Despite infrastructure issues and a lack of scenery, São Paulo has seen off local rivals and is emerging as the region’s pre-eminent financial centre. John Rumsey explains.

When Argentina’s Banco Patagonia decided to seek fresh capital to continue expansion, it listed in New York and Buenos Aires. Right? Actually, the bank also raised funds through the São Paulo stock exchange, Bovespa. Through its Brazilian Depositary Receipt programme it reached close to 3000 investors, 84% of whom were from outside Brazil.

The deal, the first of its kind, confirmed Brazil’s emergence as the financial capital of South America with São Paulo as its hub. Of the roughly $30bn raised through equity markets in the region to the end of August, 80% of the deals came through Bovespa.

The city’s role as a financial centre was not always so assured. The former capital Rio de Janeiro was seen as a serious contender and it was unclear which would become the financial centre as recently as 25 years ago, says Alkimar Moura, professor at the Getulio Vargas Foundation in São Paulo.

São Paulo was a gritty industrial centre by the 1960s and that attracted banks in its wake, says Graham Nye, a partner at PricewaterhouseCoopers in the city. At the end of the 1980s, further changes tipped the balance in São Paulo’s favour, says Alfredo Moraes, president of the association of investment banks, ANDIMA. A corruption scandal on the Rio exchange led to a wave of brokerage bankruptcies and shifted the centre of gravity to the Bovespa. And in the revival of the mid-1990s, the Brazilian banking sector was seized with merger fever and São Paulo, which hosted the country’s large banks, furthered its lead, notes Mr Moraes. The final straw for Rio came with Bovespa’s buying out of smaller regional exchanges.

Still, the rivalry between Brazil’s two mega cities is not dead and buried. Rio still hosts parts of the Central Bank, as well as the headquarters of the BNDES, the country’s national development bank and the regulatory agency, the Comissão de Valores Mobiliários. In the past two years, coastal Rio has been successful in attracting many of the new wave of hedge fund managers with leading firms such as Gávea Investimentos and Polo Capital headquartered there. Having Copacabana and Ipanema beaches probably does not hurt in stopping talent leaving for its arch-rival São Paulo.

Banking and markets

São Paulo’s confirmation as the centre of core financial services means it is hosting the second dynamic round of fund raising and consolidation in the banking sector. There have been six initial public offerings (IPOs) of banks in the past six months, almost all of them mid-sized. “Financial intermediation is increasing and leading to new opportunities for small banks. They are likely to cluster in São Paulo, enhancing the city’s attractiveness,” says Mr Moraes. The titans Bradesco and Itaú have been buying up specialised credit banks. Consumer lending is growing year-on-year by some 25%, with the hottest areas such as automotive loans growing by 35% a year for the most successful banks.

Banks are also celebrating the dramatic rebirth of capital markets. A series of legal changes in the early 2000s has seen Brazil adopt almost all of the recommendations of the Bank for International Settlements, including central counterparties and excellent delivery versus payment standards, notes Pedro Guerra, managing director at Citigroup Brazil. That means Bovespa’s clearing and settlement functions have leapfrogged those of many markets in the developed world.

A further key change has been more investor-friendly tax legislation, says Mr Guerra. Associations have been tirelessly lobbying Brasilia to make financial markets more appealing. They succeeded with the removal of the onerous financial transaction tax followed by the elimination of the 15% withholding tax on government debt last February.

A sign of the maturity of market authorities and regulators is the ease with which the transition to international accounting standards was made in Brazil, adds Mr Nye. Finally, the demutualisation of both Bovespa and the futures market, the BM&F, should also shake up the cosy brokerage system and cut trading costs.

Current dynamism

The speed of the development of São Paulo’s financial markets has been breathtaking. The past four years have seen Bovespa go from a backwater to one of the world’s most dynamic markets. And Mr Guerra reasons that the Argentine listing could mark the embryonic emergence of Bovespa as a pan- South American exchange. He notes that consolidation between exchanges is taking place in the rest of the world and that the small economies of most Latin countries means one large liquid exchange makes sense.

If that starts to happen, the only possible competitor in the region is Mexico City, although Madrid, too, is trying to wrest business away from New York and local exchanges, notes Mr Moura. Mr Nye cautions, though, that the success of Bovespa in attracting foreigners has been so great that ironically its very dominance – foreigners buy some 70% of new issues – poses a concentration risk for the market.

If equity markets have been performing impressively, debt markets have been developing more slowly. The government has been helping by slashing its overall debt burden and bowing out of the dollar market and building an ever-longer fixed-rate yield curve in the local currency, the real.

Key to the speed of the further development of financial markets will be the achievement of an investment grade rating. Brazil is the only one of the four BRIC (Brazil, Russia, India and China) markets not to have this but its rating has been steadily improving and now lies tantalisingly close at one notch below with the three major rating agencies. Most expect the upgrade to come in the next 18 months. The fly in the ointment is the withholding tax which is likely to mute foreign interest in corporate debt.

Mr Moraes points out that the continued fall in interest rates is putting pressure on the way Brazilians save. Traditionally, parking savings in government bonds was a sure-fire way to make double-digit returns. That dynamic has changed with lower rates and that means the asset management industry is one to watch. Already, the hedge fund market and private equity shops are in frank expansion. For example, Advent International recently raised $1.3bn for a private equity fund, the most ever raised in the asset class for investment in Latin America.

Promoting the city

The development of the country’s financial markets has been largely organic and is squarely down to improvements in the macroeconomic situation of the country, stability and the better legislation prevailing in capital markets. The grouping of key players to spread the good news has helped. Mr Guerra has been key. He recognised in 2002 that foreign investors were basically ignorant of the huge improvements going on in Brazil’s financial markets years after they had been implemented. He determined to do something about it. Out of this was born BEST, a body that brings together representatives from major government and private sector bodies. It has organised a series of roadshows in the US, Europe and Asia, hosted by senior government officials.

Still, BEST is something of a voice in the wilderness. The attitude of the federal government to São Paulo is laissez-faire at best, says Mr Moura. In part, it is inertia and in part a reluctance to further centralise power in São Paulo. The lack of support is disappointing and compares poorly with centres such as New York and London that have developed a range of sophisticated marketing techniques, such as British Invisibles, points out Mr Nye.

The lack of a government’s enabling hand is evident elsewhere, particularly in the city’s infrastructure. While São Paulo has been highly successful in bringing down serious crime numbers in the past five years, it seems stalled on how to tackle the city’s huge congestion problems with economic growth propelling a 25% increase in new car sales over the past two years. Still, senior bankers fuming in the traffic might just take consolation in their new Porsche. Sales of the brand to date this year have rocketed.

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