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Leading lawyers on interpreting international banking laws, advising clients on entering latin american capital markets, and predicting financial market.
Finally, all markets in their development process offer risk but also very good opportunities and Brazil is still one of those markets. Therefore, there are several opportunities, especially in the oil and gas sector, where we could say that Brazil is one of the top leading countries in the world in technology and development. Even in the 2008-2009 world crises, the oil and gas market was not affected. The Brazilian government is creating new opportunities, and stimulating and seeking investments, especially to develop the pre-salt area recently discovered on the Brazilian coast.
BANKING AND FINANCE CLIENT STRATEGIES IN CENTRAL AND SOUTH AMERICALEADING LAWYERS ON INTERPRETING INTERNATIONAL BANKING LAWS, ADVISING CLIENTS ONENTERING LATIN AMERICAN CAPITAL MARKETS, AND PREDICTING FINANCIAL MARKETDEVELOPMENT AND STABILITY
USING BRAZIL'S REGULATORY SYSTEM AS A THOUGHTFUL EXPERIENCE
Daniella Tavares [FNa1]Partner
Leite, Tosto e Barros Advogados
Copyright © 2009 by Thomson Reuters/Aspatore; Daniella Tavares
Introduction
The Brazilian banking system is currently among the most modern and efficient in the world. Years of inflation led to investments in technology and efficiency that continue to pay off. The current regulatory scheme is comparatively healthy and could even be seen as a model for markets where regulatory schemes are under attack due to the antecedents and impacts of the global economic crisis.
Commencing approximately in the 1990s and throughout the first decade after 2000, a number of foreign banks and companies entered the Brazilian market, often through privatizations or acquisitions. We could say that the privatization process in Brazil occurred in two phases. We can consider the first phase from 1990 to 1994, starting with the issuance of Law No. 8.031 (Apr. 12, 1990), which created the National Program of Privatization. On such a period there were thirty-three privatizations in Brazil and eight public bids for minority acquisitions, generating approximately US$12 billion dollars for the Brazilian government. It is important to mention that foreign banks and companies had a little participation on this first phase, corresponding to just 5 percent of the total amount mentioned above.
However, on the second phase, which was from 1995 through 2002, foreign investors increased their participation to 53 percent of the total gained by
the Brazilian government, which was approximately US$94 million dollars. One of the most important processes in this period was Petroleo Brasileiro S.A.-- Petrobras public global offers. The first one occurred in 2000, when the exceeding ordinary shares representing the control held by the Federal Union were sold and the second one occurred in 2001, when 41 million preferred shares were sold, with 81 percent of those shares sold to foreign investors.
Since late 2008, we have seen some consolidation, as the sector has responded to the global economic scenario of stress. We can expect to see further consolidation, but also perhaps international expansion by Brazilian-origin banks, as buying opportunities present themselves.
Brazil has not, at least in recent years, developed a strong culture of debt in the private sector, so over-leverage of the banks and other financial institutions and their customers is not generally a major problem for the sector as a whole. Some exceptions are creating issues, such as relatively high debt levels in some sectors, such as in the agricultural area where there are some specific products available for such market, including micro-finance for small producers and importers/exporters where there are also specific products available.
*2 In the public sector, leverage is not currently a serious threat either because companies have a history to be conservative or because pure public-owned companies have the government to directly increase their share
participation when needed.
After the debt crises of the 1980s and early '90s, the public sector has not been permitted to indulge in a great deal of debt either, given Complementary Law No. 101 (May 4, 2000), dated as of May 4, 2000, the so-called "FRL--Fiscal Responsibility Law." The FRL was based in certain international experiences, such as the fiscal Responsibility Act enacted in 1994 by the New Zealand government and the Budget Enforcement Act (Budget Enforcement Act,
Pub. L. No. 101-508, 104 Stat. 1388 (1990)) together with the accountability system adopted by the American government.
But we can not say that such FRL was only based in international experiences, as internally, the Brazilian government has worked hard since 1995 on several programs which were used as "inspiration" to the FRL. Such FRL establishes some goals of tax results, leverage limitations, investment guidance and limits, among others. That is why Brazilian banks tend to be conservative when extending credit and in workout or insolvency scenarios.
The global economic scenario can be expected to result in continued conservatism on the part of lenders, though the government may attempt to encourage expanded lending to the poorer segments of the population for social reasons. As in other parts of the world, one may expect Brazilian financial institutions to undertake simpler, secured lending transactions.
Brazil enacted a new insolvency and bankruptcy law--Law No. 11.101 (Feb. 9,
2005) on February 9, 2005 (the New Insolvency Law). In previous downturns, the prior scheme was inadequate and thus neither debtors nor creditors wanted to test the waters by entering into proceedings. One of the most important changes brought by the New Insolvency Law was the extrajudicial recuperation, which enables, differently from the previous law, the company to try agreements with lenders without being considered a bankrupted company.
The Insolvency Law has been tested in some cases--the most "famous" is the Varig (airline company) case--but we have already seen a number of companies enter into proceedings, especially at the end of 2008 and beginning of 2009 due to the world crisis, which may be a trend to watch.
History
The Brazilian banking system was based on a European model where the main services rendered by the banks at that time were cash deposits and loans to the clients.
In 1964, there was a banking reformulation in Brazil through the issuance of Law No. 4.595 (Dec. 31, 1964), followed in 1965 by the reformulation of the capital markets sector through the issuance of Law No. 4.728 (July 14, 1965), which established several guidelines related to the capital markets, as well as certain definitions related to products available to develop capital markets in Brazil.
*3 Also at that time, the National Monetary Board and the Brazilian Bank were incorporated. Ten years later, the Brazilian Exchange Commission (CVM) was incorporated through the issuance of Law No. 6.385 (Dec. 7, 1976).
Then, in 1988, through Resolution No. 1.542 (1988), financial institutions were able to organize themselves, concentrating all activities in one single institution named multiple banks, which we have had until now in our banking sector. The multiple bank involves the commercial bank (regulated by the Brazilian Central Bank), investments (regulated as an investment bank), real estate credit lines (regulated mainly by Resolution No. 2.735/00 issued by the Brazilian Central Bank), among others. In 1994, Brazil had signed the Basileia Agreement and then the leasing area was included in the sector of a multiple bank.
Besides the bank institutions, there are other types of financial institutions also regulated by the Brazilian Central Bank and/or Brazilian Stock Exchange Commission, depending on their type and characteristics. We could mention some of those institutions, such as the leasing companies, factoring companies, securitization vehicles, and insurance companies, which through Law No. 4.595/64 were considered financial institutions, although regulated by SUSEP-- the regulatory insurance agency.
It is important to mention that Law No. 4.595 established the creation of the Brazilian Central Bank, the Brazilian Monetary Council, and the definition of
certain rules for the financial institutions. Such act also grants to financial institutions the competence to develop certain privative activities.
Lately, the Brazilian Central Bank has used several maneuvers involving compulsory reserve rates in order to favor the injection of resources in the Brazilian economy, to prevent cash leakage and maintain regular conditions among the bank fund-raising mechanisms.
As an example, we may point out Act No. 3.375 (2008), issued by the Brazilian Central Bank during early 2008, which was intended to stop the increasing use of "compulsory reserve free" banking funding structures. The practice involved leasing companies from the same economic group of Brazilian financial institutions, which issued debentures and then lent the collected proceeds-- through inter-company loans--to the financial institutions, which are prevented from issuing such kind of securities.
Upon the enactment of Act No. 3.375/08, inter-company loans between leasing companies and financial institutions became subject to compulsory reserve requirements created to reduce inflation in Brazil through the decrease of money circulation, and consequently the number of debentures issued in the Brazilian market decreased.
Current Regulatory Framework
The National Monetary Board (CMN) is the main body of our banking system
responsible for the regulation of the sector and main rules related to the economic environment and goals. As CMN is the ruling body of our financial system, the Brazilian Central Bank is responsible for the implementation of such rules.
*4 In addition to those two main bodies, we also have some supporting authorities such as: (i) the Brazilian Stock Exchange Commission, responsible for regulation and for the fiscalization of the capital markets sector, especially for listed companies; and (ii) BNDES--Economic and Social Development National Bank, responsible for rules related to long-term investments from the Brazilian federal government.
Main Structuring Issues in Financing
We would like to stress that foreign lenders/creditors need to address the usual issues presented by cross-border finance transactions, including country and political risks, foreign exchange risk, credit risk, and others. One must grapple with choice of law issues, as there are some Brazilian regulation and limitation on such matters, whether disputes should be settled by Brazilian or foreign courts, or by arbitration when and if agreed by the parties as per required by Brazilian law, and the complex Brazilian tax scheme that may impact financing structures.
Moreover, complex foreign law documentation may confuse borrowers and even
create risks on enforcement. A significant issue in structuring financings is how to structure the security package, which varies a lot based on internal requirements of each institution, country risk, and borrower conditions. Especially under current market conditions, unsecured lending will likely be rare. Foreign lenders often mistrust the judicial system and need practical advice about their collateral security, including how to perfect their security interests, how enforcement will work in practice, and other related issues.
Especially in Brazil, where we face, beyond the regular issues involved in typical finance transactions, the political/economic country risk, lawyers and financial advisers need to have an extra creativity and ability to handle both lender and borrower needs.
Certain structures with which parties may have become comfortable in other jurisdictions may not be workable in
Brazil. For example, in
Brazil, it remains difficult to use a "pure" project finance structure, where the financing is secured only by project assets and revenues and the developers or equity are not required to support the project during construction and/or operation. We believe that the main difficultly in having such a structure implemented in Brazil is due to the fact that even now we have certain political, regulatory, and economical instability.
A very important development occurred in 1996 when Law No. 9.307 (Sept. 23, 1996), the Brazilian Arbitration law, was passed. The Arbitration Law, together
with a few supportive judicial decisions, has favorably affected the confidence levels of foreign lenders because it established clear rules supporting arbitration in Brazil.
*5 Another important issue to be addressed on a finance deal in Latin America is the regulatory risk. In Brazil, as an example, we have in most of the sector regulatory agencies regulating and issuing rules regarding each sector beyond the existing legislation and sometimes even contradictory rules.
Sometimes such uncertainties bring additional risk to a finance transaction from a lender point of view, especially for a foreigner lender, and the only way lenders envisage mitigating their risk due to certain uncertainty is to be
very conservative and always work with the worst-case scenario, which, in most of the cases, generates a more expensive transaction for all parties.
Capital Markets Recent Developments
Parallel to the usual types of financing in Brazil and prior to a capital market growth in this decade, the Brazilian Securities and Exchange Commission (CVM) and the Sào Paulo Stock Exchange (Bovespa) made enormous efforts to strengthen the capital market and attract the participation of investors, either Brazilians or foreign investors.
The main initiatives implemented were the enactment of Law No. 10.303/01 (Oct. 31, 2001) and the creation of corporate governance levels by Bovespa. Such mentioned law was very important to give more comfort to companies and individuals to enter the capital markets as minority shareholders, increasing the volume traded at Brazilian stock exchange significantly.
In this sense, from 2003 to 2008, the Brazilian capital market has seen an increasingly high number of 103 Initial Public Offerings and 95 Secondary Public Offerings. This astonishingly high number of new Brazilian corporations listed on the capital market was due to the fact that some of those corporations envisage the capital market as a way to fund themselves for future growth, either through investments in the ongoing business or consolidation by acquisition of minor players. Therefore, instead of issuing debt, a great
number of corporations in Brazil found on an equity issuance a way to leverage their business and activity.
This rapid capital market growth attracted the attention of the usual investors and newcomers. The environment was then set for large, medium, and small investors. The Brazilian companies start to provide in their bylaws sophisticated poison pills to avoid future hostile takeovers. However, different from the U.S., this mechanism is still very premature in
Brazil, as there are not so many companies having their controlling voting shares traded in the stock exchange.
In
Brazil, hostile takeover is described in our corporate law and detailed in CVM (Brazilian Stock Exchange Commission) Ordinance No. 361/2002 duly amended by Ordinance No. 436/2006, which determines that a public offer is required to acquire the control of a listed company.
As an example of a protection clause used to avoid hostile takeovers and used by some of the companies listed in the Brazilian Stock Exchange, is the one that states that the investor who acquires more than a certain percentage of the ordinary shares is obliged to acquire 100 percent of the shares through a public offer, where there is a floor for the share price, including a premium over a certain percentage of the share price.
*6 The new corporate structure proved to be very efficient from a minority shareholder protection perspective, but at the same time brought new concerns
to the authorities. The enhancement of CVM's performance helps the maturity of the market, as questions are answered and new limits outlined.
The activities of CVM during 2008 provided more contributions to the development of the Brazilian capital market, such as: (i) tag along rights were no longer triggered by incorporation operations; (ii) penalties for malpractice related to assets management reached another level; and (iii) managers' duties in operations of merger and assets or shares incorporation were clarified.
It is also worth mentioning CVM's effort to create specific rules regarding the adoption of the IFRS (International Financing Reporting Standards) accountability methods implemented by Law No. 11.638 (Dec. 28, 2007), issued on December 28, 2007, which will enable Brazil to be more compatible with international accounting practices and will bring more transparency to companies' financial statements.
Further to that, by the end of 2008, CVM submitted to a public hearing minutes of an ordinance to modify the rules regarding listing of securities.
On January 16, 2009, CVM issued a new ordinance related to limited efforts to public offerings related to issuance of debt. Pursuant to this new rule, limited efforts are: (i) offer for up to fifty qualified investors; and (ii) subscription and/or acquisition of securities for up to twenty qualified investors.
The following are considered qualified investors under Brazilian regulations:
(i) financial institutions; (ii) insurance companies and capitalization companies; (iii) private welfare opened or closed capital organizations; (iv) individuals or legal entities that hold financial investments in an amount superior to R$300.000,00 and that additionally attest in writing their qualified investor condition according to an own term; (v) investment funds directed exclusively to qualified investors; (vi) portfolio administrators and securities consultants authorized by CVM; and (vii) own social security regimes by the federal government, by the states, by the federal district or by municipalities.
Conclusion
All those continued efforts by the regulatory agency of the Brazilian capital market indicate an ongoing concern for the market, with the main objective the continued growth of Brazilian capital market, either through issuance of debt or equity, both of them extremely regulated to protect investors and incentivize the increase of our market.
Finally, all markets in their development process offer risk but also very good opportunities and
Brazil is still one of those markets. Therefore, there are several opportunities, especially in the oil and gas sector, where we could say that
Brazil is one of the top leading countries in the world in technology and development. Even in the 2008-2009 world crises, the oil and gas market was not
affected. The Brazilian government is creating new opportunities, and stimulating and seeking investments, especially to develop the pre-salt area recently discovered on the Brazilian coast.
[FNa1]. Daniella Tavares, a partner at Leite, Tosto e Barros Advogados, practices in the corporate area with a focus on mergers and acquisitions and joint ventures, and in the banking and finance area.
Ms. Tavares enrolled with the Brazilian Bar Association (OAB) under N. 93.241. In the same year, Ms. Tavares took a course at Harvard University in privatization and infrastructure related to the financing of projects designed for the power and basic sanitation sectors. In 2000, Ms. Tavares returned to the United States, that time to New York University where she took a course in financial statements analysis under US GAAP. Until 2002, she worked at Orrick, Herrington & Sutcliffe as an international associate lawyer. She is a member of the Oil Commission of OAB/RJ. Ms. Tavares received her LL.B. from PUC-RJ. She speaks Portuguese, English, and Spanish.
Dedication: To Maria Antonia and Mary Rose Brusewitz
In
Brazil, it can take as long as ten years or more to arrive at a final judicial resolution of a dispute in a regular court. In contracts, the Arbitration Law permits the parties to select arbitration and more rapidly resolve disputes. Particularly in technical areas or in transactions involving complex structures, the Brazilian judiciary may not be prepared to efficiently handle the cases. In an arbitration procedure, depending on the arbitration clause, one may choose arbitrators with appropriate expertise. The arbitrators may be of any nationality. Under the Arbitration Law, it is best to have the arbitration in Brazil, but one is free to choose virtually any arbitration court and rules. The arbitration can take place in the English language, for example.
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