BRAZIL: CAPITAL MARKET REGULATION
An overhaul of the capital markets is removing red tape with the ultimate goal of attaining developed market status. There’s a long way to go, but the new rules are helping.
By Rodrigo Amaral
Brazil’s capital markets have been steadily growing over the past two decades, but red tape is still holding back the issuance of bonds, stocks and other securities. The stock market alone may be the largest in Latin America, at a market capitalization of nearly $1 trillion. But that still pales to the $45 trillion in the United States, $13 trillion in China and more than $6 trillion in Japan and Hong Kong each.
Brazil’s securities commission, known as the CVM, is taking steps to change this to help fuel long-term economic growth and development.
“Capital markets are a tool with the potential to help meet the goals of important public policies, such as social and economic development and the agenda linked to sustainability and climate change,” says João Pedro Nascimento, the CVM’s chairman.
The complex process to do this may seem the dull stuff of lawyers and compliance officers, but a flurry of new regulations could push the capital markets into the league of developed economies, and that is bringing cheer to companies and investors. The new rules, in a nutshell, are making it easier for issuers to sell securities and more investors to buy them.
Juan Giráldez, a partner at the Cleary Gottlieb law office in São Paulo, says the process of public offerings, for example, is becoming more market friendly and flexible.
This revamp fuses dozens of regulations implemented over the past few decades that have already brought constant growth. Issuance of fixed income securities surged to a record BRL457 billion ($88 billion) in 2022 from BRL127 billion in 2012, according to Anbima, an association of asset managers. Equity issuance, of course, had a rotten year in 2022, in line with a surge in interest rates. Brazil’s equity issuance fell to BRL32.1 billion from peaks of BRL128 billion in 2021 and BRL116 billion in 2020 when there was a boom in initial public offerings.
More people in the country of 214 million are investing in bonds and stocks for potentially higher returns than parking their money in the bank. The number of equity investors surged 35% in the 12 months to the third quarter of 2022, reaching 4.6 million, according to the B3 stock exchange in São Paulo. The fixed income market closed the same period with 12.6 million investors after a 25% increase.
The overhaul is helping with this growth by expanding the menu of bonds and stocks.
“The new rules introduce a more intelligent approach to issuance. It looks both to the issuance of debt and to whom the bonds are sold,” says Rafael Garcia F. F. Lima, head of fixed income at Bradesco BBI.
A key change has been to require all deals to be registered with the CVM. While that may sound like adding extra red tape for issuers, it actually allows for further streamlining. Once registered as a frequent issuer, for example, issuers can sell bonds and stocks faster and easier.
Jana Araújo, a partner at the Lefosse law office in São Paulo, says that registered issuers can now hit the market with equity deals in just a couple of weeks.
Previously, the CVM’s analysis of an IPO deal could take up to two months. Now companies can pre-register and wait for the right time to launch the transaction, allowing them to go to market soon after a roadshow when investors are keen.
“Our experience is that the market often turns sour after three weeks of roadshow,” says Araújo.
There are a few catches for issuers. Registering to sell equity, for instance, means that companies must meet governance requirements, including filing financial earnings. The benefits, however, outweigh these new costs. Companies can now register as frequent bond issuers, allowing them to go to market right when they can sell at a lower rate of interest.
The CVM has also taken steps to build a secondary debt market. Bonds can be sold to a wider array of investors, for one thing, and the buyers of a new bond can, in most cases, sell them in the secondary market from the first day after issuance.
“We may have a secondary debt market, which is something that has never existed in Brazil,” says Jean Marcel Arakawa, a partner at the Mattos Filho law office in São Paulo.
To help encourage more investors to make an informed decision about purchasing in a deal, issuers are now required to publish more accessible data about their offerings.
Another goal is to bring more small and medium companies to market, including by allowing more advisors and investment banks – not just the large financial institutions – to coordinate public offers.
“If we start to see coordinators that are not linked to the big banks, there will be more competition in the market, and issuance costs will come down,” says Júlia Franco, a partner at the Cescon Barrieu law office in São Paulo. “It will also make capital markets more attractive to smaller issuers.”
Marina Rodrigues, head of local fixed income at Bradesco BBI, says that smaller companies can also offer commercial notes, a sort-of mix between debentures and promissory notes with fewer restrictions.
The overhaul will also ease the requirements on investment fund managers. Effective in April, they will only have to answer to investors when the shares in a fund decline. This limited liability is expected to reduce costs for asset managers and fuel the development of innovative products, including the setting up subclasses to diversify strategies within a single fund. Before that, every new strategy required the creation of a new investment vehicle.
“It will have a very important impact on the market,” Franco says. “The new protections to fund investors bring the Brazilian market much closer to developed economies.”
“The new protections to fund investors bring the Brazilian market much closer to developed economies.”
– Júlia Franco
Another change allows investment funds targeting retail investors to fully invest in foreign-listed assets, up from a previous limit of 20% of the fund’s assets. This will provide more protection to investors, particularly at times of volatility, Franco says. During the pandemic, the Brazilian market was more volatile than others, but retail funds couldn’t shift more funds to safer markets, hitting them with large losses.
“Managers who could have higher exposures to international markets were able to better protect their funds,” Franco says. “Others opted to turn their retail funds into vehicles for qualified investors.”
The CVM has also authorized investment funds to invest in crypto assets traded on legally recognized exchanges, another form of protection. Many Brazilian investors were burned recently by investments in crypto assets as they looked for alternatives to low returns in the local market.
Nascimento at the CVM says that the goal of the new rules is to help investors understand the funds offered in the market, while reducing the compliance costs faced by asset managers.
“We have revoked 38 scattered rules that were systematized and organized into a single one,” he says.
Also in April, Brazilian issuers will have to comply with new ESG disclosure rules that should bring the local investment framework in line with international sustainability trends. Nascimento says a new resolution that regulates the obligations that listed companies must meet when disclosing their ESG commitments in reference forms was inspired by European Union rules, as well as a standard of the Organisation for Economic Co-operation and Development and the International Organization of Securities Commissions.
Lawyers point out that this new ESG framework is significantly less intrusive than that of the US Securities and Exchange Commission, and that the CVM will only worry about the fulfilment of disclosure obligations. The idea is to provide information so that investors and other stakeholders can do the legwork to make sure that issuers are complying with their sustainability promises.
Even then, the new regime should provide fodder for litigation by investors and activists that feel defrauded by issuers, something that is already a tendency in Europe and the United States. This puts companies at risk of legal consequences for greenwashing, for example.
“Board oversight on ESG will be crucial,” says Roberta Cherman, a partner at the Shearman & Sterling law office in São Paulo. “It will eventually be required by regulation, and right now it is already required by the market.” LF