Latin American Capital Markets

DEVELOPING A STRATEGY FOR REFORMING CAPITAL MARKETS 13conditions of market access reflects the lack of a significant, dedicated investor baseand the dominant role of crossover investors in Latin American financial markets.The role of crossover institutional investors is particularly important in transmittingthe effects of asset price volatility from mature to emerging markets. Crossoverinvestors typically hold most of their investments in mature markets and investa relatively small fraction of their holdings as claims on emerging markets. 5 During aperiod of uncertainty about emerging market developments and/or increased riskaversion, investors reduce or eliminate investments in emerging economies. A recessionin the United States would reduce capital flows to Latin America and theCaribbean due to deterioration in the region's prospects for exports, smaller inflowof funds from crossover investors, and weaker business prospects. A lower internationalinterest rate would be unlikely to be sufficient to change the scenario. 6In this difficult environment, Latin American countries with severe domesticimbalances, somehow hidden by the now ending exceptionally favorable external environmentof the 1990s, might have to confront more supply constraints and see littleincrease in net flows. This scenario emphasizes the importance of reform of domesticcapital markets in the region.Factors Affecting Market DevelopmentThe past decade witnessed severe financial crises in emerging economies—most notably,the devaluation of the Mexican peso in 1995 and the Thai baht in 1997, theBrazilian crisis of 1998, and the Argentina crisis of 2001 —that highlight the risks of investingin emerging markets. In addition, the expectations of low correlation in investinginternationally do not fully apply for many securities in emerging countries.Thesetwo factors have made investors wary of investing in international and, in particular,emerging capital markets.The demand for securities from emerging markets depends on expected returnsand the stage of development of the market infrastructure, especially the legaland regulatory framework and the level of transparency under which listing firms operate.In Latin America and the Caribbean, the securities that have successfully attractedinternational investors have been characterized by international activity, applicationof international standards in accounting and auditing, and simultaneous listings5 According to 1995 data, I percent of domestic equity holdings by institutional investors in the G-7 countries isequivalent to slightly more than I percent of global stock market capitalization but to 66 percent of the market capitalizationof the Latin American economies.6 Furthermore, the events of September 2001 will certainly have an adverse impact on the global economy.Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub