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Brazil Capital Markets Target More Liquidity
Amidst local IPO boom, many also see potential in Brazilian depositary receipts.
BY FINANCIAL SERVICES ADVISOR
Inter-American Dialogue
Amid low interest rates in Brazil, domestic investors have been seeking alternatives for their money, including international investments and more exposure to local equities. Earlier this year, Brazil’s Securities and Exchange Commission, or CVM, announced the expansion of Brazilian depositary receipts, potentially increasing access and reducing barriers for local investors to invest internationally. Will this change increase the internationalization of Brazilian portfolios? What impact will this change have on local financial markets? Is further regulation needed in order to see substantial adoption?
Dominik Rohe, head of Latin America at BlackRock: At BlackRock, we believe that the recent expansion of the Brazilian depositary receipts (BDRs) platform to allow a broader set of instruments, including exchange traded funds (ETFs), to be ‘listed and traded’ locally is a significant step for Brazilian capital markets and investors. This will lead to the expansion and democratization of access to global markets. The new BDR rules will lead to a broader number of products that investors can choose from and make those products more accessible to institutional and retail investors, while reducing the complexities of investing abroad. For example, retail investors will be able to access the U.S. market through diversified, liquid and low-cost ETFs at a time when the number of retail investors is growing exponentially, having more than tripled since 2018. Additionally, we believe this is particularly relevant now given rates are at an all-time low of 2 percent and investors are actively looking to internationally diversify what have been significantly home-biased portfolios. We believe the impact will also extend to local capital markets and the asset management industry. This happened in Mexico, which allowed for the trading of international securities through the Mexican Stock Exchange in 2003. The platform has grown to approximately $40 billion and today represents more than 45 percent of the trading volume on the exchange. We’ve also seen the local mutual fund market, and the offering, evolve as managers increasingly use ETFs as building blocks to offer international solutions. We believe we’ll see similar impacts for capital markets and the asset management industry in Brazil.
Walter O’Leary, managing partner at South Pointe Capital, and Roberto Nemr, portfolio manager at FRAM Capital: The update by Brazil’s Securities and Exchange Commission, known as ‘Resolução CVM 3,’ went into effect on Sept. 1, allowing nonaccredited Brazilian investors access to ETFs and international equities. This decision, according to Marcelo Barbosa, the president of the CVM, will enable a higher degree
of flexibility to both issuers and investors as demand for portfolio diversification increases due to decreases in local interest rates to multi-decade lows. These changes come on the back of decisions by several highly visible Brazilian companies, such as Stone, PagSeguro and XP, to list their shares in the United States. Liquidity is the oxygen that allows company valuations to rise, and these listings were too important for the CVM to ignore. Therefore, the new regulation was aimed at attracting more liquidity to the local market. The depositary receipt market was created in the United States in the 1990s in order to capture investor interest in international companies. In the early days, the most actively traded issues became privatized state-owned enterprises and financial institutions. Telebrás became the most actively traded issue on the New York Stock Exchange in the mid to late 1990s.
Therefore, the issuance of BDRs has a tried and tested infrastructure behind it. The main risk is the market cycle. Unsophisticated investors will chase tech stocks such as Tesla as opposed to Ford and General Motors.
Helder Soares, chief investment officer at Claritas: We think the recent change by Brazil’s CVM regarding Brazilian depositary receipts, or BDRs, is a step in the right direction, especially due to higher demand for international diversification from local investors, both individuals and institutional. Basic interest rates in Brazil came down from more than 13 percent in the beginning of 2017 to 2 percent currently, triggering a search for international investment opportunities as Brazilians still have the vast majority of their resources allocated in local fixed income. In this context, the recent changes in BDR regulation were welcomed. The most important change was the broadening in asset classes eligible to be offered through BDRs. Prior to the change, only listed equities (with operations primarily outside Brazil) were allowed, and now debt instruments (both of Brazilian and international companies) and ETFs were included as accepted underlying assets.
Another important change was the authorization for individual investors to be allowed to invest in BDRs if the underlying asset has its higher trading volume in an organized exchange and the issuer is supervised in the same jurisdiction by a security and exchange commission. Finally, the CVM also reduced the hurdles in the process of authorizing BDRs. Translation of the information regarding the issuers or ETFs is no longer required.
The CVM also allowed ETFs to postpone for up to three months the disclosure of its full composition, making possible the existence of active ETFs in form of BDRs. BDRs of ETFs are granted automatic registration, significantly expediting the listening process.
Isabel Costa Carvalho, office managing partner at Hogan Lovells in Brazil, and Camila Ornellas Smith de Vasconcellos, visiting international attorney at Hogan Lovells in New York: Brazil’s Securities and Exchange Commission has been softening requirements for fundraising by companies and expanding access to foreign markets for Brazilian investors. As of September, the CVM expanded the scope of BDRs’ coverage, including by allowing BDRs to be backed by foreign shares issued by foreign companies; as well as by allowing titles of foreign debts traded in the foreign markets and issued by foreign companies or by publicly held Brazilian companies; and by allowing ETFs to be traded in the foreign market. Surely, these regulatory changes will increase access and reduce barriers for local investors to invest internationally, will foster Brazilian capital markets and increase the internationalization of Brazilian portfolios. At the same time, Brazilian companies have been offering shares in the international capital markets, especially in the United States, in addition to tapping the local market. Also, to the extent that such changes to the regulations make it easier for companies to raise money through the Brazilian stock exchange, an increase in liquidity in the local capital markets is likely to occur and may also affect allocation of local versus international offerings by Brazilian companies. The changes and purpose of the CVM’s changes can only benefit the market, locally and internationally.
Republished with permission from the Inter-American Dialogue's biweekly Financial Services Advisor
