Foreign entrants to Brazil's financial markets are subject to some specific tax and regulatory requirements.
As well as the unique features of Brazil's clearing and settlement systems, foreign individuals and companies entering Brazilian financial markets should be aware of several other factors that apply only to overseas players.
Requiring legal and fiscal representatives within Brazil
Resolution 2,689 of the National Monetary Council requires all foreign investors to nominate both a legal and a fiscal representative within Brazil. A legal representative is required to respond to any civil claim that may arise against the foreign investor, and a fiscal representative to liaise with the Brazilian Internal Revenue Service.
In practice, a single financial institution can often act as a foreign investor's legal and fiscal representative, and take responsibility for the investor's regulatory reporting to the BCB or the Brazilian Securities & Exchange Commission (Comissão de Valores Mobiliários or CVM).
Foreign investors are also required to hire a local custodian, and firms wishing to trade on an exchange need to establish a local office or enter into partnership with a local institution. Any organization establishing a mutual fund in Brazil should also be aware of the requirement for daily net asset value reporting to the CVM, for disclosure on their website.
Lastly, and most importantly, foreign currency investments in Brazil are liable to a financial transactions tax (Imposto sobre Operações Financeiras or IOF).
Unlike a withholding tax applied to outflows, the IOF is levied on capital inflows to the Brazilian financial markets. Apart from revenue generation, the main aim of the IOF is to limit the effect of short-term capital flows on the value of the Brazilian real. The real has gained significantly against the US dollar over the past two years, reflecting a hawkish interest rate policy and the effect of growing commodity prices.
In October 2010, the IOF levy on foreign currency conversions for investment in bonds, derivatives and many other financial instruments was raised to 6%, with a lower rate of 2% applied to equities. This has not prevented international investors from allocating funds to Brazilian assets, but it has certainly encouraged them to look more carefully at their Brazilian strategies and operating structures.
It also illustrated how important it is for foreign entrants to plan an optimal route through the complexities of Brazil's laws, taxes and regulations.
Foreign players to play an increasing role in the evolution of Brazil's financial markets
We have summarized some of the most important features of the Brazilian payments system that foreign investors should be aware of, along with some other key regulatory and tax-related requirements. As already mentioned, these complexities – and their associated costs – are often seen as having partially insulated Brazil's financial markets from global trends.
This has helped to limit the impact of the global financial crisis on the Brazilian economy, but it has also tended to hold back the pace of market development.
Nonetheless, Brazilian financial markets are evolving. Asset classes such as real estate funds, private equity funds, alternative investments and ETFs are gaining increasing traction, even if they are at an earlier stage of development than in many other emerging markets.
Similarly, the vertical integration that is still a notable feature of Brazil's financial markets is the subject of growing discussion. At a time when regulators in the US, Europe and elsewhere are looking to break up vertical silos, BM&F BOVESPA is rare in providing the trading platform, post trade processing, clearinghouse and depositary services for a large proportion of national securities transactions.
In response, Brazilian asset manager Claritas has recently signed an agreement with BATS Global Markets, an alternative trading venue, to explore the creation of a new Brazilian trading platform with its own clearing and depositary services. At the same time, BM&F BOVESPA is taking steps to attract more high frequency traders. It is currently developing a new multi-asset platform in conjunction with the CME of the US. 7
In a separate development, US futures exchange ICE has acquired a 12% stake in CETIP. It therefore seems certain that the structure and features of the Brazilian investment market will continue to evolve, albeit under the watchful eye of the BCB, CVM and the National Monetary Council.
Foreign investors may find some features of Brazil's settlement systems a challenge. However, in our view this is likely to be outweighed by their appreciation of the resulting benefits.
7 ”BATS and Claritas consider Brazilian Exchange,” Financial Times, 12 February 2011.
8“ICE buys into Brazilian clearing firm,” Financial Times, 15 July 2011.