A recent wave of public offering activity points to a re-opening of the Brazilian equity markets to foreign investment
After a period of three years with little activity, the market for initial public offerings (IPOs) of common equity by Brazilian issuers is finally showing signs of recovery.
Since 2014, there has been a high level of uncertainty with respect to the Brazilian economy stemming from a number of political crises. The political scandal at the heart of such crises, known as Lava Jato, involves widespread corruption and investigations by local authorities that has had far reaching implications, leading to Brazil's worst recession in years. As a result of the difficult political and economic climate, the inflow of capital and investments from international investors into Brazil experienced a dramatic decrease from pre-scandal levels, as investors have waited for increased political stability and economic growth before investing large amounts of capital in the country. During the years 2014 through 2016, only three Brazilian companies (one per year) were able access the capital markets by means of an IPO. Those three IPOs had an aggregate value of approximately $570 million.
In the context of this political and economic climate, in 2016, the Brazilian federal government began the implementation of measures focusing on budgetary austerity and more effective management of public expenditures. These measures have to some extent contributed to the recovery of investors' confidence in investing in Brazil, even in light of the on-going political scandal that appears destined to continue indefinitely.
This newfound interest by international investors in Brazilian businesses is evidenced by the recent flurry of IPO activity during the current year. There has been a significant uptick in IPOs listed on the B3 (the São Paulo Stock Exchange, formerly known as BM&FBOVESPA) in the current year – up until the date of the writing of this article seven IPOs have been successfully executed, raising a total aggregate amount of approximately $3.866 billion (based on the current US dollar/Brazilian real exchange rate). There has also been increased issuance activity by existing Brazilian public companies. During 2017 through to the date of this article, Brazilian companies with securities already listed on the B3 had raised an amount of approximately $3.8 billion through the issuance and sale of additional equity securities.
In addition to the increase in the number of IPOs and follow-on equity offerings, other positive indicators are news and rumors about other companies that have filed or are intending to file issuer registration requests with the Comissão de Valores Mobiliarios (CVM), the Brazilian regulatory authority equivalent of the US Securities and Exchange Commission (SEC), which is the initial step that a prospective issuer must undertake to issue equity securities in the Brazilian capital markets.
Overview of the IPO process in Brazil
In Brazil, equity securities offerings are subject to rules provided by the Brazilian Corporate Law (Law No. 6,404 of December 15 1976), the Brazilian Capital Markets Law (Law No. 6,385 of December 7 1976) and regulations issued by CVM.
According to CVM regulations, an IPO process encompasses two registrations: one with respect to the prospective issuer and the other with respect to the equity securities to be issued. Both registrations can be, and normally are, filed simultaneously as a single request with the CVM. Once filed, the CVM's review process with respect to any such request usually takes approximately eight to 10 weeks from the initial filing through the grant of the registrations, allowing for two to three rounds of comments from the CVM.
The Novo Mercado segment requires the most stringent standards of corporate governance and is utilised by a majority of companies that have shares listed on B3
Upon the grant of the registration of the offering by the CVM, the prospective issuer and the underwriters may proceed with announcing the transaction to the market and publishing and distributing the final offering disclosure on public websites. Such publication of disclosure sets the timeline for the beginning of the trading of shares on the B3.
At the same time the process is triggered by filing with the CVM, documents mirroring the application for registration must be filed with B3 for purposes of having the prospective issuer's shares listed under one of the six available listing segments in B3, which distinguish listed issuers according to the level of corporate governance structures and practices adopted by such issuers. Of the listing segments, the Novo Mercado segment requires the most stringent standards of corporate governance and, as a matter of market practice, is the segment utilised by the majority of companies that have shares listed on B3.
In addition to the laws and CVM regulations applicable to a prospective issuing company and the offer of its equity securities, there are additional CVM, National Monetary Council (CMN) and Central Bank of Brazil rules that must be complied with in connection with an IPO offered internationally by a Brazilian company. These rules regulate investments in the equity of a listed Brazilian company made by non-Brazilian residents with respect to stock listed on B3.
From a US law perspective, sales of shares issued in a Brazilian IPO executed and listed on B3 are typically offered and sold utilising the exemptions from registration under the US Securities Act of 1933, as amended (the 1933 Act), provided by rule 144A of the 1933 Act as well the exemption provided for non-US persons under regulation S of the 1933 Act. An offering conducted in accordance with rule 144A would involve the resale of securities to 'qualified institutional investors' from the underwriters in the transaction, unlike SEC-registered offerings pursuant to which securities issued could be sold directly both to institutional and retail investors.
Issues in executing an IPO in Brazil
The IPO process for an issuer seeking a listing in Brazil is a complex process with a number or peculiarities and issues that must be considered in order to ensure the successful execution of the contemplated transaction. While there are a multitude of issues to be carefully analysed and addressed in any such transaction, the following is a discussion at a high-level of a few of the more critical sets of issues to be considered.
Equity research reports
While equity research reports are a common feature in offerings of equity securities by issuers in many jurisdictions, they remain a critical component to an IPO that merits review and analysis by parties to any such transaction. Equity research reports are prepared by financial institutions to provide an analysis to be used by investors in a particular issuer's securities. In the US, the Financial Industry Regulatory Authority (Finra), a self-regulatory for the financial services industry, has a number of rules addressing potential conflicts in the content and distribution of such reports. These rules address a key concern that research reports prepared by a financial institution could be subject to conflict of interest where the institution is also involved in the marketing of the securities as underwriters. In this circumstance, the financial institution may be tempted to prepare research that is favourable to the issuer and the transaction in question rather than providing a more independent assessment of the merits of the offering. Finra defines an equity research report as:
"[A]written or electronic communication that includes an analysis of equity securities of individual companies or industries, and that provides information reasonably sufficient upon which to base an investment decision."
The Finra rules focus on requiring information barriers and similar safeguards within a financial institution between deal team members (those bankers working on an IPO) and the research analysts who prepare research guidance to be used by potential investors, as well providing restrictions with respect to the timing of publication of any such report during quiet periods relating to the offering in question.
While larger financial institutions have robust internal policies and mechanisms to address the preparation and publication of equity research reports, these institutions rely on their external US counsel working on the transaction to prepare research report guidelines and provide specific guidance relevant to the particular transaction. This guidance includes the preparation of detailed equity research guidelines containing a comprehensive discussion of restrictions on content (such as avoiding projections and limiting coverage to information otherwise provided to investors through the transaction disclosure), timing of publication and interactions between analysts and members of a transaction deal team. International counsel to the underwriters will also be relied upon to review the draft equity research reports ahead of their publication to ensure compliance with the relevant guidelines.
In addition to the Finra rules in the US, there are specific rules imposed in Brazil by the CVM regarding the content of any equity research report and restrictions on their distribution in connection with transactions registered with the CVM. Much like international counsel prepares guidelines with respect to US law considerations and market practice, Brazilian counsel to the underwriters provide the underwriters with written guidelines with respect to compliance with CVM rules which, in some instances, are more stringent than international standards. As such, consideration must be given both to the international standards and norms relating to research reports and also to the rules provided under Brazilian regulations. International counsel must work closely with their Brazilian counterparts to provide clear guidance to the underwriters with respect to all elements of the research report process.
Brazilian federal government as a selling shareholder
Under Brazilian law, the Brazilian federal government may hold, directly or through controlled entities (such as the Banco Nacional de Desenvolvimento Econômico e Social, or BNDES, the Brazilian development bank), corporate stakes in companies, which can be as controlling shareholders as well as minority interests.
In order to address budgetary constraints and access funding, the Brazilian federal government may seek to raise funds by selling ownership interests in entities they have invested in through the IPO process. However, the involvement of a governmental selling shareholder could raise a number of issues and concerns in the IPO process. As an initial matter, the Brazilian governmental bureaucracy could affect the speed of execution and ability to negotiate the terms of the offering, particularly in the context of any agreement with the underwriters retained to bring the IPO to market. Obtaining government consents and internal approvals can be a lengthy process and can cause significant delays if not managed effectively by the parties to the transaction. In addition, there may be certain terms that a governmental entity cannot agree to, whether as a result of a prohibition proscribed by law or as a matter of practice or internal policies.
Furthermore, the lack of proper corporate governance structures and effective internal controls may also cause delays as a governmental selling shareholder may need to take additional steps to be able to make certain market standard compliance and corruption representations. In order to provide guidance to state owned or controlled companies in implementing and including corporate governance practices and structures, B3 has proposed measures related to transparency, internal controls, board structure and controller commitment to be applied to state-owned or controlled entities, which could facilitate the resolution of these concerns where state-controlled shareholders are involved.
Mirroring disclosure documents
Further to the earlier discussion regarding the local filing requirements, Brazilian securities laws require that an offering prospectus containing the terms of the securities in question and related matters (prospecto) and disclosure document regarding the issuer (formulário de referência) be filed with the CVM. The content and format of this disclosure is governed by a fulsome set of rules and regulations. One such key requirement is that the documentation must be in the Portuguese language. Brazilian qualified lawyers prepare the local offering disclosure and other documents needed for filing with the CVM and otherwise executing the local offering (offering to investors in Brazil), with the input of the other parties to the transaction, which include underwriters as well as lawyers retained for the international leg of the IPO (which are typically US qualified lawyers from international law firms).
The Brazilian governmental bureaucracy could affect the speed of execution and ability to negotiate the terms of the offering
The sale of securities to investors outside of Brazil is typically made pursuant to the exemptions to registration under the US federal securities laws pursuant to rule 144A as well as applicable provisions in other jurisdictions. While rule 144A does not contain specific disclosure requirements (as would be the case for an offering registered with the SEC under the US federal securities laws), market practice and general US anti-fraud considerations have developed to the effect that US investors in offerings made pursuant to rule 144A expect disclosure standards similar to what would otherwise be required were the transaction to be registered. As such, the relevant SEC disclosure standards are used as guidance by US counsel in preparing the offering documents, resulting in disclosure that is substantially similar to that which would be found in an offering registered with the SEC (with some exceptions). Thus, a prospectus (or offering circular, as used in the context of an offering under rule 144A) used in connection with a rule 144A offering must contain thorough disclosure with respect to, among other things, an issuer's business, financial condition, risk factors relating to the issuer's business and other disclosure relevant to an investor's investment decision. In the context of the international offering of securities in an IPO transaction, international law firms will be responsible for the preparation of disclosure, negotiating the terms of the transaction, and otherwise executing the offering.
Difficulties arise when preparing the Portuguese language local offering disclosure for purposes of the requisite CVM filings and the English language offering disclosure to be used in connection with the offer and sale of securities to investors outside of Brazil. The two sets of disclosure have to mirror each other in terms of substance, as investors must be provided the same level of information on which to base an investment decision. A mismatch in the information disclosed between the local offering disclosure and international offering disclosure could open up the parties to an IPO to legal proceedings from investors and in some instances, enforcement actions by regulators.
In order to mitigate this risk, the drafting processes with respect to the local offering disclosure (in Portuguese) and of the offering circular for the international offering (in English) must be aligned and carefully managed by the parties to a transaction. In practice, the parties involved in the IPO transaction discuss, negotiate, and work in the documents used in the local offering and once the transaction progresses and filings have been made with the CVM, the international transaction documentation is drafted to reflect the negotiated terms and disclosure. Any revisions made with respect to the disclosure and documentation with respect to one leg of the offering must be properly reflected in the other leg of the offering, with special attention to the accuracy and context of translations. This requires the lawyers in the local offering (Brazilian qualified attorneys) working closely with the lawyers in the international offering (typically US qualified attorneys) in order to successfully execute the IPO transaction.
Considerations with respect to best practices
While every equity transaction has its particular difficulties and points of sensitivity, careful attention should be paid to a number of issues that may be prevalent in IPO transactions in Brazil. Where the IPO involves a secondary offering (sales of already issued shares by one or more selling shareholders), there may be sensitivity on the part of the prospective issuer and the relevant selling shareholders as to how selling shareholders should be treated with respect making certain representations and for purposes of the underwriters' indemnification, particularly when the selling shareholders are entities that are controlled by Brazilian federal, state or municipal governments. As this point of risk allocation could be critical to the selling entities and those involved in the underwriting an IPO transaction, parties should come to an agreement at the outset of the process so as to avoid any issues in executing the proposed transaction in a timely manner or to avoid terminating the transaction after significant work has been undertaken.
Given the close relationship between the requisite filing and offering process in Brazil and the offering of securities to international investors, legal teams working on the transaction should include individuals fluent in both Portuguese and English. International lawyers will need to ensure that disclosure is consistent between the local offering documents (which would be written in Portuguese) and international offering documents (which would be written in English), and should be comfortable making comments with respect to the Portuguese language disclosure that is filed with the Brazilian regulators.
Timing is driven by the filing process in Brazil and international lawyers will need to align the international components of a transaction to that timing, which will require quick turn-around times so as not to cause any delays in execution once the local offering is approved for launch by local regulators. As such, language skills are critical from both a substantive as well as timing perspective.
As with IPO transactions in jurisdictions outside of Brazil, best practice dictates careful review of relevant market practice with respect to transaction terms such as representations and obligations as well as disclosure standards. Counsel should undertake a thorough analysis of recent transactions for comparable issuers with respect to geography, industry and financial condition in order to facilitate the successful execution of a transaction.
Despite market challenges arising from the on-going political scandals in Brazil, the recent IPO activity demonstrates that international investors have an increased appetite for equity securities issued by Brazilian companies. Following several years of modest issuance activity, Brazilian issuers may be increasingly more likely to access the equity capital markets to finance their operations. Of course, economic activity in emerging markets such as Brazil can be volatile and issuance activity can quickly freeze as a result of systemic pressures and shock events – but recent transactional activity is a positive indicator that the market for international investment in Brazilian businesses will continue to expand.
|Lewis Rinaudo Cohen|
Hogan Lovells (NewYork)
|Isabel Costa Carvalho|
Hogan Lovells (São Paulo)
|David Contreiras Tyler|
Hogan Lovells (NewYork)