Brazil
06 October 2015
Brazil is Latin America’s biggest market, but some agent lenders are still seeing its central counterparty model as a barrier to further growth
Image: Shutterstock
Throughout the securities lending industry, professionals agree that Brazil is a market with ample potential for further growth that offers rich returns to early investors.
“We [J.P Morgan] were the first non-domestic lending agent to go live in the Brazilian market and we have been very active there on a custody and non-custody basis for five-and-a-half years,” explains Paul Wilson, global head of agent lending product and portfolio advisory at J.P. Morgan Investor Services.
“We have a good ‘outbound flow’ of business from Latin America-based clients and it continues to be an area of interest for us.”
But he adds: “We do see strong demand from borrowers to borrow Brazil and there is also a lot of interest from clients to lend in this market, but it’s still not mainstream.”
“What will likely drive volumes up is more supply. We’re not at the stage where there is so much supply that fees are driven down.”
Other stumbling blocks exist in the Brazilian securities lending market, specifically the requirement to use the BM&FBovspa central counterparty (CCP).
All collateral offered by the borrower is held within the CCP in broker-level accounts and the lender does not receive or even have clear sight of it.
This system is made more secure through the financial backing of the Bank of Brazil, but beneficial owners losing sight of their collateral remains a concern.
Wilson explains: “The Brazilian market doesn’t come without a number of complexities, such as operating via a CCP. One of nuances is that while the CCP does collect and hold collateral from the borrower, this is not passed on to the lender nor does the lender have sight or reporting what and how much collateral has been collected by the CCP.”
“For a number of lender types, such as UCITS or US mutual funds, the market is challenging as it is not apparent under their own regulations that these clients could participate given the absence of collateral.”
Agent lenders such as J.P. Morgan have tried to combat this concern by offering to indemnify lending transactions in Brazil, but the strict mandates that the likes of mutual funds operate under are not up for negotiation.
This is unnerving for international beneficial owners that are more accustomed to enjoying full control of their collateral management processes.
This divergence from traditional lending protocol also creates further operational challenges regarding recalls and market timeframes.
“We have a sense that if the CCP would allow individual collateral accounts per lender and provide reporting of that collateral, then one of the biggest barriers would be eliminated,” concludes Wilson.
Northern Trust’s head of international product management, Mark Jones, offers an overall vote of confidence in the effectiveness of the Brazilian CCP model, but also echoes the concerns of Wilson on the controversial point of collateral management.
“Through working closely with BM&FBovespa we gained some comfort in the sophistication of their risk management techniques and their fairly conservative approach to collateral margining,” says Jones.
He adds: “We are also confident that they understand the market they are supporting and the needs of its participants. However, the operational processes involved in lending in Brazil through the CCP are significantly different to a ‘standard’ lending market and require the adoption of some very bespoke solutions to manage.”
“The lack of visibility of collateral is a significant hurdle for some offshore lenders and educating our beneficial owner clients on the intricacies of the market has been key to our ability to implement. The model does work, but there are some areas that could be developed to attract higher offshore participation.”
Unfortunately, BM&FBovespa could not comment before press time, but a spokesperson for the CCP said in September 2014: “As the CCP model for securities lending is mandatory in Brazilian regulation, these international investors need to understand the system’s safeguards, a process which may take some time, as well as understand access to such a model vis-à-vis their own regulatory framework and modus operandi.”
“To overcome this issue BM&FBovespa has been working along to major international associations, intermediaries and the beneficial owners to engage the market participants on the discussion of the CCP model and the regulatory framework in Europe and the US.”
“Regardless of these challenges, high return for lenders in the Brazilian market seems to be an additional stimulus for them to start doing business in it. The only institution currently authorised to provide securities lending in Brazil is BM&FBovespa,” said the spokesperson.
“As the CCP model has proved extremely reliable even in stress situations like the 2008 financial crisis, it is unlikely that regulators in Brazil will accept a different model than a CCP-based one for the market.”
Further evidence that market participants will, and are, learning to adapt to this mandatory system can be seen by data that highlights a recent uptick in securities lending transactions in June compared with the month before. The CCP saw the total number of transactions reach 123,285, compared to 117,292 in May.
The financial volume related to securities lending amounted to BRL 61.64 billion ($19.05 billion) compared with a total of BRL 58.62 billion ($18.97 billion) in May.
It would be unfair and incorrect to accuse the CCP model of being the sole reason behind some beneficial owners’ lack of interest in the Brazilian securities lending market.
As Jones points out, there are wider national economic and social issues that have negatively affected and delayed Brazil’s emergence into the mainstream market.
“I think the main challenge at present is the economic and political situation in Brazil. No matter how good the product, concerns over the likelihood of further deterioration of the economy are likely to outweigh any benefits that can be obtained through lending in the minds of many asset owners,” says Jones.
He adds: “If those macro issues can be addressed, I am confident that there will be a successful lending market in Brazil, but those issues should not be underestimated.”
Ultimately, all debate around increasing complexity of securities lending, either through regulatory, reporting or cost burdens, is confronted by the fact that securities lending is just one, relatively small scale, of many operations of asset managers, and if regulatory demands become too onerous people will simply opt out—and Brazil is no different.
In the rest of Latin America, the picture is less complex. “Demand to borrow Chilean securities is minimal,” says Wilson. “Demand to borrow Mexican equities is generally low to moderate and there are generally few specials in that market.”
Mexico’s securities lending framework subscribes to the standard model of not requiring a CCP be used, which makes the process of signing up new beneficial owners a lot more straightforward. This means agent lenders that are active in Latin America can open their beneficial owner clients to the Mexican market without the high level of ongoing involvement required in Brazil.
Although the interest in securities lending in Mexico isn’t ready to challenge Brazil as the top Latin America market, once uptake does develop it will not have to tackle the regulatory challenges that Brazil may have to face if it wants to join the big leagues.
“We [J.P Morgan] were the first non-domestic lending agent to go live in the Brazilian market and we have been very active there on a custody and non-custody basis for five-and-a-half years,” explains Paul Wilson, global head of agent lending product and portfolio advisory at J.P. Morgan Investor Services.
“We have a good ‘outbound flow’ of business from Latin America-based clients and it continues to be an area of interest for us.”
But he adds: “We do see strong demand from borrowers to borrow Brazil and there is also a lot of interest from clients to lend in this market, but it’s still not mainstream.”
“What will likely drive volumes up is more supply. We’re not at the stage where there is so much supply that fees are driven down.”
Other stumbling blocks exist in the Brazilian securities lending market, specifically the requirement to use the BM&FBovspa central counterparty (CCP).
All collateral offered by the borrower is held within the CCP in broker-level accounts and the lender does not receive or even have clear sight of it.
This system is made more secure through the financial backing of the Bank of Brazil, but beneficial owners losing sight of their collateral remains a concern.
Wilson explains: “The Brazilian market doesn’t come without a number of complexities, such as operating via a CCP. One of nuances is that while the CCP does collect and hold collateral from the borrower, this is not passed on to the lender nor does the lender have sight or reporting what and how much collateral has been collected by the CCP.”
“For a number of lender types, such as UCITS or US mutual funds, the market is challenging as it is not apparent under their own regulations that these clients could participate given the absence of collateral.”
Agent lenders such as J.P. Morgan have tried to combat this concern by offering to indemnify lending transactions in Brazil, but the strict mandates that the likes of mutual funds operate under are not up for negotiation.
This is unnerving for international beneficial owners that are more accustomed to enjoying full control of their collateral management processes.
This divergence from traditional lending protocol also creates further operational challenges regarding recalls and market timeframes.
“We have a sense that if the CCP would allow individual collateral accounts per lender and provide reporting of that collateral, then one of the biggest barriers would be eliminated,” concludes Wilson.
Northern Trust’s head of international product management, Mark Jones, offers an overall vote of confidence in the effectiveness of the Brazilian CCP model, but also echoes the concerns of Wilson on the controversial point of collateral management.
“Through working closely with BM&FBovespa we gained some comfort in the sophistication of their risk management techniques and their fairly conservative approach to collateral margining,” says Jones.
He adds: “We are also confident that they understand the market they are supporting and the needs of its participants. However, the operational processes involved in lending in Brazil through the CCP are significantly different to a ‘standard’ lending market and require the adoption of some very bespoke solutions to manage.”
“The lack of visibility of collateral is a significant hurdle for some offshore lenders and educating our beneficial owner clients on the intricacies of the market has been key to our ability to implement. The model does work, but there are some areas that could be developed to attract higher offshore participation.”
Unfortunately, BM&FBovespa could not comment before press time, but a spokesperson for the CCP said in September 2014: “As the CCP model for securities lending is mandatory in Brazilian regulation, these international investors need to understand the system’s safeguards, a process which may take some time, as well as understand access to such a model vis-à-vis their own regulatory framework and modus operandi.”
“To overcome this issue BM&FBovespa has been working along to major international associations, intermediaries and the beneficial owners to engage the market participants on the discussion of the CCP model and the regulatory framework in Europe and the US.”
“Regardless of these challenges, high return for lenders in the Brazilian market seems to be an additional stimulus for them to start doing business in it. The only institution currently authorised to provide securities lending in Brazil is BM&FBovespa,” said the spokesperson.
“As the CCP model has proved extremely reliable even in stress situations like the 2008 financial crisis, it is unlikely that regulators in Brazil will accept a different model than a CCP-based one for the market.”
Further evidence that market participants will, and are, learning to adapt to this mandatory system can be seen by data that highlights a recent uptick in securities lending transactions in June compared with the month before. The CCP saw the total number of transactions reach 123,285, compared to 117,292 in May.
The financial volume related to securities lending amounted to BRL 61.64 billion ($19.05 billion) compared with a total of BRL 58.62 billion ($18.97 billion) in May.
It would be unfair and incorrect to accuse the CCP model of being the sole reason behind some beneficial owners’ lack of interest in the Brazilian securities lending market.
As Jones points out, there are wider national economic and social issues that have negatively affected and delayed Brazil’s emergence into the mainstream market.
“I think the main challenge at present is the economic and political situation in Brazil. No matter how good the product, concerns over the likelihood of further deterioration of the economy are likely to outweigh any benefits that can be obtained through lending in the minds of many asset owners,” says Jones.
He adds: “If those macro issues can be addressed, I am confident that there will be a successful lending market in Brazil, but those issues should not be underestimated.”
Ultimately, all debate around increasing complexity of securities lending, either through regulatory, reporting or cost burdens, is confronted by the fact that securities lending is just one, relatively small scale, of many operations of asset managers, and if regulatory demands become too onerous people will simply opt out—and Brazil is no different.
In the rest of Latin America, the picture is less complex. “Demand to borrow Chilean securities is minimal,” says Wilson. “Demand to borrow Mexican equities is generally low to moderate and there are generally few specials in that market.”
Mexico’s securities lending framework subscribes to the standard model of not requiring a CCP be used, which makes the process of signing up new beneficial owners a lot more straightforward. This means agent lenders that are active in Latin America can open their beneficial owner clients to the Mexican market without the high level of ongoing involvement required in Brazil.
Although the interest in securities lending in Mexico isn’t ready to challenge Brazil as the top Latin America market, once uptake does develop it will not have to tackle the regulatory challenges that Brazil may have to face if it wants to join the big leagues.
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