Preserving Brazil’s attractiveness as a high-return destination

Author: | Published: 25 Sep 2012
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2011 was a great year for Brazilian private equity with approximately $7 billion raised and a great participation of funds in Brazilian mergers and acquisitions. In 2012, despite a slowdown in global private equity activity, investments continue to pour into Brazilian consumer sectors for consolidation purposes as well as into infrastructure projects. The infrastructure deficit that must be reduced as promptly as possible due to big sporting events scheduled for 2014 (World Cup) and 2016 (Olympics). The pre-salt oil and gas market has also been quite attractive since Brazilian energy pressure has been kept at the high end. Along with such opportunities, the Brazilian investment regulatory framework continues to evolve. Relatively recent changes to Brazilian corporation laws, developments in the regulation of private equity funds – including industry self-regulation – along with case law decisions in trade finance have been contributing to keeping Brazil as a destination for funds seeking returns that are hard to find elsewhere.

Since 2010, Brazil has adopted a series of measures to stimulate investment in public and private equity and private long-term financing through the capital market.

New accounting standards

To start with, since 2010 – following a transitional period – Brazilian companies are required to prepare their financial statements according to new rules set forth by Law 11,638 of December 28 2007, which constitute new accounting rules in line with IFRS rules. All Brazilian companies (no matter if they are limited liability companies or corporations) are required to follow the new accounting rules which include a cash flow statement and, for listed companies, an added value statement.

CVM Normative Instructions 496 and 498

Normative Instruction 391 of July 16 2003, from the Brazilian securities and exchange commission (CVM), provides for general corporate governance rules of private equity investment funds. Additional CVM regulations set forth the rules for FIP IE (infrastructure funds) and FIP PD&I (companies with innovative production techniques and with intensive research and development activities). On May 11 2011, CVM Normative Instruction 496 allowed FIPs to enter into derivative transactions with assets not included in the fund portfolio, though for protection purposes only. On June 13 of the same year, CVM Normative Instruction 498 allowed the negotiation at regulated markets of quotas distributed with restricted efforts (as per Normative Instruction 476). The previous ruling limited market negotiation to quotas previously distributed through public offerings.

Online shareholders' meetings

Law 12,431(Law 12,431) of June 24 2011 (Article 6th) introduced a change to Article 121, sole paragraph of Law 6,046/76 (the Brazilian corporations law) and authorised shareholders of listed companies to remotely participate and vote in shareholders' meetings. CVM Normative Instruction 481 of December 17, 2009 (NI 481) had already regulated the procedure for shareholders and the management to remotely request and obtain a power of attorney. By the time of issuance of the NI 481, there was no obligation for listed companies to implement the remote voting system. The procedure does not exactly allow the remote participation of the shareholder but the online appointment of an attorney-in-fact to vote in a pre-determined way. Nevertheless, the CVM may soon regulate the matter in more detail, probably by amending NI 481.

Tax exemption for infrastructure debentures

Law 12,431/ further created incentives for investments in tax-exempted debentures and in quotas of FIP IE and of a newly-created type of fund (FIP PD&I) to invest in companies with innovative production with intensive research and development activities. It reduced the income tax rate to 0% on the income provided by securities issued by FIP IE and FIP PD&I. This Law provides tax relief either to local and foreigners investors (except to those domiciled in a country where income is not taxed or is taxed at a maximum rate lower than 20%).

Securities public offerings for infrastructure projects did not take off as expected, however. The occurrence of very few securities offerings linked to infrastructure projects may be due to limitations and uncertainties contained in the law, such as those that imply certain penalties, as well as those concerning to the possibility of using the funds for payment of expenses incurred before issuance. These restrictions may be cleared as a result of the approval of the Bill of Law (PLV) nr. 18, of July 04,2012 (PLV) that proposes changes in the Law 12.431/. The Bill of Law was approved by the Brazilian National Congress and is still pending presidential approval.

In offerings aimed at foreign investors, four changes promoted by the PLV to achieve the 0% income tax rate stand out, such as: (i) authorisation for early liquidation of the securities in accordance with the conditions to be regulated by the National Monetary Council (CMN) – the current provision prohibits this practice; (ii) authorisation for using the raised funds to reimburse expenses incurred before the securities issuance, if certain requirements are met; (iii) income tax exemption for earnings with Real Estate receivables (CRIs); and (iv) reduction of the required minimum percentage of exposure in infrastructure investment projects for investment funds.

The PLV intends to include a penalty that was not provided in the Law 12.431, by proposing a fine of 20% on the raised funds from foreign investors if the total amount is not allocated in the investment projects. The fine would be applicable to the security's issuer or to the originator in the case of Real State receivables. Arguably, it is not appropriate to impose the penalty on the total raised amount. A better alternative would be to have the penalty calculated on the amount not allocated to the project, on the same basis as for issuances aimed to local investors. In any case, the PLV provides that in such event, the income tax for foreign investors will remain exempted.

In public offerings aimed at Brazilian investors, the PLV also brings other relevant innovations. According to the PLV, the tax benefit would only be granted to debentures issued by concessionaries of public services (or by its holding companies) organised with the scope of raising funds for projects in infrastructure or intensive economic production in research, development and innovation, all considered as priorities under Decree 7,603/11 – the current law does not include such restriction. With regard to the investment funds for infrastructure projects, the required minimum percentage on equity allocation would decrease from 85% to 65% in the first two years after closing of the distribution of the initial shares.

In general, the proposed changes are positive and clarify obscure points that concern the market. This may be good starting point from which to bring the debentures issued for infrastructure investments to reality.

CVM Normative Instruction 501

On July 15 2011 CVM enacted Normative Instruction 501 (which amended Normative Instruction 460, of October 10 2007, governing FIP IE) and reduced the minimum quota-holder number for both the FIP IE and the FIP PD&I from 10 to five. No quota-holder can have more than 40% of the quotas or earn more than 40% of the profits of the fund. A minimum of 90% of the fund assets must be invested in shares, warrants and debentures, convertible or not, of eligible companies. Infrastructure projects eligible for FIP IE projects are those relating to energy, transportation, water, sanitation and irrigation.

ABVCAP/ANBIMA code of best Practices for funds

On March 1 2011 ABVCAP (the Brazilian Association of Venture Capital) and ANBIMA (the Brazilian Association of Capital Markets Entities) enacted a code of regulation and best practices for FIPs and FMIEEs (a fund investing in companies with net revenue up to R$150 million ($73.96 million)). The code must be mandatorily adopted by members of such entities and voluntarily by non-members, and provides for more strict corporate governance rules.

The code classifies funds into three different categories, depending on their regulations as follows: (i) Fund Type one provides for an investment committee chosen by the quota-holders and may provide for a supervising committee; (ii) Fund Type two provides for an investment committee composed exclusively of members of the administration and management of the fund and for a supervising committee; and (iii) Fund Type three does not provide for an investment committee but may provide for a supervising committee. In accordance with the code, the change of the type of fund must be subject to the quota-holders' approval according to the voting quorum established by the fund regulations.

Central Bank circular-letters 3,580 and 3,609

As far as bank finance is concerned, trade finance regulations have also recently undergone changes. Since 2008, the world credit crisis has been affecting Brazil as well. The crisis leads several companies form different sectors, many from the agribusiness, to ask for bankruptcy protection. Brazil trade and commodity finance has been changing since then, with producers and exporters seeking finance and offering collateral against a backdrop of unstable fiscal policies.

In export finance transactions, the exporter commits to timely perform an export of goods as payment of an anticipated credit. In the event of a default in shipping the goods, the outstanding financing amounts must be converted into a loan in foreign currency, be converted into an equity investment, or be returned, in cash, to the creditor. The advantage of export finance with respect to a straightforward financing lies in the fact that it is exempted from tax on financial transaction (IOF) and withholding income tax.

On March 1 2012, the Brazilian Central Bank issued CL 3,580 amending export prepayment rules to prohibit foreign entities, except importers, to prepay exports made by Brazilian companies. This represented a tremendous set back in the export finance market since virtually all finance transactions were intermediated by foreign banks. CL 3,580 also limited transactions to 360 days. Once such term expires, the transaction must be converted into a straightforward financing subject to IOF and income tax.

On June 28 2012, the Brazilian Central Bank issued CL 3,604 further amending export finance rules. CL 3,604 partially revokes CL 3,580 and reintroduces the ability of any foreign entity (and not only importers), including financial institutions, to prepay exports made by Brazilian companies. The prohibition imposed on foreign financial institutions to carry out export prepayment transactions lasted for a very short term (from March 1 to June 28). The 360-day prepayment limitation period introduced by CL No. 3,580 was, however, maintained and is in full force and effect.

A straightforward loan (also known as a 4,131 Loan) between an exporter and a foreign bank differs from an export finance transaction in what the principal amount must necessarily be repaid in cash. Furthermore there is no fiscal benefit and, as such, the loan is subject to IOF and to withholding income tax on interest payments at a rate between 15% and 25%. Since June 2012, 4,131 Loans are subject to the IOF rate at 6% in transactions with a minimum average tenor of up to 720 days.

Both an export finance and a 4,131 Loan may be structured with in rem guarantees such as a mortgage, a pledge or a fiduciary lien. And in the situation of a credit crisis, such guarantees demand special attention. A mortgage or a pledge are ranked – after labour credits limited to 150 minimum salaries per employee – at the top of the priority order. A fiduciary lien in turn is not affected by a court-approved credit restructuring (known in Brazil as a judicial reorganisation) and the creditor may seek repossession of the asset either immediately or, in the case of a fixed asset, at the end of the stay period (180 days following the court decision approving the processing of the moratorium). The Court of Appeals of the State of São Paulo has already taken the position that foreign creditors of export finance are not affected by bankruptcy or judicial reorganisation and have priority over all credits submitted to such procedures no matter if the debtor has performed or not the obligation to export (for instance, Appeal number 0041309-26.2008.8.26.0000, among others). The matter is yet controversial in the court of appeals of other federative states and may be a good reason for foreign creditors to elect São Paulo as a choice of law for purposes of collateral formalisation.

Brazilian merger control

Law No 12,529, of May 29 2011, became effective as of May 30 2012 and modified competition law rules in Brazil. As per the new regulation, any merger transaction (merger, as a class, comprises also acquisitions and joint venture) where the revenues within the Brazilian territory of one of the groups involved in the previous fiscal year equals or exceeds R$750 million while the revenues of the other party equals or exceeds R$75 million, must be submitted for the antitrust body Cade's approval before its completion. Otherwise the transactions will be null and void and the parties may be subject to a monetary fine varying from R$60,000 to R$60 million. The procedural fee of R$45,000 for submission has been maintained.

From the enactment of the new law, parties are free to determine the appropriate timing to submit the operation to Cade, as long as they do not conclude the deal and keep their unrelated activities without any integration that could be looked upon as a joint or somehow concerted operation in advance to the approval of the transaction. The parties may also request permission to complete the transaction regardless of the previous approval of Cade to the extent the parties evidence the inexistence of irreparable damages to market conditions, the possibility of reverting the transaction and the absence of material financial losses to the target company if the transaction is not approved. Provided all required information is given, Cade will authorise (or not) the transaction within 30 days. Cade maximum period of analysis is 330 days. The regular term is 240 days which may be extended for an additional 90-day period for additional diligence.

For the purposes of evaluating the revenue threshold for submissions, companies under common control and companies holding at least 20% of the total stock or voting stock of other companies should be treated as members of the same economic group. As far as investment funds are concerned, the following are cumulatively considered members of the same group: (i) funds under the same management; (ii) the manager; (iii) the investors directly or indirectly holding more than 20% of the quotas of at least one of the funds that are under the same management; and (iv) companies comprising the portfolio of funds in which the fund's direct or indirect participation is equal to or exceeds 20% of the total or voting stock. The chart below illustrates the criteria for examination of merger control of companies invested by funds.

Because the revenues of all the above entities must be cumulatively considered, most transactions involving investment funds may have to be notified.

In addition, Law 12,529 is very strict in preventing the parties from agreeing upon conditions that hinder competition, before the transactions is actually approved. One may expect CADE to raise controversy on contractual provisions such as negative covenants which are quite usual in M&A transactions to preserve the value of the acquired assets.

Mergers and Acquisitions Committee

On June 27 2012 the BM&FBOVESPA (The São Paulo Stock Exchange), Brazilian Financial and Capital Markets Association, Brazilian Corporate Governance Institute, and Capital Market Investors Association formalised an agreement creating the Mergers and Acquisitions Committee (CAF). CAF's purpose is assuring an equitable treatment to shareholders in public offerings, mergers, acquisitions and spinoffs, by reviewing these transactions of listed companies that voluntary submit to CAF. The agencies that created CAF are presently working on applicable regulations that may soon be published. The agencies estimate CAF to start its activities on October, this year.

Antonio Carlos Cantisani Mazzuco

Madrona Hong Mazzuco Brandão

Antonio Mazzuco is a corporate partner with Madrona Hong Mazzuco. He has extensive experience representing Brazilian and foreign clients in structuring operations in Brazil, joint ventures, M&A transactions, private equity, corporate and debt restructuring, and local and cross-border financing.

He received his JD from the University of São Paulo in 1985, and has also completed the Specialisation in Accounting and Finance with Getulio Vargas Foundation in 1993, and negotiation workshops at Harvard Law School in 1998. Mazzuco is a member of the International Bar Association's Corporate Committee and Banking Committee, the Turnaround Management Association of Brazil, and the Brazilian Association of Private Equity & Venture Capital.

Mazuco is recognised by Practical Law Company as a leading professional in restructuring projects, including M&A of distressed assets. He is fluent in English, Italian, Spanish and Portuguese.

Byung Soo Hong

Madrona Hong Mazzuco Brandão

Byung Soo Hong is a partner at Madrona Hong Mazzuco with strong experience in M&A, capital markets, investment funds, financial institutions, and energy and information technology companies. He received his LLB from the University of São Paulo, graduating in 1993. In the same year he completed a specialisation in Orientation in the US Legal System at Georgetown University Law Center and International Law Institute. Hong is an MBA Professor at Fundação Instituto de Pesquisas Contábeis, a member of the International Bar Association's Capital Markets Committee, and a member of the Brazilian Association of Private Equity & Venture Capital.

Hong's experience includes local and cross-border transactions, acquisitions and sales of shares/quotas and assets, and corporate restructuring. He is fluent in English, Korean, Spanish and Portuguese.

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