copyright by ricardo correa 2020
TRANSCRIPT
Copyright by
Ricardo Correa 2020
The Report Committee for Ricardo Correa
Certifies that this is the approved version of the following Report:
The Development of a Municipal Bond Market in Brazil: A Comparative Case Study of the Deodoro F1 Race Track:
Rio de Janeiro & COTA, Austin, TX.
APPROVED BY
SUPERVISING COMMITTEE:
Supervisor: Peter M. Ward
Co-Supervisor: Martin J. Luby
The Development of a Municipal Bond Market in Brazil: A Comparative Case Study of the Deodoro F1 Race Track:
Rio de Janeiro & COTA, Austin, TX.
by
Ricardo Correa
Report
Presented to the Faculty of the Graduate School of
The University of Texas at Austin
in Partial Fulfillment
of the Requirements
for the Degrees of
Master of Public Affairs
and
Master of Arts
The University of Texas at Austin
May 2020
iv
Acknowledgements
This research initiative could not have been possible without the unwavering support of my professional report advisors, Dr. Martin J. Luby and Dr. Peter Ward from the LBJ School of Public Affairs with support for fieldwork - from Dr. Ward (C.B. Smith Sr. Centennial Chair #1) & the Lozano Long Institute of Latin American Studies (LLILAS) Graduate Student Scholarship. Thank you for your vested interest in my scholarly achievement, personal endeavors, and professional development. I would also like to extend my sincerest gratitude to Paul Kinscherff, Executive in Residence at the McCombs School of Business for his continued support and valuable feedback as a mentor. Thanks are also due to Paul Jack and Rudy Mejia at Estrada Hinojosa Investment Bankers here in Austin, TX. My time with the firm undoubtedly informed the direction this research project would eventually take. Thank you as well to Dr. Stephen Magee of the McCombs School of Business for sponsoring my postgraduate independent study, “Politics, Leadership, and Inspiration.” Thank you to Professor Michael Dodd also at the McCombs School of Business for leading the International Business Seminar. This multidisciplinary seminar course helped cultivate a mindfulness and appreciation of political history along with its implications on government, business, and society. Finally, thank you to Dr. Lorraine Leu (of the Lozano Long Institute of Latin American Studies and Department of Spanish and Portuguese) for introducing me to the culture and language of Brazil. Muito obrigado! In closing, my hope is that this paper will serve as a foundation for future discussions within the domain of municipal finance development and meet the commonly uttered aphorism here at UT of, “What Starts Here Changes the World” and beyond.
v
Abstract
Ricardo Correa, M.P.Aff. | M.A.
The University of Texas at Austin, 2020
Supervisor: Peter M. Ward
Co-Supervisor: Martin J. Luby
Considering the long history of privately financed capital projects in Latin America, this research paper examines the theory that the US municipal finance structure may serve as a prudent legal, regulatory model for emerging markets in Latin America. As such, the development of a sub-national debt finance apparatus is critical for the liberalization of financial markets in Brazil. Mired by institutional corruption and public distrust, this paper offers a comparative examination of the capital infrastructure development of Formula 1 racetrack in Deodoro, Rio de Janeiro, Brazil and Circuit of the Americas (COTA) in Austin, TX: a case study which examines alternative banking solutions, transparency through regulatory reforms, and the viability of subnational capital markets for improving social inclusion in Brazil. By developing a municipal bond market in Brazil, state and local governments would in effect be better equipped to gain access to efficient capital markets for the public provisioning of capital infrastructure projects through taxable, tax-exempt bond issuances, or other non-traditional public financing mechanisms.
The Development of a Municipal Bond Market in Brazil: A Comparative Case Study of the Deodoro F1 Race Track: Rio De Janeiro & COTA, Austin, TX.
vi
Table of Contents
List of Tables …………...……………………………………………….……..viii
List of Figures…………………………………………………………….……..ix
List of Illustrations ……………………………………………………………x
CHAPTER 1: SUB-NATIONAL CAPITAL MARKETS IN BRAZIL?.........6
A NOTE ON THE RESEARCH PRESENTED THROUGHOUT REPORT
INTRODUCTION
DESCRIPTION OF THE TOPIC
THE POTENTIAL FOR A BRAZILIAN MUNICIPAL BOND MARKET
REPORT ORGANIZATION AND METHODOLOGY
CHAPTER 2: THE POLITICS OF F1 RACETRACK CONSTRUCTION..19
INTRODUCTION
THE INTERLAGO TRACK IN SÃO PAULO
THE DEODORO BID-RIGGING SCANDAL
PUBLIC PROVISIONING VS. PRIVATIZATION
CHAPTER 3: FINANCIAL MANAGEMENT IN CIRCUIT OF THE……29 AMERICAS (COTA) | AUSTIN, TX
INTRODUCTION
ECONOMIC DEVELOPMENT STRATEGY
PUBLIC PRIVATE PARTNERSHIPS (P3)
‘NON-TRADITIONAL’ PUBLIC FINANCE MECHANISMS
Introduction:...................................................................................1
vii
CHAPTER 4: CORPORATE POLITICAL STRATEGY AND NON-MARKETENVIRONMENT IN FORMULA 1………36
INTRODUCTION
EXAMINATION OF NON-MARKET ENVIRONMENT IN FORMULA 1
NON-MARKET ISSUE ANALYSIS
LEGAL REGULATION OF NON-MARKET STRATEGY
NON-MARKET ACTORS: PUBLIC OPINION, COMPETING INTERESTS, & ISSUE FRAMING
LEGISLATIVE LOBBYING, ELECTORAL POLITICS, & RULE-MAKING
CHAPTER 5: THE US MUNICIPAL FINANCE STRUCTURE AS PROSPECTIVE REGULATORY MODEL FOR EMERGING MARKETS INLATIN AMERICA…………………………………………………………46
INTRODUCTION
A ROADMAP TO POLICY INTERVENTION
STRENGTHENING THE SUBNATIONAL BORROWING FRAMEWORK
ENHANCING TRANSPARENCY CONTROLS
REDUCING INEFFICIENCIES IN DISCLOSURE INFORMATION
FORMAL FINDINGS
AFTERWORD:
THE IMPACT OF COVID-19 ON GLOBAL FINANCIAL MARKETS..............59
Works Cited 61
viii
List of Tables
Table 1: Timeline of Implementation (Nonmarket Strategy), Stakeholder Relations Management Approach…………………………………………………..…...……..44
ix
List of Figures
Figure 1: (MIT Sloan Management Review, “What every CEO needs to know about
Nonmarket Strategy”, Bach & Allen)....................................................................38
Figure 2: Medas, Paulo, et al. Strengthening the Framework for Subnational Borrowing. International Monetary Fund (IMF), 2019, pp. 1–55, Strengthening the Framework for Subnational Borrowing………………………………….…………...……...50
Figure 3: Bloomberg Barclays Municipal Bond Index Returns……..………....51
Figure 4: Policy Instruments in Support of a Municipal Credit System…....56
x
List of Illustrations
Illustration 1: Formula 1 Racetrack Rendering, Rio de Janeiro, Brazil. Source: Rio de
Janeiro City Hall…..……………………………….…………………………....………….....19
Illustration 2: Aerial Photo of Interlagos Track, São Paulo, Brazil. Pulsar Imagens,
Alamy Stock Photo. (April 2011) …………………………………………………..........24
Illustration 3: Movimento Pró Autódromo, Facebook Group Banner. (March 17,
2020)....……………………………………………………………………………………….…….26
Illustration 4: Google Map Ramil Japeri (Train) from Central Brasil Train Station to
Ricardo Albuquerque……………………………………………………..…...………....….28
Illustration 5: Circuit of the Americas (COTA) Map…………………………….32
1
Introduction:
In light of President Jair Bolsonaro’s formal announcement in May 2019 of
constructing a formula grade circuit to host the 2021 Formula One track in Rio de Janeiro,
this paper explores the traditional financing mechanisms, politics, and timing in Brazil as
the F1 contract with Interlago is set to expire in São Paulo this calendar year of 2020.
Before we proceed, I would like to propose the theory that the US municipal
finance structure may serve as a prudent legal, regulatory model for emerging markets in
Latin America considering the long history of privately financed capital projects in Latin
America.1 In particular, this paper examines the question of whether the development of
subnational capital markets in Brazil may serve to deter politically entrenched corruption
in the financing of ‘socially desirable capital projects’ at the federal level.2 As an example,
recent evidence collected by the Federal Prosecution Service (MPF) in Rio de Janeiro (the
US equivalent of the Attorney General) suggests fraudulent behavior occurred throughout
the bidding process of the Deodoro track, with recent allegations pointing squarely to
RioMotorPark S.A, the winning vendor tasked with constructing the F1 circuit.
While the President of RioMotorPark, Jose Antonio Soares Pereira, has adamantly
denied compliance irregularities in the bidding process, information collected by the
Federal Prosecution Service (MPF) indicated the small holding company only had .14%
1 Engel, Eduardo, et al. “Privatizing Highways in Latin America: Fixing What Went Wrong [with Comments].” Economía, vol. 4, no. 1, 2003, pp. 129–164. JSTOR, www.jstor.org/stable/20065452.
2 Ibid.
2
of the mandatory legal minimum which requires potential vendors to maintain liquid
assets equal to the tune of 10% of R$ 697 million, or R$ 69 million respectively, in order
to qualify as a potential bidder for the Deodoro project.3 RioMotorpark had $R 100
thousand at the time of bidding. In addition, Rio MotorPark’s Jose Pereira also failed to
disclose his involvement in serving on the Board of Directors of Crown Assessoria, the
consulting agency tasked with selecting the winning vendor in building, operating, and
maintaining the F1 circuit on military land. When interviewed by Globo Reporters -
Brazilian legal scholar, Manoel Peixinho, faculty at the Private Catholic University (PUC)
in Rio de Janeiro, made his public opinion clear, “Jamais o presidente de uma empresa
vencedora da licitação poderia efetivamente participar como consultor da licitação. O
que houve sem dúvida, [foi] a utilização de informação privilegiada.” In plain English,
“Never could a president on the board of directors [engaged] in a bidding process [elect]
themselves as the winner of the bid. What occurred here was without doubt the usage of
privileged information.”4
Considering the historical backdrop of crony capitalism in Brazil, this direct
conflict of interest serves to remind civil society actors, its tax-paying constituencies, and
institutional investors involved of the potential governance vulnerabilities characteristic
of a federalist structure in the management of project financings at the state and national
3 Grandin, Felipe e Gabriel Barreira. “Empresa que fará autódromo no Rio tem 0,14% do capital exigido; presidente é sócio de consultoria que ajudou a fazer licitação”. Globo News. June 29, 2019. 4 Mann, Richard. “G1 Scrutinizes Bidding Procedure for Construction of Projected F1 Racetrack in Rio de Janeiro”. The Rio Times. June 30, 2019.
3
level.
As a comparative example in the Postwar Period of Mexico, Sarah Babb highlights
the contradictory logics of awarding upper-level personnel with government positions
based on their political loyalty toward the incoming president and connections rather
than credentials.5 She also builds on this notion by stating, “different forms of
legitimation mean that professions in government tend to thrive in environments that are
relatively insulated from the influence of politics” (Babb: 84). In the context of Rio de
Janeiro, the current Bolsonaro regime, and the polarized political climate - these
contradictory logics appear to have become more blatant now than ever in a regulatory
environment whereby bid-rigging, administrative impropriety, and violation of the
principles of the federal Public Bids Law are perceived commonplace, and perhaps,
situated as the social norm in public-private dealings in Brazil.6
From a policy perspective, the evidence collected throughout this research argues
that the advantages of a subnational debt structure in lieu of a nationalist federalist
framework substantially outweigh the negative transaction costs of fraud and
transparency costs that arise from a loosely regulated administrative landscape. Taking
into account the erosion of institutional integrity and public distrust in Latin America, the
Formula 1 project financing serves as a case study to analyze the characteristics of an
5 Babb, Sarah. Managing Mexico: Economists from Nationalism to Neoliberalism. Princeton University Press. (2004). 6 Grandin, Felipe e Gabriel Barreira. “Empresa que fará autódromo no Rio tem 0,14% do capital exigido; presidente é sócio de consultoria que ajudou a fazer licitação”. Globo News. June 29, 2019.
4
open, fair, and efficient capital market system that benefit state and local governments in
Brazil. While the nuanced policy exchanges between ‘neoliberal’ paradigm shifts, crony
capitalism and Brazilian politicians are beyond the scope of this paper, it may be useful
to highlight the salient features of what we mean by an efficient municipal bond market
in the US context and if it could ever work in the Brazilian experience.
Before embarking on such a task, I would like to first outline Brazil’s current legal
and regulatory environment in connection with financing socially desirable capital
projects. Chapter 1 of this paper seeks to do just that by exploring the privatization of
capital projects in Brazil and demystifying the notion that publicly provisioned projects
are inferior to those launched by the private sector. Chapter 1 also explores the potential
for a municipal bond market in Brazil and whether alternative banking solutions exist for
enhancing social inclusion in regulatory environments mired by poor governance and
institutional corruption. Chapter 2 of this paper offers a deeper analysis of the politics of
the F1 circuit construction in Rio de Janeiro. This section is corroborated by recent
archival evidence of Brazilian newspapers that were published since the inception of the
project (e.g. The Rio Times, Folha de São Paulo). Chapter 3 focuses on examining the
financial management strategies of the Circuit of the Americas capital project and
compares private transactions with the advent of nontraditional public financial
instruments. Chapter 4 applies the seminal research on non-market strategy formulation
and presents a policy formulation proposal for the Deodoro track in Rio de Janeiro, Brazil.
And finally, Chapter 5 concludes with a comprehensive analysis of the US municipal
5
finance structure as a potential regulatory model for developing a municipal bond market
in Brazil. This segment of the report offers policy instruments and relevant frameworks
in support of a municipal finance credit system as applied to the Brazilian experience.
This report’s goal is not to compare the public finance investment banking model of the
United States with the federal banking system of Brazil. The goal of using two cases is to
highlight how similar municipal finance structures and regulatory models may be
adopted to increase access to capital markets by subnational governments in Brazil.
6
Chapter 1: The Development of Subnational Capital
Markets in Brazil |
● A Municipal Bond Market on the Horizon?
“Municipal finance development does not mean that anything goes. Core principles such
as debt affordability, competitive sale, due diligence and disclosure, investor outreach,
informed decision making by municipal finance managers, and services provided by
independent financial advisory to avert conflict of interest are required to ensure prudent
municipal debt management and avert moral hazard.”
-A Brazilian Municipal Bond Market: Theory, Repression & Prospects,
Kurt Von Mettenheim.
Historical Background (1964-present):
From 1964-1985, Brazil operated under military dictatorship with the armed forces
in direct command of the state.7 After a successful coup d’état on March 31, 1964, the
reformist government of President João Goulart was overthrown by the military
authoritarian regime under the guise of populist support for the common welfare of
Brazilian society. The transition to democratic development has not been without
collective struggle and the oppression of left-wing political groups throughout the course
7Napolitano, Marcos. The Brazilian Military Regime, 1964-1985. Oxford Research Encyclopedia. April, 2018. DOI: 10.1093/acrefore/9780199366439.013.413
7
of Brazilian political history. As it relates to contemporary Brazilian society at present, the
Bolsonaro regime with its vestige military connections of the past appears to obfuscate
the path in which economic reforms intended to lure back investors stand in connection
with municipal finance development. A social scientist must cite Levy, Bruhn & Zebadúa’s
proposition that the presence of “formal democratic institutions may not necessarily
improve the situation of [state and local governments] (Levy, Bruhn & Zebadúa, 2006, p.
262).”8 There certainly exists the outcome that the development of a municipal finance
system may not function in parallel with a hyper-partisan political climate in Brazil.
Investors in the US generally favor political candidates who introduce economic stability,
monetary and fiscal policies aimed at deregulation of the finance sector, as well as
favorable interest rate environments from a credit-lending perspective. With a polarized
political landscape in Brazil, the advent of a municipal finance system may encounter
turmoil if democratic elections usher in a left-wing political group that does not support
the fiscal autonomy of subnational sovereigns. This presents a central challenge to the
viability of a municipal finance structure in Brazil if economic reforms are not judicially
protected from potential rollbacks associated with turmoil and the advent of sectarian
interest groups within the historical backdrop of a hyper-partisan political culture.
It is possible, however, the Bolsonaro regime could legislatively support the plight
of state and local governments seeking access to capital markets for financing needs to
meet budgetary gaps and expand public infrastructure. Pre-Covid-19, Central Bank Chief,
8Levy, Daniel, Kathleen Bruhn & Emilio Zebadúa. Mexico: The Struggle for Democratic Development - 2nd ed. The University of California Press. 2006.
8
Roberto Campos Neto, recently stated “[Brazil] spent all its time finding public solutions
to private problems. Well, that didn’t work. Now we are trying to find private solutions to
public problems.”9 He went on to highlight low rates as “conducive for people putting
money in emerging markets.”10 Yet, instability due to “trade tensions, political
polarization, and Brexit” public spending with its current federal banking system is not
the answer.11 This shows a potential nonmarket opportunity for an alternative banking
system that puts power at the hands of subnational sovereigns and offers a political
configuration for enhancing municipal resource mobilization.
In presenting this perspective, it is important to highlight the historical
background of Brazil’s comprehensive set of fiscal reforms (1965-67). The primary policy-
objective of these reforms were to: “increase domestic resource mobilization, eliminate
fiscally-induced distortions in the production and distribution processes, promote capital
formation and economic growth, and reduce interregional disparities in the financial
capacities of state and local governments [in particular].”12 Such taxes were administered
to improve the performance of state and local governments, “reduce [their] large public
sector deficits”, and in turn, a more “regionally redistributive system of
intergovernmental revenue-sharing was put in place.”13 During the 1980s, Weyland
9 Harris, Bryan. “Bolsonaro’s Central Bank Chief vows to ‘reinvent’ Brazil economy.” October 15, 2019. Financial Times. 10 Ibid. 11 Ibid. 12 Varsano, Ricardo. "O Sistema Tributário de 1967: Adequado ao Brasil de 80?", Pesquisa e Planejamento Econômico, XI, 1 (1981), 208-21. 13 Mahar, Dennis & William R. Dillinger. Financing State and Local Government in Brazil. World Bank Staffing Papers, Number #612. August 1, 1988.
9
argues “the economic and political crises [in a fragmented Brazil] led to a sharp
deterioration of state capacity.”14 This, in turn reduced state autonomy as the government
was forced to respond to the consolidation of interest groups.15,16 As such, it is commonly
understood that Brazil’s intergovernmental fiscal system and public sector is overly
centralized despite the economic liberalization policies under the Cardoso administration
(1995-2002).17
Simply put, the federal government dominates the banking system in Brazil which
comprises an overwhelming percentage of both revenues and expenditures while state
and local governments are situated as “providers of public services, particularly
investments, rather than [revenue-raising entities].”18 This is punctuated by the rise of
intergovernmental revenue-sharing, extensive fragmentation of spending authority
between the federal government, states, and municipalities, accompanied by grant
schemes.19 A World Bank Report on Financing State and Local Government in Brazil
pointed out in 1988 that “this administrative feature has interfered with the ability of
budget authorities at all levels of government to control the size and sectoral allocation of
14 Wampler, Bryan. Restructuring Brazil: Institutional Reform, Economic Liberalism, and Pluralism. Latin American Research Review, Vol. 40, No. 2 (2005), pp. 242-252. 15 Ibid. 16 Weyland, Kurt. The Brazilian State in the New Democracy. Journal of Interamerican Studies and World Affairs, Vol. 39, No. 4 (Winter, 1997-1998), pp. 63-94 (32 pages). 17 Mahar, Dennis & William R. Dillinger. Financing State and Local Government in Brazil. World Bank Staffing Papers, Number #612. August 1, 1988. 18 Mahar, Dennis & William R. Dillinger. Financing State and Local Government in Brazil. World Bank Staffing Papers, Number #612. August 1, 1988. 19 Ibid.
10
public expenditures.”20 To date, the federal banking system in Brazil continues to pervade
the ability of public sector entities to reign in reforms in favor of municipal resource
mobilization and upgraded fiscal autonomy.
Professor of Political Sociology at the Getúlio Vargas Foundation in São Paulo,
Brazil, Kurt Von Mettenheim proposes three distinct guidelines that could lead to
consolidated democratization in the public finance domain with the policy objective being
the modernization of “deeply leveraged bank credit” and the development of a municipal
bond market in Brazil.21 In particular, Von Mettenheim underscores that, “the repression
of municipal finance is perhaps the single most important unrecognized cause of slow
[economic] growth and disappointing politics and local public management in
Brazil...with the most critical bottleneck for Brazilian economic and political development
being municipal finance underdevelopment.”22 The public policy imperative to mitigate a
weakening economy whereby capital markets are not accessible nor efficient to local
governments requires “encouraging the modernization of the public sector, increasing
growth, and improving public management for the emergence of a new generation of
market savvy political leaders in local government.”23 This policy proposition, in turn,
would serve to eliminate the rigid structure of “top-down command-and-control”
20 Mahar, Dennis & William R. Dillinger. Financing State and Local Government in Brazil. World Bank Staffing Papers, Number #612. August 1, 1988. 21 Von Mettenheim, Kurt. Federal Banking in Brazil. Pickering & Chatto, 2010. 22 Von Mettenheim, Kurt. “A Brazilian Municipal Bond Market: Theory, Repression and Prospects”. RAE, São Paulo, Brazil (Nov. 2012). 23 Babb, Sarah. Managing Mexico: Economists from Nationalism to Neoliberalism. Princeton University Press. (2004).
11
nationalist variations of public management, and instead, provoke markets towards non-
traditional public financing mechanisms that would be more accessible and efficient to
state and local governments in Brazil. Without the ability to access capital markets,
municipalities and local governments are left in a precarious state hampered by local
budgetary constraints, crippled by rising pension obligations, and at the national-level
exposed to elevated risk of currency-exchange crises.24 Moreover, the government option
of exploring bond issuance proposals for the purpose of establishing advanced
refinancings with a cost-savings interest rate reduction under favorable market
conditions remain inaccessible to sub-national sovereigns without the emergence of a
uniform municipal bond market. Von Mettenheim notes that corruption will not
disappear overnight in Brazil. As such, the development of a municipal finance system
would inevitably pave the way for a rebalancing of historically entrenched power
asymmetries between federal, state and local political factions under a traditionally
centralized bureaucratic regime. If Brazil is to advance forward within the domains of
political economy, public policy, and banking, adopting a resilient legal and regulatory
framework will be necessary in order to deter disclosure noncompliance, enhance
transparency of state and local credit ratings, and mitigate potential consequences of
moral hazard within a nascent public finance industry.25 Regulatory pitfalls and fraud
prevention tactics will be discussed in subsequent sections of this paper.
24 Von Mettenheim, Kurt. Federal Banking in Brazil. Pickering & Chatto, 2010. 25 Ibid.
12
Modernization of municipal credit and local government bond issues do indeed present risks such as crony
credit and market bubbles. However, with sound regulation, transparent market valuation and controls,
the work of credit rating agencies, banks and risk analysts, independent advisory services and the entry of
new actors such as bond banks and insurance companies, as a whole, are capable of providing powerful
incentives and premiums for innovative municipal finance management while vetoing unsustainable
projects. -Kurt Von Mettenheim. 2010.
The evidence collected throughout this research study suggests that the traditional
centralized theory, that private monies will serve as the bedrock for future infrastructure
financings in emerging markets, undoubtedly carries with it its range of fiscal, public
policy and political dilemmas. While from a regulatory perspective, the development of a
sustainable municipal bond market may seem too good to be true or overreaching for
some private sector critics, a paradigm shift of such magnitude would require increased
cooperation between the regulatory agencies, obligated parties, participating federal
banks, and municipal market participants to better position the timing and viability of a
municipal credit system for forthcoming state and local financing needs. To enhance
transparency and provide a fair marketplace for prospective investors, the emergence of
a new municipal bond market in Brazil would thus necessitate the installation of a new
set of rules, policies, and procedures for issuers of sub-national debt. For example, the
post-issuance compliance requirements related to the continuing disclosure of material
financial information to prospective investors would entail a similar compliance system
13
adopted such as the Electronic Municipal Market Access (EMMA) website administered
by the Municipal Securities Rulemaking Board (MSRB) here in the US.
An increased reliance on the private sector to administer capital infrastructure
financings has impeded the probability of “deepening credit and capital markets in
Brazil.”26 The consensus however is clear. Brazil has developed a “reputation for
successfully implementing economic and financial reforms, along with world class
regulatory frameworks, institutions and markets in banking and finance” (KVM). A policy
challenge of implementing a public finance banking alternative in Brazil carries with it a
range of precarious institutional considerations: the lack of political will, international
currency-exposure risks, as well as perplexities related to potential bankruptcy
stipulations at the sub-national level. Such compliance framework challenges could
potentially deter proponents of federal banking in Brazil away from developing a
municipal credit system due to the widespread uncertainty. The macroeconomic effects
of developing a municipal bond market to finance subnational capital market activity in
Brazil remains inconclusive at the federal, state and local levels, in partnership with their
respective regulatory agencies and credit rating institutions as it has never been executed
in the Brazilian experience. Emerging markets in neighboring Latin American countries
(e.g. Chile, Argentina, Peru) have expressed similar legal concerns as well as institutional
considerations in developing a compliance framework that could be employed to deter
sub-national sovereigns from declaring bankruptcy and thus preventing federal
26 Von Mettenheim, Kurt. A Brazilian Municipal Bond Market: Theory, Repression and Prospects. RAE, São Paulo, Brazil (Nov. 2012).
14
government financial bailouts.
The limited research on municipal finance development in emerging markets
suggests that implementing a sub-national debt financing structure would serve to enable
state and local governments to financially engineer socially innovative bond issuances
with greater fiscal autonomy while tailoring issuances to their respective interest-rate
benchmarks, and perhaps even when applicable, consider the voting population’s
approval. Taking prudent policy objectives into account, successful implementation of a
municipal bond market in Brazil could result in: the meta-formation of state and local
fiscal autonomy within public management, increased transparency in financial markets
(BF&M-Bovespa), with the likely result being improved investor confidence in bond
offerings and a reduction in market inefficiencies.27 As such, state and local governments
would be better equipped to provision finance plans for capital projects with enhanced
transparency measures while working in accordance with pre-established compliance
criteria in connection with the credit rating agencies, bond counsel, underwriters, and the
investment banks tasked with bringing the municipal securities to market. Such
regulatory reforms for a municipal bond market in Brazil would substantially reform
financial markets towards a more liberalized economy, thereby advancing beyond the
traditionally centralized paradigm of privatization for financing infrastructure projects in
Brazil and thus improving growth in the economy.28 Furthermore, the modernization of
27 Von Mettenheim, Kurt. A Brazilian Municipal Bond Market: Theory, Repression and Prospects. RAE, São Paulo, Brazil (Nov. 2012). 28 Ibid.
15
a regulatory compliance framework in municipal finance development, if implemented
correctly, would be administered at the federal and statutory levels, per the US municipal
finance model.29
Recent evidence gathered by the Organization for Economic Cooperation and
Development (OECD) regarding subnational governments with developing economies in
Asia highlighted that generally speaking most local governments receive much of their
funding for long-term development investments from intergovernmental transfers.30
Thus, “access of subnational [sovereigns] to capital markets has been a primary source of
infrastructure finance in more advanced industrial economies”. Similarly, as in the case
of Brazil, fiscal resources could be leveraged by tapping the long-term credit markets best
suited to long-dated maturity requirements of the capital project31. The subsequent
chapter aims to deconstruct in further detail the advantages and disadvantages of
privatization versus public provisioning of capital infrastructure projects within the
backdrop of a resilient regulatory environment in Latin America with a focus on Brazil.
29 Von Mettenheim, Kurt. A Brazilian Municipal Bond Market: Theory, Repression and Prospects. RAE, São Paulo, Brazil (Nov. 2012).
30Smoke, P. 2019. Improving Subnational Government Development Finance in Emerging and Developing Economies: Toward a Strategic Approach. ADBI Working Paper 921. Tokyo: Asian Development Bank Institute. DOI: https://www.adb.org/publications/improving-subnational-government-development-finance-emerging-developing-economies
31 El Daher, Samir. World Bank. Municipal Bond Markets: Prospects for Developing Countries. Feb, 1997.
16
Prospectus Towards a Legal and Regulatory Compliance Framework for
Municipal Bonds in Brazil
While corporate bond issuances in Brazil are heavily regulated by the Brazilian
Securities and Exchange Commission (Comissão de Valores Imobiliários or CVM) to provide
funding for companies to raise capital, no such framework exists for a city, water and utility
district, public school district, or local municipality to raise capital via municipal financial
instruments.32 This paper embraces Johnson, Luby, & Moldogaziev’s theoretical view that
subnational sovereigns are indeed better equipped to optimize social welfare for its
constituents “rather than [a centralized] government [that] provides a single uniform
level of public output in all jurisdictions” (Oates, 2005, p.351).33 Similarly, the Emerging
Market Investors Association (EMIA) notes that a primary setback for the viability of
municipal bond finance systems in Latin America can be traced to the exposure to foreign
exchange movements and the volatility of international money flows.34 To reduce such
negative externalities, Patricio Abdal, a project-evaluation attorney based in Buenos
Aires, Argentina, purports that fixed-rate securities should be “issued in local currency
and purchased by domestic firms managing substantial amounts of capital such as
32Carvalho, Antonio Gledson de, & Marques, Felipe Tumenas. The Microstructure of the Brazilian Market for Corporate Bonds. (2019). Fundação Getúlio Vargas São Paulo Business School Administration. 33 Johnson, C. L., Luby, M. J., & Moldogaziev, T. T. (2014). State and local financial instruments: policy changes and management. Cheltenham, UK: Edward Elgar. 34 Abdal, Patricio. “Municipal Bonds in Latin America”. Emerging Market Investors Association (EMIA). November 29, 2013.
17
pension funds, insurance companies, and mutual funds.”35
Brazil’s sovereign credit rating from Moody’s (Ba2, stable) remains a primary
concern to government actors as it pertains to renewed pension reforms and a poorly
performing national economy. A basic credit analysis of sovereign and country risk would
assume that political and macroeconomic factors will continue to influence Brazil’s credit
profile as the Lusophone nation deals with lower than expected growth, rigid bipartisan
polarization and widespread social unrest.36 Maziad, VP of Sovereign Risk Analytics at
Moody’s, highlights that fiscal consolidation is key to Brazil’s sovereign credit prospects
which could lead to a return to an investment grade credit profile. “We expect debt to
stabilize above 80% of GDP in the next two to three years on the back of low interest rates,
fiscal reforms, and economic recovery, but fiscal imbalances are likely to prevent a decline
in debt burden”, reported Maziad.37 Moreover, Moody’s “expects Brazil’s GDP growth to
pick up to 2% in 2020; Brazil’s economy would need to expand at an annual rate close to
3% on a sustained basis to bring debt ratios materially down.”38
Comparatively, Brazil’s corporate bond market underwriting is predominantly
captured by the federal banks in Brazil with over one third of credit being issued by the
35 Abdal, Patricio. “Municipal Bonds in Latin America”. Emerging Market Investors Association (EMIA). November 29, 2013. 36 Maziad, Samar, Cooper, Patrick, Leos, Mauro, Lemay, Yves, “Moody’s: What will influence Brazil’s Sovereign rating in the coming years?”. January 21, 2020. 37 Ibid. 38 Ibid.
18
three big banks (e.g. Banco do Brasil, Bradesco, and Itaú).39,40 Similarly, should a
municipal finance system grow into fruition in Brazil the federal banks should represent
the overwhelming majority of underwritings in municipal bonds. Private sector
involvement is key here in the underwriting of municipal financial instruments in that
they would offer liquidity support to public agents. The microstructure of the Brazilian
market for corporate bond market comparison serves to highlight the banking entities
that would subsequently serve as underwriters for state and local financings of capital
projects on the debt financing side.
39 Carvalho, Antonio Gledson de, & Marques, Felipe Tumenas. The Microstructure of the Brazilian Market for Corporate Bonds. (2019). Fundação Getúlio Vargas São Paulo Business School Administration. 40 Von Mettenheim, Kurt. Federal Banking in Brazil. Pickering & Chatto, 2010.
19
Chapter 2: The Politics of F1 Circuit
Construction in Rio de Janeiro, Brazil.
Illustration 1: Formula 1 Racetrack Rendering, Rio de Janeiro, Brazil.
With the looming fate of the Formula 1 precarious for the Brazilian Grand Prix, the
cities of São Paulo and Rio de Janeiro have forged their own long-term plans
independently of one another to serve as host for the event as the contract with the
Interlagos track in São Paulo is set to expire late this year (2020). São Paulo’s Municipal
Council for example approved this past May (2019) the “concession, not privatization” of
the Grand Prix to maintain it at Interlagos.41 A concession rather than privatization of the
Interlagos track would mean that the “F-1 would remain in São Paulo because the
41 Emert, Harold. Grand Prix Could Remain in Sao Paulo After All. The Rio Times. May 16, 2019.
20
concessionaire would [by default] be interested in promoting the event.”42 A concession
would also translate into avoiding the sale and real estate speculation associated with
privatization, according to the Council’s President Eduardo Tuma.43 To be exact,
privatization shifts all provision of services along with revenue risks to the private sector.
While concessions may be characterized by the public sector specifying problems and
solutions where the private actor executes the collective contract resulting in the provision
of services by private actors.44
In direct contestation with the F1 São Paulo Interlagos negotiations, President Jair
Bolsonaro recently declared in May (2019) plans to relocate and approve construction of
a new Formula 1 Grade racetrack in Rio de Janeiro instead. Mired in controversy related
to recent allegations of bid-rigging, “Brazil’s Public Ministry requested a court order
prohibiting the municipality of Rio from constructing a new racetrack” in light of reported
bid-rigging allegations against Rio Motorpark.45 The financial capital of Brazil, São Paulo
has a decorated history of hosting F1 Grand Prix from (1972-1979), (1979-1980), and
(1990-2019) respectively.46 From a financial valuation and economic development
perspective, the political rivalry remains clear between São Paulo and Rio. A new F1 track
would presumably enhance Rio’s lackluster economy due to the high-risk high-reward
42 Emert, Harold. Grand Prix Could Remain in Sao Paulo After All. The Rio Times. May 16, 2019. 43 Ibid. 44 Willems, Tom & Van Dooren, Wouter. (2011). Lost in Diffusion? How Collaborative Arrangements Lead to an Accountability Paradox. International Review of Administrative Sciences. 77. 505-530. 45Emert, Harold. Injunction Could Stop New Racetrack in Rio and Possible Grand Prix Move. The Rio Times May 21, 2019. 46 Emert, Harold. Grand Prix Could Remain in São Paulo After All. The Rio Times. May 16, 2019.
21
potential a facelifted racing attraction could bring to the second most populous
municipality of Brazil. The numbers speak for themselves with the Interlagos scenario, as
reported earnings in the amount of R$334 (US$83) million served as a revenue-
generating tourist attraction in 2018, a notable increase of 20 percent from 2017.47 The
appeal for bringing F1 to Rio however remains further complicated by the fact that the
track’s construction contract on the West-Zone of the city inevitably would require partial
deforestation of the Camboatá forest, a forest recognized to have water treatment
properties and budget saving costs to the city.48 The current state of affairs from Rio
prosecutors is such that they will challenge any further development of the region due to
environmental impact issues.49 As such, an environmental impact study will need to be
conducted before any further construction is set to occur. Rio Motorsports, the vendor in
charge of constructing the track, recently released a statement that it would take the lead
to build and operate the track for the next 35 years according to information obtained by
The Rio Times.50 Once an environmental license is obtained by RioMotorpark,
construction is expected to resume as normal. In terms of seeking an extended
negotiation of its current contract with Liberty Media, the new owner of Formula 1, the
47Emert, Harold. Grand Prix Could Remain in São Paulo After All. The Rio Times. May 16, 2019. 48Ozment, Suzanne, Rafael Feltran-Barbieri, Erin Gray, Perrine Hamel, Juliana Baladelli Ribeiro, Samuel Roiphe Barrêto, Aurélio Padovezi and Thiago Piazzetta Valente. Natural Infrastructure in Sao Paulo’s Water System. The World Resources Institute. September, 2018. DOI: https://www.wri.org/publication/natural-infrastructure-sao-paulo. 49 Kapoor, R. (2019, May 22). "Will the Brazilian Grand Prix move to Rio from 2021 after Interlagos contract expires?" Financial Express. 50Ibid.
22
cards are stacked against São Paulo.51 A ten-year extension at Interlagos seems highly
unlikely due to the city of Rio de Janeiro’s coordinated effort to offer F-1 R$250 million
to host the Brazilian Grand Prix from 2021 onwards.
According to The Rio Times, (cited this past December, 2019):
According to reports from the newspaper Estado de S. Paulo, the summit of the world’s leading auto racing
category recently received an offer with a schedule of bank deposits relating to fees and the submission of
financial guarantees to ensure the signing of the contract and, consequently, the event to be held in the
neighborhood of Deodoro, West Zone of the City of Rio de Janeiro.
- The Rio Times (December, 29, 2019).
A cash-strapped municipality such as Rio de Janeiro would assuredly benefit from
the revenue-generating potential hosting F1 would bring to the local economy along with
its expected increase in short-term and long-term job creation. The previously cited
R$250 million Rio offered to F-1 would be subsequently disbursed in four annual
installments through the form of a tax waiver from the City’s Secretariat of Sports,
Leisure, and Youth which has already been approved in an effort to secure the city’s net-
bargaining position as a potential host.52 Due to a confidentiality agreement with F-1, Rio
51 Savarese, Mauricio. “Brazil’s Major Cities Lock Horns for the F1 Race after 2020. The Associated Press. November 14, 2019. 52 Petrov, Arkady. The Rio Times. “City of Rio Offers R$250 Million to Formula 1 from 2021”.
23
Motorsports is limited in the amount of information it can release to the media relating
to current negotiations. A formal decision was expected to be made by F1 owners Liberty
Media in March 2020. However, due to the cancellation of F1 events as a result of
coronavirus official decisions have been delayed. Yet, “the State of Rio de Janeiro has
approved a bill granting a tax incentive of $302 million for the first two editions of F1 in
2021 and 2022.”53 As such the odds of F1 moving from Interlagos to Rio de Janeiro are
highly probable. Additionally, the city was able to secure a contract in October to host the
MotoGP circuit in 2022 for five years.54
53 Dhruv, George. “Brazilian GP set to move from Interlagos as Rio de Janeiro makes arrangements to pay fee.” Essentially Sports. Dec. 5, 2019. 54 Ibid.
24
Public Provisioning of Capital Projects vs Privatization in Brazil.
Illustration 2: Pulsar Imagens, Alamy Stock Photo. April 2011.
Before venturing into the financing options available that undergird socially
desirable projects such as an F-1 racetrack, one seminal argument established by
theoretical economists Engel, Fischer, and Galetovic highlights that two options exist to
finance major infrastructure projects in Latin America. The traditional approach which
involves the government designing, financing, and operating the [project] through public
provisioning.55 Private entities are encouraged to participate in the construction stages of
the capital project, but ultimately the government operates and maintains it.56 On the
55 Engel, Fischer, and Galetovic. Privatizing Highways in Latin America: Fixing What Went Wrong. Fall, 2003. 56 Ibid.
25
other end of the financing spectrum, private firms may engage in autonomous
privatization in the development of the project, and as such, bear the risk of reduced
marginal earnings in the event of a down-turn in demand projections. While Engel,
Fischer, and Galetovic’s research focus examines the implications of cost-based tolls in
Latin America, the theoretical framework may be applied in the context of the
construction of the Deodoro track. Specifically, “cost-based tolls may be easier to justify
politically when infrastructure providers are private (EFG: 130).”
When superimposed on the Deodoro example, a racetrack funded by private
capital may be easier to justify financially amongst a politically apathetic electorate. This
is precisely where the dilemma arises when assessing the viability of a municipal credit
market in a developing nation such as Brazil. Are certain projects more amenable to a
traditional public provisioning approach whereby taxpayers bear the longitudinal costs
through the lens of intergenerational equity? And, if so, which types of projects fit the
mold of being politically justifiable to finance via the underwriting of municipal bonds?
In particular, this report seeks to examine this conundrum of the “when” and “under
what” subnational economic conditions a traditional versus privately funded approach
could yield efficient and positive results in an equitable manner for civil society.
26
The Pró Autódromo Movement in Rio de Janeiro, BR
Illustration 3: Movimento Pró Autódromo, Facebook Group Banner. March 17, 2020.
While this report generally relied on primary archival materials, news articles, and
peer-reviewed journal contributions in the fields of finance, economics, and banking
theory - this report aimed to explore non-traditional channels of information and actively
monitor such accounts via social-media platforms (e.g. Instagram, Facebook, and
Twitter) to gauge the character (and presence) of public perception as it relates to the Pro
Autodromo Movement in Rio de Janeiro launched by Rio Motorsports. In many ways, the
news agencies in Brazil (as well as most developing nations equipped with governments
and bipartisan political agendas), have a tendency of providing a strategically tailored
27
segment of newsworthy events as a means of exerting influence over the electorate and
their relevant social constituencies. Rio Motorsports in particular has opted to capitalize
on the advent of social media by situational framing while highlighting the societal
benefits the development of the Deodoro track will have on the City of Rio de Janeiro and
its resident constituents. With the advent of the Deodoro track, the construction of
adjacent transportation networks leading to the track are expected to improve mobility
challenges in the heavily populated urban center of Rio. The development of the already
operational Ricardo Albuquerque Train Station through Rio’s Rail network is staged to
amplify the Ramil Japeri Line’s connectivity throughout the region. Such public policy
initiatives aimed at improving the resounding toll suffered from congested highways on
the Rio economy is expected to alleviate arterial rail-networks through this policy
intervention as resident passengers would no longer be burdened with such perils on the
human condition as having to sit aimlessly in traffic on their way to work.
Additionally, the Deodoro project is slighted to improve the quality of life of Rio
residents by constructing a recreational center called the “Cicloparque” in an effort to
increase access to physical training, group exercises, and sporting engagements for the
underlying community writ large.
28
Illustration 4: Google Map Ramil Japeri (Train) from Central Brasil Train Station to Ricardo
Albuquerque.
29
CHAPTER 3: FINANCIAL MANAGEMENT IN CIRCUIT OF
THE AMERICAS (COTA) | AUSTIN, TX
“OUR THESIS IS THAT THE IDEA OF A SELF-ADJUSTING MARKET IMPLIED A STARK UTOPIA. SUCH AN INSTITUTION COULD NOT EXIST FOR ANY LENGTH OF TIME WITHOUT ANNIHILATING THE HUMAN AND NATURAL SUBSTANCE OF SOCIETY; IT WOULD HAVE PHYSICALLY DESTROYED MAN AND TRANSFORMED HIS SURROUNDINGS INTO A WILDERNESS.”
― KARL POLANYI, THE GREAT TRANSFORMATION: THE POLITICAL AND ECONOMIC ORIGINS OF OUR TIME (1945)
Traditional public financial instruments as a means of raising capital for
infrastructure projects are widely accepted in the US context due to the presence of a
robust municipal bond market. Through the collective machinations of financial
intermediaries the underwriting of municipal bonds may be prudently brought to market
while considering the long-term budgetary impact on a state and local governments’
balance sheets. Since financial plans are generally designed from the vantage point of
whether a property-tax implication may occur for its social constituencies, municipal
advisors are better able to provide guidance to subnational governments on whether
intergenerational equity concerns may arise. The challenge, however, lies in determining
whether debt service coverage may be maintained at covenanted levels through the life of
the bonds.
With general obligation bonds as a capital raising instrument, the property tax base
serves as the securitization tool to provide assurance to potential investors that expected
earnings may be protected from extreme revenue volatility. Notwithstanding the effects
30
of Californian wildfires on property tax collections for municipalities, general obligation
bonds in the US municipal finance structure are widely reputed for providing a stable
credit-quality outlook on bonds issued for state and local governments’ financing needs.
With these factors taken into account, allocating future property taxes to build, operate,
and maintain an FIA grade racetrack may spur reasonable doubt amongst resident
taxpayers if not simultaneously met with collective protest and social unrest. Property
taxes are typically earmarked for the benefit of school districts and provisioning of much
needed social services in city centers (e.g. roads, fire stations, law enforcement, etc.).
In the Circuit of the Americas (COTA) example however, private capital as a
financing mechanism “makes sense politically” for the construction of an auto-sports
facility as its own-source revenue does not directly incur a property tax implication or
burden on local stakeholders, nor would it “crowd out” future spending on Travis County’s
capital budget.57 Politically, the infrastructure financing of COTA adheres to the SEC’s
regulatory standards for capital transactions according to recent filings.58 As such, private
means of financing may serve as a socially favorable configuration for financing the F1
track as it avoids public scrutiny while offering the potential for economic development
57 Engel, Eduardo, et al. “Privatizing Highways in Latin America: Fixing What Went Wrong [with Comments].” Economía, vol. 4, no. 1, 2003, pp. 129–164. JSTOR, www.jstor.org/stable/20065452. 58 Circuit of the Americas LLC - SEC Report (Rep. No. SEC CIK #0001539722). (n.d.). Washington D.C.: Securities and Exchange Commission. doi: https://www.sec.gov/Archives/edgar/data/1514553/000153972214000003/xslFormDX01/primary_doc.xml
31
tools through a comprehensive network of anchor-institutions.59 Additionally, recent
studies examining the residual consequences of football stadiums in US cities reveal that
the primary benefits of economic development are largely not equitably disbursed to the
underlying community.60 Instead, profits are primarily accumulated to the wealthy
financiers that spearhead such projects.61 While the evidence suggests that sports
complexes may not generate observable economic development benefits to their
constituencies or local governments, I would like to loosely propose that this may be due
in part to a deficit in transit-oriented development frameworks that connect urban
infrastructure in most US cities.
59 Pedigo, Steven and Kim Zeuli, “Anchor Institutions and Urban Economic Development,”Initiative for a Competitive Inner City, 2011. 60 Vegesna, K. (2019). "The Economics of Sports Stadiums: Does public financing of sports stadiums create local economic growth, or just help billionaires improve their profit margin?". Berkeley, CA: Berkeley Economic Review. Doi: https://econreview.berkeley.edu/the-economics-of-sports-stadiums-does-public-financing-of-sports-stadiums-create-local-economic-growth-or-just-help-billionaires-improve-their-profit-margin/ 61 Decker. 2019. “Should Governments Subsidize the Construction of New Professional Sports Facilities?”
32
Illustration 5: Circuit of the Americas (COTA) Map.
Public Private Partnership (P3) Involvement
The Circuit of the Americas allocated $13 million (USD) to install water and
wastewater lines in a socially desirable development zone in Austin. As part of the public
water system, the City of Austin has demonstrated interest in purchasing the water lines
following the construction. As an infrastructure delivery model, the “primary financing
responsible resides with the private sector” in the above example.62 This procurement
strategy enhances the institutional capacity of public sector involvement within the
backdrop of socially desirable projects. Under this P3 configuration, “the private firm
participates in the construction stage...and the government operates and maintains it.”63
62 Kim, Julie, New Cities Foundation (2016), Handbook on Urban Infrastructure Finance. 63 Engel, Eduardo, et al. “Privatizing Highways in Latin America: Fixing What Went Wrong [with Comments].” Economía, vol. 4, no. 1, 2003, pp. 129–164. JSTOR, www.jstor.org/stable/20065452.
33
‘Nontraditional’ Public Financing Mechanisms
Urban infrastructure financial planning is not a politically neutral exercise where
certain apolitical means achieve certain agnostic ends. Specifically, “nontraditional
capital financing mechanisms” (Johnson, Luby, Moldogaziev 2014, pg. 187) can
encompass blended approaches which may include fixed-rate financial instruments as
well as private-sector participation.64 Moreover, it is counterproductive to view financial
processes as binary traditions involving siloed public-private actors disjointed at every
step of the supply chain. Instead, sound public management of fiscal resources may
include financial planning models across a blended spectrum whereby a range of cross-
sector actors may interact to produce harmonious and socially desirable results.
Optimization of budgetary resources, reduction of fiscal constraints in balance sheets,
streamlining of accounting procedures, along with transparency and accountability
controls are but a few pragmatic avenues whereby multiple actors may engage in and
strategically deliberate across the financial cycle as it relates to infrastructure planning.
The “functions and instruments “ (Oates 1999, pg. 1120) of certain modalities in
public finance are better suited when considering the political calculus of the project in
question.65 Simply put, socially desirable capital projects may be more politically viable
with public financing mechanisms when they contribute to the tax-paying resident
community. These may include improvements in roads, public provisioning of school
64 Johnson, Craig L., Martin J. Luby, Tima Moldozagiev, State and Local Financial Instruments Policy Changes and Management. Edward Elgar Pub. Ltd., 2014. 65 Allen, R., Hemming, R., & Potter, B. H. (2016). The International Handbook of Public Financial Management. Basingstoke: Palgrave Macmillan.
34
facilities, government buildings, municipal courts, as well as the provision of local public
goods to resident constituents. On the opposite side of the financing spectrum, a grade 1
FIA-specification motor racing track may be better suited employing private capital as
previously stated. The challenge however becomes 1) under what conditions would a
blended financing approach become politically feasible, and 2) would such a project
benefit the regional economy or merely make the administrative elite who finance such
projects richer at the behest of public finance? Moreover, the issue becomes more
problematic from an ethics standpoint when sources of repayment (e.g. own-source
revenues of the tax-base) originally used for the provision of local public goods are
employed to administer large-scale entertainment facilities in partnership with private
partners. A contemporary example of a blended financing approach involves the
securitization of hotel occupancy taxes (HOT) to build, operate, and maintain a football
stadium in the San Diego Convention Center in an effort to convince the Chargers to
return from Los Angeles. In this retrofitted sports facility example, the securitization of
hotel occupancy taxes was put to referendum and approved by voters in San Diego as it
would subsequently be used to alleviate poverty and homelessness in the surrounding Bay
Area. Therefore, the nonmarket interaction amongst civil society stakeholders and public-
private institutions ultimately may impact the viability of capital projects throughout
stages of their development. The “micro-relations of power” between institutions and civil
35
society may become insidiously connected as asymmetries of information may ebb and
flow throughout the public-private management of capital projects.66
66 Foucault, M., & Gordon, C. (2015). Power/knowledge: Selected interviews and other writings 1972-1977. New York: Vintage Books.
36
Chapter 4: The Non-Market Environment |
Formula 1 | Brazilian Grand Prix.
What constitutes the nonmarket environment of RioMotorsports? How are
market strategy and nonmarket strategy distinct? Why do executives have a
difficult time crafting nonmarket strategy?
The nonmarket environment of the firm (RioMotorsports) includes: the Brazilian
public, civil society institutions, environmental advocacy groups, stakeholders,
government actors, the media (Rede Globo), and anchor-institutions particularly
academic and legal scholars in Brazil. The nonmarket environment may be characterized
by majority rule, due process, broad enfranchisement, collective action, and the state of
public exposure to the firm’s operations. While a firm’s market strategy may consist of a
concerted pattern of actions taken in the market environment to create value by
improving performance from a financial valuation perspective, as characterized by the
calls for a renegotiated F1 contract with racetrack Interlagos in São Paulo,
RioMotorsports’ nonmarket strategy in Rio de Janeiro, on the other hand, may be
defined as a concerted pattern of actions undertaken in the nonmarket environment to
create a value proposition by improving the firm’s overall performance within the current
regulatory framework. In most cases, corporate executives might have a difficult time
37
crafting nonmarket strategy or considering it important since it does not directly involve
private transactions or de facto exchanges of property or capital that may or may not affect
the firm’s overall bottom-line. However, the opposite may be true. Developing quality
relationships with political actors through a stakeholder relations management approach
may generate value-creation potential dependent to what degree the firm’s practices are
regulated by its respective regulatory authorities.
Despite the complex nature of recent events, RioMotorsports’ executives, the City
of Rio de Janeiro, and President Jair Bolsonaro would need to develop a nonmarket
strategy as a means to better position the firm’s interests within the regulatory approval
process as it relates to environmental issues and the isolated clearing of an estimated
(180,000 to 200,000 trees) of the Camboatá forest located in the Deodoro west-zone of
the city.67 Through strategic implementation, the development of RioMotorsports’
nonmarket strategy may improve viable opportunities for value-creation in the
nonmarket environment as F1 negotiations are underway and may subsequently
influence nonmarket institutions in alignment with its decision-making political actors.
An example of a successful nonmarket strategy would involve influencing legislation
amenable to the interests of the firm (e.g. regulatory approval for the construction of the
new F1 track in Rio de Janeiro, acute deforestation of the Camboatá forest, and
establishing quality rapport with members of Congress and environmental regulatory
agencies.
67 Petrocilo, C. "Cutting of 180 Thousand Trees Substantiates an Order Against Racetrack in Rio." Plataforma Media.(May 23, 2019).
38
Figure 1 - (MIT Sloan Management Review, “What every CEO needs to know about
Nonmarket Strategy”, Bach & Allen)
What factors influence the importance of nonmarket strategy? Which factors
are present in the examples of integrated strategies?
The degree to which the firm is regulated by federal regulatory agencies determines
the importance of nonmarket strategy. The more regulated the firm is, the more
important nonmarket strategy may be to the interests of the firm. The less regulated the
firm’s business practices are, the less important nonmarket strategy is (e.g. information
services, consumer electronics in the US context).68
68David Bach, & David Bruce Allen. “What every CEO needs to know about Nonmarket Strategy”. MIT Sloan Management Review. April 1, 2010.
39
Professor Emeritus David Baron at the Stanford Graduate School of Business
writes in order “for a business strategy to be effective, the [market and nonmarket factors]
must be tailored to the firm’s market and nonmarket environment, as well as to its [core]
competencies.”69
What does Baron describe as the importance of non-market assets and
competencies? How do these assets and competencies traverse the
boundaries between the market and nonmarket environments?
Baron states the importance of nonmarket assets and competencies are rooted in
the firm’s competitors’ ability to join together and collectively push for regulatory
approval. Despite the highly contentious bid-rigging scandal involving the winning
construction vendor, Rio Motosports, the City of Rio de Janeiro finds itself at a critical
inflection point in which it must decide on how to balance the negotiation proceedings
with Formula 1 that will ultimately affect its long term market viability as a potential host
of the Brazilian Grand Prix upon termination of the F1 contract with Interlagos.
Since being delegated as the approved vendor of construction, RioMotorsports has
had to circumnavigate the ambiguity of statutory interpretations in the law to outcompete
the prospect of a renegotiation of São Paulo’s contract with F1 officials. Most regulatory
challenges for RioMotorsports in Rio have relied heavily on the municipal interpretations
69Baron, David P. “The Nonmarket Strategy System.” MIT Sloan Management Review. October 15, 1995.
40
of locally enforced environmental statutes which differed from one jurisdiction to the
next. As such, Rio Motorsports’ nonmarket strategy formulation in response to recent
state prosecutor’s actions to halt construction operations must take into account the
societal benefits a new F1-grade racetrack may generate to Rio’s labor market, increasing
urbanization demographic, and ever changing socio-political landscape within the
context of a poorly performing urban economy.
In particular, RioMotorsports must embrace the non-market environment and
push for abiding by the regulatory standards set forth by environmental law in Brazil.70
While RioMotorsports has an assortment of non-market and market options available, it
can select from three in particular; the first option would require litigation in the courts
to challenge the current regulatory status quo and push for the legal definitions of
environmental impact reviews for itself, civil society, and its investors; the second strategy
available to Rio Motorsports would suggest accepting the current regulatory authority’s
decision to set environmental impact monitoring and inspection; and the third option
available to Rio Motorsports would be to acquiesce to the currently established political
order, the Interlagos São Paulo lobby, and in turn, exit the F1. market. The long-term
market potential of Rio Motorsports in Rio would suggest that the former option (i.e.
challenging the regulatory status quo) would result in the most favorable legal conditions
in which to operate in, now, and in the foreseeable future.
70Article 225. Brazilian Federal Constitution. “All the people have the right to an ecologically balanced environment.”
41
The first option available to Rio Motorsports would be to challenge the current
cease and desist orders proposed by state prosecutors on the grounds that such an order
would effectively violate the constitutionality of generating a “just and reasonable rate of
return” for a local enterprise. Due to the unconstitutional action of negating procedural
due process, the probability exists whereby imposing antiquated legislation to 21st
century businesses would curtail future markets in the automotive racing-domain from
developing to its optimal potential. Rather than promulgating the legislation on the
grounds that such cease and desist orders would impede the profitability of the firm, I
recommend that Rio Motorsports allocate resources to gather the necessary substantive
information that may be valuable in maintaining a positive track record of good
stewardship for forthcoming F1 negotiations based on the argument undergirding the net-
economic benefits Rio Motorsports would bring to the Rio metropolitan area. Such
information would include, but not be limited by, detailed accounts of financial reporting
which highlight the economic development strategy Rio Motorsports’ automotive tourist
venture would produce along with efficient competition in local labor markets. In
addition, Rio Motorsports could frame the narrative of its public relations strategy to
convey that bringing Formula 1 and MotoGP will in effect increase jobs to a particular
sector of society, while also enhancing arterial connectivity vis-a-vis expansion of the
Ricardo Albuquerque rail terminal, and in turn, serving an environmental benefit to the
rapidly urbanizing city landscape. Fewer vehicles on the road and more passengers on
public transportation would equate to a more environmentally conscious output for
42
Brazilian society. Replanting two trees for every one cleared due to acute deforestation
may serve to increase the face-value of meeting the state of Rio de Janeiro’s renewable
energy portfolio standards within the context of climate change and partisan politics.
The second option available to Rio Motorsports would be to accept the terms of
condition determined by state prosecutors environmental impact studies and acquiesce
to the currently established political order in Rio. In this scenario, accepting these terms
of agreement would certainly impact the future likelihood of shaping public policy (and
law) as it pertains to Rio Motorsports’ core business model. Halting construction of the
Deodoro project according to state prosecutors would diminish Rio Motorsports’ ability
to effectively obtain the 2021 Formula 1 contract negotiations all while curtailing its future
economic potential to engage the market outside of the MotoGP deal. While the short-
term benefit of accepting the terms of an environmental impact study would allow Rio
Motorsports to enter the Grand Prix market, the long-term residual consequences would
certainly impede Rio Motorsports’ non-market posture in an already precarious
regulatory environment.
The third option available to Rio Motorsports would be to exit the Rio market
altogether. Such a decision however would disrupt Rio Motorsports’ ability to capitalize
on potential revenue streams in the district and would instead galvanize its competitors
in São Paulo to capture the market and succeed in contract renegotiations with F1 to
continue hosting at Autódromo José Carlos Pace (i.e. Interlagos). In addition, by waiting
to enter the market (and abiding by environmental law rules, policies, and procedures) -
43
it may award Rio Motorsports the opportunity to engage with a more favorable electorate
that may be politically amenable to Rio Motorsports’ social welfare model.
In short, the more favorable option Rio Motorsports could take would require
promulgating the regulatory environment to codify laws amenable to its business model.
By obeying environmental laws with the respective delegated authorities, Rio
Motorsports would be in a more optimal position to shape future legislation both in the
long-term and short-term for its constituencies. Entering this “grey area” of corporate
social responsibility would afford Rio Motorsports the ability to leverage network contacts
with political decision-makers, while cultivating these relationships in the long-term.
Moreover, by entering the market now - Rio Motorsports would be in a more favorable
non-market position to negotiate future regulations that may stifle innovation as the F1
and MotoGP market continues to grow in Brazil. Finally, Rio Motorsports has the
requisite platform to launch grassroots mobilization efforts directly through its
constituency base via push notifications. These push notifications may provide
information to local constituencies on how to mobilize regulators to draft legislation that
may be favorable for all parties involved (minus the Interlagos track and its
administrative elite).
44
Table 1 Timeline of Implementation:
Phase 1 Phase 2 Phase 3 Phase 4
1) Open letter from RioMotorsports CEO and key leadership addressing an environmental impact
statement and mechanisms to support inclusive labor rights.
1) Design enforcement mechanisms regarding
community benefits agreements & publish
economic development strategy
online.
1) Develop stakeholder relations management strategy
to promote social inclusion of Rio local
economy.
1) Schedule and uphold recurring meetings with
local stakeholders involved in the political
process.
V.) Guidance for Implementation (TimeLine):
The recommendations carried out will be considered successful when Rio Motorsports employees, local stakeholders, and civil society members report zero violations as they relate to conflicts of interest or corruption. Moreover, successful implementation will require senior leadership to not only combat misconduct at all levels of Rio Motorsports, but also, incorporate an internal whistleblowing platform that protects the identities of those who report against violators within and outside the Deodoro community.
45
In summary, RioMotorsports’ non-market strategy should include:
1. Removing any ‘feeling’ of corruption regarding the bid-rigging scandal and perceived asymmetries of information in the construction process of the new F1 track in Deodoro.
2. Interacting equitably (in a socially inclusive manner) with the general public through public hearings to advance political efforts while also launching a multifaceted corporate social responsibility campaign to correct previous deficiencies in transparency.
3. RioMotorsports’ business model in Deodoro should include labor rights protections for its construction workers, as well as equal pay guarantees to women in similar positions to men laborers. Moreover, upward advancement from contractual labor to permanent positions in the land development process should be underscored to improve RioMotorsports’ social responsibility character within the nonmarket landscape.
4. “Enforcement mechanisms” surrounding ‘community benefits agreements, which were legally binding contracts that required businesses to invest in concrete projects and undertake certain obligations regarding their employees’71 (Diermeier, pg. 7).
5. Coordinate ethically with surrounding faith-based religious organizations and enhanced outreach efforts with local businesses and banks (i.e. acknowledging their existence).
71Diermeier, Daniel. Wal-Mart: The Store Wars. Kellogg School of Management.
46
CHAPTER 5: THE US MUNICIPAL FINANCE STRUCTURE AS PROSPECTIVE REGULATORY MODEL FOR EMERGING MARKETS IN LATIN AMERICA | BRAZIL
Recent History in US Municipal Finance (2008-2020):
Why is this relevant to US municipal finance, infrastructure financing, and
economic development today? The Dodd-Frank Act paved the way for increased
transparency and accountability resulting from negative lending practices on behalf of US
banks in the subprime mortgage market following the Great Recession of 2008. Section
975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act also “required
registration of municipal advisors with the Securities and Exchange Commission (SEC)”
and “[provided] for their regulation by the Municipal Securities Rulemaking Board
(MSRB).”72 The enactment of this regulatory and compliance legislation would serve to
function as the institutional foundation required for promoting informed financial
decision-making amongst financial intermediaries working in support of state and local
governments across the US.
Additionally, the primary policy advantage of establishing such a regulatory and
compliance reform would serve to increase the magnitude of fiscal autonomy amongst
subnational sovereigns, thereby enhancing institutional transparency frameworks within
the US governance structure. As noted in Espinosa’s study on property tax collections and
72 Municipal Securities. Doi: <http://www.sec.gov/spotlight/dodd-frank/municipalsecurities.shtml>
47
debt affordability in Mexico, a robust legislative framework that encourages “good local
government fiscal behavior” must be actively embedded to increase the prospect of
“borrower capacity for own-source revenue generation, fiscal management, debt
management,” and in turn, encourage “greater market access and lower borrowing
costs.”73
Specifically, the role of securitizing future revenues in a municipal transaction
promulgates retail and institutional investors to accept the probability of bond repayment
capacity and perhaps result in an upgrade of the overall creditworthiness of the
subnational government throughout the duration of medium to long-term bonds. A range
of performance criteria are generally observed in determining the credit profile of a
public-entity which issues debt for the purpose of raising capital for infrastructure
projects or the refinancing of currently outstanding debt obligations. A study by (Cuny &
Dube 2017) indicated that the frequency of disclosures by subnational governments
issuing debt was inexorably linked to its overall credit profile.74 Subnational governments
that disclosed a higher number of financially material information to its investors
exhibited favorable credit ratings in the (AAA/AA+/AA-) investor-grade quality. While
subnational governments that performed poorly in the frequency of voluntary disclosures
(or did not disclose at all) received poorer credit markings whilst compared to samples of
73 Espinosa, Salvador and Martell, Christine (forthcoming). “Building Bond Repayment Capacity in Developing Countries: A Study on Property Tax Collections and Debt Affordability in Mexico. International Journal of Public Administration. 74 Cuny, Christine and Svenja Dube. 2017. “When Transparency Pays: The Moderating Effect of Disclosure Quality on Changes in the Cost of Debt.” Hutchins Center Working Paper.
48
observations in the dataset. The evidence suggests that within the US municipal finance
structure, the design of a municipal bond market’s viability may be causally related to the
presence (or absence) of a 1) robust regulatory / compliance framework that functions to
improve investor confidence, 2) a subnational governments’ ability to efficiently gain
access to domestic capital markets, 3) the presence of a secondary market.
Prior to creating an effective municipal bond market in Brazil, municipalities
would need to demonstrate that “moral hazard” concerns will not be violated such that a
subnational sovereign “will not [behave] differently to the risk of default when it is
insulated from said risk” compared to “when it is fully exposed to the possibility of
[bankruptcy].”75 Echoing Espinosa’s criteria for the design of a municipal bond market in
Mexico, municipalities in theory would need to “demonstrate improvements in own-
source revenue generation and debt management before being authorized to contract
long-term debt.”76 Therefore, the impetus exists for a robust insolvency framework to
strengthen the borrowing capacity for subnational sovereigns, and thus allow for efficient
access to domestic capital markets in Brazil’s financial sector.
75 Abdal, Patricio. “Municipal Bonds in Latin America”. Emerging Market Investors Association (EMIA). November 29, 2013. 76 Espinosa, Salvador and Martell, Christine (forthcoming). “Building Bond Repayment Capacity in Developing Countries: A Study on Property Tax Collections and Debt Affordability in Mexico. International Journal of Public Administration.
49
The Current Federal Financing Framework | Brazil
The traditional mechanism for financing capital infrastructure amongst Brazilian
states requires coordination by the Federal Housing and Savings Bank, the Federal
Development Bank, as well as municipal development funds to state and local
governments transacted by the World Bank and Interamerican Development Bank
(IADB).77 Private banks rarely play any role in the financial dealings of state and local
governments due in part to their inability to compete with the “subsidized below market
interest rates” offered by the federal banking system in Brazil.78
Similarly, “restricting the use of federal guarantees and limiting lending by public
banks would reduce the incentives for fiscal profligacy, contain the risks to the federal
government, and resolve part of the institutional tensions between different levels of
government and the judiciary.”79 The democratic transition to a subnational borrowing
framework if properly implemented would result in more efficient borrowing activity if
accompanied by stern disciplinary oversight of disclosure obligations material to market
participants. As stated by (Freire, Petersen, Huertas and Valadez: 2004), “the [Brazilian]
federal government should promote market-oriented funding policies to break away from
old traditions of borrowing from public institutions.”80
77 Mila Freire & John Petersen & Marcela Huertas & Miguel Valadez, 2004. "Subnational Capital Markets in Developing Countries : From Theory to Practice," World Bank Publications, The World Bank, number 15044, March. 78 Ibid. 79 Medas, Paulo, et al. Strengthening the Framework for Subnational Borrowing. International Monetary Fund (IMF), 2019, pp. 1–55. 80 Ibid.
50
Figure 2: IMF Report (July 2019) | OECD (2016)
Strengthening the Subnational Borrowing Framework | Brazil
The US municipal finance model possesses institutional characteristics that
reward issuers upon practicing prudent budgetary behavior. Rather than engaging in
fiscally irresponsible behavior that may impact one’s credit profile (e.g. surpassing annual
debt limits, treatment of debt service reserve funds), state and local governments are
actively incentivized to engage in financially sound management of fiscal resources. The
rating methodologies employed offer issuers the framework to convey fiscally prudent
budgetary behavior that may be subsequently awarded via favorable ratings from the
credit rating agencies. And thus, the long-term reward for issuers could be positive
interest rate savings upon financings of debt obligations in the US municipal bond
51
Figure 3: Bloomberg Barclays Municipal Bond Index. Nuveen Study
market. Tapping the domestic capital markets offers accessible capital fund-raising
liquidity to subnational governments in the American context through the coordination
of municipal market participants and their investors, both at the retail and institutional
level.
Despite an elevated level of fiscal decentralization in Brazil, public forms
of administering borrowing have proven difficult if not politically infeasible within the
current federalist framework. A recent technical report published by the International
Monetary Fund (July 2019) cited that “relative to OECD countries Brazil’s subnational
governments play a larger role in public spending, with about 23 percent of GDP in
spending equivalent to over half of total public spending.”81
Since “subnational governments [possess] considerable revenue autonomy”, the
prospect for building the foundations of a subnational borrowing framework are fiscally
81 Medas, Paulo, et al. Strengthening the Framework for Subnational Borrowing. International Monetary Fund (IMF), 2019, pp. 1–55.
52
viable given the high revenue-generating tax-base of Brazilian states. As such, the IMF
report advocates a significant series of comprehensive reforms aimed at “introducing
hard budget constraints for subnational governments” and proposing “market-induced
fiscal discipline” with “borrowers’ incentives and transparency” at center. Given the “fiscal
pressures rising from hard budget rigidities (e.g. pension obligations)”, the impetus to
avoid subnational dependence on federal banks is critical for a streamlined transition to
accessing untapped private credit markets.82
In the US experience, the municipal bond market is characterized by offering tax-
exemptions of financial instruments which are backed by the full faith and credit of the
federal government.83 These tax exemptions offer prospective investors the credibility of
stable tax havens with callable features or options throughout the life of the bonds.
Subnational borrowing is not a novel financing option for state and local governments.
Early records indicate that one of the first publicly documented municipal bond
transactions occurred in New York City for a canal system in 1812.84 Fixed-income capital
investments may be employed to mitigate budget rigidities as well as regional
infrastructure crises. Following the aftermath of Hurricane Katrina, Gulf Opportunity
Zone Bonds were treated as “exempt facility bonds if 95% or more of the net proceeds of
such bonds” were used for “qualified projects” in support of the redevelopment of Gulf
82 Medas, Paulo, et al. Strengthening the Framework for Subnational Borrowing. International Monetary Fund (IMF), 2019, pp. 1–55. 83 O'Hara, Neil. The Fundamentals of Municipal Bonds. Wiley, 2012. Securities Industry and Financial Markets Association (SIFMA) 84 Ibid.
53
Opportunity Zone.85 These specialized financial instruments served to incentivize the
private sector by stimulating “the acquisition, construction, reconstruction, and
renovation of nonresidential real property” through tax-exempt building costs.86
Similarly, “Liberty Bonds” were employed in rebuilding lower Manhattan following the
hijacking of aircraft into the World Trade Center.87 With the support of Congress, “tax-
exempt municipal bonds [played] a significant role in rebuilding lower Manhattan.”88
Moreover, global investment manager Nuveen stated in a 2018 report that municipal
bonds have demonstrated “resilience during uncertain environments.”89
Enhancing Transparency Controls in State and Local Government
Would comprehensive regulatory reforms aimed at modifying the subnational
borrowing framework reinforce, neglect, or hinder the fiscal capacity of state and local
governments to advance social change? A blended mix of sound infrastructure financing
by subnational sovereigns to manage their debt limits at prudent levels along with the
efficient access to private capital markets increases the probability whereby a subnational
borrowing framework could work in the Brazilian experience. Therefore, the impetus to
enhance available institutional frameworks between urban authorities, investors,
85 IRS. Doi: https://www.irs.gov/tax-exempt-bonds/gulf-opportunity-zone-act-of-2005-pl-109-135 86 Ibid. 87 Dunlap, D. (2004, May 30). The New York Times. "Liberty Bonds' Yield: A New Downtown". 88 Ibid. 89 "The Case for U.S. Municipal Bonds". (2018, September). Nuveen.
54
municipal market actors, and their constituencies remains critical in the wake of short-
term decentralization policies. By doing so, the disbursement of funding to qualified
projects must be tactically embedded with transparent disclosure rules, policies, and
procedures amongst market actors to engender and subsequently solidify state
accountability and institutional transparency in the Brazilian context. Additionally, the
participatory budgeting method approach may increase the probability whereby social,
economic, and environmental needs may be adequately met within the context of city-
wide improvement. Thus, how can sustainable financial and monetary policies increase
the prospect for social equity, social integration, and social stability, while working in
accordance with a subnational borrowing framework? Simply put, there are scenarios in
the Brazilian subnational borrowing proposal where certain projects would fare better via
public financing mechanisms while other projects would be more efficiently streamlined
via private sources of capital as evidenced in the FIA-grade racetrack scenario.
The Fiscal Responsibility Law (FRL) established efforts aimed at improving
disclosure of financial information in Brazil.90 This legislative action provided the vision
to:
1) “Negotiate fiscal adjustment programs for municipalities under distress;
2) Assist in debt renegotiation;
90 Pereira, Carlos. “Brazil’s Fiscal Responsibility Law and the Quality of Audit Institutions.” Brookings Institution, 2016, doi:https://www.brookings.edu/wp-content/uploads/2016/06/12_brazil_pereira.pdf.
55
3) Provide assistance in the form of conditional loans and guarantees under a fiscal
adjustment program; and
4) Monitor compliance with the program.”91
Reducing Inefficiencies in Disclosure Information
Pursuant to SEC Rule 15c2-12 (the “Rule”), issuers of debt obligations are required
under most circumstances to provide financial and operating information on an annual
basis with the Municipal Securities Rulemaking Board (MSRB) using the Electronic
Municipal Market Access (EMMA) system. These rules, policies, and procedures are
intended to assure that all filings required under the Rule are made timely and completely
and meet all requirements of the Rule. The issue however amongst municipal market
participants has been the litany of filings along with the degraded quality of information
in connection with most filings. Over submissions of filings and low-quality disclosures
has forced municipal actors into a data-dump conundrum. Therefore, higher quality
submissions with information that matters more to credit rating agencies, bond lawyers,
public finance investment bankers, and investors is key for improving the efficacy of
transparency in a municipal market system. Higher quality disclosures should also be on
the radar for issuers that aim to promote internal tracking of financial obligations as a
means of improving their overall creditworthiness.
91 Medas, Paulo, et al. Strengthening the Framework for Subnational Borrowing. International Monetary Fund (IMF), 2019, pp. 1–55.
56
Formal Findings:
Figure 4: Policy Instruments in Support of Municipal Credit System, Correa, R. (May, 2020)
In short, a robust regulatory compliance reform overhaul would be required to
deter state and local governments from depending on intergovernmental transfers and
“”IMF-like” loans for financing needs. Instead, the development of a municipal credit
market in Brazil would benefit from transparent tax administration and public
management of own-source revenues accompanied by credit rating proxies. Moreover,
Brazilian policymakers would need to strengthen a subnational borrowing framework by
providing assurance to the financial sector that subnational sovereigns will adopt
57
insolvency frameworks to prevent state and local governments from depending on federal
government bailouts. Such measures to deter subnational bankruptcy through active
monitoring of debt management practices may increase the probability of a resilient
municipal bond market in Brazil.
Market reforms may reduce or eliminate the ability of state and local governments
to capture the capital benefits of own-source revenue maximization. This report has
aimed to emphasize the innate potential for financing municipal investment through a
decentralized system whereby state and local governments administer own-source
revenues, “improve local tax management for direct financing [on the revenue side],
[promote] better pricing of municipal services and [advocate] improvement of the
regulatory environment of public utilities.”92
The development of a municipal bond market for funding public sector debt
financing is not a novel proposition. The thought experiment of administering a stable
municipal credit system in Brazil has been in circulation amongst Brazilian academic
researchers, government actors, international financial institutions and the private sector
for decades now. With “the participation of the private sector and more reliance on market
interest rates,”93 the adoption of a municipal credit system should situate the public sector
to more efficiently participate in debt financing in an effort to espouse substantive social
change through sound financial decision making. The realization of this regimented
92 World Bank Report. Brazil: Financing Municipal Investment, Issues and Options. April 20, 2001. Report No. 20313-BR. 93 Ibid.
58
process will hinge on the amount of administrative “support from the central
government” state and local governments receive “in terms of technical assistance, the
establishment of transparent rules, enforcing accountability,”94 as well as securing a
preventative insolvency framework to deter potential subnational bankruptcies. More
indirectly, private banks can bolster a democratic transition to uphold the rule of law,
establish a fair judiciary to administer a stable municipal credit system, and provide
regulatory guidance to federal authorities overseeing municipal finance development in
Brazil.
94 World Bank Report. Brazil: Financing Municipal Investment, Issues and Options. April 20, 2001. Report No. 20313-BR.
59
Afterword:
The Impact of COVID-19 on Global Financial Markets:
As it relates to COVID-19 and the impact on financial markets, difficult economic
times have served to highlight the importance of sound financial decision making in all
levels of government.95 Especially now with the increased probability of a virus-induced
recession in financial markets, state and local governments will need to increasingly rely
on financial intermediaries to steer them through the ongoing turbulence and
forthcoming times of uncertainty. This could mean that subnational entities issuing
government debt will need to increasingly depend on a well-vetted team of public finance
investment bankers, financial advisors, and fixed-income traders to better optimize their
budgetary needs.
The time for socially conscious financial advisory is relevant in today’s market
environment right now more than ever. Incorporating intergenerational equity
considerations will become increasingly important as it relates to how state and local
governments will continue to manage their capital budgets in connection with their
balance sheets and the social services its constituents will depend upon during this global
pandemic. Subnational sovereigns will also require the financial expertise of municipal
advisors to navigate a noticeably volatile market environment as it relates to financing
future capital projects as well as qualifying for potential refinancings of current debt. As
recession job losses continue to strike America, municipal bond market participants will
need to advocate for an increase in the magnitude of fiscal autonomy amongst subnational
95 Johnson, Craig L., et al. State and Local Financial Instruments Policy Changes and Management. Edward Elgar Pub. Ltd., 2014.
60
sovereigns with the policy goal of enhancing institutional transparency frameworks
within the US governance structure. From the vantage point of public finance investment
banks in the US context, regulatory efforts should be placed upon actively increasing a
subnational governments’ ability to efficiently gain access to the domestic capital market
especially in these times of uncertainty in the markets through the design and
implementation of a Health Finance Corporation.
61
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