Barclays structured the private placement in something of a coup for the British bank, beating the local investment banks to become the first to issue Lei 12431-approved securities.
The Brazilian government passed Lei 12431 in September 2010 to allow infrastructure-related corporate bonds to be issued that are income tax-exempt for both domestic and international investors, as well as IOF-exempt for foreign investors. It took until the end of April this year for the first eligible transaction to come to market. Barclays is forbidden by the local securities regulator from discussing the deal for about 60 days after it closes. To qualify for tax-exempt status the bonds must be related to an infrastructure project and have a tenor of at least four years.
Investors expect demand for the product to be good as it offers access to higher yields with little increase in risk. Karina Saade, co-head of BlackRock’s São Paulo office, says the investment group is close to launching a buy-and-hold fund for international investors that would invest in these bonds. The fund would be the first time BlackRock has managed a domestic credit fund in Brazil, having previously restricted onshore investments to sovereign paper.
“[This new structure] levels the playing field between domestic and foreign investors – everyone gets a tax advantage,” says Saade. “There have been two main impediments to international investors entering the domestic market. The first is tax, which this new product addresses. The second is liquidity, because there is no secondary trading of domestic credit in Brazil.”
The domestic Brazilian credit market is valued at about R$400 billion, of which three-quarters is held by banks and other financial intermediaries. The remaining 25% is sold to institutional investors such as public asset managers and pension funds who typically hold to maturity. As such, foreign investors – who typically invest in mark-to-market funds and have shorter investment horizons – find that the lack of secondary trading makes pricing the liquidity appropriately a challenge.
The government has been debating how to address the liquidity issue and has put forward a range of proposals from establishing a liquidity fund for local banks and using BNDES to establish secondary trading. Brazil has also created a novo mercardo on the debt securities to mirror its initiative on equities. This has focused on standardizing documentation and prospectuses as a means to encourage foreign investor confidence and participation. Other ideas include removing the fiscal penalties that prevent local companies buying their own bonds, and thereby potentially making Brazilian companies marginal liquidity providers. Another idea is to increase the investment hurdle rates of local investors, who can currently hit targets by investing in products that yield the benchmark rate, which would in theory incentivise secondary trading.
Another feature of the bonds is that they cannot be linked to the Selic rate, but must be linked to other indices such as the IPCA index. “You see this trend [away from linking bonds to the Selic benchmark] in sovereign borrowings as well because the government has been trying to take issuances away from being linked to the benchmark rate to other types of indexation – and they are now doing that in the credit market as well,” says Saade.
BlackRock has been following the development of the local credit market and thinks the time is nearly ready for entry, although Saade says it is still too early to think about structuring a product that needs liquidity. “We are already interested in launching a buy-and-hold fund. The real question for us is whether global investors are looking for a Brazilian credit product or [they’d like to invest in Brazil as part of] a broad Latin American product. But we do think there will be lot of interest because investors are looking for yield, and there will be a lot of supply so the investable universe will grow,” says Saade. “There will be a sizeable investable universe and lots of diversification by name and industry, so the opportunity is significant.”
