Publish in Perspectives - Wednesday, October 6, 2021
Brazilian insurer Caixa Seguridade raised $925 million through an IPO on the Sao Paulo stock exchange B3 advised by Hogan Lovells. (Photo: B3)
Isabel Carvalho, Office Managing Partner of Hogan Lovells in Sao Paulo, Brazil. (Photo: Hogan Lovells)
Reasons, lessons learned and what to expect from the Brazilian IPO Surge.
BY ISABEL CARVALHO, FELIPE BORGES LACERDA AND ANA LAURA PONGELUPPI
Brazil is currently experiencing an unprecedented surge in the number of initial public offerings (IPOs) registered with the Brazilian Securities Commission (Comissão de Valores Mobiliários, or the CVM). This recent wave of CVM registered equity offerings has been ongoing for the last two years and the market continues to show signs of high levels of activity. Issuers that have gone to market during the current surge vary in terms of industry, geographic region and size. The prior peak of activity was in 2007, when over 60 companies registered IPOs with the CVM that were listed on the São Paulo Stock Exchange (now known as B3 S.A. – Brasil, Bolsa, Balcão). This period was followed by slower periods of equity capital markets activity during the ten years between 2008 and 2018. After a long period of reduced activity, the Brazilian capital markets saw over 20 companies register IPOs in 2020 and over 35 IPOs have been completed in 2021 as of the date of this article.
The current wave of IPO activity can be primarily explained by the excess of liquidity in global markets as a result of monetary and fiscal measures implemented by governments and central banks throughout the world to mitigate the effects of the recent global recession and as well as the impact caused by the COVID-19 pandemic. In Brazil, the depreciation of the Brazilian real against the U.S. dollar, thereby reducing the U.S. dollar equivalent prices of Brazilian assets to foreign investors, and changes in monetary policy to reduce interest rates have played an important role in fostering equity capital markets activity, by incentivizing investors to shift their focus from debt products to equity securities. Since 2016, there have been significant reductions in interest rates in Brazil, from 14.25 percent in September 2016 to a historic low of 2.00 percent in December 2020. However, while it is unlikely that there will be any significant appreciation of the Brazilian real against the U.S. dollar, recent inflationary pressures have resulted in the Brazilian federal government raising the official interest rate in March 2021 for the first time in 6 years. Further increases were approved in May, June, August and, as of the date of this article, the official interest rate stands at 6.25 percent, as 12-month inflation flirts with double digits.
REFORMS, ELECTIONS, ESG
In order for Brazil to keep increasing the flow of equity offerings in the local market, it is essential not only that interest rates are maintained at low levels, but also that legislators pass key structural reforms that are currently under discussion, such as tax and administrative reforms, and that the Brazilian federal government remains compliant with public spending cap rules and does not increase the country’s fiscal deficit.
Another relevant factor that could affect IPO volume is political instability. Brazil will have presidential elections in October 2022 and depending on the candidates running for office and the expected outcomes, businesses and investors may pull investments out of Brazil and investors may become averse to investing in Brazilian companies until the outcome of the elections and the consequences thereof become more apparent.
It is worth noting that investors in Brazilian equity securities, particularly those investors residing in Brazil, have become increasingly more sophisticated, which has made it more difficult for issuers to launch and close deals in comparison to 2020, when it was relatively common that books were already oversubscribed before the launch of a particular IPO. CVM listed IPO transactions typically have a dual offering structure with an offering to investors in Brazil as well as a concurrent issuance to international investors. Historically, in many instances, a majority of the shares sold in these transactions were to international investors. However, one element of this current wave of equity transactions is that there has been an increased participation by Brazilian investors. Following international trends, Brazilian investors are now more selective in their investment decisions and prioritize sustainable and responsible investment opportunities. Issuers with stronger corporate governance practices, including those that are aligned with environmental, social and corporate governance (ESG) standards, differentiate themselves and attract the attention of funds and institutional investors focused on making investments in ESG focused issuers. The recent launch of ESG rating indexes by rating agencies is indicative that this is a not a concern limited to regulators and activists, but also an important factor to be considered by investors. In the current environment, demonstrating satisfactory ESG performance is becoming a mandatory component to aggregate value to issuers, rather than solely a “nice to have” feature and companies that couple business performance with responsible social conduct are in a better position to complete successful IPOs.
Adherence to risk management and internal controls, especially with respect to anticorruption rules and standards has long been an important point of attention in Brazilian capital markets offerings, particularly since the revelations of the “Car Wash” investigation (Lava Jato) implicated several Brazilian companies and politicians in widespread and systematic corrupt practices. Compliance with data protection rules is also a key issue after the European Union’s Global Data Protection Regulation (GDPR) became effective in 2018 and the corresponding and similar Brazilian Data Protection Law came into effect in 2020, particularly for companies engaged in the technology sector and/or business-to-consumer (B2C) activities, which are sectors not previously well represented in B3 listed issuers.
AGRO, ENERGY, FINTECHS
We expect that Brazilian companies will continue to seek access to the equity capital markets and consider IPOs and follow-on equity issuance as a source to finance their activities and expansion plans. Companies involved in the agribusiness and energy sectors should continue to represent a significant part of future issuances, given the characteristics of Brazil as a commodities export-oriented economy. In addition, offerings of small caps from the technology sector, including fintechs and other internet-based companies are becoming increasingly popular, which represents a change to the traditional profile of issuers listed on the B3 stock exchange, where the focus has historically been on larger cap companies.
Having well-developed capital markets is a common characteristic of successful nations in the modern world. Brazil, the largest economy in Latin America, suffers from income inequality, infrastructure gaps and lack of access to credit. This current wave of IPO activity could foster economic growth by allocating capital to companies in a position to spur economic activity. While economic activity in Latin American emerging markets such as Brazil is subject to a high degree of volatility, the recent IPO activity is a positive sign of continued growth in investments in Brazil, from both international investors as well as investors resident in Brazil.
Isabel Carvalho is the Office Managing Partner of Hogan Lovells in Sao Paulo, Brazil. Felipe Borges Lacerda and Ana Laura Pongeluppi are associate attorneys at the Hogan Lovells office in Brazil.
Counsel David Contreiras Tyler also contributed to this article.
This article was written for Latinvex.
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