Latin American Capital Markets

350 A. M. CORCORAN, R. B. HOBSON, G. I. KUSERK, K. K.WUERTZ,AND QWESTparticipation of speculators who are capable of assuming significant positions. A portionof this interest may come from local financial firms (or so-called intermediaries)willing to make a market on the exchange—which may be easier to organize thannonfinancial commercials—and the remainder must come from outside the market.Attraction of such users requires that the culture of the jurisdiction seeking to developa market be supportive of speculative activity.A more recent way to provide liquidity is to permit commercials, which havean active cash market, to seek an organized electronic derivatives market to host theirproduct.The host brings with it a liquidity facility and committed users and permitsthe commercial interest to develop trading liquidity from local traders or investors ormarket makers already doing business on the facility. Although fungibility is considereda necessary component of a contract that would attract such interest, it is often notsufficient 16 There also must be an arbitrage or profit potential and traders with an appetiteto take as well as transfer risk 17 Even in the experience of the United States,a country that is especially rich in speculative capital, many more contracts fail thansucceed on account of the absence of profit potential.Characteristically, organized derivatives markets (as opposed to OTC and alternativemarkets) are highly transparent. This is because making pricing transparentis part of their purpose and permits the liquidity essential to anonymous risk shifting.When price and market information is revealed in a timely manner; market participantsare able to assess the quality of prices they obtain on transactions. Where thequality of price fills (the price at which the contract is executed) is low, a participantmay elect to seek higher-quality venues. Where these do not exist, entrepreneurs willbe encouraged to improve the market or establish better ones.Thus, there should bea tendency for participants to gather in markets offering the fairest prices, therebyconcentrating liquidity and enhancing the efficiency of the market18 In the absence oftransparency, or where price negotiations are between counterparties of similar expertise,knowledge, and market power market participants may remain in illiquid, inefficientmarkets for extended periods of time because of the search costs involvedin seeking out better markets and prices. Such markets may prove deficient for riskmanagement purposes. Transparency ensures that derivatives markets can function16 The cleared OTC contracts at BM&F may be an exception.17 New types of arrangements are now being contemplated that would couple the tailoring possible on the front endthat is characteristic of OTC markets, with the credit support of a central counterparty or other guarantee arrangementspreviously characteristic of exchange markets. Market developers should consider what combination of frontend (trading) and back end (credit) would most likely support their risk management needs.18 The dissemination of ticker or prices traditionally has been a significant source of revenue for futures markets.Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub