UPDATE 1-BM&FBovespa's index changes not driven by OGX plunge, CEO says

Thu Sep 12, 2013 10:02am EDT

By Guillermo Parra-Bernal and Asher Levine

SAO PAULO, Sept 12 (Reuters) - SAO PAULO, Sept 12 (Reuters) - Brazilian financial exchange BM&FBovespa SA decided to change the methodology of its benchmark Ibovespa stock index to reflect the new reality of the country's economy and not because of a slump in the stock price of Grupo EBX-controlled companies, Chief Executive Edemir Pinto said on Thursday.

The changes, the first to the Ibovespa index since its inception in 1968, will give more weight to a share's free float than its average daily trading volume, boosting the presence of large companies in the gauge and excluding companies whose shares introduce significant short- and medium-term distortions in the market. Pinto said the changes had been considered for a long time.

The decision underscores the growing pressure from international and local investors for a stock market gauge that better mirrors the new realities of Brazil's economy. During the past decade, more than 40 million people joined the middle class, driving a hefty expansion in services and helping re-balance the influence of commodity and industrial companies.

Pinto rebuffed the notion that a tumble in shares of cash-strapped oil producer OGX Petróleo e Gas Participações SA , which shed 91 percent of their value this year, motivated the decision. OGX, which has been one of the Bovespa's five-biggest stocks since late 2011, is currently trading below 1 real and is partly to blame for the index's poor run this year.

"The changes had been considered for quite a long time, they didn't come up because of short-term situations," Pinto said at an event to present the new methodology in São Paulo, adding that the steps were aimed at better reflecting the new reality of Brazil, the second-largest emerging market economy.

Strategists said the changes will favor companies with large market capitalization in the electricity, education, mining, banking and consumer goods sectors. Airlines, real estate developers, power holding companies and steelmakers could lose room in the index under the changes, which take full effect next May after being phased in through the first four months of 2014.

Local and foreign investors have for years urged for modifications to the index's formula, pointing to the comparatively heavy weighting of commodities exporters, which have underperformed stocks linked to domestic consumption over the past two years. The calls for change grew much louder in recent months after the weighting of OGX, controlled by embattled tycoon Eike Batista, led to steep drops in the index.

The index, which traded slightly higher on Thursday morning, is down 12 percent this year.

Moving to free-float weighting "is positive and should correct most of the distortions," said Felipe Hirai, head of Brazil equity strategy with Bank of America Merrill Lynch.

STOCK BORROWING CAPS

OGX closed on Wednesday's session at 0.38 reais, just one-fourth the value of the second-lowest priced stock on the index. But because the Bovespa's weighting is based primarily on the total number of trades in a stock, OGX's share of the index rose in the most recent rebalancing, meaning even small changes in the stock's price contribute to wide swings the broader index.

A decision by BM&FBovespa to fine-tune criteria for stock borrowing - the basis for short-selling shares in the exchange - and which affected limits for short interest in OGX aimed at "lowering potential capital and market inefficiencies," said Cicero Vieira Neto, BM&FBovespa's senior vice president for operations, clearing and depositary services.

Capital markets in Brazil will better assess the risk of pre-operational companies such as OGX before buying shares in those type of companies, Pinto added. Most of Batista's Grupo EBX-listed companies did not generate revenue at the time of their initial public offerings a few years ago, and many still do not.

In fact, OGX and some of its sister companies bear copious amounts of debt and are engaged in ambitious capital spending plans. "The lesson is that - investors will learn to better read the risk embedded in start-up companies," Pinto noted.

NEGOTIABILITY INDEX

Under terms of the changes, weighting criteria will be based on free-float, or the amount of shares trading in the market, with a two-times cap on liquidity. Trading volumes, not number of trades, will be the main driver for the Bovespa's so-called negotiability index - a key compenent of the index - under the new criteria.

Stocks ranked within the top 85 percent in terms of negotiability index, or that traded in at least 95 percent of the trading days in the three previous index rebalancings, could be included in the Ibovespa. Shares with prices below 1 real, known as penny stocks, and stocks that enter into special situations such as bankruptcy proceedings, could be removed from the Bovespa.

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