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AmericasMay 1 2012

Brazil targets deeper debt capital markets

A buy-and-hold mentality is thwarting Brazil’s debt capital market, limiting access to long-term funding in the country. A number of initiatives have been launched to help deepen the market, but will they help it meet the mounting finance requirements of domestic development projects and local corporates? 
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Brazil targets deeper debt capital markets

The international debt capital markets have generated a number of opportunities for investors interested in Brazil. Between January and early April 2012, a total of $24.84bn was raised across 31 deals, against $38.49bn from 57 deals in the whole of 2011. The local market has been relatively active too, with 20 real-denominated debentures worth more than $5bn in the first quarter of 2012 – almost 40% of the total number of issuances in 2011.

“Activity on the primary market has been very strong,” says Alexandre Aoude, Itaú BBA’s global head of fixed income. He says that the international market has benefited from the backlog of transactions that built up when the markets shut down in 2011, as many of these deals have since taken place. Local markets have seen an upturn of activity owing to the increasing number of issuers considering the real-denominated market, which in turn attracts foreign investors and benefits from the liquidity provided by the very banks that structure the deals.

It is Brazilian lenders, in fact, that play a pivotal role in the success of local issuance, thanks to the substantial underwriting power they put behind each of their clients’ offerings. This has created a safety net for issuers and good opportunities for the country’s top banks as they find a use for their excess liquidity. But by doing so, liquidity is prevented from reaching the secondary market, which is almost non-existent throughout Brazil.

“It is always the main commercial banks using their balance sheet to provide commitment,” says Allan Libman, who is in charge of the investment banking structuring department at Credit Suisse, Brazil. “If there is a market, they sell. If not, they keep the debentures on their balance sheet, and maybe sell later. With that, you don’t have a secondary market.” 

Buy and hold

It is not only banks that have this buy-and-hold mentality. With double-digit interest rates not uncommon for investment-grade debentures and sovereign bonds, pension funds and other institutional investors have been able to meet their return targets by simply holding those assets to maturity.

Not surprisingly, such an illiquid market has attracted mainly investment-grade names, led by state-owned oil giant Petrobras, mining group Vale and engineering conglomerate Oderbrecht, which supplement their dollar-based funding with local notes, leaving the fast-growing high-yield corporate segment with limited funding alternatives. According to bankers, high-yield names are a rarity in the market.

Furthermore, asset managers with very short-term liabilities cannot afford to invest in such illiquid assets; and in a vicious cycle, limited long-term funding has capped the duration of local notes to a maximum of five or seven years. Long-term lending to corporates is typically the remit of Brazil’s development bank, Banco Nacional de Desenvolvimento Economico e Social (BNDES), and not even private sector banks are accustomed to lending beyond the medium term. The risks of investing in an illiquid high-yield asset would be too high for a foreign investor, or indeed a local asset manager, both of which have very short-term liabilities.

“Currently, the asset management industry is overnight liability based, meaning that you can withdraw your money overnight,” says Mr Aoude. “It is very hard to buy an illiquid asset when you have liabilities like that. What we are trying to create is a system where there will be liquidity in the secondary market and where this [asset/liability] mismatch will be more comfortable.” 

Brazil targets deeper debt capital markets GRAPH

Pushing for change

Capital markets players and regulators are indeed about to change the rules of the game, urged on by the mounting financing requirements of the country’s corporates and its development needs in general. The growth of smaller companies in the local real estate, consumer and infrastructure markets – Brazil’s infrastructure investment needs alone are forecast to be worth about $100bn a year over the next five years – make the issue of long-term funding more pressing than ever.

Brazil’s capital markets association, Associação Brasileira das Entidades dos Mercados Financeiro e de Capitais (Anbima), has been promoting various initiatives to generate a healthy local debt capital market and has made this its top priority for 2012.

“We have a market that is not small, with more than $1000bn in securities, but this market is concentrated on big issuers, on not very long durations, and it has a buy-and-hold behaviour,“ says Marcelo Giufrida, outgoing president of Anbima and CEO of BNP Paribas Asset Management Brasil. “It is time for the local debt capital markets to play a bigger role in the financing of infrastructure too.”

Renato Ejnisman, head of Bradesco BBI’s investment banking division, shares a similar view. He says: “Everybody is looking very carefully at [the infrastructure] market. With the investment flow that we expect to see in Brazil, there is a lot to be done: growth in the oil and gas industry, logistics and transportation sectors. It is hard to imagine that only the local development bank will be able to address those needs.” 

Factors at play

A number of changes will need to take place if Brazil is to deepen its debt capital markets. One of these is the decreasing of the Selic, the central bank’s overnight rate. This rate has largely remained in double digits in recent times, helping to cultivate the buy-and-hold culture among investors. As of March 2012, however, the Selic has decreased to 9.75%, and some expect it to go as low as 8.5% by the end of 2012.

The creation of tax incentives to investors in debt issued by infrastructure-related companies – so-called infrastructure bonds, which were introduced in 2011 – will also help deepen markets.

The government has removed the 6% imposto sobre operacoes financeiras (IOF) tax that foreign investors are subjected to, and it has also removed withholding tax on income or investment gains, which typically ranged between 15% and 27%. Local individual investors will also see this tax on investment gains eliminated and Brazilian firms will see it slashed to 15%, if they invest in local debentures. But short-term flows are still being penalised. In March 2012, the government extended the IOF tax on foreign loans of up to five years, in an aim to further encourage the development of real-denominated funding tools.

“[The infrastructure bond law] is what we expect will change the landscape,” says Mr Aoude. “If you had interest rates at 14%, people would say ‘I am not going to take the credit risk’. Now, at potentially low nines or high eights, people will shift their attention to [riskier] credit assets.” And there are other appealing investment aspects too, says Mr Aoude, such as being able to add the currency element to the infrastructure investment. “Offshore investors will be able to send money to Brazil, no IOF, take a risk on currency and on credit on projects. And these projects are great projects.”

Platform for growth

The effort to develop a secondary market would not be complete without the improvement of the trading platform for these securities. Brazil’s largest securities clearing house, Cetip, plans to have an improved platform ready by the end of 2012, says Marcelo Fleury, Cetip’s head of institutional relations. He says that the system will create connections to platforms foreign investors use abroad, attracting more of them to the Brazilian real market. And foreign investors are indeed the ideal buyers of those infrastructure bonds.

“There is a desperate need for infrastructure investment in Brazil, and we need this for the replacement of BNDES as the sole provider of [long-term] funds to the country,” says Mr Fleury. “Foreign investors would naturally be the buyers of these bonds because they are very used to analysing corporate credit and are comfortable buying longer duration bonds. The fact
 is they simply have not been attracted to buying them because of the complex
 taxation involved and the buy-and-hold mentality.” Mr Fleury believes that currently only about 1% of foreign investments in Brazil go to corporate bonds, with the rest being directed towards government bonds and equity.

Others agree on the need for greater participation from foreign investors. Eduardo Mueller Borges, managing director of Santander Brasil’s credit markets, says that foreign investors are vital in ensuring a liquid secondary market but, as things stand, the lack of liquidity is the very reason why many international investors stay away.

“[We need] secondary market liquidity, we need the ability to move positions; but it is a sort of chicken-and-egg situation, because we also need international investors to come to Brazil and provide liquidity,” says Mr Mueller Borges.

Right positioning

Even before getting to the trading of existing debentures, however, another matter must be tackled, and this is ensuring that smaller issuers are in a position to be attractive issuers. The fast growth of so many Brazilian businesses means that a lot of them have now become suitable to raise funds through the capital markets but they are not always able to bring the necessary data to potential investors and comply with certain corporate governance requirements – or at least not always in time to tap the market at the right moment.

This is reflected in the limited number of smaller companies that issue debentures. “First-time bond issuers need more time and when there is a window of opportunity, they normally miss it” says Mr Libman at Credit Suisse. “Ninety per cent of the issuers that get the best momentum are always the same frequent names.”

Mr Mueller Borges says: “There is an emerging class of companies within our corporate sector in Brazil; we have 8000 names [in the bank’s corporate client segment] of which only half is really active. These are emerging companies that have been growing at 25% per annum and that need to finance their growth.”

Some changes are going to be introduced in this area too. Anbima has been working on the development of a Novo Mercado for fixed-income securities, similarly to that which was created in the equity capital market more than a decade ago.

The Novo Mercado was introduced in the Brazilian stock exchange, BM&FBovespa, for companies which voluntarily met higher corporate governance standards than the ones required by law. The segment has been very successful and has added liquidity to securities of less well-known issuers. Anbima’s Mr Giufrida says that the association and all market participants are keen to replicate this success in the debt market too.

The Brazilian debt market is certainly gearing up for change. The hope is that these initiatives will ensure that it can match corporates’ funding needs and reshape market participants’ roles to mirror those of its international peers, where it is the norm for bookrunners to place securities with investors, rather than hold them on balance sheet. As Mr Aoude says: “Our business is not a storage business, it is a transportation business, which means that we originate, structure and sell.”

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Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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