Brazil Exchange Cools in a Hot Market

Brazil needs no introductions when it comes to investors looking for hot
markets. But lately the exchange at the center of it all is facing
serious head winds.

BM&FBovespa SA has been pivotal in spurring growth in Latin
American capital markets. Stock trading on the exchange, the region’s
largest, surged to 1.6 trillion reals (about $887 billion) in 2010 from
150 billion reals in 2001. The Ibovespa index nearly quadrupled from
Dec. 31, 2000, to the end of 2010, as local and overseas investors
bought into Brazil’s prospects as a leading exporter of commodities like
iron ore, soy, sugar and beef to emerging markets like China.

Chief Executive Edemir Pinto says he expects a rush of new listings
when the global outlook improves, and a flood of investment before the
2014 World Cup and 2016 Olympics, both to be held in Brazil.

Toll of Taxes

But in the meantime, shares of BM&FBovespa,
which began at 11.84 reals in 2008, closed Friday at 9.23 reals. Market
watchers are concerned about Brazil’s exports in the face of a global
slowdown, and a few issues for BM&FBovespa itself: the effects new
taxes on investment are having on the market, a large tax bill the
company is contesting, and the possibility of a rival exchange arising.

BM&FBovespa was formed in 2008 through the merger of São Paulo’s
commodities and derivatives exchange, BM&F, with the São Paulo stock
exchange Bovespa. The new company continued to benefit from Brazil’s
exuberant domestic economy, with stable growth and a swelling middle
class. Service and consumer-goods companies eagerly lined up for
listings, seeking new capital.

The exchange grew in sophistication as well. Derivatives trading
increased at a pace similar to that of equities, climbing to $3.25
trillion in volume in August from $375 billion a decade earlier. This
was fueled largely by an appetite for stock-index, dollar and
interest-rate futures, and the creation of contracts such as ethanol
futures, begun in 2010 and already trading in monthly volumes over $200
million.

Profit for the combined companies jumped to 1.14 billion reals last
year from 756 million reals on a pro-forma basis in 2007. Revenue
climbed to 1.89 billion reals from 1.38 billion reals over the same
period. But revenue has been flat in recent quarters, as stock-options
trading volumes fell while high-frequency trading—which carries fee
discounts—grew.

Brazil has levied new taxes on speculative inflows to cool the strong
real: a tax on equity and fixed-income asset purchases, and a tax on
investors who cash in depositary receipts to get the underlying stock.

Mr. Pinto says these taxes could shift derivatives trading from Brazil to other markets, including offshore.

The taxes “killed” the arbitrage business in stocks on the exchange,
says Henrique Caldeira, an analyst for Barclays Capital, a unit of
Barclays PLC.

Brazil’s tax agency, meanwhile, wants 410 million reals from the
exchange, which has claimed the money as a credit in line with a tax
incentive it used during the 2008 merger. If the exchange loses,
analysts say it could knock more than one real off its stock price.

Rival Arrival

Then there is the looming possibility of a
competitor entering the market. In February, BATS Global Markets Inc., a
stock-exchange operator based in Lenexa, Kan., and Brazilian
asset-management firm Claritas Investimentos announced they will
cooperate on the possible creation of a new stock exchange with clearing
and depository services in Brazil.

The appearance of a pending rival “came about three or four years
earlier than we imagined,” Mr. Caldeira says. “It’s a player with
credibility and a history of entering a market with an aggressive
pricing strategy and lean structure.”

But BATS and partners are unlikely to set up a clearing service
quickly. They likely will pay BM&FBovespa for its post-trade
services until they can set up their own clearinghouse, a process slowed
by regulatory hurdles. BATS is in a quiet period ahead of its initial
public offering. Neither it nor Claritas were available to comment.

BMF&Bovespa, meanwhile, is seeking other growth opportunities through partnerships with CME Group Inc., the world’s largest futures-exchange operator, as well as bourses in Chile and China. These contacts could lead to cross-listing of shares and other contracts, especially as there is already great interest in developed markets for the underlying Brazilian assets.

Mr. Pinto says a deal is in the works with the Latin American
Integrated Market, which links the markets of Colombia, Peru and Chile,
that could attract more investors to Brazil and “show regional companies
that international markets don’t mean the U.S. only.”

Brazil needs no introductions when it comes to investors looking for hot markets. But lately the exchange at the center of it all is facing serious head winds.

BM&FBovespa SA has been pivotal in spurring growth in Latin American capital markets. Stock trading on the exchange, the region’s largest, surged to 1.6 trillion reals (about $887 billion) in 2010 from 150 billion reals in 2001. The Ibovespa index nearly quadrupled from Dec. 31, 2000, to the end of 2010, as local and overseas investors bought into Brazil’s prospects as a leading exporter of commodities like iron ore, soy, sugar and beef to emerging markets like China.

Chief Executive Edemir Pinto says he expects a rush of new listings when the global outlook improves, and a flood of investment before the 2014 World Cup and 2016 Olympics, both to be held in Brazil.
Toll of Taxes

But in the meantime, shares of BM&FBovespa, which began at 11.84 reals in 2008, closed Friday at 9.23 reals. Market watchers are concerned about Brazil’s exports in the face of a global slowdown, and a few issues for BM&FBovespa itself: the effects new taxes on investment are having on the market, a large tax bill the company is contesting, and the possibility of a rival exchange arising.
[BRAZIL]

BM&FBovespa was formed in 2008 through the merger of São Paulo’s commodities and derivatives exchange, BM&F, with the São Paulo stock exchange Bovespa. The new company continued to benefit from Brazil’s exuberant domestic economy, with stable growth and a swelling middle class. Service and consumer-goods companies eagerly lined up for listings, seeking new capital.

The exchange grew in sophistication as well. Derivatives trading increased at a pace similar to that of equities, climbing to $3.25 trillion in volume in August from $375 billion a decade earlier. This was fueled largely by an appetite for stock-index, dollar and interest-rate futures, and the creation of contracts such as ethanol futures, begun in 2010 and already trading in monthly volumes over $200 million.

Profit for the combined companies jumped to 1.14 billion reals last year from 756 million reals on a pro-forma basis in 2007. Revenue climbed to 1.89 billion reals from 1.38 billion reals over the same period. But revenue has been flat in recent quarters, as stock-options trading volumes fell while high-frequency trading—which carries fee discounts—grew.

Brazil has levied new taxes on speculative inflows to cool the strong real: a tax on equity and fixed-income asset purchases, and a tax on investors who cash in depositary receipts to get the underlying stock.

Mr. Pinto says these taxes could shift derivatives trading from Brazil to other markets, including offshore.

The taxes “killed” the arbitrage business in stocks on the exchange, says Henrique Caldeira, an analyst for Barclays Capital, a unit of Barclays PLC.

Brazil’s tax agency, meanwhile, wants 410 million reals from the exchange, which has claimed the money as a credit in line with a tax incentive it used during the 2008 merger. If the exchange loses, analysts say it could knock more than one real off its stock price.
Rival Arrival

Then there is the looming possibility of a competitor entering the market. In February, BATS Global Markets Inc., a stock-exchange operator based in Lenexa, Kan., and Brazilian asset-management firm Claritas Investimentos announced they will cooperate on the possible creation of a new stock exchange with clearing and depository services in Brazil.

The appearance of a pending rival “came about three or four years earlier than we imagined,” Mr. Caldeira says. “It’s a player with credibility and a history of entering a market with an aggressive pricing strategy and lean structure.”

But BATS and partners are unlikely to set up a clearing service quickly. They likely will pay BM&FBovespa for its post-trade services until they can set up their own clearinghouse, a process slowed by regulatory hurdles. BATS is in a quiet period ahead of its initial public offering. Neither it nor Claritas were available to comment.

BMF&Bovespa, meanwhile, is seeking other growth opportunities through partnerships with CME Group Inc., the world’s largest futures-exchange operator, as well as bourses in Chile and China. These contacts could lead to cross-listing of shares and other contracts, especially as there is already great interest in developed markets for the underlying Brazilian assets.

Mr. Pinto says a deal is in the works with the Latin American Integrated Market, which links the markets of Colombia, Peru and Chile, that could attract more investors to Brazil and “show regional companies that international markets don’t mean the U.S. only.”