The decision by the Brazilian government to extend its financial transactions tax to foreign loans of up to five years will dramatically change the way trade finance is conducted in the region. Rebecca Spong reports.
In early March, the Brazilian government decided to extend its financial transactions tax to foreign loans maturing in up to five years.
The decision follows on from the announcement at the end of February that all foreign loans under three years would be subject to the 6% tax. Previously the tax only applied to loans under two years in duration.
The move is intended to prevent the further appreciation of the Brazilian real against the US dollar, and comes after remarks made by the Brazilian President Dilma Rousseff earlier this year that developed nations were being highly protectionist by implementing measures that depreciated their currencies.
Rousseff hopes the measures will stall the flow of hot money entering Brazil, causing the overvaluation of the real. The appreciating real also hurts Brazilian exporters, making their exports expensive and imports cheap.
Regardless of Rousseff’s intentions, the decision has inadvertently caused widespread concern among foreign banks offering trade finance products to Brazilian borrowers.
“These measures will have a very negative impact, especially to foreign banks that do not have a presence in Brazil as a financial institution established under Brazilian law,” remarks Christian Ramos, partner at Ramos, Zuanon e Manassero Advogados.
Indeed, the move brings an end to certain types of trade finance lending. In particular it will no longer be feasible for foreign banks to consider lending large-scale pre-export finance (PXF) deals. Transactions such as the US$500mn pre-export finance facility raised for Brazilian firm Multigrain last year will become a distant memory.
“There is no way to finance exports from Brazil through PXF for more than 360 days,” confirms Domicio dos Santos Neto, partner at law firm Santos Neto Advogados.
Further to the new tax legislation, at the beginning of March the Brazilian government announced changes to the conditions that qualify a transaction as an export prepayment. It is a further move that will impede foreign banks’ ability to operate in the Brazilian market.
Under the new terms, an export prepayment transaction will only qualify as such if the prepayment is carried out exclusively by the importer or offtaker and a transaction cannot exceed more than 360 days between disbursement and the export of the goods.
Export prepayment facilities lent by foreign banks no longer qualify as an export prepayment transaction, but will be treated as a cross-border loan from a regulatory and taxation standpoint.
Essentially this means export prepayment facilities are no longer recognised as a trade finance product. A source at a local Brazilian bank tells GTR that the market is looking for alternatives to the export prepayment structure, yet in the meantime there is likely to be increased demand for local currency deals and ACCs [advance on a future foreign exchange].
ACCs are short-term (one-year) loans extended by Brazilian banks to exporters. Upon maturity of the loan, shipping documents are presented, the exporter pays the interest and the importer pays for the goods. These transactions are not subject to any tax.
This move towards ACCs is further confirmed by Tom van Nimwegen, director, wholesale banking, at Rabobank Brazil. “We do foresee some migration of medium-term pre-export needs to short-term trade finance instruments such as ACCs.”
As foreign banks operating in Brazil digest the new legislation, they are beginning to look for ways to adapt to the new regulatory environment. “We are working on new structures, seeking to link Brazilian regulations with traditional trade finance elements, potentially coming up with alternatives shortly,” notes van Nimwegen.
However, it won’t just be the foreign banks that lose out following this new legislation; the middle market Brazilian borrowers are also likely to suffer the consequences.
“Our concern is that this lack of availability of funding to third tier will lead the market into new crises,” suggests dos Santos Neto, at Santos Neto Advogados.
He argues that foreign banks will not lend five-year money to mid-cap companies due to their perceived poor credit-worthiness and hat financing in the domestic market could prove to be too expensive.
Rabobank’s van Nimwegen adds: “Our estimate is that financial costs may go up for exporters.”
The foreign banks in Brazil will be left with the options to either only lend to top-tier companies or to grant loans to offshore entities, trading companies or importers who then on-lend to the Brazilian exporter, as allowed by the Brazilian Central Bank.
Dos Santos Neto adds that some Brazilian exporters are already forming offshore entities to be a vehicle for pre-financings as a means of adapting to the new tax rules.
Ramos at Ramos, Zuanon e Manassero Advogados disputes the notion that the prepayment product is completely dead as a result of this new legislation.
“Banks can basically enter into a financial transaction similar to the one they were offering [until recently], but now with the offshore subsidiary of the Brazilian company which in turn will remit the money to the Brazilian company,” he explains.
The new legislation is likely to see trading companies becoming more active in lending to Brazilian exporters. “Trading companies are being used to front several deals,” remarks dos Santos Neto.
Foreign banks will lend three to five-year loans to an offshore trading company and this company will use the funds to prepay on annual basis the Brazilian exporter, whether it is an affiliate of the trading company or not. Dos Santos Neto tells GTR that there are lots of deals like this being renegotiated.
The new tax legislation is expected to have a limited impact on the ability of the main Brazilian banks to maintain theirforeign funding sources.
“Most of the recent overseas fundraising operations have consisted of bond sales with maturities substantially longer than five years,” observes Antonio Timoner-Salva, senior Latin American banking analyst at IHS Global Insight.
Furthermore, the wholesale funding of smaller local banks relies, to a significant extent, on the capital raised overseas by their larger counterparts, according to a research note issued by IHS Global Insight in April.
Timoner-Salva argues the Brazilian government’s decision was fuelled in part by the recent liquidity injections by the European Central Bank.
“Major European banks operating in Brazil may see this new regulation aimed at preventing their idle funds at home from taking a short-term tour of Latin America to obtain yields higher than current market interest rates in Europe,” he comments.
Unfortunately, the trade finance market has been inadvertently caught up in this wider politically-driven piece of legislation.