Volume 4, Number 22, Page 2

Costa Rica

A New Capital Markets Legal Framework?

by Pedro Oller-Taylor

The Costa Rican Congress is looking at pending legislation concerning local capital markets and their operations. The proposed legislation is the first of its kind since the integral reform that affected the legal and financial communities in 1990. That particular piece of legislation introduced a number of important institutions into the legal and financial environments, including the cumulative vote for minority shareholders of corporations; the right of information for shareholders of corporations; and a valiant effort to regulate capital market activities and to promote the development of the stock market by creating the ill-named "open capital corporations." Unfortunately, the ultimate impact of this law was hindered by a number of loopholes and mistakes in the phrasing of the law that have seriously undermined its significance and effect.

The new piece of legislation is part of a collection of laws promoted by the Inter-American Development Bank (IDB) and aimed at consolidating the development and performance of the financial sector of Costa Rica. As part of this initiative, other reforms concerning pensions, insurance, the Central Bank, government owned Banks and financial supervision, currently carried out by the Superintendencia General de Entidades Financieras (the local equivalent of the SEC), have been approved or are pending approval. In exchange, the IDB promised US$100 million, to be paid in three installments according to the progress shown by Congress in this area.

One has to wonder, upon reading the language of the proposed new capital markets law, what exactly are the spirit and motivation of this law, particularly in light of its sponsorship by an international bank of such high standards. At first glance the conclusions are not favorable.

The universal purpose in regulating capital markets is to guarantee the participation of all interests involved, especially the investor. However, the proposed new law quite clearly does not meet this criterion. It lacks strong requirements for the flow of information across the entire financial process and consequently is oblivious to its obligation to protect the investor, notwithstanding the apprehension experienced by those involved in the sector as a result of the weakness shown in the market in past months (due to the default of a number of high-profile issuers).

Also disturbing is the realization that the proposed new legislation will not guarantee its efficacy in the near future. It seems to answer, at least partially, the needs and circumstances of local capital markets at this place and time, but by no means does it appear to transcend the present conditions. It will take a new piece of legislation to deal with the ever-changing characteristics of this industry, which exists in a world of derivatives and internationalization that does not seem to be contemplated by the legislators or their aides.

Lastly, there is no specific or tacit intent to develop the ever-sagging stock market. Costa Rica is a country with feudal enterprises and mostly close corporations with high leverage levels and autochthonous methods of indebtedness. In the midst of three years of recessive symptoms and its resulting effects on the private sector, the stock market could have proved to be a viable way to jump-start the economy and lead local corporations into the 21st century. For unknown reasons, the opportunity was again missed.

However, not all aspects of the law are negative. There are a number of innovations and reforms worth mentioning. For one, the role of the supervising entity (previously named Comisión Nacional de Valores, now proposed as "Superintendencia de Valores") is magnified and strengthened to accurately reflect its actual obligations. The importance of this entity in diagnosing and preventing financial crashes is confirmed and, as a result, it guarantees the continuity of the system and the protection of all participants.

Additionally, institutional investors receive favorable treatment within the market. Costa Rica has not been immune to the presence and increase of pension and investment funds; the law seeks to regulate their operation and direct their efforts within an efficient and particularly suitable framework. Small investors will look to these vehicles of economic involvement as appropriate means for financial planning, a criterion the new law satisfies.

In summary, the proposed legislation, from the dual standpoint of an attorney and an investor who participates in the local market, fails to meet the expectations that should have been realized. In drafting the legislation, practicalities and actual experience should have been more influential than the focus groups involved. Perhaps then a proposal meeting international standards associated with established and emerging markets throughout the world could have been adopted. Actual information, investor interests and the country's entry into the international financial market should have been the bases for attempting legal reform of this critical area of the local economy.

Mr. Pedro Oller-Taylor is a member of the law firm Bufete Quiros & Asociados in Costa Rica.