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MILA: A New Phase of Integration in Latin America

Strong growth in Latin America is catching the eye of many business and investors. But when it comes to decision time, Brazil is often the only financial market big and sophisticated enough to make a trade worthwhile. However, three of Latin America's smaller but most dynamic economies plan to combine forces to offer a viable alternative and open up their markets to local and international investors.

Chile, Colombia and Peru have already begun the first phase of integration in a process that will eventually lead to direct trading on a common bourse. The Integrated Latin American Market, known under its Spanish acronym MILA, will unite 563 companies and have a total market capitalisation of US$647 billion, according to Bloomberg data. That would make it second only to Brazil's Bovespa in the region, relegating Mexico into third place. Trade volume is also set to be among the highest in the region, with initial estimates pointing to a daily sum of US$300 million.

The three Andean states make natural companions: they share a Pacific coastline, an economic model based on openness to trade, and democratic values. But individually, each market is too small to attract large sums of investment compared to the continent's economic and financial powerhouses.

By pooling liquidity and deepening capital markets, each of the countries should be better placed to compete for foreign investment with the region's traditional powerhouses, with Mexico the most likely to lose market share, according to Victor Hugo Rodriguez, CEO of LatAm Alternatives. This scale advantage applies especially to the two smaller markets in the MILA group, Peru and Colombia, which hope to gain more weight in regional indices.

As well as the obvious benefits of lower transaction costs and improved cross-border trade efficiencies, the combined market will allow investors to diversify their holdings. Where now most investors in Peru are concentrated in the booming mining sector, a portfolio in MILA could be expanded to include Chilean retailers and Colombian construction firms. Each individual market, especially Peru and Colombia, has traditionally been too small or risky for most investors, particularly foreign, to look beyond the countries' dominant industries.

Attracting the Big Players

The increased market depth and new trading opportunities should make each of the MILA countries more attractive to institutional investors such as hedge funds. The injection of liquidity that funds could bring will benefit companies operating in all the nations involved as they will be more likely to draw on the increased capital and issue shares. There is also hope for a fresh wave of IPO's, particularly among medium-sized firms that have traditionally struggled to raise equity finance due to the limited number of buyers.

However, according to Victor, for hedge funds to be drawn to the integrated market, the project needs to be complimented with new regulation that makes it easier for investors to trade on the short side. "While there are a lot of opportunities on the long side, they are hedge funds, so they need to hedge the risk. If they don't have an easy way to short the securities then there is no appetite to even go long."

Prior to the launch of the first phase of integration in November, Chile was the only market out of the three that permitted short selling. As liquidity grows, Carlos Rojas, Chief Investment Officer at the Compas Group, expects a new derivatives market to develop rapidly from 2012, with an "explosion" of activity in the short market. Carlos expects the creation of many new hedge funds in the next 12-24 months, drawn in by the region's growth potential as well as the considerable arbitrage opportunities that will exist, in the short term at least, between the three merged markets.

The Practicalities of Integration

International investors such as hedge funds will also require evidence of a solid and harmonised market infrastructure. The alignment of tax and legal systems across the three countries is a complex project already underway. Peru's involvement in the regional integration was temporary stalled as legislators resisted reducing capital gains tax to a flat 5%, so as to align regulation with the other two countries. This hold up was largely behind the decision to delay the launch of the new bourse – originally scheduled for end-January – until March at the earliest.

These complications aside, the MILA project is part of a concerted effort among certain Latin American countries to consolidate their markets and make them more attractive for global investors. In a move that is separate but complementary to MILA, Colombia and Peru have also announced a corporate merger of their respective bourses, the first deal of its kind in Latin America. Carlos believes that by end-2011, these two markets will be fully integrated and then expects Chile to join the process.

In addition, Panama's stock exchange has expressed interest in combining with other bourses in Central America and does not rule out petitioning to join MILA at some point. Argentina is also reportedly considering integration options so as not to be left behind in the region.

Closer financial ties will also support broader economic integration in the region: in December, for example, Mexican officials joined the three countries involved in MILA in talks over a new trade and development deal provisionally named the "Pacific Pact".

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