Investors are keeping tabs on Brazil’s efforts to create a sustainable local corporate bond market, which, if it succeeds, will set a precedent for other emerging market countries looking to do the same.
For years, emerging market nations across the world have aspired to create fully functioning, deep and liquid local bond markets – markets that can easily finance the medium and long-term funding needs of domestic companies with the support of a solid domestic investor base, and can also prove attractive enough as an investment opportunity to foreign investors.
Yet achieving this goal has just not been easy for a multitude of reasons, and emerging market countries that have tried to develop their local corporate bond markets have failed.
Now Brazil stands a chance of succeeding where others have not. With the launch of a new programme, the Novo Mercado de Renda Fixa (or the New Market for Fixed Income) that is designed to catalyse the country’s domestic corporate bond market, Brazil may finally be on the road to creating a long-term, sustainable local corporate bond market.
Sponsored by Anbima (the Brazilian Financial and Capital Markets Association), the country’s central bank and the Banco Nacional de Desenvolvimento (BNDES), the programme aims essentially to mobilise credit for much-needed infrastructure investment in Brazil by providing a set of standard issuance procedures and certain codes of conduct. Bond issues that comply with the rules set out in the code will obtain Anbima’s Novo Mercado seal of support, which, proponents hope, will help to attract increased domestic as well as foreign investor interest.
Ultimately, the programme would help provide the regulatory framework and confidence needed to bring about liquidity in Brazil’s secondary market for corporate bonds. If it works, Brazil would prove itself a trailblazer for emerging market nations that, albeit well established on the international capital markets, have just not been able to put in place the necessary measures to successfully launch and sustain healthy domestic markets, says Richard Segal, an emerging markets strategist at Jefferies in London.
“Although this is a very long-term project that’s not going to show any results in the immediate future, it would be a landmark achievement for Brazil and serve as a template for the other emerging market countries that have tried to do the same and failed,” Segal said.
In essence, the Novo Mercado de Renda Fixa was created to meet Brazilian corporates’ need for both medium and long-term capital market funding, both of which are in very limited supply, said Ruy Piza, head of domestic sales at BLR Trust Investimentos, the Sao Paulo-based asset management arm of Banco BVA.
“Except for pension funds, insurance companies and development banks, very few investors are used to and have the appetite to invest in longer-term issues,” Piza said.
There are many historical reasons for this, not least the staggering rate of inflation that existed in Brazil until the mid-1990s.
The high interest rates paid by Brazilian Treasury bonds – the benchmark Selic rate is still at 10.5% per year, one of the highest levels anywhere – as well as the floating component that is used on most debt issues, and may result in coupon changes throughout the tenor of a deal, have also contributed towards the unpopularity of medium to long-term debt instruments, Piza said.
There’s little doubt, though, that the need for longer-term funding is strong, particularly when it comes to infrastructure development – a huge necessity for all the BRIC countries. According to Piza, Brazil has the lowest ratio of infrastructure investments-to-GDP of the BRIC countries. Yet BNDES has an infrastructure lending portfolio that is far bigger than that of the Inter-American Development Bank, and it is just not going to be able to increase its lending pace to finance everything on the list.
Indeed, in 2010, BNDES disbursed a whopping R$52.4bn to infrastructure projects alone, and this represented around 31% of its total disbursements for the year.
The Novo Mercado de Renda Fixa will help ease the pressure on BNDES because it calls for the creation of two funds that would provide liquidity to issuers. BNDES, along with Anbima, would put money into the funds, but that amount would be less than lending directly to the many infrastructure projects it has on its roster, Piza says, and it would also give investors the layer of security that they may require to purchase instruments of a longer tenor.
There’s little doubt that the idea works well on paper and while giving a much-needed boost to the development of the Brazilian capital markets will also provide a financing venue for sub-sovereign issuers in Brazil, which up to now, have never been able to find enough depth in the local markets.
“Although this is a very long-term project that’s not going to show any results in the immediate future, it would be a landmark achievement for Brazil and serve as a template for the other emerging market countries that have tried to do the same and failed”
But seeing is believing, and as yet, it is too early to judge the success or failure of the programme, Segal said. While Brazilian power company Cemig has signed up for a R$1bn (US$582m) issue in the New Market (and Anbima also has said that there are a couple more deals in the pipeline for the first quarter), that transaction has not yet been completed, and it is only after its completion that there will be some kind of barometer by which investors will be able to judge the programme, he said.
“Teething problems and delays in new programmes are normal, but until this market can prove that transaction costs will be minimal, I think it’s too early to judge,” Segal said.
“Corporate bond trading in emerging markets is often low because of high transaction costs, as regulators pay little attention to technical problems that raise the cost of launching and trading local currency bonds, so issuance costs – ratings, filing and listing requirements, stamp duties and the like – are high given the issue sizes. Investors would have to feel assured that costs will be lower before they really get involved in this market.”
And even then, how interested would foreign investors be in the New Market? Undoubtedly, emerging market countries cannot do without foreign investment and they rely on it heavily. But while Daniel Broby, CIO of investment management firm Silk Invest in London, feels that the Novo Mercado is a great initiative for Brazil’s capital markets, he believes that international fund managers will continue to focus on the liquidity offered in the dollar market by issuers such as oil company Petrobras, which last year issued a US$6bn bond on the overseas market.
In fact, issuers such as Petrobras and others that have long used the dollar market for their funding needs are more likely to continue favouring it, Broby says, not least because international borrowing costs are still so low. The international investment world is also familiar with the Brazilian companies that borrow on the overseas market, and at riskier times, would opt for both the familiarity and the liquidity offered by the tried and true issuers, he says.
Nevertheless, Piza believes that over time, New Market instruments do stand a chance of interesting foreign investors, too. Brazil remains a hot investment destination, and recently the government enacted legislation to overturn a previous ruling that imposed an entry tax on foreign investors in the fixed income space, he said. This will soon be followed by new rules aimed at attracting foreign capital into Brazilian infrastructure projects.
However, Piza concedes that he is not likely to make his final bet on the success or failure of the Novo Mercado programme until it is clear that all parties are truly on board, and, most importantly, the funds designed to provide liquidity are set up.
“I think that putting in place the code and already having an issue being made under the new rules is an achievement, but until the liquidity mechanisms become a reality, I do not see this new market growing fast,” he said. “Until these funds are actually implemented, the liquidity enhancement provided by the mere grant of a seal to an issue will not be relevant.”
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