Investing in BRIC Countries: Evaluating Risk and Governance in Brazil, Russia, India, and China (PROFESSIONAL FINANCE & INVESTM) - Hardcover

BORODINA

Hardcover

ISBN 10: 0071664068 ISBN 13: 9780071664066

Publisher: McGraw Hill, 2010

Synopsis

Chart a course for success in the fertile terrain of BRIC investing!

The world's largest and fastest-growing emerging markets are those of the BRIC nations-Brazil, Russia, India, and China. Combined, these countries house more than 40 percent of the world's population, and their respective GDPs are growing at an impressive rate.

This economic success comes partly from a trend toward good corporate governance, a concept virtually unheard of in these four nations just a decade ago. Still, the BRICs have a long way to go. Corruption, doubledealings, and other conflicts of interest are regular business practices for far too many companies. Although investing in BRIC nations can be wildly profitable, you must familiarize yourself with the realities of their corporate governance to avoid catastrophe.

With Investing in BRIC Countries, you are equipped with the best available tool for detecting the signs of poor governance. Edited by Standard & Poor's® equity research and governance group, it details the group's highly successful approach to analyzing risks in emerging economies.

With case studies illustrating the effectiveness of corporate governance scrutiny, Investing in BRIC Countries examines the economic structure and governance status of each BRIC nation-and then explains how to:

• Detect the malevolent influences of a powerful minority of shareholders
• Protect yourself from misleading or false audits and risk assessments
• Recognize regulatory weaknesses with regards to shareholder rights
• Distinguish effective boards of directors from weak or corrupt ones

As the financial crises in Mexico, Russia, and Asia during the 1990s prove, corporate governance is the pivot on which an emerging market's success or failure hinges. Before entering one or more BRIC markets, perform the due diligence they require.

Investing in BRIC Countries is the best tool available for mitigating your exposure to risky deals and other problems that can arise when dealing with international companies.

About this title

About the Author

Svetlana Borodina is director of corporate governance at Standard & Poor’s® Equity Research in Moscow. She served in a number of senior executive positions in the areas of investor relations and financial communications with TNKBP and Sibneft oil companies.
Oleg Shvyrkov is associate director for Standard & Poor’s® Governance Services group and serves as lead analyst on corporate governance scores and GAMMA scores at MTS, MDM Bank, EroChem, and other companies in Russia, Kazakhstan, and Brazil. The authors live in Moscow, Russia.

From the Back Cover

The definitive guide to evaluating corporate governance in the world's largest emerging markets

Investing in Brazil, Russia, India, and China is a whole new game. In order to avoid nightmare scenarios, you have to inform yourself about the corporate governance problems rampant in BRIC companies--general corruption, weak boards of directors, individual shareholders wielding undue influence, and other critical conflicts of interest. You'll find, though, that the benefits are well worth it.

Investing in BRIC Countries explains:

• Why governance is critical to international investing success
• The secrets of S&P's(R) methodology for analyzing governance in emerging markets
• How to apply advanced thinking based on a number of real-life cases

Written by two high-level figures at Standard & Poor's(R) who apply their company's own methods and processes, this is a detailed road map to analyzing corporate governance in the world's top emerging markets, helping you make sound decisions and proper evaluations prior to investing in them.

Excerpt. © Reprinted by permission. All rights reserved.

Investing in BRIC COUNTRIES

Evaluating Risk and Governance in Brazil, Russia, India & China

By SVETLANA BORODINA, OLEG SHVYRKOV, JEAN-CLAUDE BOUIS

The McGraw-Hill Companies, Inc.

Copyright © 2010 McGraw-Hill, Inc.
All rights reserved.

ISBN: 978-0-07-166406-6

Contents

Foreword Good Governance Does Make a Difference Peter Montagnon
Preface Why Governance Is Key to the Future of BRIC Countries Svetlana 
Borodina and Oleg Shvyrkov
PART 1 Introducing the BRICs and Their Governance Status
Chapter 1 A Guiding Light for Investors in Brazil Eduardo G. Chehab
Chapter 2 Corporate Governance Is Advancing in Russia Oleg Shvyrkov
Chapter 3 Corporate Governance Is Growing Modestly in India Preeti S. 
Manerkar
Chapter 4 Moving toward Accountability in China Warren Wang
PART 2 Fundamentals of Emerging Market Governance Analysis Principal 
Contributor: Oleg Shvyrkov
Chapter 5 Ownership Influences: The State, Company Founders, Majority 
Shareholders, and Other Dangers
Chapter 6 Shareholder Rights: Do You Really Have Them?
Chapter 7 Transparency, Audit, and Risk Management: Risk-Averse, 
Risk-Adjusted, and Just Plain Risky
Chapter 8 Board Effectiveness, Strategy, and Compensation: Boards of 
Directors versus Potemkin Villages
PART 3 Case Studies
Chapter 9 Wimm-Bill-Dann Foods OJSC (Russian Federation) Oleg Shvyrkov 
and Anna Grishina
Chapter 10 EuroChem Mineral and Chemical Co. OJSC (Russian Federation) 
Oleg Shvyrkov and Anna Grishina
Appendix A Transparency and Disclosure by Russian Companies 2008: 
Insignificant Progress along with Fewer IPOs
Appendix B Transparency and Disclosure 2008: Disclosure Levels for China's 
Top 300 Companies Lag Far Behind Global Best Practices Warren Wang
Index

Excerpt

CHAPTER 1

A Guiding Light for Investors in Brazil

Eduardo G. Chehab

Introduction and Executive Summary

How Brazilian Corporate Governance Bloomed

Corporate governance is a set of practices designed to optimize a company'sperformance, protect stakeholders (investors, employees, and creditors), andfacilitate access to capital. The analysis of corporate governance practices asit is applied to securities markets encompasses transparency of ownership andcontrol, equal treatment of shareholders, disclosure of information, boardeffectiveness, and risk management controls, among other topics.

For investors, this analysis is an important aid in making investment decisions.These practices determine the kind of role investors may play in a company,enabling them to influence its performance. Good corporate governance practicesincrease a company's value and reduce the cost of capital, increasing theviability of securities markets as sources of funding. Companies with agovernance system that protects all investors tend to have higher valuationsbecause investors recognize that everyone will receive the due and appropriatereturn on his or her investments.

In the last few years significant reforms have been made in Brazilian corporategovernance, including the introduction of the New Market (Novo Mercado) conceptand changes in company and securities law that stem from a conviction thatcapital markets should play a much larger role in the country's economicdevelopment than they did in the past. Proponents of capital markets in Brazilbelieve that one of the keys to a healthy and successful market is theintroduction and support of strong corporate governance measures.

Historically, Brazil's capital markets played only a minor role in providingcompanies' financing needs, which were met from companies' retained earnings andfunding provided by financial institutions and state-owned entities. However,the country's enormous social demands and scarce financial resources havelimited the state's ability to maintain its role as a capital provider. Agradual change in funding availability started with the opening of the Brazilianmarkets in the 1990s. Companies faced intense international competition andrequired more capital to upgrade and meet competitive threats. Those capitaldemands could be met only by developing and expanding local capital markets andimproving the domestic economy. In support of those goals, new laws addressedgovernance problems and focused primarily on greater transparency and disclosurerequirements as well as protection of the rights of minority shareholders.

The Brazilian stock market has developed strongly since 2006. Almost U.S.$40billion was raised through equity issuances, along with U.S.$78 billion throughissuances of debentures in the period 2006–2008. At the same time,investor concerns about corporate governance also increased, mainly in regard tothe rights of minority shareholders and corporate enterprise risk management. InNovember 2008, to help address those concerns in Brazil, Standard & Poor's (S&P)launched the GAMMA (Governance, Accountability, Management Metrics, andAnalysis) score, an important tool for selecting companies with higher corporategovernance levels and guiding companies in improving their governance policies.

Market Infrastructure

Summary of Economic History: Brazil Emerges as a Resourceful Dynamo

When Portuguese explorers arrived in Brazil in 1500, the native tribes, totalingabout 2.5 million people, had lived virtually unchanged since the Stone Age.From Portugal's colonization of Brazil (1500–1822) until the late 1930s,the market elements of the Brazilian economy relied on the production of primaryproducts for export, such as sugar, precious minerals, and coffee. Thepost–World War II period up to 1962 featured intense import substitution,especially of consumer goods. A period of rapid industrial expansion andmodernization occurred between 1968 and 1973. Import substitution of basicinputs and capital goods and the expansion of manufactured goods exportshighlighted the 1974–1980 period.

However, the following years, mainly the period 1981–1994, were marked byconsiderable difficulties because of the world oil crisis, a moratorium onpayments of the external debt in 1982 and 1987, and the consequent low increasein gross domestic product (GDP) (average of only 1.4% per year). Thosedifficulties were fueled by several unsuccessful economic stabilization programsthat were aimed at reducing high inflation rates and the impeachment of apresident, Fernando Collor de Mello, in 1992 for corruption.

Finally, in 1994, the Real Plan was implemented, and the annual inflation ratedropped from more than 5,000% to 20% in 1996 and eventually in the range of 5%.

The successful Real Plan was based on three pillars:

• Monetary reform

• Further opening of the economy

• Privatization of several state-owned companies in the steel, power, banking,mining, and telecommunication segments, raising around U.S.$100 billion

After another period of ups and downs, the economy began to grow more rapidlystarting in 2003, strongly influenced by the worldwide trade boom. GDP grew 5.7%in 2004, 3.2% in 2005, 3.8% in 2006, and 5.4% in 2007. In 2008, the economy grewanother 5%. In the beginning of the current global economic crisis, Brazilsurprised observers with its resistance to an extreme fallout. Nevertheless, thestunning drop in world demand has affected the domestic economy. The GDP growthforecast for 2009 ranges around 0%.

Currently, with abundant natural resources and a population of 190 million,Brazil is one of the 10 largest markets in the world, with a GDP of U.S.$1.35billion (R$2.7 trillion, considering an average exchange rate of U.S.$/R$ of2.00 for 2009). Exports reached almost U.S.$198 billion in 2008, an increase of23.2% over 2007. The major exported products were aircraft, iron ore, soybeans,footwear, coffee, vehicles, automotive parts, and machinery. Imports amounted toU.S.$173 billion, 43.6% higher than in 2007, influenced by the local currencyappreciation up to September and increased domestic demand. The major goodsimported were machinery, electrical and transport equipment, chemical products,oil, automotive parts, and electronics. For 2009, a drop of 25% in exports and30% in imports was expected due to the world economic crisis.

Nominal per capita GDP remained around U.S.$6,500 in 2008. The industrial sectoraccounts for 60% of the Latin American economy's industrial production. Foreigndirect investment has experienced remarkable growth, averaging U.S.$30 billionper year in recent years (reaching a peak of U.S.$45 billion in 2008), comparedwith only U.S.$2 billion per year during the last decade.

This growth is attributed to a stable economy with lower inflation rates andhigher technological development that attracts more investors. The agribusinesssector also has been remarkably dynamic. For two decades, agribusiness has keptBrazil among the most highly productive countries in areas related to the ruralsector. The agricultural sector and the mining sector also supported tradesurpluses that allowed for huge currency gains (rebound) and external debtpay-down.

The Brazilian Financial Markets: Institutionalizing the Effectiveness andRegulation of Capital Markets

We consider Brazil's capital market one of the most strongly regulated in theworld. The basic features of the Brazilian financial system were set by a seriesof institutional reforms that started in 1964–1965 with the creation ofthe National Monetary Council (CMN, the Brazilian acronym for the ConselhoMonetário Nacional) and the Brazilian Central Bank (BCB) and were completed in1976 with the creation of the national Securities and Exchange Commission (CVM,or Comissão de Valores Mobiliários). The role of these entities is describedbelow.

National Monetary Council

The finance and planning ministries and the president of the Central Bank arethe main members of the National Monetary Council. The CMN is the main rule-making,or normative, agency of the financial system and regulates theconstitution and functioning and supervision of financial institutions. It hasno executive function. The CMN is also responsible for establishing theinflation target to be pursued by the Central Bank. The inflation targets areestablished two years in advance and may be revised in the year before which thetarget takes effect. For instance, in June 2008 the CMN confirmed the inflationtarget for 2008 and defined the target for 2009, both at 4.5% with a range of±2.0%.

Central Bank of Brazil

The Central Bank was created in 1965 and is a federal agency, officially part ofthe national financial system. Although the CMN is the principal normative body,the Central Bank carries out executive functions for the financial system. It isresponsible for ensuring compliance with the CMN's directives and decisionsregarding monetary policy and the exchange rate system and for monitoring andenforcing the activities of financial institutions. The main goal of the CentralBank is to ensure the stability of the purchasing power of the currency and thesoundness of the national financial system; those goals currently are beingpursued by means of an inflation-targeting policy.

Both the president and the directors of the Central Bank are appointed byBrazil's president and must be approved by the full Senate. Since theimplementation of the Real Plan, the president and directors of the Central Bankhave operated with strong autonomy, especially in the management of monetarypolicy. However, there is no law guaranteeing formal autonomy, and the directorsdo not have fixed mandates.

Some important functions of the Central Bank are

• Managing monetary policy to meet the inflation target

• Managing international reserves, including both decisions to buy and selldollars in the market and decisions on investment policies

• Organizing, regulating, and supervising the national financial system

The Central Bank regulates the national financial system, grants authorization,and provides regulation for the functioning of financial institutions. Thesupervisory activity may be performed directly or indirectly. Direct supervisionis done by technical teams in the Central Bank's regional offices. Indirectsupervision consists of monitoring, through a computer system, financialinstitutions and conglomerates regardless of the demand for such supervision.

In the middle of the 1980s the creation of Sisbacen, an information system,established electronic communication between financial institutions and theCentral Bank. All transactions made by financial institutions are registeredwithin Sisbacen, facilitating the Central Bank's supervision of the wholefinancial system.

Securities and Exchange Commission

The CVM, a federal agency linked to the Ministry of Finance, was created in1976. It is administratively independent and is empowered to discipline, govern,and supervise the activities of all market participants. The CVM's mainobjective is to regulate and strengthen the capital markets in Brazil. Itsregulatory activities encompass all matters related to the securities market,such as the following:

• Registration of listed companies, offers, and asset distribution (e.g., stocksand debentures)

• Accreditation of independent auditors and mutual fund managers

• Establishment of rules concerning the institution, functioning, andoperational procedures of stock exchanges and securities trading andintermediation

• Suspension of the issuance, distribution, or trading of a specific asset orthe decreeing of withdrawal rights from stock markets

Brazilian law empowers the CVM to investigate, judge, and punish anyirregularity in the securities markets. Its supervisory activities involvemonitoring the information disclosure process, the behavior of all securitiestraded, and the registry and follow-up for foreign and domestic investors. Afterthe huge losses in derivatives booked in the end of 2008 by companies known forcareful management, the CVM became stricter in mandating listed companies toexpand the disclosure of hedging deals, including sensitive analysis, withexpected and worst-case scenarios.

BM&F Bovespa

Founded in 1890, the São Paulo Stock Exchange (Bovespa, or Bolsa de Valores deSão Paulo) trades assets, contracts, and financial securities such as stocks,options, stock futures, stock forwards, debentures, and ABSs (asset-backedsecurities). It is composed of a stock market segment and an OTC (over-the-counter)segment. The fixed-income securities are traded on the Bovespa Fix andthe SomaFix, markets intended for the trading of debentures and ABS shares. TheBrazilian Mercantile & Futures Exchange (BM&F, or Bolsa de Mercadorias &Futuros), founded in 1986, is responsible for the intermediation andregistration of trades made on the trading floor or via electronic system andalso for clearing and settlement services, both physical and financial. The BM&Fcreates an environment for the trading of commodities' and indexes' futurecontracts in the forward futures segment. It has three clearinghouses—forderivatives (cash, forward, futures, options, and swap agreements), foreignexchange, and securities—that are in charge of the settlement of alltrades, with a risk management structure in place to eliminate the major risks.

In 2008, Bovespa and BM&F merged their activities. They created a company calledBM&FBovespa S.A. and became the largest exchange in Latin America and the thirdlargest worldwide in terms of market value.

Other Relevant Entities

National Association of Investment Banks

ANBID is an association that was created in 1967 to represent the financialinstitutes operating in the Brazilian capital markets. It acts to strengthen thecapital markets as a vehicle for the self-regulation of activities upon theadoption of standards that are normally more rigid than those required by theapplicable legislation. ANBID is also the leading source of information for thecountry's capital markets. Therefore, ANBID works on the promotion of actionsand practices for improving capital markets' efficiency, information,transparency, and security, by doing the following:

• Supporting the CVM as a supervisor

• Providing incentives for the adoption of better practices among associates andrespect for investors' rights

• Improving services and operational practices

• Enhancing law, regulatory aspects, and the taxation of capital markets

In 1999, in addition to the representative and informational functions, thecompany started its autoregulatory activities. Today ANBID has over 70 associatemembers.

National Association of Financial Market Institutions

Established in 1971, Andima is a non-profit-oriented entity that brings togethernumerous financial institutions, from multiple, commercial and investment banksto stockbrokers and securities distributors. Its main objective is to providetechnical and operating support to those institutions, encompassing dailymonitoring of market behavior and legislation supervision, publication ofstatistical data and prices for the market, development of systems to improvefinancial transactions, and economic analyses and reports to supply relevantinformation on the national financial system. Andima gave rise to the followingimportant systems, providing financial transactions with greater security,transparency, and agility:

• The Special Settlement and Custody System (Selic), an electronic tradingsystem for publicly traded securities

• The Center for Custody and Financial Settlement of Securities (Cetip), whichis an entity, regulated by the Central Bank along with the CVM, that specializesin trading private securities

• The National Debenture System (SND), developed by Andima and operationalizedby Cetip, where debentures are kept in custody

• The System of Protection against Financial Risks (SPR), which enables theregistration of swaps without a guarantee and also accepts the registration ofswap transactions with delimiters (cap, floor, collar, and third curvedelimiter), swaps with barriers (knock in, knock out, and knock in–knockout), and swaptions

Andima offers the public indicative rates for all market maturities of domesticfederal public securities. It also releases statistics on the stock,profitability, and turnover volume of bank deposit certificates (CDBs). Theseprices have been used as parameters for market scoring the bonds that constitutethe portfolios of financial institutions and third-party asset managers.

The Domestic Bond Market

Resuming Strong Growth in Issuance Volume

The market for private fixed-income bonds has grown at a very strong pace inrecent years, benefiting not only from Brazil's greater macroeconomic stabilitybut also from changes in legislation that have enabled the development of newcredit methods, such as larger utilization of receivables as backed securities.

The private sector issues various types of securities in the domestic market,especially CDBs and bank deposit receipts (RDBs), private securities debt(debentures), bank credit notes (CCBs), real estate receivables certificates(CRIs), and credit receivables funds (FIDCs). Among those securities, the mostsignificant are CDBs/RDBs and debentures. The stock of corporate debt bonds inthe domestic market has grown at a very rapid pace, driven by the strong growthin the volume of issuances, mainly in the last three years. Trading in thesecondary market is carried out on the trading floor or on an OTC market byinstitutions authorized by the Central Bank and the CVM. The secondary market ofdebentures in Brazil still has very low liquidity compared with the liquidity ofassets such as shares and public bonds and is concentrated almost entirely inthe SND.

(Continues...)

(Continues...)

Excerpted from Investing in BRIC COUNTRIES by SVETLANA BORODINA, OLEG SHVYRKOV, JEAN-CLAUDE BOUIS. Copyright © 2010 by McGraw-Hill, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

Edition details

• Publisher: McGraw Hill
• Publication date: 2010
• Language: English
• ISBN 10: 0071664068
• ISBN 13: 9780071664066
• Binding: Hardcover
• Number of pages: 334