Thought Magazine

Key Liberalisation Efforts in the BRIC Markets

“A range of market developments is evolving worldwide at any given point, and our preference, obviously, is that the changes are favourable to foreign investors as markets seek to attract foreign investment,” said J.P. Morgan’s Mike Guy in a recent discussion. “The course to liberalisation is not straightforward, so while we see many positive changes, there are some that move the needle in the opposite direction.” The ‘hot’ markets vary over time, but Guy notes that the BRIC markets (Brazil, Russia, India and China) are still a staple in any emerging markets portfolio. While there is a tendency to discuss the four BRIC markets as one, each has a distinct identity that evolved in its own way.

“The path to liberalisation is indeed a winding road, and each market will evolve in its own way and at its own pace.”

Brazil—most friendly to foreign investors

In comparison to its BRIC counterparts, Brazil is arguably the most friendly to the foreign investor with relatively low entry requirements and a more clearly defined regulatory framework. However, one consistent challenge over the past few years relates to tax regulations that have been subject to frequent and short notice changes, which can be disruptive to the foreign investor.

The most familiar is the Imposto Sobre Operações Financeiras, more commonly referred to as IOF tax, a tax levied on purchases of the local currency BRL. Over the past years, the regulation has changed numerous times, with tax reductions or increases introduced depending on local policy at different points. Most recently, the tax has been reduced to zero percent for certain fixed-income securities in order to spur foreign investment in Brazil’s infrastructure and technology research and development. Another change welcomed by foreign investors was the decrease in the rate on foreign exchange inflows for secondary market investment in real estate investment funds purchased through the exchange (BM&FBovespa) from 6 percent to 0 percent.

As is the case in many markets, the process for foreign individual investor access in Brazil has been somewhat opaque. An additional development on the radar is a move to simplify the local tax identity process. This will make ease of access for individual investors comparable to that of institutional investors.

Beyond tax liberalisation, additional efforts by Brazilian authorities are underway to attract investment. As noted by Ricardo Nascimento, the head of J.P. Morgan direct custody and clearing in Brazil, “Local market entities and financial institutions are coming together to broaden the off-shore individual investor base here.” A good example of this is the BM&FBovespa initiative named Brazil Easy Investing (BEI), a software that will provide foreign investors with improved access to trade Brazilian equities in the investor’s home currency. “Brazilian banks and brokerage houses will benefit from the flexibility BEI offers, opening greater access to an investor segment that is largely absent from the local equity investor profile,” said Nascimento.

In aggregate, the changes in the market appear to be positive, and as the largest market in Latin America, Brazil continues to feature prominently for investors.

Global Investment Allocation in BRIC Markets

2Q2013 GlobalInvestmentAllocationinBRICMarkets.gif
Source: MSCI, J.P. Morgan Investment Analytics & Consulting estimates

Russia—an opening investment landscape

At the opposite end of the spectrum, the Russian market has been hampered for many years by the lack of internationally recognised practice in the capital markets arena and by complex market entry requirements.

The lack of a central securities depository (CSD) historically proved to be a major stumbling block for many foreign investors, particularly 1940 Act investors and other fiduciary funds. This caused some investors to avoid the market, and it subjected others to complex settlement processes and high processing costs. However, recent and planned market developments have been significant in setting the foundation for a dramatic transformation of the Russian marketplace and have been well received by the foreign investor community. The trading infrastructure has led the way with the merger of the RTS and MICEX exchanges to create a single entity, the Moscow Exchange, which now supports all exchange trading activity across equities and debt. The Moscow Exchange has recently listed itself with an IPO to further increase its profile and transparency.

The Russian regulatory framework has also received significant attention and amendment recently. The long-awaited creation of regulation to support the concept of a single CSD was welcomed by investors, and the National Settlement Depository (NSD), through the acquisition of the Depository Clearing Company, has established itself as the CSD, recognised under local and international standards for all instrument types.

The recognition of the foreign nominee concept is another anticipated development and is expected ultimately to lead to the reduction of market documentation. Further clarity and guidelines still are needed for registrars and issuing companies to ensure that the treatment of these nominee companies, particularly for voluntary corporate actions and participation in general meetings of shareholders, is understood and supported.

Eddie Astanin, chairman of the executive board of the NSD, told Thought that he considers these changes to be very significant. “I believe they will have an extremely positive impact on foreign investors, infrastructure, issuers and the Russian capital markets in general,” said Astanin. “The rapid changes associated with the central depository development, the establishment of the united stock exchange, etc., are important milestones for our national infrastructure development to become in line with leading global financial centers.”

With the infrastructure aligning to international standards, the investment landscape should open to a wider range of institutions, but a bit more clarity is needed. Astanin agreed: “I tend to think we are at the beginning of our way of the infrastructure rearrangement. Specifically, Russia needs to have more clear disclosure procedures and a clear tax regime, especially the one associated with foreign nominee accounts. Furthermore,” he added, “the market needs CCP with T+2 settlement scheme, based more on STP and SWIFT messages, corporate actions procedures, tri-party services, etc.”

India’s Net Cumulative Foreign Institutional Investor (FII) Inflows

FII inflows on February 28, 2013 stood at approximately US$170 billion. Of these overall, 80 percent have been invested in equity with the remaining 20 percent in debt.
2Q2013 IndiasNetCumulativeForeignInstitutionalInvestorInflowsSource: SEBI

India—a focus on attracting incremental foreign investment

The importance of foreign investment to India was clearly reflected in a speech delivered in the parliament by P. Chidambaram, the minister of finance, as he presented the Union Budget for the year 2013-2014. He stated: “This year, and perhaps next year too, we have to find over US$75 billion to finance the CAD [current account deficit]. There are only three ways before us: FDI [foreign direct investment], FII [foreign institutional investment] or External Commercial Borrowing (ECB). That is why I have been at pains to state over and over again that India, at the present juncture, does not have the choice between welcoming and spurning foreign investment. If I may be frank, foreign investment is an imperative.”1

India is a dynamic market where foreign investors tend to experience frequent changes to regulations and processes as well as new requirements. With a view toward promoting foreign investment in the debt market, the Ministry of Finance along with the Securities and Exchange Board of India (SEBI) and Reserve Bank of India have recently introduced a number of measures, including an increase in debt investment limits and a relaxation in associated investment restrictions pertaining to the lock-in period and initial and residual maturity requirements. Since these changes were implemented in different stages and are applicable to certain instruments, there is still a disparate set of rules of which foreign investors need to be aware. By 2014, the expectation is that a common approach to allowing reinvestment of debt limits will take effect.

The regulators have also undertaken important measures for the overall development of market infrastructure and deepening of capital markets, such as the launch of new avenues like offer for sale (OFS) and the institutional placement programme. The OFS model has been periodically fine-tuned by the regulator to provide greater flexibility to investors in placing margins. Additional measures include the mandatory settlement of commercial paper and certificates of deposit through the Indian Clearing Corporation, as well as a reduction in withholding tax rates applicable to foreign investors on their investments in long-term infrastructure bonds.

“We anticipate further developments to ease access to the Indian market for foreign investors given the focus on attracting incremental foreign investment,” said Guy. One key area of change that would be welcome and which is under consideration by Indian regulators is a simplification of market entry requirements. “We are watching the market dynamics closely and remain in regular discussions with regulators locally to support any improvements on the landscape,” he added.

China—further liberalisation expected in 2013

The China A securities market opened to foreign investors in late 2002 through the Qualified Foreign Institutional Investor Scheme (or QFII Scheme). Upon introduction, local regulators tightly controlled market access and investment. Though the market entry process is still extensive, initially it was even more so, and could not be compared to that of any other market. Many investors were prohibitively challenged by its complexity, from the initiation of the application to the initial investment.

In subsequent years, local regulators gradually relaxed various regulations governing the QFII Scheme. In the last 12 months in particular, local regulators have undertaken significant steps toward liberalisation by introducing several major changes.

One key change was the relaxation of QFII’s eligibility criteria, which lowered the requirement on track record and operational experience, as well as a substantial reduction in the assets under management requirement from US$5 billion to $500 million. In addition, the application process has been simplified with reduced documentation requirements. These changes have effectively opened the floodgates for prospective QFIIs, particularly small and medium-sized financial institutions that now meet eligibility thresholds. QFIIs have also experienced a much quicker pace of approval by the China Securities Regulatory Commission (CSRC) and State Administration of Foreign Exchange (SAFE), now averaging about only six months as opposed to 18 to 24 months previously.

Additionally, the market now permits QFIIs to open multiple securities accounts with the China Securities Depository and Clearing Corporation, allowing QFIIs who manage assets on behalf of their underlying clients to segregate their individual clients’ assets.

In addition to exchange-traded securities, including equities, bonds and funds, since the beginning of 2013, QFIIs have been allowed to invest in index futures and the interbank bond market (pending operational guidelines to be further announced by local regulators). This significant change enables QFIIs to further diversify their portfolios and hedge their risks.

Mike Guy notes that “the recent market liberalisation efforts in China will offer great opportunities for foreign investors, not only for those already in the market, but also those now able to enter the market.” J.P. Morgan expects local regulators to further liberalise the market throughout 2013, thereby making it more accessible to a broader range of investors. A welcomed clarity on the applicability of capital gains tax to QFIIs, another key area of focus for foreign investors, is anticipated.

A winding global road

“The path to liberalisation is indeed a winding road, and each market will evolve in its own way and at its own pace,” says Mike Guy. The BRIC markets are changing dynamically year on year and Guy feels that process is expected to continue. “We know that BRIC will remain a priority for our clients, and we look forward to further positive developments.”

Approved QFII License and Investment Quota in China

2Q2013 ApprovedQFIILicenseAndInvestmentQuotainChina
Source: based on data published by CSRC and SAFE

Total QFII Quota in China

  • 2003—initial total QFII quota was US$4 billion
  • 2005—total QFII quota increased to US$10 billion
  • December 2007—total QFII quota increased to US$30 billion
  • April 2012—total QFII quota increased to US$80 billion
  • March 2013—available unallocated quota as of 31 March: US$38 billion
  • Total number of individual QFII licenses approved since 2003—217 (as of March 2013)

1 February 28, 2013, practices.

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Thought, Q2 2013


Mike Guy

Mike Guy
Head of Global Network
Market Management


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