Derivatives in Brazil

[Stuber]

The Brazilian monetary authorities are known worldwide to regulate and supervise the financial sector tightly and unlike other jurisdictions Brazil always adopted a very restrictive approach in the derivatives market. After the global financial crisis of 2007, several prudential initiatives have been taken in our jurisdiction to monitor and control the risks assumed by the participants of the Brazilian financial system and of all derivatives transactions entered into by Brazilian companies.

The applicable rules are set forth by the Brazilian Monetary Council (Conselho Monetário Nacional – CMN) and the regulators in charge to monitor and supervise the enforcement of such rules are the Central Bank of Brazil (Banco Central do Brasil – Bacen) and, insofar the securities market is concerned, the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM). The current regulations which govern this matter are outlined below1.

For the purpose of this analysis, the following topics will be covered herein: I. Credit Derivatives Transactions; II. Swap Transactions; III. International Hedging Transactions; IV. The Position of CVM regarding Derivatives; V. Multilateral Netting; and VI. Conclusion.
I. CREDIT DERIVATIVES TRANSACTIONS

CMN Resolution No. 2,933, of February 28, 2002, authorized financial institutions and other entities accredited by Bacen to perform credit derivatives transactions. The only institutions authorized by CMN to bear the credit risk in a transaction are multiservice, commercial and investment banks; the Federal Savings Bank (Caixa Econômica Federal – CEF); loan, finance and investment companies; real estate loan and leasing companies. In the specific case of leasing companies, the transaction may only occur if the underlying asset relates to credits deriving from leasing transactions.

In this regard, "credit derivatives" is a contract where the credit risk of the transaction is negotiated without the transfer of the respective underlying asset(s). Underlying asset is any credit deriving from loan, financing and leasing transactions; credit instruments; securities; guarantees; sureties; credit derivatives and other instruments and financial or commercial agreements that are subject to credit risk and negotiated and performed in the domestic market.

Bacen Circular No. 3,106, of April 10, 2002, establishes two modalities of credit derivatives: (i) credit default swap (swap de crédito), when a party (the buyer) buys the credit risk from the other party (the seller), the remuneration is based on a predetermined protection fee. In case of default of the debtor of the underlying asset, the buyer of the risk is liable for the payment obligations of the debtor before the seller. However, if the underlying asset is duly paid up, the buyer earns the protection fee; and (ii) full return swap (swap de taxa de retorno total), when both the credit risk and the credit remuneration are assumed by the buyer. In this modality, the remuneration is based on the flow of payments, comprising interest and other charges received in connection with the underlying asset.

The following transactions are expressly forbidden: (a) options linked to any of the above-mentioned modalities; (b) credit derivatives between related parties, comprising individuals or legal entities which are controllers, affiliates or controlled companies2; (c) any assumption of risk of these related parties; and (d) credit derivatives whose flow of payments in connection with the underlying asset is not in the same currency or index of such asset.

Swap transactions are the trades between a protection buyer and a protection seller for settlement on a future date, which result, upon the occurrence of one or more credit events, in full or partial recovery of the reference value set out in the contract by the protection buyer.

Credit events are the events defined between the parties in the contract and connected with the underlying asset or its obligors, and which, independently of any reason, cause the payment by the protection seller of the protection contracted by the protection buyer.

The contract must establish at least the following situations as credit events: (a) bankruptcy or civil insolvency, as well as company´s recovery plan and liquidation, judicial or extrajudicial, or moratorium of the obligors of the underlying asset; (b) restructuring of the obligors´ debts, and change of control, consolidation or merger of the obligors, when any such situation represents a loss or credit downgrade affecting the underlying asset; (c) default on the underlying asset; (d) compulsory advance payment of the underlying asset, in the event of a contractual provision in this regard; and (e) repudiation or challenging in court of the underlying asset.

As to the liability for the risk, the transferor of the risk is the party acquiring, under a credit derivatives contract, the protective right against a given credit risk by making the mutually agreed payment. On the other hand, the bearer of the risk is the party assuming, under the same kind of contract, the credit risk related to a given underlying asset and undertaking to compensate, as agreed, the party transferring the risk upon occurrence of a given event.

Transfer of the credit risk of the underlying asset is considered effective when: (i) the contract contemplates the above-listed credit events; (ii) the underlying asset is legally transferable, if the credit derivatives contract so stipulates upon the occurrence of a credit event. (iii) there is no co-obligation on the part of the protection buyer in relation to the portion of the underlying asset contemplated by the transaction; (iv) there is no clause allowing for unilateral cancellation of the contract by the protection seller, except in the event of nonpayment by the protection buyer of the protection fee; and (v) there is no clause allowing the protection seller to default on the obligation to make prompt payment of the amount due to the protection buyer upon the occurrence of a credit event.

Credit derivatives transactions may be performed on two occasions: (i) if and when the underlying asset credit risk is effectively held by the party transferring it at the time of contracting; or (ii) the underlying asset is regularly traded on the organized market3 and whose price can be confirmed.

The party transferring the risk is required, in the case of underlying asset existing in portfolio, to make available to Bacen adequate records evidencing that the underlying asset risk existed at the time of contracting, being it understood that the amount of risk transfer is limited to the underlying asset value. Additionally, no direct or indirect assignment, transfer or disposal of the underlying asset during the term of the credit derivate contract is allowed.

The performance of such transactions is conditioned upon the designation by each of the authorized institutions of a director (a technically qualified officer) to be the contact person with Bacen. Institutions shall maintain, at the disposal of Bacen, proper documents regarding their policy and procedures for credit derivatives transactions, as well as the exposure limits established, irrespective of acting as protection buyer or protection seller.

In addition, information containing at least the following aspects of credit derivatives transactions shall be disclosed in the explanatory notes to the institution´s financial statements: (i) the institution´s policy, objectives and strategies; (ii) the credit risk received and transferred (book and market values), specifying the overall volume and during the respective period; (iii) effect (increase/reduction) on the capital adequacy requirements (Patrimônio Líquido Exigido – PLE) calculation; (iv) amount and characteristics of the credit transactions transferred or received during the period as a result of the triggering events stipulated in the contract; and (v) breakdown per type (credit swap and total return swap).

Furthermore, the credit derivatives transaction must be mandatorily registered with a relevant assets registration entity duly authorized by Bacen to render this type of service, such as CETIP OTC Clearing House (CETIP S.A. - Balcão Organizado de Ativos e Derivativos - CETIP), which is the leading clearing house and central securities depository and derivatives registrar for operations carried out in the over-the-counter (OTC) market4 and the Derivatives Clearing House (Câmara de Derivativos) of the Brazilian Securities, Commodities and Futures Exchange (BM&FBOVESPA S.A. – Bolsa de Valores, Mercadorias e Futuros - BM&FBOVESPA)5.
II. SWAP TRANSACTIONS

CMN Resolution No. 3,505, of October 26, 2007, deals with the performance in Brazil in the OTC market of derivatives transactions by the financial institutions and other entities authorized to operate by Bacen. By means of this Resolution, CMN authorized multi-service, commercial, investment and exchange banks, savings banks, securities brokerage houses and securities dealership companies to perform in the domestic OTC, on their own account or on account of third parties, term or option swap transactions registered in the OTC or in a system administered by entities of registry and financial settlement of assets authorized by Bacen or by CVM, such as CETIP and the BM&FBOVESPA Derivatives Clearing House. Other financial institutions or entities accredited by Bacen may only perform these transactions on their own account.

A transaction is deemed to be performed in the OTC when it is made out of the floor of exchange, open outcry or electronic environment, based on a bilateral agreement and parameters agreed between the parties.

The price indices, stock indices, interest rates and exchange rates used to back these transactions must have a series regularly calculated and be publicly disclosed. The quotation for other underlying assets must obey the prices quoted by the stock exchanges, commodities and futures exchanges, organized over-the-counter markets or by entities of registry, trading, custody and financial settlement of assets authorized by Bacen or CVM, when available in these environments or be determined based on prices or methodologies consistent and subject to verification, taking into consideration the independency in the data collection regarding the parameters practiced in their respective trading room.

It is also possible to perform these transactions backed on underlying assets traded abroad (i.e. outside Brazil), provided that their prices are regularly disclosed in the foreign country of origin and follow the same criteria applied to the domestic market. This means that the prices of the overseas assets must also be determined based on prices or methodologies consistent and subject to verification, taking into consideration the independency in the data collection regarding the parameters practiced in their respective trading room in the foreign country of origin.

The information, documents and methodology regarding any of the above-mentioned transactions must be kept in the financial institution or accredited institution at the disposal of Bacen. All transactions must be duly registered in the OTC or in any system administered by an entity duly authorized by Bacen or CVM.

The financial institutions or accredited entities involved with these transactions must designate before Bacen the name of the director in charge of the performance of derivatives transactions in the OTC. The data regarding such director must be inserted and updated in the Information System about Entities of Interest to Bacen (Sistema de Informações sobre Entidades de Interesse do Banco Central – Unicad). However, the director may also exercise other functions except those related to the management of third parties funds.

Bacen is empowered to adopt any measures and issue complementary regulations which may be necessary for the execution of these derivatives transactions, including to limit the underlying assets to back the transactions to be made by the financial institutions and other entities accredited by Bacen.

In this regard, Bacen Circular No. 3,474, of November 11, 2009, establishes that Brazilian companies will have to register with Bacen their derivatives transactions linked to the raising of funds abroad. According to this Circular, financial institutions must register, in a system administered by entities of registry and financial settlement of assets duly authorized by Bacen or CVM, the derivatives financial instruments such as options, forward contracts, futures contracts and swaps, regardless of their index or reference, that are linked to the cost of indebtedness originally contracted in loan transactions entered into between persons residents or domiciled in Brazil and persons residents or domiciled abroad, including individuals and non-financial legal entities.

Such registration: (i) must be made prior to the entry of funds into Brazil or, whenever is the case, before the granting of any relending; and (ii) shall comprise the involved amounts and currencies, terms, parties, form of settlement and adopted parameters such as limits, multipliers and events of accelerated maturity (early repayment). The proof of registry shall be duly identified in the document(s) evidencing the exchange transaction (operação de câmbio de ingresso), in the case of remittance to Brazil of foreign currency proceeds, or the international transfer of Brazilian currency (transferência internacional de reais).
III. INTERNATIONAL HEDGING TRANSACTIONS

CMN Resolution No. 3,312, of August 31, 2005, as amended by CMN Resolution No. 3,833, of January 28, 2010, regulates international hedging transactions made with financial institutions abroad or at foreign exchanges. These rules do not apply to transactions made by investment funds of any kind, even those regarded as customers, which are subject to specific regulation.

International hedging is a security (protection) for commercial or financial rights and obligations subject to risks of variation, in the international market, of interest rates, foreign exchange parity or of commodities prices, carried out by financial institutions abroad or at foreign exchanges.

All individuals and legal entities, resident, domiciled or with registered office in Brazil are authorized and may transfer funds to and from abroad in relation to international hedging transactions, using banks authorized to operate in the exchange market in Brazil.

Within that context, any kind of hedging found in the international market, traded abroad with financial institutions at foreign exchanges or over-the-counter market, with the purpose of protecting risks of variation, as indicated above, can be used. Included in the rights and obligations subject to hedging are: (i) payables and receivables in Brazilian currency (Real), deriving from obligations assumed in foreign currency; (ii) importations, exportations or negotiations in the domestic market of commodities whose price is fixed on quotes of a foreign exchange; (iii) trading in commodities and futures exchange in Brazil; and (iv) exposures assumed in Brazil by banks accredited to operate in the exchange market with their costumers, so long as they are tied to rights or obligations which may be hedged abroad.

International in Brazil requires, therefore, the intervention of a bank in the exchange transaction to be entered for payment or receipt of funds from the hedge-related obligations and rights. The intervening bank must be duly authorized to operate in the Brazilian exchange market. It is incumbent on that intervening bank to follow the existing rules in the international market applicable to similar transactions, and ensure the legality and legitimacy of the transaction, by checking the documentation submitted by or profile of the customer and its financial adequacy.

Additionally, financial transfers can be made with respect to hedge of interest rates variation and currencies parity: (a) intended for the establishment of collateral or escrow accounts; and (b) required for hedging international funds to be disbursed in the future.

International hedging allows remittances for the opening of accounts with foreign brokers and margin deposits, as well as financing of those margins by banks accredited to operate in the exchange market, with the use of foreign credit facilities.

As from March 15, 2010 any hedge transactions made by Brazilian companies in the international market with financial institutions abroad or at foreign exchanges must be compulsorily registered in Brazil in a system administered by entities of registry and financial settlement of assets authorized by Bacen or by CVM, such as CETIP and the BM&FBOVESPA Derivatives Clearing House. This registration must be effected through a financial institution or any other entity duly authorized to operate in Brazil by Bacen and must comprise the underlying assets, the involved amounts and currencies, terms, counterparties, form of settlement and adopted parameters, such as limits, multipliers and events of accelerated maturity. The proof of registry and the available documents regarding the transaction must be kept by such financial institution or entity at the disposal of Bacen for a period of five years.
IV. THE POSITION OF CVM REGARDING DERIVATIVES

Derivatives in the context of the securities market and all the transactions performed by publicly-held corporations6 are under the supervision and inspection of CVM.

Pursuant to CVM Instruction No. 467, of April 10, 2008, the forms of derivatives agreements admitted for trading in the domestic securities organized markets must be previously approved by CVM before the beginning of the negotiations, as well as any changes to these forms of agreements. The terms of any such changes will only be valid after the CVM approval.

The CVM approval is not required in the case of derivatives agreements which are not traded in the organized markets, but only registered in such markets. If this situation occurs, then the agreement must be approved by the entity in charge of the administration of the market where the registration is made. This entity will have to maintain at the disposal of CVM, for a term of five years counted as from the date of termination of the agreement, the supporting documentation to be analyzed by the regulator, and must establish and publicly disclose the rules about the procedures and criteria for approval of derivatives agreements registered in its market. Such rules must enable the entity to identify and suppress any violation to the applicable laws and regulations.

The underlying assets which back these derivates agreements traded in the organized markets must have their value determined based on prices and methodologies consistent and subject to verification. The entity which administers the market must divulge broadly and without any restriction whatsoever the prices of the underlying assets within a certain periodicity which may be compatible to the nature of the assets.

The form of agreement must include at the following: (a) the purpose (underlying asset), unit of trading and the form of quotation; (b) the dates of trading, maturity and settlement of the agreement; (c) the criteria for calculation of the prices of settlement, the adjustment and the margins; and (d) the admitted forms of settlement, including the possibility to deliver or not physically the underlying asset.

The application for the CVM approval submitted by the entity which administers the market shall include: (i) the form of agreement and its exhibits; (ii) a detailed description of the characteristics of the underlying asset, of the market(s) where the trading will occur and of the participants; (iii) the access restrictions applied to certain investors, if that is the case; (iv) the position limits by investor, by intermediary and of the open agreements; (v) a manifestation regarding the adequacy of the methodology for determination of the reference value of the underlying asset; and (vi) a statement of the entity that the initiative of the new agreement proposal belongs to the own entity or otherwise specify the person originating such initiative.

The CVM approval will normally be granted within a maximum term of 30 business days as of the filing. This period may be interrupted once, if CVM requests additional information. If this happens, the entity will have 30 business days to send this information and CVM will have another 30 business days after delivery of the information to analyze it. Before denying the application, CVM will sent an official letter to the entity, giving the opportunity to remedy any identified failure within 10 business days as of the receipt of the official letter. If the application is denied, the entity will have the right to appeal to the Board of CVM to try to reverse this decision. If CVM does not take any action whatsoever during the terms provided for in CVM Instruction No. 467, then the application will be deemed approved for all legal purposes and effects.

CVM Deliberation No. 550, of October 17, 2008, which is a simplified anticipation of convergence norm for the Annual Report, subsequently ratified and confirmed by CVM Instruction No. 475, of December 17, 2008, required all publicly-held corporations to disclose qualitative and quantitative information on all their derivatives, whether or not recognized as assets or liabilities on their balance sheet, splitting hedge and speculative positions. This certainly encourages companies to use derivatives more carefully.

In its capacity of regulator of the securities market, CVM is also responsible for defining whether any instruments shall be treated as securities (valores mobiliários) or not. For this reason, on July 21, 2009, CVM informed to the market7 that the Certified Emission Reductions, or CERs, also known as carbon credits8, are not derivatives or assets to which investment funds are linked (títulos de investimento coletivo), and consequently shall not be treated as securities or regulated as such by CVM at least for the time being, and consequently are not subject to the requirements of the Brazilian Securities Law9. They are deemed to be assets whose sale can occur to meet emission-reduction goals or for investment purposes.

CERs are instruments issued by the CDM Executive Board, a body created under the United Nations Framework Convention on Climate Change. This body supervises the Clean Development Mechanism (CDM)10 that represents the voluntary reduction emissions of a certain quantity of greenhouse gases (GHGs), which hold heat within the surface of the Earth and contribute to its global warming.

However, some carbon credit products related to CERs, such as certificates, synthetic instruments or derivatives, depending on their specific characteristics and in view of their nature, may be considered as securities by CVM on a case-by-case basis. If this happens, such products will be subject to the Brazilian Securities Law.

Brazilian investment funds are duly authorized to acquire CERs or other carbon credit certificates or derivatives by force of the applicable rules which govern these funds11. In this regard, among the authorized financial assets, investment funds can apply their resources in warrants, trading contracts for the purchase and sale of products, merchandise or services for future delivery or future provision, titles or certificates representing such contracts and any other credits, titles, contracts and operational modalities if expressly stated in the funds´ regulation.

CERs are financial assets issued abroad and their acquisition is permitted by investment funds provided that this possibility is expressly stated in the fund´s regulation and the CER is admitted to negotiation in the stock exchange and in the commodities and futures exchange, or is registered in the registry, custody or financial liquidation systems duly authorized in their original countries and supervised by a recognized local authority. This registration shall also be performed in specific accounts opened directly under the name of the fund.

In case of credit carbon certificates or derivatives issued in Brazil, then it is important to note that the fund's portfolio can only be composed of financial assets approved for trading on either the stock exchange or the futures and commodity exchange, or recorded in the registration system, with custody or financial net liquidation duly authorized by Bacen or CVM, in their respective areas of competence. This registration shall be performed in specific accounts opened directly under the name of the fund.

CVM concluded that the Brazilian market already has certain mechanisms developed to the finance and structure of projects which enable the issue of carbon credits and which do not need to be regulated at this stage. However, if and when the need arises, CVM will analyze in the future the implementation of specific rules governing fund-raising structures and financial products derived from carbon credits.
V. MULTILATERAL NETTING

Another important consideration for derivatives is the existence of multilateral netting. Law No. 10,214, of March 27, 200112, was enacted to recognize multilateral netting in the environment of a clearing and settlement system and sets forth that, in all multilateral netting systems considered systemically important by Bacen, the corresponding clearing house must act as central counterpart. Law 10,214 is the main legal instrument for the Brazilian payment system. It sets forth among other things that:

* it is up to Bacen to define which systems are systemically important;
* multilateral netting of obligations in a clearing and settlement system is admitted;
* in systemically important systems, the respective clearing houses must act as central counterparties and adopt mechanisms and safeguards that ensure certainty of settlement of the operations;
* assets posted as collateral to clearing houses cannot be seized even by judicial order; and
* the bankruptcy law does not affect the fulfillment by a participant of its obligations to a clearing or settlement system, which will be brought to completion and settled in accordance with the system regulation.

Bacen, in its capacity to regulate the functioning of clearing and settlement systems, has set forth through Circular No. 3,057, of August 31, 2001, among other things, that:

* systemically important deferred settlement systems should promote the final settlement of net positions directly in accounts held at Bacen;
* all settlement systems that settle operations with securities and other financial assets, including foreign currency and financial derivatives, are considered as systemically important, as well as the funds transfer systems that process transfers of values higher than R$ 10 million or present daily turnover higher than R$ 5 billion;
* maximum settlement lag is: (1) at end of day for systemically important funds transfer system; (2) one business day for spot operations with securities (except stocks); and (3) three business days for operations with stocks carried out on stock exchanges. The settlement deadline in any other situation is established by the Central Bank of Brazil, which examines each particular case;
* clearing houses should keep net worth compatible to their risk exposure, observing a minimum limit of R$ 30 million for a system considered systemically important and R$ 5 million for a system that is not.

With respect to set-off and settlement contracts within the Brazilian Financial System, CMN issued Resolution No. 3,263, of February 24, 2005.

Article 1 of CMN Resolution No. 3,263 allows financial institutions and other entities accredited by Bacen to enter into contracts for obligations of set-off and settlement within the Brazilian Financial System.

According to the provisions of Article 3 of CMN Resolution No. 3,263, the contracts must be either reduced to a public deed or, alternatively, to a private instrument. As a condition to be effective, a private instrument must be registered with a Registry of Deeds and Documents (Cartório de Registro de Títulos e Documentos) in Brazil or in a clearing and settlement system of assets authorized by Bacen or in any entity which already registers transactions of derivative organized markets, provided that such entity has been duly accredited for this purpose by Bacen or CVM. This registration must be made within up to five business days of the date of execution of the agreement.

Furthermore, Law No. 11,101, of February 9, 2005, which is the Brazilian Company Recovery and Bankruptcy Law (BCRBL), introduced important changes with regard to the obligations assumed by the debtor to clearing houses. Submission by participants to judicial recovery, extrajudicial recovery or bankruptcy will not affect their obligations to clearing houses, as provided in articles 193 and 194 of the BCRBL. Such obligations must be settled in accordance with the clearing house's internal rules. The proceeds of the execution of guarantees pledged by participants or clearing houses and clearing and financial settlement service providers subject to the requirements of the future law, as well as the proceeds of instruments, securities and stock and other assets subject to clearing or liquidation, will be used in the settlement of obligations assumed to the clearing houses and clearing and financial settlement service providers.
VI. CONCLUSION

In summary, the current Brazilian regulations on derivatives induce companies, financial institutions and all participants in the market to be transparent, by requiring them to report all the transactions, as well as to effect their registration in a system administered by entities of registry and financial settlement of assets authorized by Bacen or CVM, such as CETIP and the BM&FBOVESPA Derivatives Clearing House. In addition, the derivatives operations must be duly revealed by the participant in audits and disclosed in their respective financial statements. This transparency enables our regulators (Bacen and CVM) to monitor closely the volumes of derivatives traded and as a result improves surveillance to mitigate systemic risks.

Footnotes

1. This article has been produced on March of 2010 and is updated until the beginning of such month. In Brazil the applicable regulations are reviewed and changed from time to time.

2. These terms are defined by Law No. 6.404, of December 15, 1976 as subsequently amended (the Brazilian Corporation Law – BCL). Affiliate (coligada) is a company in which the investor has a significant influence over it (article 243, § 1 of the BCL, as amended by Law No. 11.941, of May 27, 2009). One company will have significant influence over another when it holds or exercises the power to participate in decisions on financial or operational policies of the affiliate (article 243, § 4 of the BCL, added by Law 11.941/2009). Significant influence is presumed to exist when one company holds at least 20% of the voting stock of another, but does not control it (article 243, § 5 of the BCL, added by Law 11.941/2009). Controlled company (controlada) is a company in which another company, known as the controller (controladora), either directly or through other controlled companies, has the rights of a partner in the first company which permanently grants to the controller prevalence in voting the first company´s corporate decisions and the power to elect the majority of its management (article 243, § 2 of the BCL).

3. Pursuant to article 3 of CVM Instruction No. 461, of October 23, 2007, amended by CVM Instruction No. 468, of April 18, 2008 (which governs the securities regulated markets in Brazil and also the incorporation, organization, operation and winding-up of stock exchanges, commodities and futures exchanges and organized and non-organized OTC markets), organized markets of securities shall mean 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. Organized markets of securities shall be administered by entities authorized by CVM. Nowadays, the only relevant Brazilian exchange is the BM&FBOVESPA, which is responsible for all the organized markets (stock, commodities and futures and OTC market), and concentrates all the Brazilian publicly-held corporations.

4. CETIP estimates that as it holds more than 95% of the private fixed income assets in custody in Brazil and registered more than 75% of the notional value of OTC derivatives held in custody in Brazil. There are approximately 50 different types of assets processed by CETIP, including fixed income securities, such as CDB – Certificate of Deposit; Debentures; agribusiness securities, such as LCA – Agribusiness Credit Bills and CPR – Rural Product Notes; quotas of open-end and closed-end funds; and Derivatives, such as Swaps, Non-Deliverable Forwards and Flexible Options on Foreign Exchange, among others.

5. BM&FBOVESPA was created in 2008 with the integration between the Brazilian Mercantile & Futures Exchange (Bolsa de Mercadorias & Futuros – BM&F) and the São Paulo Stock Exchange (Bolsa de Valores de São Paulo – BOVESPA). It is one of the largest exchanges in the world in terms of market value, the second largest in the Americas, and the leading Exchange in Latin America. Spot, forward, futures, options and swaps contracts are traded at BM&FBOVESPA. They are mostly referred to interest rates, foreign exchange rates, and price and stock indices. BM&FBOVESPA acts as central counterpart and guarantees the transactions, besides mechanisms of protection based on transactional limits and daily margin calls, the Clearing House maintains three settlement funds. The Clearing House also registers OTC derivatives, whose settlement can or cannot be guaranteed according to the contracting parties´ option. For guaranteed transactions, the Clearing House also acts as central counterparty.

6. A corporation shall be publicly-held or closely-held depending on whether its securities are accepted for trading in the securities market (article 4 of the BCL). Only securities issued by a corporation registered in CVM may be traded in the securities market (paragraph 1 or article 4 of the BCL). No securities may be publicly distributed in the market without previous registration with CVM (paragraph 2 of article 4 of the BCL).

7. The CVM notice about carbon credits is available at www.cvm.gov.br.

8. One carbon credit is equal to one ton of carbon.

9. The Brazilian Securities Law (Law No. 6.385, of December 7, 1976, as amended by Law No. 10.303, of October 31, 2001) disciplines the securities market and creates the regulatory entity (CVM). For the purposes of the Brazilian Securities Law, the term "securities" comprises the following: (i) shares, debentures and subscription bonuses; (ii) coupons, rights, subscription receipts and split certificates relating to the securities indicated in the previous item (i); (iii) certificates of deposit of securities; (iv) debentures certificates; (v) shares of mutual funds investing in securities and shares of investment clubs investing in any type of assets; (vi) commercial paper; (vii) futures, options and other derivatives agreements whose underlying assets are securities; (viii) other derivatives agreements regardless of the respective underlying assets; and (ix) when publicly offered, any other collective investment instrument or agreement that creates the right of participation on profits or remuneration, including as a result of the rendering of services, and whose profits derive from the efforts of the entrepreneur or from the efforts of third parties. All securities are subject to the supervision and control of CVM. Federal, State, or Municipal government bonds and negotiable instruments guaranteed by a financial institution (other than debentures) are not deemed to be "securities" within this context and are subject to the supervision and control of the Central Bank of Brazil and not of CVM.

10. The concept underlying the CDM is that of the voluntary reduction of GHGs emitted by an industrial process or their sequestration from the atmosphere by a company based in an emerging country, creating credits which can be traded in the global carbon market with industrialized countries (or with their companies) in need of these credits to meet their emission reduction targets in accordance with the Kyoto Protocol. This flexibility mechanism, therefore, enables countries to reducer their global GHG emissions while also providing an attractive alternative method to foster sustainable development in the emerging market countries. The CDM is the only mechanism applicable to Brazil.

11. The current basic regulations on the incorporation, administration, operation and disclosure of information of the investment funds in Brazil have been approved by CVM Instruction No. 409, of August 18, 2004, as amended.

12. Law No. 10,214 provides for the activities of clearing houses and clearing service providers within the scope of the Brazilian payment system, and makes other provisions.


Walter Stuber Consultoria Jurídica
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