Brazil's Need to Implement IFRS

Data published by the Brazilian Central Bank in September 2004 reveals the high cost of operations for Brazilian companies that depend on third-party capital. According to the Central Bank, the real average bank interest rates for working capital loans, discount of trade bills and overdraft accounts were approximately 26 per cent, 31.2 per cent and 55.2 per cent a year, respectively.

In the current global economy, in which company competition does not recognize national boundaries, the cost of capital plays an important role for the success of the Brazilian companies. The real basic interest rate in Brazil is currently above 12 per cent a year. The US and member countries of the European Union have historically had real interest rates much lower than the Brazilian ones, not exceeding 3 per cent or 4 per cent a year. Also a concern is the fact that, among the so called emerging countries with which Brazil competes more directly, real interest rates are at 0.1 per cent in Argentina, 2.7 per cent in Mexico, 1.3 per cent in Russia, 0.5 per cent in India, 0.6 per cent in China, approximately, and negative in South Korea.

There appears to exist a consensus that in the long term the basic interest rates in Brazil will be unsustainable and will have to be reduced, which would decrease the costs of funding debt for Brazilian companies. An alignment with international rates, however, does not appear to be in the short and medium-term horizon. Furthermore, the access to capital at a volume and cost compatible with the needs imposed by global competition will require that an increasing number of Brazilian companies raise funds with the issue of shares, at a lower cost, especially in the international markets.

The competitiveness of Brazilian companies and their longevity in the long term depend, therefore, on the existence of a strong capital market, capable of supplying capital at lower costs. The improvement in the economic scenario, the increase in the volume of funds from institutional investors and the consolidation of good practices of corporate governance indicate that we are at the start of a cycle that will strengthen the Brazilian capital market.

Either through debt or share issues, the reduction in corporate funding costs depends on the adoption of modern, proper and transparent practices of corporate management, supported by financial statements able to provide the information needs of investors, analysts and other market participants. The differences between the accounting practices followed by companies in many countries and the resulting effects in transparency impair the comparison of the financial performance of the market, making it difficult for investors to make analyses and take decisions.

The investment in shares or debt, especially of multinational companies, will always involve risk. However, the existence of complete, pertinent and reliable financial statements, prepared in accordance with internationally accepted accounting practices eliminates or at least reduces the risk perceived by the investor regarding the information, enabling him to focus exclusively on the economic factors of the investment.

In view of this scenario, important world economies have been preparing for the “war” of attracting foreign capital, based on modern and transparent corporate governance practices and on international financial reporting standards (IFRS).

Up to the end of 2005, Germany, France, Spain, UK, Italy and the other 25 member countries of the European Union will require financial statements prepared in accordance with IFRS to issue debt (except in the less frequent cases of exclusive funding from institutional investors) and shares in the regulated markets of the region. Companies with debt and shares already issued will have to prepare financial statements 7,000 listed companies, whose financial volumes approximate the volumes negotiated in the North American Stock Exchanges. Following the trend in Europe, Australia and New Zealand have also announced their commitment to follow international accounting standards.

On the other hand, China, Russia, South Africa and the other “direct competitors” of Brazil in the attraction of international investments have already announced that they will adopt the new universal accounting language. Among these countries, a closer competitor, Mexico has also formally decided to adopt IFRS. By the end of 2005, approximately 92 countries will be using the new standards and many others will join this list up to 2007.

Even the US, whose accounting standards (US GAAP) are acknowledged as extremely sophisticated and have been accepted in certain international capital markets, are committed to the international convergence. The entities responsible for the issue of the US and international accounting standards (Financial Accounting Standards Board – FASB and International Accounting Standards Board – IASB) have committed to eliminating the significant differences between both standards until 2007. It is expected that by 2009, IFRS financial statements will be admitted for registration in the North American market without reconciliation to US GAAP. This is the biggest and most important capital market in the world, with approximately 2,750 listed companies, a daily volume of negotiations of US$46bn and total capitalization of approximately US$18 trillion, in the New York Stock Exchange alone.

Undoubtedly, there are various factors that contribute to the currently high “Brazil risk”, which is transferred to Brazilian companies as high interest rates and the consequent increase in the cost of capital. This article is not aimed at analyzing them. However, it is a matter for reflection. Can Brazil, whose economic policy model depends on international capital and where the cost of capital is one of the highest in the world, afford the luxury of ignoring international accounting standards?” If Brazil does not adopt these standards, what effects will this have on the attractiveness of Brazil and Brazilian companies in a scenario of global competition for international capital in which new technologies, such as XBRL, will allow investors and analysts to access financial data and prepare investment analyses quicker than ever previously imagined? As time goes by and Brazil does not take a concrete stand regarding the adoption of international accounting standards, the country will suffer a competitive disadvantage before other world economies that are advancing towards IFRS convergence.

While Brazil does not progress in the convergence of accounting standards, currently dependant on the approval of a project for amendment of the Brazilian Corporation Law, which has been dormant in the National Congress since 2000, the Brazilian companies that intend to increase their operating leverage or competitiveness and efficiency by decreasing funding costs should assess the voluntary disclosure of information prepared in accordance with international accounting standards. Otherwise, considering the speed that the standards are being adopted in European and Asian markets and the commitment of the US to convergence, these companies risk having their competitiveness severely impaired.

It should also be noticed that, even for a possible funding in Brazil itself, the presentation of more transparent financial statements with improved quality should be rewarded with increased investor interest and lower return requirement on the investment, either as interest or dividends.

This article is based on an article published in Valor on 9/02/2005