The explosive trade relationship between Asia and Latin America is on the radar of most firms and asset servicing providers are expecting the dynamics of the region to work in their favour.
The explosive trade relationship between Asia and Latin America is on the radar of most firms and asset servicing providers are expecting the dynamics of the region to work in their favour.
There is a tendency to treat Latin America as a homogenous territory, but this region covers eight countries in North and Central America, 12 countries in South America and, if you include the Caribbean, another 13 sovereign states; two overseas departments and 14 dependent territories tied to the UK, France, Netherlands and US – although these figures are disputed between different sources depending on definitions. The point is, there is great diversity in the size and liquidity of markets across Latin America’s part of the Western hemisphere.
While the world focuses on political and financial risks in Europe as well as the disappointing performance of the US, writes Standard Chartered Bank in a recent report, a growth boom story is developing in the Asia-Latin American (Asia-Latam) trade corridor. Latin America has an abundance of raw materials, such as agricultural and mining products, to meet Asia’s demand, while emerging Asia is a low-cost producer of manufactured items such as electronics, textiles, and clothing, for which Latin America is a growing market.
“Asia-Latam is one of the world’s fastest growing trade corridors, with China-Brazil trade at its core. Growth in the economic and financial linkages between China and Brazil over the past five years has been impressive,” writes Standard Chartered.
Furthermore, the region has become a more viable export market for Asia because of greater macroeconomic stability resulting from reserve accumulation, trade/current account surpluses and more prudent fiscal policy.
That does not change the fact, however, that global market turmoil is hitting the region hard. Markus Schomer, managing director and chief economist for Pine Bridge Investments, remarks that seeing Latin America undeperform the rest of the emerging markets by a huge margin “was surprising” in a report just after global markets nose-dived in the summer.
In general, the drop is viewed as a temporary correction and certainly does not seem to make experts on the region think that there will be a slowdown in the tremendous growth of the fund management industry, particularly Brazil’s.
“B” is for BRICS
The country most at risk of an overheating economy is still Brazil. Over the past few years, the exchange rate shot up, creating a rush of foreign funds, says Jorge Vrljicak, research director at Westside Consultants, based in Buenos Aires. Last year, some of that pressure was absorbed by increased productivity and one-off taxes on private capital to discourage funds from coming into the country, yet the risks persist.
Economic cooperation between developed economies and Latin America in general had already been chilling. In 2008, the World Trade Organisation (WTO) Doha Rounds became deadlocked, with only half-hearted attempts at revival from the European Union (EU). This was quickly followed by the Lehman Brothers collapse, which triggered a financial crisis and the “great recession”. Markets are still see-sawing throughout the third quarter of 2011, when most analysts had predicted an economic recovery this year.
The US Federal Reserve’s quantitative easing programmes did not help matters either, says Vrljicak, adding that this has negatively impacted the views that Brazil, and Latin America in general, holds towards the US as an investment destination.
“Brazilians have not responded well to what Guido Mantega, the Finance Minister, calls a ‘currency war’ and while the country had a huge stock of US Treasuries in its foreign reserves, US officials were concerned that Brazil might dump them on the market,” Vrljicak says. At the time of publishing, Mantega was warning against any further quantitative easing measures by the Fed.
Although BRICS nations (Brazil, Russia, India, China and South Africa) are engaging with Washington on economic cooperation with the EU, at the same time the eurozone is still grappling with a seemingly never-ending sovereign debt crisis and the size and scale of any BRICS-led response is in question.
“As a result of these factors, in the past 12 to 18 months, the Europeans have become more absent, the US is not a favoured investment destination, so trade is moving to Asia,” he says. “And now, Brazil is getting into the mode of balanced budgets and refusing US dollars, which tells you something about the business sentiment, the business community is quite protectionist and the leadership has started saying that employment is the top priority.”
Still, the central bank in Brazil has turned a corner in using policy tools to control the situation. In what is being described as a surprise decision, the central bank lowered the overnight rate 50 basis points to 12 per cent at the beginning of September. Meanwhile, inflationary expectations for 2012 are over five per cent and are currently above the 4.5 per cent target.
“The central bank lowered the exchange rate by dropping the interest rate, and it came down a bit but not much. This first step, however, of lowering the interest rate, is a marked fundamental change in the central bank’s way of handling foreign exchange,” Vrljicak notes.
Whether this move continues to have the desired effect remains to be seen, but one thing is for sure, Brazil’s funds industry is evolving rapidly and becoming increasingly savvy and sophisticated.
“Fundamentally, you are going to have locals after that business, what I see is that this is going to be a very competitive arena…but the growth trend will be within the South American region itself,” says Vrljicak.
Asset servicing providers in the region agree. Michael Kalavritinos, managing director at BNY Mellon Asset Servicing, the largest independent fund administrator in Brazil, sees the same trend developing. He is responsible for Latin America and the Caribbean (excluding Brazil onshore).
“Historically, Brazilians who have invested offshore have looked to the US and Europe, and to some extent Asia,” says Kalavritinos. “But given the macroeconomic and political situation of Latin America, the region is in a much more solid position today than it has been in many years, and we are increasingly seeing interest among Latin investors in the their own turf.”
As an example, he points to initiatives like the stock exchange merger between Chile, Colombia and Peru, Mercados Integrados Latinoamericanos (Mila), which allows trading in the stock of all the listed firms from each individual exchange.
“Latin American banks are increasing their research staff and coverage of sectors and of the region as a whole. Looking at Chile, the country has an advanced and sophisticated retail mutual fund market and there are a number of mutual funds in Chile that are specific to Latin America providing expertise on investment in the region,” Kalavritinos says, adding that this trend will likely grow.
BNY Mellon, however, is not a bank in the region, operating just its asset servicing business for Latin and Caribbean clients which are focused on servicing cross-border assets, such as fund managers, central and commercial banks and pension funds. It has some $160 billion in AUA, of which about a third is from its Brazilian business which is focused on fund administration, fund accounting and other fiduciary services for local investment managers.
“We have approximately 400 staff on the ground in Rio de Janeiro and to a lesser extent in Sao Paulo, so we have a longstanding presence and a strong commitment not only to the Latin American market but also to the Brazilian market, which happens to be one of our core strategic global markets,” Kalavritinos says, adding that BNY Mellon continues to invest in not just asset servicing but other product and business lines as well.
The largest and most developed onshore domestic fund market - mutual funds, pension funds, hedge funds - is in Brazil. Though there are no explicitly defined hedge funds in Brazil, a multi-asset fund, or ‘multi-mercado’ in Portuguese, is essentially a similar structure. Mexico, however, is an important retail pension fund market and increasingly retail mutual fund market. And Chile has one of the most progressive pension fund markets since privatisation in 1981, says Kalavritinos.
In terms of credit risk, apart from international and local regulators overseeing the Brazilian market, Kalavritinos says that BNY Mellon has the proper risk controls and compliance procedures in place to mitigate concerns on creditworthiness.
“The Brazilian fund market is a daily NAV market, it is highly regulated and these are not the usual associations made when thinking about hedge funds or alternative investments,” he says.
The offshore market is the Caribbean domicile, meaning it could be a Luxembourg or Dublin entity and though Brazilian financial institutions and fund managers have offshore holdings to invest outside of Brazil, in many cases the Caribbean offshore market caters to non-Brazilian residents.
In general, investors that are domiciled in Brazil can tap into the market via local funds that in turn invest within certain limits in an offshore vehicle for exposure.
“This is still an emerging trend, not a large trend yet, but as the interest rate goes down in Brazil, I think investors will take a closer look,” says Kalavritinos.
“For the asset servicing provider, it is a positive thing, globally we service over $26 trillion in assets, we offer a network of over 100 sub-custodians which is one of the largest networks,” he says, “I think we are appropriately and positively positioned to service assets that are invested outside of Brazil and in a number of countries and we are optimistic that we will be well positioned as these investors become ready to dip their toes into the market, whether it is in the US, Europe or Asia. We look forward to that increased diversification of assets.”
Although funds are growing within Latin America and trade is growing with Asia, in terms of safe-keeping of assets, from a global custody perspective, that is still happening in the US, though BNY Mellon is looking at how additional resources might be used to allow it to become more locally rooted.
“It is important to be close to the market, close to our clients, to be consistently visible and present so that we have the local presence to understand the idiosyncrasies of each of the markets, the evolving regulatory changes and fiscal changes and to be positioned properly so that we are there when the right opportunities arise,” says Kalavritinos, adding that the region as a whole is rapidly changing and its needs are becoming more global.
“It is an opportune time to be expanding and not contracting,” he adds.
Fund administration boom?
It’s the microtrends that are most important and not the macroeconomics, says Alejandro Berney, head of securities and fund services for Latin America at Citi’s Global Transaction Services. “It is really the growth of the fund management industry that is driving growth in the fund administration business,” he says.
Today, Citi Global Transaction Services offers fund administration in Brazil, Colombia, Mexico Cayman Islands, British Virgin Islands, Bahamas, Bermuda and Panama, to fund managers that specialise in credit, private equity, equity, fixed income, hedge funds and ‘multi-mercados’. In Brazil, it is third in market share for independent asset managers not affiliated with larger banks.
Berney notes that the region has a growing middle class which is increasing its savings. Looking at the pension fund industry, for example, shows between 12 and 18 per cent growth.
“That is a lot of new money that needs to get invested, some of it goes to fixed income, but some if it is going into alternatives or funds, people are trying to find uncorrelated asset classes. Asset managers, meanwhile, sell funds to institutional investors like pension funds or high net worth individuals who are trying to diversify portfolios or increase returns.” Berney says.
Some 10 years ago, regional asset managers started to become much more sophisticated, using European and American investment strategies which are now boosted by sufficient, growing savings.
“We are seeing our market share grow. In the private equity space, we are at the top in terms of market share, [providing fund administration for] 17 per cent of assets under management. In terms of FIDICs, which is the name for credit receivable funds, we also have a relatively high position in terms of market share. The segments we are looking at most are the private equity, credit receivable and hedge fund spaces because they require higher added value services,” he says.
Brazil is home to the third largest derivatives exchange in the world and the seventh largest fund industry in the world with some one trillion dollars in assets under management. The size and depth of this market has much to do with the country’s regulatory framework which makes it attractive to use mutual fund structures for a wide variety of funds such as private equity and asset backed securities, even trusts – instead of a separately managed account, portfolio managers create a dedicated mutual fund.
“There is a long demand history in Brazil for fund administration because mutual funds are created for a many different reasons. Since the late nineties, it has been common for portfolio managers or asset managers to hire fund administrators, simply for the sheer load of work,” he adds. “What we find is that fund administration is growing not because funds are trying to reduce their internal costs but rather because they need to grow very quickly and need assistance both in terms of sheer processing and in terms of intelligence to develop new products.”
Yet, only three years ago pension funds were authorised to invest offshore, however, can only do so through a local multi-mercado which allows up to 20 per cent of assets to be invested offshore while a plain vanilla equity fund can invest only 10 per cent offshore. Funds allowing 100 per cent offshore investment are restricted to qualified individuals, which tend to be high net worth individuals who have more than $200,000 in investable assets.
Although Citi does provide fund administration services to clients trying to distribute more in Brazil to capture some of these flows, the opportunity cost of diversifying is very high for a Brazilian, Berney explains.
“Brazil has the highest real interest rates in the world, why invest in Europe at one per cent if someone can get a real, risk-free interest rate of six per cent? So although there are avenues to invest outside of Brazil and these avenues have existed for three years now, we see that investments outside of Brazil are minimal,” Berney says.
In the rest of the region, it is still market practice to keep fund administration in-house. However, Citi has started providing services for local exchange traded funds in Colombia and Mexico. Berney sees the same trend which is now booming in Brazil starting in those two countries as well as Chile and to a lesser extent Peru.
“Asset managers in [those countries] are really looking at the region, it is a matter of developing the products, going into complexity and needing assistance in terms of know-how and the best way to set up a regional fund – a Chilean manager launching a new fund in Colombia needs to set up a local fund but doesn’t want to set up a whole new office in Colombia. They want to start as lean as possible and therefore they outsource the fund administration, the custody and other services as well,” Berney says. “It is similar to the Brazil story but a couple of years behind in evolution. We are sure it is going the same way though.”
Offshore capacity
Another trend is emerging as the region gears up for additional funds flow. Though the Caribbean is not at this time on the radar screen as a potential competitor for the fund administration business, say major transaction services providers, at the same time, some market participants are seeing an increase of funds flowing from Brazil to the Cayman Islands and other locations.
“We are seeing a lot of flow from Brazil going offshore and are seeing firms building capacity to invest off shore on the Brazilian risk profile,” notes Guillaume Weeger, manager and market specialist in the Americas for Calypso, an integrated platform provider.
