Latin American Capital Markets

340 A. M. CORCORAN, R. B. HOBSON, G.J. KUSERK, K. K.WUERTZ, AND D.WESTshifting functions served by futures markets can be effective tools for dealing with thevolatility common to emerging market economies, the development of futures marketsin such economies can assist in better management of expected revenues incountries dependent on export commodities and otherwise enhance commercialmarkets. For example, the ability to neutralize and price interest rate risk in an organizedderivatives market may make a jurisdiction's own sovereign debt more attractive.In this regard, the primary example of a successful derivatives market in LatinAmerica is in Brazil, where the derivatives market evolved from a cash commercialmarketThe Bolsa de Mercadorias & Futures (BM&F) in Brazil originated from the bottomup through the evolving activities of cash market participants. The market hasprofited from price volatility survived macroeconomic instability and learned from itsmistakes (see the appendix). In Brazil, the regulatory framework for derivatives productsis changing, with new legislation adopted this year providing additional powers tothe securities regulator to regulate the market in financial as well as equity-based derivativesand to enhance the scheme of central bank supervision of institutions engagingin derivatives transactions. Brazil is also unique in that a number of the transactionsthat occur at the BM&F are not typical of most futures markets; they are moretailored counterparty transactions that are guaranteed by the exchange.Although this chapter focuses on the development of exchange-traded derivatives,in the past three decades, OTC options and swaps (and in some markets,more customized exchange offerings) have increasingly been part of the mix of derivativesinstruments available to market participants. Many of the benefits associatedwith these bilateral contracts, which can be tailored precisely to specific risks, are similarto those associated with futures contracts traded on an exchange. That is, theyallow users to manage price risk However OTC transactions differ from futures inthat they permit users to fine-tune their risk management activities and consequenthedges to a greater degree than is easily accomplished with the more standardizedcontracts generally thought necessary to support most traditional exchange trading.Substantial standardization is viewed as essential to the functioning of the exchangemarkets because a contract entered into between A and B is intended to be offsetwith a transaction between A and C. Identity of contract terms makes the contractsfungible. In contrast, an interest rate swap is a financial transaction between two specificcounterparties who agree to exchange, at specified intervals and for a set term,streams of payments based on specified interest rates calculated on an agreed notionalprincipal amount Typically, one party will agree to pay the other party a streamof payments based on a fixed interest rate, while the latter party agrees to pay theformer party a stream of payments based on a variable interest rate, although thereare other models. Of course, the flexibility of OTC derivatives is not obtained with-Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub