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Latin America


26 April 2011

The big players are already gaining a foothold on the continent, and
investors are excited about its potential


Image: Shutterstock
Along with Asia, Latin America is the big hope amongst the financial community for long term high growth, innovative product development and a range of opportunities. As one of the BRIC countries alongside Russia, India and China, Brazil is at the forefront, but there are a number of other territories where much is expected.

In the last ten years, several elements have come together to make Latin America a very exciting location for managers of and investors in hedge funds. These elements include a substantial and increasing population of wealthy and institutional investors, continuously improving managers and a flood of international investors looking for geographic diversification.

As the size of the market has grown, so too has its level of sophistication. Just as US, Asian and European investors have come to demand greater levels of operational and investment excellence, Latin American investors also now expect to receive the same standards. This includes institutional quality risk management, compliance, execution and a clear, repeatable and consistent investment methodology, among other things.

Wherever you go south of the US border, the international players can be found. Spanish banks have historically had a strong presence in most markets thanks to their colonial ties, and this has been strengthened with the mergers of Spanish and Portuguese providers. But the US banks are well represented, with Citi, J.P. Morgan and Northern Trust just three of the larger players. From Europe, HSBC has significant operations, as do Deutsche Bank and BNP Paribas. And there are a number of local providers who still claim to have the greatest market knowledge and the best service.

Mexico

Although there are some players with a more pessimistic view, the general feeling is that securities lending has done remarkably well during the downturn. Within Mexico, we have seen the volumes of securities lending increasing about 25 per cent in the last two years, says Patrick Avitabile, managing director and global securities finance head of equity trading at Citis Global Transaction Services in New York. The short sells are increasing, and therefore, the market need for securities lending has grown. Offshore, we have witnessed an increase of roughly the same magnitude.

The increase is mainly an offshoot of additional borrowers participating in the Mexican market. We now trade with in excess of a dozen counterparties, where that number was two-to-three two years prior.

Its international players that are driving the market, agrees fund consultant Enrique Sanchez. Were seeing an increased confidence in the underlying strength of the Mexican market, he says. Pretty much everything that could go wrong [in the economy] did go wrong in the last three years, yet the country remains on a firm footing. And thats a good advert for encouraging inward investment.

Were also seeing more domestic funds involving themselves in lending securities. They have learned from their North American neighbours about the best ways to earn income while protecting themselves, and have an increased confidence in allowing their securities to be used. They still prefer the reassurance of a major international player to act on their behalf, however - at the moment, size really does matter when it comes to outsourcing these sorts of services.

The securities most lent and borrowed are the major companies of Mexico, especially those that are offshoots of multinational firms - the Mexican offshoot of Wal-Mart, for example, is very popular, as are telecoms, oil and mineral stocks.

When it comes to collateral, the eligible resources are set out by the regulators. Federal bonds are the most popular form, although corporate bonds remain an option. Cash is not allowed, which creates significant differences from the US market, while if share are to be offered, they have to be in the most liquid and high-profile companies.

Perhaps uniquely amongst emerging economies, its difficult to find someone prepared to criticise Mexicos regulatory or the regulators themselves. We have never had a serious problem with the regulators here, says a representative of one of the major Spanish banks, who adds that this is not the case in other markets on the continent, particularly Brazil and Argentina.

As securities lending has developed within Mexico, the authorities have taken the attitude that this instrument is good for the market and they have applied a light touch that others really should learn from. Thats not to say that the market is unregulated - far from it - but that they do not make knee-jerk decisions that damage the market. They make sure they understand what is going on and what the impact of any new rules will be before they act. Its a breath of fresh air.

Brazil

Two firms dominate the securities lending market: the mining company Vale, and the oil business, Petrobras. Together, they make up almost 20 per cent of the market. Minerals and oil firms, along with banking, are the biggest securities, reflecting their positions within the investment markets.

The Brazilian stock market is one of the fastest-growing markets in the developed world, says one player. At the moment, the securities borrowers are interested in are limited because only a handful of companies dominate the financial landscape. But as the market grows and becomes more mature, and more companies become listed on Bovespa, this will filter down into the securities lending market because more people will be more comfortable working with more securities.

In terms of the participants in the securities lending market, mutual funds, both foreign and domestic dominate. Its simple really, theyve been in the [securities lending] market the longest, and they are most comfortable with the strategies involved, says fund consultant Eduardo Sanchez.

Theyve also got the international reach, although many of the domestic ones stick to South America, so their lending decisions can be made on an international basis. Where were not doing as well as we can is in getting pension funds involved - if they do any lending at all, they prefer cash collateral.

The providers encompass the major international players in the region, in particular Santander, trading as Banco Santander Brazil, and J.P. Morgan. But there is also a strong domestic industry, with smaller firms servicing their local counterparts.

The major international investors prefer to use the international banks, says Sanchez. And in Brazil, this is not a bad thing - the likes of Santander have been here for many decades and have a deep understanding of the market. Their local expertise is just as good as the domestic providers and they have the global breadth to help with wider strategies.

However, I would like to highlight that the domestic firms are also very good value. They tend to service the smaller funds, and because their fees are sometimes lower - for the same quality of domestic service - they will always have a valued place in the market.
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