Brazil: The Brazilian Monetary Council changes again the rules on Financial Bills

By means of Resolution No. 4123, of August 23, 2012 (Res. 4123/2012), the Brazilian Monetary Council (Conselho Monetário Nacional – CMN) amended and consolidated the rules on the issuance of Financial Bills (Letras Financeiras – LFs) by the authorized financial institutions.

The LF was created by Provisional Measure No. 472, of December 15, 2009, which was approved by the Brazilian Congress and converted into Law No. 12249, of June 11, 2010 (Law 12249/2010), and is also governed by the legislation applied to the other Brazilian credit instruments1 to the extent that such legislation does not conflict with the provisions of Law 12249/2010. It is a credit document that constitutes a promise of payment in cash, issued in the registered form, which may be transferred to third parties and it is freely negotiable. It must be exclusively issued in book-entry form, through the registration in a registry and financial settlement of assets system authorized by the Central Bank of Brazil (Banco Central do Brasil – Bacen).

The LF must contain the following characteristics: (i) the title "Letra Financeira"; (ii) the name of the financial institution, which is the issuer; (iii) the number of order, the place and the date of issuance; (iv) the par value; (v) the applicable interest rate, which may fixed or floating, being admitted the capitalization of interest; (vi) the exchange correction clause (if any); (viii) other forms of remuneration, including those based on an index or a rate of public knowledge (if any); (ix) the subordination clause (if any); (ix) the maturity date; (x) the place of payment; (xi) the name of the person to whom it should be paid; (xii) the description of the in rem or personal guarantee (if any) and (xiii) the periodical payment of earnings clause (if any)2.

The main goal of the new regulation issued by CMN is to expand the use of LFs as an instrument of long-term funding and create conditions for the development of a secondary market for these papers. The rules were relaxed to stretch the maturity terms of LFs and at the same time improve the conditions of fundraising for financing in infrastructure works. Although the new rules are more flexible, Bacen intends to monitor the LFs with caution, because these credit documents are exempt from compulsory payment (depósito compulsório) and have no coverage of the Brazilian Credit Guarantee Fund (Fundo Garantidor de Créditos - FGC).

The institutions authorized to issue LFs are the following: (i) multiservice banks (bancos múltiplos); (ii) commercial banks (bancos comerciais); (iii) development banks (bancos de desenvolvimento); (iv) investment banks (bancos de investimentos); (v) savings banks (caixas econômicas); (vi) mortgage companies (companhias hipotecárias); (vii) loan, finance and investment companies (sociedades de crédito, financiamento e investimento); (viii) real estate loan companies (sociedades de crédito imobiliário); and (ix) the Brazilian Development Bank (Banco Nacional de Desenvolvimento Econômico e Social – BNDES).

This list has now been increased with the addition of the development banks. In practice, this change should benefit basically three development banks, which are controlled by the State of Minas Gerais (Banco de Desenvolvimento de Minas Gerais S.A. – BDMG), the State of Espírito Santo (Banco de Desenvolvimento do Espírito Santo S.A. – BANDES) and the States of the South Region (Banco Regional de Desenvolvimento do Extremo Sul S.A. – BRDE), and can also issue LFs. The new regulation issued by CMN aims to help these development banks to maintain economic activity promotion projects guaranteed by such banks in the areas where they operate.

The issue of LFs by development banks must meet the conditions laid down in Res. 4123/2012 and in the specific regulation.

BNDES is authorized to issue LFs under the following conditions:

(i) the total aggregate amount to be issued is limited to the Capital Base (Patrimônio de Referência) value, level 1, of BNDES; and

(ii) preparation of a feasibility study, which should contain at least the economic and financial analysis on the use of the LF compared to other fund-raising alternatives and additional sources of funds available to BNDES, considering volume, term, fees, indexing, liabilities´ composition and other conditions of the issuance as well as the potential demand for long-term bonds and the planned destination for the proceeds.

The documents proving the above-mentioned feasibility study should remain available to Bacen for at least five years at the headquarters of the issuing institution.

The conditions of tradability of the LF in the market were also improved by the new regulation. The improvement is evidenced by the permission to issue LFs with repurchase and resale clauses and subordination clause (cláusula de subordinação). In addition, the exchange of LFs was allowed and the minimum par value by unit of LFs with subordination clause was reduced from R$ 300 thousand to R$ 150 thousand.

The LF cannot be issued with a par value by unit lower than: (i) R$ 300 thousand, if it contains subordination clause; and (ii) R$ 150,000, if it does not contain subordination clause. The concept of subordination clause is set forth by article 40 of Law 12249/2010 and means that the LF may be issued with subordination clause in relation to the unsecured creditors, with right of preference solely over the issuer´s shareholders to the remaining assets, if any, in the event of liquidation or bankruptcy of the issuing institution.

The vast majority of the financial instruments of this kind available on the market are composed by LFs without subordination clause. Now, a larger audience can acquire these papers, but the target audience will still be composed of qualified investors, because the minimum par value by unit of the LF without subordination clause remains the same (R$ 300 thousand).

The LF can pay interest rate fixed in advance, combined or not with floating rates3, or with a price index, observing the legal provisions and regulations applicable in each case. The issue with exchange variation clause is not admitted. Payments shall always have a minimum interval of 180 days.

The minimum maturity term of the LF is 24 months (i.e. two years). The partial or total redemption before the agreed maturity continues to be expressly prohibited.

The LF with a maturity exceeding 48 months (i.e. four years) that it is not remunerated based on the rate applied on the interbank loans (DI rate)4 may be issued with a repurchase option clause by the issuing institution or resale option clause to the issuing institution, combined or not with the modification of the LF´s financial burden if the option is not exercised. The first option date should observe the minimum agreed term. The interval between the option dates must be of at least 180 days. The repurchase option by the issuing institution of the LF subject to public offer must observe fair criteria, in the form of the special regulation enacted by the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários - CVM).

Therefore, there was also a change in the rules for issuance of LFs with a term over four years. In this case, the authorized financial institutions may issue papers with resale and repurchase clauses so that the investors can exit this type of application more easily. This paper can pay periodic income every 180 days. This change aims to increase the average term of the LFs, which currently stands at 2.3 years.

The new regulation also allows the public offer of LFs with subordination clause, which was previously expressly prohibited. However, as already mentioned, the minimum par value per unit of R$ 300 was maintained in the case of the LFs with subordination clause.

Any institution authorized to issue LFs can exchange LFs of its own issuance at any time by another LFs issued by it under the following terms and conditions: (i) the nominal par value per unit must be equal to or higher than the exchanged LF, but it is possible to exchange new LFs with a nominal par value per unit below of the original LFs, provided that the sum of these amounts be equal to or higher than the nominal par value per unit of the original LFs; (ii) with a maturity exceeding the remaining term of the exchanged LF, subject to the minimum time limit of 24 months; and (iii) in the same condition of subordination of the exchange LF, provided, however, that a LF without subordination clause may be exchanged by another LF with subordination clause.

This measure allows the authorized financial institutions to exchange LFs traded at a higher cost per others with longer maturities and more attractive rates.

The exchange transaction must be made at the exchanges or organized over-the-counter (OTC) markets. Pursuant to CVM Instruction No. 461, of October 23, 2007, the Brazilian regulated markets comprise organized markets of securities, meaning the physical space or electronic system designed for the negotiation or registration of operations with securities by a certain number of people authorized to trade, whether they are acting on their own account or on behalf of a third party. Organized markets of securities are the Stock Exchanges, Commodities and Futures markets and the organized OTC markets. These markets shall be administrated by managing entities authorized by CVM.

The LFs without subordination clause may be acquired by the issuing institution at any time, provided that the transaction is made at the exchanges or organized OTC markets, to be kept in treasury and to be subsequently sold, up to the limit of 5% of the total LFs issued without subordination clause. The LFs without subordination clause acquired by third parties from the financial institutions of the same economic conglomerate must be computed in this 5% limit. The concept of same economic conglomerate used herein has the same meaning adopted by Bacen for the purposes of defining "consolidated financial statements of entities of the same group", which comprises the equity participations in companies located in Brazil and abroad which hold, directly or indirectly, solely or jointly with other partners, including by force of voting agreements, rights of partner which grant: (a) prevalence on the corporate decisions; (b) power to elect or dismiss the majority of the administrators; (c) effective operational control, by means of the common administration or management; (d) corporate control, represented by the aggregated sum of all the equity participations held by the institution, regardless of the percentage, with those held by its administrators, controllers and related companies, as well as those acquired, directly or indirectly, through investment funds. It is also necessary to consider and include in the same category all the financial institutions and other entities accredited by Bacen linked by effective operation control or acting in the market under the same trademark or trade name, even when there is no equity participation whatsoever5.

The LF used for the purpose of capital formation of the issuing entity must comply with the conditions established by Res. 4123/2012 and the specific regulation.

Furthermore, the LF may be used for the performance of linked credit transactions (operações ativas vinculadas) funded with resources delivered or place at their disposal by third parties, as permitted by the current regulations6.

The linked credit transaction must comply with at least the following conditions: (i) the funding provided by the third party acting as creditor will have to be linked to the credit transaction made by the financial institution which is the debtor; (ii) the funds so raised will be subordinated to the flow of payments (interest and other charges) of the credit transaction; (iii) the remuneration of the linked credit transaction must be sufficient to cover the costs of the funding; (iv) the cash flow of both operations (credit transaction and funding) must be compatible; (v) the term of the funding must be equal to or exceeds the term of the credit transaction; (vi) any payment to the creditor, including interest or other charges or repayment of principal, will be postponed, in the event of default of the linked credit transaction; (vii) partial or total non-payment of principal and interest or other charges due to the creditor, in the event that the enforced guarantees are insufficient to settle the linked credit transaction, or in other situations whereby the transaction is not financially liquidated. Furthermore, the funding cannot be guaranteed by the financial institution which will receive the funds so raised to perform the linked credit transaction, or by any related person, i.e. any individual or legal entity who/which forms the same consolidated economic group as defined by Bacen.

In view of the need to adapt the systems of record to the new characteristics of the LFs, Res. 4123/2012 will come into force only on November 1, 2012.


1 The legislation relating to credit documents in Brazil is basically contained in the Civil Code. Supplementary material is also contained in the Bills of Exchange Law. This legislation has been amended in relation to certain credit documents as a result of the Uniform Law adopted by the international conventions at Geneva which was promulgated in Brazil by Decree No. 57595 of January 7, 1996 (checks) and Decree No. 57663 of January 24, 1966 (bills of exchange and promissory notes). On September 2, 1985, Law No. 7357 was enacted dealing with checks, based on the Uniform Law of Geneva.

2 Furthermore, the LF is an extrajudicial executive instrument, which may be executed regardless of protest based on a certificate containing all the informational data registration, issued by the entity authorized by Bacen to administrate the above-mentioned registry and financial settlement of assets system. Depending on the remuneration criteria, the LF may generate a redemption value inferior to its issuance value. Its transfer of ownership is made by through the above-mentioned registry and financial settlement of assets system and the entity authorized to administrate such system will have to keep in its registries all the historical sequence of trading of the LF.

3 Pursuant to CMN Resolution No. 1143, June 26, 1986, financial institutions are authorized to perform transactions at floating rates, which may be adjusted for fixed periods, provided that the term of the transaction is equal to or exceeds 180 days.

4 DI in Portuguese means Depósito Interfinaceiro, which can be translated into English as inter financial or interbank deposit. The money is borrowed via interbank deposit certificate (Certificado de Depósito Bancário – CDI). The applicable rate is known in Brazil as "taxa DI" and it is the average of the interest rates negotiated between the banks for short-term loans.

5 This definition is expressly set forth by article 3 of CMN Resolution No. 2723, of May 31, 2000, with the wording of CMN Resolution 2743, of June 28, 2000.

6 The linked credit operations are governed by CMN Resolution No. 2921, of January 17, 2002.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Walter Stuber
Adriana Maria Gödel Stuber
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