Colombia - Financial Markets Technical Assistance Loan

Report No. PIC634 Project Name Colombia-Financial Markets Technical... Assistance Loan Region Latin America and the Caribbean Sector Finance Project ID COPA6884 Implementing Agencies Ministry of Finance Guillermo Perry Carrera 7A No. 6-45 Bogota, Colombia Date PID Prepared February 21, 1996 Projected Board Date August 27, 1996 1. Country/Sector Background: Colombia has embarked upon a program of major economic reforms aimed at improving resource allocation by opening the economy to the competition and opportunities of international markets and liberalizing domestic markets. To facilitate the supply response to the trade, industrial and agricultural reforms, the Government is carrying out an extensive reshaping of the financial sector. Efforts have been focussed until now mostly on the financial intermediation system, which in the pat has been the main source of financing for the productive sectors and where the most urgent problems were concentrated. These included a widespread banking crisis in the mid-1980s and the subsequent nationalization for financial institutions. 2. A Financial Policy Framework (FPF) was adopted by the government in 1991 laying out the key reforms to be undertaken in the financial sector. These reforms include liberalizing interest rates, phasing out credit subsidies and forced investments, reducing financial system segmentation and the role of public financial institutions, increasing the autonomy of the Central Bank, and strengthening banking supervision. With the implementation of the FPF well underway, the government has now shifted its attention towards complementary steps of financial sector development, including issues related to non-banking areas such as liberalization and strengthening of the securities markets, social security reform entailing the creation of private pension funds, active promotion of competition, and facilitating the development of new financial markets and instruments. 3. Project Objectives: The proposed project would support the Government's efforts to foster more effective financial intermediation of resources, as well as more efficient operation of markets in general, as a key ingredient for sustained economic growth. Specific objectives are to: (i) develop the financial markets into a more efficient channel for mobilizing domestic savings (including long-term savings generated by social security funds) and financing investment; (ii) strengthen the prudential regulation framework in order to decrease the risk of loss of investor, confidence in the securities market; (iii) improve the institutional capacities for financial sector policy formulation and its linkage to macroeconomic policy; (iv) contribute to increase the supply of securities, one of the main constraints to the growth of the markets,  by inter alia facilitating the introduction of new financial instruments; (v) contribute to more efficient operation of financial and non-financial markets by promoting competition and deterring anti- competitive practices in those markets. 4. Project Description: Preliminary analysis suggests that the project would provide technical assistance in the following areas: (a) Securities Market Regulatory and Supervisory Framework: (i) Upgrading of regulations for market intermediaries on capital adequacy, own-account operations, short sales, margin transactions, borrowing operations, professional requirements, independent brokers, and market-makers; (ii) Strengthening of regulations on exchanges including membership criteria, qualification of member brokers, self-regulatory systems, and guarantee funds; (iii) Development of market infrastructure including rating agencies, unified trading systems, and efficient custody, clearing and settlement systems; (iv) Upgrading of information disclosure standards, including aspects related to accuracy of information and accounting and auditing standards, establishment of a modern public registry of securities; (v) Strengthening of SV's monitoring and enforcement capacities on intermediaries, institutional investors, market operations, development of early warning and market manipulation detection systems; (iv) Development of regulatory framework on unfair market practices (insider information/trading, conflict of interest, etc.) including definition of legal concepts, guidelines about what does and what does not constitute such practices, and monitoring, enforcement and sanctioning of forbidden practices; (vii) Strengthening of SV's surveillance and inspection capacities of market intermediaries, exchanges, custody and similar entities, institutional investors, and(since transfer of responsibilities from Supersociedades) issuers; (viii) Training of SV's staff on legal, economic and financial topics; and, (ix) Upgrading of SV's information systems. (b) Financial Sector Policy Formulation: (i) Building up of policy formulation capacity in Executive Branch through strengthening of skills of recently created Technical Viceministry of Finance and development of information tools needed for adequate policy making; (ii) review of insurance sector framework and its future linkage with private pension fund system; (iii) Facilitation of regional integration of financial markets and development of homologation process of norms on banking, securities and insurance activities; (iv) Review of financing policies and mechanisms for low income housing and proposals for improved system; (v) Feasibility study of financing mechanism for post-secondary education; and (iv) Definition of comprehensive strategy for development of Government Securities market. (c) Financial Markets Promotion: (i) Study and development of strategy for reducing remaining disincentives to offers of existing types of securities; (ii) Feasibility study of introduction of mortgage- backed securities and other asset-backed instruments; (iii) Assistance in the development of new financial instruments - 2 -  necessary for financing of private sector sponsored infrastructure project; (iv) Feasibility study of development of an over-the counter market among financial institutions; (v) Feasibility study of development of a secondary market for small-cap companies, which would have lighter issuing requirements and would be limited to institutional investors; (iv) Feasibility analysis and possible development of derivative markets, including futures and options on foreign currency, interest rates and market indexes; (vii) Analysis of strategies to deepen the securities market, including possible mechanisms for extension of maturities of debt instruments; and (viii) Feasibility analysis of development in Colombia of non- traditional financial activities such as venture capital, investment partnerships, etc. (d) Social Security Reform: (i) Development of investment portfolio guidelines for new pension funds, from a prudential regulation point of view; (ii) Analysis of gaps between expected investment needs of pension funds and availability of investment options in Colombia; and (iii) Development of a strategy to best fulfill unsatisfied investment needs, in coordination with (c) above. (e) Promotion of Competition: (i) Development of institutional know how on competition policy and substantive areas; and (ii) Development of institutional know how on procedural matters. 5. Project Implementation: The Borrower would be the Government of Colombia, with the Ministry of Finance and Public Credit as the executing agency. The project would be managed at two levels: a Steering Committee would be in charge of overall orientation, and an executing Unit of the Ministry of Finance would be in charge of project administration. A project coordinator from the Technical Viceministry of Finance would be in charge of the executing unit and would be assisted by consultants hired to do specific tasks as required. 6. The Executing Unit would have primary responsibility for preparing terms of reference and short lists, and selecting consultants, subject to Bank no-objection. All consultants would be selected and hired in accordance with the Bank's Guidelines for Use of Consultants. All reports and recommendations of the consultants engaged to assist in the execution of the project would be submitted to the Bank for its review and comments. 7. The Government and the Bank would use UNDP to administer the contracts and payments under a management arrangement satisfactory to the Bank. Its management fee would be financed from the proceeds of the loan. UNDP would disburse directly to consultants and would maintain supporting documentation on file for review by Bank supervision missions. 8. Environmental Aspects: The Project belongs to Environmental Category C and has no adverse environmental impacts. 9. Program Objective Category: The Project, by supporting the development of financial markets and their regulatory framework, would contribute to Financial Intermediation, Private Sector Development, and -3 -  improved Public Sector Management. 10. Procurement: Procurement methods to be determined during project appraisal. 11. Account and Audit: UNDP will maintain separate accounts for receipt of project funds and payments for all project activities. UNDP accounts and statements of expenditures, both of the Executing Unit and of UNDP, would be audited each year by auditors acceptable to the Bank in accordance with the Bank's Auditing Guidelines. The audited reports would be submitted to the Bank not later than six months after the close of its fiscal year. 12. Benefits: Developing the financial markets would increase the overall efficiency of financial intermediation between savings and investment. A robust non-banking market not only would serve the purpose of fulfilling the needs of economic agents who require non- traditional financial services, but would also contribute to reduce the high intermediation costs of the credit institutions by putting competitive pressure on that subsector. Strengthening the regulatory and supervisory framework of securities markets would help prevent possible unforeseen events that could lead to disenchantment with the market and eventual collapse due to loss of confidence. Developing a deep financial market would also allow the pension fund reform to achieve its desired objective of long-term capitalization of workers' resources. Furthermore, solid financial markets would also enable the important privatization reform of infrastructure activities to take place successfully; the development of infrastructure by the private sector in many cases entails long-gestation bulky investments which would not be appropriately financed without long-term resources mobilized through the domestic market. Finally, active promotion of competition would help prevent welfare losses from non-competitive arrangements and contribute to decreasing the causes which are currently limiting the supply of securities. Task Manager: Andres Jaime Contact Point: Public Information Center The World Bank 1818 H Street N.W. Washington D.C. 20433 Telephone No.: (202)458-5454 Fax No.: (202)522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. - 4 -