Latin American Capital Markets

316 CLEMENTE DELVALLEfinancial practices, and market integrity (see Vittas 1998,2000). Government securitiescan fulfill the need for long-term, fixed-interest, and low credit risk instruments. Incountries where equity markets are well developed, institutional investors usually allocatea substantial portion of their portfolios in those markets, but where they have notdeveloped, pension funds and insurance companies invest heavily in bonds. In addition,where the bond market is well developed, institutional investors prefer nongovernmentalfixed-income securities, while in nondeveloped bond markets, pension fundsand insurance companies invest heavily in government bonds. Finally, it is important tonote that institutional investors and securities markets complement and improve eachother; thus generating a virtuous circle. Chile was the first Latin American country thatimplemented pension reform. Other countries that have implemented similar schemesare Argentina, Colombia, Mexico, Peru, and Uruguay. Due to their professionalism,these new market participants have introduced better risk management and bettermarket practices to Latin American countries.The main challenge going forward is toavoid a high level of concentration in industry as a result of the high concentration inthe financial system due to economies of scale or barriers to entry.Retail investors constitute a nonvolatile source of funding, but the problemof reaching out to this clientele has to do with high processing and distributioncosts. However; the use of new technologies, such as the Internet, may open newopportunities to sell government securities directly to retail investors efficiently andat low cost.Nonfinancial corporations do not tend to invest in government securities. Althoughthey use these securities to manage liquidity and hedge risks, they are notlong-term investors. Despite this circumstance, nonfinancial corporations can contributeto the development of money markets by investing directly in treasury billsand short-term government bonds or indirectly via money market funds.Foreign investors are important participants in emerging markets and couldbe heavy investors in domestic government bonds.They not only add liquidity to themarket but also help extend the yield curve of government securities. Foreign investorsdemand high-quality and cheap financial services and credible and safe infrastructure.And, because they are especially sensitive to market movements and theirportfolios are actively managed, foreign investors can add volatility to the market.Thiscould aggravate a delicate financial situation and, because emerging markets are perceivedas one asset class, foreign investors could spread a contagion effect to countrieswith sound economic fundamentals. However; economies with more stable andsound macro conditions will be better equipped to make the participation of foreigninvestors in local markets a win-win situation.Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub