Lessons from emerging Lessons from emerging markets: how applicable is the markets: how applicable is the

regulatory framework for regulatory framework for emerging debt marketsemerging debt markets

Washington, June 2nd 2003

Clemente Del Valle

Chairman Securities Commission, Colombia

Lessons from developed markets

Colombian debt market: ongoing reforms

AGENDAAGENDA

Colombian debt market experience: an illustrative case of its achievements and mistakes

Final remarks

Derivative market

Money market

Government bond market

Private sector bond market

Well-developed capital markets provide benefits for the entire

economy…

Well-developed capital markets provide benefits for the entire

economy…

Provides liquidity

Supports the building of the short-term yield curve

Reduces the cost of GS

Provides short-term bonds and standardized issues for the money market

Provides the market benchmark yield curve

Supports the development of capital markets infrastructure

Expands investors’ options

Leads to a more balanced domestic financial architecture

Better financial management practices

Leads to low interest rates

…and are an essential tool for

growth

Level of development of the financial sector

Basic legal framework and infrastructure

Issuer Investor

Intermediaries

Macroeconomic policy

Money market

Primary market

Secondary market

SOURCE: Developing Government Bond Markets Handbook, World Bank – IMF, 2.001

Fair, efficient and transparent market

Objectives of regulatoryframework

Principles of the legal frameworkPrinciples of the legal framework

Minimization of systemic risk

Protection for investors and

consumers of financial services

Prevent improper market conduct (market manipulation & insider trading)

Intermediaries with minimum capital requirements

Internal control procedures

Transparent information disclosure

Reliable systems for settlement of cash and securities transactions

“Fit and proper” rules for management in securities firms

A well-developed debt market implies:A well-developed debt market implies:

High levels of professional standards, self-discipline, ethics and size of the intermediaries ( a “professional market”)

A well functioning money-markets

Good enforcement capacity of the legal and regulatory framework (e.g. ordinary justice, SEC capacity)

And /or effective self-regulatory schemes

However a major hurdle in many emerging markets going forward is that

those pre-requisites have not been properly assess or have been taken for

granted

Macroeconomic

Stability

Financial

Stability

Bankruptcy

Law

Debt Policy• Debt strategy

•Market oriented funding strategy

•Auction procedures

•Transparency

•Gov. Bond standardization

•Short-term yield curve

Money Markets

(repos market)

Competition

Infrastructure andRegulation

Debt Policy• Strength government debt teams

•Use of primary dealers

•Risk management

•Extend bonds maturities

Infrastructure andRegulation upgrade

Secondary Gov. Bondmarket liquidity

Secondary intermediaries

Credit RatingSystem

Disclosure System

ExpandInvestor base

TIME

Measures in the short and medium term

Measures in the short and medium term

Lessons from the developed markets

Colombian debt market: ongoing reforms

AGENDAAGENDA

Colombian debt market experience: an illustrative case of its achievements and mistakes

Final remarks

SOURCE: Ministry of Finance.SOURCE: Ministry of Finance.

5,000

10,000

15,000

20,000

1996 1997 1998 1999 2000 2001 Sep-02

Bill

ions o

f U

SD

5%

10%

15%

20%

25%

GD

P %

Local Debt Local Debt (%GDP)

The domestic sovereign debt has experienced a major development in the

last decade…

The domestic sovereign debt has experienced a major development in the

last decade…

0%

50%

100%

150%

200%

250%

300%

% G

DP

1996 1997 1998 1999 2000 2001 2002

Transactions of TES

Outstanding balance of TES

…It has deepened the capital market…It has deepened the capital market

SOURCESOURCE: Ministry of Finance.: Ministry of Finance.

0,8

11,3

3,0

12,9

3,8

11,7

5,4

12,5

6,8

11,5

0

4

8

12

16

1998 1999 2000 2001 2002

Dematerialized securities Securities under custody

Most of the fixed income securities are dematerialized

Most of the fixed income securities are dematerialized

Evolution of securities under custody and and dematerialized securities - DECEVALBillions of dollars

SOURCESOURCE: DECEVAL.: DECEVAL.

Daily Average 1997 - 2003

0

200

400

600

800

1.000

1.200

1.400

1.600

1.800

jun-

97ag

o-97

oct-9

7di

c-97

feb-

98ab

r-98

jun-

98ag

o-98

oct-9

8di

c-98

feb-

99ab

r-99

jun-

99ag

o-99

oct-9

9di

c-99

feb-

00ab

r-00

jun-

00ag

o-00

oct-0

0di

c-00

feb-

01ab

r-01

jun-

01ag

o-01

oct-0

1di

c-01

feb-

02ab

r-02

jun-

02ag

o-02

oct-0

2di

c-02

feb-

03

Mill

ions

of

dolla

rs

Source: BVC and Banco de la República

Private DebtPublic Debt

Main electronic transactional systems have deepened the market

Main electronic transactional systems have deepened the market

0,0313,88

28,00

141,00

253,40

0

50

100

150

200

250

300

1998 1999 2000 2001 2002

SEN Transactions

Millions of dollars

SENSEN

Daily Average 1998 - 2002

MECMEC

0,0%

50,0%

100,0%

150,0%

200,0%

250,0%

300,0%

350,0%

400,0%

450,0%

1998 1999 2000 2001 2002

Pro

po

rció

n d

el P

IB

MEC INVERLACE with out REPOS REPOS Inverlace SEN Equity market

Repos inverlace

SEN

INVERLACE without ReposMEC

EQUITY

Developing the secondary marketDeveloping the secondary market

SOURCESOURCE: Superintendence of Securities.: Superintendence of Securities.

SOURCESOURCE: Superintendence of Securities.: Superintendence of Securities.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1998 1999 2000 2001 2002

EXTERNAL BONDS PUBLIC BONDS TESCDT PRIVATE BONDS REPO OPERATIONSOTHERS

However, showing a high concentration of TES …

However, showing a high concentration of TES …

0%

20%

40%

60%

80%

100%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

TES CDT Private Bonds T.P. Others

Stock MarketStock MarketThe TES market has increased its The TES market has increased its

participation in the stock market from participation in the stock market from 6% in 1.993 to 40% as of December 6% in 1.993 to 40% as of December

2.002.2.002.

TESTES

TESTES

Debt portfolio profile has been extended

Debt portfolio profile has been extended

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Bill

one

s d

e p

eso

s

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

Dec-97Dec-02

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

1995 1996 1997 1998 1999 2000 2001 2002

Año

s

Duration

Average Term

SOURCE: Ministry of FinanceSOURCE: Ministry of Finance

The strategy used has improved the portfolio structure, increasing

duration conditions, and average term.

TES PORTFOLIO PROFILE

TES PORTFOLIO PROFILE

Likewise the yield-curve has been extended

Likewise the yield-curve has been extended

SOURCE: Ministry of Finance, April 2003SOURCE: Ministry of Finance, April 2003

0

2000

4000

6000

8000

10000

12000

Millio

ns U

S$

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

F.C.O. Pensiones y cesantías Fondos Valores

Seguros Patrimonio Ecopetrol

Fondos Comunes Ordinarios, Fondos de Pensiones y Cesantías, Fondos de Valores, Compañías de Seguros y

Patrimonio Autónomo ECOPETROL

In the same way, Institutional Investors have grown

In the same way, Institutional Investors have grown

SOURCE: SOURCE: Superintendence of Securities and Superintendence of BanksSuperintendence of Securities and Superintendence of Banks

Investor Base StructureInvestor Base Structure

Others13%

Financial Corporations

1%

Insurance Companies

2%

Central Bank3%

Retail Investors9%

Others2%

Depositories4%Trustee Entities

12%

Pension Funds9%

Commercial Banks15%

Treasury Division

9%

Public Sector34%

2.0022.002

SOURCE: Ministry of FinanceSOURCE: Ministry of Finance

0

10.000.000

20.000.000

30.000.000

40.000.000

50.000.000

60.000.000

1995 1996 1997 1998 1999 2000 2001 2002

Collective Investment Scheme Stock Fix Income + TES

Financial System Total Loans

SOURCE: SOURCE: Superintendence of Securities and Superintendence of BanksSuperintendence of Securities and Superintendence of Banks

The size of securities market has consistently increased during the last

years…

The size of securities market has consistently increased during the last

years…

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1995 1996 1997 1998 1999 2000 2001 2002

DIVISAS UTILIDAD VALORACION INVERSIONES

DERIVADOS INGRESOS VENTA, DIVIDENDOS INVERSIONES

SERVICIOS FINANCIEROS LEASING (SIN AJUSTES POR INFLACION)

PROPRIETARY

TRADING

INCOME STRUCTURE (CREDIT ENTITIES)

Likewise, development of proprietary trading in banks has brought increased sophistication of

the market

Likewise, development of proprietary trading in banks has brought increased sophistication of

the market

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1998 1999 2000 2001 2002COMISION ADMON. FONDOS DE VALORES

CUENTA PROPIA OTROS INGRESOS OPERACIONALES

PROPRIETARY TRADING

COMMISSION

As well as in the brokerage firms…

As well as in the brokerage firms…

SOURCE: Asobancaria and SOURCE: Asobancaria and Superintendence of SecuritiesSuperintendence of Securities

Industry standards:

• Low professional standards of the market intermediaries

• Absence of market integrity

Improper use of securities and public resources

Distortion of the financial operations and statements

Absence of proper Chinese-walls

• Shortage of capital adequacy and proprietary trading rules

• Inadequate risk management skills (prudential issues)

Nevertheless, some problems have put the market in a risky situation in

recent years ………

Nevertheless, some problems have put the market in a risky situation in

recent years ………

Deficient supervisory capacity

• Imbalance between supervision and regulatory capability

• Weak enforcement and surveillance

• More focus on equity markets and brokerage activity (instead of fixed income market)

• Scarce budgetary autonomy

Lack of a self-regulation scheme:

• A Weak SRO system in place ( stock exchange)

• There is not enough independence between the SRO role and the commercial and association roles

• Weak oversight capacity of the supervisor

Nevertheless, some problems have put the market in a risky situation

Nevertheless, some problems have put the market in a risky situation

Limited development of the money markets:

• Unclear legal definition of the Repo contract: guarantee loan or temporary buy-sell back guarantees

• Regulatory arbitrage given lack of coordination between Superintendence of Banks and SEC (terms, discount, operation limits)

• Unsecure and inefficient settlement system for securities lending and repos (not assume counterparty risk)

• Inappropriate haircuts and margin calls

• Inadequate transparency for creditors

Nevertheless, some problems have put the market in a risky situation

Nevertheless, some problems have put the market in a risky situation

Price formation distortions (Mark to market):

• Regulatory arbitrage. Two different regimes between Superintendence of banks and the SEC

• Inflexible accounting structure impedes an update to international standards

• Numerous mark to market methodologies that do not reflect market conditions

• Absence of a pricing system

• Mark to market methodology completely outdated with respect to the international trend

Nevertheless, some problems have put the market in a risky situation

Nevertheless, some problems have put the market in a risky situation

Lessons from the developed markets

Colombian debt market: ongoing reforms

AGENDAAGENDA

Final remarks

Colombian debt market experience: an illustrative case of its achievements and mistakes

Mark-to-market valuation• SV and SB already issued identical rules to value securities (to avoid

regulatory arbitrage) - September 2002

• SV has approved the methodology developed by BVC to act as a price vendor for TES - January 2003

• Development of a methodology to provide market prices needed to apply the valuation rules

• Establishment of a private sector advisory committee - May 2003

Proprietary position• Rules of capital adequacy have been issued with industries’ approval (March

2003 - August 2003)

• Standard ratio of capital to weighted risk assets and market risk

• Based on IOSCO principles and the new Basel Capital Accord

Priority given to issuance of prudent regulation

Priority given to issuance of prudent regulation

Coordination with State entitites: Ministry of Finance, Central Bank, Superintendence of Banks and Superintendence of Securities to align regulation with respect to:• Limits• Participating agents • Collateral• Risk factors

Work orientated towards development of Repos market, as base for other markets.

... And to develop the money-market

... And to develop the money-market

Identify the risky areas within the industry activities

Establish the standards for the participants that would diminish those risks (e.g. brokers, dealers, clearinghouses, rating agencies, advisors)

Discourage and sanction improper trading and practices

Separate treatment and management of intermediary and client assets

Brokers, asset managers and advisors must acquire licenses to operate ( professional exams)

Increase the professionalism standards of the industry

Increase the professionalism standards of the industry

Strengthen the governance of BVC

• Clear mandate for the independent directors

• Auditing committee

Detach self-regulation arm from BVC administration

Diversify the composition of the independent members

Spin off their association activity

Governance of the Colombian Stock Exchange - BVC

Governance of the Colombian Stock Exchange - BVC

Securities Law

• Adoption of IOSCO principles

• Regulation based on “activities” and not on “entities”

• Adoption of standards applicable to the market participants

• Adoption of new sanctioning procedures

Strengthening of the supervision capability introducing international accounting standards and improving oversight of the auditing industry

Modernize the regulatory frameworkModernize the regulatory framework

Internal function specialization.

• Reassignment of functions such as surveillance, enforcement and authorizations.

Creation of the Collective Investment Schemes division

Reducing red tape.• Avoiding duplicity.• Abolishing some previous authorizations.

Developing an automated system for the surveillance function

Strengthening the oversight capacity over the BVC.

Strengthening of the Superintendence of Securities (SV)

Strengthening of the Superintendence of Securities (SV)

Lessons from the developed markets

Colombian debt market: ongoing reforms

AGENDAAGENDA

Final remarks

Colombian debt market experience: an illustrative case of its achievements and mistakes

Primary emphasis should be focused on a sound legal and regulatory framework to develop an adequate debt market

Building that framework and a professional market takes time and requires a strong commitment of the industry and the regulator

The Ministries of Finance as issuers should involve early in the process the securities regulatory agency

Regulatory agencies should reassess the relative priority in terms of supervision (equity market vs. debt market), given the reality of their market.

The regulatory framework should take into account the enforcement capability of the supervisor

There is a need to strengthen the SRO scheme given the lack of resources of the supervisor (administrative restrictions and budgetary capability).

Final remarksFinal remarks

Lessons from emerging Lessons from emerging markets: how applicable is the markets: how applicable is the

regulatory framework for regulatory framework for emerging debt marketsemerging debt markets

Washington, June 2nd 2003

Clemente Del Valle

Chairman Securities Commission, Colombia