1.1 On April 26, the Brazilian National Monetary Council (Conselho Monetário Nacional – “CMN”) has issued the Resolution No, 4,656, which provides for the creation of two new types of financial institutions that originate credit transactions (referred herein as “Credit Transaction”, irrespective of the type of Fintech referred to) through digital platforms (the so-called “Fintechs”) (“Fintech Regulation”) that are: the (i) direct credit company (Sociedade de Crédito Direto - “SCD”) (ii) and the P2P loan company (Sociedade Entre Pessoas - “SEP”).
1.2 The most innovative issue brought by the Fintech Regulation is to avoid the current requirement to have certain form of collaboration with traditional banks to fund the Fintech’s clients (referred herein as “Debtors”, irrespective of the type of Fintech), as only financial institutions were allowed to do so through a banking credit note (so-called “CCB”) or other financial instruments provided for in our laws and regulations. In the current unregulated framework, the Fintechs have been responsible for the origination (credit scoring), user experience, disbursement and the collection of the funds– as a general rule, operating as a bank correspondent.
1.3 The Fintech Regulation was made available for the market and public in general through the Public Consultation No. 55/2017, proposed by the Brazilian Central Bank (Banco Central do Brasil – “BACEN”) on August 30, 2017. In a nutshell, regulations covering fintech in Brazil, as well as most countries, are still evolving. However, we have noted in Brazil that the main regulators of the financial and capital markets - the BACEN and the Brazilian Securities Commission (Comissão de Valores Mobiliários – “CVM”) - have been showing signs and efforts to stimulate financial inclusion, aiming to achieve a modern and positive approach towards innovations to these sectors and “unlock” the Brazilian credit market dominated by few. The Fintech Regulation – irrespective of any adjustments that the Brazilian market would need in the following years - represents, of course, an evolution towards the policymakers’ intentions.
1.4 The Fintech Regulation should foster the emergence of new competitors for the Brazilian credit markets, as well as more organization for the digital lending initiatives that have been booming in Brazil specially in the past two years. As any innovation, there are, however, some important issues that still require clarification, some of which are expected to be regulated by BACEN directly within the next couple of months, others that may be part of discussions with other public authorities, such as the CVM and the Brazilian IRS (Receita Federal do Brasil – “RFB”).
1.5 The Fintech Regulation brings two definitions that should be observed in order to understand the players from other industries that may shift their efforts and capital towards the marketplace lending industry, that are: (i) “qualified share”, as the direct or indirectly equity holding, hold by individuals, legal entities or investments funds, representing 15% or more of the shares issued by a corporation; and (ii) “controlling group”: individual, group of people (a) bound by a voting agreement; (b) under common control or (c) investment fund, that have shareholders’ rights corresponding to the majority of the corporation’s capital .
1.6 In this regard, please find below the main features of each type of Fintech, followed by the provisions that commonly govern both Fintech, including a brief description of Fintech’s requirements to operate and the BACEN’s approval process (“Application Process”).
2. SCD – Balance Sheet Lending:
2.1. SCD is a Fintech that funds their loans exclusively through equity capital (so-called “balance sheet lending”). The SCD is not allowed to raise funds from third parties to further funds the Debtors, meaning that the Fintech Regulation prohibits SCDs to (i) raise capital from the public, except by means of the issuance of shares or stocks, and (ii) have equity in other financial institutions.
2.2. The Fintech Regulation also allows the SCD to sell and or assign the credits related to a certain Credit Transaction to (i) other financial institutions; (ii) Receivables/Credit Rights Investment Funds” (Fundos de Investimento em Direitos Creditórios – “FIDC”); and (iii) securitization companies that distribute the underlying assets exclusively to qualified investors, as defined by the CVM. Therefore, it is not under the SCD’s role to help individuals or legal entities to join the financial market as Creditors without a proper vehicle that justify that initiative.
2.3. It is important to note that, as the SCD will lending its own funds (balance sheet lending), SCDs must comply with BACEN’s regulations regarding prudential supervision. BACEN has created a special segment for institutions with a lower/simplified risk profile such as the SCDs (Patrimônio de Referência Simplificado (PRS5), which has a simplified calculation basis and less complex criteria to define the prudential ratio.
3. SEP – P2P Lending:
3.1. Under the Fintech Regulation, SEP is the Fintech responsible for the so-called “Peer-to-Peer Lending - P2P Lending”. The P2P Lending is the frontrunner and most innovative type of player within the “marketplace lending industry”, as it enables retail or institutional investors to purchase notes representing fractional interests in specific underlying loans.
3.2. SEP’s operational activities ended up being more regulated than those of the SCD, which makes sense due to the fact that it allows more parties to be engaged in the Credit Transaction, i.e., the Creditors are not part of a financial institution as a shareholder thereof. As a general rule, SEPs are forbidden to use their own capital to fund loans within the platform and, thus, cannot be exposed directly or indirectly to the credit risk of the Credit Transactions it generates.
3.2.1. A remarkable amendment that was object of discussion with BACEN during the Public Consulted created an exception in case the SEP and/or its affiliated or controlled company invest in subordinated shares of a FIDIC that holds underlying assets generated by the SEP, provided that such acquisition represents not up to 5% of the net equity of the FIDIC and are not considered substantial assumption or retention of risks and benefits, under the terms of Brazilian regulation.
3.3. Therefore, SEP is prohibited to: (i) carry out any Credit Transactions using its own financial resources, provided the exception provide above; (ii) hold equity of another financial institution; (iii) co-oblige or provide a guarantee or security for any of the Credit Transactions existing in its digital platform; (iv) pay its services or use the resources related to the Credit Transactions in its own benefit; (v) transfer financial resources to the Debtors before the resources be made available to the Creditors; (vi) transfer financial resources to the Creditors before the payment be made by the Debtors; (vii) keep the financial resources of both the Creditor and the Debtor on its own account, not related to the Credit Transactions; and (viii) link the performance of the Credit Transaction with the efforts of a third party or Debtor, in his capacity as an entrepreneur.
3.4. The Creditors to the loans may be individuals, legal entities or investment funds. The Debtors may be individuals or legal entities domiciled in Brazil. In principle, the Creditors will not be protected by the Brazilian Credit Guarantee Fund (Fundo Garantidor de Crédito – “FGC”) and their exposure must be limited by credit, R$15,000.00 per Debtor and per SEP– which in our opinion was an evolution from the proposed rules that established the limited amount of R$50,000.00 per individual in all platforms. In any case, such thresholds do not have to observed by qualified investors.
3.5. As the SEP will be entitled to receive Creditors’ funds, the Fintech Regulation provides several information that must be provided in the credit document, which includes: (i) the unequivocal manifestation of the potential Creditors and Debtors’ will to enter into the Credit Transaction within the digital platform; (ii) the release of the funds to the SEP by the Creditors, which will eventually be available for the Debtors; and the (iii) issuance or execution with the Debtors of credit-related instrument and issuance or execution with the Creditors of instrument that link the credit-related instrument to the Credit Transaction. The referred instruments must be issued by the SEP or in favor of the SEP or have the SEP as a party thereof.
3.5.1. In addition to it, the Credit Transaction’s documents provided for the SEP’s structure shall provide for, at least, provisions regarding the following:
- conditions of the Credit Transaction, including the rate of return contracted with the Creditor (and the respective payment flow, interests rate, tax implications, fees, insurance, and other expenses related thereto);
- rights and obligations of the Creditors, Debtors and of the SEP;
- the indication that SEP is not co-obliged nor grant any guarantee or security to the Credit Transaction;
- the link between the financial resources made available by the Creditors to the SEP and the correspondent Credit Transaction with the Debtors;
- that the Credit Transaction shall be enforced only and as from the disbursement of the funds by the Creditors to the SEP;
- information with respect to guarantees or securities granted, if any;
- the conditions for the transfer of the resources to the Creditors, which shall be transparent and be equally provided among different Creditors;
- the effectiveness of the Credit Transaction is conditioned to the transfer of the funds to the Debtors; and
- statement of the Creditors with respect to the risks of the Credit Transaction.
3.6. The financial resources of the Creditors must be segregated from the SEP’s own resources. The financial resources received by the SEP must be transferred by the SEP (i) within 5 business days to the Debtors of the date that the Creditor deposit it to SEP’s accounts; (ii) within 1 business day to the Creditors from the day that the Debtor repaid it to the SEP to the benefit of the Creditor; and (iii) alternatively, within 1 day to the Creditor if the funds made available to the SEP was not eventually disbursed due to the cancellation or annulment of the Credit Transaction.
3.7. Finally, Fintech Regulation also provides for SEP’s obligations regarding the transparency of the Credit Transactions and its operations, including the disclosure of (i) some SEP’s market and operational information (such as the default rate) and of (ii) the risks and information that are important to the Creditors’ engagement with the P2P Lending business, and (iii) the need to have a credit policy in place.
4. SCD and SEP Common Provisions - Requirements and Application Process:
4.1. SCD and SEP have some similarities as per some requirements that must be fulfilled and obligations to be complied with. Fintech is also obliged to maintain certain controls and policies applicable to other financial institutions.
4.2. Both types of Fintechs may only provide the services set forth under the Fintech Regulation, which includes, in addition to either the balance sheet lending (SCD) or the P2P Lending (SEP), the following additional services:
- credit scoring and review for clients and third parties;
- collection of clients and third-party’s credits;
- sales representation services in connection with the distribution of insurance products related to the Credit Transactions that the Fintech can carry out, according to the applicable laws and regulations that govern the Insurance sector in Brazil; and
- issuance of E-money (moeda eletrônica), as provided for under the rules of the Brazilian Payments System.
4.3. The corporate name of the Fintech also must include the correspondent activity by means of the inclusion of “Sociedade de Crédito Direto” for the SCD or “Sociedade Entre Pessoas” for the SEP, and the Fintech is forbidden to add into its corporate name terms related to other financial institutions, whether in Portuguese or foreign language (e.g. “Bank, “Banco”, “Financeira”, etc).
4.4. The Fintech must (i) be incorporated as a corporation and (ii) have a permanent minimum requirement of R1,000,000 for both the Fintech corporate capital and net worth - the Fintechs cannot fall below such threshold. BACEN may also require additional amount of minimum paid-up capital and net worth in case an investment fund belongs to the Fintech’s controlling group.
4.5. The Application Process must be filed by means of the presentation of a formal requirement, which must be presented to BACEN with the following:
- incorporation act as a corporation, as provided for under the Brazilian Corporation Law;
- payment of the corporate capital and withhold to the BACEN of the cash, according to the Brazilian Banking Law;
- corporate document regarding the appointment or election of the Fintech’s managers (Board of Directors/Officers), according to the Brazilian laws;
- substantiated justification, that must provide for, at least, (a) the type of Fintech (SCD or SEP); (b) corporate capital; (c) services to be rendered, including the Fintech intention to issue “e-money”; (d) target public/customers; (e) headquarters and branches; (f) market opportunities that justify the Fintech; (g) competitive advantages of the Fintech; (h) intention to open a liquidation account as from the date of its activities; and (i) technological systems and resources.
- documentation that identify (a) all the individuals or legal entities that are part of the economic group and may exert directly or indirectly influence within the Fintech’s businesses (b) the Fintech’s controlling group and the holders of the qualified share of the Fintech, with all the equity share distribution; (c) the type of investment fund, the negotiation of its shares, number of investors, the information with respect to its six major investors, amount and distribution of the assets held by the fund, the segments of activities, historical yield, divesting policy and conditions, among others;
- proof of origin and of the respective transfer of the financial resources invested on the Fintech by controllers and holders of “qualified share”;
- statement of correspondence of the Fintech financial-economic capacity vis-à-vis the size, nature and the Fintech’s purpose, for the controlling group or, individually, by each member of the controlling group, under BACEN’s discretion;
- authorization signed by each of the members of the controlling group and of the holders of qualified share: (a) to the Brazilian Federal Revenue Service allowing it to provide information with respect to the last three fiscal years; (b) to BACEN for its access to information provided for by public or private information systems, including administrative or judicial claims, irrespective of the nature; and
- statement signed by the members of the controlling group and for the holders of “qualified share” related to the inexistence of any restriction that may, under BACEN’s discretion, affect their reputation, also applying certain rules already set forth under Resolution No. 4,122/2012.
4.5.1 It is important to point out that, in case an investment fund is part of the controlling group or holds “qualified share” of a Fintech, the investor/fund and or its management team may not be also a part of the management of the Fintech. Also, Fintech must comply with the Brazilian law that require presidential authorization - in the form of a decree – to allow international fintech and investors to become equity holders of their shares. That is certainly an important topic that we believe will still be object of further understanding among Brazilian authorities and players of the fintech ecosystem, as there are many Fintech that had received foreign capital up to the date hereof.
4.5.2. In addition to the referred documents, BACEN may also require the execution and further presentation of a shareholders’ agreement, by means of which the Fintech directly or indirectly controlling group must be clearly and expressly defined.
4.6. Finally, the Fintech Regulation also provides for some rules that normally govern other financial institutions, such as: (i) rules regarding the cancellation of the Fintech’s authorization and (ii) in connection with the transfer of the Fintech’s controllership and corporate reorganizations; (iii) changes to the Fintech’s management team.
We understood that the Fintech Regulation will bring more benefits than pitfalls for the booming fintech ecosystem; although we expect fintechs will face important challenges that require a shift to a different mindset towards the complexities of the financial industry aiming to thrive in a more regulated framework.