Brazil’s National Monetary Council has just announced that as of March 15, all hedge operations undertaken by Brazilian businesses abroad will have to be registered in Brazil. The head of the Norms Department at the Central Bank, Sergio Odilon dos Anjos, explains that the objective is to make the derivative market more transparent.
Derivatives are defined as investments that are supposed to provide protection against losses. On the other hand, it must be remembered that Warren Buffet famously attacked all derivatives, calling them “… time bombs, both for the parties that deal in them and the economic system.”
In 2008, some large Brazilian exporters, such as Sadia and Aracruz Celulose, lost billions with derivative investments. The companies were engaging in a common and often necessary practice: trying to avoid losses from exchange rate variations or, in other words, hedging foreign-currency risk.
This was being done through investments in exchange rate derivatives. However, there are two ways to deal with derivatives. You can use them to protect gains and keep business operations balanced or you can speculate in derivatives, trying to obtain financial gains from them.
It is now pretty clear that some people in financial departments were speculating. That can be extremely dangerous with derivatives because when the markets go the wrong way (against your bets) your losses do not just increase – they explode. In the case of Sadia and Aracruz, all bets were on a continued valorization of the real, but in September 2008 the dollar suddenly rose sharply in value.
“One of the consequences of the recent international financial crisis is a movement toward more transparency. This new rule is a tool we can use to oversee the derivatives market as a whole. It does not prohibit anything. There is no bias in favor of or against anything. It is simply a transparency measure,” declared Odilon.
So, the new rule’s mechanism is that operations carried out by companies will now be registered by banks because they control exchange contracts. Actually, this latest rule is just one in a series.
Brazilian authorities already required the registration of funds obtained abroad through derivative instruments. And last month, the Monetary Council made it mandatory for branches of Brazilian banks operating outside the country to report derivative operations even if the money does not enter Brazil.
As most of the rest of the world debates the pros and cons of tighter controls on financial activities (at Davos, for example), Brazil moves ahead in favor of very tight controls. The future will show who got it right.