Last November 8, FIAP’s Secretary-General, Francisco Margozzini, attended the seminar “The Latin American ETF Market is about to change,” jointly organized by S&P Dow Jones Indices and the Santiago Stock Exchange.

On the occasion, FIAP’s Secretary General referred to the prospects of the Latin American Integrated Market (MILA), due to the novelty of funds being traded on the stock exchange (ETF). Below is a summary of the main questions and ideas presented in his speech.

How have the Pacific Alliance (AP) countries been working with the pension funds in the region to encourage investment in these countries? What is MILA’s role in this issue?

The pension funds of the four PA countries have almost US$ 473 billion in managed assets.

However, intra-regional investment is low: Chile and Peru invested 1.5% of total assets in PA countries; Colombia 1.3%, and Mexico has virtually no investment (it only records 0.03% invested in Chile). There is still a long way to go.

Source: FIAP.

Foreign investment has practically reached its limits in Mexico and Peru. There is still some leeway in Chile and Colombia.

The pension funds are involved in financial integration in the PA, in 2 areas:

1. Mobility of the pension funds of workers who migrate from one country to another. Due to the strong existing migratory processes, and the fact that there are pension systems of similar characteristics in these 4 PA countries, the goal appears to be easy to achieve. Obstacle: The Ministers of Finance and Economy froze this topic due to the regulatory change in Peru that allows the withdrawal of 95.5% of the fund.
2. The Funds Passport would allow the free marketing of mutual and investment funds approved in any PA member country.

In April 2017, the Financial Supervisors of the PA agreed on a road map for the implementation of the funds passport. This is not a simple task, since it requires unifying investment fund criteria, such as: protection of the investor, corporate governance standards custody of funds, eligible assets, liquidity of funds, investment limits, indebtedness and use of derivative instruments. The idea is to take the experience of the European UCITS, to establish a common set of rules for a number of countries that make up a significant joint market.

What is the trend in ETF use by the pension funds in the MILA markets?

Investment in ETFs by the PFs in Colombia and Peru is approximately 60% of foreign investment. In Mexico it is 92%, since the regulations only allow foreign investment through ETFs or structured vehicles. In Chile it is less than 20%.

ETF investment by the pension funds
(MUSD and % of foreign investment)

Source: FIAP.

Greater use of ETFs by the pension funds has been observed in the last few years.

With the draft pension system reform law in Chile (which seeks to address the issue of the mistakenly denominated “hidden commissions,” despite the fact that they are regulated, controlled and reported by the Superintendency of Pensions), which will make it mandatory for the AFPs to pay part of the costs of investment in mutual and investment funds, the PFs are expected to prioritize investment in ETFs.

What would you recommend to MILA for the regional pension funds to make more investments in the markets comprising it?

Continue working on the funds passport, not only to increase intra PA investments, but also to encourage investors from anywhere in the world.

In general, the PA member countries are small in global terms, so investing in them is expensive (analyze domestic regulations, illiquidity, etc.).

Stock market participation in the global stock index
MSCI all countries worldwide (ACWI), May 2017

The funds passport should promote the liquidity of funds and lower transaction costs.

What factors would make them consider investing in MILA funds?

• Costs
• Liquidity
• Importance of the funds passport for giving the funds liquidity by allowing the participation of other investors.

Obstacles to investing in the PA

• Market obstacles. Pension funds have access to most of the instruments that interest them in each PA country, through markets outside the region (New York, Luxembourg, Cayman Islands), that provide them with liquidity and low operating costs.
• Investment strategies of the PFs. Investment in PA countries does not contribute significantly to the diversification of portfolio risk, since there is high degree of correlation between the 4 economies. However, these markets are known, since they are closer.

Regulation. Chile requires a minimum risk rating of countries in which AA classification funds are domiciled, which in practice prevents the Chilean FPs from directly investing in instruments of any other PA country. The Risk Classification Committee (CCR) can exceptionally approve funds domiciled in countries with BBB ratings, due to which investments could be made in PA countries, although, in practice this has not been done.  Foreign investment has practically reached its limits in Mexico and Peru. In Mexico, moreover, investment in active funds is not allowed (they can only invest in ETFs).