Picking up the pace
Brazil’s regulator, Comissao de Valores Mobiliarios, has overseen significant reform in its financial supervision regime, reflecting the advances made in the underlying markets. But it has plenty more to do, as Anthony Dovkants reports.
An overhaul of local accounting; a dramatic speed-up in debt and equity transaction approvals; and a crackdown on market misbehaviour: just some of the core goals facing one of the world's toughest regulators this year. Third parties are pulling Brazil’s local debenture and ABS markets in different directions in their attempts to revive them.
For Sergio Weguelin, commissioner of Brazil's Comissao de Valores Mobiliarios, these challenges represent business as usual as Brazil continues to embrace modern global practices, further distancing itself from what has been described as its rapid emergence from the dark ages of the 1990s.
"When we were on a recent roadshow for foreign investors and we started to present the advances we had made, what really drew my attention was just how far we had come since 1994. Analysts' reports did not even cover adequately Eletrobras (then state-run energy system and one of the largest companies of Brazil), at the time there was no comprehensive research in the market that adequately portrayed the different components of the company. We did not have many players in action either, we did not have enough people raising the pertinent questions, we did not have private equity, venture capital let alone mezzanine funds or real estate instruments, there was no governance. Quite simply, the law was the same as the one of 1976," said Weguelin.
It’s a fair observation. The regulator has sought to bring in new norms to help develop the nation's equity capital market, which ranks as one of the fastest growing in the world. From a mere US$7bn plus of issuance in 2003, it can now boast more than US$24.4bn worth of deals in the first two and a half months of this year.
For this year, a key challenge will be to bring a new accounting law called 11.638 aimed at embracing the best of global practices. It simplifies the system that has operated on two tiers. All corporates adhere to a more lax Brazilian GAAP accounting system, but a select few, wishing to list on Bovespa's Novo Mercado – new market – supplement this with US GAAP.
The changes to the corporate law's accounting section tackle much-needed areas such as cash flow, changing present transaction values and donations for investment subsidies. "The proposed amendment to the law first arrived in Congress in 2001 and there were many delays. We did not think it would materialise until early this year but it came in the last week of 2007. The law brings Brazilian accounting standards much closer to IFRS (International Financial Reporting Standards) but it does not cover all of them. We are going to try to obtain full convergence over the next two years," said Weguelin.
As part of this, the CVM will be talking to the IASB (International Accounting Standards Board), questioning on those areas that are open to interpretation and addressing those that will not work for Brazilian companies, having not been tailored to suit the intricacies of Brazil’s system.
"In some cases, there will be some minor local adaptations, as is the case with other countries," said Weguelin. The CVM is looking to introduce the standards in full by 2009. "We will advance in areas that are not in the law but are in the IFRS," he added.
"The changes will put Brazil on a level playing field with other entities around the world,” said Weguelin. “We hope to eliminate any possibility of interpretation by creating one type of accounting language that will lead to reduced costs and fewer problems. It will also lower investor concern about the financials hiding any potential traps and should boost international confidence in Brazil,"
Aside from IFRS, the CVM is reducing its workload significantly in the capital markets arena by handing over responsibility for capital market transactions analysis and approval to ANBID, the national association of investment banks. Government funding has been unable to keep up with the rapid increase in capital market transaction flow since 2005 when IPOs, debentures and ABS were making large strides in volume growth.
The landmark decision follows criticism by senior bankers about how long transactions have taken to gain approval. Usually, transactions can take between one to three months. Deals issued off a two-year shelf programme, however, can get done within a month. At worst, some debentures have ended up stuck in a rut for six months before being approved. That at least was the record during pre-volatility days. Today, issuer reluctance to have to pay extra has meant deals have stopped altogether.
Even the one-month, best case scenario is not fast enough. The CVM has brought in key fast-tracking rules that will allow issuers to get deals done in as little as one or two weeks, after introducing a five-day approval programme for new deals. Many hope it will lower risk, boost issuance, attract more investors and remove uncertainty as issuers will file with the CVM, announce the deal publicly the following day and offer a prospectus at the same time. Issuers, however, are yet to embrace such speed.
Now the hope within the banking fraternity is that ANBID will be able to reduce the transaction approvals process by half to a matter of weeks before streamlining it to a week. To achieve this, ANBID is setting up a new department, to be headed up by the highly-respected debt capital markets veteran Emilio Otranto, who left his role as head of DCM origination at Banco Votorantim earlier this year.
Otranto has played a key role in building up Votorantim's presence in the energy sector, and worked on a number of ground-breaking transactions locally and internationally in local currency. Otranto will be busy building up his team over the coming months, and the handover of roles between the CVM and ANBID is expected to be completed by the second half of 2008.
By speeding up the process, the hope is that more issuers will turn to debentures and ABS, allowing the CVM to dedicate more resources to policing market misconduct . On the capital markets front, more needs to be done if Brazil is to ever get a true primary and secondary debt market. The country is riddled with structural problems, including a high proportion of bought transactions, issuers requesting firm guarantees, the inability of certain funds to conduct their own credit and quantitative strategy analysis and a lack of knowledge about products. There is a pervasive reluctance for top credits to construct benchmark points in the local debenture and ABS markets, providing reference curves for the rest of the market, as local investors are not prepared to buy paper pricing through the sovereign.
Neither does it help that major local banks wish to avoid reform to prevent foreign banks from competing The market will not evolve if foreign investors are not given any incentive to buy into this market en masse.
For the debenture market, the CVM has gone as far as it can when it comes to providing a model for such transactions by providing recommendations, including the size of a debenture, so as to facilitate retail interest. But banks have not adhered to the changes.
For ABS, the CVM is criticised for hurting the market by forcing issuers to provide greater transparency, for example disclosing debt on their balance sheets. This was its most unpopular move by the regulator, but it brought ABS accounting rules in line with international standards. Bankers now admit this is no longer a problem, though it contributed to the market's decline alongside a pick-up in IPO issuance.
"We cannot enforce laws to make the debenture model structure a national standard. The ABS regulation was very cautious and we are waiting to see how the market responds, and while there are banks that call us and say let's sit down and try to develop this debt market, we need a bigger effort from all round. We need the government, the BNDES and perhaps the Bovespa to get involved," said Weguelin. "Perhaps we should create a standardised new market for fixed-income like the Novo Mercado for equities but we are yet to see interest from all sides for a change in the debt capital market, when we see this we will try to move forward with it," he added.
For now, a tug of war remains between the foreign and the local banks. The latter are defending their territory. Yet if the former were truly interested in competing in debentures and ABS, they would have made a more powerful case for change in local debenture taxation, and on rules of firm commitments. Such a change in foreign banks’ stance may not come until the IPO pipe and fees start to dry up, forcing overseas players to step up the pressure and try to diversify into local debt. That change, however, may not happen for another two years.