Report No. 11581 -BR

The Development of BrazilianCapital MarketsOctober 7, 1994

Country Operations DivisionCountry Department ILatin America and the Caribbean Region

Document of the World Bank

MICROGRAPHICS

Report No: 11581 BRType: SEC

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BRAZIL

FISCAL YEAR: JANUARY 1 TO DECEMBER 31

AVERAGE EXCHANGE RATES (SALES)

1980 52.7 CrS/USS 1993 jun 48106.46 Cr$/USS1981 93.1 " Jul 6277.24 11 U1982 179.5 "1983 577.0 " UAug 82.74 CR$/USS Id1984 11E48.0 a Sep 111.19 " "1985 6200.0 " Oct 151.23 a a1

Nov 205.79 " n1986 13.66 Cz$/USS /a Dec 279.37 " 1987 39.23 1988 262.01 "

1994 Jan 390.85 a1989 2.83 NCzS/USS lb Feb 550.81 a

Mar 768.12 aa1990 68.55 CrS/USS jc Apr 1109.56 a a1991 406.72 " may 1585.48 ' 1992 4513.02 " "Jun 2296.26 a a

1993 88.45 CR$/USS /d Jut 0.93 RS/US$ Ie

/a on February 28, 1986, Brazi t announced an economic stabilization plan. Amonkg theprincipal meaures adopted was the creation of a new currenkcy, the cruzado (CzS),worth 1000 cruzeiros (Cr$).

lb on January 15, 1989, BrazIt announced the aSumer Plan." Among its measures wasthe creation of the new cruzado dollar (NCz$), worth 1000 cruzados (Cz$).

Ic On March 16, 1990, the Brazilian nati onalI currency was renamed the cruzeiro (CrS)as part of the Cottor Plan.

Id in August 1993, a new nationat currency, the cruzeiro real (CRS), was createdand set equat to 1000 cruzeiro dollars.

/e On July 1, 1994, the Real (R5) was introduced as the new currency in Brazil.Existing currency was converted at the rate of CR$2,750 per RS1. The Real wasset equal to US$1.00.

THE DEVELOPMENT OF B CAPITALMARKETS

LIST OF ACRONYMS

ABRAPP : Brazilian Association of Private Pension Fund miniABRASCA : Brzilian Association of Open Capital CompanieADEVAL : Associaiion of Securities DistributorsADR American Depository ReceiptsANDIMA : Natonal Association of Open Market InstitutionsBBF Brazilian Futus Exchange (Rio de Janeiro)BCB Central Bank of BrazilBCBA Buenos Aires Stock ExchangeBCS Santiago Stock ExchangeBM&F Commodites and Futues Exchange (Sbo Paulo)BNDES The National Economic and Social Development BankBNDESPAR : BNDES Participations (BNDES ivestment subsidiary)BOVESPA : Sao Paulo Stock ExchangeBVRJ Rio de Janeiro Stock. ExchangeCATS An electonic twading system developed by the Toronto Stock ExchangeCMN National Mmetary CounciiCNBV Nafional Commission of Stock ExchangesCNSP National Council for Private InsuranceCVM Securities CommissionFINSOCIAL: Social Investment FundGDP Gross Domestic ProductGS Government DebtIBMEC Brzilian Capital Markets InstituteIBOVESPA : So Paulo Stock Exchange IndexIFC International Finance CorporationIMB Intemational Monetary FundIOF Fincahl Operations TaxIRB Brazilian Reinsurance InstituteNAFTA North America Free Trade AsociationPD: Private DebenturesPIS-PASEP : Social Integation Progrm- Program for the Formation of the

Patrimony of the Civil ServantPOE Private Owned EnteprisesPS Private SectorSAFP Superintendency of Pension Fund AdmistraionSEC Securities and Exchange Commission (U.S.A.)SENN National Electonic Negotiation SystemSOE State Owned/Controlled EnterprisesSPC Complementary Security Secretariat, Ministry of Social SecuritySTF Federal Supreme CourtSUSEP Private Insurance Superintendency

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SVS Supetintendency of Securities and InsuranceTR Monthly Reference Index RateTRD Daily Reference Index Rate

11T REGULATION OF NCAPTAL MARKC

TABLE OF CONTES

EXECL 7VESUMMARY .. *........... i

L. COPITAL MARh ETh AMCROECONOMICLNSTA YAND CROWDANG OUT .... ................... .. I

A. Stock Exchae Indicatotsand Comparative Performance ....................... I

B. Private vs. Statewned Enterprises:Profitability, Risk, and i.quidly ...................... 9

Profitabiity and HedgeAgainst nflstion ............. 10Liquidity ................................. 13

C. 7IheFluncial Seor ................ .. ............ 14

HI. Co4P1TAL ARKET17RE. ,ULAd7VRY S1RrC7URF ............. ......... 17

axation .. . . . . . .. ............................. 22

Ml. A STAI7S7CAL DESCUfH7ON OF YE BRA227fNJAC.OffALh9 Z MAIM .................................. 25

WidespreadParticipaion.. ....... 25Mnarket craon. . ...... .... 0....... 26Stgtlatlon and Corporate Fiac .......... . ...... 27

IV. GLAI ONAlYDE EQrUMES MARXET ......... 29

Int.oduction .... 29Operaionall .... ....... ...... 29Sondary Market Regulation.... ... 32NewIssues...... 34CorporaWtAccountingandDiscloureStandads ..... 36Corpora Property Rights ad Contol . . . .. 37Taxationand Incentives ..... 39Fisa and Crdit Subsidies ..... 40

V*am ari (rs Maagr wa EepnI1 fo Shptt gM 3KEl~t w O _ _ 1 fo. C , u!

wa epnil forsceaia supot | 1

-2 -

TABLE OF CONTENTS (Cont'd.)

V. DOMES71CIJNS 7ONALINVESrRS .......................... 41

uta Funds. ....... Cosed PensionFunds .................................. 43Insurance Companie and OpenPensionPlas ................... 45

W. FOREiON CAPtTAL MARKETINVESTMENT ........................ 49

Kn. HE DEBT SECURnES MARKET ............................... 53

VII. LONG-UURk BAAK CREDIT ....... .......... ................. 57

IX LESSONS J CONSIDER FROM RECENTARGEt7NE7 ND CHEIEAN EXPERIENCE ........................ 59

Capita Market Compisons ............................... 59Arge ineMarketStructWeand Regulation ..................... 60Chilean Capi Mauke Reglaion .......................... 61

X CONCL.(J0A5ON ...... 69

1. Regultons .................................... 692. New Issues Market ............................... 693. CorpoAte Disclosure and AccountingS dards ..... ........ 704. CompayPoperty Rights andControl ................... 705. Taxation ...................................... 716. InstitutionalInvestors ............................... 717. ForenInvestors .......................... 728. DebtSecuridties Markets ............................ 739. Log-Term Bank Credk .................. . .......... 7310. Macroeconomic Framework and SUt-Owned Enapris .... ... 7411. OthersLsues ................................... 74

EXT TABLES

Table 1.1: TURNOVER RATI0 AND INFLATION RATE .................. 8Table1.2: RANKING OFREALPROFrrABU1TY(R) .................... 10Table1.3: RANKING OFRISK ................................... 11Table 1.4: AVERAGE RATES OF GROWTH OF REAL

STOCK EXCHANGESINDEXES ......................... 12Tablel.5: I.QUIDrrY INDEXES ................................. 14

Table 5.1: INSTIUTIONAL INVESTOR PORTFOLIO REQUMREMENTS... ... 42

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TABLE OF CONTENTS (Cont'd.)

Fa$eNo.

Table6.1: FOR3IGN PORTFOUO INVESTMENT IN BRAZILCOMP ARATIVE CHART .............................. 52

Table 9.1: CAPITAL MARKET COMPARISONSARGENTNA, BRAZIL, AD CHILE . ...... ............... 65-66

Table 9.2: STOCK EXCHANGE SHARE TRADING AS X OF GDP .......... . 67

Table9.3: CORPORATESTOCK PUBLICISSUESAS % OF GDP .... ........ 68

TEXTFIGURES

1.1: Stock Exchanp Real Id .................................... 11.2: Growth of the Real Bovespa ndex ............................... 21.3: Brazil: Market Caplalzation, 1981-92 ............................. 31.4: Brazil, Kor, Mexico and he U.S.: Market Capitalization ............. . 41.5: Brazil: TrAing Values ...................................... 51.6: Brazil, Korea, Mexico and the U.S.: Traded Values ..................... 61.7: Brazil: Turnover Ratio - Ratio of Trading Value

to Market Capitdazin ...................... 71.8: Turnover Ratio in Brazil, Korea, and Mexico: Ratio

of Trading Value to Maket Capitaization ..... ........... . 91.9: PrivateSector:Real StockofCreditOutstanding .............. iS1.10: BNDES and BowdoBrazil:CredittothePrivateSeor ................. 16

APPENDiX ................................................... 75

STA7MSCALLAPPEADiX .......................................... 77

REFERENS .. ................................................ . 94

Executive Summary

THE DEVLPMENT OF BRAZILIAN CAPITAL MARKS

E XECUTIVE SUMMARY

Inroduction

i. Development of Brazil's capital markets has been hindered by the existence ofgiant stateowned enteprie (SOB). In June 1994, SOEs accounted for about 53 percent ofthe stock-exchange capitalizion in contrast with almost 80 percent of trng volume m theprevous year. The giant Telebras alone has reached a 46 percent weighting in the Bovespa(SSo Paulo Stock Exchange) price index.

U. Although the shares of SOEs are a good hedge aginst inflation and havehighly liqud markets, the dominance of SOEs may have held back capital markets growth bycrowding out new issues of private companes. High and variable inflation, too, hurts capimarkets. In such times, the public is wary of new Nanti-inflaton paqgeW and liqudity andlow transactions costs become key issues-two reasons why investors prefefred governmentbonds in the 1980s.

iii. There are huge numbers of participants in Brazil's capital markets, evencompared with many developed countries, but there is also heavy concentration. Untl themid-1980s, Brazil was probably among the most developed and active of emerging capialmarkets, but stagnated in terms of volume until the early 1990s. It has been extmeyvolatile by any measure- trading, new issues, stock returns, or market capitalization. Tlisvolatility is due to changing macroeconomic and company performance (and e tns),exaceted until mid-1994 by rmpant inflation.

iv. In the 1990s, the sharus of five compnies have accounted for around 70percent of share trading volume and an even higher percentage of options trading; the fivelargest conmany pension funds account for half of closed pension fund assets; the five lageststock mutual funds administered 55 percent of stock mutual's assets; conistently, the 10largest undenriters have been responsible for over half of share, bond and converdbledebenture issues. In some other areas, such as brokerage, concenation is not sopronounced. Direct or indirect governmental presence dominates the market. The mostheavily traded shares are of government-controlled companies; the largest institutionalinvestors are pension funds for employees of state-owned companies. The NationalEconomic and Social Development Bank (BNDES) is a major, although not dominant, playerin underwriting; and the Bank of Brzil is the second largest stock mutual fund admini.

v. In spite of this concentrtion, there are many market participants. lhere are826 open capital companies, with 569 Lised on the stock exchanges. The nearly one hundred

The Developfnent of BrAzlim - ii -Capital Markets

stock muual funds have almost 6 million account holderse. There are around 300 closedpension funds, 100 insurance companies, and over 600 investnent clubs. Amongintermediaries are 34 investment banks, 78 multiple banks, 287 brokerge firms, 493securities distribution firms, nine stock exchages, and two futures exchanges.

vi. Trading and new issue volumes had osciated through the last decade withoutany discernible trend. With the libealization of foreign investments m capital markets, mostvolume measures increased in the eardy 1990s. In 1993, stock exchange trading volume wasUS$40 billion, new share issues stayed below US$1 billion and bond and convertibledebenture public offers reached US$3.8 billion. In the first half of 1994, although marketcapitalization and trading volumes continued to grow, new share issues remined stable andnew bond and convertible debenture Issues plummeted due to uncertainties related to theintroduction of the -Rea? Plan. The difference between peak and trough years in 1986-93period was (n dollars) 5.9 times for market catalization, 7.1 times for stock exchangetading volume, 3.9 times for share public offerings, and 174.7 times for bond andconvertible debenture public offerings. Volafility in stock maket returns was just asstiking: of the last thirteen years, in six the real return of the market index was 49 percentor higher, in contrast there were also six years of negative real remns of m-nus 10 percentor less. In 1991, an investor in the Sio Paulo index eamed 316 percent in real terms; in1990, he had lost 74 percet of the value of his investment.

vii. A standard measure of stock exchange depth is the ratio of marketapitaliaion to GDP. Prom 1981 to 1992, this too showed a remarkable variability and no

trend, but has expanded raidly in the last year and a half. The minimum was four percentof GDP in 1982, the maximum sixteen percent in 1993.

vii. The eve 'lution of market in Brzil has been lggard when compared t that ofKorea, Mexico, and the US. In 1981, Brazi had the same market capitaliztion as Koreaand Meico-about 7 percent of GDP. By 1992, market capitiaion in Korea was threetimes larger and in Mexico had reached about 40 percent of GDP. The NYSE marketcapitalizon bad increased from 40 to 63 pernt of GDP.

ix. Trading values relative to GDP also shows that the Brnila capitl market hasnot increased according to expectaions. From 1981 to 1993, trading values flucatingbetween 1.4 and 8.6 percent of GDP. In contrast, the markets of Korea, Mexico and the UShave shown substantial inceases since 1981.

x. The reason for this low growth is two-fold. First, macroeconomic instability,which in theory should strengthen shares because they are backed by real assets, tends to

/ This large number results from the large number of 157 fiscal incentive mutualfimd accounts from the pre-1984 period merged with voluntary share mutual funds.

- iii - Executive Summary

p¢oduce the opposite effect when it causes uncetainty and insecurity about the economicgime. Sod, in Brazil activity ih private securities has been crowded out by both thes urities of SOEs and government bonds. The SOEs have had a dominant presence in thestock ecchanges. In an inflationary environment, these shares are preferred by the investorsbecause they have provided good profitability (some SOEs in Brazil are monopolhes),excellent liquidity and no risk of bankruptcy. Consequently, high demn= for those shareshave crowded out the new issue of shares by private owned enterpiss by depressing theirproswecive price to book value. New issue of goenment debt, likewise, has aowded outnew issues of sewrities by the privae sector. This is seen not ondy in the stock exchangebut in the credit markeL

Reultons

Xi Capital market regulaton is divided among a handful of governmentorgnizations- (1) the National Monetar Council (wh!ch makes policy and approveregulats for the financial system); (2) the Centra Bank (responsible for financialinstitions, including brokerage firms, securities distributors, investnent bank, fixedincome and commodity mutual funds, and the regist of capital flow of foreign investos);(3) thij Securities Commission (CVM) (n charge of public issue and sedary tradingregiies, stock mutual funds and foreign inmsitutional investors); (4) the Prvate Insurance-in (SUSEP) (reonsible for insuance companies and open pension pLans); and

(5) The Secretriat of Complemetary Security within the Social Security Ministy (SPC)(respnble for closed pension fimds). The CVM, SUSEP, and SPC lacked continuity inleadership and suffered from a lack of financial resources affecting the hiring, maintenanceof personnel, capacity to inspect, and disclosure of information to the public.

xii. The fion of the powers and fumctions of the reguatory organsproduce inefficiencies, which are exploited by market participants. Banlkng secrecy lawsimpede the Securities Commission from close surveillance of the financial health ofinstitutions and tacing financial chicanery. Both the Securities Commission and CentralBank have been limited by a Supreme Court injunction from inspecting closed pension fundOperations in financial and capital markets.

xi. Legal procedures for regulat are also cumbersome, although some of theseproblems may be resolved through revision of the 1988 Constitution. As yet, thecomplementary legslaion establishing the struchtre of the national financial system and itsregulaon as required in that Constituon has not been dealt with by Congress. Legislatonhas been proposed but has not yet been discussed by Congress to modify the companies' law,reform aion, and change the social scunity system. Government progams to reformcapita markets and the insurance sector were approved in 1991 and 1992 respectively. Butmany items of the progams which are intended to deregulat and/or develop the markets aresill to be implemented.

TUe Development of Brazilian - iv -capital Markets

Renieudatlous

1. Regulatory Structure

xiv. The authonties responsible for regulation of markets should consider thefollowing policy measures:

(a) Leadershp Stability. Coi sistent with similar measures beingconsidered with respect to the Presidency and Drectors of the CentralBank, the President and Directors of the Secuities Commission shouldbe appointed for fixed staggered mandates of at least four years. Theywould only be replaced before the end of their mandate due toresignation or proved iLcit practices. Their nomination should beconfirmed by one house of the Ccagress. A similar stucure should beadopted for the Private Insurance Superintendency.

(b) Fiancial Autarchy. User fees for securities market regulation shouldfinance the Securities Commission, Private Insurance Superintendency,and the reformed Secretariat of Complementary Security. Even withpartal retention of these revenues by the Treasmy to compensate forincome tax base losses, the remainder should be directly and promptyavailable to the regulatory organs for their expenditures or be paid intoa fund for this purpose. The user fee schedule and Commission budgetshould be approved periodically by the Congress. This financialindependence is necessary to mAnntain a professional staff and toundertake investnents necessay to effectively regulate the securtiesmarkets.

(c) Centalize Regulatory Activities. Regulatory effectiveness and staffeconomies could be achieved by centralizng the regulation of secuitiesmarkets and their participants in a single organizaton, with appropriatedivisions. The inspection of insurance companies and pension fundsbasically involves financial questions. Infornation exchange forregulatory purposes would be facilitated by market regulationconcentrated in a single agency. If it is decided to maintain separatesecurities and insurance regulation bodies, it should be considered tounify insurance and closed pension fund regulation in a single body.

(d) Concentrate on Regulation. With greater independence from politicalintervention, regulatory bodies should concentrate more on normativeand inspection functions. The efficient performance of these functionsshoud be the key to market development if macroeconomic conditionspermit.

- v oExecuive summay

(e) Ease Bak See Reshtrtions. The effecdve invegn ofsecurities marot malprce requis easier to bank records.

(M) Faceltte Adminis tative Pses. Mea are needed to mvethe backlog of disciplinary pedings. T include use of conntdecres, arbitration p u, migation of pnalt forcolaboraon, faciito of the applicability of summay Fproceedigs,sffer financial penies, and einidnat of laws for which it isviay impossible to present proof. Penal might be Imposed orltor who do not conduct prceeding within reasonble pods.Appes procedures might rein the intermedia step Of th SupeioResoures Council befre going to common jusice. Hower, thisCounci should be reformed in its composition to avoid the inclusion ofthe private-seor intrs groups whose own members are frquentybing disciplined.

2. Ssendary Markets

(a) letter Defition of Self-Reguation. While self-tion of thecnday market should be more effident, investor and company

ellace and punhment emain the progative of the SeuidtiesCommission, whie broker inspection and punishment areresponsibiities of the self-regulating stock excage. Either stockexchange board partcipation should be bodened with the ehagbeing given greater self-reguatoy powers with rect to investo andlsed companis; or the Securities Commission should insist on diretacces to the exchnges' mformation systems to monit these maktpartciplants.

(b) Create a C monTrading Ifomato System. Given thedispostion of Brziian stock exchanges to rmain separate, it should berequired that there be devdoped a common tading information systemthrough which brokers must place orders on the exchmge offeing thebest price.

(C) Etabb Comon Cleag Faiti. Although the two major stockexchanges have established seprat cleadng cpomion andintmarket opeatons have been facilited through their cooprtionwith one another, sock markt credit remains efecvely controed bytese clearing corportions whose owners are the stock exchanges.With different cleaing corporations, hdinfg praices are more difficultfor reguators to tracL he Secis Commision sIhd intsify

The Development of Brilian - vi -Capital Markets

efforts to establish a single cleang house whose ownershp would bespread among the stock exchanges, banks, and others.

(d) Inprove Liquidity. The stock exchanges should consider whatmeasures could improve liquidity of lesser taded stocks. The

cipaton of non-members through direct terninal use shouldincrease investor interest Special members who trade for their ownacunt could be admitted. Also, the requiement of bkers to act asmarket makers for specific shares, always presentng buy and sell offersfor minimum quantities of shares, is a possibility which should beexmined in the effort to increase liquidity.

(e) Clarer Rules for Derivatives. Futums and options markets have inthe past suffered from unsuccessful economic stabization progmms.Legal procedures should define procedures for liquidation or adjustmentof contrac when their objects are suspended due to economic polcyshock.

3. New Tunes Market

xv. To reduce issue underpricing and issue cost, the following measures should beconsidered:

• MEimination of the requrement for contacting a financial institution forpublic placement;

* Permitting shorter periods for prefierential subscription of new issues byexist sbareholders, recogized that this is already available forcompanies constituted under the authorized capital regime;

* Educational efforts to explain auction procedures, as an alternative, tothe sale of shares or subscription rights;

* Efforts to explain altenatives-say, price setting on the eve of a publicissue;

* Stricter enforcement of the requirement for the public availability ofprosectus for initial public offerings. Elimination, too, of the need fora detailed prospectus for public issues of companies aldy registeredwith the Securities Commission and which already must discloseregularly corporate financial infomnaion; these cnopanies should beempowered to publish a simplified prospectus, describing issue

- v - Executive Summary

charactriscs and more detailed information about the intended use ofthe funds raised.

4. Corporate Disdlsure and Accounting Standards

(a) PenalHze Failure to Disclose Results. Financial penaldties for delays inpublhing financidal results should be strengthened. Prvision in thecompames' law should be considered for punishing extreme andunreasonable disclosure delays through requiring buybacks of shares atthe shareholders' option at a minimum price, equal to the greater of networth per share or market price.

(b) Reduce Disclosue Costs. The compulsory publication i-a newspapersof annual financial statements could be eiminated if public availabilityis guaranteed and facilitated at the Securities Commission and stockexchanges.

(c) Insider Disclosure. The Secuities Commission should better ornizeand inspect the filing of information conemring insider trading andinsider commecial relationships with publicly traded companies.Broader disclosure of the trading and relatips, as is curently donein Chile (see Part m should be consideed.

5. Company Property Rights and Control

(a) Mainain Share Proportions. The spirit of company law reformshould be to facilitate the issue of different types of scurities ratherthan force changes in proportions of non-votng preferential shares andordinary shams Compulsory changes might result in compnieswitdrawing from the public market and impede investment. Marketpices should reflect the importance (or not) of secutiescharactedstics, such as voting rights.

(b) Strengthen Minority Shareholder Rights. Companies' law reformshould contemplate various forms of pwrttng minority shareholders.Preferred shareholders should have voting rights on, for example,capital increases that affect them specificaly. Means for increasing theeffectiveness of 'fiscal councils' which have minority and preferredshareholder representation should be sxdied. In the case of theresurgence of inflation, the payment of dividends should have to beindexed from the end of the financial year to the date of paymentCompanies should retain their flexibility in setting the form of

The Developmt of Brilian - viii -Capita Markets

remuneration of prefeed stock, where fixed, minimum, and vriabledividends can be paid.

(c) Relaon of State-Controled Publik Companies. Governmentpolicy should be clear coernig the subordin of st-controledcompanies to market rgulatry procedures.

6. Talon

(a) Elmnailon of Double Taxation Biased Aga_s bivestment. lheelimination of the capital gains tax on stock market operatios wuldreverse the esting bias for companies to distribute dividends instead ofreinvesting profits. Tax policies should be harmonized with theMercosul, thus avoiding posible distortions in capital flows within thearea. Mm revenue effect of capital gains taaion is small. If capitgains taxaon is maiained, in the dterminIo of taable income,capital gains should be filly offsettable against capil lossesindpedent of the type of asset during the entire tax year.

(b) Defeol for Retimnbt Savins. The success of any refbm offinancing retment through capitaiion schemes (investment ofsaving) will depend on partiipants being able to defer the incometaaon on curent contributions and the income accumulated by thamundl they receive distrbutions, as is currently done with corpatecontributions to pon funds.

(c) Ellminatonof Transactions Taxes. The effect of edsting txes basedon the term for which financil investments are held and on the value offinancial trnatons contributes to inceased sr forintermediation. These spreads increase costs for securities isur andborowers. lhese taxes also lead imvests to freeze thir portios,thus reducing market efficiency.

7. Isllional Investors

(a) Private Plon Reforu. LTe rrms arising from cunrent and futuwfinanci difficulties of the government pay-as-you-go social securitysystem should result in expansion in coverg of capitized pensionprogms. These should occur through loweing the maximum benefitsof a government plan and permifttng alwrnatives for thoseemloyeesnot covered by company pension plans. Tax deferral of income tax on

- ix - Execudve Summary

contributions and accumuatons would be essential to make tie plasviable. Adminisation of pension plans should be opened to includedosed company plans, those sponsored by insurance companies, andmutual fumd asset accumulaton plans. As in Chile, the resourcesmobilizd by such plans should provide fte major source of domesdcsavings for capital market investment.

(b) Refonn of Mutul Fnd egislaton. Mutual funds in Brail aeealisbed under various resolutions for speialized fimds based onoriginal general legiation. More simplified procedures are needed.For emple, asset concenaon and dverificaion standads dould beestablished in fund bylaws and not through lesadon. Greaterfreedom should also be given to portfolio management outside offinancial institutions, aDlowing separte managing and trubee agents asin Argentina and Chile.

(c) Reduction of Portfolio ConeettioSomcrequirements may be necessary to insure adequate dveificato.Minimum investent uits, however, should be eliminated.Free portio muta funds are a first step m this diecton, with

diversification policy established in the fund's bylaws.

(d) Inceasing Regulatory Effectenes. The financi quesdonsconrning closed and open pension fund and insur companyrulation are of similar natures. Pooling the regulatory resources nowsparted in the Private Inswance Superntendency and theComplementary Security Sec would be advisable.

8. ForeIgn Inestors

xvi. Rdorms of the past few years have eliminatd the principal reguatoryoba es to feign investment in the capital markets. But problems need to be resolved in:

* Individual investor direct access;

* Elimination of remaining restrictions on fixed-income investments;

* Reconcliat of shareholder preferential rghts with ADR isprocedures;

* Lack of a foreign exchange sight market with transactions liqufidaed onfinancial futures exchanges;

The Development of Bailian - x -Capital Market

* Differential exchange rates for institutional and individual investorsfrom the Mercosul area; and

* Lack of future markets in Mrcosul cunrrncies;

9. Deb Securities Markets

(a) Reduction of PubLc Offer Reg o uments. Corporatebonds and commercial pa exclusively issued to and traded by lareinsdtutional investors should have reduced registration requirementswith the Securities Commission. Requirements smilar to SEC Rule144A should be considered. As is already the case for issuers of largeunit-value denominations of commercial paper, in operations destinedexclusively to the institutional market, companies should not berequired to regit as open capital companies for the trading of theirdebt secuities. Open capital status should be reserved for true publicssuers of their securities.

(b) Strengthening of the Role of the Flduciary Agent. In the case ofresdticted bond issues, information concerning the issuing companyshould be concented in the fiduciary agent selected in a bondholders'meetng. This agent should be compensated by the bondholders, ratherthan the issuing company. Penalties for not furnishing corporatefinancial information to the fiduciary agent would include the immediaterefund of the bond issue to investors.

(c) Rafting for Pension Fund Investments. Investors in pension funds orother redrement plans have little means for redress if the plan fails.Regulatory authorities should consider the desirability of requiringsmnimum ratings for fixed income instruments purchased by pensionfunds. In this manner private sector services would supplementgovernment sunveillance of these institutional investors.

10. long-Tenn Credxt Market

xvii. In the transition of the Bilian economy, various long-term credit marketproblems shoud be resolved:

(a) Offical Credit Institon Shift of Fnancing to the Private Sector.BNDES will have to shift more resources to the private sector. In theearly eighties BNDES portfolio with the private sector rresented