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The next Brazilian government will end the availability of short-term, tax-free instruments that have been a popular investment vehicle for the country’s wealthy individuals, leading bankers predict.
The market is estimated to be worth between R$300 billion ($133 billion) and R$400 billion, with the effective tax subsidy by the government equal to about R$5 billion.
Speaking at a Euromoney private banking event in São Paulo in August, Luiz Severiano, commercial director at Itaú Private Bank, predicted that whoever forms the next government in Brasilia will likely end this private bank staple: “I believe we are very close to the end [of the short-term, tax exempt cycle] because… next year we will have a fiscal issue in Brazil,” says Severiano.
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We find difficulties with the long-standing behaviour of the Brazilian financial industry that operates in the short term
João Carlos Ferraz
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“Whoever forms this new government will look at this [tax subsidy] and say 'it doesn’t make any sense'.”
Vitor Ohtsuki, head of wealth planning at Santander Private Banking, agrees: “This strategy will probably be closed in 2015 or 2016. The government needs to make some fiscal adjustments and we believe clients are waiting until after the elections to see what kind of adjustments the government will do before they decide into which type of investments, or which type of products, to allocate money.
"I believe we are going to see this cycle ending by the end of next year.”
As well as costing the country billions of reais, the bankers say the instrument no longer functions as designed, with the bulk of the tax benefit being slowly passed to the investor, rather than being an incentive to the issuer.
“The whole idea behind those instruments was to provide cheaper funding for the real estate and agriculture industries,” says Rogério Pessoa, co-head of wealth management at BTG Pactual. “Of course part of the [tax] benefit went to the investor [but] nowadays it has come to the point that almost 100% of the benefit is on the investors’ side. The market will eventually come to an end.”
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The prospective closure of one of the most popular and effective wealth management instruments would be good news to many private banking shops. The publicly-owned banks enjoy the majority of the supply of these fixed income products and use this competitive advantage to require high net worth individuals to open accounts with them to secure access.
This has led to a bifurcation of the market and the rise of base rates – to 11% from a cyclical low of 7.25% – has heightened demand from clients for this type of investing strategy that is available from the public banks.
Meanwhile, the private banks try to develop consulting services predicated on the design of longer-term, diversified risk portfolios across asset classes – and including geographical diversification.
“The big client – the R$1 billion or R$100 million client – has more power and can invest in many banks. He/she can go to BTG and to Itaú, as well as to the public banks,” says Severiano.
“But we still have space to work with clients with R$10 million to R$5 million because they can’t put all their money – or a big part of the money – in a public bank because they value our advice. We are facing a bigger challenge with the ultra-high net worth clients than with the high net worth clients.”
Frustration
Another reason the next government may look to end short-term, tax-free products is that it is frustrating the development of longer-term tax-free financing structures that are aimed at developing liquidity for Brazil’s infrastructure needs.
“We find difficulties with the long-standing behaviour of the Brazilian financial industry that operates in the short term – it provides investors with very attractive, liquid returns,” says João Carlos Ferraz, director of planning at BNDES, who has been trying to boost private sector involvement in infrastructure finance through the development of tax-free bonds.
“The logic of creating a bond market for infrastructure is very much based on what incentives we managed to provide on the tax incentives – the upside for good projects is huge and then we will see the famous ‘crowding-in’ of the Brazilian finance industry.”
