In the second part of an interview, Fabio Zenaro (pictured), products superintendent at Central de Custódia e de Liquidação Financeira de Títulos (Cetip), talks about how the interest rate in Brazil is forcing investors to look for alternative assets for their structured (certificado de operações estruturadas – COE) investments, the use of these products in pensions and the challenges around suitability and how to create a robust regulatory framework to avoid shortcomings seen in other markets.
Will the Brazilian market open up to new wrappers once public distribution is in place?
Once certificado de operações estruturadas (COEs) become a public distribution market, investors may demand other types of wrappers based on tax considerations. Structured products can be wrapped in different ways and investors will eventually vote with their feet. This market will open up a whole new world in terms of ideas and assets, and we see already how investors are using products providing exposure to foreign markets to hedge themselves against the uncertainty around Brazil’s economy. The challenge at the moment for the COE market is the interest rate in Brazil, which currently stands at 14.25%. This is pushing investors to demand new and different investment propositions such as basket of shares commodities and indices (information regarding volumes).
COEs are flexible enough to deploy in different situations and we also think that these products will have a very important role in pension funds, as they provide exposure to markets but also capital protection, which is what pension funds are designed for. In the past, if a Brazilian pension fund wanted to invest in a structured product, it had to be done in the offshore market.
Are there any concerns around public distribution?
There are issues around public distribution that will need to be addressed, such as suitability. At the moment, the issuer is responsible for making sure that the products are suitable and fit the risk profile of the end investor. But once public offering is approved, distributors will also have to take some responsibility around disclosure, transparency and suitability. That’s why we also believe that, in the early stages, products offered under the new public offering rules will be very standard and vanilla with simple payoffs and underlying structures mainly seeking exposure to local assets (equity index) as they are well known by the Brazilian public. This also applies to the capital protection element of these products. One of the main selling points of COEs is the capital protection, but as the market evolves and investors get used to them, we may see investors seeking yield demanding capital-at-risk structures. We are aware that some banks are considering and assessing possibilities, but we don’t think we will see these kind of structures in the short term.
What is Cetip’s role in the COE market? Can Cetip help the market develop?
Cetip’s role in the development of the COE market will be key in providing information and educating investors about these products. The regulatory guidelines require that COEs are registered with a clearing house and this is a requirement that will add transparency to the market. Any COE reaching the market must be registered on Cetip or other clearing house approved by the Securities and Exchange Commission of Brazil (CVM). The CVM has the information about issuance and Cetip also provides information about mark-to-market and settlement calculations. There is no secondary market for these products in Brazil, but any transaction around COEs has to be reported and registered with Cetip.
Once the public offering is approved, the need for a secondary market will increase and providers of COEs will feel that providing liquidity to the products they sell will be seen as post-sales added value, but this is also something that will happen with time. This will also encourage the development of a listed products market provided by the domestic stock exchange.
Are there any issues around compliance with global regulatory requirements?
We don’t see any issues around suitability because under new international regulatory requirements issuers of COEs will have to demonstrate that they have the right processes in place to avoid mis-selling. Banks have learned the lessons of the financial crisis and compliance teams play a very important role. All these processes will also be beneficial for the end investors, as issuers are now focused on providing value. Selling COEs to the wrong investor could have reputational consequences and we believe that issuers and distributors will make sure that any product they bring to the market will comply with suitability guidelines. As the market grows and investors become more familiar with COEs, we may see more complex structures, but I think these will only made available to professional or sophisticated investors.
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