The report gives details of the economic analysis for the implementation of Chile's inflation targeting framework. It reviews the current state of liquidity in the Chilean fixed-income markets and developments and impediments to the supply of corporate bonds to the market. The paper considers a number of microstructure issues, transparency in the Over-the-Counter (OTC) market, addresses the role of public debt in facilitating development of the financial markets, and discusses a potential debt management framework that would support the development of a liquid public debt market.


The report gives details of the economic analysis for the implementation of Chile's inflation targeting framework. It reviews the current state of liquidity in the Chilean fixed-income markets and developments and impediments to the supply of corporate bonds to the market. The paper considers a number of microstructure issues, transparency in the Over-the-Counter (OTC) market, addresses the role of public debt in facilitating development of the financial markets, and discusses a potential debt management framework that would support the development of a liquid public debt market.

II. Deepening Liquidity in the Chilean fixed-income Markets1

Executive Summary

  • This paper reviews the current state of liquidity in the Chilean fixed-income markets. It assumes that the authorities maintain a minimum supply of public debt necessary to support the development of a risk-free yield curve in both peso and UF.

  • It also reviews developments and considers a number of potential impediments to the supply of corporate bonds to the market, recommending that the authorities seek to reduce the time required to register a bond and remove the distortions caused by the current operation of the stamp tax.

  • The paper goes on to consider the characteristics of demand in the market, recommending that liquidity could be improved by relaxing some of the investment restrictions on private pension funds and reviewing the procedures surrounding the taxation of foreign investors.

  • Finally, the paper considers a number of microstructure issues, recommending enhanced transparency in the OTC market and a strengthening of the regulatory framework in some specific areas, including the provisions covering market intermediaries, clearing, and settlement. It also makes a case for the introduction of a system of specialists in public debt, tailored to the current needs of the market.

A. Introduction

1. The Chilean securities market has deepened significantly in recent years, but it remains characterized by a low degree of liquidity. This aspect was highlighted in the 2003–04 Financial Stability Assessment Program (FSAP) report, which identified some specific weaknesses in market infrastructure. Building on this report, the present paper focuses on liquidity in the fixed-income markets. It reviews the current situation and proposes a number of potential changes.

2. Ensuring an adequate level of liquidity in the domestic capital market is an important objective for policy makers. Liquidity enhances the resilience of the economy to shocks, enabling it to absorb the impact of budgetary or external shocks. It also enhances the risk management capacity of the financial system, facilitating financial intermediation and corporate sector access to capital; reduces the cost of capital, by lowering liquidity premia; increases the efficiency of pricing, improving the allocation of capital across the economy; and facilitates more effective monetary policy implementation. The paper is organized as follows: Section B provides an overview of liquidity in the fixed-income markets; sections C and D discuss some issues in the supply of bonds to the market; section E reviews the characteristics of demand and section F addresses issues in the market microstructure. Section G concludes.

B. Overview of the Fixed-Income Market

3. The size of the Chilean fixed-income market is comparable to that in several OECD countries.2 As a ratio to per capita GDP, the government bond market in Chile is larger than in Norway and New Zealand but, relative to Mexico, it is small.3 The corporate bond market, at twice the level of GDP per capita and 12 percent of GDP, is of a size similar to that of Norway and New Zealand.

Table 1.

Selected Countries: Domestic Bond Market

(In US$ billions)

article image
Source: BIS, WEO.

2005 data.

4. International comparisons suggests that there is scope for improving liquidity in the fixed-income market. A liquid market is generally defined as one in which trading can be accommodated with little effect on price. Measuring the liquidity of a market is not straightforward, but it can be proxied by measures such as the turnover ratio. Although, at an aggregate level, Chile’s average turnover ratio has trended upwards in recent years, it remains well below that in other countries (Figure 1). In 2005, total turnover in fixed income on the Bolsa de Comercio de Santiago (BCS) was US$37.4 billion, consistent with an overall turnover ratio of 1.1; this ratio was significantly lower than in Norway (2.5) or Australia (3.9).4

Figure 1.
Figure 1.

Turnover, 2001–05

Citation: IMF Staff Country Reports 2006, 336; 10.5089/9781451807653.002.A002

5. Liquidity is concentrated in the public debt market. Close to 70 percent of all fixed-income transactions on the BCS involve public debt instruments, with most activity concentrated in the 5–and 10–year inflation-indexed benchmarks, which are also actively traded in the OTC Tasas market. Bid-ask spreads for these benchmark bonds are indicative of relatively good liquidity. However, activity in Chilean public debt instruments significantly lags that in other comparable markets: the turnover ratio for such instruments is 1.6 in Chile compared with 2.1 in Norway, 4.2 in New Zealand, 6.1 in Australia, and 17 in Canada.5

C. Supply of Public Sector Fixed-Income Securities

6. Initiatives taken by the Chilean central bank in recent years have helped enhance the role the public debt markets play. In 2002, shifting away from the older-style Pagarés Reajustables con Pago en Cupones (PRCs), the central bank introduced standard bullet bonds denominated in both pesos (BCPs) and in inflation-indexed Unidades de Fomento (UF) (BCUs). It also began establishing benchmark bonds at key maturities on both the peso and inflation-indexed yield curves. At end–2005, 39 percent of all public debt outstanding in the domestic market was comprised of these new standardized bullet bonds (24 percent in BCUs and BTUs and 15 percent in BCPs).6 This has allowed the development of a yield curve, out to 10-years in pesos and 20-years in inflation-indexed bonds (such a development would have been significantly more cumbersome with the older bonds, given their amortizing structure). Auctions, held at regular intervals, were introduced in 2003 as the main mechanism for issuance in the primary market, modernizing the approach to public debt management. This, together with the introduction of an annual issuance calendar in 2006, have also helped increase transparency in the market.7

7. In the government bond market, a clear and explicit market development strategy would help resolve uncertainties regarding future debt issuance. This strategy could include several elements, including a decision to meet the government’s financing requirements primarily in the domestic market and a clear commitment to the development of a liquid yield curve. This strategy should also include a clear calendar of issues, coordinated with the central bank’s issues, and other structural measures to strengthen the market, such as the introduction of designated market specialists or market makers.

D. Supply of Corporate Debt

8. The market for primary issuance of corporate debt is active, with rising volumes. Net issuance in the domestic market has increased significantly in recent years; since 2000, it has averaged more than double the volume of net issues abroad—US$1.5 billion compared with US$0.6 billion (Table 2). There has also been an increase in the number of corporates issuing: Between 1995 and 2004, the total number of corporates with domestic bonds outstanding rose from 48 to 72. Outstanding domestic corporate debt securities account for 11 percent of GDP in Chile compared with 4.6 percent of GDP on average for emerging markets and 2.6 percent for Latin America. In that respect, Chile is closer to the OECD countries (16½ percent of GDP on average) than to neighboring economies.

Table 2.

Corporate Debt Issuance and Stock, 1995–2005

(In US$ billions)

article image
Source: SVS, BIS.

9. To some extent, the increase in domestic corporate debt issuance reflects a shift in issuance from external to domestic markets. The preference of some issuers for the domestic market suggests that they fully appreciate the benefits of accessing the local pool of liquidity. Market participants report that there is now a significant cost advantage to issuing in the domestic market and generally consider that it is easier to issue longer tenors in the domestic market than abroad. They also stress that the increasing liquidity of the US$/UF and US$/CLP forward market allows issuers to issue domestically and swap the proceeds into U.S. dollars, if needed.

10. Corporate issuance is concentrated in UF-denominated instruments. Corporates have two main incentives for issuing inflation-indexed paper: (i) there is a strong demand from life insurance companies for such paper; and (ii) the absence of a nominal government yield curve at longer tenors hinders the pricing of peso-denominated debt. As a result, corporates have to bear some unwanted inflation risk given that the market for long-term CLP/UF swaps remains limited, despite some recent improvements in liquidity.

Issuance process

11. The regulatory framework for the issuance of fixed-income products does not appear to present major impediments to the development of the market. The framework provides sufficient flexibility to issuers in terms of issuance size, structure, and characteristics. Public offering requirements are reasonable and in line with international standards.

12. Corporate debt issuance is relatively easy for large corporates, but small corporates face significant hurdles. The problems for smaller issuers seem to arise primarily from their credit quality and size. In practice, they are often unlikely to obtain the credit rating required for private pension fund investments. Also, the generally smaller size of issuance tends to deter private pension funds and other major institutional investors. Altogether, this has led to a compartmentalized capital market, with reduced opportunities for smaller issuers.

13. The length of the registration process for new bond issuance does act as an impediment to the development of the market, particularly for smaller issuers. Issuers and banking sources report that it takes a minimum of 90 days to issue a corporate bond, even for large corporates. This includes 30–40 days to register with the Superintendencia de Valores y Seguros(SVS) and an additional period of at least 30 days to complete the registration process with the Comision Clasificadora de Riesgo (CCR). These delays tend to be longer for smaller and lower credit grade corporates. Although the SVS has taken several positive steps to reduce the burden for issuance of new tranches of pre-registered bonds, the regulatory authorities should explore ways to reduce the approval process further. In particular, given that local credit rating agencies are now well established, the authorities could consider streamlining the role of the CCR, refocusing its activities on the areas where it can add most value.

14. The stamp tax adds to the cost of issuance, particularly for shorter tenors. The stamp tax is applied as a flat rate tax (of 1.6 percent) on all financing activities. Consequently, its cost impact on long-term financing is significantly lower than on short-term financing. For example, assuming a general level of interest rates of 5 percent, the stamp tax adds 172 basis points to the cost of a one-year instrument, 38 basis points a year to a 5–year instrument, and 21 basis points a year to a 10–year instrument.8 This structure tends to impact small and medium-sized enterprises (SMEs) more significantly, given their relatively volatile and uncertain financing needs. This may also encourage them to favor bank lending over capital market financing, as banks may be able to offer more flexibility in the type of instruments provided. The stamp tax also hinders competition in the provision of financing, as the relief available on rolled-over debt is restricted to roll-over with the same lender.

15. The authorities could consider equating the incidence of the stamp tax across maturities, reducing current distortions. Ideally, a comprehensive review of the taxation of financial instruments would be undertaken to allow an assessment of the overall cost-benefit impact of the stamp tax. Reducing or eliminating the tax could be considered within an overall framework that would take account the impact on fiscal revenue as well as agents’ behavior in the market.

Foreign issuers

16. Recent regulatory changes have opened up the possibility for foreign corporate debt issuers to tap the domestic Chilean market. Recently-issued SVS regulations facilitate the issuance of debt by non-resident corporates. Although these regulations have only been in place for a few months, there are some encouraging signs of interest from Latin American corporates. Likely barriers include the stamp tax and the requirement that the issuer be approved by the CCR to ensure that it can access the pool of liquidity held by pension funds. Whilst it would be surprising if non-resident issuance grew to a significant share of the market quickly, the SVS and other market participants could advertise this facility internationally to help enhance its development.

Securitization market

17. Although the market for mortgage-related bonds functions well, securitization is still modest. The market combines both mortgage-backed securities (letras hipotecarias) and endorsable mortgage loans (mutuos hipotecarios). While the securitization of mutuos hipotecarios has virtually disappeared, following the decline in interest rates in recent years, securitization of letras hipotecarias continues at a steady pace. More recently, other assets have been securitized, mainly related to department store credit cards and leasing associated with housing and car loans. Complex forms of securitization are almost non existent.

18. Securitization could be enhanced as a useful mechanism to provide SME access to capital. Given the importance of small and medium sized enterprises (SMEs) for the growth of the economy, many countries have developed programs to help improve their access to credit through securitization. The Chilean authorities could explore ways to link guarantees issued by the Fondo de Garantia para Pequeñas Empresas (FOGAPE) to securitization schemes (Box 1 outlines a potential framework, based on the experience of Spain).9

E. Characteristics of Demand

19. The Chilean domestic market is dominated by a small group of large buy-and-hold investors. In general, market activity is enhanced when investors have different risk-return characteristics and investment motives. In Chile, the majority of domestically issued public sector bonds is held by buy-and-hold investors—private pension funds hold 56 percent of the outstanding stock and the insurance sector another 15 percent. Combined with low levels of public sector debt issuance, this is a strong impediment to the development of a liquid secondary market in debt. At the same time, the Chilean private pension funds hold close to 20 percent of their assets in cash and bank deposits, compared to an OECD average in the low single digits (Table 3). Such high holdings reflect unsatisfied demand for domestic fixed income assets and, in such a situation, new issues by investment grade corporates are often over-subscribed.

SMEs Securitization: The Spanish Case

Foreign experience. Since the late 1990s, several European countries have incorporated securitization into their SME programs; Germany and Spain have been the most active. These programs are also developing in other regions of the world; in 2005, Singapore launched its SME Loan Access program. A key feature of these programs is the provision of some sort of public guarantee.

Main features. The Spanish program is likely to be the most relevant for Latin American countries, since it is based on cash securitization rather than synthetic securitization, as in Germany. Its mechanics are as follows: The SME loans are passed by the originator to a special purpose vehicle, the Fondo de Titulizacion para PYMEs (FTPYME). The Treasury commits to guaranteeing specific tranches issued by the FTPYME, provided that the fund holds a minimum percentage of bank loans to SMEs in its portfolio. In return for the liquidity gained through the sale of the SME loans, the originator commits to reinvest part of this liquidity in SME financing.

Developments. Initially, FTPYMEs had to hold at least 40 percent of SME loans in their portfolios; the Government was committed to guarantee tranches with credit ratings of at least BBB; and the originator was committed to reinvest 40 percent into new SME financing. These features were subsequently modified and, at present, the minimum percentage of SME loans is 80 percent; the Government is committed to guaranteeing tranches with AA credit ratings and above; and originators need to reinvest at least 80 percent of their liquidity into new SME financing. The scheme is supported by a master agreement signed with the Ministry of Economy.

Bank participation. Approximately 60 Spanish banks have participated in the scheme. In a few cases, SME portfolios from several banks have been packaged into one single securitization transaction. In 2004, SMEs securitization in Spain amounted to 18 percent of the total volume of securitization issuance (€9.3 billion out of total issuance volume of €51.6 billion).

Table 3.

Portfolio Composition of Pension Funds: Chile and Selected Countries

(In percent)

article image
Sources: SAFP, OECD, APRA, Irish Pension Fund Association, Danish Supervisor, Davis (1995 and 2001).

20. Greater liquidity in the secondary market would improve the efficiency of portfolio valuation. The regulatory authorities in Chile take two approaches to valuation of institutional investors’ portfolios. In the case of mutual funds, the Mutual Fund Association has taken the lead in developing the Sistema Unificado de Precios (SUP), the pricing source for the industry. In the case of private pension funds, the Superintendencia de Administradoras de Fondos de Pensiones (SAFP) has developed a pricing vector, providing daily prices to pension funds and insurance companies for the valuation of their portfolios. Market participants have expressed concern about the quality of prices generated by this pricing vector. A more coordinated approach would leverage industry expertise, improve the quality of valuation overall, and allow greater differentiation of performance across different institutional investors.

Domestic Investors

21. The Chilean pension system is highly concentrated, with no significant cross-fund variation in portfolio asset allocations. There are 6 private pension funds in Chile, with the largest 3 managing more than 70 percent of total assets. The high elasticity of substitution between pension funds due to minor differences in performance, coupled with asymmetric penalties for under-performance relative to the industry average, has led to funds achieving almost identical returns. As a result, they hold similar asset allocations, a lack of diversity which generates inertia and low liquidity in the secondary market.

22. Greater competition in the provision of private pension funds management services might lead to an increase in diversity of views, generating greater activity. Achieving this increase in competition will not be straightforward. One approach that could be considered would be to split the administration business from asset management, allowing firms to specialize in the provision of those services where they have the greatest comparative advantage. As economies of scale considerations are likely to be relatively less important on the asset management side, such a split might encourage new entrants.

23. The tight regulatory framework imposes strict limits on private pension fund investment opportunities. An important quantitative restriction is that funds cannot invest more than 30 percent of their assets in foreign issues, and this allowance is fully utilized (Table 3). As noted, investment restrictions on pension funds result in holdings of cash that are significantly higher than in other developed systems, thus reducing the returns to contributors.

24. Relaxing the restrictions on holdings of foreign assets appears desirable. This would allow private pension funds to transfer much of their cash holdings into foreign equity and fixed income, which would help increase the expected return to contributors. In many small developed countries, large private pension funds not subject to binding foreign investment limits do invest a significantly larger share of their assets abroad. For example, pension funds in Ireland and the Netherlands invest over 60 percent of their assets abroad, in part because of the lack of suitable liquid instruments domestically. The increasing availability and liquidity of foreign exchange forwards means that the resultant foreign exchange exposure could be effectively hedged.

25. The development of the derivatives market is also hampered by existing restrictions on private pension fund activities. At present, private pension funds are only permitted to use derivatives to hedge an exposure, which in effect means hedging a currency exposure. While new regulations might allow private pension funds to participate in the interest rate derivatives markets, current restrictions limit their ability to actively manage their duration and/or take strategic views on interest rate developments. It also limits activity in the derivatives markets, reducing liquidity and the effectiveness of that market.

26. Life insurance companies tend to hold long-dated inflation-indexed securities, which are scarce. Insurance companies represent the second largest buy-and-hold investor class in the fixed-income market, with life insurance accounting for 70 percent of total insurance business. In 2005, total investments of insurance companies amounted to US$22.1 billion, with 15 percent of total held in public sector debt, 21 percent in mortgage-related debt, and 34 percent in corporate debt. As the pension fund system matures and more annuities are required when contributors retire, there will be added pressure for the life insurance sector to acquire inflation-indexed long-dated debt. In the absence of significant new public sector issuance, the majority of such debt will need to come from the corporate sector. To the extent that such supply will not be forthcoming, there could be an increasing mismatch between the assets and liabilities of the life insurance sector, with unwanted consequences for the provision of annuities.

27. The mutual fund industry has grown steadily over the last 10 years, resulting in a new source of demand for fixed-income assets. At end-2005, the mutual fund industry managed US$13.7 billion in assets, up from US$2.5 billion in 1995. During 2005, the net value of funds under investment grew by 5 percent, with a 17 percent increase in the number of participants (Table 4). Since only 3 percent of the population presently holds such a fund, there seems to be significant scope for this industry to experience continued growth. Mutual funds are increasingly active in the public sector and corporate debt markets, providing much needed competition and alternative investment perspectives to the pension and insurance sectors. They also tend to hold longer-dated paper than in the past and now participate directly in the primary debt issuance of both government and corporate paper.

Table 4:

Developments in Mutual Fund Industry, by Type

article image
Source: SVS.

28. The growth of a high-yield market in Chile may be determined by developments in the mutual fund industry. Investment restrictions prevent private pension funds from playing a significant role in the development of a high-yield sector in Chile.10 Even if some additional flexibility were granted to invest in sub-investment grade bonds, it should only be marginal, given that the private pension funds are the main pillar of the social security system, requiring a high degree of conservatism in determining investment parameters. As Table 4 suggests, there appears to be an increase in the risk appetite of mutual fund investors, with a significant increase in the numbers of participants in the more flexible and exotic funds—types 5 (capital instruments), 6 (free investment), 7 (structured) and 8 (qualified investors). This could provide a basis for development of the high-yield market, with mutual funds providing a source of funding for corporates unable to access other investor segments.

29. Broad financial literacy programs would foster the development of a healthy market. As markets develop, the need for more informed investors increases. However, financial literacy often lags the development of financial products. A broad financial literacy program could help relax the strong conservative culture that prevails in the Chilean financial market, further facilitating the development of a high-yield market and enhancing SME access to credit. Programs such as those developed by Singapore and Australia could serve as a reference for the Chilean authorities.

Foreign investors

30. Foreign investor activity in the Chilean fixed-income markets is very limited. In the equity market, the removal of tax impediments in 2001 led to a significant increase in foreign investor participation. In the fixed-income market, although provisions exist to exempt foreign institutional investors from the capital gains tax, the registration process is still cumbersome and some uncertainties continue to exist about the application of these provisions. Improving the operational effectiveness of these provisions, through clear regulations, and simplifying the registration process, by relying to a greater extent on the exchange of information provisions in existing double tax agreements, could increase foreign investor participation. Their presence would add liquidity to the fixed-income market, given likely differences in the risk appetite of foreign investors relative to domestic investors.

31. The lack of information on trading conditions in the Chilean fixed-income market also acts as a deterrent to prospective foreign investors. Some market participants commented that more efforts should be devoted to promoting Chile among foreign investors. They noted the contrast with the situation in Brazil, where the authorities work closely with the Brazilian Mercantile and Futures Exchange and the Brazilian Clearing and Depository Corporation to promote the market to foreign investors through the BEST—Brazil Excellence in Securities Transactions—initiative.

F. Developing Market Infrastructure

32. Turnover in the Chilean fixed-income markets is concentrated on the Bolsa de Comercio de Santiago. The BCS provides full price transparency through an electronic trading platform. Corporate debt securities are traded through periodic call auctions which, given the lower level of liquidity in these instruments, appear to be an appropriate choice of trading mechanism. This concentrates supply and demand at particular points of time, maximizing available liquidity. Meanwhile, public debt securities are traded on a continuous basis on the order book, reflecting their higher liquidity. Liquidity on the exchange is further maximized through a requirement that private pension funds execute their secondary market transactions there.

33. The lack of a block trading facility on the BCS may impede the ability of pension funds to undertake significant portfolio reallocations. While the trading platform provides an adequate mechanism to execute a normal trade size, pension funds are exposed to significant execution risk when undertaking a large portfolio reallocation trade. They are required to either expose the full extent of the trade to the market, risking an adverse price impact, or split the trade, extending the time required to complete the transaction and, thus, increasing their benchmark tracking risk. Many exchanges provide a block-trading facility for larger trades, with delayed publication of transaction prices. Such a facility might bring benefits to the Chilean markets, as it would provide some protection to market participants undertaking large trades, without reducing the quality of regulatory oversight.

34. Transparency in the OTC markets could also be improved. Currently, the wider market only has access to price information from trades executed on the BCS; information on trades conducted in OTC markets is much more limited. Only banks have access to information on OTC Tasas, the electronic interbank market used to trade inflation-indexed instruments, and the telephone market (mercado puntas) is almost completely opaque. The opacity of the market has prevented both market participants and the regulatory authorities from developing a comprehensive picture of its size and structure. While there is little evidence of price distortions, this lack of transparency is thought to discourage new entrants.11 Also, the fragmentation of responsibilities between the SVS and the Superintendency of Banks may reduce the overall effectiveness of regulatory oversight of the markets.

35. The authorities should consider implementing comprehensive reporting and dissemination requirements of trades.12 Reporting could be centralized in the SVS, the Depósito Central de Valores (DCV), or the BCS. A dissemination tool should also be developed. The experience of the U.S. with the implementation of TRACE in the corporate debt market could serve as a reference for the Chilean authorities (Box 2).

Market makers and intermediaries

36. A tailored system of specialists in public debt could add value. It is not clear that a traditional market making system could be supported, given the limited supply of public debt. Neither Australia nor New Zealand, two countries which only have a limited supply of government debt, possesses such a system. Given the dominant position of the pension funds and life insurance companies in the market, a traditional market making arrangement requiring market makers to make firm two-way prices to clients would expose them to an unacceptable level of risk. However, establishing less traditional arrangements would be feasible:

Price Transparency in the U.S. Corporate Bond Market: The Implementation of TRACE

Transparency. In 1998, the U.S. Securities and Exchange Commission requested the National Association of Securities Dealers (NASD) to enhance the transparency and integrity of corporate debt markets through: (i) the adoption of reporting obligations in all transactions in U.S. corporate bonds and the development of a system to receive and distribute transaction prices; (ii) the creation of a database that would enable NASD and other regulators to supervise the market; and (iii) the development of surveillance mechanisms.

TRACE. In response, NASD developed the Trade Reporting and Compliance Engine (TRACE). It was introduced in July 2002, and implemented in phases. Originally, dealers had 75 minutes to report trades to the system. Currently, dealers must report all trades within 15 minutes. Transactions and price details are published immediately on receipt of the report.

Impact. Studies on the impact of TRACE suggest that transaction costs decreased for both retail and institutional investors. While these studies suggest that the effects may not be uniform for bonds with different levels of liquidity and while the observed changes may not be wholly attributable to TRACE, NASD has concluded that increasing price transparency has not had any detrimental effect on liquidity and, indeed, has improved liquidity at the margin.

Regulators. Regulators have also benefited from TRACE. In a testimony before the U.S. Senate Committee, NASD officials stated that “NASD now has a better view into the U.S. corporate debt market ..we have learned that [it] is far more active than originally anticipated and ... contrary to popular belief ... the bond market has a substantial retail participation.

  • Requirements. In Chile, the main purpose of specialists could be to actively promote the development of fixed-income securities to new market participants by providing price information and market analysis. Success could then be determined by increased turnover. This would be similar to the approach in Brazil, where market makers are required to achieve certain turnover requirements in a small selection of designated bonds.

  • Privileges. In return for providing enhanced services to prospective participants, specialists could be given certain privileges in the auctions of public debt—for instance, access to a non-competitive bidding facility—but they would not be given exclusive access to the primary market (Box 3).

  • Meetings. Other benefits might include participation at regular meetings with the authorities to discuss market development issues and issuance plans. Such a regular dialog between key market participants is common in the European and U.S. markets.

37. Market intermediaries should be subject to a robust risk-based supervisory framework, with adequate enforcement mechanisms. Current capital requirements are insufficient, and there are no “fit and proper” requirements in place for securities intermediaries. Although the draft Capital Market II law contains provisions for the development of such requirements, the authorities should consider a more comprehensive review of the licensing requirements applicable to securities intermediaries. With respect to market conduct rules, it would be important to impose symmetric requirements across all intermediaries, including dealers. The BCS has recently constituted a regulatory committee, composed of independent members, to enhance its enforcement capabilities. Close coordination of BCS and SVS efforts should be ensured.

A Potential Framework for Specialists in Public Debt

Introducing a designated group of specialists in public debt. The principal obligation of these specialists would be to actively promote the Chilean fixed-income markets to new market participants by providing price information and market analysis. The principal benefit would be some degree of privileged access to the primary issuance process, such as through a non-competitive bidding facility. This could be achieved through either: (i) allowing them to bid for a quantity of the auction on a non-competitive basis as part of their auction bid; or (ii) providing them with a ‘green shoe’ option, where they could bid for an additional quantity of the bond at a non-competitive price following the auction.

Access to a non-competitive bidding facility could be a function of performance. Performance could be determined on the basis of increased turnover with target groups of investors. This would require specialists to report details of their trading activity on a regular basis to the authorities, a common practice abroad. For example, in Europe, debt managers have harmonized their primary dealer reporting obligations to reduce the burden on primary dealers active in several markets. The authorities may want to consider discounting activity with private pension funds, life insurance companies, and group affiliates, as well as activity in the interbank market. This would increase the relative weight of activity with the more diverse participants the authorities want to attract, such as foreign investors and mutual funds.

General Regulatory Framework

38. The authorities will need to evaluate how best to address deficiencies in the legal framework for clearing, settlement, and custody. Beyond approval of the draft Capital Market II law, which contains key provisions in the areas of netting and movable collateral, reforms are needed to incorporate the concepts of finality and novation. The draft law would also strengthen custody arrangements. However, the authorities will need to evaluate whether additional provisions should be included to clearly address the status of assets held in custody in the event of insolvency.

39. Risk management arrangements for the clearance and settlement of BCS trades should continue to be overseen by the SVS. Operational improvements have taken place in this area: the central bank has recently implemented RTGS, while the BCS has introduced multilateral netting, accompanied by a set of mechanisms to manage settlement risk. It is important, however, that the SVS continue to keep the adequacy of these mechanisms under review and assess whether additional mechanisms, such as a settlement fund or a central counterparty, are needed.

40. Additional changes at an operational level could improve the services provided by the DCV. In particular, if the number of foreign investors increases, the DCV should actively seek arrangements with other central securities depositories abroad, which could generate additional activity by foreign investors at the margin. However, given the presence of foreign banks in Chile, the current arrangements are unlikely to represent a significant impediment to foreign investor activity.

G. Conclusion

41. The authorities should continue to work closely with market participants to develop the fixed-income markets more broadly. Establishing a forum where representatives of the market, market operators, and regulators could exchange views on specific factors impeding the development of the fixed-income markets would be beneficial.13 For example, market development could be enhanced by encouraging the use of standardized repo contracts or developing an active interest rate futures contract.

42. Reducing concentration in demand and increasing the diversity of the investor base would help enhance liquidity. This could be achieved by relaxing the constraints on private pension fund investments abroad; this would also reduce the crowding out effect on other investors, allowing them to develop further. Foreign investors could be encouraged through greater provision of information and effective operationalization of the existing capital gains tax exemption. More generally, the authorities could consider, within a comprehensive review of the taxation of financial instruments, exempting all investors from capital gains and income tax on fixed-income instruments, as they have done for equities. They could also consider specific measures to encourage greater issuance of fixed-income securities, including reviewing the mechanics of the stamp tax.

43. Liquidity could be further enhanced by growth in the mutual fund industry. This objective could be supported by a broad financial literacy program, creating a more sophisticated investor base with more diverse appetites for risk. This source of demand represents a hope for the development of a high-yield market, which would facilitate greater access to the capital markets by SMEs.


  • Battellino, Ric and Mark Chambers, 2006. “An Overview of the Australian Corporate Bond Market,” BIS Papers No. 26.

  • Canada, 2005. “Debt Management Report 2004.–2005,” Department of Finance, Canada.

  • Cifuentes, Rodrigo., Jorge Desormeaux and Claudio Gonzalez, 2002. “Capital Markets in Chile: From Financial Repression to Financial Deepening,” BIS Papers No. 11.

    • Search Google Scholar
    • Export Citation
  • Gravelle, Toni., 1999. “Liquidity of the Government of Canada Securities Market: Stylized Facts and Some Market Microstructure Comparisons to the United States Treasury,” Bank of Canada Working Paper 99–11.

    • Search Google Scholar
    • Export Citation
  • IMF and World Bank, 2001. “Handbook for Developing Government Bond Markets,” IMF and World Bank.

  • Jeanneau, Serge and Carlos Verdia, 2005. “Reducing Financial Vulnerability: The Development of the Domestic Government Bond Market in Mexico,” BIS Quarterly Review.

    • Search Google Scholar
    • Export Citation
  • O’Hara, Maureen, 1995. “Market Microstructure Theory,” Blackwell Publishers.

  • Singh, Manmohan., 2003. “Establishing Debt Benchmarks in Chile: The Role of the Public Sector,” IMF Chile Selected Issues.

  • Zervos, Sara., 2004. “The Transactions Costs of Primary Market Issuance: The Case of Brazil, Mexico, and Chile,” World Bank Policy Research Working Paper 342.

    • Search Google Scholar
    • Export Citation

Prepared by Allison Holland, based on the findings of an MFD Technical Assistance mission comprising Julian Alworth, Brian Bell, Ana Carvajal, Hervé Ferhani, and Allison Holland.


Note bonds issued by financial institutions are excluded from the data on corporate bonds.


Relative to GDP, it is of a similar size.


The turnover ratio is 1.6 if activity on the OTC Tasas market is included. Based on data from the Oslo Stock Exchange and Battellino and Chambers (2006).


Combining activity on the BCS and on the OTC Tasas market. Based on data from the Oslo Stock Exchange, the Reserve Bank of New Zealand, Battellino and Chambers (2006) and Canada (2005).


This excludes two outstanding bonds issued by the state-owned copper company CODELCO in the domestic market.


Previously, the central bank only published its issuance calendar on a monthly basis.


The computations assume that the stamp tax is financed out of the proceeds of the borrowing.


FOGAPE is a government fund that provides guarantees on bank loans to SMEs.


They may not invest in any corporate issue that is not rated at least BBB.


For public sector debt, the two markets, BCS and OTC Tasas, appear to be well linked with prices and activity in the BCU 5- and 10-year benchmarks broadly equal on both.


A specific project is underway in conjunction with FIRST to address this issue.


An example of such a committee would be the Securities Lending and Repo Market committee in the U.K. The committee meets on a quarterly basis and consists of representatives of international securities lending and repo practitioners and bodies such as the Financial Services Authority, the Debt Management Office, the Inland Revenue, CREST, the London Stock Exchange, and the London Clearing House. The Bank of England chairs the meetings and provides the secretariat.