Interview with Walter Mendes: The evolution of governance in Brazil has not been keeping pace with the recent growth of the stock exchange operations

With extensive experience as equity manager in some of the most prominent local and foreign asset management firms – Unibanco, Schroders, Itaú -, twice member of Petrobrás Board of Directors, and more recently as CEO of pension funds, Mr. Walter Mendes analyzes the current scenario and the challenges to advance  corporate governance and the protection of minority shareholders’ rights.

One of the founders of Amec in 2006 and current CEO of the pension fund Vivest (former Funcesp), the executive highlights the unfair practices of controlling shareholders that eventually misappropriate other shareholders’ funds. “Today, we have been seeing the multiplication of “non-compete” clauses. In takeovers, former controlling shareholders, founders or important executives are paid to not compete in the future, but the values are unreasonable. We are talking about disproportionate values,” he says during the interview.

Former CEO of Amec (2006 – 2011), Mr. Mendes is an advocate of Amec’s efforts towards improving the companies’ governance practices. Currently chairman of Amec Board of Directors, he also addresses the growing interest among pension funds in participating more actively in Amec’s initiatives, driven by the need of engaging more with their investees.

The creation or strengthening of a body such as CAF (the Brazilian Takeover Panel), which plays a role similar to the UK Takeover Panel, is another important initiative he defends. Former CEO of CAF in Brazil, Mr. Mendes regrets that the body has not “taken off” yet in its role of analyzing and preventing conflicts in corporate restructurings in Brazil. Please find the full interview below: 

Hhow the current scenario has been encouraging the participation of institutional investors in the stock exchange?

Walter Mendes, Vivest.

Investments in higher-risk assets, especially in the stock exchange, have seen a significant growth in the last two or three years because of the lower interest rates in Brazil. Individuals have also been investing more in these assets. The participation of balanced mutual funds and pension funds in the stock exchange has also increased. That is to say, all domestic investors have been investing more in equity products. Foreign investors are the exception here, considering they reduced their positions in higher-risk assets.

In your opinion, are the stock market valuation and the increase in the participation of local investors sustainable?

This is the big question today. To date, the lower interest rates have been pushing this growth, but we do not know whether the companies will be able to support that. We notice that the growth in investments by individuals creates some distortions in the valuation of some companies. “Trendy” companies, so to speak, are overvalued. But in general and on average, the Brazilian stock exchange is not “expensive.” The difficulty lies in evaluating how sustainable the economic growth and the macroeconomic balance are, mainly when it comes to the fiscal policy.

In general terms, do you think the governance in listed companies has improved?

The development of governance was far below what it should be to keep pace with the growth of the stock exchange. Major advancements were achieved in the past with the creation of the ‘Novo Mercado’ and others listing segments. Since then, we have not evolved much. Governance needs to evolve “pari passu” with the growing investments by individuals and institutional investors. Otherwise, risks increase due to the structural component itself. In Brazil, the poor governance practices may represent an additional risk. In this sense, Amec plays a crucial role.

And what is the Amec’s role on this matter?

Amec plays a decisive role in helping companies and the market to improve their governance. It is a prominent institution that identifies flaws and problems in M&A. It also works on issues related to non-equitable relationships between both controlling and minority shareholders, or between shareholder in the case of Corporations. The latter can pose serious damages to minority shareholders. This shows that the developments in governance have been lagging behind the market’s needs, posing risks to the companies’ and the market’s sustainability in the future. 

What are the main recurrent governance problems in companies that should be addressed?

One of the main problems is the abuse of power by controlling shareholders and the losses incurred by minority shareholders in mergers, acquisitions and corporate restructuring operations. Generally speaking, companies are very creative in appropriating values from minority shareholders. Today, we have been seeing the multiplication of “non-compete” clauses. In takeovers, former controlling shareholders, founders or important executives are paid to not compete in the future, but the values are unreasonable. We are talking about disproportionate values. In fact, it is a way they find to pay control premiums. 

And how could the problem be tackled?

In Brazil, we lack a body similar to the UK Takeover Panel, which regulates mergers and acquisitions and prevent minority shareholders from being damaged in these operations. Here, there is the  “Comitê de Fusões e Aquisições (CAF)”, but it has not received the necessary support from the investor community and authorities as the UK body had. The legislation always lags behind the creativity of companies and law firms. Unfortunately, CAF is not yet able to work to solve these problems.

Would it be possible to create or strengthen a body like the UK Takeover Panel in the Brazilian market? How should it be structured?

It could be in the form of CAF itself or any other body responsible for analyzing operations before they are conducted. Since the market has not been able to make this body feasible by itself, I think the government should do that. In the UK, it was organized on an independent basis, but it had the government’s support. In Australia and other European countries, these bodies were created by the government, but have always maintained their independence and are led by skilled people hired from the market. I attended their course in England, it is an awesome experience that should be replicated in Brazil.

There is no body like that in the USA, isn´t there?

No, there is not a body like CAF that supervises operations before they are conducted in the USA, on the other hand, they have the Securities and Exchange Commission, which is fast, efficient and strict in its role of overseeing the market, not to mention its strong enforcement power. Although operations are not analyzed before they are conducted, companies have to respond later if any problem arises. In the USA, there are also the class actions that create a legal mechanism that makes it possible that minority shareholders are paid damages. In Brazil, this virtually does not exist.

Do you think we should import these solutions?

We import a number of innovative ideas in restructuring terms, such as the super-voting shares, among others, but we lack a framework to protect investors. Operations have been more and more diversified, but our market has not developed in regulatory terms to protect shareholders. 

Do companies with no controlling shareholders, the so-called corporations, face this same problem, that is, the lack of an adequate regulatory framework?

Corporations started timidly in Brazil, but they have been developing on a rapid pace in recent years. But there is some room for a framework to protect shareholders. For example, the role of the board of directors in a corporation is much more relevant than the role of the board in a company with a controlling shareholder. In a corporation, shareholders are the ones that actually have to take decisions, not on an individual basis, but on a collective basis. That is why they need boards with highly-skilled, independent and democratically-elected members. 

Regarding your work as the CEO of a pension fund, how do you analyze the growing participation of these investors in the stock exchange and in the companies?

In general terms, all pension funds tried to increase their investments in equity, some of them more aggressively than others. In 2012, when there was a cut in interest rates during Dilma’s mandate, some pension funds of state-owned companies tried to diversify their portfolio by investing in higher-risk assets. But it was not the right moment and the result was negative. Yet in the case of pension schemes sponsored by private companies, with less political interference such as Vivest, it fortunately did not happen.

The current scenario is different, isn’t it?

Yes. Almost all pension funds have increased their investments in higher-risk assets and shares recently, when the drop in interest rates is perceived as more sustainable. It was a very fast process and now  pension funds need to focus on their investment policies to follow these companies more closely. They need to engage with the boards and be more attentive to governance issues not to be damaged.

How does Amec perceive this new move among pension funds

The number of pension funds joining Amec has increased. In the past, few ones were members, today there are several and, in the future, they will likely become closer to the association. Until recently, equity products represented a very small percentage of their portfolio, but this number has been increasingly growing. We will see a deeper engagement in the companies’ governance and ESG investments. In more developed markets, pension schemes are the main drivers and supporters of better governance practices. Despite the slow pace, this is a growing trend in Brazil.