A visionary plan to put Brazil and São Paulo in pole position as financial centres for Latin America was unveiled on March 24th, backed by luminaries from the private and public sector. The nuts-and-bolts of how this scheme will be translated into reality, however, are lacking, and it is unclear just how great is the prize, which seems to involve consolidating Brazil in its already undisputed lead position in the region.
A new association, dubbed BRAiN, from a Portuguese acronym for Brazil Investment and Business, aims to identify obstacles and propose solutions with the aim of consolidating Brazil as the international pole of investments and business in Latin America. It is not lacking in clout. The filmed press launch and a subsequent cocktail reception attracted luminaries such as Brazils finance minister Guido Mantega and president of the Central Bank Henrique Meirelles as well as leading figures from the exchange and banking industry.
BRAiN is the fruit of close to two years work and is headed by respected and senior figures, with Paulo Oliveira, the chief business development officer at BM&F Bovespa, acting as president. The recent, highly successful listings of the two exchanges, their merger and subsequent trajectory testify to his ability to deliver.
The association has already scored some notable successes. It has signed up some very large financial sector and industrial organisations as associates which promise to fork out BRL1m per year for three years. Bradesco, BTG Pactual, Citibank, Itaú Unibanco, HSBC, Santander, Votorantim and Banco do Brasil have all joined or are negotiating to do so.
Furthermore, BRAiN is spearheaded by a group of organisations similar to that behind the highly successful BEST initiative. Public-private sector grouping BEST promoted Brazilian financial markets around the world, taking the Brazilian story to centres of liquidity and explaining the regulation and make-up of Brazils financial markets to overseas investors, note José Carlos Doherty and Alberto Kiraly, executives at Financial and Capital Markets Association ANBIMA. BEST was wound up in 2008 after a series of global roadshows that were seen to have fulfilled their mission and is widely seen as a clever initiative that helped Brazil capitalise on the wave of interest in the BRIC and emerging markets.
BEST met a specific knowledge gap. In the 1990s, investors had very little understanding of how Brazilian markets worked and had the wrong impression regarding the security of transactions and corporate governance, say Doherty and Kiraly. BEST educated investors on the regulatory environment, legal framework and infrastructure such as payment systems and trading platforms, they note.
The initiative paid off in spades. Today, the Bovespa BM&F market is the fifth biggest derivatives in the world and 11th largest stock market, says Oliveira. It also has one of the worlds highest market capitalisations of some $14bnthird after the CME (Chicago Mercantile Exchange) and Hong Kong exchange. That reflects the markets confidence that there is huge potential for Brazil to grow, says Oliveira.
The launch of BRAiN will see a fresh series of roadshows with the emphasis on the size and depth of Brazilian markets. The plan is to provide detailed profiles of the main players, talking about the growing range of products and the evolution of markets. We are highlighting the size and opportunities of the market in attracting capital. For example, most investors still dont know that we have deep portfolio management expertise and on some gauges, Brazil is the sixth largest asset management industry in the world, says Oliveira.
So far, so good. However, the new BRAiN plans seem to have less raison dêtre than its BEST predecessor. Brazilian finanical markets have taken off and in hindsight are seen to have overheated in 2007 when 63 companies were brought to market. The global crisis saw equity markets fall from close to 74,000 to less than 30,000 points, but they have come back with a vengeance and were trading at close to 70,000 at the end of March.
If anything, equity markets need cooling down with valuations that are looking stretched by international emerging market standards. Nicholas Morse, LatAm fund manager at Schroders Asset Management in London, comments: Brazil is looking less attractive than it was. The risk-return benefits have shifted.
BRAiN is a long-term initiative and valuations come and go. Even so, leaders seemed unable to flesh out the proposed concrete measures and plans, and preferred visionary language and catchphrases. The use of buzzwords and phrases such as multi-sector, regional international hub and developing skills were in abundance; practical steps to strip away Brazilian impediments to market growth, such as the non-convertibility of the real, a limited talent pool in financial services and high taxation levels, were not addressed. Brazil is moving cautiously towards convertibility as the reals positive track record lengthens, but BRAiN is not seeking to formalise the process and nor does it see its role as pressuring government on taxation.
Investors are fretting more about the role of the government. The valuation of the real has also been an on-off concern and at its peak prompted the sudden imposition in October last year of a 2% tax on foreign investments in equities.
More worrying, there are serious concerns over the governments industrial policy and its ramifications for companies in which it is a signifcant shareholders, such as Vale and Petrobras, which still account for some 35% of the Bovespa Index, and much of the liquidity.
Walter Mendes, the president of the Association of Capital Markets Investors (AMEC), points to the proposed capital raising for Petrobras. The first stage of the transaction will see the government sell Petrobras the right to explore and produce five billion barrels of oil, although the mechanism for pricing this right remains unclear. Then, the government plans to launch a rights issue, which might prove to be the largest ever such deal globally in dollar terms. So far, it is pushing to achieve this through legislation, excluding minority shareholders from participating in the discussion on the need for and size of such a deal. Not only that but the government will pay for its share by issuing bonds rather than cash, he notes. The organisation is fighting all these measures and sees them as a significant reversal for minority shareholders.
The government has also been pressing Vale to invest more in Brazil rather than overseas and source more of its inputs locally, notes Mendes. These measures in such critical companies undermine efforts to improve corporate governance in the country.
Listings from abroad
Finally, the government seems to have influenced the agenda of BRAiN with a particular emphasis on developing multi-latinas based in Brazil. This is a cornerstone of the strong industrial policy advocated by President Luiz Inácio Lula, and likely to be followed by his successor who will take office at the start of next year after elections scheduled for October. Its relevance to turning São Paulo into a regional hub seems tenuous.
One of the cherished aims of BRAiN is to attract more Latin listings to BM&F Bovespa, with key target markets identified as Chile, Peru, Colombia and Argentina. Many financial transactions routed through London and New York could be carried out within Latin America, the argument goes. That would enhance liquidity on the BM&F Bovespa; induce more brokers, both foreign and local, to set up shop; and end up trimming the costs of capital for corporates.
The success of Brazilian financial markets makes this seem less ambitious: São Paulo already accounts for 70% of equity transactions in the region and a full 90% of derivatives. So expanding Brazils share of Latin transactions would appear both difficult and not particularly fruitful. The Portuguese language also makes transactions in Brazil more cumbersome for companies from Spanish speaking countries.
The record in developing the liquidity that would attract foreign companies to list is mixed. The exchange has been active in seeking to enhance liquidity, for example through new trading platforms and agreements with other exchanges.
BM&F instigated a cross-share swap with the Chicago CME Group (formed by the merger of the Chicago Mercantile Exchange and the Chicago Board of Trade) whereby the BM&F gained a 2% stake in CME, which took a 10% stake in BM&F, and NYSE Euronext bought a 1% stake in Bovespa at the time of its listing in 2007. The two went on to sign an agreement in December last year to distribute each others market data as well as provide NASDAQ products and services to listed Brazilian companies.
In key areas for liquidity, however, Brazil is lagging behind. Its asset management industry, while large, remains relatively unsophisticated. Development of a local fund industry is nascent and one difficulty remains the lack of competitiveness of the industry, says Otávio Yazbek, director at CVM, the market regulator. Asset management remains very centralised through banks. The CVM recently discussed rule 490 to increase transparency of funds and measures to stimulate the growing independent asset management business. We need a burst of competitiveness and we have a role in this, says Yazbek.
Chile is leagues ahead in the sophistication of its pension fund industry, which is already sufficient to cover a large part of the financing needs of the companys corporates. Peru and Colombia, the other two large target markets, have been working hard to encourage the development of their rapidly-growing institutional fund marketplace and allow funds more scope to invest in equities. Today, only corporates seeking to bring to market large deals need to seek external financing.
Meanwhile Argentinas stock market continues to decline in relevance. Ironically, one of the very few Brazilian Depository Receipts to date was a BRL76m equity deal from Banco Patagonia of Argentina. The Argentine bank may be swallowed up by Banco do Brasil, which is seeking to build a larger presence in the country.
For those deals where external financing is needed, it is unclear just how Brazil will win over clients from more established, sophisticated and liquid centres such as New York or London. The image of Brazil remains a problem. Yes, the macroeconomic conditions have been stable for the past 15 yearswith a blip or two, particularly in the run up to the elections of 2002and regulation ensured a smooth passage for local banks through the crisis. However, Bovespa has neither the long track record nor the sophistication of global markets.
Latin corporates do not yet see São Paulo as an alternative to New York and London, says Yazbek. Changing the image of Brazil requires not only regulatory changes but the greater integration of Brazil into the global economy and a drive to bring overseas investors. Foreign investors will be key, he admits.
The Brazilian legal system is a drag on corporate governance. The CVM has earned its spurs by continually updating and improving rules in corporate governance and pushing the exemplary Novo Mercado, a market segment that has tough corporate governance standards. It is difficult, however, for the regulator to successfully prosecute cases of abuse through Brazils legal system, thanks to protracted timeframes.
More details, less waffle
There are other areas which seem not to be on the radar screen of BRAiN, yet which will prove hugely important in the development of São Paulo as a financial market, including tapping into new pools of emerging liquidity such as China and the Middle East.
The BRAiN initiative has lofty aims and an excellent team to realise them as well as the goodwill of an important swathe of the Brazilian banking and business community. The outstanding success of its predecessor BEST is also cause for optimism that it is a powerful association. It is not clear, however, exactly what BESTs priorities are, nor how it proposes to achieve them.
Recent interventionist moves by the government also beg the question whether the public and private sector might increasingly pull in different directions. The key stated aims of BRAiN, such as improving training and education and fostering Brazilian multilatinas, seem to have the governments fingerprints all over them. Yet treatment of Brazils state-owned companies is tending towards the paternalistic and away from a due respect of minority shareholder rights.
BRAiN would do well to put its thinking cap on. It would do well to educate the government on treating markets and minority shareholders with equanimity; seek to bring more Brazilian retail and consumer companies to market to enhance diversification on the exchange, which is still way too dependent on commodity companies; and work to encourage broader shareholding and a stronger asset management industry.