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Page last updated
February 15, 2003




"Latin lovers"
Brazil & Argentina; unique neighbours

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 America’s 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.


Entry Requirements
Brazil, frequently seen as more sophisticated with larger volumes and market capitalization, has many restrictions of which foreign investors must be aware. These foreign investor restrictions extend not only in terms of legal investment vehicle and registration requirements to gain access to the market, but also with respect to cash payment flows, taxes, and to foreign exchange transactions.

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.

Restrictions apply to foreign investors in Brazil as well, some which pertain to the instruments in which they can/cannot invest depending on their investment mechanism, while other restrictions apply to investors’ operations within the market. Generally, foreign investors in Brazil can only acquire securities of companies that are publicly traded, and must conduct these transactions over an authorized stock exchange or approved

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 company’s 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.

The trading and settlement methodology in Brazil has some unique characteristics as well.

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.

Another unique characteristic of the Brazilian market is its tax regulations which are imposed differently depending on the mechanism

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.

Foreign Exchange
The Banco Central do Brasil controls the foreign exchange market closely, and until January of 1999 required that inflows and outflows of currency be classified into one of two foreign exchange markets: (a) the commercial exchange (commercial and financial operations), and (b) the floating rate exchange market (the tourism exchange). As of January of this year, the two markets have been unified into one floating rate. Foreign exchange does not have to be related to a security settlement in Brazil.Other foreign currency restrictions exist requiring foreign investment capital flowing into Brazil to be explicitly directed to a foreign investors account. If a client wishes to repatriate funds, these funds must leave the country under the same account name. Also, because the Brazilian currency (real) is not freely convertible, FX deals are quoted into U.S. dollars.


Entry Requirements
In contrast to Brazil, Argentina’s legal framework governing foreign investment is one of the most liberal in Latin America. This approach has paralleled the economic transformation that has taken place in Argentina over the past decade, emphasizing foreign investment as one of the pillars of the new economic system. As a result of this approach, few restrictions apply to foreign exchange transactions, to exchange and off-exchange trading, or to the vehicles in which foreign investors may invest. There are few taxes that apply in this market but those that do are not significant.

Historically, the principal stumbling block for foreign investors in Argentina has been accepting the risk relating to securities settlement. This has been a complicated issue in the capital market as the central securities depository in Argentina, the Caja de Valores (CVSA), is only responsible for securities transfers. Cash associated with trades is transferred at the Central Bank, but these two movements (cash/securities) are not linked, simultaneous, nor revocable. Thus, true DVP/RVP has been difficult to achieve, and this helps to explain the high market fail rates which typically run between 12% and 16%.

Operating as an independent entity the CVSA, or Stock Clearing Corporation, is Argentina’s 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 “Argenclear”To 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 Argenclear’s 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 Bolsa de Comercio de Buenos Aires, the Buenos Aires Stock Exchange (BASE), accounts for 95% of the securities trading in Argentina. The remaining activity occurs in bourses located in provincial cities, but these are small and therefore not significant for foreign investors. The BASE lists over 130 securities, and has a market capitalization of over USD 90 Bn as of January of 1999. While being the exclusive exchange for equity trading, the BASE also trades government and corporate debt, and options. In 1995, the average daily volume for all instruments traded at the BASE was greater than USD 400 Million, but today following the tequila crisis and the more recent crisis in Brazil, daily average volume has dropped to approximately 200 Million.

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.

The tax regime employed in Argentina is very liberal. There is no withholding tax associated with the payment of dividends or capital gains relating to foreign investors in Argentina. Also, most interest is free from withholding with the exception of interest earned on savings accounts, certificates of deposit, and Private Debt instruments (i.e. commercial papers) which are subject to a 15.05% tax. This rate can change if the investor provides evidence of being either tax-exempt or subject to a lower tax rate in his tax domicile. There is no tax reclamation in Argentina.

Foreign Exchange
The Foreign Exchange Market in Argentina is not subject to any restrictions, and transactions do not have to be related to a stock exchange execution. Foreignexchange transactions can be conducted through Banks, Financial Institutions, and FX brokers in Argentina, and instruments include same day, 24hour, and 48hour foreign exchange. A forward market also exists where 30, 60, 90, and 180 day forward deliverables are the most common instruments traded.

The Futures and Options Market (MAFO) and its clearing house is currently being developed in Argentina. Clearing members have begun to clarify the implementation plan for the clearing house as they prepare for its introduction to the Argentine market. The new market will offer futures on a stock exchange index, a local fixed income instrument, interest rates, and foreign exchange contracts. Expectations in the future are to expand this list to include options contracts and other derivative products. All

instruments that trade on the MAFO will be settled through the exchange’s 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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