Convertible Instruments of Brazilian Companies in the International Capital Markets. IBRADEMP Conference New York City, October 22, 2008

Transcription

1 Convertible Instruments of Brazilian Companies in the International Capital Markets IBRADEMP Conference New York City, October 22, 2008

2 Key Legal Constraints Fundamental legal constraint: Preemptive right of shareholders to acquire a pro rata portion of newly issued convertible instruments (What about already issued shares or instruments?) Exception for public offering (i.e., CVM registered) of convertible instruments A fully marketed offering of convertibles is generally not consistent with the preemptive rights process Terms and conditions must be set before 30-day exercise period begins to run On the other hand, a CVM registered public offering of convertible instruments assumes Brazilian law governs the convertible instruments 2

3 Key Legal Constraints Outcome: Either the security or the offering process is not suited for international capital markets Domestic market offers limited liquidity and investor appetite Offshore investors will be particularly interested in convertible securities of companies having liquid equity markets to allow for volatility plays New York law instruments would need to be offered abroad 3

4 Key Legal Constraints Additional constraint: Laws and CVM regulations regarding company purchase, sale and repurchase of its shares General rules are that a company may not trade in its shares and may only sell treasury shares on a stock exchange A company may not convert debt into equity in a private sale using treasury shares CVM Rule 10 offers limited exception to allow share repurchases Limit of 10% of free float of shares of a class Limit of accumulated earnings and reserves (measured at the time of repurchase and at each succeeding balance sheet date) Option to restart repurchases after cancelling treasury shares 4

5 Key Legal Constraints CVM Rule 390 regarding company issuance of options on its shares Limits mirror limits for repurchase: Treasury shares and shares covered by options may not represent more than 10% of free float of shares of a class Physical settlement only available up to limit of accumulated earnings and reserves (measured at the time of exercise) European-only options and must expire within no more than 365 days Options must be issued over a stock exchange (i.e., an arms length transaction in a dual auction environment) CVM Rule 390 also applies to cash-settled options and potentially to cash-settled convertibles 5

6 Limited Track Record Few offerings have been made or attempted in the international market Early forerunners in the 1990 s Vale mandatorily convertible bond Dual offering model BNDESPAR exchangeable offerings Domestic market offerings often are tailored for specific investor groups and not for the public markets Structured financing via convertible debentures Pension fund investments in holding companies Debt restructurings Regulatory constraints on ownership 6

7 Option 1: Dual Domestic and International Offerings CVM accepts that the public offering exception to the preemptive rights will apply to New York law governed convertible securities offered abroad IF simultaneous issuance of almost identical Brazilian law governed convertible securities is made in the domestic market Advantages: Precedents in the 1990 s and more recently Ability to fashion a New York law governed convertible instruments that fits investor expectations No surprises in legal regime Complete resolution of preemptive rights problem 7 7

8 Disadvantages: Option 1: Dual Domestic and International Offerings Full-blown CVM registration process for the Brazilian law governed convertible securities Timing mismatch compared to typical automatic registration in U.S. markets Premature announcement of convertible offerings Selling pressure from funds aiming at volatility play New and expected CVM regulations may mitigate issue Strange, doomed offering of Brazilian law convertible securities No market, no interest and risk of selling unsuitable securities to individuals 8

9 Option 2: Using Treasury Shares (the Vale Model) Vale Capital Limited issued a mandatorily convertible (actually an exchangeable) bond in June 2007 with a guarantee from Vale Vale Capital entered into a share purchase agreement with Vale by which Vale agreed to provide treasury shares covering full amount of shares deliverable by Vale Capital The CVM waived the rule that a company may not sell its treasury shares or grant options on shares outside a stock exchange a company-issued options must expire in up to 365 days company-issued options must be a European-style option (exercisable at maturity only) The offering was made abroad as a mandatorily convertible bond and no preemptive rights were granted 9

10 Advantages: Option 2: Using Treasury Shares (the Vale Model) Ability to fashion a New York law governed convertible instruments that fits investor expectations No surprises in legal regime No preemptive rights problem (with caveats) Disadvantages: Need to acquire and hold treasury shares via a subsidiary Need for a waiver from the CVM of CVM Rules 10 and 390 Challenges for future deals: How to create a holding of treasury shares in a timely fashion? What if the issuer lacks offshore subsidiaries and operations? How is a sale of treasury shares any different from a new issuance? A few variations on the Vale Model 10

11 Option 3: Cash-Settled Convertibles No preemptive rights apply to cash-settled convertibles Advantages: Complete resolution of preemptive rights problem No need for waivers of prohibition on private sales of treasury shares Disadvantages: Potentially unlimited cash liability CVM Rule 390 may apply to a cash-settled convertible, resulting in unworkable constraints (365-day maximum term to maturity, issuance on a stock exchange, etc.) The CVM has not raised this issue in other potentially cash settled registered offerings If issuer retains option to deliver shares, then waivers will be required before the delivery of shares (or preemptive rights will need to be respected at the time of conversion) 11

12 Other Options: Creative Deal Structuring Debt plus warrants repackaged by a trust for the benefit of investors U.S. dollar indexed debt plus warrants would be made available to shareholders Controlling shareholder would assign its pro rata portion to a trust Investors would purchase New York law governed instrument issued by trust, economically equivalent to a convertible note, with a guarantee from the company Variation on debt plus warrants: CVM registered public offering under CVM Rule 400 exemption for block of shares 12

13 Tax Issues in Convertible Offerings Interest payments are deductible expenses for company Interest income of non-resident holders from a Brazilian source (but not an offshore subsidiary) is subject to withholding taxes at 15% or 25% tax rate A portion of interest income may be equity upside In the case of a cash-settled convertible, amounts in excess of principal will be deemed interest and taxed at 15% or 25% Gross-up of capital gains, if necessary, lead to prohibitive costs No capital gains taxes are due upon conversion into shares but will be due upon sale unless shareholder holds through Resolution 2689 account Conversion of shares into ADRs will be deemed a sale and is a taxable event but investor controls timing Cost basis of shares is the original acquisition cost of the convertible instrument Additional interest in the amount of shareholder distributions is also likely tax deductible as an expense 13 13

14 Capital Control Issues in Convertible Offerings Convertible issuances structured as international offerings are subject to registration as debt instruments with the Central Bank Resolution 2689 does not apply at the outset Issuance of convertibles is registered under RDE-ROF system for debt claims Hybrid instruments often fall outside the existing categories Resolution 2689 status is critical to tax treatment and logistics of transfers At the time of conversion, investors local representatives will need to convert the RDE-ROF registration into a Resolution 2689 registration The Central Bank has confirmed that the conversion is feasible and does not require additional action from the regulator The mechanism remains untested Tax effects (deemed sale) are still a hindrance 14 14

15 Remaining Issues in Convertible Offerings Well-known seasoned issuers (WKSI s) and qualified investors benefit from expedited offering procedures outside Brazil WKSI can use automatic effectiveness of registration in the US but require a full-blown registration process in Brazil Delay in registration hampers ability to issue convertible debt disadvantages local markets CVM and industry groups seek to close regulatory gap CVM has requested comments on draft regulations relating to limited efforts public offering to qualified investors CVM has issued rules allowing the ANBID to review certain offerings 15 15

16 Remaining Issues in Convertible Offerings Key question: How complete is the solution offered by the Vale model? Few companies will have sufficient treasury shares on hand Few companies (exporters mostly) will have use for offshore proceeds Will local investors or local markets object? Unless CVM establishes a practice of exempting treasury shares from CVM Rules 10 and 390, the Vale model will not suffice Look for a push for a local market to develop Local appetite for convertibles remain unclear Will international investors ever accept a Brazilian-law governed convertible instrument? Equity investors already have overcome the hurdle 16 16

17 Further inquiries If you have any questions regarding this presentation, please contact any of the following partners of Mattos Filho: New York Daniel Calhman de Miranda 135 East 57th Street 12th Floor New York, NY, USA Tel.: Fax: São Paulo Luiz Octavio Duarte Lopes Marina Anselmo Schneider Al. Joaquim Eugênio de Lima, 447 São Paulo SP Tel.: Fax: