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As investment flows begin to return to Latin America following the stabilisation of Brazil, many investors are trying to learn more about these emerging markets, and in particular about the intracacies of South America's largest market, Brazil, and its smaller, yet high profile neighbour to the south, Argentina. These two markets, frequently seen as operationally similar, are in reality two very distinct markets, and to make the most of investments here, investors should understand the principal issues that differentiate them.
The latest economic crisis in Brazil and the sharp decrease in foreign investment that followed throughout the region has shown that foreign investors tend to think of all South American markets as a single unified market. As investment flows begin to return to Latin America following the stabilization of Brazil, many investors are trying to learn more about these emerging markets, and in particular about the intricacies of South Americas largest market, Brazil, and its smaller, yet high-profile neighbor to the south, Argentina. These two markets, frequently seen as operationally similar, are in reality two very distinct markets, and to make the most of investments here, investors should understand the principal issues that differentiate them.
In Brazil, investors need authorization from the CVM, the Brazilian Securities and Exchange Commission, to begin investing into the market. Depending upon the investment vehicles in which they are interested and the tax benefits they wish to accrue, investors may choose several different mechanisms in which to enter the market. Registering as an Annex IV investor is usually best for equity investors; Annex III registration is used for closed-end investment funds; Annex VI for investors with a fixed-income focus; and there are a few other investment mechanisms which provide investors with a variety of flexible benefits. Each of these mechanisms requires a particular know-how in order to operate within its legal constraints, and brings a different set of regulations and operational requirements along with it.
Depending on the investment mechanism chosen, the investor may need to appoint a Local Administrator, a Brazilian institution authorized by the CVM to assume the role of legal representative of the investor in front of Brazilian authorities and the market. The Local Administrator acts on behalf of the investor for the payment of taxes, the execution of foreign exchange, registration of transactions with the CVM, and for the registration of foreign capital with the Central Bank. For securities settlement, safekeeping, and reporting the investor must also have access to the services of a Local Custodian, though the Local Administrator can perform these duties as well.
OTC market. Annex IV investors cannot purchase fixed income instruments under this regulation. The petrochemical sector is nearly closed to foreign investment, while other sectors contain ownership thresholds. A single foreign investor may not own more than: 49% of a companys voting shares, or 20% of its total shares; 49% of the preferred shares for petrochemical companies; 30% of information companies; and 50% preferred or 33.33% ordinary shares of insurance companies.
Also, Brazilian legislation only permits the transfer of beneficial ownership of assets as a result of a transaction executed in the market, unless it is authorized by the CVM or Central Bank following a specific request.
Fixed income instruments are not usually negotiated in the stock exchanges, as they are regulated by the Brazilian Central Bank in the
over-the-counter market. For public fixed income instruments, transactions settle on Trade Date through SELIC (Special System for Settlement and Custody), via reserve funds, a concept similar to Fed Funds in the United States. Reserve funds utilize local currency balances at the Central Bank to mimic a versus payment transaction. The investor must then purchase reserve funds from his custodian in order for the security transfer to his account.
Corporate bond trades are settled by book-entry through CETIP (Clearing House for the Custody and Financial Settlement of Securities) and can be settled free-of-payment on Trade Date or they can settle versus payment on Trade Date plus one.
For equity transactions, the two major stock exchanges also maintain their own depository and clearing systems. The clearing system for BOVESPA (the Sao Paulo Stock Exchange), where nearly 90% of all transactions occur, is known as the CBLC or the Brazilian Clearing and Depository Corporation. The clearing system for the stock exchange in Rio, the Cāmara de LiquidaÁao e CustÛdia (CLC), has responsibility for clearing/settlement of the eight other small, regional stock exchanges in Brasil. All are linked with one another making it possible to settle transactions done on one exchange using the services of the other. Though there is no central depository system in Brazil, both of the Exchanges depositories are eligible to hold shares of U.S. mutual funds assets under Rule 17f-5 as they have each received No Action letters from the U.S. SEC.
The related cash transfer for trades at BOVESPA or at the Rio Stock Exchange are done through checks or wire transfers which clear one day following settlement date. As the Central Bank in Brasil has responsibility for the interbank payment system, many of these payments are netted and cleared overnight in cash accounts at the Central Bank, therefore good funds are truly known one day after value date following their confirmation.
through which the investor has entered the market. The most significant taxes relate to money transfers (foreign exchange, money inflows/outflows) and capital gains.
Presently, the most common tax is the IOF tax, Imposto sobre Operacoes Financeiras, which is levied on financial transactions (insurance transactions, loans, transactions on marketable securities, exchanges). It applies a 2% tax to foreign currency inflows originating from investors resident/ domiciled abroad whose transfers come for the purpose of short-term availability of the Real. There has been a temporary resolution to reduce the tax, for some investors, to 0.5% through June 30, 1999, at which time the tax will return to its 2% level.
Another principal tax levied is the CPMF tax (Contribuicao Provisoria sobre movimentacoes Financeiras) a 0.2% rate which took effect in January of 1997, and applied through Jan. 23, 99 when it was suspended temporarily. The tax was applied to all cash accounts of foreign investors operating under Annexes I, II, III and IV, and was applied for every debit/foreign
exchange connected with transfers into or out of Brazil. The tax, per new regulations passed in Brazil, will be effective once again as of June 17, 1999, at a 0.38% rate for the first year (through June 00), after which time it will drop to 0.30% for the next two years (through June 02).
Finally, a 15% tax rate, withheld at source, is levied on income that is received from Fixed Income instruments.
Operating as an independent entity the CVSA, or Stock Clearing Corporation, is Argentinas principal institution providing securities clearing and depository services. The CVSA clears both equity and fixed income instruments and does so by book-entry, while simultaneously registering securities using the account name. On trade date plus three after the buying party delivers a certified transfer document, which verifies sufficient position in the sellers account, the CVSA transfers the securities by book-entry.
CRYL, the Central de Registracion y Liquidacion de Instrumentos de Endeudamiento Publico, is another clearing house in the market. It was created by the Argentine Central Bank in 1995. This clearing mechanism is responsible for the settlement of Government debt issued after April 16, 1996, and also takes responsibility for security registration, settlements, and income payments associated with new debt issues. Participants of the new system include agents from the OTC market, the MERVAL, and CVSA.
Agents and their clients can elect to hold these securities (called LETES or Bontes) at the CRYL or at the CVSA. Currently, all newly issued government securities are held at CRYL. These securities settle on a trade date plus three schedule as well.
Cash settlement for all instruments transferred at the CVSA and CRYL is done at the Central Bank through a new mechanism in the market known as MEP (Medio Electronico de Pagos). The MEP system is an on-line, real-time system that effects cash transfers on a transaction by transaction basis in the order that instructions are received by participants. The system verifies sufficient cash balances before effecting the transfer, and will reject instructions for accounts with insufficient balance. MEP is a less risky environment for cash transactions than the previous facility which required the delivery of paper forms to the Central Bank in order to initiate cash transfers.
New Clearing House ArgenclearTo combat the undeveloped security settlement process in Argentina, market entities have proposed the creation of an all-encompassing securities clearing agent, Argenclear. This entity is being designed to settle all securities transactions, including OTC trades, on a true against payment basis. Partly owned by the foreign banks association (40%), Argencontrol, by the local banks association (20%), ADEBA, and by two local banks, Argenclear will cooperate with the local brokers association and permit them to continue their settlement of all guaranteed trades of securities listed on the Buenos Aires tock Exchange. Phase I of Argenclears development has been completed. Currently, Phase II is under development.
Argenclear was expected to begin in March 1999, but there have been some delays involved. It is expected that once Argenclear is underway, the operations of CRYL will be merged with it.
The Over-the-Counter market is responsible for nearly all Argentine bond trading (95%).This activity is regulated by the Mercado Abierto Electronico (MAE), a body who oversees the OTC market. Eighty-nine member brokers are authorized to deal in OTC debt, a market whose 1997 figures for average daily turnover were over USD 1.5 Billion.
instruments that trade on the MAFO will be settled through the exchanges clearing house. Operations were expected to begin near the close of 1998, but delays have pushed the project to an undisclosed start date.
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