RIO DE JANEIRO - In an effort to encourage companies to switch to defined contribution plans, Brazil's National Monetary Council has set down new investment rules for the country's retirement plans.
The rules establish separate stock allocation ceilings for defined benefit and defined contribution plans. Companies have, in recent years, shifted to defined contribution from defined benefit plans to achieve higher returns, but the monetary council, or CMN, wants to speed up the conversion rate, sources said. The rules set down in late March maintain the current 60% ceiling for pension fund stock allocations for defined contribution plans, but lower it to 45% for defined benefit and other plans.
Currently Brazilian pension funds invest an average of 35% of their assets in stocks, according to ABRAPP, the national pension fund association. Some state-owed company pension funds, however, invest more.
Defined contribution participants generally are allowed to choose from among several options with varying risk levels - much like lifestyle funds offered to U.S. participants - but do not choose specific investments.
The new rules also aim to boost a four-month-old stock rating system on the Sao Paulo exchange, or Bovespa, on which more than 95% of the country's stock trades take place. Because the rules are new, only a small number of Bovespa's 470 listed companies have shown interest in receiving classifications, a spokeswoman at Bovespa said.
Goals for system
The classification system is meant to encourage disclosure and minority shareholder protection. Companies that receive Level 1 classification must provide disclosure that meets U.S.-style generally accepted accounting practices, which are far greater than Brazilian law requires; those at Level 2 must meet the same disclosure standards and offer minority shareholders tag-along rights and some voting rights under limited, not-yet-determined circumstances.
The monetary council, or CMN, pension rules allow defined contribution plans to invest up to 45% of their stock allocations and defined benefit plans to invest up to 35% of their stock portfolios in Level 1 listed companies; up to 55% of their stock allocations and up to 40%, respectively, in Level 2 listed companies; and up to 35% of their stock allocations and up to 30%, respectively, in Bovespa-listed companies that are not rated.
Officials at a number of pension funds have sharply criticized the CMN rules pertaining to the ratings because, they argue, it isn't clear if the classification system will even take hold.
"The CMN is being precipitous in setting stock allocation ceilings for Level 1 or Level 2-classified Bovespa companies, because no companies have even received such classifications," said Benni Faerman, investment director of Rio de Janeiro-based Fundacao Eletrobras de Seguridade Social, the pension fund of Eletrobras, the holding company for the state-owned electric sector. "In similar fashion, how can the CMN set stock allocation restrictions for investing in non-Level 1 and non-Level 2 companies when no one knows whether most Bovespa-listed companies even want to take part in this classification system?"
A Bovespa source said the exchange expects companies to have pursued classification by the September 2002 deadline for pension funds to fully comply with the new rules and investment limits arrives. The source added the CMN ceilings are expected to encourage Bovespa-listed companies to seek ratings.
The rules have little effect on investment limits for other asset classes. The ceiling on real estate investments will remain at 16% until 2003, then decline by two percentage points every two years until it reaches 8%. This replaces a similar plan already in place in which the real estate ceiling was to drop to 10%.
The ceiling for fixed-income investments will remain at 100%, and the ceiling on loans to contributors will remain at 10%. The average Brazilian pension fund invests 50% of its assets in bonds.
The CMN rules also force pension funds to annually disclose their broad investment strategies to the Social Security Ministry, something not now required. They must show allocation levels for their main assets - fixed income, stocks, real estate and loans to contributors - and calculate risk levels for their stock assets. The rules also require quarterly disclosure of how those strategies have changed and monthly performance reports.
The new rules also expand the use of derivatives to include strategies not used as hedges. Under the rules, defined contribution plans can invest up to 35% of their stock allocations in derivatives - regardless of whether they're part of a hedging strategy - and defined benefit plans, up to 30%. In both cases, funds must provide stock guarantees to cover the investments.
Mr. Faerman believes this is misguided. "I think it's a mistake for the CMN to allow pension funds to invest in derivatives for non-portfolio hedging reasons, because it's simply too risky an investment, even when covered by stock guarantees."