So far this century, Peru’s economic story has been one of unmitigated success. The economy has almost tripled in size, while poverty has halved. But that hasn’t been matched by the stockmarket. In recent years, Peru’s bourse, the Bolsa de Valores de Lima, has been beset by falling liquidity and plummeting values.
It is tough to invest in a country where the total market capitalisation makes up less than 30% of GDP. Especially when almost half the market is dominated by just three companies and the rest are small and illiquid. It’s not just a problem for investors either. Deep, liquid, sophisticated capital markets help countries make the difficult jump from middle-income to rich, so it is vital for Peru too.
The struggling stockmarket
One of the surprising elements about the slow development of Peru’s capital markets is that the country has most of the ingredients needed. It has a well-established stockmarket, indeed the BVL can trace its roots back more than 150 years. The country also has a solid financial system, which shrugged off the financial crisis, and a well-run, prudent central bank. Throw in a booming, open economy and you would imagine Peru has all of the elements required for a vibrant stockmarket. But Carlos Garcia, who founded one of Peru’s largest independent investment banks, Summa Capital, believes that serious, structural challenges remain to be solved before capital markets can expand.
“the BVL can trace its roots back more than 150 years…”
“I worked in the US for 14 years, so when you compare Peru to a market like that you can see the areas that we are missing. The major one is the huge informality in our market. Unless we reduce informality we won’t have large capital markets. We also have to educate business people because they don’t want to open their books up to investors. The previous government focused on the tax incentives but that is not the whole picture. We need a major restructuring with a more diverse and independent set of actors. When you have a situation that most of the participants are connected to Peru’s major financial groups then you have a huge concentration and you don’t get the freedom needed to support expansion and innovation. The final problem is overregulation. Regulators are too paternalistic which stifles the market.”
People may disagree with Garcia about the causes but few can quibble about the results. “We have 240 shares in the BVL but only 18 have some liquidity and of them only three meet international criteria. The market cap is around $70billion down from $120billion a few years ago. You don’t have depth, liquidity or secondary markets, so there is very little interest from Peruvian companies to raise money by debt issuance.”
The lack of local enthusiasm for the stockmarket has not gone unnoticed. Indeed the government and the exchange have been working to make the BVL more attractive to investors. Last year the government cut the stockmarket’s 5% capital gains tax, which brought the BVL inline with other bourses in the region. Meanwhile the exchange has worked to reduce transaction costs, which have roughly halved in the last few years. Indeed it is continuing to look at bringing down the costs, says, Francis Stenning, CEO of the BVL. “It is something we are working on. One important element will be changing the model, from charging for transactions to charging for connectivity. Effectively it would make it more of a fixed cost than a variable cost. We want to bring costs down but really it needs an integral solution. All of the players from the brokers to the regulators need to be part of the change. We are working on a package and the market can expect news on further cost reductions some point this year.”
Another important step that should encourage more people in Peru to use the stockmarket was the recent decision by the outgoing administration to free up retirees’ pension pot. It had been obligatory for pension holders to buy an annuity from an insurance company but now 95% of funds can be invested freely. That has encouraged providers to develop new products that guarantee the principal while offering a yearly income. Other options for retirees include bank savings, debt repayment or property, so only time will tell if equities and fixed income succeed in winning a share of this new bonanza.
Positive efforts have also come from the private sector. Late March saw the launch of the Asociación de Administradoras de Fondos Mutuos (AAFM). It is made up of five local asset managers: BBVA Asset Management Continental, Credicorp Capital, Fondos Sura, Interfondos and Scotia Fondos. Given that there are just eight asset managers present in Peru the association already represents a significant chunk of the market. AAFM should help by improving industry standards and raising awareness of the benefits of mutual funds.
Increasing the offer
You can attract as many investors as you like but the major lifeblood of an exchange is the amount of companies on offer. Until now Peruvian firms have been reluctant to open up to investors via capital markets. One reason, says Stenning, is the tough competition from local banks. “Peru’s large corporations are overbanked with many sources of corporate sector debt at competitive rates. The rounds of quantitative easing exacerbated that trend.” But Stenning hasn’t given up the fight yet. In recent years the BVL has established a trial scheme for medium-sized firms that want to experiment with capital markets. The BVL helps them meet the required reporting and corporate governance standards before they issue short-term debt. “We have 15 firms that came through the window for mid sized companies. It was a great success for them and many now plan to follow up with an equity listing at some point. These are 2nd or 3rd generation family-owned firms, so listing some equity can be a good way to handle ownership issues. After the initial success of the scheme there are more local companies that want to get involved.”
Peru’s economy is dominated by small to medium family-owned firms, so investors need to find a way to gain exposure to them. At the moment these small and medium-sized firms can get bank loans with an annual rate between 7% and 15%, so they pay far more than their larger peers. Moreover credit for smaller firms is overwhelmingly short-term. This stunts their growth, says Garcia. “The banking system when it lends it is short tenure, normally three to five years, so 80% of cashflow is focused on servicing debt.”
And this is where the BVL thinks it can help. “We need to work on providing smaller firms with lower cost finance”, says Stenning, “and that means coming up with innovative products.” One useful ally in this regard may well be the new government. President Pedro Pablo Kuczynski, is a former US private equity investor, while Minister of Economy and Finance, Alfredo Thorne, worked at JP Morgan Chase. It means this government is far more pro-market than its predecessor and is keen to develop Peru’s capital markets.
Peru’s capital markets have not developed as quickly as most analysts expected but, in the long-term, it is inevitable that they will expand. The combination of top-down support from the new government and the innovation from market participants, set against a backdrop of a rapidly expanding economy makes it only a matter of time.