TECHNICAL ANNEX COLOMBIA FINANCIAL MARKETS DEVELOPMENT...

Document of

The World Bank

Report No. T-7135-CO

TECHNICAL ANNEX

COLOMBIA

FINANCIAL MARKETS DEVELOPMENT PROJECT

May 28, 1997

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CURRENCY EQUIVALENTS

(Exchange Rate Effective February 1997)Currency Unit = Pesos ($)

US$1.00 = $1,075$ 1.00 = US$0.001

FISCAL YEARJanuary 1 to December 31

ABBREVIATIONS AND ACRONYMS

BANCOLDEX - Export-Import Bank of ColombiaBR - Banco de la Republica (Central Bank)CAS - Country Assistance StrategyCONPES - National Council for Economic and Social PolicyDANCOOP - National Department of CooperativesDPPC - Promotion of Competition VicepresidencyDNP - Departamento Nacional de Planeaci6nFINDETER - Financial Corporation for Territorial DevelopmentGDP - Gross Domestic ProductGOC - Government of ColombiaICETEX - Institute for Financing of Higher EducationICB - International Competitive BiddingICR - Implementation Completion ReportIFI - Institute for Industrial DevelopmentISS - Instituto de Seguros Sociales (Social Security Institute)MHCP - Ministry of Finance and Public CreditPCD - Public Credit Directorate, Ministry of FinancePCU - Project Coordination UnitSES - Superintendency of Cooperatives (to be created)SB - Superintendencia Bancaria (Banking Superintendency)SIC - Superintendency of Industry and CommerceSOE - Statement of ExpendituresSV - Superintendency of SecuritiesTA - Technical AssistanceTES - Titulos de Tesoreria (Treasury Securities)UIIF - Unidad de Informaci6n e Inteligencia Financiera (Financial

Intelligence and Information Unit)VT - Viceministerio Tecnico (Technical Viceministry of Finance)

Vice President S. J. BurkiDirector P. IsenmanDivision Chief K. ChallaTask Manager A. Jaime

COLOMBIA


TECHNICAL ANNEX

I. Background

1. Since the late eighties, Colombia has embarked upon a program of economicreforms aimed at improving resource allocation by liberalizing domestic markets andopening the economy to competition and opportunities in the international markets. Tocomplement the reforms in the trade, industrial and agricultural sectors, the Governmenthas also undertaken an extensive reshaping of the financial sector.

2. Most of the earlier initiatives in the financial sector focused on the financialintermediation system, which has traditionally been the major source of financing andwhere the most urgent issues were concentrated due to the banking crisis of the mideighties and the subsequent nationalization of many financial institutions. These initiativesincluded the liberalization of interest rates, phasing out of credit subsidies and forcedinvestments, reduction of segmentation in the financial system, reduction in the role ofpublic financial institutions, an increase in the autonomy of the Central Bank andimprovements in banking supervision. As a result of these sustained efforts, the bankingsector recovered from the crisis of the eighties and has since consolidated its strength andstability of its operation under a much improved supervision regime.

3. Despite these achievements in the financial intermediation sector, capital marketsin Colombia have remained small and rudimentary as companies have traditionallypreferred to use the financial intermediation sector. Though Colombia has three stockexchanges - in Bogota, Medellin and Cali - there is a very limited supply of securities dueto several policy and market inefficiencies. The shallowness of capital marketsdevelopment in Colombia has deprived domestic industry of efficient financial instrumentsand has also contributed to higher interest rate spreads in the banking sector because oflimited competition from the capital markets.

4. The Government of Colombia appreciates the importance of well functioningcapital markets, and in 1995 appointed a high level commission to make recommendationson measures to develop capital markets. The recommendations of this Commission',which were based on analytical work carried out by capital markets specialists with theassistance of the World Bank, have been a major input in guiding Government policy forcapital markets development. This project is designed to support the implementation ofthese initiatives.

The final report of the Mision de Estudios del Mercado de Capitales was presented in July 1996. Thework of this Commission was supported by a PHRD project preparation grant.

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II. Financial Markets in Colombia

5. The Colombian financial system comprises of a large number of institutions, withthe primary actors being - 32 commercial banks that represent 51.2% of the assets of thefinancial system, 25 Development Finance Corporations (21 private and 4 public)providing credit for productive enterprises representing 13% of the assets of the financialsystem, 75 Commercial Finance Companies for trade and consumer credit and leasingwith 10.6% of the assets of the financial system, 9 Savings and Loans Corporations whichare specialized mortgage lending institutions and represent 22.1% of the assets of thefinancial system. In addition, there are also credit cooperatives, deposit warehouses,fiduciary companies and investment, mutual and pension funds systems. Since 1994,pension funds have grown and represent a much larger percentage of the financial system.

6. Traditionally, financial intermediation has been the primary form of financing in theColombian markets. Substantive policy reform and strengthened banking supervision afterthe banking crisis of the mid 1980s helped the banking sector regain its strength andstability. A World Bank study undertaken in the early nineties2 identified the mainoutstanding issue in this sector to be ones of efficiency and competitiveness withcontinued high financial margins and large variances in interest rates. The main sources ofthese problems were identified to be a combination of high quasi-fiscal burden of reserverequirements, mandated investments and a low level of competition in the markets. Sincethis study was undertaken, Government has taken several steps to reduce significantly thereserve requirements and the pattern of mandated investments. It has also taken steps toreduce the level of public sector intervention in the banking sector by privatizing banksand other financial institutions and by taking the decision to restructure public sectorfinancial institutions, such as the Banco de Comercio Exterior de Colombia(BANCOLDEX) , Financiera de Desarrollo Territorial (FINDETER) and the Institutode Fomento Industrial (IFI), into second tier banks providing rediscount facilities to firsttier private sector institutions. The restructuring of the latter two is being supportedthrough World Bank projects3 . In addition, the Government has also undertaken steps toimprove the regulatory framework, including competition policy, and supervision capacitywithin the banking sector. These are discussed further below.

Financial Markets4

7. Financial markets in Colombia in contrast, remain small, highly concentrated andilliquid - characteristics not dissimilar to other emerging economies. The capital marketin Colombia has languished since the sixties, even though Colombia had the benefit ofrelatively low and stable inflation rates compared to other countries in Latin America.

2Colombia: Financial Sector Reform, Green cover report, World Bank, 1992.

3 The restructuring of FINDETER is being supported through Loan 3336-CO (Municipal DevelopmentProject) and is being undertaken jointly with the IDB. The restructuring of IFI is being supportedthrough Loan 3449-CO (IFI Restructuring and Divestiture Project).

4 Comprehensive analysis of the financial sector and the financial markets are available in the tworeports mentioned in footnotes 1 and 2. These reports are available in the project files.

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Since the early nineties, many financial market indicators have shown an upturn, except fora decline in 1995.

* Size of the Market: Capital markets in Colombia have been historically small.Over 1986-1993, average market capitalization on the Colombian markets wasonly 7% of GDP, comparable to Argentina, Indonesia and Nigeria, but well belowthe new industrialized countries like Hong Kong, Malaysia, Singapore and Chilewith similar ratios greater than 100%. Since the early nineties, however, themarkets have shown a substantial increase due to an increase in prices and numberof listed companies. In 1996, the stock market capitalization had recovered togrow to US$ 15.35 billion or nearly 21% of GDP. The number of listedcompanies, which had languished during the eighties and the early nineties, alsobegan to increase in 1993 and reached 440 in 1996. Nevertheless, the annualincrease in the number of listed companies of 5.6% per annum over 1989-94 wasvery low compared to other emerging economies such as Indonesia and Turkey(about 35%) 5.

* Concentration: Concentration indices for the Colombian stock market, measuredas the share of the ten largest stock in market capitalization, have been among thehighest in the world. During 1986-1993, the ten largest stock represented 74%of the market capitalization, while the value of the same index in the US and Japanwas between 14-19%. A high degree of concentration, however, is typical ofmost small and emerging markets. Lately, there are encouraging signs that inColombia, as well, market concentration numbers have begun to decline. In 1994,the value of this index was 61.2%. However, this level is still high compared toother emerging markets in the region, all of which share similar characteristic -Argentina (47.5%), Chile (39.9%), Mexico (36.5%). The market transactionconcentration index as measured by the transactions of the 10 principal companiesto total transactions however remained between 65% and 80% in each of the threeColombian stock markets (Misi6n report).

* Liquidity: Transactions as a percentage of the GDP, have increased significantly inthe last five years, with stock transactions rising by 47%. Nevertheless, at 5.19%of GDP for total securities transactions and 2.1% of the GDP for equitytransactions, the Colombian capital market remains highly illiquid. In contrast,equity transactions as a percentage of the GDP are close to 45% in Japan,Malaysia and Singapore (Misi6n report). Another indicator of market liquidity isthe turnover ratio or total value traded divided by average market capitalization forthe year. In Colombia, this was a low 7%, comparing poorly to other countries inthe region like Peru (39%), Mexico (33%), Jamaica (21%), Chile (15%), andVenezuela (9.8%) 6. (IFC)

Factors Constraining Financial Markets in Colombia

5 Source: Report of Misi6n de Estudios del Mercado de Capitales

6 Source: IFC -Emerging Markets Database

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8. The key feature constraining the growth of financial markets in Colombia has beena paucity of supply of securities, particularly from companies in the real sector. Demandfor securities, on the other hand has been robust and rising exponentially, as theGovernment privatized large parts of the pension and the severance payments systems inthe early nineties unleashing a large potential demand for securities.

9. The Supply of Securities: Constraining Factors Some of the factorsconstraining the supply of securities have been macroeconomic. A decline in savings andhigh interest rates in the seventies and the eighties led to a general decline in investmentexpenditures and reduced the need for the companies to go to the financial markets. Inaddition, the former trade and market restriction policies provided considerable protectionto domestic companies, again reducing their need for investments to modernize or expand.

10. Other factors, however, relate specifically to policy and market inefficiencies thathave led companies to favor financing through commercial banks and other financialintermediation agencies over the capital markets. A large number of public sectorinstitutions had offered directed credit at rates substantially lower than those available inthe capital markets. This bias was compounded by a tax policy regime that provided amore favorable tax treatment to debt over equity. Regulatory provisions such as very highnorms about minimum quorums required for corporate decisions have reduced theincentive of companies to make public offerings of shares as they have feared deadlock indecision making. Another factor constraining underwriting activities and liquidity in thesecondary market has been the underdevelopment of market infrastructure, such asadequate intermediation services. This is attributable, inter alia, to weak capitalization ofintermediaries, lack of regulatory framework for own account operations and marketmaking activities and, in the past, fixed bands for commissions on transactions. Nor havethere been adequate market services such as custody, clearing and settlement systems,rating of securities, inter-connection and cross listing across the exchanges, all of whichtranslate into increased transaction costs.

11. The practice of mandated high reserve requirements and forced placement ofgovernment securities has also hindered the development of a market for public securities.In other countries, treasury bonds and bonds issued by other government agencies such asmunicipal bonds have been an important instrument for increasing the size, term andliquidity of domestic capital markets and establishing a yield curve for reference in othertransactions. As these are relatively secure investments, their introduction and wellfunctioning securities markets is likely to attract new players initially into the market forpublic securities and progressively into private securities.

12. Another set of reasons that has constrained the growth of capital markets has beenthe lack of a full regulatory framework to meet the needs of a changing financial marketand the introduction of new and specialized instruments. In 1991, the Governmentestablished a Superintendency of Securities (SV) which has rapidly moved to develop itsinstitutional capacity and to promote capital markets development. Nevertheless, itsinstitutional capacity and the regulatory framework for the securities markets is still underdevelopment. Recently, securitization, venture capital funds, new instruments to finance

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housing leasing schemes such as have been introduced in Chile, are some examples thathave been specifically cited where the absence of a regulatory framework has beenconstraining market development.

13. Actions Taken By The Government To Promote Financial Markets. Theoverall policy thrust of the Government harbors well for the growth and development ofthe capital markets in Colombia. Recent Government initiatives in opening up theeconomy to competition, privatizing the financial intermediation sector, reducingrestrictions on foreign participation in the financial market and the establishment ofprivately managed severance payments and pension funds are all factors that willcontribute to the long term development of the financial markets in Colombia. Inaddition, the Government's policy and increasing momentum of private investments inlarge infrastructure projects will also provide a positive impetus to the growth in the sizeand deconcentration of the markets.

14. The Government has also undertaken a policy direction in the financial sector tosignificantly reduce the level of government intervention and state participation byvirtually eliminating mandated investments, reducing reserve requirements to minimallevels and by reducing the total participation of the public sector in the financial sectorfrom 50% of all assets in early 90s to less than 22% by 1995. Even within the remainingpublic sector financial intermediaries, the Government is restructuring agencies such asBANCOLDEX, IFI and FINDETER into rediscounting second tier banks that wouldparticipate in the markets only through first tier private sector institutions.

15. In addition, the Government has already undertaken several measures to addressspecific issues that have constrained capital markets development. These include reformsin the tax code to eliminate double taxation of dividends, elimination of property taxationof stock holdings, elimination of tax deductibility of inflation component of interestpayments, and other biases against participation in the capital markets, simplification ofnorms and rules regarding participation in the financial markets through subsidiarycompanies, provision of tax exemptions to certain funds investing in securities, removal offloors and ceilings on commission charged by brokers, reform of the commercial code tointroduce preferential shares without voting requirements, reduction of voting quorum forcertain types of decision making and upgrading of information disclosure requirements.Some of the specific actions taken by the Government are detailed in Box 1.

Box 1: Recent Measures Taken by the Govemment for Financial Markets DeveloDment

Policy Area Effects on Financial Market Effects on the Stock Markets

Tax Policy Gradual elimination of the deductibility of the inflationary component of Gradual leveling of the income tax applicable to publicly tradedinterest payments. companies and the elimination of double taxation of dividends.

Elimination of property tax for stock ownership. The income obtainedfrom capital gains is not imposed with an income tax or a windfall gaintax. Provision of income tax exemption and other complementaryexemptions to investment funds, severance payment funds, pensionfunds and securities funds. (Decree 1321 of 1989 and Law 49 of 1990).

Financial legislation Law 45 of 1990 sought to promote the transition from a scheme of Authorization for financial intermediaries to undertake activitiesspecialized banks to one of banks with subsidiaries with the objective of different from banking tuough their subsidiaries, includingimproving the efficiency of the system. It also fixed the minimum intermediation of securities, thus increasing the types of entities that cancapital requirements for the formation of different types of financial participate in the broker-dealer business. Also, expansion of the scope Oentities, facilitated the transformation across different types of of activities for brokerage finns. (Law 45 of 1990).intermediaries, eliminated restrictions on foreign investment in banksand opened the door for foreign investment in acquiring up to 100% ofstock capital of national financial entities.

Prudential Regulation Establishment of prudential nonus for capital adequacy based on risk- The Financial Reform included certain monetary sanctions and civilweighted assets. Required entities to get their portfolio classified every actions against the use of privileged information. From 1991,six months according to five categories. Imposition of limits on regulations were introduced for the participation of rating agencies inindividual credit exposure and establishment of new nonns for valuing the financial market.investments with market pricing (marked to market).

Introduction of new Based on the opportunities opened by the new legislation, many The introduction of new agents in the market, in particular the creationagents financial intermediaries undertook investments in related financial of severance payment funds, pension funds and foreign investment funds

businesses that provide complementary financial services, such as has contributed to strengthening the demand for securities in the capitalfiduciary (trst) societies, pension and severance payment funds, and market.brokerage firms.

Creation of new Introduction of preferential shares (without voting rights) to address the

instriments concerns of major shareholders about dilution of corporate control

Creation of a regulatory framework for securitization of assets.

Design of a structure for the operation of a second-tier market.

Privatization Privatization of financial intermediaries to reduce public participation in A large part of the privatizations were undertaken through auctions andthe financial sector from 50% of the assets of the sector at the beginning realized USS 660 million leading to an increase in the number of stockof the nineties to 22% by 1995. transactions. More privatizations and the new policy of private

participation in infrastructure projects will contribute to the continuedgrowth in the size, liquidity and deconcentration of the stock markets.

Reform of the With regard to information disclosure requirements, the existing biasesCommercial Code against publicly listed companies were elininated.

Quorum requirements for decision making were revised to require onlya simple majority of shareholders

Regarding distribution of profits, only 51% majority needed if more than50% of the profits are to be distributed. For the decision to distributeless than 50% of the profits, a higher majority of 78% of votes isrequired. (Law 222 of 'I 995).

Source: Final Report of the Commission for the Development of Capital Markets, 1996.

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16. With regard to the development of the market for public securities, Law 31 of1992 mandates that as of 1999, the Central Bank will fully substitute the bonds issued forless than one year with treasury bonds issued by the Government - Tiuulos de Tesoreria(TES). This would create a single sovereign instrument, reducing the segmentation in themarket for public securities and eliminating the inefficient competition between these twosovereign instruments. The development of a market in public securities is also beingaided by the elimination in the mandated placements of such bonds with official agencies.The recent decentralization initiative that has transferred responsibility for infrastructureand social sectors to departments and municipalities also represents an opportunity fordeepening of capital markets through bonds issued by these entities. Some sub-sovereignentities such as the city of Bogota and the Department of Guajira have already begun theprocess of issuing bonds on their own account, on both the international and (primarily)on the domestic market.

17. The Demand for Securities- Pension Reform Though the supply of securitieshas lagged in the Colombian markets, demand for securities has increased substantially inthe past decade with the approval of foreign investment funds, the repatriation of capitalby Colombian nationals and the liberalization of the insurance sector. The demand forsecurities received another significant boost with the creation of a system of privatelymanaged severance payment funds (Cesantiafondos) and the pension reform of 1993. In1992, a system of privately managed severance funds was established and in 1993,Congress passed a law that has established the framework for privately managed,compulsory defined-contribution pension funds.

18. The main thrust of the pension reform of 1993 is a change from the pay-as-you-gosystem to a filly funded one and the introduction of competitive pressures with the co-existence of private and public sector pension funds actively managing the savings of theirmembers. Privately managed pension funds were created in parallel with the existingpublic sector agency Social Security Institute (Instituto de Seguro Social (1SS)) withindividuals having a choice of which institution is to manage their pension fund account.For all affiliates of the old pension system, their former pension management entity("caja") is obliged by law to transfer the equivalent of its accrued pension liabilities to theiraffiliates, earned during their past years of service, to the new pension fund chosen bythem. Subsequent pension contributions bv individuals go directly into their newlychosen pension funds.

19. As these reforms deepen, it is estimated that the total resources of the institutionalinvestors such as pension funds, severance payments funds, insurance companies andmutual funds, will increase from 3.7% of GDP in 1994 to between 9-12% of GDP by theyear 2000 (as estimated by the Commission on Capital Markets). The amounts they investin the capital markets are also expected to multiply three to four times in the same timeperiod, significantly increasing the demand for securities - particularly those with longermaturities. Such a positive effect from private pension funds on the equity market wasalso experienced in Chile, where stock market capitalization has reached over 100% ofGDP, up from 24% a decade ago. In addition, pension fund reform has allowed Chile to

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be the only country in Latin America to have today a significant long term corporate bondmarket.

20. Competition Policy. It is widely recognized that the heritage of tariff protection,licensing, foreign investment controls, and other government policies coupled with therelative small size of the domestic market led to high levels of industry concentration inColombia. The lack of effective domestic and import competition has traditionally enabledColombian firms to engage in oligopolistic behavior. Some firms have been able to chargehigh prices and earn high profits while simultaneously being high cost and inefficientproducers. Potential efficiencies and economies of scale have not been adequatelyexploited. In addition to high levels of industry concentration, the Colombian economy isalso characterized by high levels of ownership concentration and conglomeration amongfinancial and industrial enterprises.

21. Although competition policy in Colombia has existed dejure since 1959 with thepassage of Law 155, that has not been the case in practice, as until very recently antitrustregulation was an almost completely nonexistent function. Law 155 of 1959 determinedthat the Superintendency of Industry and Commerce (SIC) was to be in charge ofenforcing antitrust, price controls, intellectual property rights and quality controllegislation and regulations. While the purpose of the law was to promote competition,antitrust legislation was never applied nor tested. This is attributed to the extent ofgovernment regulation of industry, lack of political will, and inadequacy of the regulatoryand institutional structure aimed at maintaining and encouraging competition. Thus, thereis no precedent on how should antitrust cases be analyzed, prosecuted and litigated.There are no standards of proof nor clear articulated defenses.

22. The opening of the economy and the initiation of an overall deregulatory process(apertura) in the 1990s, provided the impetus to starting correcting this vacuum. As aresult of it, the Government issued Decree 2153 (with the status of Decree/Law),representing a turnaround in policy direction. The Decree seeks to safeguard and promotecompetition with the primary objectives of improving economic efficiency and consumerwelfare. Decree 2153 is the legal document underpinning the new antitrust framework ofColombia. It provides SIC with a new legal mandate, a new organization and newfunctions"1, and also provides some guidance on what competition policy should be. TheDecree gives the mandate to SIC about all aspects of antitrust enforcement, includingcarrying on investigations, arranging cease and desist agreements concerning particularpractices, blocking mergers, prosecuting parties on competition violations, and imposingsanctions and fines. These powers are sufficient to have deterrent and punitive impacts.

23. The Decree also establishes the SIC as a "technical agency" within the Colombianpublic service system, and thus autonomous from an administrative, financial andbudgetary point of view. This is of great importance in avoiding political interference inthe operation of antitrust enforcement; it is also useful for SIC in being able to attract high

7 As part of this restructuring, the Delegatura para la Promocion de la Competencia (DPPC) has beencreated to be in charge of implementing competition policies.

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quality staff as the agency can now have a salary scale above the general civil service paylevels.

Remaining Agenda for Financial Markets Development

24. Though much progress has been made, and is reflected in the improvements in theindicators of market growth and performance in recent years, considerable challengesremain before Colombia can aspire to truly modem and efficient financial markets. Inparticular, the remaining agenda includes:

* Further reform in the legal and regulatory framework to reduceimpediments to the supply ofpublic and private securities The unfinishedagenda includes continued changes in the Commercial Code to reduce thedisincentives for companies to go public, changes in the valuation system inthe tax code to remove biases against long term securities, harmonization ofthe different types of securities offered in the market, upgrading andclarification of information disclosure requirements for companies and marketintermediaries, improvements in interconnection and cross listing across stockexchanges within and outside the country, as well as improvements in theaccounting and auditing standards. Bonds issued by sub-sovereign entitiesalso present an opportunity for the development of a new segment of thedomestic capital markets. The development of a domestic market segment forthis purpose still requires agreement on accounting standards for these sub-sovereign entities and the rationalization of the tax code to take theseinvestments properly into account.

* Development of market infrastructurefor public andprivate securities toreduce transaction costs in the placement and trading of securities in themarkets. These include actions to promote the emergence of specializedmarket makers, actions to promote an increase in the number and technicalcapacity of brokerage services, as well as improvements in the clearing,settlement and custody systems. The broadening and deepening of themarkets for public sector securities also requires the creation of aninfrastructure to stimulate both the primary and the secondary marketsthrough the creation of market makers and underwriters ("primary dealers")who can assume own positions as well as promote a secondary marketthrough the provision of daily quotations.

* Introduction of new, state of the art instruments to meet new business needssuch as those already being used in other developed and developingeconomies - e.g.securitization, venture capital funds, the use of derivatives,etc. In addition, the Government has also expressed an interest in developingfinancial instruments in the private markets for the introduction of newinstruments to mobilize private participation in housing finance andeducational finance. Much work needs to be done to develop the legal andregulatory framework governing the introduction of these instruments, the

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dissemination and development of technical knowledge, development ofprudential norms within financial institutions that want to participate in theseas well as the development of supervision and regulatory capacity.

* Further promotion of institutional investors in the market With privatesector management of pension and severance payment funds, institutionalinvestors will increasingly play a much larger role in the financial markets.Changes are needed in the regulatory framework governing differentinstitutional investors to enable them to adjust their portfolios to a dynamicand growing market, to invest in long term securities and the new instrumentsbeing introduced in the markets and to develop their capacity to manage theportfolio risks of these instruments.

* Consolidation ofpension sector reforms Another major agenda inmaximizing the participation of the institutional investors is the fullimplementation of the changes introduced by the pension reform of 1994.While this process of transferring the pension liabilities from the Governmentto the private pension funds is well underway for the central government,many sub-national entities have been slower to undertake this task. In largepart, this has been due to the complex technical knowledge and humanresources needed to reconstruct the employment history of each employee,calculate the pension liability and issue bonds to the pension funds, as well asensuring that the decentralized entity has been able to put in place otherfinancial arrangements to back these obligations. To ensure the credibility ofthe innovative pension reform, it is important that this process be undertakenas quickly as possible.

* InWroving regulation and supervision of markets to generate consumerconfidence and to develop depth. This is discussed in greater detail in thesection below.

m. Regulation and Supervision of the Financial Sector

Institutional Reform

25. The new Constitution of 1991 initiated a major reorganization process of theinstitutional framework for the regulation and supervision of financial markets. Itestablished the creation of the Superintendencia de Valores (SV), and gave theGovernment the mandate to further reorganize the regulatory and supervisory frameworkthrough the submission to Congress of Leyes Marco (Frarnework Laws) for the FinancialSector. In this context, Law 35 and several complementary decrees with power of lawhave been enacted by the Government, overhauling and modernizing the institutionalstructure of the financial system.

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26. Among the most fundamental reforms included in this restructuring of theinstitutional framework carried out by the authorities are: (i) making the Central Bankindependent from Executive Branch control, and enacting a new Organic Charter for theentity; (ii) separating the responsibilities for promotion and regulation of financial marketsfrom those of supervision and control of the markets, thus allowing a more effectiveundertaking of each of them; (iii) creation of the Technical Viceministry of Finance, anentity which was set up to have a broad vision of financial sector issues as well as theresponsibility to generate government policies across the overall financial sector, includingall areas where resources from the public are at stake, such as banking, insurance,securities markets and pension funds; (iv) overhauling the objectives, responsibilities andfunctions of the supervisory bodies related to financial markets. Moreover, the reformprocess included -- in particular for the two weakest of these agencies (the formerComision Nacional de Valores, now transformed into SV, and the SIC), upgrading of theirinstitutional status, provision of more adequate physical resources, and the means to beable to attract quality staff through the realignment of salary scales.

27. Before this reform process, there had been overlaps ofjurisdictions andresponsibilities across the agencies which lead to significant unnecessary costs both forissuers as well as market intermediaries. The overlaps implied duplication of efforts bysupervisory agencies and increased costs of public offerings due to regulatory delay andinconsistent information disclosure requirements among supervisory agencies. TheGovernment's decision to consolidate the number of regulatory institutions involved inoverseeing securities markets, including the transfer of Superintendencia de Sociedades'responsibilities about overseeing issuing companies to SV, reflects the Government'scommitment to enhanced supervision and greater facilitation of securities issuance.

Institutional Responsibilities and Capacities

28. Subsequent to this institutional reform process, the policy, regulatory andsupervisory responsibilities for financial markets in Colombia are allocated among thefollowing major agencies:

29. Central Bank of Colombia (Banco de la Republica) is responsible for settingmonetary, credit and foreign exchange policies and is an independent entity with no directcontrol from other branches of the Government. Prior to the reform process, it was underthe authority of the executive branch.

30. Technical Vice Ministry of Finance. Created by Law 35 in 1993, this ViceMinistry is responsible for setting and implementing macroeconomic and regulatory policyon all banking, insurance and securities activities as well as on any activity involvingmanagement or investment of resources from the public. The creation of this ViceMinistry was a big improvement in pulling together the financial sector policy makingfunctions under one entity and to separate the formulation of policy for the promotion andregulation of the financial markets from the supervision and enforcement functions, thusallowing greater focus on both areas and less conflict among them.

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31. Th7e Superintendency of Banks (Superintendencia Bancaria (SB)) oversees allcredit institutions, insurance and leasing companies, deposit warehouses, fiduciarycompanies and pension and severance payment funds. Substantial efforts have been put inplace to strengthen the institutional capacity of SB after the banking crisis of the lateeighties. In particular, SB has made considerable progress in developing expertise inprudential regulations related to portfolio classification, asset and liability management,valuation of investments with market determined prices ("mark to market"), etc.Nevertheless, SB needs continuing inputs to upgrade its institutional capacity and train itsstaff, especially with the increasing globalization and complexity of financial institutionsand transactions. SB has decided to overhaul its organizational structure - from itspresent functional organization to a more client based one of multidisciplinary teamsfocusing, inter alia, on specific groups of entities that they supervise. As financialintermediation has become more complex and international, with banks undertaking anumber of transactions through intermediaries and other members of conglomerates, SBhas realized that multi-disciplinary teams focusing on specific economic groups wouldprovide more intensive and effective supervision. Such a reorganization and change in thefocus of the supervision philosophy will need to be accompanied by significant stafftraining.

32. Staff training is also particularly urgent and important in two areas - supervision ofpension funds and the development of anti-trust regulation within the financial sector.Recently, SB has also taken over the regulation and supervision of the newly establishedprivate pension and severance payments funds systems, creating a new Delegatura(equivalent to a Vice Presidency) for this function. Staff capacity in this relatively newarea, which is new both for Colombia and much of the rest of the world, is less developedand requires considerable training inputs. Another area in which the institutional capacityof SB needs to be particularly enhanced, is in the implementation of competition and anti-trust regulation in the banking sector. With the restructuring of the Superintendency ofIndustry and Commerce (SIC) in 1992, (see below) the responsibility for theimplementation of competition policy for the banking sector was assigned to SB.However, this responsibility has not been well integrated into the operations of the agencyand is not being effectively discharged by SB. If the Government's objectives of anefficient financial system are to be realized, significant efforts are needed in this area.

33. Superintendency of Securities (Superintendencia de Valores (SV)) isresponsible for the supervision and inspection of stock exchanges, custody companies(depositories), clearing houses, brokers and dealers, mutual funds and some types ofvoluntary pension plans. It also has responsibility for authorizing public issues ofsecurities and for maintaining the National Registry of Securities, as well as promoting thedevelopment of securities markets. Established by the 1991 Constitution, SV is arelatively new entity in a growing and diversifying market. Although predisposition ofSV's top management and commitment from the Government is excellent to make SV astrong institution responsive to the needs of a modern and efficient securities market,reality still differs significantly from that desired objective. This is to be expected, since

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SV and its staff are so new. Most of SV's staff are not only new to the institution, butrelatively inexperienced in securities markets operation and supervision as well.

34. SV has considerable institution strengthening needs, especially in staff training andlearning from the regulatory and supervision practices in other countries with moredeveloped financial markets. SV also needs to develop processes and systems to put inplace more pro-active supervision with market monitoring and early warning systems, andstrengthen in-house capacity for financial analysis and inspection of supervised entities.Staff training is also required so that SV be able not just to follow up, but anticipate thetechnical developments taking place in the securities markets of both Colombia andabroad.

35. Departamento Administrativo Nacional de Cooperativas (DANCOOP) Inaddition to the major superintendencies outlined above, DANCOOP ( as an"Administrative Department") is responsible for the supervision and regulation of some2,070 financial cooperatives, 2,300 employee funds, 400 mutual associations and some5,000 other cooperative entities. The financial cooperatives sector has more than 3million members that account for some 9.5% of the population of the country and theassets of this segment of the financial markets have risen considerably in recent years toaccount for US$ 2.5 billion. Nevertheless, there has been considerable concern within theGovernment that the quality of regulation being undertaken for this segment of thefinancial sector has been very weak. The mission of DANCOOP is clearly complex - thenumber of entities overseen is large and the range of its responsibilities very wide -judicial examination, registration, policy formulation as well as the promotion andstrengthening of the cooperatives sector.

36. To bring in greater professionalism and expertise in sector regulation and toseparate the promotion and regulatory functions, the Government has proposed asubstantive overhaul of the regulatory framework of the cooperatives sector. A draft lawhas been prepared which puts forward a three pronged approach to sector regulation:

* The transfer of responsibility for the supervision of the largest financialcooperatives to the Banking Superintendency which already has considerableexpertise in supervision of financial intermediaries. The rationale for thistransfer is that these cooperatives are of a size and complexity similar to thetraditional intermediaries supervised by SB.

* Liquidation of the current organization and staffing of DANCOOP and thecreation of a new entity called the Superintendencia de Economia Solidariaas the regulator of all other institutions in the cooperatives sector.

* The transfer of the responsibility for the development and promotion of thecooperatives sector to a third entity, such as a mixed public-privatecorporation.

37. The proposed law is currently in Parliament for discussion and is expected to passin the second half of 1997. While Government policy on the regulation of this sector isclearly evolving, it is also clear that the creation of an effective system of regulation and

15

supervision will require considerable and sustained institutional development andstrengthening activities. In particular, significant efforts will be needed to developprofessional regulatory capacities within the newly constituted Superintendency ofEconomia Solidaria.

38. Sistema de Inteligencia Financiera. A significant issue in the financial sector inColombia is a concern about the use of the domestic financial system for laundering fundsfrom illegal activities. Thus far, there has been no single and organized way for theGovernment to monitor and control money laundering activities. However, theGovernment has now put forward a strategy to create a comprehensive financialintelligence system to monitor transactions and detect suspicious activities.

39. Conceptualized as a three tier system, the basic information for this financialintelligence system would be gathered by financial institutions and other "first-tier"entities, which have the direct contact with the markets and the economic agentsparticipating in them. These first-tier institutions will have specially trained staff tomonitor transactions and flag those that give some indications of being part of possiblemoney laundering activities. Such information will be routinely transmitted to the secondtier entities which will be comprised of regulatory agencies such as SB, SV and otherinstitutions. These entities, which have broad knowledge of the respective sector, willgather and refine the information received from the first-tier, including cross-institutionlinkages and consolidation. The top tier of the system will correspond to the Unidad deInformaci6n e Inteligencia Financiera (UhF) , which will be the focal point of the systemof financial intelligence.

40. The UIIF will be a small and highly technical unit with the following functions:

* To design and oversee the implementation of the financial intelligence system in itsmultiple components.

* To provide guidance to the first- and second-tier entities in their involvment in thesystem.

* To promote the legal and regulatory developments needed to efficiently monitormoney, and in general asset, laundering.

* To lead the investigations that would arise as a result of the possible money launderingoperations detected at the first- and second-tier levels, and be the channel to turn overthe relevant information to the judiciary authorities for criminal investigation andprosecution, if warrranted.

41. A draft law providing a comprehensive legal framework to such a system will bepresented to Congress in mid-1997, and is expected to be approved before end- 1997.This is an important Government initiative towards the objective of systematically fightingcorruption.

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42. Superintendency of Industry and Commerce (SIC) Overhauled in 1992, theSIC had traditionally been responsible for protecting intellectual property rights, enforcingprice controls, and quality control regulations. As a result of this restructuring, theDelegaturapara la Promocion de la Competencia (DPPC) was created to be in charge ofimplementing competition policy and to oversee the Chambers of Commerce, includingthe operation of the commercial registries. While the DPPC is still in its early stages, theinitial steps taken by the SIC to organize the unit are very positive. The DPPC is beingstaffed in a lean manner, with high level professional staff, and it is taking an appropriatelycautious attitude to its new powers and is conscious of its limitations.

43. Given that the DPPC is a very new entity, it presents both manpower andinfrastructure deficiencies in order to start properly developing its mission of implementingcompetition policy. Since antitrust and industrial organization analysis are almostunknown technical fields in Colombia, hiring professionals with high quality academicbackgrounds does not suffice for DPPC to acquire the necessary technical skills.Moreover, much of the acquisition of specialized knowledge in competition commissionsaround the world takes the form of in-house or on-the-job training. Agencies have overthe years developed a way of doing "case work", and a set of implicit and explicitprocedures. This knowledge of how to initiate, manage and carry a case to itsconclusions, including negotiating with the defending parties, is not learnt in academia, butrather acquired mostly in an on-the-job basis. The DPPC, however, has no "institutionalhistory" on which to base on-the-job training for new staff. Obviously, DPPC will developsuch knowledge over the years. In the meantime, the knowledge has to be acquired fromoutside sources and transferred to the new staff.

IV. THE PROJECT

Project Objectives

44. The main objective of the project is to support the Government's efforts to fostermore effective financial intermediation of resources, as well as more efficient operation ofmarkets, as a key ingredient for sustained economic growth.

45. Specific project objectives are to: (i) develop the financial markets into a moreefficient channel for mobilizing domestic savings (including long-term savings generatedby social security funds) and financing investment; (ii) improve the institutional capacitiesfor financial sector policy formulation and strengthen the regulatory and supervisoryframework in order to, inter alia, minimize the risk of loss of confidence in the financialmarkets; (iii) contribute to increase the supply of securities, one of the main constraints tothe growth of the financial markets, by inter alia facilitating the introduction of newfinancial instruments; (iv) consolidate the implementation of the social security reform; (v)contribute to deter corrupt or fraudulent practices such as money laundering; and (vi)contribute to more efficient operation of financial and non-financial markets by promotingcompetition and deterring anti-competitive practices in those markets.

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Project Components

46. The following table provides the main components of the project and the principalareas to be addressed within these components. A detailed description of the objectives,activities to be undertaken under each sub-component, outputs/impact, timing andresponsibilities is provided in Table 2 of Annex III.

Table 1: Proiect components [ Cost (US$)

L Developing the financial markets into a more efficient intermediation channel

A. Improving the Functioning of the Market This sub-component is designed to 575,000improve regulations and market infrastructure services to increase the efficiency of thefunctioning of the securities market. In particular, it will address issues of upgrading inthe pricing, trading, custody, clearing, settlement and payments systems, promotion ofinter-connection and cross listing across domestic and international exchanges,harmonization of different types of securities, and promotion of new types of tradinginstruments, such as short sales and repos.B. Developing the Marketfor Public Securities This sub-component will be aimed at 487,000developing the primary and secondary markets for public securities through review andreform of regulatory and tax constraints that have thus far impeded the deepening of thismarket and the emergence of market makers and primary dealers for this market. It willalso review and refine the financial management systems used by the Treasury for itsborrowing operations, develop a methodology for controlling risks in this market,develop regulations and standards for market operations of sub-national entities offeringpublic securities, improve depository functions, and support the development ofinformation systems to monitor the market for public securities. The sub-component willalso provide training and dissemination activities for government officials, regulatoryagencies and other key market participants.C. Promoting Greater Participation of Institutional Investors in the Financial 175,000Markets The primary focus of this sub-component will be to review and irvise outdatedregulations governing portfolio management of institutional investors and to developtechnical capacities to assess and properly manage the risks inherent in instrumentssuch as mutual funds, life insurance, and severance payment fundsIL Strengthening Regulation and Supervision Capacity in the Financial Sector

A. Harmonization and Refinement of the Regulatory Framework This sub-component 440,000will support the analysis and review of the overall regulatory framework of the financialsector, with a view to improving its efficiency, reducing regulatory arbitrage,harmonizing its different components and enforcement mechanisms, developing auto-regulation mechanisms, and an evaluation of the desirability of establishing a specializedjudiciary instance to deal with cases of financial sector nature.

B. Strengthening Institutional Capacityfor Supervision in the Financial Markets 2,075,000Provision of international exposure, practical experience and training to staff of thedifferent supervising entities - in particular the Superintendencies of Securities andBanking - to increase their knowledge of state of the art financial instruments andsupervisory approaches and techniques, and to support a more modern institutionalmodel of supervision at Superbancaria. This sub-component will also strengthen the

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policy formulation capacity in the Technical Vice Ministry of Finance through technicalassistance and staff training to update their skills and knowledge in best practice infinancial sector policy and regulation.

C. Creation of a New Regulatory Frameworkfor the Cooperatives Sector. Following 1,865,000on the new legal framework currently under discussion, this component will support thepossible liquidation of D XNCOOP, and support the establishment, staffing andinstitutional strengthening of a new Superintendency to regulate cooperatives(Superintendencia de Economia Solidaria). This sub-component will also support theestablishment of a "Delegatura" for cooperatives in Superbancaria, in order to ensureappropriate supervision of the large financial cooperatives..

HL Increasing the supply of securities and the availability of other financial instmments

A. Increasing Supply of Securities This sub-component will focus on necessary 715,000changes in the legal and regulatory framework, including possible changes to theCommercial Code and its regulations, that continue to impede firms' interest to raisefinancing in the capital markets. It will also undertake promotion, training anddissemination activities for government officials, regulatory agencies, marketintermediaries and potential issuers of securities to promote the use of the capitalmarkets.

B. Introducing and Promoting New Instruments - Inter Alia Securiftization, 1,891,000Derivatives, Venture Capital Funds, Housing Finance and Education Finance Thissub-component will provide technical assistance for review of legal and regulatorychanges and dissemination activities for the introduction and promotion of new financialinstruments such as the securitization of assets, derivative products, and venture capitalfunds to promote nascent small and medium companies. It will also provide assistancein studying the feasibility of introducing new instruments such as leasing finance forhousing and private finaneing for student loan p.ograms for higher education.

IV. Consolidating the Implementation of the New Social Security System

A. Implementing the Transfer of Pension Liabilitiesfrom the Decentralized Public 3,370,000Sector Entities (e.g. Municipaltties) to the New System. This sub-component willsupport the process of transfering past affiliates of Departmental and Municipal publicpension schemes to the new pension funds. It will assist in the process of compiling thepast contribution records, determining the actuarial value of those liabilities, andcalculating and issuing the pension bonds that will result from those liabilities. It willalso assist these decentralized public entities in devising mechanisms to funds theseliabilities.

B. Institutional Strengthening of the Delegatura of Pension and Severance Payments 218,000Funds This sub-component will strengthen the institutional supervisory capacities ofthis relatively new entity which is in charge of overseeing the recently created pensionfunds as well as related institutions.

C. Institutional Strengthening of the Institute of Social Security This sub-component 250,000will assist the ISS in devising a strategy for upgrading its information systems to improvefinancial management, collection records and clienv services data including verificationof eligibility for pension and health benefits under the new pension system.

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D. Continue Implementation and Regulation of Law 100 on Social Security Reform 533,000This component will help compile all norms and explanatory texts to the Reform Law,and provide support to decentralized entities to aid compliance with the new laws andregulations. It will also monitor the experience in the implementation of the new s;-stemand prcvide legal and financial expertise for continued finetuwing of the regulationsbased on the development over time of the system.

V. Development of a system for Control of Corrupt and Fraudulent Practices

A. Establishment of the System of Fnancial Intelligence and Preparatory Activities 850,000for Subsequent Implementation. This sub-component will support the development ofmechanisms to control money laundering, and specifically the initial creation of afinancial intelligence system. This system will have at its core an umbrella unit whichwill guide the collection, monitoring and analysis of relevant information at the otherlayers of the system (e.g. supervisory institutions in ths middle layer and financialintermediaries in the bottom layer). This financial intelligence system will be developedthrough a structured sequence of building blocks. The major challenges are to build thenecessary information and communication systems, to develop the capacities in allinstitutions involved, and to train the staff in the three layers.

B. Impkmentation of the System of Financial Intelligence in Three Priority Sectors 500,000This subcomponent will allow the system to be implemented in three priority sectors(banking, securities markets and corporate ownership), after approval of the necessarylegal framework.

C. Expansion of the System of Financial Inteligence to Additional Sectors of the 1,330,000Economy This subcomponent will allow the system to have expanded coverage in othersectors of the economy, possibly such as cambios (foreign exchange brokers), customs,income tax, financial cooperatives, real estate, etc.

1,880,000VL Development of Competition and Anti-Trust Policy Capacity This componentwill support the development of policy guidelines and procedural norms for anti-trustenforcement, not just in the financial sector but economy wide. It will also support thedevelopment of institutional capacity and specialized know-how on competition policyand enforcement practices

VILL Project Management and Administration

The project will support the administrative costs of the project management unit 816,000including a project coordinator, an assistant, an accountant, secretarial support and alimited amount of office equipment, as well as the cost of an externaladministration/contracting agent.

Physical Contingencies (5%/6) 898,000

Price Contingencies (3% per year, 4 years) 1,132,000

Total Project Cost 20,000,000

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Project Costs

Total project costs are expected to be US$ 20 mnillion and are broken down byexpenditure categories as follows:

Table 2: Project Costs by Expenditure Categories(US$ million)

WithProject Components Before contingencies contingencies

Consulting services 13.29 14.79

Training 2.79 3.11

Equipment 1.89 2.10

TOTAL PROJECT COST 20.00

Financing Plan

Table 3.1: Proiect FinancinE Plan(US$ million)

Local Foreign Total

Government 5.0 0.0 5.0

IBRD 3.2 11.8 15.0

Total 8.2 11.8 20.0

Table 3.2: Allocation of Loan Proceeds(USS million)

Expenditure Category Amount Financing Percentage

Consultants services 9.9 100% net of taxes

Training 2.1 100% net of taxes

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Goods 1.5 100% net of taxes of foreignexpenditures and ex-factory,and 85% of other locallyprocured goods

Unallocated 1.5

TOTAL 15.0

V. Project Administration and Implementation

Project Execution

47. The Borrower would be the Government of Colombia, with the Ministry ofFinance and Public Credit as the implementing agency. The project would be managed attwo levels: a Steering Committee would be in charge of overall orientation, and a ProjectCoordination Unit (PCU) established in the Technical Vice-Ministry of the Ministry ofFinance and Public Credit would be in charge of project administration. The SteeringCommittee would be comprised of representatives from the Ministry of Finance, theNational Planning Department, the Superintendency of Banks, the Superintendency ofSecurities, and the Superintendency of Industry and Commerce. This committee would beheaded by the Technical Vice-Minister of Finance, who would be the project's NationalDirector. A project coordinator from the Technical Viceministry of Finance would be incharge of the executing unit and would be assisted by consultants hired to do specifictasks as required. The PCU would be headed by a project coordinator and composed of aproject assistant, an accountant and secretarial personnel. The PCU would coordinate theproject activities with the different beneficiary agencies of the Government and themunicipalities.

48. The Coordination Unit would have primary responsibility for the preparation ofterms of reference, identification of consultants and preparation of short lists, publicationof notices and evaluation of proposals. Draft operational guidelines for the technicalassistance program, setting out procedures and responsibilities, are included in Annex I.

49. Consistent with other similar projects in Colombia, the Government and the Bankhave agreed to contract an external administration agent to provide support services toundertake procurement and manage payments, under a management arrangementsatisfactory to the Bank (see Annex II). Its management fee of US$0.6 million would befinanced from the proceeds of the loan. The external administration agent would disbursedirectly to consultants and would maintain supporting documentation on file for review byBank supervision missions.

50. The proposed project would be completed in four years. The completion date isAugust 31, 2001, and the Closing Date is February 28, 2002. The National Director will

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be responsible for project execution as planned, within time and budget, and withensuring compliance with all Loan Agreement covenants. Bank requirements foraccounting, administration and procurement procedures will be the responsibility of theProject Coordination Unit, with assistance from a contracting agent (see below).

Procurement

51. Procurement will be carried out in accordance with the Bank's Guidelines forProcurement under IBRD Loans and IDA Credits (January 1995, revised August 1996).The bulk of the procurement of goods consists of computer equipment and software foran estimated US$1.6 million equivalent which will be procured through InternationalCompetitive Bidding (ICB) and, to a limited extent, National Competitive Bidding(NCB). Miscellaneous computer equipment and software and office and photocopyingequipment required for project implementation and administration, will be acquired byNational Shopping by price comparisons of at least three quotations, in packages valuedat less than US$50,000, up to an aggregate of US$500,000 over the life of the project.

52. Consulting services will be contracted in accordance with the Guidelines forSelection and Employment of Consultants by World Bank Borrowers (January 1997).To the extent possible, the Borrower would employ consulting firms in preference toindividual consultants for the provision of consulting services to the Project. Trainingactivities (e.g. attendance to courses, seminars and workshops) would be procured basedon the quality of the programs offered (see Table 3 of Annex III).

53. Standard contracts, based on the Bank-issued Standard Form of Contracts, andprocurement documentation, based on Bank Standard Bidding Documents, modified asnecessary for the purposes of the project, were agreed with the Government duringNegotiations. Agreement was also reached on formats for the technical specifications inthe case of goods, and terms of reference (including objectives, activities, results,performance indicators, and estimated breakdown of costs) and the use of the Bank'sstandard Letter of Invitation for consulting services.

Bank Prior Review

54. Prior review by the Bank will be exercised for (see Table 4):

* All goods procured through ICB and NCB* Consultant contracts over US$100,000 equivalent (in the case of consulting

firms) and over US$50,000 (in the case of individual consultants and trainingactivities); however, in all cases the Bank would exercise review of terms ofreference for individual consultants or firms.

55. All contracts would be subject to post-review sampling during supervisionmissions. These arrangements imply that the substantive aspects of approximately 90percent of the total value of all Bank-financed contracts will be reviewed ex-ante by theBank.

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Disbursements -- - -------------

56. TheGovernment, Consulting < 50 (indiv.) Selection according None (TORsthrough the Services <100 (firms) to Consultant only)executing Guidelinesagency, will >50 (indiv.) | Allperiodically >100 (firms) "submit l l _|_|

withdrawal Goods < 50 National Shopping Noneapplications. >50 ICB AllThe contracting |_l_l_ lagent will make Training fees, < 50 Other Nonepayments Workshops >50 Alldirectly to and Seminarsconsultants andsuppliers. Expenditures for individual contracts of goods or services, for which priorreview by the Bank is not required, will be disbursed against Statement of Expenditures(SOEs) if the Bank so requests. Detailed supporting documentation for all expenditureswill be kept by the PCU. Full documentation for all contracts requiring Bank's priorreview will be submitted by the borrower to the Bank. Disbursements, representingmainly expenditures under short term technical assistance, will be made over a 4-yearperiod, which is the average disbursement profile for technical assistance projects in theLatin America and Caribbean Region. Since the implementation of some activities hasalready started, retroactive financing not to exceed US$1.2 million (i.e., 8% of the loanamount) would be applied to finance eligible expenditures made after April 30,1997 but nomore than a year before loan signing.

57. Accounting and Auditing Arrangements The PCU within the Ministry ofFinance and Public Credit will be responsible for fulfilling the accounting, reporting andaudit requirements. The PCU will be responsible for ensuring compliance of allaccounting and auditing requirements and will maintain records and accounts to reflect, inaccordance with sound accounting practices, the operations, resources and expendituresfor each project activity. It will also be responsible for coordinating with the contractingagent for obtaining all necessary financial information from the procurement performed byit. The accounts will be consolidated annually to prepare financial statements for theproject as a whole and project financial statements will be prepared in accordance withBank guidelines and models. Supporting documentation will be maintained and madeavailable to Bank missions and independent auditors as renuir-ed. For expendituresincurred on the basis of Statement of Expenditures, all records will be retained by the PCUuntil at least one year after the Bank has received the audit report for the fiscal years inwhich the last withdrawal from the Loan Account was made. Project records andaccounts, including the SOEs, will be audited annually in accordance with appropriate

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auditing standards consistently applied by auditors acceptable to the Bank, with terms ofreference for the auditors approved by the Bank. The Bank's Financial Accounting,Reporting and Auditing Handbook (FARAH) published in January 1995 and other Bankguidelines will be used by the auditors in accordance with the Bank's auditing guidelines.Audit reports will be furnished to the Bank within four months after close of theGovernment's fiscal year.

Project Monitoring and Evaluation

58. Within the Government, monitoring and evaluation would be undertaken by theProject Steering Committee, and would be done continually with activities grouped in six-month cycles. Bank supervision would also be carried out on a continuous basis, withsupervision missions every six months. Twice a year, specific Action Plans would beprepared, describing in detail the activities, inputs, outputs, timing, personnel responsiblefor their execution, how the performance of the various activities will be measured and bywhom, and other information necessary for the execution of the project.

59. The Project Coordinator, in consultation with the contracting agent, would preparea Semi-Annual Progress Report to be formally presented by the National Director to theSteering Committee. This report would provide financial and procurement information onproject execution, as well as status of performance indicators to date (input, output,outcome and impact) as compared to the last Semi-Annual Action Plan. The SteeringCommittee would review and approve the progress report, including the proposed newAction Plans. These Plans would be agreed with the Bank during the semi-annualsupervision missions. Agreement on the model of the Semi-Annual Action Plans andProgress Reports was reached before Board presentation. Submission of the first Semi-Annual Action Plan would be a condition of loan efectiveness.

60. A Mid-Term review will be carried out jointly by the Bank and the Ministry ofFinance during the mission scheduled for the first semester of 1999, to measure projectprogress and impact and agree on activities for the remainder of the project. The reviewwould provide a formal opportunity for the Bank to assess covenant compliance by theBorrower with regard to the Project, an opportunity which the Bank nevertheless willhave at all other times as well pursuant to the General Conditions incorporated in the LoanAgreement for this Project. This review would also serve as an opportunity to assess theneed for any potential follow-up activity related to the Project.

61. An Implementation Completion Report (ICR) would be submitted to the Bankafter project completion and no later than six months after the Loan Closing Date.Included in this ICR would be an assessment of the execution of the project, costs andbenefits derived, the performance of the Borrower, the World Bank and other agenciesinvolved in their respective obligations and accomplishments, and lessons learned.

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Benefits

62. Developing the financial markets would increase the overall efficiency of financialintermediation between savings and investment. Specifically, the Project is expected toexpand the size, depth, liquidity and intermediation efficiency of the financial markets.This would not only permit the companies going to the securities markets benefit from theexpansion of the base of savings mobilized for investment, but it would also putcompetitive pressure on the lending spreads charged by the financial intermediary sector.The introduction of new financial instruments would also allow for expansion of theavailable capital for investment and allow for more efficient instruments to meet specificneeds of companies at a lower cost of capital.

63. Strengthening and improving the regulatory and supervisory framework of thefinancial markets would provide better risk management, reduce the regulatory costs tothe economic agents (issuers, market intermediaries, investors and financial institutions),contribute to the avoidance of market crises and build greater public confidence in thesystem that mobilizes savings. Implementing pension reforms would help in capitalizingworkers' resources, facilitate the development of a long-term capital market, and increasethe welfare of an important segment of the population, i.e. future retirees. Furthermore,solid financial markets would also enable the important privatization reform ofinfrastructure activities to take place successfully; the development of infrastructure by theprivate sector in many cases entails long-gestation bulky investments which would not beappropriately financed without long-term resources mobilized through the domesticmarket. Finally, active promotion of competition would help prevent welfare losses fromnon-competitive market arrangements, while active control of money laundering activitieswould deter corrupt practices that distort the efficiency of financial intermediation andresource allocation.

Risks

64. There are three potential risks to the Project - institutional capacity forimplementation, maintenance of a sector-wide vision of achivement of objectives and thepolitical commitment to reforms. The project design has addressed these risks by placingproject management with a specialized unit within the Technical Viceministry of Finance,an agency that is well experienced in handling multi-agency technical assistance projects.The Project also provides for the engagement of experienced procurement/contractingagents for added capacity. The implementation risk in this project is considered low.Potentially more important is the concern that it would be possible for key actors in theGovernment to lose the broad vision of sectoral reform. The Government has alreadyappointed a Standing Commission consisting of the heads of the three stock exchanges,heads of the supervising agencies and representatives of the Ministry of Finance to followup on the broad sectoral policy issues reviewed by the Comision de Mercado deCapitales. The views of this commission will be fully integrated in the work of theSteering Committee of the Project and the implementation Actions Plans to ensure focuson the achievement of development objectives. Finally, there is some risk of politicalcommitment for needed legislation for some sub-components, specifically the restructuring

26

of the cooperatives sector and the control of corrupt practices such as money launderingactivities. However, past experience with other legislative modernization initiatives inColombia has shown that as long as these initiatives are presented to Congress with solidtechnical justification, approval is more likely to be expeditious. The Project also providesfor the necessary activities that need to be carried out in order to solidly prepare thoselegislative initiatives.

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Annex I

COLOMBIA


DRAFT OPERATIONAL GUIDELINES FOR PROJECT IMPLEMENTATION

Preparation of Terms of Reference

The participating entities (i.e., Ministry of Finance, SV, SB, etc.) producefinal TORs (based on draft TORs already prepared in conjunction with thesemi-annual Action Plans), with assistance of the Bank when requested.Final TORs are submitted to the Project Coordinator of the Executing Unitfor approval and to the Bank for no-objection prior to issuing toconsultants.

2. Creation of Short List for Recruitment of a Firm

The participating entities prepare an initial list for review/approval by theExecuting Unit. The short list is subsequently submitted to the Bank forno-objection.

3. Selection of Individual Consultants

The participating entities make an initial selection, send the curriculumvitae (with a briefjustification of the fee) to the Executing Unit forreview/approval and to the Bank for no-objection.

4. Draft Letter of Invitation, including Evaluation Criteria, and Contract

The participating entities draft the documents (based on an agreed model)for review/approval by the Executing Unit. If approved, the Unit forwardsthem to the Bank for no-objection.

5. Evaluation of Proposals

The participating entities evaluate proposals and select the winning firm.Before notifying the firms, the selection committees will send theevaluation report and winning proposal to the Executing Unit for approvaland to the Bank for no-objection.

6. Negotiation of Contract

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The negotiation of the contract is handled by the participating entitiesbased on guidelines issued by the Executing Unit. Prior to signature, thenegotiated contract will be sent to the Executing Unit coordinator forapproval and to the Bank for no-objection.

7. Supervision of Consultants

Supervision is the direct responsibility of the participating entities.Program reports on technical assistance progress will be included in thesemi-annual reporting prepared by the Executing Unit for the SteeringCommittee.

8. Disbursements

Payments to consultants and suppliers will be made directly by thecontracting agent. Based on the information on actual payments made toconsultants and suppliers by the contracting agent, the Ministry of Finance,through the Executing Unit, will prepare and submit withdrawalapplications. These application for withdrawal requests submitted by theBorrower to the Bank will be for a minimum of US$250,000. TheBorrower will submit to the Bank Statement of Expenditures for contractsbelow US$100,000 equivalent for consultant firms, and below US$50,000equivalent for goods, training and individual consultants. The Borrowerwill maintain the supporting documentation which will be readily availablefor review by Bank supervision mission and the Auditors. Disbursementsfor all other contracts will be fully documented.

9. Audit

An annual audit of the Project accounts will be undertaken at the end ofeach fiscal year by independent external auditors and submitted to theBank.

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Annex IICOLOMBIA


LOAN ADMINISTRATION AGREEMENT BETWEENTHE GOVERNMENT OF COLOMBIA AND CONTRACTING AGENT

1. The Ministry of Finance will be the Executing Agency on behalf of theGovernment for the Financial Markets Development Project (Loan) to be extended bythe World Bank. AGENT will be in charge of the project administration as agreedbetween Ministry of Finance and AGENT in a letter of agreement.

2. For recruiting and managing consultants to be financed by the proceedsof the Loan, the division of responsibilities between Ministry of Finance and AGENTwill be as follows:

Ministry of Finance:

* Repayment of principal amount, interest and other loan related charges* Granting approval to the Loan Administration Agreement• Compliance with Loan Conditionalities as specified in the Loan

Agreement between the Bank and the Government of Colombia

Ministry of Finance (Executing Unit1:

* Identification of consultants and preparation of shoit lists* Drafting of terms of reference* Preparation of letters of invitation for proposals* Evaluation of proposals and selection of consultants* Negotiation of contracts* Supervision of performance and review and acceptance of reports* Preparation and submission of withdrawal applications* Approve AGENT's selection of external auditors for project accounts* Supervision of funds allocation* Obtaining the Bank's no-objection for consultant's short lists, terms of

reference and contracts* Compliance with budget norms outlined in the current budget law* Establishment of a Budget Section (item) to which Ministry of Finance

will assign disbursements of the World Bank loan and of counterpartfunds

In some of these functions the Executing Unit will not itself be carrying out the task, but reviewing/approvingthe actions of the beneficiary agency

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AGENT:

* Administration of consultant's contracts, including drafting and signing ofcontracts, verification of payments requests and carrying out payment toconsultants and suppliers

* Opening and maintaining separate accounts for receipt of Project fundsand effectuating payments

* Preparation of financial statements* Selection of outside auditors of AGENT's Project accounts and financial

statements* Submission to Ministry of Finance of all information and supporting

documentation necessary to enable Ministry of Finance to prepareappropriate withdrawal applications

* Provision to Ministry of Finance with such other services incidental tothe above as Ministry of Finance may reasonably request

3. In discharging the responsibilities set forth above, AGENT should act asagent and on behalf of Ministry of Finance.

4. It is understood that AGENT, which should make all payments requiredunder contracts administered by it, should be periodically reimbursed by the Bank andthe Ministry of Finance (for the Loan proceeds and the counterpart funds, respectively).It is further understood that, for this purpose, Ministry of Finance should submitwithdrawal applications to the World Bank on a monthly basis, except as the WorldBank may otherwise require in accordance with the provisions of the Loan Agreement.

5. In payment of its services and expenses, AGENT will charge, and theGovernment will pay, an all-inclusive fee of (_J % of the amount of payments made byAGENT. Ministry of Finance should request the World Bank to make all disbursementsfrom the Loan Account to the order of AGENT into the AGENT's Account No.

6. AGENT agrees to cooperate with Ministry of Finance and theGovernment at large to enable them to comply with all requirements of the LoanAgreement, including the General Conditions. Without limitation upon the generality ofthe foregoing, AGENT should keep records and separate accounts and provide for theauditing thereof in such manner as to enable the Government to comply with itsobligations under the correspondent Section of the Loan Agreement and with theprovisions of the disbursement letter.

31

Annex m

Annex m Table 1: Proiect Costs by Component and ExDenditure Cateeorv

(US$ mn.)

L Developing the financial markets into a more efficient intermediation channel 1.24

Consulting services 1.115

Training 0.122

Equipment --

]EL Strengthening Regulation and Supervision Capacity in the Financial Sector 4.38


Training 1.275

Equipment 0.505

IIL Increasing the supply of securities and the availability of other financial 2.60instruments


Training 0.927

Equipment --

IV. Consolidating the Implementation of the New Social Security System 4.37


Training 0.048

Equipment

V. Development of a system for Control of Money Laundering Activities 2.68


Training 0.270

Equipment 1.230

32

VL Development of Competition and Anti-Trust Policy Capacity 1.88


Training 0.150

Equipment 0.120

VIEL Project Management and Administration 0.82


Training

Equipment 0.030

Sub-total Project Activities 17.97


Training 2.79

Equipment 1.89

Physical Contingencies 0.90

Price Contingencies 1.13

TOTAL PROJECT 20.00

Annex m Table 2: Financial Markets Development Loan: Proiect Activities. Expected Outputs. Timinz and Costs

Objectives and Project Activities Outputs/Impacts Timing Cost (US$) | Agenciesl__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ In v o lv e d

L Developing the financial markets into a more efficient intermediation channel

A. Improving the Functioning of the Market

* Legal study to harmonize different types of A consistent and transparent framework for the 8/97-10/97 85,000 VT/SVsecurities, universe of securities.

* Study to assess the feasibility and strategy for Development of action plan to inter-connect 9/97-2/98 110,000 VT/SVinterconnection across the three Colombian the exchanges..exchanges.

* Diagnostic and reconunendations for ways to Improvements in the securities depositories, 9/97-6/98 190,000 VT/SVimprove pricing, trading, clearing, settlement, trading and compensation systems.custody and payment systems. _

* Technical assistance to develop and promote new New and improved norms and regulations to 7/98-12/98 80,000 VT/SVfinancial transactions such as short sales and allow short sales and reposrepos

* Study the feasibility and requirements for linking Adoption of a strategy for linking domestic 1/99-9/99 110,000 VT/SVdomestic stock exchanges with other markets to international exchanges.international exchanges.

B. Development of the Marketfor Public SectorSecurities

* Development of the policy and institutional 8/97-12/99 165,000 VT/PCDframework

* Definition of a short term financial program Implementation of a new system of auctioning(financial programming system) for the public securities in the primary market.Treasury and the Directorate of Public Credit,taking into account macroeconomic and A well functioning secondary market for publicoperational aspects. securities with an established network of

* Carrying out a review of the current system of traders.

auctions in the primary market, and redefining A functioning and efficient electronicprivileges and obligations of market makers. information system to track pricing,

* For the secondary market, drafting of transactions, and clearing and payments.regulations for the participation of the primarydealers in this market, for the creation of a Implementation of a more efficient financialnetwork of blind brokers, and for the use of management and borrowing strategy for theTES in open-market operations Treasury.

. Diagnostic and design of the basiccharacteristics of an information system totrack prices, transactions and custody andclearing.

. Reform of Regulations 9/97-3/01 120,000 VT/PCD/SV* Review of the valuation system of market

pricing with a view to removing any biases A more equitable regulatory and tax regimeagainst long term investments. that removes constraints to investment in long

* Review of the tax regime, paticularly the one term securities.applicable to foreign investment in fixedincome securities. Improved regulations for short-sales and repos.

* Development and modification of regulationsfor financial instruments for market making in Improved financial strength of market-makers.public sector securities: repos, short sales andderivatives

. Development of a special methodology formanagement of risks inherent in marketmaking activities.

* Supervision and Monitoring of the Market 1/98-12/99 112,000 VT/PCD?SV/* Analysis and definition of institutional BR

responsibilities for supervision of public sector Improvements in facilities and instruments tosecurities markets. monitor and supervise the primary and

* Studies to rank primary issuers, to assist in the secondary trades of public securities.rating of secondary trades in securities issuedby these entities. Improved coordination among the main issuers

* Design of systems to manage communication, of public sector securitiesinformation and coordination between the

Treasury and the Central Bank. STandards and control systems for registry and* Design of mechanisms for supervision of custody

centralized registry and custody systems.Training and Dissemination Greater knowledge amongst policy makers, 9/97-12198 90,000 VTIPCD/SV

* Training for financial institutions on market potential market participants and regulators onmaking activities for public sector securities. the issues related to the efficient functioning of

* Training on portfolio management, including the primary and secondary markets for publicinterest rate risks, liquidity, duration etc. debt securities.

* Training for regulators on risk managementissues related to public debt securities. An increase in the number of market makers

and entities trading in governmuent securities.

C. Promoting Greater Participation of InstiutionalInvestors in the Financial Markets co

* Legal and financial review of regulations Changes to the prudential regulations and 1/98-6/01 175,000 VT/SB/SVgoverning investments of institutional investors minimum profitability norms of institutional(mutual funds, pension funds, severance payment investors to enable them increase their resourcefunds, insurance companies, etc.) mobilization, particularly of long-term savings.

* Analysis of minimum profitability required ofpensions and severance payment funds Improvements in the risk evaluation and

* Review of rating systems for securities from the portfolio management capacity for institutionalpoint of view of the demand side. investors.

* Training for developing portfolio managementinstitutional capacities.

IL Strengthening Regulation and SupervisionCapacity in the Financial Sector

A. Harmonization and Refinement of theRegulatory Framework

* Analysis of feasibility of revising existing Changes to the institutional structure and the 2/97-9/00 440,000 VTregulatory norms and institutional arrangements system of regulation to make it more efficient,in order to increase the use of auto-regulation transparent and effective.and allow better coordination of subjective andobjective criteria regulation. Greater knowledge and improved institutional

* Studies to analyze the existence and causes of processes within the regulatory entities toregulatory arbitrage. enforce the regulatory framework.

* Feasibility analysis of the advisability of creatinga special judiciary instance for financial sectorissues.

* (Advisory services for) Carrying out the changesin the laws, regulations and operationalprocedures needed as a result of the studiesundertaken above, including changes inregulations regarding on-site and off-siteregulation, consolidation of foreign subsidiariesin regulation, etc.

B. Strengthening Instiutional CapacityforSupervision in the Financial Markets )

. Superintendency of Securities Improved capacity within the Superintendency 1/97-6/01 930,000 VT/SV* Training activities in the following areas: of Securities for effective supervision of the

project finance, privatization, portfolio money and capital markets.management, risk management for derivativeproducts, options, valuation, hedging, creditrisk management.

* Strengthening of supervision systems andprocedures, including drafting of operationalmanuals, harmonization of on-site and off-sitesupervision procedures, and refinement ofmarket monitoring and early warning systems.

. Superintendency of Banking Improved capacity within the Superintendency 3/97-6/01 625,000 VT/SB* (Consulting services for the) design of a new of Banking for effective supervision of the

organizational structure focused on group-

entity based supervision rather than functional banking and financial institutions sector.areas.

* Review and upgrading of operational manuals.* Training activities in state of the art

supervision techniques, familiarity with newprocedures for consolidated supervision,financial analysis and risk management.

Strengthening Capacity for Policy Formulation Strengthened capacity within the Vice 3/97-6/01 520,000 VT* Technical assistance and training activities for Mimsterio Tecnico foi financial sector policy

staff in the Directorate of Economic Regulation formulation.of the Ministry of Finance in the followingareas: financial regulation, financial Improved financial sector policies.cooperatives and credit unions, capital marketsdevelopment and regulation, internationalcapital markets and banking, law making anddevelopment, practical yield curve building,securitization, futures and options, portfolio cadministration, currency trading, inernationalfinance, insurance, over the counter markets,brokerage activities and money launderingregulation.

* Establishment of small library and subscriptionto international trade journals _ _

C. Creation of a New Regukitory Frameworkfor the Cooperaives Sector

* Creation and institutional development of a new A new Delegatura will be created with 3/98-6/00 735,000 VT/SB/Delegatura for supervision of large financial appropriate infiasucture to undertake such DANCOOPcooperatives in Superbancaria. supervision.

* Creation of the entity and legal assignment ofresponsibilities. Adequate capacity, an appropriate institutional

* Development of the administrative structure and a regulatory framework for theinfiasucture. supervision and control of the financial

. Training of personnel. cooperatives sector.* Analysis of information requirements for

effective supervision* Development and implementation of the

required information systems (systemsanalysis, provision of hardware and software,establishment of procedures for data collection,validation and analysitical processing,establishment of historical databases, design ofreports system for the Delegatura).

Creation and institutional strengthening of the Approval of legislation to establish new 3/98-6/01 1,130,000 VT/Superintendency of Economia Solidaria. supervisory framework for cooperatives DANCOOP/

* Liquidation of DANCOOP, separation of SESpersonnel and staffing of new A new Superintendency will be created withSuperintendency. adequate staff and appropriate infrastructure to

* Development of institutional and undertake effective supervision of theadministrative infatnwture for the new cooperatives sector per se.Superintendency.

* Training of new personnel. Adequate capacity, an appropriate institutional* Determination of information requirements on structure and a regulatory framework for the O

the entities to be supervised. supervision and control of the cooperatives* Development of management information sector will be in place.

systems (systems analysis, provision ofhardware and software, establishment of A working information management systemprocedures for data collection, validation and with relevant data and information collectionanalysitical processing establishment of mechanisms will be in placehistorical databases, design of reports systemfor the Superintendency). Separation of the responsibility to promote the

* Dissemination of the new norms and cooperatives sector from the responsibility toregulations for cooperatives and provision of supervise ittraining to associations of cooperatives for thesubsequent spreading of the disseminatedinformation and knowledge

m. Incremasing the supply of securities and the availability of other fmancial instruments

A. Increasing Supply of Securdiesl

* Technical assistance to upgrade norms and Adoption of recommended changes in the 1/98 - 8/98 130,000 VT/SVprocedures in order to increase the flexibility and norms and regulations for public issues..speed of public offerings of securities.

* Legal analysis and recommendations on possible Amendments to the Commercial Code and 9/97-3/98 48,000 VT/SVchanges needed to the Commercial Code to issuance of necessary regulations (draft bill ofreduce disincentives for companies to go public Law and related regulatory decrees).

* Training activities for regulators, supervisors, Improved understanding arnongst market 8/97 - 12/00 217,000 VT/SVbrokers, financial corporations, and potential participants, intermediaries and regulators onsuppliers and buyers of securities, including the working of the capital market and itstraining courses, seminars and workshops. regulatory requirements.

* Market promotion through dissemination Upgraded knowledge among actual and 8/97 - 9/00 320,000 VT/SVactivities, publications and informational potential market participants of thematerials characteristics and advantages of the securities X

marketsB. Introducing and Promoting New Instruments -Securitization, Derivatives, Venture Capital Funds,Housing Finance and Education Finance

* Promoting Securitization Improved norms and regulations governing the 8/97-10/98 291,000 VT/SB/SV* Development of norms to measure and account issuance and trading of securitization

for the riskiness of securitized instruments. instruments and their treatment for portfolio* Legal studies needed for the broadening of risk management and classification

regulations on investment by institutionalinvestors in such instruments. Definition of methodologies for computing

* Study of the financial and legal feasibility of default rates of securitized asstes.the creation of securitization companies.

* Training on skills and knowledge development Adequate knowledge amongst potential marketfor market participants, regulators and participants and regulators on the keysupervisors. operational and regulatory principles of

* Dissemination activities for legislative and securitization, such as the financialjudicial personnel on treatment of such assets independence of securitized assets in case ofin case of bankruptcy or liquidation

proceedings. bankruptcy of the originator..

Promotion of Venture Capital Funds Adoption of regulations on the establishment 3/98-2/99 130,000 VT/SV* Diagnostic to evaluate implications of the legal and portfolio management of venture capital

definition of venture capital funds as funds.independent entities or as authorizedoperations of existing funds. Adequate knowledge amongst potential market

* Drafting of regulations for greater flexibility in participants and regulators on theinvestment critera for such funds. characteristics, operations and advantages of

* Dissemination activities for promotion of this this instrument.instrument and familinazation of theinvestment public with it.

* Promotion of the Derivatives Markets Possible establishment of an appropriate 3/98-6/01 800,000 VT/SV* Diagnostic of the legal and financial framework for markets for derivative

implications and requirements for the creation instruments.of organized derivatives markets andexchanges. Regulations on the establishment and

* Development of the legal and institutional operations of markets, and portfolio aframework for the introduction of derivatives management of derivatives. oand futures.

* Training and dissemination activities for policy Adequate knowledge amongst potential marketmakers, regulators and market participants on participants and regulators on the operationsderivatives markets. and regulatory aspects of these complex and

risky instruments.

* Development of Housing Leasing Schemes Development of a strategy and legal and 10/97-6/99 310,000 VT/ SB/ SV/* Diagnostic studies to assess economic and regulatory framework to mobilize private Development

financial feasibility of housing leasing financing in housing. Ministryschemes.

* Diagnostic study to assess legal implications Adequate knowledge amongst potential marketand constraints. participants on the strategy, government policy

* Analysis of of legal, regulatory and and support, financial instruments andinstitutional framework required for housing regulatory aspects.leasing schemes.

• Training and dissemination activities for policy Improved access to owned-housing for low

makers, regulatory agencies and market income familiesparticipants.__ _ _ _ __ _ _ _ _

Development of Education Finance Schemes Development of a strategy and legal and 8/97-9/00 360,000 VT/ICETEX* Studies to evaluate alternative mechanisms to regulatory framework to mobilize private

mobilize long term savings for educational financing in education.finance loans.

* Diagnostic of alternative financial mechanisms Adequate knowledge amongst potential marketthat operate through the financial sector, to participants and students on the strategy,provide student loans, including the conversion government support, and financial instrument.of ICETEX into a second tier institution.

* Definition of criteria for eligibility for student Implementation of the new system of educationloans. finance and a new role for ICETEX.

* Analysis and definition of risk-sharingarrangements between public and privatesector institutions for the student loans.

* Diagnostic of the role and responsibilities ofICETEX in policy-making about student loansin ColombiaC

* Design and drafting of legal and regulatorynorms to put in place new education financingpolicies.

* (Technical assistance for) ICETEX toundertake institutional restructuring andconversion into second-tier institution.

* (Technical assistance for) the implementationof the student loan schemes, including thenegotiation of contracts between ICETEX andthe commercial banks,

* Training and dissemination activities.

IV. Consolidating the Implementation of the NewSocial Security System

A. Impkmening the Transfer of Pension Liabilitiesfrom the Decentralized Public Sector Entities (eg.Municialities) to the New System

* Reconstruction of the emDlovment histories of the Identification of the necesary information to be 8/97-8/00 1,250,000 VTpublic emplovees collected from the decentralized entities

* Design the data templates for the collection ofinformation Validation methology for data to be inputed in

* Training of national and regional coordinators calculation of pension liabilitiesand of data collectors

* Design of the databases to store the collected Databases with employment histories of allinformation affiliates to these 1000+ entities

* Collect, input, validate and rectify the sourceinformation into the unified system

* Supervision of the above process at thenational level (over 1,000 institutions) toensure validity and consistency in the system

Actuarial model to compute pension liabilities 8/97-8/00 2,120,000 VM* Calculation of the nension liabilities of

decentralized entities Determination of the value of pension bonds* Identification of data fields to make the for the affiliates and of the value of the

actuarial computation and design of validation aggregate liabilities by decentralized entitiesmechanisms for these fields

* Identification of additional relevant Issuance of bonds by municipios to the pensioninformation such as collective bargaining funds to reflect the transferred pensionagreements, special contractual benefits, etc. liabilities

* Evaluation of existing actuarial calculations* Design of the mathematical and actuarial Better knowledge of the expected impact of the

models to quantify pension liabilities pension liabilites on public finances.* Running of the system of models for the

1,000+ decentralized entities and theiraffiliates

* Design of a macro model to simulate theevolution of public sector pension liabilities __.______ _

over time and their cash flow and fiscalimplications

R Institutional strengthening of the Delegatura ofPension and Severance Payment Funds

Improve off-site and on-site supervision and Upgraded supervision of this type of 9/97-12/99 218,000 VT/SBsystems auditing of pension funds by, inter alia, contractual savings institutionssharing experiences with pension supervisoTyagencies of other countries (e.g. Argentina, More efficient collection of contributionsChile, Spain, Peru).

* Upgrade framework for collection of Lower transaction and marketing costs forcontributions, including distilling experiences affiliatesfrom other reformed pension systems

* Review of the regulatory framework, particularly Improved investment performance of pensionwith respect to procedures for affiliations, fundswithdrawals and transfers, investment regimes,acknowledgement and payment of pensions,reserve funds, fees and marketing expenses,etc.

* Study to upgrade the supervision system of thepension funds' management of employmenthistories of affiliates

* Upgrade the statistical databases on the pensionsystem, based, inter alia, on the experiences ofother reformed pension schemes.

* Training of the Delegatura's staff, in subjectsincluding actuarial valuation, estimation ofpension liabilities and life insurancemethodologies.

C. Institutional Strengthening of the Institute ofSocial Security

* Comprehensive diagnostic and evaluation of the Improvements in the financial management of 9/97-8/98 250,000 VT/ISSexisting information systems of the ISS as well as the ISS.ot its present and future needs for managementinformation systems.

* Preparation and design of a strategic plan for the Better capacity of the ISS to serve its affiliatesmodernization and upgrading of the managementinformation systems.

D. Pending Regulation and Impkmentation of Law100 on Social Security Reform* Analysis of alternative options for filling the Isuance of appropriate regulations and 10/97-6/01 533,000 VT

resource gap for decentralized entities to fulfill establishment of efficient implementationtheir oension obligations and liabilities mechanisms to implement the Social Security

* Analysis of harmonization of norms on collective Lawbargaining agreements with regime of individualcapitalization Parties affected by the new social security

* Collection and analysis of operational guidelines system will have adequate knowledge of theirbeing applied by entities of "prima-media" to responsibilities and how to carry them out.venfy their compliance with the above Law andits regulatory decrees Improved financial perfonnance of new

* Compilation of all legal and regulatory nonns pension fund system and resulting higherwith reference to the new pension system, and pension benefits for its membersissuance of dissemination and explanatory textsto aid compliance with the social security law.

* Evaluation of the impact of different provisionsof the law and continued fine-tuning of theregulatory system emerging from the law.

V. Development of a system for Control of MoneyLaundering Activities

A. Estabishment of the System of FnancialIntelggence and Preparatory Adivitesfor SubsequentImpkmentation

* Creation of the Financial Intelligence Establishment of core entity to initiate process 3/97-7/98 850,000 VT/UIIF/SB/Information Unit (UI1F) of building the financial intelligence system SV/SS

* Detail design of the UIEF in terms of itsstructure, technical and administrative Hiring of staff and assembling of

procedures, operational manuals, definition of administrative and procedural infrastruture.organizational and staffing structure, jobdescriptions, etc. Development of pilot information system to

* Hiring of UIIF Director, strategy coo.dinator, gather, monitor and detect potential moneyoperations coordinator, and administrative laundering transactions.coordinator

* Design of the norms and procedures to launch Staff have the capacity to monitor and analyzethe system for control of money laundering in information for detection of irregular practices.the first three sectors (banking, securitiesmarket and corporate control)

* Provision of initial systems for data gatheringand information processing for the UIEF

* Drafting of legislation to expand the systembeyond the initial unit

• Initial training of UIF staff. n* Strengthening of institutional capacities for

control of money laundering in the threeselected 2nd tier institutions (Superbancaria,Supervalores, Supersociedades)

* Creation of the specialized units in the threeabove institutions

R Impkmentaton of the System of FinancialInteUgence in the three priority sectors

* Approval of legislation to implement the Approval of legislation to implement the 8/98-11/99 500,000 VT/UIIF/SB/system in the priority sectors financial intelligence system SV/SS

* Development of information systems linkingthe three superintendencies with the UIJF Information systems to gather, monitor and

* Development of monitoring system for detect potential money laundering transactionsROIS/SUOR (Suspicious or Unusual are in place and are generating relevant data.Operations Report ng)

* Training of laundering analysts of the UIF Staff from the relevant institutions in the three* Development of query systems for accessing sectors have the capacity to monitor and

databases of the three 2nd tier institutions __ _

. Expansion of UIEF's information systems analyze information.capacities, to allow for future incorporation ofadditional sectors and volume of operations

C. Expansion of coverage of the system offinancialintelUigence to additonal sectors of the economy(cambios, customs, income tax, real estate, etc)

* Development of information systems linking Financial Intelligence System reaches broad 12/99-6/01 1,330,000 VT/UIEF/Otherthe additional 2nd tier entities with the UIIF coverage of the economy agencies TBD

* Development of monitoring system forROIS/SUOR (Suspicious or Unusual Money laundering practices are generallyOperations Reporting) identified, and the relevant authorities receive

* Training of staff of UIEF and 2nd tier the necessaly information to take appropriateinstitutions in newest techniques of money action to deter them.laundering

* Strengthening of institutional capacities forcontrol of money laundering in the additional O

2nd tier institutions* Creation of the specialized units in the above

institutions* Development of query systems for accessing

databases of the new 2nd tier institutions* Study to evaluate the system of financial

intelligence for possible future modificationand upgrading

VL Development of Competition and Anti-TrustPolicy Capacity

Development of Institutional Know How on * Expertise in industrial organization and 9/97-9/00 470,000 VT/SICPolicy and Substantive Areas antitrust regulation acquired by 5 lawyers

* Transfer of knowledge from experienced and 4 economistsacademics in anti-trust and industrial * Four foreign academics to be brought toorganization SIC for a full summer each to upgrade

* Obtain advice and intellectual leadership theoretical skillsthrough in-house part-time top notch economic a Hiring of permanent local part-timeconsultant consultant for period of three years

* Development of Institutional Know How on * Three annual seminars will provide SIC 9/97-9/00 380,000 VT/SIC

Procedural Matters staff with the distilled knowledge of those* Intensive one week seminars by current or that have managed antitrust cases

former staff of established competition * Issuance of Procedural Guidelines oncommissions anttrust management

* Development of Organizatonal Guidelines * 12 staff of SIC will participate aswith support from above staff apprentices in the work of established

* Apprenticeship program at foreign competition competition commissioncommissions .

* Development of Policv Guidelines and As policy guidelines need to be based, inter 9/97-9/99 250,000 VT/SICRegulatorv Normsl alia, on domestic experience, issuance process

* Guidelines and Norms for mergers and would be in steps:acquisitions * Preliminary guidelines

* Guidelines and Norms for anti-competitive * Official Guidelines 4

investigations* Guidelines for sanctions and penalties

* Inftructur Development Creation of an inaUtte for acquisition 12/97-6/99 330,000 VT/SIC* Creation of anti-trust library and management of information:* Development of bibliographic database * Acquisition of library materials* Development of Case Loan database * Operation of bibliographic database* Development of a specialized Local Area * Operation of Case Loan database

Network * Operation of specialized LAN

* Analvsis of mergers and anti-competitive * On economically, and possibly politcally, 12/97-6/01 450,000 VT/SICinvestigations sensitive cases: (i) approval/Rejection of

* Large and complex cases of mergers and anti- mergers; and (ii) decisions on existencecompetitive investigations need to be handled and penalizaton of anti-competitivewith specialized expertise in order to avoid practiceswrong decisions in potentially critcal cases Technically superior and faster decisions on

* Technical and economic work to be contracted cases at stakewith specialized foreign consultants to support _ ._.._..._

policy decisions on specific cases. Wouldinclude 2 to 3 cases per year

VIIL Project Management and Administration 816,000 VT

VIIL Contingencies

Physical Contingencies (5%/) 898,000

Price Contingencies (3% per year in US$) 1,132,000


Agencies:

VT: Technical Viceministry of Finance (Viceministerio Tecnico)SV: Superintendency of Securities (Superintendencia de Valores)SB: Banking Superintendency (Superintendencia Bancaria)BR: Central Bank (Banco de la Republica)PCD: Public Credit Directorate, Ministry of Finance (Direcci6n de Credito Publico)DANCOOP: Department of Cooperatives (DANCOOP)SES: New superintendency for cooperatives, to be created (Superintendencia de Economia Solidaria)ICETEX: Institute for financing of higher education (ICETEX)ISS: Social Security Institute (Instituto de Seguridad Social)UHIF: Financial intelligence and information unit (Unidad de Informaci6n Inteligencia Financiera)SIC: Superintendency of Industry and Commerce (Superintendencia de Industria y Comercio)

49

Annex m

Table 3: Procurement Arraneements

Activities Total Cost Procurement method for(US$) Consulting Services

Developing the financial markets into a more efficient intermediation channel

A. Inproving the Functioning of the Market 575,000 QCBS, SBCQ,SS,IC

B. Developing the Marketfor Public Securities 487,000 QCBS, SBCQ,FB

C. Promoting Greater Participation of Institutional 175,000 QCBS, SBCQ, FBInvestors in the Financial Markets I _I

IL Strengthening Regulation and Supervision Capacity in the Financial Sector

A. Harmonizeation and Refinement of the Regulatory 440,000 QCBS, SBCQ, ICFramework

B Strengthening Insutional Capacity for 2,075,000 QCBS, SBCQ, FBSupervson in the Financial Markets

C. Creation of a New Regulatory Frameworkfor the 1,865,000 QCBS, SBCQ, IC, FBCooperatives Sector.

mL Increasing the supply of securities and the availability of other financial instruments

A. Increasing Supply of Securities 715,000 QCBS, IC, FB

B. Introducing andPromoting New Instruments - 1,891,000 QCBS, SBCQ, IC, FBInter Alia Securitization, Derivatives, Venture CapitalFund, Housing Funance and Education Fnance.

IV. Consolidating the Implementation of the New Social Security System

A. Implementing the Transfer of Pension Liabilties 3,370,000 QCBSfrom the Decentralized Public Sector Entities (e g.Municipalities) to the New System.

B. Institutional Strengthening of the Delegatura of 218,000 SBCQ, IC, FBPension and Severance Payments Funds.

C. InstiAutional Strengthening of the Institute of 250,000 QCBSSocial Security.

D. Continue Implementation and Regulation of Law 533,000 QCBS, IC100 on Social Security Reform

50

V. Development of a system for Control of Money Laundering Activities

A. Establishment of the System of Fnancial 850,000 QCBS, SCBQ, IC, FBIntelligence.

B. Implementation of the System of Fnancial 500,000 QCBS, IC, FBIntelligence in Three Priority Sectors

C. Expansion of the System of Financial Intelligence 1,330,000 QCBS, IC, FBto Addional Sectors of the Economy

1,880,000 QCBS, SS, IC, FBVL Development of Competition and Anti-TrustPolicy Capacity

VIL Project Management and Administration

816,000 QCBS, IC

Physical Contingencies (5%/o) 898,000

Price Contingencies (3% per year, 4 years) 1,132,000


QCBS: Quality- and Cost-based SelectionSBCQ: Selection Based on Consultants' QualificationsSS: Single Source selectionIC: Individual ConsultantsFB: Selection under a Fixed Budget

IMAGING

Report No.: T 7135 COType: TAN

TECHNICAL ANNEX COLOMBIA FINANCIAL MARKETS DEVELOPMENT...

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