Brazil
10 August 2010
An exciting and growing market, that is attracting interest both globally and domestically, Brazil has a lot to offer. But it needs to ensure it鈥檚 regulatory and taxation infrastructure is attractive to outsiders
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It鈥檚 holding the football World Cup in 2014 and the Olympics in 2016. It鈥檚 been on the list of many of the most forward-thinking investors as a place to watch. Its economy is booming and its political clout is growing. No longer an emerging market, Brazil has staked its claim as a major player on the world stage. And funds are pouring in.
It鈥檚 not all good news of course - the Bovespa has dropped by around four per cent this year, and while there鈥檚 a long term confidence about the market, there are concerns from some investors. 鈥淭he market ran ahead of itself and outperformed,鈥� said Mark Mobius, who heads up Templeton Asset Management. 鈥淚t鈥檚 a natural correction.鈥�
Growth, however, has been extremely positive. Market activity in 2009 was almost three times that of the year before, an admittedly quiet period globally, but in Brazil there was a drop of almost 80 per cent. The rebound, though, has been exceptional.
Two firms dominate the securities lending market: the mining company Vale, and the oil business, Petrobras. Together, they make up almost 20 per cent of the market. Minerals and oil firms, along with banking, are the biggest securities, reflecting their positions within the investment markets.
鈥淭he Brazilian stock market is one of the fastest-growing markets in the developed world,鈥� says one player. 鈥淎t the moment, the securities borrowers are interested in are limited because only a handful of companies dominate the financial landscape. But as the market grows and becomes more mature, and more companies become listed on Bovespa, this will filter down into the securities lending market because more people will be more comfortable working with more securities.鈥�
The players
In part, this is down to new participants entering the market. Long/short investment funds in Brazil are extremely popular, with several launching in recent months.
In terms of the participants in the securities lending market, mutual funds, both foreign and domestic dominate. 鈥淚t鈥檚 simple really, they鈥檝e been in the [securities lending] market the longest, and they are most comfortable with the strategies involved,鈥� says fund consultant Eduardo Sanchez. 鈥淭hey鈥檝e also got the international reach, although many of the domestic ones stick to South America, so their lending decisions can be made on an international basis. Where we鈥檙e not doing as well as we can is in getting pension funds involved - if they do any lending at all, they prefer cash collateral.鈥�
The providers encompass the major international players in the region, in particular Santander, trading as Banco Santander Brazil, and J.P. Morgan. But there is also a strong domestic industry, with smaller firms servicing their local counterparts.
鈥淭he major international investors prefer to use the international banks,鈥� says Sanchez. 鈥淎nd in Brazil, this is not a bad thing - the likes of Santander have been here for many decades and have a deep understanding of the market. Their local expertise is just as good as the domestic providers and they have the global breadth to help with wider strategies.
鈥淗owever, I would like to highlight that the domestic firms are also very good value. They tend to service the smaller funds, and because their fees are sometimes lower - for the same quality of domestic service - they will always have a valued place in the market.鈥�
鈥淪antander has operated in Brazil for many decades and our customers respect the depth of our market knowledge,鈥� says a spokesman for the bank. 鈥淲e are able to combine our local knowledge with the local knowledge we have of other markets, as well as a global outlook, so we can offer our clients the approach they need - whether that is local or international.鈥�
Infrastructure
Brazil鈥檚 securities lending industry is an operation in which the Brazilian Clearing and Depositary Company (CBLC) acts as counterparty and guarantees business. The securities lending programme - known as BTC - is accessed electronically. Any CBLC depository agent may put up shares for loan, from their own portfolios or from clients who have given express permission for the loan. Although pension funds are not major lenders, they are fully entitled to participate.
The BTC electronic access system, available on the CBLC services network, enables borrowers and lenders to consult the offers available and register the securities loan operations. Fees are negotiated separately between the borrower and lender, and loan contracts previously formalised between borrowers and lenders are also accepted. Any security listed on Bovespa is eligible for securities lending.
Borrowers must deposit a guarantee margin with the CBLC by way of a clearing agent. The margin is equal to the updated value of the securities plus a percentage defined by the BTC - based on a daily account of the liquidity and volatility of the securities. All fees and costs are debited from the borrower on the first day following the end of the loan operation.
Regulation for the securities lending market comes from the Brazilian 麻豆传媒 Commission, the CVM, and by the Brazilian Monetary Council, the CMN. There is no dedicated law on tax rules for the securities lending programme, but guidance is provided through an ordinance known as Instrucao Normativa RFB 742/2007.
Tax treatment depends on where the lender and borrower is resident or domiciled. If the lender or borrower is domiciled within Brazil, lending fees and interest income on cash collateral is taxed at 15 - 22.5 per cent depending on the period of the lending arrangement.
The tax for lenders and borrowers domiciled outside Brazil is slightly more complicated. The amount of tax payable depends on whether the territory in which the participant is based is classed by Brazilian law as a 鈥榣ow tax jurisdiction鈥�.
鈥淭he tax system is complicated and needs sorting out,鈥� says a spokesman for one international bank. 鈥淭he costs of doing securities lending for international players in Brazil are high. And this is not because of the fees, or the charges levied by the CBLC. It鈥檚 because they have to spend so much money on tax lawyers to ensure they have a full understanding of the business before they carry out any transactions.鈥�
The future
Brazil is a shining light in the South American financial market. Domestic and international funds are making a real impact, and the securities lending market is booming, despite recent falls in the stock market. As the markets grow, more players are looking at opening or expanding their securities lending offerings, and Brazil is expected to become a major global player and a hub for the region. But the costs need to come down.
It鈥檚 not all good news of course - the Bovespa has dropped by around four per cent this year, and while there鈥檚 a long term confidence about the market, there are concerns from some investors. 鈥淭he market ran ahead of itself and outperformed,鈥� said Mark Mobius, who heads up Templeton Asset Management. 鈥淚t鈥檚 a natural correction.鈥�
Growth, however, has been extremely positive. Market activity in 2009 was almost three times that of the year before, an admittedly quiet period globally, but in Brazil there was a drop of almost 80 per cent. The rebound, though, has been exceptional.
Two firms dominate the securities lending market: the mining company Vale, and the oil business, Petrobras. Together, they make up almost 20 per cent of the market. Minerals and oil firms, along with banking, are the biggest securities, reflecting their positions within the investment markets.
鈥淭he Brazilian stock market is one of the fastest-growing markets in the developed world,鈥� says one player. 鈥淎t the moment, the securities borrowers are interested in are limited because only a handful of companies dominate the financial landscape. But as the market grows and becomes more mature, and more companies become listed on Bovespa, this will filter down into the securities lending market because more people will be more comfortable working with more securities.鈥�
The players
In part, this is down to new participants entering the market. Long/short investment funds in Brazil are extremely popular, with several launching in recent months.
In terms of the participants in the securities lending market, mutual funds, both foreign and domestic dominate. 鈥淚t鈥檚 simple really, they鈥檝e been in the [securities lending] market the longest, and they are most comfortable with the strategies involved,鈥� says fund consultant Eduardo Sanchez. 鈥淭hey鈥檝e also got the international reach, although many of the domestic ones stick to South America, so their lending decisions can be made on an international basis. Where we鈥檙e not doing as well as we can is in getting pension funds involved - if they do any lending at all, they prefer cash collateral.鈥�
The providers encompass the major international players in the region, in particular Santander, trading as Banco Santander Brazil, and J.P. Morgan. But there is also a strong domestic industry, with smaller firms servicing their local counterparts.
鈥淭he major international investors prefer to use the international banks,鈥� says Sanchez. 鈥淎nd in Brazil, this is not a bad thing - the likes of Santander have been here for many decades and have a deep understanding of the market. Their local expertise is just as good as the domestic providers and they have the global breadth to help with wider strategies.
鈥淗owever, I would like to highlight that the domestic firms are also very good value. They tend to service the smaller funds, and because their fees are sometimes lower - for the same quality of domestic service - they will always have a valued place in the market.鈥�
鈥淪antander has operated in Brazil for many decades and our customers respect the depth of our market knowledge,鈥� says a spokesman for the bank. 鈥淲e are able to combine our local knowledge with the local knowledge we have of other markets, as well as a global outlook, so we can offer our clients the approach they need - whether that is local or international.鈥�
Infrastructure
Brazil鈥檚 securities lending industry is an operation in which the Brazilian Clearing and Depositary Company (CBLC) acts as counterparty and guarantees business. The securities lending programme - known as BTC - is accessed electronically. Any CBLC depository agent may put up shares for loan, from their own portfolios or from clients who have given express permission for the loan. Although pension funds are not major lenders, they are fully entitled to participate.
The BTC electronic access system, available on the CBLC services network, enables borrowers and lenders to consult the offers available and register the securities loan operations. Fees are negotiated separately between the borrower and lender, and loan contracts previously formalised between borrowers and lenders are also accepted. Any security listed on Bovespa is eligible for securities lending.
Borrowers must deposit a guarantee margin with the CBLC by way of a clearing agent. The margin is equal to the updated value of the securities plus a percentage defined by the BTC - based on a daily account of the liquidity and volatility of the securities. All fees and costs are debited from the borrower on the first day following the end of the loan operation.
Regulation for the securities lending market comes from the Brazilian 麻豆传媒 Commission, the CVM, and by the Brazilian Monetary Council, the CMN. There is no dedicated law on tax rules for the securities lending programme, but guidance is provided through an ordinance known as Instrucao Normativa RFB 742/2007.
Tax treatment depends on where the lender and borrower is resident or domiciled. If the lender or borrower is domiciled within Brazil, lending fees and interest income on cash collateral is taxed at 15 - 22.5 per cent depending on the period of the lending arrangement.
The tax for lenders and borrowers domiciled outside Brazil is slightly more complicated. The amount of tax payable depends on whether the territory in which the participant is based is classed by Brazilian law as a 鈥榣ow tax jurisdiction鈥�.
鈥淭he tax system is complicated and needs sorting out,鈥� says a spokesman for one international bank. 鈥淭he costs of doing securities lending for international players in Brazil are high. And this is not because of the fees, or the charges levied by the CBLC. It鈥檚 because they have to spend so much money on tax lawyers to ensure they have a full understanding of the business before they carry out any transactions.鈥�
The future
Brazil is a shining light in the South American financial market. Domestic and international funds are making a real impact, and the securities lending market is booming, despite recent falls in the stock market. As the markets grow, more players are looking at opening or expanding their securities lending offerings, and Brazil is expected to become a major global player and a hub for the region. But the costs need to come down.
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