Brazil: Market Model for the New World

Brazil’s capital markets are poised for a boom. A confluence of trends is set and within five years we will see the formation of a true yield curve, the flourish of new markets, and the rise of competition across multiple liquidity venues. This just touches the tip of the iceberg.

While admittedly the rosy projection of an optimistic crystal ball, economic trends in Brazil’s capital markets all point to this direction. Most important is an unprecedented period of low interest rates that veers sharply from the past thirty years of Brazil’s economic history. Inflation has been kept below 10 percent for most of the past decade. The Central Bank of Brazil has lowered the overnight SELC rate to a now record low annualized 7.3 percent. A paradigm shift is now underway, as the USD $1 trillion domestic asset management industry responds to this new interest rate environment. A market wide search for yield, whether it drives investments in offshore markets, or in fixed rate public or private debt, or even new structured products – is a powerful force not to be ignored.

The development of a true yield curve is an exciting trend that promises to expand the rates market beyond the inflation legacy of overnight rate interest rate futures. Brazil’s National Treasury is making steady progress in its effort to finance liabilities with fixed rates and shift the public bond market out of floating rate debt. New market-derived benchmark reference rates already have reduced overall microstructure inefficiencies in the rates market. Add to this a formal program to raise standards in private credit issuance and build liquidity in secondary credit market – and you have a recipe for an exciting fixed income market.

Brazil’s derivatives market structure is also a model for reform of US post-trade clearing infrastructure. Brazil faced its own financial crises in the 90s with the introduction of the Real, and subsequence reforms have set in place a structure that is well buffered against systemic risk. Here, all trades must have a central counterparty and settled at the end-investor level or in the case of OTC trades, registered on an organized repository. This philosophy even applies to modern electronic markets. Well-designed pre-trade restrictions and market surveillance ensure HFT liquidity is not to the detriment of participants.

For investors, the slowdown in GDP growth – which analysts project at 0.95 percent for 2012 – has a silver lining as an impetus for policies to set the foundations of sustained long term growth. A USD $66 billion stimulus package road show is now underway to drum up investor capital for much needed improvements to the nation’s infrastructure. A survey by the University of Sao Paulo estimates that the gross economic impact of the 2016 Olympics will add an additional USD $51.1 billion in the economy. Investors continue to place their vote for Brazil’s potential. More than USD $4.3 and $5.7 billion of capital has been allocated into Brazilian bond and equity funds, respectively, in 2012 alone.

Brazil is the country of the future. The future is now.

TABB Group Vision Note Brazil: Market Model for the New World is based on in-depth conversations with key participants in Brazil’s capital markets, including brokers, dealers, exchanges, hedge funds, asset managers, connectivity providers, and securities lending agents. The study provides a detailed look at important structural developments that drive the next evolution of Brazil’s capital markets.