The São Paulo Stock Exchange Expansion Would Be a Good Move
This article originally appeared in The Huffington Post on Jan. 6, 2015.
By Susan Perkins
Though the LatAm capital markets are fighting to ward off further downward movement due to stumbling oil prices and weakening currencies, one long-term strategy that will continue to bring more liquidity to these markets is better corporate governance practices.
Considerations of LatAm capital market consolidation have been on the horizon. Most recently, The São Paulo stock exchange -- BM&F BOVESPA -- announced it may soon acquire significant stakes in the national stock exchanges of Argentina, Colombia, Chile, Mexico, and Peru. In exchange for this ownership stakes, the BM&F BOVESPA executives want to ensure a seat on the boards of each, which could put them in a position to consolidate the regulatory infrastructure and also create standardization for regulatory practices throughout the region.
Such a move is likely to increase the liquidity of stock markets throughout Latin America, which will be needed to get past this economic downturn. What is most needed in Latin America are regulatory mechanisms that have already been tried and proven in Brazil, to mend weak investor protections and surpass inefficient judicial systems. In fact, considering the effectiveness of regulatory strategies that Brazil has put in place in their capital markets over the last decade to reform problems of "bad corporate governance practices" that often left minority shareholders getting the short end of the stick, this may be a winning strategy.
Why is Brazil a model for others? In 2001, the Brazilian securities and exchange commission, Comissão de Valores Mobiliários, reformed the "rules of the game" on the BOVESPA with the hope of providing more mechanisms for greater transparency, disclosure rules requiring using U.S. GAAP audited financials, boards requirements to adopt independent directors at a ratio of 1 to 5 per board seat, and limits to the disproportions between voting stakes shares versus non-voting shares. Without these kinds of shareholder protections, foreign investment rates slow, dragging down the overall liquidity of the market.
One outcome from these 2001 changes was the introduction of three new corporate governance listing categories, the "Novo Mercado," being the most stringent, followed by Level 2 then Level 1 corporate governance classes. This regulatory change provided both existing and new equity offerings listed on the BOVESPA a voluntary path to signal to the market stronger shareholder rights designed to divvy up voting rights equally (e.g., one vote, one share) to reflect normative practices on par with those of the New York and NASDAQ exchanges.
This corporate governance change is a far cry from the estimated 65 percent average control premiums associated with a period on the BOVESPA before these successful reforms. Today, Brazil's stock market is the largest in Latin America, already representing the majority -- approximately 70 percent -- of the stock volume and value in the region.
Right now, the question many are asking is should Latin American stock markets consolidate, be it by means of the MILA or with the São Paulo stock exchange? But perhaps the question we should ask instead is how can these good corporate governance practices become more of the norm throughout Latin American stock exchanges to keep capital markets afloat and mobile regardless of what happens?
To start, we can look to Brazil's Novo Mercado, among other regulatory reforms such as the BOVESPA MAIS implemented in 2010, as they opened up greater shareholders' protections that are needed across all the stock exchanges in Latin America. Evidence suggests that reforms like these that are focused on stronger corporate governance are associated with increases in market capitalization and trading volume overall (Figure 1).
According to the financial accounts of Economatica, a leading stock analytics tool, all of these exchanges' average listed stock are majority owned by just one shareholder (see figure 2). This is such a far cry from the dispersedly owned listed U.S. company such as Procter & Gamble with over 2 million shareholders. This governance pattern seen not only in Brazil, but across the Lima, Caracas, Bogota and Santiago exchanges, by default often puts outside investors in the minority stakeholder position. Though not necessarily a problem, recent global investment strategy studies have shown that these types of investment environments, whenlacking strong minority shareholder protections, are particularly risky for outside investors. Expropriation risks are higher because the main shareholder, which is often a dominant owner of a powerful business group, could effectively govern and determine the strategic decision of the firm with limited to no rights given to minority shareholders.
Economists predict that markets without these fundamental minority shareholder protections provided through good corporate governance practices will receive less overall investments and fewer firms will be inclined to go public. The corporate governance reforms in Brazil provide great examples to solve this problem.
Providing further assurance to the market should such minority shareholder's fear of being frozen out by the dominant majority occur, in Brazil, the BM&F BOVESPA created a solution, market arbitration chamber, where disputes are settled within six months, which is a fraction of the time relative to the slowness to have a case heard and lack of specialization around these issues within the courts in Latin America.
Since stability and regulatory enforcement drives liquidity of capital, buying the neighboring countries stock market might be a long-term solution to creating mobile capital across Latin America. What many don't recognize are the similarities in ownership structure of the average listed company across Latin America. Regulatory requirements that address this corporate governance distinction between North American versus South American capital markets already has been solved by the BM&F Bovespa regulators. So such an expansion of these rules to the other exchanges in the region could be a winning solution to raising capital efficiently in these neighboring markets as well.
Only time will tell whether such a unified set of rules in Latin America is valued by investors looking to tap into the growth potential in these emerging markets.
- Susan Perkins is an assistant professor at Northwestern University's Kellogg School of Management.