Brazil: Central Bank Of Brazil Regulates Covered Bonds

Last Updated: 3 November 2017
Article by Marcelo Cosac and Camilla Paiva

Pursuant to the provisions of Law 13,097 dated as of January 19, 2015 ("Law 13,097"), the National Monetary Council approved, in extraordinary meeting, the publication by the Central Bank of Brazil ("BCB"), on August 29, 2017, of Resolution No. 4,598 ("Resolution"), which regulates the issuance of Covered Bonds (Letras Imobiliárias Garantidas – "LIG") by full service banks, commercial banks, investment banks, credit entities, financing and investment companies, savings banks, mortgage companies and savings and loan associations. The purpose of the new bond is to complement the sources of funds for the real estate sector.

LIG is very similar to covered bonds, widely used abroad. The typical characteristic of covered bonds that LIG brings to the Brazilian market is its double guarantee, that is, like covered bonds, LIG is secured (i) both by assets, mainly for real estate credits, organized in a cover pool, i.e., in a portfolio of assets, (ii) and by the maintenance of the issuing institution as the one liable to investors for the performance of the issued LIGs, in case the asset portfolio is insufficient to pay the LIG.

Unlike the securitization process, for example, in which the real estate credit is assigned to the securitization company, in the issuance of LIG and covered bonds the credit is maintained with the issuer itself, integrating its balance sheet. This allows the issuer to replace the assets of the asset portfolio (see the Portfolio Management section below), subject to the requirements on the Replacement and Reinforcement of the Asset Portfolio established in the Resolution.

We highlight below the main aspects related to the LIG regulated by the BCB.

Definition and Conditions for Issuance

The Resolution repeats the concept given to LIG in Law 13,097, that is, "registered, transferable and freely negotiable commercial paper, secured by a portfolio subject to the fiduciary regime."

Several conditions have been set for the issuance of LIGs by institutions authorized to do so; non-compliance will subject the institution to the suspension of any new LIG issuances. In summary, these conditions are focused on: (i) the restriction of the values of the assets comprising the portfolio that guarantees the security in relation to the total assets of the issuing institution (10% of the total assets of the issuing institution in the S1 segment – financial institutions whose size equals or is greater than 10% of GDP or that carry out relevant international activity, regardless of size – and 30% of the total assets of the issuing institution in the other segments established by the BCB in Resolution 4,553, dated as of January 30, 2017); and (ii) with respect to the minimum requirements for Reference Equity, Level I and Principal Capital established by the BCB.

The issuing institution, together with the issuing fiduciary, shall inform the BCB who the officer responsible for the LIG issuance is, who may be in charge of other tasks at the issuing institution, except for those related to the management of third-party funds, internal audit, internal controls and other tasks that may imply a conflict of interest or represent a deficiency in separation of duties.

LIG and Issuance Features

LIGs must be issued by means of an LIG Issuance Term, containing the terms and conditions related to the LIG or LIG Issuance Program (as seen below). Among other clauses, the Issuance Term shall contain (i) the rules and conditions of the Special Repayment Scheme (to be implemented in the event of intervention, extrajudicial liquidation or bankruptcy of the issuing institution, or recognition of its insolvency status by BCB); (ii) the Transition Plan for the Portfolio Management (also implemented in the cases listed in the previous item); (iii) the conditions for early redemption and repurchase of LIGs, which may not occur before 12 months, save for the exceptions provided for in the regulation; (iv) the rules governing the procedures applicable to general meeting of investors holding LIGs, with special focus on the conditions for calling, commencement and resolutions; (v) the proportion of real estate transactions relative to the total value of real estate credits in the portfolio, indicating the portfolio profile according to the preponderant real estate credit type, and emphasizing its residential or non-residential nature; and (vi) the fiduciary's compensation amount, as well as the frequency and payment conditions.
Also, the LIG Issuance Term must be registered with an entity authorized by the BCB to perform centralized deposits, and published in a specific section at the issuing institution's internet address.

The Resolution also defines the general characteristics of the LIGs themselves. With regard to LIG remuneration, it may be based on fixed or floating interest rates, even if not combined, as well as on various rates, provided they are publicly known and calculated on a regular basis. It is worth emphasizing that LIGs may generate a redemption value lower than the issuance value itself, according to its remuneration criteria. LIGs must be issued with a minimum weighted average term of 24 (twenty-four) months.

In addition, their anticipated maturity may only occur in the event of insolvency of the portfolio, as provided in Article 36 of the Resolution (LIG default on payment or non-compliance with the sufficiency requirement).

Special Amortization Scheme

In the event there is an intervention, extrajudicial liquidation or bankruptcy of the issuing institution, or the adjudication of insolvency status by the BCB, when the LIG principal is not paid on the original maturity date, the Special Amortization Scheme will apply, and it must be included in the LIG Issuance Term.

The Special Amortization Scheme may provide for the postponement of the maturity date of LIG's principal payments, and it may not establish (i) different amendment periods for payments of LIG's principal that are guaranteed by the same portfolio, except in case of postponement of payments for the same final date, and (ii) the maturity date of the postponed payment is on a date subsequent to the last maturity date of the assets included in the portfolio.

LIG Issuance Program

The Resolution provided that LIG Issuance Programs may be established when the issuing institution intends to issue LIGs in series, taking into account the fact that, when issued in this manner, they will be guaranteed by the same portfolio, and will have identical form, frequency, place of payment, par value, interest rate, and issuance and maturity dates.


The Resolution established several requirements that must be met to form the portfolio that guarantees LIGs. Failure to comply with the portfolio requirements subjects the issuing institution to having new LIG issuances suspended. The requirements are as follows:

1. Eligibility requirement: the portfolio can only be comprised of: (i) real estate credits, (ii) National Treasury bonds, (iii) derivatives and (iv) financial assets derived from the assets included in the portfolio. In addition, the Resolution lists a series of formal requirements indispensable for the election of each specific asset.

The legislator defined real estate credits as those created through: (i) financing for the acquisition of residential or non-residential property; (ii) financing for the construction of residential or non-residential property; (iii) corporate financing for the production of residential or non-residential real estate property; and (iv) loan to an individual with a mortgage or a fiduciary sale clause of residential property, a typical transaction known in the market as "home equity".

2. Composition Requirement: the sum of the adjusted par values of the real estate credits, including derivatives, must represent at least 80% (eighty percent) of the total adjusted face value of the portfolio.

3. Sufficiency requirement: the portfolio must be sufficient to meet all the commitments related to the LIGs it secures; however, regardless of the sufficiency of the corresponding portfolio, the issuing institution will be liable with respect to all obligations arising from the LIG, pursuant to the sole paragraph of article 63 of Law 13,097. Under the Resolution, the sufficiency requirement is met if: (i) the sum of the updated par values of the assets in the portfolio exceeds by at least 5% (five percent) the sum of the updated par values of the payment commitments of the LIGs secured by it and the compensation of the fiduciary; and (ii) the sum of the present values of the assets in the portfolio corresponds to at least the sum of the present values of the payment commitments of the LIGs secured by it and the compensation of the fiduciary when submitted to stress tests.

For the purpose of verifying the sufficiency requirement, the issuing institution shall conduct stress tests in order to measure the impact of the main risk factors to which the portfolio is exposed in relation to compliance with the sufficiency requirement. Such stress tests will be performed according to the issuing institution's own procedures and must be carried out at least every three months.

4. Term Requirement: the portfolio weighted average term may not be lower than the LIG's weighted average term secured by the portfolio, to avoid the issuance lacks sufficient backing.

5. Liquidity Requirement: the portfolio must have liquid assets (thus taking into consideration National Treasury bonds, and cash and cash equivalents from the assets included in the portfolio) in amounts corresponding to secured commitments maturing in the next 180 (one hundred and eighty) days.

6. Asset Value: for the purposes of verifying compliance with the requirements mentioned above, the par value of the LIGs and the assets in the portfolio must correspond to the respective book value, calculated according to the criteria established in Cosif.

Portfolio Management

In addition to the obligation to verify compliance with the requirements for the composition of the portfolio on the fifth business day of each month, among other responsibilities the issuing institution has as the portfolio manager, we emphasize the following:

(i) To keep accounting controls that allow: (a) identifying the assets that are part of the portfolio; (b) identifying the financial resources derived from the assets in the portfolio; (c) verifying compliance with the LIG issuance condition; (d) verifying compliance with the portfolio requirements; and (e) identifying National Treasury Bonds part of the Liquidity Reserve, in case it chooses the option provided for in Article 44 of the Resolution (maintaining liquidity reserve in substitution for assets in the portfolio);

(ii) To disclose, in notes to financial statements, information that shows the portfolio situation in relation to the fulfillment of the requirements set forth in this Resolution, as well as of the LIGs secured by it, and the percentage ratio between the sum of the assets included in the portfolio and the institution's total assets.

Whenever any of the portfolio composition requirements are not met, the issuing institution must reinforce the portfolio, replace the assets in it, repurchase or early redeem the LIGs within two (2) business days date as of the non-compliance.

The LIG issuing institution must have fiduciary regime established for the portfolio, as required by article 68 of the aforementioned Law 13.097, so that the portfolio is only liable for obligations arising from the LIG itself, which brings LIGs closer to the Certificate of Real Estate Receivables – CRI, created by Law 9,514, dated as of November 20, 1997, issued by the Real Estate Credit Securitization Companies (although it is important to emphasize that in the case of CRI issuancies, the fiduciary regime is not mandatory). However, the financial resources derived from the assets included in the portfolio will be released from the mandatory fiduciary regime and, consequently, from the LIG guarantee, pursuant to Article 45 of the Resolution, provided that all requirements regarding portfolio composition and the conditions to comply with LIG due obligations are met.

In the event any of the cases in Article 47 of the Resolution (intervention, extrajudicial liquidation or bankruptcy of the issuing institution or adjudication of insolvency) occurs, the fiduciary will be in charge of the effective management of the portfolio. Such investiture will occur through the Transition Plan, to be prepared in advance by the issuer and the fiduciary. In turn, the fiduciary will enjoy the attribution of several specific powers, such as the possibility of hiring third-party service providers related to portfolio management, as well as verifying the liquidity and sufficiency requirements of the portfolio.


Fiduciary may be (i) real estate credit securitization companies, dependent on prior authorization of the BCB to do so, (ii) securities brokerage firms and (iii) securities distributing companies.

It is expressly prohibited that fiduciary's activities be performed by any entity connected to the issuing institution. In addition, the institutions that intend to act as a fiduciary must have, among other requirements set forth in the Resolution, net worth equivalent to at least R$ 1,500,000.00.

Provision of Information

Every quarter, the LIG-issuing institution must prepare a report that shows the situation of the portfolio and the LIG it secures, containing at least (i) risk assessment related to the LIG issuance or the LIG Issuance Program and the corresponding mitigation mechanisms used; (ii) verification of compliance with the portfolio requirements; and (iii) verification of compliance with the conditions established in the LIGs.

The institution is also required to immediately disclose material act or fact that could represent a significant change in the portfolio or LIG situation.


The Resolution went into effect on the date of its publication, August 31, 2017.

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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