A FAMILIAR FOE
Brazil’s banks are generally family-owned, so they’ve escaped the pressure to meet shareholder demands for short-term gain. But if governance is to improve in the country, this entrenched family culture will need to be opened up to greater scrutiny.
In November, Brazil’s central bank detected what appeared to be large-scale fraud at Banco Panamericano and was compelled to inject R$2.5 billion ($1.45 billion) to rescue the midsized bank, Brazil’s 22nd in size at the time.
Panamericano, which focused on consumer finance and car loans to lower-income clients, had allegedly been on-selling loan portfolios to larger banks while retaining the portfolios on its books. The case, however, was an exception in what is seen as a solid and safe market with conservative regulations and high reserve requirements. "It was the central bank that identified the problem, showing its good auditing practices and highlighting the limits of auditing by independents who had not spotted it," says Alexei Koslovsky, superintendent of compliance and risk at Banif Investimentos in São Paulo.
Brazilian banks are generally family-owned and so were not subject to the enormous pressures faced by banks in Europe and the US to meet shareholders’ short-term goals under the intense glare of analysts. Instead, the challenge for Brazilian banks is to open up and expose the cosy family culture to more scrutiny as minority investors take a larger stake in the finance industry and banks tap capital markets more frequently.
Brazilian banks will need to recognize the importance of their investor relations department and enhance its clout by moving the head of the area up the hierarchy from manager to director level, says Marcus Manduca, partner at PricewaterhouseCoopers in São Paulo.
Itaú-Unibanco has prioritised the investor relations area, beefing up its team, says Alfredo Setúbal, head of the department at the bank. Today, Itaú-Unibanco has close to 40 people and more at a senior level. The bank is also expanding its programme of roadshows, webcasts and talks with investors. "Investor demands for a bank of our size are great. What we give is much more than the minimum requirement and often more than international standards," says Setúbal.
The country’s largest private bank, Itaú-Unibanco had R$686.2 billion in assets at the end of 2010, and is the fruit of a merger announced in 2008 between two family-controlled banks. The presidents of the two banks had thrashed out much of the flesh and bones of the deal in an apartment in São Paulo, and took the market completely by surprise when announcing the transaction.
Since then, the combined bank has beefed up its conselho de administração (a second board that reports to the main board of executive officers), which has been delegated more power. The bank established a series of committees on risk and compliance and defined a corporate governance strategy to report to the second board, says Setúbal.
"After the merger, our corporate governance policies had to be updated and we needed to centralise more functions to reflect the size of the post-merger bank. We have imposed more controls and more uniformity, and both the second board and our auditing function were repositioned," he says. The second board has 13 members, six of which are from the three families that control the bank, while others have connections to the bank, typically as former executives. Three are independent.
Over time, Setúbal sees the board becoming more independent as former executives are replaced by outsiders. “The concept of board distance from management is more confused in Brazil as banks are owned by controlling shareholders and not corporations as is typical in the US," he says.
The other challenge is to dedicate more time to corporate governance and foment communication within the organisation, says Setúbal. This year, the second board is going to meet every month and there will be more full-day sessions. Previously it met eight times a year. There will also be more meetings between the second board and the executive officers.
The bank already has a full structure to analyse risks as well as the committee structure, says Setúbal. That precludes the need for much hiring, which is hard in Brazil because of a limited pool of talent. “There is little expertise in the market. It’s difficult to find professionals,” admits Setúbal.
The problems related to governance are different for a smaller bank such as Banif Investimentos. “Internal controls, compliance, and risk processes are still very mixed, with tenuous differentiation,” says Koslovsky. More clearly defined structures, with small teams to monitor risks, internal controls and compliance reporting to a head of corporate governance, would be ideal. Governance is still not as formalised as it should be, he says. Koslovsky sees pressures to step up to the plate not just from regulators but also Brazilian clients, who are showing more interest in how banks manage risk and compliance policies.
For such smaller banks, guidance from regulators is key. The central bank does a good job in understanding banks’ risk profile, says Koslovsky. Ahead of a recent audit of Banif Investimentos, the central bank sent a 700-question form with an annex for evidence and the audit team stayed more than two months at the bank.
However, the volume of work hitting the desks of independent auditors and difficulties in finding properly qualified staff has meant that often teams are composed of inexperienced staff who are not able to ask the right questions, says one banker.
This year, Brazilian banks will grapple with an array of issues. They need to continue to focus on credit, over-the-counter trading, the US Sarbanes-Oxley Act, Basel II, accounting, and new policies and procedures, says Manduca. Moreover, he says, there are new regulations regarding client suitability and more change as Pillar III of the Basel Accord is developed. Koslovsky says regulations on suitability are welcome but need to be tightened as each bank defines suitability differently.
Progress on new regulations
Meanwhile, for listed banks regulations continue to get tighter. Last year, the Comissão de Valores Mobiliários (CVM), the Brazilian equivalent to the US Securities Exchange Commission, passed Rules 480 and 481 to encourage transparency and disclosure by all listed companies. These measures have been warmly welcomed by investors and corporate governance experts. “These rules help Brazil set the pace in Latin America and enable Brazil to maintain its lead in the region,” says Sandra Guerra, founder of Better Governance in São Paulo.
However, a number of carefully crafted rules on independent boards and takeovers that were put to companies by BM&FBovespa, the Brazilian commodities and futures exchange, were voted down, showing the limits to companies’ appetite for ceding control. The CVM, too, needs to have more backbone and stick up for minority investors in cases of abuse, as well as developing clarity in areas ranging from independent boards to takeovers, investors say.
The two new rules brought higher disclosure standards, particularly related to remuneration and the duties of board members, as well as reducing obstacles to participating at shareholder meetings. A leading provision of Rule 480 regards the annual reference form Brazilian companies must submit to the regulator, which has been enhanced so extensively it resembles a full-blown issuance prospectus, says Guerra. A highly controversial proposal to provide a much more detailed remuneration breakdown was successfully introduced and is now mandatory, although there have been attempts to block the measure by disgruntled company managers, she notes.
Setúbal says Itaú-Unibanco has complied with the remuneration rules, adding that in some areas they require more openness from listed Brazilian companies than would be the norm in Europe and the US. Before the rules came in, companies were expected to detail total remuneration for the board of directors and senior executives. Today, companies must release the highest and lowest payments and list all perks and benefits, which allows investors to see whether there are discrepancies between managers holding similar positions, says Guerra.
The danger with the Brazilian, family-owned model is that family members might reward themselves a disproportionate amount of the pie. The rule also makes members of the board of directors declare other interests and positions, thereby revealing how much time they can really dedicate to the company in question, says Guerra.
Rule 481 tackles the thorny issue of proxy solicitations, among other issues. Shareholders used to have to attend meetings or send a proxy, typically a lawyer appointed by the sub-custodian in the case of foreign investors, which is costly in Brazil thanks to its size and poor transport. Moreover, little information was revealed ahead of time and forms were unwieldy. The new rule standardises the proxy forms and calls for information to be provided earlier on the voting issues.
“Rules 480 and 481 place complex compliance demands on listed companies,” says Guerra. “They put governance at a very different level.” These two changes have proven a big step forward on how Brazilian companies are run and their transparency, says James Davidson, manager in responsible investment at Hermes in London, which has $1.5 billion in Brazilian equities under stewardship.
The rules are particularly useful for foreign shareholders, Davidson believes. Two years ago, it was especially hard for London-based investors to grasp how much individual executives were paid in Brazil, while information on proposed board members was made available at such short notice that voting was almost impossible, according to Davidson. “In the past, voting was not transparent. Companies did not provide information on key issues and you really didn’t know what you were voting on. You were effectively disenfranchised,” he says.
The measures have provided “vastly improved guidance on proxy access, the annual meeting process, compensation and disclosure”, says Pat Tomaino in the governance and sustainability team at F&C Asset Management. F&C has $500 million in Brazilian equities under management, a figure that has increased over the past two years.
Tomaino also believes the CVM has become more open to talking to minority investors and sees signs that it is willing to be more active on their behalf. “These interventions, while still rare, are encouraging,” he says.
Yet, both Tomaino and Davidson agree the CVM has been responsive only in certain areas. Davidson thinks it has been remiss in enforcement and the especially thorny problem of insider dealing. In Brazil, it is not uncommon to see prices moving significantly before a corporate announcement is made, he says.
Tomaino has a laundry list of proposals for the regulator to make its role more systematic. These include making a bid mandatory when a shareholder reaches a 30% stake; strengthening boards with more independent directors; clearer guidelines for relatedparty transactions; and holding the fort on executive compensation disclosure. “Important market reforms are needed to ensure minority rights are systematically protected well into the future, and not just in exceptional cases,” he says.
The proposed round of improvements by the BM&FBovespa met a more undignified fate than the CVM’s new rules. The most important gain for minority shareholders was an approval to separate out the position of chairperson and chief executive. Tomaino welcomes the move: “The separation is an important reform that we advocate across all the markets in which we invest,” he says.
However, other key measures failed. They included a proposal to impose a minimum of 30% independent directors on the board; force a takeover bid once a shareholder has built a 30% position; and adopt a board audit committee.
“It should not be a massive burden to increase the percent of independent shareholders from 20% [the current mandatory level]; it would typically require just one extra independent person,” says Davidson. He believes 50% is a more reasonable figure for independent directors and says that in the US almost all board members are independents. “We were disappointed that that some of the core reforms were not ratified,” says Tomaino.
The decision by listed companies to reject these measures has underlined the ambivalence of Brazilian company owners regarding more disclosure and yielding a bigger role to minority shareholders and their representatives.
Tomaino does see a genuine willingness to improve overall. Many Brazilian companies have embraced the Novo Mercado or one of the special M&Fbovespa governance segments. “Voluntary adherence to high standards is key to building a governance culture right at the heart of the business,” he says.
Even so, there are serious exceptions. “In 2008, some of the core provisions of the Novo Mercado were being flouted: minority investors were not being paid fair market price for shares, with controlling parties benefitting at their expense,” he says.
Tomaino says he was relieved and impressed by BM&FBovespa’s attention to the issue and openness to dialogue even though not all situations were fully resolved to the satisfaction of minority shareholders.
Davidson points to the corporate decision-making process in Brazil as problematic. It is far from transparent, with deals cut in backrooms, far up the shareholder ‘tree’, creating opportunities for information to leak to the benefit of the few, he claims. Unlike other jurisdictions, Brazilian takeover rules do not take into account final ownership, he says.
There is a certain culture of arrogance from controlling shareholders that says because the market is doing well there is no need to pay much attention to minority shareholders, says Davidson. “We still haven’t got there in terms of a governance culture in Brazil. Companies are complying with the letter rather than the spirit of rules and regulations.”
The constantly improving corporate governance culture is reflected among large Brazilian banks, which are enhancing structures to monitor their risks and compliance more closely and developing ties with the market. However, the strength of market performance appears to be emboldening listed companies to challenge the implementation of new rules and, in some cases, flout existing ones. And in Latin America, Brazil has to watch its back. “The growing markets of Peru and Colombia as well as Mexico are innovating quickly in corporate governance as well,” Guerra says.