Cracking Brazil

Cracking Brazil As Brazil’s booming economy becomes ;increasingly integrated with the world’s markets, more local companies and entrepreneurs are exploring the benefits of using offshore structures to facilitate their expansion into the global flows of commerce and capital.

Where other regions have benefited for decades from the well-established and sophisticated use of offshore structures, it is perceived that Latin America has lagged behind due to protectionist policies that have created obstacles to the use of offshore structures. However, a recent report on the flow of Brazilian investments abroad published by Brazil’s Central Bank confirms that for years Brazilian businesses have utilised offshore structures to protect and direct their investments abroad.

According to the report, direct investments abroad increased by nearly 50 per cent in 2006, and for the first time in its history the country’s direct investment abroad outweighed the foreign direct investments into Brazil. The one factor that has remained constant throughout the period of analysis (2001-06) is the destination of Brazilian investment capital – principally to leading offshore centres the Bahamas, the British Virgin Islands (BVI) and the Cayman Islands. These three plus Bermuda and Denmark accounted for 66.8 per cent of all Brazilian capital abroad in 2006.

As more Brazilian companies establish fixed presences and acquire companies globally, they are expected to take advantage of the well-established benefits offered by jurisdictions such as the BVI, where companies can be set up with great efficiency, flexibility, security and at a low cost. Another recent development that augurs well for the offshore industry is the increased use of offshore structures to facilitate access to leading capital markets, London’s AIM market being an attractive destination for a growing number of dynamic Brazilian companies in key areas such as biofuels and commodities.

Going internationalAnother area of growth and internationalisation of the Brazilian economy is the investment funds industry. Brazil’s investment funds market has experienced spectacular growth in recent years. According to some estimates it has grown from $171bn (£86.17bn) worth of net asset under management in 2003 to more than $600bn (£302.34bn) by the end of 2007. Estimates are that the ;Brazilian ;funds industry accounts for more than 85 per cent of all assets managed by investment funds in Latin America.

Historically, Brazilian investment funds have been largely prohibited from investing their capital outside Brazil. Recent ;regulatory changes aim to remove such restrictions and allow certain Brazilian funds to invest an unlimited portion of their assets outside Brazil.

The Brazilian law on investment funds is based on a series of instructions enacted by the Comissão de Valores Mobiliários, the Brazilian entity responsible for regulating the country’s financial markets and its participants, including investment funds. Although the Brazilian framework mirrors some aspects of other sophisticated regulatory models – for example, recognising a distinction between open and closed-ended funds – in other aspects Brazilian law differs significantly, establishing strict and detailed restrictions on the types of investments that funds can invest in.

Lifting restrictionsIn recent years the regulator has moved to loosen some of these restrictions. This reflects a desire to allow greater flexibility and diversification of investment portfolios, and is a result of increasing comfort that the local industry has reached an adequate level of maturity.

It also shows a recognition by the regulator that, as interest rates in Brazil come down, fund managers will need to look elsewhere to generate the high returns that are demanded by sophisticated investors, and also that international diversification must play a significant role in producing a balanced risk-reward portfolio. Three particular enactments have revolutionised the market – Instruções 450 and 456 passed in 2007 and Instrução 465 released this year. Instruções 450 and 456 began the opening by creating limits on the amount of investment a fund could place on securities outside Brazil. Hedge funds were allowed to invest up to 20 per cent of their capital in securities abroad, subject to certain conditions. Instrução 465 goes significantly further and allows hedge funds to invest up to 100 per cent of their capital outside Brazil, subject to conditions including that such funds must require a minimal investment of R$1m (£301,000) and that they expressly state that they constitute investment abroad.

Brazilian funds may or may not set up offshore structures as a result of these changes, but it can be expected that as they become more global they may begin to compete for global investors, at which point, like their counterparts in all developed markets, they too will benefit from using offshore structures. nMarco Martins is head of the Latin America practice at Harneys, Brazil