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History of the Capital Market
Before the 1960, Brazilians invested mainly in real assets (real estate), before the 1960's, avoiding investments on public or private bonds. To an economic environment of growing inflation - mainly from the end of the 1950's - a legislation that imposed limits of 12% per year to maximum interest rate charges was added, called the Usura Act, which used to limit the development of an active capital market.
That situation begin to change when the Government that was ascended to power on April 1964 starded a program aimed at great national economy reforms, amongst which one could see the restructuring of the financial market when many new laws were being edited.
Among the ones that brought greatest importance for the capital market is Law No. 4.537/64, which instituted the monetary adjustment through the creation of the ORTN; Law No. 4.595/64, named the Banking Reform Act, which reformulated the entire national financial intermediation system and created the National Monetary Council and the Central Bank; and mainly Law No. 4.728, dated 04.14.65, the first Capital Market Act, which disciplined that market and established measures for its development.
The introduction of the abovementioned legislation resulted in many alterations in the stock market, such as: the reform of the legislation governing the trasactions in the Stock Market, the transformation of public fund brokers into Legal Entity Brokerage Firms, forcing the practice to become professionalized, the creation of Investment Banks, to which was attributed the main task to develop the investment fund industry.
With the specific goal to regulate and inspect the securities market, the Stock Market Exchanges, the financial intermediaries and the public-held companies functions that are nowadays carried out by the CVM - a directive board in the Central Bank was created - the Capital Market Board of Directors.
At the same time, some incentives for investment on the stock market were introduced, among which one may highlight the Funds 157, created by Decree Law No. 157, dated 10.02.1967. The Funds 157 were an option given to taxpayers to use part of the owed income tax at the time of the Filing of Income Tax to purchase shares of public-held companies' share funds, managed by any financial institution of the choice of the investor.
With the great volume of resources taken to the stock market, mainly due to tax incentives created by the Federal Government, there was a rapid demand growth for stocks on the investors' side without accounting for a simultaneous increase of new stock issuance by the companies. That chained a "boom" in the Rio de Janeiro Stock Exchange between December 1970 and July 1971; there was a strong speculative tide and the stock values did not stop rising.
After reaching its highest point on July 1971, a process of cashing in the profits by more experienced and knowledgeable investors who started to sell their positions began. The situation was progressively worsened when new issuances started to hit the stock markets, increasing the stocks supply at a time in which many investors, taken aback by the quickness and the magnitude of the low slope, looked to sell their positions.
The speculative tide known as the "boom of 1971" did not last long, but its consequences yielded many years of a depressed market for some stock offerings from extremely fragile companies without any commitment to its stockholders during that time, generated large losses and surprisingly left the stock market's reputation tarnished for a long time.
In spite of that, it was observed a recovery of the quotations beginning in 1975, due to the new investment of resources (the technical reserves of the insurance companies, the resources from the PIS/PASEP Fund, additional to the Fund 157 and the creation of the Investment Companies Decree Law No. 1401 to collect external resources and invest on the stock market), besides the greater investments by the Pension Funds.
As time passed by, many other incentives were adopted purposing to incentive market growth, such as: tax exemption of the gains obtained in the stock markets, the possibility of income tax deduction of part of the amounts invested in the public subscription of stocks deriving from capital increases and financial programs at interests subsidized by the BNDES Brazilian Development Bank to the subscribers of stocks publicly allocated.
It was within that stagnation condition and stock market recovery attempts that, in 1976, two new legal rules still in effect today were issued: Law No. 6.404/76, known as the New Corporations Act which aimed at modernizing the rules that guided the corporations that were until then regulated by an old Decree-Law from 1940 and the Law No. 6.385/76, the second Capital Market law that, among other innovations created the CVM and introduced, in the market, a governmental institution exclusively destined to regulate and develop the capital market, inspect the Stock Exchanges and the public-held companies.
In spite of all those incentives, the capital market did not present the expected growth, even though in some lapses it had experienced an increase in the quantity of companies going public and in a reasonable volume of recourses collected by the companies through initial public offerings occurred during the 1980's.
Despite the pioneer experience to attract external capital for the investment in the Brazilian capital market represented by Decree-Law No. 1.401/76, the market internationalization process becomes a reality in the end of the 1980's, given that its initial milestone was the editing of the CMN Resolution No. 1.289/87 and its annexes.
From mid 1990's, with the acceleration of the opening up of the Brazilian economy, the volume of foreign investors operating in the Brazilian market increases. Furthermore, some Brazilian companies begin to access the foreign markets through the listing of their stocks in foreign stock market exchanges, mainly the New York Stock Exchange, under the ADR American Depositary Receipts format, purposing to capitalize through the issuing of securities abroad.
When listing their stocks in the American stock markets, the Brazilian public-held companies were forced to comply with the rules imposed by the SEC Securities and Exchange Commission, regulating body of the North-American capital market, related to accounting aspects, transference and information disclosure aspects, the so-called "corporate governance principles".
From then on, the Brazilian companies begin to establish contacts with more demanding and sophisticated stockholders, accustomed to invest on markets with corporative governance practices more advanced than the practices applied in the Brazilian market. It is added to the growing number of foreign investors a greater participation of large-sized Brazilian institutional investors more aware of their rights.
As time strode ahead, the Brazilian capital markets started to lose space to other markets due to lack of protection to the minor stockholder and due to uncertainties as regards to the financial investments. The lack of transparency in management and the absence of adequate instruments for the supervision of the companies influenced the perception of risk and, consequently, increased the companies' capital cost.
Some institutional and governmental initiatives were implemented in the last few years, aiming at ensuring improvements in the corporate governance practices of Brazilian companies, from which we highlight the following: the approval of Law No. 10.303/01 and the creation of the New Market, as well as the 1 and 2 Corporate Governance Levels by the São Paulo Stock Exchange Bovespa.
I - New Market
In the end of the 90's it was already evident the tremendous crisis faced by the stock market in the country. As an example, the number of companies listed in Bovespa had dropped from 550 in 1996 to 440 in 2001. The volume exchanged after reaching US$ 191 billion in 1997 retreated to US$ 101 billion in 2000 and US$ 65 billion in 2001. Furthermore, many companies were going private and only a few were going public.
It is within that scenario that Bovespa creates the New Market as a special segment of the stock listings of companies that voluntarily commit to adopt the good corporate governance practices. In a much needed adaptation to the reality of the Brazilian stock market, two intermediary stages are created: Levels I and II, which together with the New Market establish growing commitments towards the adoption of better corporate governance practices.
The idea that guided the creation of the New Market is based on the realization that among many factors that contribute to the fragility of the Brazilian capital market is the lack of protection to the minor stockholders. So, the valorization and liquidity of the stocks in a market are positively influenced by the safety degree that the rights granted to the stockholders offer and by the quality of the information provided by the companies.
The absence of adequate rules defending the minor stockholder interest results in a demand by the investors as to a discount upon the stock price, causing depreciation in the market value of the companies. Thus, it is expected that the companies, which are listed in any of the differentiated segments of corporate governance, in which the risks involved are minimized, would present considerably reduced risk premiums, implicating the valorization of the equity of all stockholders.
II - Reform of the Corporations Act
The amendments to the Corporations Act in effect since 1976 (Law No. 6.404/76), with the objective to improve and increment the rights and protection of minor stockholders became a generalized demand of the various members of the market and purposed the strengthening of the capital market and stimulus to a greater participation of investors.
The alterations made introduced many corporate governance rules sprung from disclosure principles, equitable treatment, compliance and accountability, which had been long enhanced after the edition of Law No. 6.404/76 and reintroduced a few others that contained of the latter and had been casuistically removed as the case of the tag along- institution, revoked by Law No. 9.457/97, with the single objective to ease the privatization process and maximize the value received by the Federal Union whenever impeding the extension to the minor stockholders of the large premiums paid during biddings.
As of 2003, there was a reheating of the market, increasing three times the average daily business deal volume recorded by BOVESPA since then. To grasp the magnitude of that come back, it suffices to observe the leap in the quantity of initial public offers (IPOs) after 2003. From 1996 to 2003 only four were realized - less than one per year - whereas more than a hundred companies went pulic during the period between 2003 and 2011.
In 2008, BM&FBOVESPA was created, through the integration between the São Paulo Stock Exchange (Bolsa de Valores de São Paulo) and the Brazilian Mercantile & Futures Exchange (Bolsa de Mercadorias e Futuros). Currently, BM&FBOVESPA is the only securities, commodities and futures exchange in Brazil . Its markets include equities, commodities and futures, foreign exchange operations, exchanged traded funds, carbon credit, corporate bonds and depositary receipts. In early 2010, BM&FBOVESPA has expanded its position in the corporate structure of the CME Group, from 1.8% to 5%, which represents an investment of $ 620 million.