Latin American Capital Markets

INSTITUTIONAL INVESTORS AND CAPITAL MARKET DEVELOPMENT 141the increased liquidity costs of selling shares in large portfolios and the fact that alternativeinvestments may be limited. Other OECD countries, particularly more bankorientedmarkets, effect management discipline less through the market and morethrough representative stakeholder interests on corporate boards.Deregu/ot/on and the Prudent Investor RuleDeregulation has had a substantial effect on the growth of institutional investors bylowering the cost of securities transactions. As their economic power in the marketshas increased, institutions frequently have been the catalysts for reform. For example,institutions were instrumental in dismantling the fixed commission structure for securitiestrades in the U.S. markets.This event, which took place on May 1, 1975, or "MayDay," resulted in the introduction of discount brokerage, greater price competition,and lower transaction fees (U.S. SEC 1994). As trading costs were reduced, marketvolume and liquidity went up. Facing the loss of commission fees, securities firms becamemore innovative in designing new pooled-investment products (U.S. SEC 1992).Similar to the United States, deregulation of the London Stock Exchange in 1986 witha "big bang" was intended to reduce the transaction costs of institutional investors, increasemarket liquidity, and enhance London's role as an international financial center(Poser 1991).In addition to deregulation, institutions have also had access to a wide supplyof potential investments through liberal portfolio investment requirements. UnderERISA, pension funds are managed in accordance with a standard known as the prudentinvestor rule, which allows plan fiduciaries to invest securities in the best interestsof the overall portfolio. Under this standard, fiduciaries have considerable latitudein their investment choices and are able to diversify assets in accordance with modernportfolio theory. 12 Thus, ERISA allows pension funds the ability to invest in U.S. annon-U.S. equities, private equity, and high-risk investments, limited only by fiduciary prudenceand certain ERISA compliance rules.To protect against self-dealing by plan sponsors, each individual with discretion over plan assets can be held liable as a fiduciaryand face stiff civil and criminal penalties. In Europe, only a few countries, such as theUnited Kingdom and the Netherlands, operate pension investment schemes in accor-12 The prudent investor rule is a revised and updated version of the common-law "prudent man" standard governingthe activities of investment trustees and other financial fiduciaries. The prudent man rule dictated that each investmentbe evaluated individually in terms of risk and potential return. Under the prudent investor standard, fundmanagers were judged on the prudence of the portfolio as a whole, thus allowing them to make riskier investmentswithout fear that a single poorly performing investment would result in charges of fund mismanagement. Under ERISAthe prudent man standard has also been interpreted to hold fund fiduciaries to the level of skill of a professionalmoney manager in making investment decisions or a "prudent expert."Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub