On October 7, 2014, the federal government enacted the Provisional Measure n.º 656, creating Letras Imobiliárias Garantidas (Real Estate Secured Bills, "LIG") the Brazilian version of the covered bond. The creation of the LIG is part of the Ministry of Finance′s previously announced measures to promote the housing market and foster the offer credit in the financial markets. 

1.   Dual Recourse Mechanism 

The LIG has similar features to the European version of the covered bond, being a security issued exclusively by financial institutions, collateralized by a pool of assets composed mainly by real estate credit rights, providing its holders with the typical dual recourse mechanism intrinsic to this type of bond (i.e., investors will have unlimited and exclusive recourse to the cover pool at the same time that will be considered a pari passu creditor in relation to all senior unsecured creditors of the issuer). 

The market concern on whether the cover pool would be protect by any other obligations of the issuer (including labor and tax obligations) was very well addressed by the PM, which expressly stated that the assets encompassed by the cover pool are segregated from all other financial institutions assets and liabilities. Furthermore, on this regard, the PM determines that article 76 of Provisional Measure No. 2.158-35/01, which sets forth that segregated assets of individuals or legal entities are not effective in relation to labor and tax liabilities and because of that is a standard risk factor in securitizations in Brazil, do not apply to the LIG′s cover pool.

2.   Cover Pool Composition 

The exact composition of the LIGs cover pool, together with other relevant characteristics such as the minimum overcollateralization, is pending further regulation by National Monetary Council ("CMN"), but the PM has anticipated that the cover pool can be composed not only by real estate credit rights but also by (i) treasury bills; and (ii) derivatives executed on stock exchanges (which will be crucial to the issuance of LIG adjusted by currency exchange). 

In addition, the PM has delegated to the CMN the definition of which type of real estate credit rights can form part of the cover pool, only setting forth that such real estate credits must be (i) secured by a mortgage or real state fiduciary sale (alienação fiduciária de imóvel), or (ii) granted in relation to a real estate project which is legally segregated from the assets of the developer of such project (as provided by Law No. 4,591/64). 

3.   Possibility of Indexation to Foreign Currency 

The LIG are being created as a new financing mechanism for financial institutions and is clearly being focused on foreign investors. Thus, the possibility of indexing an issuance of a LIG to the currency exchange was a sine qua nonfeature to make such securities attractive to foreign investors.  

Within the first year from the enactment of the PM (effective in relation to the LIG from its publication on October 8, 2014), the total amount of LIG issued with the currency exchange adjustment feature cannot exceed 50% of the total amount of outstanding LIG issued by the respective Financial Institution. Notwithstanding, the PM again refers to further regulations by the CMN not only in relation to the limit of the issuance of LIG bearing foreign exchange indexation, but also in relation to mechanisms to mitigate the risk of possible currency exchange fluctuations.

4.   Tax Benefits 

Following the rationale to attract foreign investors the LIGs will benefit non-residents investors with income tax exemption on interests and capital gains, provided that such non-resident investors are not a resident on a country with favorable jurisdiction, in which case the income tax will apply with at a rate of 15%. The mentioned income tax exemption will also benefit individuals resident in Brazil.   

5.   Cover Pool Control and Trustee 

Differently from other European jurisdiction, the Brazilian Central Bank or any other government agency will not monitor the cover pool of each issuance of LIG. Such responsibility will be fully taken by the issuer, which will be supervised by a trustee.  

Pursuant to the PM, the financial institution issuing the LIG will be the one responsible to manage and control the composition, quality and sufficiency of the assets encompassed by the cover pool, being further responsible to replace or add new assets to the respective cover pool in case its ceases to comply with the required/applicable criteria.  

The trustee will be the legal representative of the community of holders of LIG and must necessarily be a financial institution or an entity authorized to act as such by the Brazilian Central Bank. The trustee must be independent in relation to the issuer, although the CMN will yet define the concept of independent party for such purpose.  

The PM sets forth that the trustee shall have full access to all information and documentation related to the cover pool and the LIG. In addition, in case the issuer suffers intervention or becomes bankrupt the trustee will be vested with the necessary powers to manage the cover pool on behalf of the holders of the LIG. However, the exact responsibilities and obligations of the trustee are yet regulated by the CMN.  

6.   Conclusion 

The LIG may become an important funding mechanism to the Brazilian Financial Institutions and an interesting asset for foreign investors. However, many of its most relevant conditions are still subject to further regulations by the CMN.