An extract from The Virtual Currency Regulation Review, 3rd Edition
Introduction to the legal and regulatory frameworki Introduction
The boom experienced in users' adoption of virtual currencies2 has also reached the Brazilian market, which has given local law practitioners, legislators and regulators a lot to discuss. Traditionally, technology and business innovation comes ahead of regulation, and this is also proving to be the case with virtual currencies businesses.
The virtual currencies industry is both globalised and localised, and the growth of its ecosystem has given grounds for discussions that range from local mining activities to global exchanges, with services and products that defy the limits of banking, payment and capital markets laws and regulations on a daily basis. This is the case in Brazil.
The first official communication by the Brazilian Central Bank (the Central Bank) regarding virtual currencies occurred in 2014. In this statement, the Central Bank clearly stated that virtual currencies are not considered legal currency in Brazil, and thus would not be subject to Central Bank scrutiny. It also stated that although it would follow the development of this market closely, the volume of transactions was not yet large enough to pose a threat to the soundness of the Brazilian financial system.
The 2017 boom in the virtual currencies market brought virtual currencies back into the spotlight and resulted in the Central Bank and the Brazilian Securities Exchange Commission (CVM) releasing more comprehensive communications to the market stating their position regarding new virtual currencies businesses in light of the existing Brazilian laws and regulatory framework. Both regulatory agencies closely follow the development of the virtual currencies market and the intersections it might have with banking and capital markets regulations.
In parallel, over the years, several bills of law aimed at regulating virtual currencies have been discussed in the Brazilian Congress and a series of public hearings to listen to regulatory authorities, market players and specialists were held as part of these discussions. However, none of the bills of law have yet been approved. The main bill (Bill of Law 2303/15) is still under discussion in the congressional houses and a special commission on virtual currencies has been set up to discuss this and other bills tackling the matter.
With the development of the market, there are renewed conversations about regulation encompassing cryptoassets by the Central Bank.ii Legal and regulatory framework applicable to virtual currencies
Although virtual currencies are capable of having the economic functionality traditionally attributed to currencies, they do not fall within the legal definition of a currency for the purposes of Brazilian law. The legal currency in Brazil is the real as provided by Decree-Law 857/69 and Law 10192/01.
According to Law 10192/01, all payment obligations enforceable in Brazil must be determined in reais, and all agreements or other documents that in any form constrain or refuse the use of the legal currency are void. These provisions are referred to as the 'legal course' of the real.
As a result, despite being able to be used as a means to carry out exchanges, a unit for the purposes of accountancy or even as reserve of value, virtual currencies do not have legal course, and therefore do not fall within the legal definition of legal currency.
Considering that virtual currencies are not currency in Brazil, they are generally classified as assets subject to the general regimen established by the Civil Code.3
Nevertheless, as with most jurisdictions, the legal treatment of virtual currencies in Brazil may vary according to the intrinsic characteristics of each virtual currency, including its purpose and usage, existence of remuneration, and distribution and issuance methods. Thus, a given virtual currency may end up being subject to certain banking and securities laws and regulations. To fully and properly understand the legal and regulatory framework that may apply to virtual currencies, it is important to have a general overview of the banking and securities legal and regulatory framework existing in Brazil.iii General overview of the banking and securities legal and regulatory frameworkGeneral aspects of the Brazilian financial system
The Banking Law, although dated prior to the Constitution, remains the main law establishing the current format of the financial system, and sets forth the ground rules for its infrastructure and regulatory framework.
It assigns the authority to regulate and oversee local financial institutions, defines the regulatory policy of the Brazilian Monetary Council (CMN) and created the Central Bank. In addition to the CMN and the Central Bank, the financial system is also composed of the national council of private insurance, the private insurance authority and the CVM, which are subject to specific legal diplomas. Other laws complement the legal framework applicable to the financial system, among which are the Capital Markets Law,6 the Securities Law,7 the Anti-Money Laundering Law8 and the E-payments Law.9
In 2013, the enactment of the E-payments Law enlarged the scope of the regulatory authority of the CMN and Central Bank. The E-payments Law was enacted to regulate the industry of electronic payments in Brazil by bringing the CMN and Central Bank's scope of oversight to the rendering of payment services in the context of the Brazilian payments system. The E-payments Law sets the ground rules of the regulatory framework applicable to payment arrangements (i.e., the set of rules governing a payment scheme, such as credit or debit card transactions) and payment agents (i.e., any agent that issues a payment instrument or acquires a merchant for payment acceptance).General aspects of the Brazilian banking and e-payment system
The banking system is highly regulated. The main piece of legislation is the Banking Law, which places the CMN as the highest authority in the financial system. It is responsible for establishing the monetary and financial policies in Brazil, and is in charge of the overall supervision of the Brazilian monetary, credit, budgetary, fiscal and public debt policies, as well as operating the Brazilian payments system (SPB).
The primary objectives of the CMN's policies are to:
- adjust the monetary supply to the needs of the Brazilian economy and its development process;
- regulate the domestic value of the real to prevent or correct inflationary or deflationary trends of internal or external origin, economic depressions or other imbalances arising from sudden events;
- regulate the value of the real outside of Brazil and regulate the Brazil's balance of payments to make better use of foreign currency resources;
- improve the quality of the resources of financial institutions and of financial instruments so as to make the payments system and the mobility of funds more efficient; and
- monitor the liquidity and solvency of financial institutions and payment institutions.
The Central Bank is responsible for implementing the monetary and credit policies established by the CMN, as well as to regulate public and private financial institutions per se, payment arrangements, payment arrangements institutors and payment institutions, applying, when needed, the sanctions stipulated in the rules applicable to such entities. It is also responsible, among other activities, for exercising control over credit and foreign capital, receiving mandatory payments and voluntary demand deposits made by financial institutions, engaging in rediscount transactions and providing loans to financial institutions, and exercising the function of a depository of official gold and foreign currency reserves.
In this sense, the CMN is responsible for regulating the criteria for the organisation, operation and inspection of financial institutions and payment arrangements and agents, while the Central Bank is responsible for effectively authorising the operations of financial institutions in Brazil and supervising their activities.
The regulatory authority of the CMN is exercised by the issuance of resolutions creating the basic regulatory framework applicable to financial institutions as per the mandate and pursuant to the limits provided by the Banking Law and E-Payments Law. The Central Bank, in its role as the regulatory and supervising authority, issues regulations aimed at implementing CMN resolutions. While CMN resolutions set the policies and guidelines for the financial and payments systems, Central Bank regulations serve to establish the technical details for implementation of CMN resolutions.General aspects of the Brazilian capital markets
The Brazilian capital markets system is also highly regulated. The main piece of legislation is the Capital Markets Law, which created the CVM, and the Securities Law, which establishes the scope of the CMN and the Central Bank in the capital markets.
The CVM is responsible for regulating, supervising and inspecting the securities market and its participants. It is also responsible, among other things, for overseeing the exchange and organised over-the-counter markets, publicly-held corporations, the commodities, futures, derivatives and securities markets, and the intermediation and custody of such assets. Its regulatory authority also extends to banks engaged in investment banking and securities activities, and to other participants in the securities market.
The regulatory authority of the CVM is exercised by the issuance of rulings and opinions that are binding on participants in the securities market and any parties involved in transactions involving securities. There are also some CMN resolutions and Central Bank regulations that apply to financial institutions and other specific capital markets participants subject to such authorities' oversight.
Securities and investment laws
Discussions on the treatment of virtual currencies in light of the Capital Markets Law and the potential characterisation of virtual currencies as securities in Brazil have gained relevance owing to the growth in interest in virtual currencies and other virtual assets throughout 2017, especially in initial coin offerings (ICOs).
ICOs consist of making an offer to the public of virtual currencies or virtual assets (financial or otherwise). The market has conventionally named these tokens or coins, as they are created within a blockchain or distributed ledger technology.
Virtual currencies offered through an ICO may represent any type of asset or instrument, from a share to a feature to access a certain platform. In this sense, as mentioned above, a given virtual currency may be subject to a specific legal and regulatory framework depending on the intrinsic characteristics of each virtual currency, including its purpose and usage, existence of remuneration, and distribution and issuance methods. If a new virtual currency created in the scope of an ICO has characteristics that match the requirements to classify as a security in Brazil, it will be subject to the Brazilian capital markets legal and regulatory framework.
In light of the growth in the number of ICOs in 2017, the CVM published two notices to the market confirming that any given virtual currency may or not be subject to the Capital Markets Law and CVM regulatory framework and scrutiny depending on whether or not it is classified as a security in light of the concept of security provided by the Capital Markets Law, and the analysis should be made on a case-by-case basis.
The concept of securities under the Capital Markets Law is composed of a list of instruments that expressly classify as securities under Brazilian law:
- shares, debentures and subscription bonus;
- coupons, rights, subscription receipts and certificates of unfolding of coupons, rights and subscription receipts;
- certificates of deposit of securities;
- debenture notes;
- quotas of investment funds in securities or investment clubs in any assets;
- commercial notes;
- futures, options and other derivative contracts, which underlying assets are securities;
- other derivative contracts, regardless of the underlying assets; and
- when publicly offered, any other securities or collective investment contracts that generate share, partnership or remuneration rights, including those resulting from the provision of services, whose income comes from the efforts of the entrepreneur or third parties.
Along with the list of instruments that are expressly considered securities (listed in points (a) to (h) above), the Capital Markets Law also provides an open-ended definition whereby any collective investment contracts that are open to public offering, generate a share, partnership or remuneration right, and whose income results from the efforts of the entrepreneur or third parties, are considered a security.
Thus, it is indeed possible to characterise some virtual currencies as securities under the terms of the Capital Markets Law depending on the economic context of its issuance and the rights conferred on investors.
In cases where a virtual currency is classified as a security in Brazil, an ICO for issuance of this virtual currency will be subject to the legal treatment of public offerings of securities in Brazil.
The main concern of the CVM is to ensure that the issuance and public offering of these securities (i.e., their large-scale offering) is carried out in a manner that ensures that the investors concerned are properly educated about the potential risks and benefits involved. Therefore, as a general rule, the public offering of securities depends on the registration by the issuer of the securities offered at the CVM, registration of the offer with the CVM and completion of the public offering through an intermediary authorised by the CVM (investment bank or others).
Public offerings of securities are currently carried out under the general public offerings regimen set forth by CVM Ruling 400/03, which requires the registration of an offer with the CVM, as mentioned above. Alternatively, public offerings of securities may be carried out under the specific regimen set forth by CVM Ruling 476/09 for offerings with restricted efforts (that is, a direct offering to a limited number of qualified investors) and the specific regimen set forth for investment crowdfunding in CVM Ruling 588/17. In both cases, the offerings do not require prior registration with the CVM but are subject to specific limitations.
Additionally, the CVM has issued specific opinions dealing with offerings of securities using the internet that occurred abroad whereby the authority has stated that an offering made using the internet is generally considered public, and that even if a certain public offering occurs abroad, in cases where it targets Brazilian investors it will be subject to Brazilian capital markets laws and regulation. In this sense, an ICO is for all purposes a public offering as it uses the internet as the main distribution method, and even if the public offering is occurring elsewhere, it should observe Brazilian capital markets laws and regulation if Brazilian investors are targeted.
As a result, the CVM may administer the applicable sanctions and penalties in the event of offers of virtual currencies that fit the definition of security in disregard of the capital markets applicable regulation, an understanding that has already been publicly confirmed by the CVM.
The same applies to the trading rules. Securities may only be traded in markets authorised by the CVM (stock exchanges and over-the-counter markets) and, therefore, virtual currencies that are classified as securities can only be traded in such markets, being prevented from listing in non-regulated environments: that is, virtual currency exchanges (see Section V).
In early 2019, the CVM published a new internal regulation modifying its rule-making process. The main changes included the introduction of a phase for assessment of the regulatory impact as a means to consider the cost-effectiveness of a proposed rule and the possibility of introducing a regulatory sandbox through the issuance of temporary rules for empirical testing of their adequacy to market requirements. In line with the discussions between the CVM and the market in the past couple of years, the new rule-making process allows for the creation of an experimental regulatory environment where temporary regulatory instruments may be issued to empirically assess the benefits and most suitable procedures to implement a recommended solution.
In early 2020, the CVM published a comprehensive set of rules establishing the conditions for the creation and functioning of a regulatory sandbox in the capital markets. The rules establish the framework for the selection process (including adequacy and suitability criteria) as well as the operation and discontinuation of projects selected to operate under this framework. It also sets the minimum obligations these projects must fulfil to operate and to make investment products or similar offerings available to the public in general. In this sense, the rules are designed to provide a safety net for entrepreneurs, regulators and the public to test innovative projects.
This experimental environment will enable the regulator to test, individually and for a limited period, regulatory changes that, owing to their features and according to the CVM Board, justify a trial environment, avoiding additional risks to the national financial system or to investors' protection. Security tokens issuances are among the first projects expected to receive this treatment and are aligned with the efforts of the regulators to foster innovation in Brazil's financial and capital markets.
Banking and money transmissioni Electronic currencies
The regulation enacted by the CMN and the Central Bank under the regulatory powers attributed to them by the E-payments Law created the concept of electronic currency in the legal and regulatory framework. An electronic currency is an electronic representation of reais transferred by the user of the payment services to the entity responsible for the issuance and management of the electronic currency – the payment institution. Such funds are stored in an electronic account in the name of the user, and might be utilised for payments or transfers among users or with third parties accredited to receive the electronic currency. The user legally owns the electronic currency and may request the withdrawal of the amount at any time.
Payment institutions' issuers of electronic currencies are required to join a payment arrangement (or establish their own) and request the Central Bank approval to operate. The payment arrangement is the set of rules governing the payment scheme (including the fee structure), and its establishment is carried out by a payment arranger who is also a regulated entity and required to request Central Bank approval to operate.
The regulatory concept of electronic currency was created to cover all prepaid cards issued in Brazil and mainly used for the acquisition of goods with merchants. Nevertheless, given the broad concept of electronic currency as established by the E-payments Law and regulation, it encompasses all kinds of electronic currency directly related to the real. In other words, the E-payments Law will apply to all electronic currencies that mimic the real. Virtual currencies do not fall into this definition and, therefore, are not considered electronic currencies for the purposes of the E-payments Law and its related regulation.
In this sense, the Central Bank issued a communication in 2014, following the enactment of the E-payments Law and at a moment when virtual currencies were not so largely adopted, clarifying and confirming that virtual currencies are different from the electronic currencies concept created by the E-payments Law and related CMN and Central Bank rules. This position was further confirmed in 2017 when the Central Bank issued additional communications to the market restating its position owing to relevant increase in the number of transactions and businesses involving virtual currencies.ii Foreign exchange transactions and remittances
The Brazilian foreign exchange rules are generally strict, and the foreign exchange laws and regulation thereof still reflect the government's historic concern with foreign exchange controls, which have been relaxed over the past decade but that still impose a significant hurdle to foreign currency flows. The foreign exchange market and transactions are subject to Central Bank oversight and regulation, as established in the Banking Law and Law 4131/62.
Remittances of funds from abroad to Brazil and vice versa can only be made through financial institutions authorised to operate in the foreign exchange market. In other words, Brazilians can purchase and sell foreign currencies or perform international transfers in reais of any nature, without limitation of amount, on the condition that the counterparty in the operation is an agent authorised to operate in the foreign exchange market, subject to the legality of the transaction and based on economic grounds and responsibilities defined in the related documentation. These rules set out the principles to be observed by banks and agents authorised to operate in the foreign exchange market in each and every transaction.
Pursuant to Decree-Law 23258/33 and Law 7492/86, a foreign exchange transaction carried out without the intermediation of an authorised intermediary is considered a financial crime characterised as the execution of an illegal foreign exchange transaction subject to the penalty of imprisonment from two to six years plus a fine.
In this context, the remittance of funds from Brazil to abroad for the acquisition of virtual currencies is not prohibited, provided that the flow of funds occurs through the appropriate channels by means of an foreign exchange transaction entered into with an authorised agent.
Remittances of funds from abroad to Brazil and vice versa can only be made for specific purposes expressly set forth in the regulation. Each purpose has a corresponding nature (or code) that must be indicated in the corresponding foreign exchange agreements. Brazilian exchange regulations do not specify objective criteria for the characterisation of foreign exchange transactions under a specific nature, and a local agent will request from its clients and keep in its files the documents evidencing that the transaction is legal and corresponds to the specific purpose indicated by the client. The remittance of funds from abroad to Brazil and vice versa not in compliance with this rule is also subject to administrative fines.
Despite the above-mentioned requirements, currently the Central Bank regulation does not provide a specific nature for transactions involving virtual currencies, and remittances must be analysed on a case-by-case basis to determine the most appropriate classification.