perceived differences between mutual funds and banking accounts because mutual funds had not previously experienced losses.
- Investor education efforts before 2005 (brochures, website, information center) largely reached existing investors; since 2005 SUGEVAL shifted toward activities attracting the average citizen, including an Investor Fair and periodic public presentations.
- Mass media is noted as an effective tool for financial literacy programs.

### Capacity building
- Importance of capacity building across market participants, including the regulator.
- Reliance on international consultants for drafting regulations is common, but sustainable market development requires investing in local staff training.
- Recommendation: include training within terms of reference of external consultants to ensure local capacity to implement and oversee regulations.

*Italic: Content derived from the supplied IMF PDF chapter/section.*

### APPENDIX I. THE STRUCTURE OF FINANCIAL REGULATION IN COSTA RICA

### APPENDIX I. THE STRUCTURE OF FINANCIAL REGULATION IN COSTA RICA

### Regulatory architecture
- Regulation and supervision of the financial sector is shared by three specialized regulators:
  - the Superintendencia General de Entidades Financieras, in charge of the regulation and supervision of the banking sector;
  - the Superintendencia General de Valores (SUGEVAL), in charge of the regulation and supervision of the securities sector; and
  - the Superintendencia de Pensiones in charge of the regulation and supervision of the pension sector.
- Although part of the central bank, the law affords the superintendencias operational (functional) independence; thus the central bank cannot give directions or orders to the Superintendencias in the areas under their competences.
- The Superintendencias share a common board, the Consejo Nacional de Supervision del Sistema Financiero, responsible for:
  - providing general guidance and approving the regulations of the three superintendencias;
  - decisions regarding the suspension and liquidation of financial intermediaries, based on a proposal of the superintendente in charge;
  - reviewing on appeal any decision taken by the superintendentes.

### Governance and decision-making
- Composition of the Consejo Nacional:
  - seven members: five members from the private sector appointed by the board of the central bank for a five year period with the possibility of reelection and removable only with due cause, and two ex officio members: the minister of finance and the president of the central bank.
- Operating practices:
  - the consejo holds separate meetings for each superintendencia; superintendents are allowed to participate in all meetings.
  - the agenda of each session begins with “issues of interest for the three superintendencias” to strengthen coordination.
- Superintendents:
  - each superintendencia is headed by a superintendent appointed by the Consejo Nacional for a five year period, with the possibility of reelection and removable only with due cause.
  - except for suspension and liquidation of market participants, day-to-day operational decisions are taken by the superintendent.
  - the superintendent is a full time civil servant and the head of the personnel of the superintendencia.

### Funding and budgeting
- Funding split:
  - Twenty percent of the actual expenses of the superintendencias are funded by fees levied on market participants, while the remaining 80 percent is covered from the budget of the central bank.
- Budget process:
  - Every year the central bank defines the maximum amount to be given to the superintendencias altogether.
  - Within this limit, the Consejo Nacional approves the budgets of each superintendencia, based on a proposal submitted by each superintendent.
  - The Consejo Nacional has instituted a budget committee to deal with budget issues in a unified way.

---

### APPENDIX II. THE PRICING VECTOR DEVELOPED BY THE BOLSA NACIONAL DE VALORES

### Purpose and scope
- The pricing vector is a system that generates a unified price report for a selected group of securities.
- It is based on observations from trades carried out in the stock exchange; when observations do not exist, prices are estimated using methodologies developed for different categories of securities.
- The current pricing vector comprises seven different categories of securities:
  - a) Issuances that comprise the sovereign yield curve (SYC)
  - b) Other public debt issuances
  - c) Private debt issuance
  - d) Foreign issuances
  - e) Equity issuances
  - f) Unit of close-end funds
  - g) Premium for other debt issuances of public entities

### Data inclusion rules
- Only prices generated by outright sales that are settled in the same currency of the issuance are considered.
- Only prices from trades that fall within certain volume thresholds are taken into account. The stock exchange has developed different thresholds depending on the type of securities. As of today, those limits are:

  For issuances that are part of the SYC
  - Colones: Inferior 30,000,000  Superior 350,000,000
  - Dollars: Inferior 100,000  Superior 2,000,000

  For all other bonds
  - Colones: Inferior 10,000,000  Superior 350,000,000
  - Dollars: Inferior 35,000  Superior 1,000,000

  For equity
  - Colones: Inferior 5,000,000  Superior 350,000,000
  - Dollars: Inferior 15,000  Superior 1,000,000

- The stock exchange determines the “weighted average price” (WAP) or the “weighted average yield” (WAY) for each category of securities.
  - For issuances that are part of the SYC the system requires at least three trades (transactions) during a trading day to run the calculations; for all other issuances the system requires one trade.

### Calculation formulas and conventions
- WAP formula (as provided):
  - PPP =    ∑ P_i,j * FV_i,j   i,j, 
            —————————————
            ∑ FV_i,j   i,j
  - Where,
    - j: Issuance
    - P_i,j: Price observed in trade i for the issuance j
    - Y_i,j: Yield observed in trade i for the issuance j
    - FV_i,j: Face value observed in the trade i for the issuance j
    - WAP_j: Weighted Average Price for issuance j
    - WAY_j: Weighted Average Yield for issuance j
- WAY formula (as provided):
  - WAY =  ∑ Y_i,j * FV_i,j   i,j,
            —————————————
            ∑ FV_i,j   i,j
- System conventions:
  - The system works with clean prices, that is, accrued interest is excluded.
  - The system uses the annual nominal yield.

### Sovereign Yield Curve (SYC) methodology
- The methodology builds first a SYC, which considers the relationship between time until maturity and the yield for that maturity for different issuances.
- Only issuances by the minister of finance and the central bank are used to build this curve.
- The stock exchange decides the specific issuances that will be part of the SYC based on turnover and diffusion.
- For issuances with fewer than three trades during a trading day:
  - the system calculates a “Mobile” WAP, which takes prices observed during the last five trading sessions – under certain circumstances.
  - If there are no observations during the last five trading days, then the last observed price is taken to run the calculations.

### Private debt issuances and premiums
- When there are no observations for a private issuance, prices are calculated based on the SYC and the “individual premium” for the particular issuance.
  - The individual premium is determined in relation to the SYC by comparing the yield of each issuance with the yield of the sovereign issuance with the same maturity.
  - The premium is added to the points in the curve to determine the equivalent yield for each particular issuance.
- The system recalculates the premium with information taken from the secondary market; if at some point the price is taken from market observations, the system will recalculate the premium as a function of the new information.

*Source: APPENDIX I. THE STRUCTURE OF FINANCIAL REGULATION IN COSTA RICA; APPENDIX II. THE PRICING VECTOR DEVELOPED BY THE BOLSA NACIONAL DE VALORES*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp06288.pdf_