Voluntary governance standards attract investors on Brazilian market
When John Wilcox first heard about Brazil’s plans for Novo Mercado, a premium listing tier with voluntary governance standards, he was skeptical. A decade later, ‘the great experiment’, as Wilcox calls it, is a wild success, with imitators from India and Turkey to the Philippines.
‘Brazil trusted in the assumption that good governance could reduce the cost of capital and attract investment – and that has proven to be very true,’ says Wilcox, chairman of Sodali and one of the world’s leading corporate governance experts.
Brazil’s stock exchange, Bovespa, was struggling with an investment drought when it launched Novo Mercado in December 2000. Brazilian companies couldn’t attract investors, domestic or foreign, and from 1999 to 2003 the number of IPOs could be counted on one hand. Only two firms joined Novo Mercado in its first three years.
Then came Natura Cosméticos’ successful IPO on Novo Mercado in May 2004. ‘That was the turning point,’ says Sandra Guerra, founding partner of Better Governance in São Paulo and coordinator of the Latin American Companies Circle, a group of 12 companies recognized as governance leaders.
By 2007 Novo Mercado was celebrating its 100th company, and it has hosted 81 of Brazil’s 113 IPOs over the last six years. Add in Bovespa’s less onerous levels one and two governance listing tiers as well as the nascent Bovespa Mais for small and mid-cap firms, and 37 percent of Brazil’s more than 400 listed companies are part of the four special governance segments, accounting for 65 percent of market capitalization and 79 percent of trading value.
Helmut Bossert, Natura’s head of investor relations, says the company spent years training to be a listed company, well before its IPO. Its roadshow pitch included an explanation of the governance attributes that made it a Novo Mercado candidate: only common voting shares, a minimum 25 percent free float, US GAAP reporting, and 100 percent tag-along rights, with all shareholders getting the same conditions in the event the company is sold.
Volunteer spirit
Brazilians talk about the ‘spirit’ of Novo Mercado, meaning companies voluntarily go beyond legal requirements to guarantee rights to minority shareholders. In a country with many family-controlled companies, perhaps the biggest challenge of Novo Mercado is the switch from issuing non-voting preferred shares to having all common shares – in other words, one share, one vote. Another big change is that shareholders can use a streamlined ‘arbitrage chamber’ instead of resorting to litigation, which can drag on for 10 or 15 years.
Marco Geovanne Tobias da Silva, head of IR at Banco do Brasil, the first big bank to move to Novo Mercado, admits it was a challenge to convince the government, which still holds voting control in the bank, that the move would benefit all shareholders – including the government itself. ‘We knew one of the reasons Banco do Brasil was being discounted was that we needed to improve transparency and shareholder rights,’ he says.
Marfrig Group, a food company that went public on Novo Mercado in June 2007, went on to do successful follow-on offerings in 2008 and 2009. ‘We realized stringent governance standards with a high level of disclosure would be the only way to have access to the capital markets,’ says Ricardo Florence, Marfrig’s head of IR and the new president of IBRI, Brazil’s investor relations association.
In the US, SOX and its harsh governance regime has been blamed for costing companies millions and driving away listings. Guerra says SOX is much more difficult and expensive to comply with than Novo Mercado. ‘Brazil’s initiatives were about creating value through good governance, not just complying with rules,’ he explains.
‘A one-size-fits-all law is always going to be much more expensive to comply with than a voluntary scheme that companies themselves come up with,’ Wilcox confirms.
One extra cost of being on Novo Mercado is holding at least one public analyst meeting a year, typically with APIMEC, Brazil’s association of analysts and investment professionals, which can be expensive. Another expense is translating quarterly financials into English and providing consolidated cash flow statements. But these practices are now the norm for all Brazilian companies.
Novo Mercado also brings some obvious savings. Adriana Fernandes Lana, IR manager at Magnesita, says switching from three share classes to one class of common shares ‘simplified all processes, systems, controls and even the trading.’ Above all, Novo Mercado’s ‘safe environment for shareholders’ gave Magnesita increased liquidity and a lower cost of capital. Last August, when the company raised around $190 mn in equity to pay down debt, 95 percent of the shares were subscribed during the first round.
By helping to attract foreign investors, Novo Mercado has saved some Brazilian firms the trouble and expense of listing overseas. ‘That was one of Bovespa’s motivations,’ Guerra says. ‘Novo Mercado is a real alternative now. Without it, more companies would certainly have to list abroad.’
Geovanne adds that Brazil has been strengthening its governance, for example with Rule 480, which has internal controls and disclosure rules similar to SOX, so listing in the US is less of a leap than it used to be. Banco do Brasil initiated a level-one OTC-traded American depositary receipt in December and, as IR magazine went to press, was planning a level-two exchange listing as early as February 2010.
Help in a crisis
Florence ventures the opinion that high governance standards helped Brazil weather the worldwide financial crisis of 2008-2009. ‘Investors needed a safe harbor, and that’s what Brazil and Novo Mercado offered them,’ he explains.
The credit crisis hit Magnesita just as it was leveraging its balance sheet to become a global player in making refractory bricks, forcing it to restructure its debt in the first half of 2009. ‘If it weren’t for our higher governance standards, it would have been much more difficult to convince investors and financial institutions that the company was on the right path to emerge from the crisis stronger than it entered,’ Lana explains. ‘In hard times, credibility is crucial.’
Good governance, Guerra says, is a difficult journey, and even when you think you’ve arrived, the journey goes on. Novo Mercado is now reviewing possible reforms, including controversial ones like a mandatory any-and-all bid upon reaching 30 percent control, which would bring Brazil into line with the European Union while effectively banning anti-takeover provisions. ‘This could be difficult in an environment where ownership concentration still prevails,’ Guerra remarks.
Novo Mercado needs the approval of a third of its companies to pass the batch of changes. It may seem like one hurdle too high, but that’s what doubters said about Novo Mercado 10 years ago. ‘Brazilian financial culture is very adaptable to these kinds of strong, new ideas,’ says Peter Firestein, a veteran of Latin American IR consulting and author of a new book, Crisis of character – building corporate reputation in the age of skepticism. ‘That’s why IR took off in Brazil. It’s why IBRI and ABRASCA [Brazil’s association of listed companies] have been so successful. Brazil has an enormous receptivity to the principles of good governance.’
Some of the reforms recommended by Novo Mercado’s advisory board:
Separate chairman and CEO roles
Increase independent directors from 20 percent to 30 percent
Raise director independence standards
Tighten insider trading policies
Mandatory audit committees
More detailed management pay disclosure
Mandatory any-and-all bid after 30 percent ownership
