Finance Ministry (press release), June 26, 2003

Finance Ministry (press release), June 26, 2003

FINANCE MINISTRY LAUNCHES SECOND CAPITAL MARKETS REFORM

Over the past few years, Chile has taken significant steps to improve capital markets regulation. In 2000, a law on tender share offers -known locally as the OPAs law- was passed, addressing the issue of the rights of minority shareholders in listed companies. This was followed in 2001 by a reform of capital markets that sought to increase domestic savings, foster the development of the country's financial markets and, in a bid to reduce firms' costs, increase competition in these markets.

However, a key challenge remained: to improve access to finance for start-up projects developed by innovative entrepreneurs. These projects, which are both the primary expression of private entrepreneurship and the engine of future economic growth, are at the core of the initiative announced on June 23, which aims to ensure that no viable project fail because of lack of finance.

This second capital markets reform, which will soon be presented to Congress, comprises six main elements:

Development of a venture capital industry
Reduction in transaction costs
Improved corporate governance standards
Improvements in supervision and enforcement
Improved voluntary savings mechanisms
Updating legal texts

Development of a venture capital industry

Guarantees for Venture Capital Investment Funds: In order to encourage institutional investors to participate in the development of a local venture capital industry, the government's Economic Development Agency (CORFO), in conjunction with the Inter-American Development Bank's Multilateral Investment Fund (MIF), will provide guarantees for debt issued by investment funds. Under this scheme, investment funds will be able to leverage up to twice their capital while their capital and debt will be packaged and offered to investors in such a way that the maximum loss they can incur is capped at one third of the total amount invested. In order to access these guarantees, investment fund administrators will have to apply for classification.

Tax Incentives:

Capital Gains Tax: Capital gains are generally at their highest during the early stage of a successful project's development and, in order to increase the supply of entrepreneurs with good ideas and solid projects, the proposed reform includes a temporary exemption from capital gains tax. This exemption, which will be subject to some minimum requirements, will be capped at approximately US$ 240,000.
Tax-exempt Earnings: Profits arising from tax-exempt income, distributed to an investment fund's shareholders, will also be exempt from taxation. This measure will eliminate a tax distortion that has discouraged the use of funds as an investment vehicle and favored direct investment in the underlying assets.

Reduction in transaction costs

New Type of Company: The proposed reform will create a new type of company -a Limited Liability Corporation- with a dynamic and flexible structure, adapted to the needs of the venture capital industry.

Assets as Collateral: In a bid to reduce financing costs and to improve market information, the reform includes a new law on the use of assets as collateral, introducing greater flexibility and creating a national register of assets used for this purpose. Experience in Chile shows that small and mid-sized companies depend heavily on the use of collateral and guarantees in order to access financing at competitive costs.

Improved corporate governance standards

In response to a recent World Bank Report on Corporate Governance in Chile, the reform seeks to bring Chilean legislation on corporate governance into line with OECD standards. As a result, it includes improvements to existing regulation in areas such as disclosure of information, voting rights, transactions between related parties, insider trading and supervision.

Improvements in supervision and enforcement

Operating Standards: Following the recent collapse of the local Inverlink financial group, a committee was set up to draw lessons from this episode. It proposed a number of initiatives that include Improved control of operational risks and increased levels of transparency in the securities industry; measures to encourage the electronic (rather than physical) issue and trading of high-value securities; higher minimum capital requirements for financial intermediaries; and, increased self-regulation by stock exchanges.

Entry Requirements: Because financial markets depend on trust and the reputation of their players, instability in one or more institutions can have serious effects on the rest of the economy and this risk is more acute when the products, offered by these institutions, carry a State guarantee. As a result, entry into this market should be subject to strict solvency and competence requirements. In this context, the proposed reform broadens the criteria that will be taken into account by the regulatory authorities, when considering applications for licenses to operate banks, life insurance companies and pension funds (AFPs). In addition, it will increase regulatory powers vis-à-vis changes of control and major stock transactions.

Crisis Management: One of the most important lessons learned from the Inverlink collapse is that it is imperative to act quickly and effectively to avoid contagion arising from a specific situation of insolvency. As a result, under the proposed reform, a company will no longer be able to obtain a stay-of-action on a suspension, ordered by the Securities and Exchange Commission (SVS), simply by filing an appeal to the courts, but will have to obtain a ruling on the appeal. In addition, the reform proposes a mechanism for the intervention of AFPs, as well as measures to speed up the existing mechanism for intervening life insurance companies.

Coordinated supervision: In order to exercise the appropriate preventive supervision, regulators must have adequate access to information about supervised entities and their main shareholders. To this end, the reform will explicitly authorize the sharing of information by the different regulators, involved in supervising financial markets. In addition, the reform proposes increased solvency requirements for the main shareholders in AFPs and life insurance companies, and will increase the powers of the Banks and Financial Institutions Regulatory Agency (SBIF) to monitor the activities of bank subsidiaries.

Coordination between regulatory and supervisory authorities: The role of three coordinating committees -the Superintendents' Committee, the Capital Markets Committee and the Financial Stability Committee- will be strengthened. The latter body has the task of coordinating institutions in order to prevent, detect and resolve situations that represent a threat to the stability of the financial system.

Improved voluntary savings mechanisms

The reform includes mechanisms to complement existing voluntary pension-savings alternatives and will open the way to collective schemes, to which both employers and employees will be able to contribute. Employers' contributions will be considered as an expense that can be deducted from taxable income.

Updating legal texts

A number of changes are proposed in order to bring legal texts into line with current practice in capital markets.

In summary, the proposed changes are expected to facilitate the development of the venture capital industry, reduce transaction costs, improve the management of corporations, strengthen supervisory mechanisms and facilitate the development of alternative voluntary savings mechanisms. The proposed bill will modernize the Chilean capital market, bringing standards up to current international levels, increasing transparency, competition and the reaction capacity of its agents. The proposed improvements should allow us to build a healthier, credible and solid capital market, further developing one of the fundamental pillars of economic growth.

Second Capital Markets Reform
Summary of Measures

Law

Main Proposed Modifications

Income Tax Law
(DL 824, 1974)

Exemption from capital gains tax for venture capital companies
Exemption from capital gains tax on transactions between funds managed by the same administration company
Transfer of tax benefits from underlying assets to shareholders in venture capital funds

Stamp Tax Law
(DL 3,475, 1980)

When the value of a securitized bond is higher than that of the underlying assets, only the difference will be liable for taxation
In the case of overseas bank loans, the debtor will be responsible for paying withholding tax.

General Banking Law
(DFL 3, 1997)

Banks will be allowed to invest the reserve requirement on sight deposits in Central Bank or Treasury securities of any term
Banks will be obliged to have a "Customer Defender"
The term "sociedades financieras" will be eliminated
Formal channels for sharing information among Regulatory Agencies will be created
The powers of the SBIF to reject an application for a bank license will be increased
The powers of the SBIF to request information from bank subsidiaries will be strengthened

Insurance Companies Law (DFL 251, 1931)

The arbitration powers of SVS will be increased
Insurance companies will be allowed to issue policies in nominal currency
Legislation will adapted in line with Chile's Free Trade Agreements with the US and the EU
The SVS will be empowered to request information from a company's controlling shareholders in order to measure their solvency
The SVS will be empowered, with the consent of other Regulatory Agencies, to forbid the purchase of stakes of 10% or more in a company
The SVS will be empowered to restrict operations between related parties
Insurance companies will be required to have a "Customer Defender"
Insurance companies will be able to use a larger part of their reserves to provide loans and for other investments that are authorized by the SVS. In addition, new limits will be established for these and other investments

AFP Law
(DL 3,500, 1980)

The percentage of securities to be held by an out-house custody service will rise to 100%, up from 90%
AFPs will be allowed to acquire bonds issued by investment funds (this modification is related to the CORFO-MIF program).
AFPs will have to pay value-added tax on voluntary savings schemes, bringing them into line with other institutions offering these schemes
Regulation of voluntary savings mechanisms will adapted to make them more flexible and competitive
The electronic issue of pension bonds (corresponding to contributions to the old State system) will be permitted
The Pension Funds Administrators' Regulatory Agency (SAFP) will be empowered to request information from a company's controlling shareholders in order to measure their solvency
The SAFP will be empowered, with the consent of other Regulatory Agencies, to forbid the purchase of stakes of 10% or more in a company
The SAFP will be empowered to restrict transactions between related parties and, in the case of a crisis, to appoint provisional management in a pension fund administrator

Securities Markets Law
(Law 18,045)

Stockbrokers will no longer have to be shareholders in a stock exchangeControls on insider trading will be tightened and the period for filing claims for damages will be extended to four years, up from one year
Third parties, other than the issuer, will be allowed to register foreign securities
The institution of "guarantor" will be created for syndicated bank loans. A bank will take on this role, accepting guarantees on behalf of both existing and future creditors
Brokers will be obliged to open a special account with the Central Securities Custody Service, if the owners of securities so wish in order to be informed as to the use of their assets. In addition, the conditions that a broker must fulfil, and sanctions for offenses, will be increased

Corporations Law
(Law N°18,046)

A new type of company - the Limited Liability Corporation - will be created to facilitate the formation of small companies and reduce start-up costs
Proxy voting mechanisms will be established in order to facilitate the exercise of minority shareholders' rights
Companies will be allowed to send information to shareholders electronically
Subscribed shares, which have not been paid, will not carry voting rights
The definition of transactions between related companies will be further clarified

Investment Funds Law
(Law 18,815)

Regulation on dividend and leverage policies will be made more flexible
Investment funds will be allowed to outsource portfolio management
Existing regulation will be adapted to foster the development of investment funds as a vehicle for venture capital

Securities and Exchange Commisssion Law
(DL 3,538)

The supervisory powers of the SVS will be strengthened" Custody services will be required to provide information about transactions of securities on the request of their owners

Securities Deposit and Custody Law
(Law 18,876)

Custody services will be allowed to provide complementary services
Regulation of the electronic issue of commercial paper, and its custody, will be improved
The SVS will be empowered to request information about the charges of custody services and how these are fixed

Mutual Funds Law
(D L 1,328)

Investment limits per issuer will be increased, and eliminated in the case of index funds
Mutual funds will be allowed to outsource portfolio management
The SVS will be empowered to define procedures in the case of differences in credit ratings.
Tax rules and the regulation of mutual funds' dividend policies will be improved.
Mutual funds will be allowed to open checking accounts

Housing Funds Law
(Law 19,281)

Regulations for House Purchase Saving Funds (AFV), dealing with guarantees, the requirements for directors and capital requirements, will be brought into line with those for mutual, investment and other funds

Civil Code and Bankruptcy Law (Law 18,175)

The existence of an order of preference among creditors, presently classified as non-preferred, will be recognized
Derivative contracts, established under a framework agreement, will have to be liquidated when bankruptcy is declared, allowing a firm's liabilities and assets to be automatically corrected

A new law of the use of assets as collateral; national register of assets used as collateral

New and comprehensive legislation will be introduced governing the use of non-fixed assets as collateral
The use of stocks, securities and contracts as collateral will be permitted
A national register of assets used as collateral will be created.

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