Brazil’s New Tax: What It Could Mean for ETFs

October 23, 2009 at 12:00 pm by Tom Lydon

real_money_brasil_237495_tn This week, Brazil implemented a 2% tax on new foreign investment. What could this mean for investors in the popular exchange traded fund (ETF) that focuses on the country?

To understand the implications of the new tax, it’s important to understand how iShares MSCI Brazil (NYSEArca: EWZ) works.

EWZ is a “cash create” product, unlike most ETFs where delivery is taken in the form of securities. Regulations in Brazil don’t allow in-kind share creations. Cash is taken in lieu of actual shares, and the money is taken and invested in Brazil.

When a market participant (MP) wants to create more shares of EWZ, there’s a fee associated with this creation that’s already built in. This new tax may eventually become a part of the fund expenses in the event that an increase in demand for EWZ leads to the creation of more shares.

According to its prospectus, Market Vectors Brazil Small-Cap (NYSEArca: BRF) also issues and redeems creation units primarily for cash.

Anything already issued in any fund is not impacted because it’s already in the local currency.

Meanwhile, money is flooding into Brazil. About $31 billion in foreign direct investment is expected this year. In turn, this news has upped their stock market and increased the value of the currency. The risk Brazil runs is the real getting too strong, which is a new problem for a country that has usually had to deal with inflation, reports Carl Mortished for Times Online.

This is what led to the tax: the country feared losing its foreign customers and exporters raised a ruckus, hence the 2% tax. While investors and the International Monetary Fund (IMF) initially balked, for the most part investors seem to feel the positives of growth prospects in Brazil outweigh the negatives of the tax.

For more stories about Brazil, visit our Brazil category.