The introduction of structured notes (certificados de operações estruturadas – COEs) in Brazil earlier this year has opened up the country’s structured retail products market, with a number of issuers including Bradesco, BTG Pactual, Citibank, Credit Suisse, Banco Santander, Safra, and Itaú BBA embracing the new marketplace. SRP spoke to the head of individual sales and structuring at Itaú BBA, Luis Fernando Mendonça, about the challenges to develop the Brazilian retail market in the short term.
According to Mendonça, the market is still at the very beginning of its development phase. “We are still in the same scenario we were six months ago in terms of market players,” he says. “But the use of underlyings has been more dynamic. The main asset classes underlying COEs include inflation and FX rates, but we have seen some new underlyings, still incipient, such as quanto structures linked to the S&P500 index.”
The introduction of the COEs was seen by the Central de Custódia e de Liquidação Financeira de Títulos (Cetip), one of the clearing houses authorised by the Central Bank of Brazil and the Securities and Exchange Commission (CVM), as a way to increase transparency and facilitate the regulator’s work as it will no longer have to monitor several transactions as it did in the past. For investors, says Mendonça, it opens a new world of opportunities.
“The main advantage is the simplicity of execution so investors can choose the index, the scenario, and the underlying indices. COEs also provide access to international markets, which could be more complicated using other investment alternatives,” says Mendonça. “These are very flexible products.”
Mendonça also believes it is a matter of time and investor education before structured products can compete with other alternative investments in Brazil.
“Education is limited at this time and local investors are not fully aware of this alternative option to diversify portfolios,” he says. “The more issuers, participants, and distributors get involved in the COE market, the more easily local investors will find out about the advantages COEs provide.”
Public distribution
The current restrictions on retail public distribution have limited the promotion of the new intruments, says Mendonça, and the current market environment is not helping either.
“Interest rates rising above the 11% mark are providing unfavourable scenarios for structure notes,” he says. “It’s more difficult for investors to get guaranteed returns in the current market conditions. Lowering interest rates to levels seen in other countries will give us more room to grow the market.”
According to Mendonça, public offering restrictions will soon be a limitation of the past. “Once the Brazilian Securities and Exchange Comission (CVM) authorises the full public offering of structured notes, we will see international banks and smaller players entering the market and increasing competition,” he says. “[Providers] will be able to access clients with all sort of profiles, as well.”
Itaú, added Mendonça, is not concerned or threatened by more competition in the market. “Actually, this would help our efforts to promote these products and increase the buyers’ market by up to three times,” he says.
Challenges
As in every other market, regulators are concerned about the disclosure of the risks embedded in structured products and are putting significant emphasis on the education of the end investor and the sales force of the different providers.
“Itaú is very committed to educating our sales force and making sure there is a clear understanding of the risks, structures, etc, making sure the suitability requirements are aligned with clients’ needs,” says Mendonça. “One of the reasons why we are the leading provider in the market is because of our commitment to provide the best alternative possible to our clients focusing on innovation according to their needs and risk profile.”
Mendonça also believes that new products and pricing are essential but that Itaú’s main concern is to sell adequate products to clients with the appropriate profile.
The current interest rate environment, says Mendonça, favours capital-protected structures. “Interest rates keep going up (currently stand at 11.25%), and the market is expecting a further rise next month,” he says. “This could change in the near future depending on how the market reacts to other factors such as changes in economic policies from the minister of finance and the central bank. If this happens we may see the market opening to capital-at-risk products, although with some sort of soft protection.”
Plans
According to Mendonça, Itaú is focusing on creating more structured products for investors with less risk aversion as there is increasing demand from sophisticated investors. “They have more appetite for risk and are looking for opportunities to balance their investment portfolios with products featuring cliquet structures, for example,” he says. “That’s because our medium-risk portfolio is complete, so we are ready to move on to the next level and target clients that we don’t support right now.”
The market, says Mendonça, is ready for more equity products linked to US stocks and indices such as the local benchmark, Ibovespa, as well as other mainstream indices such as the Eurostoxx50 index or the S&P500 index.
“We predict a bigger market, with more players, once the ‘full’ public offering regulation goes live,” concludes Mendonça. “This is something that will drive the Brazilian structured products market forward. There is an enormous potential for growth as COEs continue to exceed market expectations.”
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