Leveraging Opportunities in Latin America
Insights into Cash Management in Brazil, Argentina and Mexico
By Florent Michel, Managing Partner, and Jorge Barnfather, Consultant, Latina Finance & Co.
The global financial crisis has helped companies to refine their investment focus and to target countries specifically offering particular opportunities in supply and/or demand. While Asia, particularly China, has dominated much of the trade press, Latin America remained largely resilient during the crisis and companies of all types are increasingly recognising the potential in the region. This is reflected too by many of the major international banks announcing their expansion in Latin America, particularly Brazil. With Latin America offering both short-term and longer-term opportunities for growth, companies of all types should be reviewing not whether but how to leverage these opportunities most successfully
The financial sector in Brazil is no exception to the booming economy in the rest of the country. The growth of cross-border funds in and out of Brazil is a first in the country’s history. Three numbers to remember for 2010: a growth which should reach 7.5%, an inflation rate below 5 % and finally a currency, the BRL, which is at its highest level for the last fifteen years at around 1.7 BRL per USD in October. Political stability and strict fiscal policy governance is paying off. Brazil attracts a wealth of investors sometimes disappointed by China, Russia or India. However, bureaucracy has not disappeared and the country is developing a strong market-driven economy alongside an important public sector.
Tax, tax, tax…
The Brazilian tax system is relatively complex. Firstly because there are three levels of tax collection: federal, state and municipal. Secondly because while tax rates and their application seem to be relatively well defined on paper, they are full of exceptions and rulings depending, for example, on industrial sector or on the financial situation of the company. A reliable tax adviser is a must. Indirect taxes represent on average 40 to 50% of a company’s operational revenues, so it is far from being a benign item on your balance sheet.
The key tax on financial items is the IOF (Imposto sobre Operacoes Financeiras), which is a tax of 0.38% applicable to most, if not all financial transactions. There are no debit/credit taxes but the IOF replaces them as it touches nearly every movement of funds except bank account debits and credits. Foreign exchange and derivative transactions have additional taxes. Brazil has its own ruling in respect of transfer pricing and does not abide by the OECD rules: tax consultation is essential in order to avoid requalification.
Efficient payment and collection systems
Brazil is at the forefront in terms of cash management and electronic settlement of transactions. Banks offer state-of-the-art cash management processing platforms, accommodating the needs of corporates wanting to stay manual or others which favour outsourcing.
There is as an RGTS for mass payment (STR and CI-SITRAF) and another clearing house (CIO-SILOC) for payments of less than R$5,000 (soon to be reduced to R$ 3,000). The latter clearing house also clears Boletos (a collection instrument taking the form of an electronic invoice widely used in Brazil). The RGTS payment system is called TEDs and it settles in 45 minutes. The other is called DOCs and settles on D+1 or D-1 depending on banks. As for cheques there is a specific clearing house called COMPE which clears cheques on a national basis. Cheques are settled D+1 as well as Boletos. SwiftNet is not very well developed as the banks have their own proprietary systems and also manage the cumbersome foreign exchange authorisation process.
Liquidity management is centre stage
Liquidity management remains one of the key issues and most difficult things to manage in Brazil. Corporates are only allowed to have accounts in B$, which limits room to manoeuvre. However in certain cases corporates can open offshore USD accounts under the control of the central bank, allowing them to settle their USD payments and collections without having to convert funds to B$ and pay related FX commissions and taxes. There is strong pressure on the central bank to relax foreign exchange controls and allow companies to hold foreign currency accounts in the country.
For domestic funds, ZBA is commonly used in Brazil among subsidiaries of the same legal entity and banks offer automatic transfers of end-of-day balances. Pooling among different legal entities is IOF taxed at 0.38%, which makes the proposition unattractive. Corporates with large volumes set up their own investment fund (FIDC) where they concentrate flows using non-taxable trade instruments to net their financial position, but this is only feasible for large companies with yearly volumes exceeding B$100m. Placement is also difficult: any placement of less than 30 days is IOF taxed (on a reducing scale). However, the banks have developed a number of short-term products which can provide reasonable interest payments and sometimes avoid IOF payment. Each bank has its own brand for such products. On USD offshore accounts (when permitted) banks offer overnight cash sweeps on those offshore deposits.
Banks surfing the wave
Competition among banks is fierce in every segment including treasury and cash management. Everyone wants to capture part of the country’s growth, but bancarisation is still low at around 40%, so the prospect for banks is attractive. The local wholesale market is dominated by three large domestic banks Itau, Banco do Brasil and Bradesco. Foreign banks are also taking their fair share but their smaller network and little retail activity limits their capabilities in some areas such as payroll or tax payments.