The Structured Products Law Review: Brazil
This chapter describes certain legal and regulatory aspects related to certificates of structured transactions (COEs).
COEs, as provided under Brazilian law, are certificates issued against an initial investment and represent a single and indivisible set of rights and obligations, with the structure of yields referencing characteristics of financial derivatives instruments. In other words, COEs are bonds that may be issued by financial institutions and that can be referenced to a wide range of underlying assets such as, among other things, indexes, currencies and stock prices. Such characteristics make the COE a unique instrument that has been widely adopted by market participants in recent years. On the basis of public information provided by B3 SA – Brasil, Bolsa, Balcão (B3),2 currently approximately 21 billion reais' worth of COEs have been issued in Brazil.
With the historical decrease of Brazil's basic interest rate (known as SELIC rate) to a minimum of 2 per cent per year, as an attempt to enhance economic activity during a pandemic, it is forecast that local investors will seek diversified investments and migrate from standard fixed income financial products to more sophisticated variable income ones, such as COEs.
Investors are also becoming more interested in environmental, social and governance (ESG) products. In order to reach such investors, financial institutions are discussing and structuring new products focused on green and sustainable approaches. The COE is a very hybrid instrument that could be suitable for such investors and there are already COEs in the market whose underlying assets are focused on green initiatives.
Legal and regulatory framework
COEs were created by Law No. 12,249, of 11 June 2010, as amended (Law 12,249) and regulated by Resolution No. 4,263, of 5 September 2013, as amended (Resolution 4,263), and was enacted by the National Monetary Council (CMN).
Law 12,249 gives financial institutions the general authority to issue COEs, granting the CMN powers to provide additional conditions for such issuance. Such conditions are specified in Resolution 4,263 and enacted by the CMN, which provides general guidelines related to COEs, including on assets underlying COEs. In this respect, Articles 6 and 7 of Resolution 4,263 set forth what would qualify as an underlying asset for purposes of a COE as follows:
- the COE can be referenced to price indexes, bond indexes, securities indexes, interest rates, exchange rates, securities and other underlying assets, provided that at least:
- the price index, bond index, securities index, interest rate or exchange rate used as a reference shall be calculated on a regular basis and subject to public disclosure; and
- the securities and other underlying assets used as a reference shall present quotations that are regularly published by stock exchanges, commodities and futures exchanges, organised over-the-counter markets or clearings duly authorised to operate by the Central Bank of Brazil and the Brazilian Securities Commission;
- the use of underlying assets determined by a methodology that combines references outlined above is permissible, provided that it is consistent and verifiable;
- the use of the methodology mentioned in point (b) is the exclusive responsibility of the issuing institution;
- the values and quotations of the underlying assets shall be independent from the parameters used for the proprietary transactions of the issuing institutions;3 and
- the COE can be referenced to underlying assets made available or traded offshore provided that the requirements set out above are duly observed, including those with respect to exchanges and over-the-counter markets, which shall be regulated by the competent foreign authorities.
Resolution 4,263 also provides for two important requirements related to a COE issuance. The first is set forth in Article 11 and relates to the suitability proceedings (for further information on suitability proceedings under Brazilian regulation, refer to Section III.iii) that shall be carried out by the issuer of the COE and, if applicable, by the intermediary institution that distributes the COE to other investors (intermediary institution). The second is set forth in Article 12 and relates to the information provided by the issuer of the COE and the intermediary institution to the COE's investors.
The requirements of Articles 11 and 12 of Resolution 4,263 are as follows:
- an issuer and institution that participate in a COE's distribution, placement and negotiation proceedings must implement policies and proceedings that ensure the COE's suitability to the profile of the investors, and observe investors' needs, interests and objectives; and
- an issuer and institution that participate in a COE's distribution, placement and negotiation proceedings must ensure that the information related to the COE is rendered through documents made available to investors that must be worded in a manner that is clear, objective and adequate to its nature and complexity, in order to allow the full comprehension regarding the conditions, payments flows and risks related to the COE.
As to the requirements mentioned above, the Brazilian Association of the Entities of the Financial and Capital Markets (ANBIMA) enacted Deliberation No. 22 on 12 June 2017 (Deliberation 22 and, together with Resolution 4,263 and Instruction No. 569, of 14 October 2015 of the Brazilian Securities Commission (CVM), as amended (Instruction CVM 569), the COE Regulations).4 ANBIMA is a self-regulatory entity of the Brazilian financial and capital markets. Deliberation 22 provides for the obligations and liabilities attributable to public offerings of COEs carried out by their members.
Article 6 of Deliberation 22 sets forth, among a series of conditions, that an intermediary institution that distributes a COE must ensure that the information related to the COE is provided prior to the acquisition of the COE by its investors by means of the delivery of a COE document. The COE document is defined in Article 4 of Deliberation 22, and such definition coincides with that of the essential information document (EID).
In addition to the above, Article 4 sets forth that if a distribution of a COE is carried out by an intermediary institution, the issuer of the COE shall be responsible for the preparation of the COE document, while the intermediary institution shall be exclusively liable for the suitability proceedings (see Section III.iii). Thus, differing from Articles 11 and 12 of Resolution 4,263, Deliberation 22 provides for a segregation of the duties of the issuer of the COE and of its intermediary institution.
Offering process and post-sale requirements
The offering of a COE to the public is regulated by Instruction CVM 569, as enacted by the CVM. Instruction CVM 569 provides the rules that must be observed for the purposes of offering COEs to the public. In this sense, Instruction CVM 569 clearly sets forth the issuer and intermediary institution obligations related to the preparation of documents related to a COE offering, as well as its applicable marketing materials (as defined below).
As such, according to Article 3 of Instruction CVM 569, the intermediary institution, or the issuer of a COE acting as the intermediary institution, shall deliver an EID to investors before the acquisition of a COE, and maintain a term of adhesion and risk acknowledgement (adhesion term) signed by the investor with the following wording: 'I have received a version of the essential information document previously to the acquisition of the COE and have acknowledged how it works and its risks.'5
In addition, Article 3, Paragraph 2 of Instruction CVM 569 sets forth that the obligations mentioned in Article 3 of Instruction CVM 569 shall be waived if an investor in a COE is a professional investor.
In this sense, below is the definition of professional investor as provided by CVM Instruction No. 539, of 13 November 2013, as amended (Instruction CVM 539). According to Article 9-A, professional investors are:
financial institutions and other institutions authorised to act by the Central Bank of Brazil;
insurance companies and capitalisation companies;
open and closed supplementary pension entities;
individuals and legal entities that have financial investments in an amount higher than 10 million reais, and that additionally represent in writing their condition as professional investors, in accordance with Annex 9-A;
investment clubs, provided they have a portfolio managed by a portfolio manager duly authorised by the CVM;
independent investment agents, portfolio managers, securities analysts and securities advisers duly authorised by the CVM in relation to their own resources; and
i Information provided by the EID
The main document related to a COE issuance is the EID. The following is an analysis of the main conditions that shall be included in each EID.
Articles 6 and 7 of Instruction CVM 569 set forth the main requirements that need to be included in the EID as follows:
according to Article 6, the EID must:
contain true, complete and consistent information that does not mislead investors;
be written in simple, clear, objective, concise and adequate language that respects the nature and complexity of the COE; and
be useful for an evaluation of whether to invest in the COE; and
according to Article 7, the EID must present the following items:
the issuer's name and CNPJ number;6
a warning that receipt of the amounts due to investors is subject to the risk of the credit of the issuer of the certificate;
a description of the COE's nature and essential characteristics, highlighting whether the COE is of a 'protected initial investment amount' or 'initial investment amount under risk' modality, as well as details of the peculiarities inherent in the respective modalities, especially with respect to the possibility of the loss of invested capital;
the minimum initial investment or nominal value, if any;
when periodic payments of interest will be available;
the due date or term of the transaction;
the value of the protected investment, with a notice regarding the need for immobilisation of the investment for a certain period, if this is the case;
the underlying assets that have been used as benchmarks, and information about how to obtain the value of the indexes, rates or quotations;
a warning that it is not a direct investment in the underlying asset;
complete data on all performance scenarios related to the COE based on fluctuations of the underlying assets, including a notice that such results are valid at maturity;
a specification of the rights and covenants of the holder and the issuer, respectively, that may influence remuneration conditions;
conditions for the repurchase or redemption of the COE before the maturity date;
a warning about the physical delivery conditions of the underlying asset, when applicable;
a warning regarding the conditions that might entail the extinction of the COE before maturity;
a warning regarding the liquidity conditions of the investment, including information on the admission to trading of the COE in the secondary market and regarding market makers, if any;
an indication and brief description of the main risk factors;
a warning that the COE is not guaranteed by the Credit Guarantee Fund;
an indication of the entities that maintain systems in which the COE will be issued;
a warning using the following wording: 'This offer was waived from registration by the Brazilian Securities Commission – CVM. The distribution of the COE does not imply, by the regulatory entities, a guarantee of the veracity of the information provided or the adequacy of the COE to the current legislation or a judgment on the quality of the issuer or the intermediary institution';
information on any other factor that could significantly affect the conditions of the transaction;
a description of the applicable taxation; and
guidance on how to file a complaint or clarify questions regarding the COE.
In addition, the formatting, structure and layout of the information in the EID must not diminish the relevance of any of the items in the caput.
It is important to mention that Articles 11 and 12 of Instruction CVM 569 set forth some items that need to be included in specific scenarios, but that are not mandatory, as follows:
according to Article 11, a reference to profitability, including in a EID, must always include the effective rate expressed as a percentage per year, and it must be displayed with equal prominence; and
according to Article 12, any information disclosed by any means, including in the EID, in which a reference to the past profitability of the COE is included must:
present a chart with figures obtained on a daily basis showing the evolution of the COE's performance against certificates that are identical to the COE, and that have matured over a period identical to that of the COE's;
when reference is made to the evolution of the price of the underlying assets of the COE, include a warning with the following wording: 'These values are simply illustrative and do not represent the past performance of the COE';
include a warning with the following wording: 'Reference to past profitability is not a guarantee of future profitability';
include clear identification of the reference period of the past profitability, including the initial and final dates; and
mention that the net profitability depends on the applicable taxes.
A reasonable doubt that usually arises is whether information related to an underlying asset of a COE could be cross-referenced in the EID. In this sense, it is important to mention that the EID must necessarily contain the information requested under Article 7 of Instruction CVM 569, including Item VIII of Article 7. The original wording of Item VIII provided that the EID should present 'the underlying assets used as benchmarks', but the CVM, upon receipt of comments from market participants during the public hearing process for Instruction CVM 569, revised the original wording to provide that the EID should contain 'the underlying assets used as benchmarks and information on how to obtain the values of the indexes, rates or quotations'.
Thus, based on the above, the EID should observe Article 7, Item VIII of Instruction CVM 569, and indicate which is the underlying asset related to the COE and how further information about such underlying asset can be obtained (e.g., quotations, values, calculation methodology). The insertion of a cross-reference to information related to the underlying asset in the EID should suffice for the purposes of this requirement. In any case, the key aspect is that the information provided in the EID should allow investors to understand, inter alia, the security, index and rates used as underlying assets with the purpose of providing such investor with assistance and clarity on her or his investment decision.
From a practical standpoint, any further information about the underlying asset could be included in the EID, or the EID could provide for a web link, a specific website or guidance on how to access a website pursuant to which the investor would have access to such further information.
ii Marketing materials
Producing marketing materials to sell COEs is allowed under the Brazilian regulations. Article 8 of Instruction CVM 569 sets forth that any advertising text or audiovisual material for offering, announcing or promoting the issuance of COEs (marketing materials) shall:
follow the general rules of disclosure of information set forth in Article 6 of Instruction CVM 569, which provides for the requirements attributable to the EID;
be consistent and not contain different information related to the content of the EID;
use calm and moderate language, and contain a warning related to any investment risks, including that receipt of the amounts owed to the investor is subject to the credit risk of the issuer of the COE;
mention that it is marketing material;
alert the investor about the existence of the EID and the means to obtain a copy, as well as provide the following wording: 'Read the EID before investing in this COE';
highlight that the certificate is for an investment with nominal value at risk modality when this is the case; and
include a warning with the following wording: 'This offer has been waived from registration by the CVM. The distribution of the COE does not imply, on the part of the regulatory entities, a guarantee of the veracity of the information provided or the adequacy of the COE to the current legislation or judgment on the quality of the issuer or the intermediary institution.'
In other words, any marketing material related to issuances of COEs must observe Article 8, among other provisions set forth in Instruction CVM 569, in addition to the requirements set out by Article 12 of Resolution 4,263.
For the sake of clarity, the definition of marketing materials shall include any audiovisual material that may be embedded in marketing materials in text format, particularly in the event such audiovisual material presents language identifying that it shall be considered as marketing material for the purposes of the COE offering.
iii Suitability proceedings
Another important aspect of COE issuances is how the Brazilian regulations deal with the level of diligence in suitability proceedings that shall be carried out by an intermediary institution, as applicable.
In this sense, Instruction CVM 539 provides for suitability proceedings7 that shall be carried out by intermediary institutions with potential investors in order to recommend products (e.g., COEs) or transactions, or to provide services to such potential investors.
Article 2 of Instruction CVM 539 sets forth that an intermediary institution must verify:
whether the product, service or transaction is suitable to the investment objectives of the client;
whether the financial status of the client is compatible with the product, service or transaction; and
whether the client has the knowledge required to comprehend the risks related to a product, service or transaction.
Furthermore, Article 2, Paragraphs 1, 2 and 3 of Instruction CVM 539 provide for the information or documents, or both, that shall be presented to a potential investor under the suitability proceeding, as set forth below:
to comply with the provisions of Item I of Article 2, the persons referred to in Article 1 of Instruction CVM 539 (i.e., intermediary institutions and securities consultants) shall examine at least:
the period for which the client wishes to maintain his or her investment;
the client's preferences regarding risk taking; and
the purposes of the investment;
to comply with the provisions of Item II of Article 2, the persons referred to in Article 1 present a chart showing the evolution of the COE's performance, obtained on a daily basis, of certificates identical to the COE and that have matured in a period identical to the COE shall examine at least:
the value of the regular revenue declared by the client;
the value of the assets that compose the net worth of the client; and
the future need for resources declared by the client; and
to comply with the provisions of Item III of Article 2, the persons referred to in Article 1 of Instruction CVM 539 shall examine at least:
the types of products, services and transactions that the client is familiar with;
the nature, volume and frequency of transactions already carried out by the client in the securities market, as well as the period during which such transactions were carried out; and
the academic background and professional experience of the client.
With respect to Article 2, Paragraph 2, it is important to note that the information provided for in Items I and III may be declared by a potential investor. Notwithstanding, Item II does not expressly provide that the value and the assets that compose the net worth of a client may be declared by the potential investor. In this sense, it could be concluded that Item II should be backed up by the potential investor with concrete information (e.g., an annual income declaration).
To further understand the extension of the obligation provided for by Item II, the Brazilian Association of International Banks, when providing comments on Instruction CVM 539 (during its public hearing process), mentioned that the information provided for in Article 2, Item II is usually declared by the potential investor, and asked whether language could be added to the draft Instruction to clarify that information declared by potential investors could be used for the purposes of complying with the requirement set out by Article 2, Item II. The CVM responded as follows:
Usually this shall be the practical situation. Notwithstanding, if there is evidence that may lead to the understanding that the financial situation of the client does not correspond to the reality, the persons referred to in Article 1 (i.e., the institution carrying out the suitability proceeding) cannot refrain from checking information on the client's real financial situation.
Thus, on the basis of the CVM's response, an intermediary institution should be able to verify the financial status of a client and its suitability for the applicable product, service or transaction (which includes the value and the assets that compose the net worth of the client) by means of a declaration by the potential investor.
Notwithstanding, in the event that there is evidence that the declaration provided by the potential investor does not correspond to its real financial situation, the intermediary institution must request from, and verify, additional information and documentation about such potential investor in the context of its suitability process. It is important to mention that we are not aware of any formal guidance from the CVM on how discrepancies between such a declaration and the reality of an investor's financial situation should be identified.
iv Other provisions of Instruction CVM 539
Further to the above, it is important to mention some provisions of Instruction CVM 539 that affect the suitability proceedings adopted by institutions.
In this sense, Article 5 of Instruction CVM 539 sets forth that an institution that shall carry out a suitability proceeding is prohibited from recommending products or services to a client when the profile of the client is not suitable for the product or service (i.e., the client does not have the knowledge required to comprehend the risks related to the product or service), the information that allows the identification of the customer's profile is not obtained or the client's profile information is not up to date.
In addition, Article 6 of Instruction CVM 539 sets forth that in cases where a client does not comply with any of the items provided for above, the institution shall, prior to the client entering into any securities transaction, notify the client about an absence of information, or the outdated status of its profile or its inadequacy, indicating the causes of the divergence; and obtain an express statement from the client acknowledging his or her knowledge about the absent, outdated or inadequate profile.
With respect to the institution carrying out a suitability proceeding, Article 7 of Instruction CVM 539 further sets forth that such institution must:
establish written rules and procedures, as well as internal controls that can be corroborated, that allow full compliance with the duty to verify the suitability proceedings;
adopt specific internal policies related to the recommendation of complex products highlighting the risks of the structure of complex products compared to the structure of traditional products, and the difficulty in determining their value, including when related to their low liquidity; and
appoint a statutory director responsible for compliance with the standards established by Instruction CVM 539.
Finally, it is important to mention that Article 10 of Instruction CVM 539 sets forth that an institution carrying out a suitability proceeding must maintain, for a minimum period of five years from the last recommendation made to the client, or from the last transaction entered into by the client, as the case may be, or for a longer period, as per the express resolution of the CVM, all documents and statements required by Instruction CVM 539. Such documents may be stored in physical or electronic media, allowing for the substitution of documents with their respective digital images.
Exchange listing and trading
Once COEs are offered to the public at large, they should be deemed to be securities in accordance with Article 2, Item IX of Law No. 6,385, dated 7 December 1976.
As a general rule, securities need to be deposited with centralised depositories in order to be distributed to the public at large in accordance with CVM Instruction No. 541, enacted on 20 December 2013, as amended (CVM Instruction 541). Notwithstanding, CVM Instruction 541 provides for an exception for COEs. Such exception provides that COEs that are not authorised to be negotiated in centralised and multilateral systems maintained by an organised market administrator do not need to be deposited to be distributed to the public at large.
Despite the above-mentioned rule, it is usual that COEs are deposited in accordance with CVM Instruction 541. Such deposit is usually carried out by the issuer of the COE with B3. Because this is a quite new financial product, we are not certain whether the secondary market of COEs is thriving.
As a general rule, positive revenues obtained are subject to a levy of withholding income tax at regressive rates based on the period of investment, on settlement, on the revenues distributed or on the assignment of the investment, as per the table below:
|Applicable rate (%)||Term of the COE|
|22.5||Up to 180 days|
|20||Between 181 and 360 days|
|17.5||Between 361 and 720 days|
|15||More than 720 days|
Outlook and conclusions
Overall, the COE is proving to be a well-defined product: flexibility is provided by a wide range of underlying assets, which offers an incentive for issuers to use such instrument, while clear rules create a safe environment for investors.
The rules applicable to COEs tend to be less bureaucratic and burdensome when compared to other financial assets and securities that are constantly issued in the market. The COE is a complex financial product, but even with such complexity the regulators have found a way to promote the COE market, always looking to investors, and it should be recognised that the COE is a successful financial product.
On 15 July 2019, the CVM published Public Hearing SDM No. 04/19,9 which has the main objectives of creating rules to offer financial bills and real estate secured bills, as well as updating Instruction CVM 569, to modernise the rules in order to offer COEs to the public at large. The rules related to financial bills and real estate secured bills will apparently be based on Instruction CVM 569, which demonstrates that Instruction CVM 569 was well drafted and has become quite a market standard. Although the period for interested persons to comment on the public hearing was concluded on 13 September 2019, the CVM has neither issued a final report nor has implemented any amendments to the existing rules.
Considering the recent developments of the local market, especially in view of the lowest interest rate of Brazilian history, together with the international trend for new types of products, with a particular focus on ESG related instruments, we expect an increase in COE issuances in the near future.
1 Tiago A D Themudo Lessa is a partner, Rafael José Lopes Gaspar is a senior associate and Fábio Moretti de Góis is an associate at Pinheiro Neto Advogados.
3 The purpose of this is to avoid potential conflicts of interest and to ensure that the issuer of the COE is not able to affect the results of the COE, whether positive or negatively.
4 It is important to mention that in Brazil, laws and regulations are interpreted according to their hierarchy. In this sense, Law 12,249 ranks hierarchically higher than Resolution 4,263, Instruction CVM 569 and Deliberation 22. From a practical standpoint, considering that Resolution 4,263 and Instruction CVM 569 are administrative regulations, both should have the same hierarchy rank. Notwithstanding, from a theoretical perspective, the CVM is subject to the CMN; thus, one could conclude that Resolution 4,263 should rank higher than Instruction CVM 569. Finally, Deliberation 22 was issued by ANBIMA, and thus ranks inferior to Law 12,249, Resolution 4,263 and Instruction CVM 569 in the legal hierarchy.
5 It is important to mention that Article 3, Paragraph 1 of Instruction CVM 569 sets forth the provisions of the essential information document (EID) to the investor, and the execution of the adhesion term can be done electronically.
6 The CNJP is a register all entities are required to be entered in prior to commencing their activities.
7 Article 8 of Instruction CVM 539 sets forth that the institution responsible for the suitability proceeding shall update the information related to its clients' profiles, and carry out new analysis and classification of the categories of securities, within time frames that do not exceed 24 months.
8 Article 2 sets forth provisions related to the public offering of COEs. Article 3 sets forth certain obligations applicable to the intermediary institution or the issuer of a COE acting as intermediary institution. Article 5 sets forth that the issuer must draft a EID to allow an investor to understand how the COE works. Article 9 sets forth that marketing material providing for scenarios must not highlight the best case scenario. Articles 11 and 12 set forth how information about the profitability of a COE should be in the EID or marketing materials. Article 13 sets forth that the issuer of a COE and intermediary institutions must keep the documents and information requested by Instruction CVM 569 by five years following the maturity of the COE.