There is no market in Latin America quite like Brazil. Primarily specials-driven, there is, on average, approximately $3.7 billion on loan at any given time. Ask any agent lender where it is looking to do business next and Brazil is usually top of the list.
And it’s clear why. Chris Benedict, director and lead analyst at DataLend, says: “Brazil’s overall volume-weighted average fee across all securities on loan is approximately 153 basis points (bps), which is high compared to the rest of the region and most other markets around the globe.”
Brazil has also had an overall average utilisation of approximately 20 percent over the past 12 months, “which is also high compared to the region”, says Benedict.
Some of the most profitable Brazilian stocks for securities lending participants in the past 12 months have included B2W Companhia Digital, Kroton Educacional, Lojas Renner, Oi preferred shares and BTG Pactual. “These stocks together yielded approximately $9.6 million in securities lending revenue in the past 12 months.”
Despite some market participants being weary of Brazil because of its central counterparty design, the country’s CCP, BM&FBovespa, sees securities lending as a rapidly growing business.
A BM&FBovespa spokesperson comments: “Securities lending is a rapidly growing business at BM&FBovespa, with a 32 percent compound annual growth rate in terms of opened positions in the last six years.”
Indeed, the CCP processed 121,284 securities lending transactions in July, beating June’s total of 108,422.
But there is still work to be done to attract lenders to Brazil. The spokesperson says: “While already healthy and attractive for players, BM&FBovespa has also been working to improve its CCP securities lending programme further in order to attract equity holders to lend in this environment. In 2013, the programme still had excess borrowing demand in comparison with the lending supply.”
Among the changes were enhanced corporate action treatment and new delivery failure procedures, as well as an improved trading screen for agents that register transactions on behalf of lenders and borrowers.
Paul Wilson, global head of agent lending product at J.P. Morgan Investor Services, says that his bank is the only non-domestic agent lender currently active in Brazil, which is somewhat unique because the country’s CCP collects collateral in a variety of forms from borrowers.
“Collateral is not passed on to the lenders, so for all intents and purposes they appear to be uncollateralised.”
“That being said, the CCP is also the central securities depository (CSD), so by virtue of investing in the Brazilian market in the first place, investors would have had to take into account.”
How is Brazil aiming to make more lenders “comfortable” with its CCP model?
The BM&FBovespa spokesperson says: “International investors in Brazil hold 40 percent of the assets in the BM&FBovespa CSD and their access to the lending market is growing at a lower rate when compared to local players.”
“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.”
“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.”
Changes are afoot with BM&FBovespa’s clearinghouses. It currently has four—for equities and corporate bonds, derivatives, foreign exchange, and federal government bonds—that it is combining. Announcing the project in August, BM&FBovespa CEO Edemir Pinto said: “Sometimes the market goes for several years without any changes. In this case we’ll leap forward several years in a single day.”
“The single clearinghouse and Closeout Risk Evaluation (CORE) [risk management system] represent a revolution in modernity, security and efficiency in central counterparty and risk management services.”
“As was the case with the Brazilian Payment System (SPB), the market will be divided into before and after the new clearinghouse and CORE.”
Cícero Vieira, COO of BM&FBovespa, added: “This pioneering project will result in one of the most secure and sophisticated clearing systems in the world. The new clearinghouse will reduce the market’s back-office costs and make trade settlement and the allocation of collateral more efficient.”
“It will also bring greater flexibility and reduce time frames for the launch of new products.”
The BM&FBovespa spokesperson stresses that the project will benefit securities lending participants. “One of the major benefits for the investor is the more efficient use of capital for collateral thanks to the new margin calculation model, which will allow risk to be offset across different asset classes and between open interest and pledged collateral, while preserving the security of the system.”
“From a securities lending perspective, as long as the product is integrated and controlled along with other contracts (foreign exchange, derivatives, etc), it will allow borrowers to have a more efficient offset on calculation of margin calls and deposited collateral.”
“From the lender’s perspective, securities lending contracts that are already accepted as collateral for some operations will become accepted for a longer list of trades, facilitating capital allocation and leveraging the possibility of new trades.”
As Brazil attempts to attract more lenders to its shores, it will be interesting to see how long it will remain a specials market, and when other emerging jurisdictions will step in to take its crown as an ‘attractive possibility’.