By José Setti Diaz, partner at Demarest e Almeida Advogados [i]
According to Towers Watson 2010 research [ii], Brazil ranks among the world’s top pension markets. Currently, pension funds’ assets represent 22% of Brazilian GDP and are by far the country’s largest institutional investors. In 2009, the assets of Brazilian closed pension funds (In Portuguese: Entidades Fechadas de Previdência Complementar, “EFPC“) reached the amount of 506.6 billion reais.
In view of the country’s new economic environment of stability and declining interest rates, where exposure to greater risks is increasingly crucial for pension funds to reach profitability goals and obtain higher returns, a distinct – and more dynamic – investment approach from pension funds’ managers is vital. Today there is an evident effort from these entities to reduce their traditional concentration on federal securities and move towards the diversification of their portfolios, demonstrating a clear desire to regress from the immobility of fixed income rates and advance on equity investments.
More flexibility and a look abroad
In this context, in 2009 the Brazilian Monetary Council (In Portuguese: Conselho Monetário Nacional, “CMN“) enacted Resolution n. 3,792, of September 24, (“CMN Resolution 3,792“), providing a new regulatory framework to govern EFPC’s investments. The new rules clearly adapt the previous EFPCs’ investment policies to the new economic reality, authorizing such entities to invest more aggressively in several categories of investments, yet keeping the criteria of transparency, control and supervision. The permissible categories of investments are: (i) fixed income; (ii) variable income; (iii) structured investments; (iv) foreign investments; (v) real estate; and (vi) transactions with participants.
Among the changes brought by CMN Resolution 3,792 is the increase on the limit to invest in foreign assets from 3% to 10% of pension fund’s assets total volume, which reflects the global integration of capital markets. In the new regulatory framing, investments abroad receive more attention and are part of a whole new independent investment segment.
With the new rule EFPCs can now invest in: (i) offshore assets (through Brazilian investment funds); (ii) units of external debt investment funds; (iii) units of investment funds of index abroad traded at the Brazilian stock exchange market; (iv) Brazilian Depositary Receipts; and (v) stocks issued by foreign companies headquartered in countries located in the Mercosur region.
In addition to the 10% limit referenced above, EFPCs face some additional restrictions for offshore investments: (i) the concentration limit per issuer of 10% of: (x) the entity invested or (y) the fund incorporated in Brazil with a portfolio of offshore investments or (z) the foreign index fund traded at the stock exchange in Brazil; and (ii) the concentration limit per type of investment, that is 25% of the same type of securities.
Although the new rule grants long-awaited permission to invest abroad, the EFPCs remain focused on opportunities within the domestic Brazilian market. However, in the mid to long term the easing of restrictions will stimulate the pension funds to commit to foreign investments.
When that happens, it will be interesting to see how the EFPCs react to existing offshore governance structures, where limited partners typically have a passive role, in contrast to the active role that EFPCs have taken on investment committees with local Brazilian fund managers. The result may be a learning process that ultimately influences how EFPCs view their role as limited partners in the Brazilian market as well.
The role of EFPCs in Brazil’s infrastructure
Brazil’s entry into the so called “decade of sports”, hosting the FIFA World Cup in 2014 and the Olympic Games in 2016, is generating increased demand for investment in Brazilian infrastructure. This demand is compounded by expectations for strong economic growth and the second phase of the Growth Acceleration Program (In Portuguese: Programa de Aceleração do Crescimento – “PAC-2”), recently announced by the Brazilian Federal Government.
As a result, the EFPCs are targeting both private equity and infrastructure funds for new commitments. Several of the largest 10 EFPCs listed above – such as PREVI, PETROS and FUNCEF – already have allocations to private equity infrastructure funds.
In this regard, it is worth noting that CMN Resolution No. 3,846 of March 25, 2010, amended previous rules to allow EFPCs to increase their exposure to infrastructure. The new regulation expressly authorizes the EFPCs to guarantee investments of the special purpose companies (In Portuguese: Sociedade de Propósito Específico, “SPE“) that they own. That is allowed after the EFPCs analyze the risks represented by such investment and upon prior evaluation of the economic and financial feasibility of the project to be carried out by the SPE. The guarantees so rendered shall be computed in the same thresholds for allocations of investments by the EFPCs established by CMN Resolution 3792/2009.
In sum, the reorganization of investment categories by CMN Resolution 3,792, coupled with the rapid increase in assets managed by the Brazilian pension funds, have created a significant opportunity for new investments in offshore investments, infrastructure and other new products. This may create an impetus for change within the EFPCs as they pursue higher risk investment strategies and ultimately adopt international investment and management standards, affecting areas such as staff qualification, risk management methods and fund manager selection.
[i] Carolina Joop and Karina Cancellaro Azevedo of Demarest e Almeida Advogados have also contributed to the preparation of this article.
[ii] Global Pension Asset Study 2010.