By Marcela Ayres
BRASILIA, April 24 (Reuters) - Brazil's biggest bank failure in recent history has led to an aggressive crackdown on public pension funds, which were among its creditors, limiting their portfolios in ways that could make it harder to hit their long-term targets.
The new restraints for public pension funds, which manage some $73 billion in Brazil, are part of the widening fallout from the liquidation of Banco Master, with consequences for politicians, a state-run lender and even central
bankers.
Although Master was not considered a systemic risk for Brazilian finance, several state and municipal pension funds were heavily exposed to the mid-sized lender's securities, raising questions about their investment strategies.
In response, policymakers have sharply limited how most public pension funds can invest, effectively boxing them into sovereign bonds unless they meet strict governance standards, which just 8% of them now fulfill.
The speed and severity of the rule changes caught the market off guard, according to five professionals in the sector who spoke on condition of anonymity.
Some worry that when interest rates start falling, pension funds will struggle to deliver the returns required of them, adding to the structural challenges of financing retirement for an aging population.
FUNDS LOADED WITH MASTER'S SECURITIES
After Brazil's central bank liquidated Banco Master last year amid allegations of fraudulent loan portfolios, the National Monetary Council (CMN) in December approved the new regulatory framework that took effect for public pension funds in February.
Between 2023 and 2024, 19 public pension funds had bought 1.87 billion reais ($377.37 million) worth of so-called financial bills issued by Banco Master. Exposure ranged from 1% of assets for Amazonas state to 20% for the city of Itaguai, in Rio de Janeiro state.
While those funds represent less than 1% of Brazil's public pension funds - managing about 0.5% of total assets in the sector - the episode put the industry on high alert.
Those Master securities were not covered by Brazil's credit guarantee fund, so recoveries will depend on the liquidation process, which could drag on for years and yield partial compensation.
Heavy losses may force state and municipal governments to inject cash, ultimately shifting the cost to taxpayers.
Although authorities had been discussing public pension investment reforms for over two years, the final overhaul went far beyond what had been signaled before the Master meltdown.
Under the new rules, only 176 of Brazil's 2,133 public pension funds are currently allowed to invest outside federal government debt.
For now, Brazil's high interest rates will soften the impact on pension funds' returns, but that could change dramatically. The Treasury paid an average real yield of 7.5% on inflation-linked bonds last year, compared with 3.8% as recently as 2021.
Joao Carlos Figueiredo, head of industry group Abipem, said a sovereign-bond-only strategy will not allow most funds to hit their actuarial targets - usually 4% to 6% above inflation - setting them up for shortfalls in the future.
Asked about the concerns, Brazil's Social Security Ministry disputed that risk, arguing the country is unlikely to face structurally low real rates any time soon. It noted that over 75% of pension assets were already in federal government debt before the overhaul.
The ministry said the rules do not impose asset allocation mandates, but instead tie investment flexibility to governance improvements. Existing holdings are grandfathered for two years, giving funds time to earn the required certification, it added.
($1 = 4.9553 reais)
(Reporting by Marcela AyresAdditional reporting by Bernardo CaramEditing by Brad Haynes and Aurora Ellis)
