Brazil: The Rules On BDRs Change Again For Better

Last Updated: 6 April 2017
Article by Walter Stuber

On April 5, 2017 the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) enacted CVM Instruction No. 585 (ICVM 585/2017), which amends the applicable regulation on Brazilian Depositary Receipts (BDRs) constituted by: (i) CVM Instruction No. 332, of April 4, 2000 (ICVM 332/2000), which provides for the issuance and trading of BDRS; (ii) CVM Instruction No. 476, of  January 16, 2009 (ICVM 476/2009), which provides for public offerings of securities distributed with restricted efforts; (iii) CVM Instruction No. 480, of December 7, 2009 (ICVM 480/2009), which provides for the registration of issuers, foreign and domestic, of securities admitted to trading on regulated markets in Brazil; and (iv) CVM Instruction No. 494, of April 20, 2011 (ICVM 494/2011), which provides for the incorporation and operation of investment clubs.

The goal of ICVM 585/2017 is to improve the access of foreign issuers to the Brazilian capital market, eliminating potential regulatory barriers to the development of this market.

I. Preliminary Considerations

BDRs are certificates issued by a depositary institution in Brazil that represent securities (stocks) issued by publicly-held corporations with headquarters overseas. The BDR is issued by a depositary institution in Brazil, backed by stocks of a foreign company not registered as a publicly-held corporation in Brazil. The depositary institutions must be authorized by the Central Bank of Brazil (Banco Central do Brasil - Bacen) and CVM to issue BDRs. The responsibility of disclosing the financial information of the issuing foreign company lies with the depositary institution.

According to the current CVM regulation, there are three types of BDRs for trading: Level I, II and III. Level I BDRs can be Sponsored or Unsponsored. Sponsored BDRs are issued by a depositary institution that has an agreement with the foreign issuer (the foreign company that issues the stocks) and can only be Level II and III. Unsponsored BDRs can only be Level I and do not involve the foreign issuer.

The main characteristics of Level I BDRs are: (a) trading is limited exclusively to the non-organized over-the-counter (OTC) market or in specific segments for Level I BDRs of an entity of the organized OTC market or of Stock Exchanges and only between the authorized investors listed by CVM; (b) disclosure of financial information on a regular basis in accordance with the regulation to which the issuing foreign company is submitted (in the Portuguese language); (c) it is not necessary to register the issuing foreign company with CVM; and (d) exclusive acquisition by the authorized investors listed by CVM.

The main characteristics of Level II BDRs are: (a) admission to trading on Stock Exchanges or the organized OTC market; and (b) registration of the issuing foreign company with the CVM.

Level III BDRs presents the following characteristics: (a) public distribution on the market; (b) admission to trading on the Stock Exchanges or the organized OTC market; and (c) registration of the issuing foreign company with CVM.

The decision to issue Unsponsored Level I BDRs comes from a depositary institution established in Brazil, which requests the program´s registration with CVM and the Brazilian Exchange (BM&FBOVESPA S.A. – Bolsa de Valores, Mercadorias e Futuros - BVMF), without having to involve the foreign company that issues the stocks.

According to survey conducted by BVMF, the participation of foreign companies in volumes traded on the BVMF is 0.6% – percentage far below the participation in other stock markets abroad, as for example: Colombia (17%), Lima (15.4%), Mexican (9.5%), NASDAQ (8.5%) and London (16.19%)[1].

The main changes introduced by ICVM 585/2017 are as follows: (i) permission for public offering with restricted efforts of Level I and II BDRs; (ii) verification of the framework as foreign issuer; (iii) waiver procedure of the location of assets' criterion to be deemed a foreign issuer; (iv) composition of the investment clubs' portfolio; and (v) other relevant amendments.

II. Permission for public offering with restricted efforts of Level I and II BDRs

One of the main obstacles for the entry of a large number of foreign issuers in the Brazilian capital market was the impossibility to publicly offer BDRs with restricted efforts.

The permission for distribution of Sponsored Level I and II BDRs by means of a public offering with limited efforts aims to expand the access of the foreign issuers to the Brazilian market, through a public offering released from registration and limited to a maximum number of investors.

The inclusion of Sponsored Level I and II BDRs in the list of securities that may be offered to the public with restricted efforts falls into the same context of the reform initiated by CVM Instruction No. 551, of September 25, 2014 (ICVM 551/2014), which added Level III BDRs to the list of assets that can be the object of this type of offer. In the case of Level II BDRs, this inclusion is consistent with the rationale adopted in ICVM 551/2014, because likewise the issuers of Level III BDRs the issuers of Level II BDRs must be also registered in category A[2].

CVM also considered relevant the permission to offer Sponsored Level I BDRs, whose issuers are not subject to registration, because the specific regulation allows the offer of these certificates of deposit without resulting in additional risks to the securities market.

ICVM 332/2000 establishes that Level I BDRs will be purchased by qualified investors and employees of the sponsoring company; and will be traded on the unorganized OTC market or in specific segments of the organized OTC market or Stock Exchanges. These limitations are consistent with those present in ICVM 476/2009, which restricts the supply and trading of securities to professional and qualified investors, respectively.

Depending on the characteristics of the Sponsored Level I BDRs, there are two exceptions to the provisions of ICVM 476/ 2009, dealing with the offer with restricted efforts of securities issued by non-registered issuers. The first exception relates to paragraph 3of article 14 of ICVM 476/2009, which determines that Sponsored Level I BDRs will be traded in specific segments of the organized OTC markets and Stock Exchanges, under the specific regulation, even if it is a non-registered offeror, in accordance with ICVM 332/2000. The second exception provided for in item III of paragraph 1 of article 17 of ICVM 476/2009, releases the offeror of Sponsored Level I BDRs of the informational obligations required from unregistered issuers, once ICVM 332/2000 establishes a system of provision of information for the sponsoring companies of BDR programs.

The incentives for access from the sponsoring companies of Level I BDRs programs are high, when compared to Level II BDRs programs, since they can sell their certificates with restricted efforts in the Brazilian securities market without the need of obtaining the registration of the issuer. This creates an intermediate step to the sponsoring companies wishing to access the Brazilian market through BDRs that still do not want to be registered in category A.

III. Verification of the framework as foreign issuer

CVM believes that the elimination of regulatory barriers to stimulate the offer of Sponsored BDRs must come accompanied by normative improvements to ensure the framework of the sponsoring company as foreign issuer.

Foreign issuer[3] is the legal entity that has its headquarters outside Brazil and whose assets located in Brazil does not exceed the percentage of 50% according to its consolidated or separate individual financial statements, prevailing whichever best represent the essence of business for classification purposes.

The existing regulation provided that the condition of foreign issuer must be verified in the cases of registration of: (i) the issuer; (ii) the public offering of BDRs, and (iii) the BDR program, but it was silent about the possibility of conducting a public offering with restricted efforts. ICVM 585/2017 expressly clarifies that the verification of the condition of foreign issuer also applies in this type of offer[4].

For the same reason, other changes have been made. Articles 4-A and 4-B of ICVM 476/2009 determine that to perform  a public offering of BDRs with restricted efforts, the sponsoring company must be framed as foreign issuer and this condition must be attested through a statement of its legal representative, accompanied by the memory of calculation of the percentage of assets located in Brazil. Since a public offering with restricted efforts is not registered with CVM, a new item X was included in article 11 of ICVM 476/2009 to predict that the intermediary leader of the offer will have to verify compliance with this requirement by the issuer.

In addition, the procedure for verification of the framework as foreign issuer of the sponsoring companies of Level I BDR programs has also been improved. Accordingly, ICVM 585/2017 amends item VIII of article 5 of ICVM 332/2000, establishing that the application of Level I BDR program must be accompanied by the statement of the legal representative of the sponsoring company certifying that such company falls into the condition of foreign issuer, together with the memory of calculation proving this condition.

In view of the potential increase in the participation of foreign issuers in the Brazilian capital market, CVM requires that this condition be checked both at the time of registration of the Sponsored Level I BDR program (in the absence of registration of the issuer in these cases) and in making an offer with restricted efforts.

IV. Waiver procedure of the location of assets' criterion to be deemed a foreign issuer

The procedure for waiver of the verification of the criterion of assets located in Brazil does not confer any predictability about the assumptions on which the exemption request of the issuer will be granted. This criterion is provided for in paragraph 4 of article 1of Annex 32-I of ICVM 480/2009.

For this reason, ICVM 585/2017 reformulates such paragraph 4 to set up an automatic exemption to issuers to prove, in the case of a public offering of BDRs, that the percentage of assets located in Brazil does not exceed the maximum limit of 65% contained in the consolidated or separate individual financial statements, prevailing whichever best represent the essence of business for classification purposes.

This provision does not change the definition of foreign issuer contained in paragraph 1 of Annex 32-I of ICVM 480/2009 because this definition has served the intended purpose of preventing that genuinely Brazilian companies be registered as foreign issuers. CVM believes that a regulation that allows Brazilian issuers organized as foreign companies is undesirable but does not wish to restrict the coming of foreign issuers for the Brazilian market because Brazil has the capacity to become at least a regional center of liquidity in Latin America that would contribute to the sound growth of the securities market.

In summary, the following benefits were considered in the new proposed waiver procedure: (i) predictability and legal certainty for the market, in comparison with the discretionary waiver procedure previously in force, since foreign issuers will know the exact limits admitted by CVM for granting the exemption; (ii) maintenance of the same criterion of location of assets, which has been adopted by CVM since the enactment of ICVM 480/2009 (50%); and (iii) increased flexibility for foreign companies who wish to expand their activities in Brazil and could become unframed as foreign issuer, after the initial registration of the BDR program, due to a percentage of assets located in Brazil beyond 50% (which can be raised up to 65%).

V. Composition of the investment clubs' portfolio

ICVM 585/2017 also amends article 27 of ICVM 494/2011 to include BDRs in the list of securities which can compose the portfolio of investment clubs up to the limit of 33% of their respective net worth. This change is in line with the recent changes in CVM regulation in order to allow greater exposure of institutional investors to the securities issued by foreign companies.

However, the permission for investment in BDRs by investment clubs does not exempt compliance with any restrictions whatsoever regarding the acquisition and trading of BDRs. Therefore, in cases where the acquisition of BDRs is restricted to qualified or professional investors, only investment clubs that fit in these categories can purchase BDRs, in accordance with the provisions CVM Instruction No. 539, of November 13, 2013, which regulates the duty of checking the suitability of products, services and operations to the client´s profile.

VI. Other relevant amendments

Among other changes, ICVM 585/2017 modified paragraph 3 of article 3 of ICVM 332/2000 in order to determine that, in the case of Unsponsored Level I BDR programs, the depository institutions must disclose the information of the company whose securities underlying the BDRs "until the opening of the trading day following their release in the country of origin". The amendment made by CVM seeks to give greater legal certainty to the depository institutions, since the former wording of such paragraph 3 did not contain any objective forecast in relation to the time of disclosure of this information.

Furthermore, articles 6 and 7 of ICVM 332/2000 have been changed and standardized the procedure for registration and cancellation of BDR programs by the Superintendence of the Securities' Registration (Superintendência de Registro de Valores Mobiliários – SRE), with the adoption of the deadlines and procedures of analysis applicable to the request for registration of  the public offering of securities provided for in ICVM 400/2003, since these parameters are widely known both by the competent technical area of CVM (SRE) and the market participants.

The wording of article 10 of ICVM 332/2000 was also improved in order to clarify the performance of the depository institution to exercise the right to vote the shares that serve as ballast for the BDRs, following the pattern adopted by CVM Instruction No. 559, of March 27, 2015, which regulates the depositary receipt programs for trading abroad. Now article 10 establishes that the right to vote the shares that serve as ballast for a BDR program must be exercised by the depository institution in the manner instructed by the BDR holders whenever so permitted by the contracts for the program, or in the best interest of the BDR holders, when such contracts prevent voting instructed by them.

The informational regime of Level I BDRS, sponsored and non-sponsored has been updated, with the aim to clarify that the dissemination of information on these programs can be held in Portuguese or in the language of the country of origin, and consists of an obligation of the depositary institutions.

It is now possible to transfer the BDR program to another depositary institution on request forwarded to CVM, without the need for cancellation of the respective program, provided that: (i) the BDR holders are duly informed about the transfer with at least 60 days in advance; and (ii) the characteristics of the BDR program are not changed, except for the possibility of modification of the custodian institution, which is allowed.

The BDRs were assimilated to the shares and other variable income securities under ICVM 476/2009. Therefore, BDRs are not subject to the lock-up period[5] and the restriction which requires that the securities be only acquired by qualified investors is also not applied to BDRs[6].

In view of the various changes made in ICVM 332/2000, CVM understand convenient to republish a consolidated version of it.

[1] Source: WFE; London; Bloomberg (January-April/2014).

[2] Under the current regulations there are two different categories of registry: (i) category A, which authorizes the trading of any types of securities; and (ii) category B, which excludes shares and share certificates of deposit as well as securities which attribute to the holder the right to acquire shares and share certificates of deposit as a result of the conversion or the exercise of inherent rights, provided that these securities are issued by the same issuer or by a company belonging to its economic group.

[3] This definition is contained in paragraph 1 of article 1 of Annex 32-I of ICVM 480/2009.

[4] Paragraph 2 of article 1 of Annex 32-I of ICVM 480/2009 has been amended for this purpose.

[5] Pursuant to article 13 of ICVM 476/2009, the securities offered in accordance with such instruction can only be traded on regulated securities markets after 90 days of each subscription or acquisition by investors. This period is known as lock-up period and does not apply to shares, subscription bonus, share certificates of deposit and BDRs.

[6] This restriction is contemplated in the preamble of article 15 of ICVM 476/2009 and the exceptions are regulated by paragraphs 3, 4 and 5 of article 15, as follows:

(i) § 3 - such restriction does not apply to shares distributed with restricted efforts, if: (a) the closure of public offering distribution of shares of the same type and class registered with CVM has already occurred or will occur; or (b) the period of 18 months from the date of admission to trading on a stock exchange of shares of the same type and class has elapsed;

(ii) § 4 - in the case of public offerings distributed with restricted efforts which have as purpose shares of issuers in pre-operational phase, such restriction will cease from the date on which, cumulatively: (a) the company become operational; (b) 18 months has elapsed following the closure of the offer; and (c) 18 months has elapsed from the admission to trading of the shares on the stock exchange; and

(iii) § 5 - The provisions of § 4 shall not apply if the company: (i) has carried out the first public offering registration with CVM; and (ii) has satisfied the restriction imposed on the registered offer.

For the purposes of article 15, the company will be considered pre-operational while it has not presented revenue from its operations in the annual financial statement or in the consolidated annual financial statement prepared according to CVM standards and audited by an independent auditor registered with CVM.

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
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