Latam Briefing: Exposure to US increases demand for D&O among Latin American firms
Latin American companies often face the challenge of raising money in modest domestic markets to fund their growth strategies. Many have opted in recent years to go to the United States to find the funds that they need.
Tech firms such as digital bank Nubank, e-retailer Mercado Libre and payment group DLocal have chosen New York to launch their IPOs. More than 75 Brazilian companies have issued American Despositary Receipts, and firms from Mexico, Chile and other countries have done the same. Hundreds of groups from all around the region have raised money by selling bonds or private debt to American investors.
Such choices have good financial logic behind them. At $48tn at the end of 2022, the US has a share of 42% of the world’s equity markets, according to SIFMA, an association of asset managers. Fixed income markets are roughly the same size and equivalent to 39% of the total. All things considered, the US offers unequalled amounts of liquidity, reliable legal regimes and plenty of appetite for risks.
It also exposes companies and their leaders to the highest levels of risk litigation in the world.
The Securities and Exchanges Commission, SEC, the US capital markets regulator, is an activist agency that can pursue securities issuers with a vengeance, when they fail to meet their disclosure obligations. Whistleblowers are handsomely rewarded when they tell on companies’ misdeeds, and pugnacious investors have a knack for ganging up together to launch securities class actions when they believe that their stock holdings were affected by poor or wrongful management decisions.
SEC fines and compensation for investors can cost a company and its managers dozens or even hundreds of millions of dollars. It puts a lot of pressure on directors and officials of Latin American companies exposed to the US, which may not be used to work under that much scrutiny in their home markets.
“One gets exposed to complex regulatory changes that sometimes may be hard to understand, as, as push comes to shove, your head office is not in New York or Boston, it is in Bogotá, Buenos Aires or São Paulo,” says Mario Andrade, the head of Financial Lines at Lions Gate, a Mexico City-based Lloyd’s cover-holder. “Even if information travels fast these days, this kind of thing takes time to be fully understood. When it happens to Latin American companies, it is only when they are already an investigation or sanction under way.”
To help their leaders to sleep peacefully at night, a growing number of firms are adding specific covers to their D&O insurance policies that transfer to the market the risk of litigation in the US. It comes at US prices and conditions though, including deductibles that start at $5mn a pop.
“In Brazil, companies face a set of risks, such operational, tax, labour, environmental and so on, as well as those linked to their industries’ regulators. Suddenly, they find themselves with exposure to the United States on top of everything that it deals with in Brazil. Therefore, limits that they used to purchase are no longer adequate,” says Juliana Casiradzi, the head of FINPRO at Marsh in Brazil. “The policy has a specific deductible for US risk, which is more expensive. The buyers has a participation in the risk in the shape of deductibles.”
The main focus of the product is to cover legal defense costs, which Casiradzi says that can easily reach several million dollars. The larger the company, the higher the costs with lawyers, forensic experts and other services tend to be, as the values of the legal action will be linked to a company’s market value. Casiradzi says that insurers will often try and negotiate with the parts with the goal of reaching an off-court agreement, which aims to reduce the final cost of the claim.
Differently from the Brazilian market, where certain regulatory fines can be covered, it is harder to get protection against SEC financial punishments, though. Another common exclusion for Latin American companies is corruption, especially after scandals in the past decade like the Lava Jato operation that originated in Brazil and spread across the region.
“The insurer will always try to find out the origin of a class action. For instance, there are many companies in Brazil with exclusions for acts of corruption. After Lava Jato, many firms have had to renew their policies with it,” Casiradzi says. “Insurers will always try to find the original source of the claim so that, if possible, it can apply that exclusion.”
Brokers say that there is local capacity in the Brazilian market for this risk, although it is not enough to build the D&O towers required by the largest clients. Casiradzi notes that around five local insurers can participate with up to $30mn in D&O capacity, and to reach limits that sometimes have to be more than six times higher, buyers need to go to London or, in the past couple of years, Miami.
Brokers also says that the Latin American market still hasn’t felt the full effects of the loosening up of the D&O segment in the US and Europe and building programmes for US exposures continues to be challenging, even when it comes to local capacity, which is provided by subsidiaries of international groups.
“Insurers became much more selective when evaluating this risk. Basically, local operations in Brazil have lost authority to make decisions. Quotations are now submitted to other offices, to Miami, Chicago or New York,” says Renato Perosa, the head of Financial Lines at Aon in Brazil . “There has been a loss of authority by insurers here and it invariably makes the market to offer harder conditions. It has all become more difficult in terms of understanding situations and showing flexiblity.”
He stresses that the region has not yet seen renewals with the likes of rate reductions observed in the US, which achieve up to 30% of late. Especially companies that have issued ADR Level III, which are under a higher degree of SEC supervision, will take longer to benefit from a less hard market large. The same applies to the largest firms, those that are going through M&A cycles or have poor loss histories. Firms in sectors like mining, technology and health tech also struggle to find the covers they need due to high levels of litigation in those sectors.
On the other hand, brokers are already enjoying of a tad more leeway to negotiate better conditions for clients, he says. Their focus nowadays is on reducing the costs of D&O programmes that rocketed in the past few years.
“Lower deductibles do not seem to be the focus clients nowadays. After having premium rates overtaxed for so long, the priority now is to obtain better rates,” Perosa points out.
Recent cases such as the $56mn fine applied by the SEC to Vale, a Brazilian mining company, for its responsibility in a human and environmental disaster that took place in Brazil four years ago have reinforced the perception that US risks must be taken very seriously.
The Vale case shows that an event does not even need to take place in Brazil to wake up the SEC’s enforcement instincts. And that is not only reason the perception of risk has gone up. Andrade recalls what happened to Toshiba, a Japanese company that was the target of a securities class action even if it had only issued unsponsored ADRs in the US. This type of security was seen as not exposed to legal actions due to its lower disclosure requirements, but an American judge decided that it was enough to discard an appeal lodged by the company.
So even companies that considered themselves exempt from US litigation risks may find themselves in dangerous situations in the future.
“Jurisprudence has been set in the United States where, independently of a company’s profile in the equity markets, and no matter if it is foreign, it can be exposed to certain risks that it did not expect,” Andrade says. “Also, the exposures faced by Latin American companies are very high because their compliance systems are less sophisticated than those in Europe or North America.”