Brazil: Private Equity
Private Equity and Antitrust Challenges After Two Years of the New Antitrust Law in Brazil
29 May 2014 marks the second anniversary of Law No. 12,529 of 30 November 2011 (the Antitrust Law). The efforts of the Brazilian Administrative Council for Economic Defence (CADE) to achieve the Antitrust Law’s goals have been broadly recognised by the market and the legal community. However, after two years of enforcement of the pre-merger control rules, the antitrust agency has recognised that this may be a good opportunity to review some of its mechanisms and internal rules that have been raising discussions and need to be improved in the light of practical experience.
This is also the case for the rules related to private equity transactions. When the Antitrust Law came into effect, CADE adopted a conservative approach to transactions involving investment funds, especially regarding criteria and rules related to the concept of economic groups. The understanding that the investment funds economic group should be defined as broadly as possible is now under discussion, as the authority issued a public consultation to review the merger control rules, which narrows down the controversial concept in the light of the experience gained in the past two years. Once implemented, such rules will change the way CADE assesses the economic group of investment funds with a view to establishing a more objective and efficient merger-review system.
The relevance of private equity deals
Private equity by definition1 consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from retail and institutional investors, and can be used to fund new technologies, expand working capital within an owned company, make acquisitions or strengthen a balance sheet.
The majority of private equity investors are institutional and accredited investors who can commit large sums of money for long periods of time. The fund manager oversees the fund and decides which securities it should hold and in what quantities, and when they should be bought and sold.
Private equity transactions are increasing worldwide with a focus on emerging markets. This is because they provide a broader selection of investment opportunities, greater management expertise and lower investment fees than investors might be able to obtain on their own. According to the Brazilian Association of Private Equity and Venture Capital (ABVCAP), the capital commitment made by investment funds and venture capital totalled 100 billion reais in 2013.2
It is no surprise that the investments made by private equity firms, through their various investment funds, have been calling the attention of CADE. Indeed, they impose a number of challenges for CADE, which has been trying to conclude, as part of its merger control role, whether such investments transactions are leading to a consolidation of the markets through the sophisticated corporate structures involved.
In recent years, CADE has been looking for criteria to clarify whether investment funds’ transactions should be subject to its merger control review. As of 29 May 2012, the most recent reform of Brazil’s antitrust enforcement entered into force, with new rules applying also to private equity firms; the question now is whether the new regime has been able to address such past key concerns. The existing rules are now under discussion, as CADE has recently concluded a public consultation proceeding that may result in changes for the transactions involving investment funds.
The Brazilian Antitrust Law and the merger review process
On 29 May 2012 the Antitrust Law entered into force. The system’s structure was modified. CADE – the surviving antitrust entity – was reorganised into the Tribunal, the General Superintendent Board (SG) and the Department of Economic Studies (DEE). These three bodies carry out all the steps of the merger review process.
Of the changes implemented, the most significant among them is the replacement of the post-merger notification system to a pre-merger notification system for M&A transactions that fall under the submission thresholds (which have also changed). Therefore, reportable transactions shall be submitted and approved by CADE prior to their consummation, subject to its respective annulment and a pecuniary penalty ranging from 60,000 to 60 million reais in the event of non-compliance with the rule.
Another important change introduced by the Antitrust Law is the establishment of a more objective and detailed list of reportable transactions. Indeed, article 90 of the Antitrust Law sets forth a list of reportable transactions (merger filings) that should be submitted to CADE’s approval prior to their consummation. As such, a merger filing will occur when:3
- two or more independent companies merge;
- one or more companies acquire, directly or indirectly, the control or a portion of another company (through the acquisition or exchange of shares, quotas, bonds or securities convertible into shares, or assets, tangible or intangible);
- one company merges into another company; or
- two or more companies establish a joint venture, a consortium or other type of association.
The Antitrust Law established only revenue criteria as submission thresholds, according to which a transaction is reportable when at least one of the groups involved reaches the 750 million reais threshold and at least one of the other groups involved reaches the 75 million reais threshold.4 Both thresholds refer to gross revenues in Brazil of the economic groups in the fiscal year immediately prior to the transaction.
One should note that in case a private equity firm performs a corporate transaction that has effects in Brazil and that fits under one of the merger filing’s hypothesis described above, CADE’s approval would be required, provided that the turnover thresholds are met. This means that the Antitrust Law applies for private equity firms, and the tricky question is to define their economic groups and respective annual turnover, as further detailed below.
The merger review process was also modifiied due to the changes in the system’s structure. Under this new merger review system, the Antitrust Law created the SG, responsible for analysing and approving merger filings that fit into the fast-track procedure (or even the non-fast-track procedure, in certain situations). CADE’s Tribunal, in turn, is responsible for reviewing a merger filing in those cases in which the SG decides to challenge a transaction (ordinary cases) after considering it harmful to competition. CADE’s Tribunal may approve the transaction without restriction, approve it subject to conditions or also issue a non-approval decision.
The statutory time to review a transaction submitted to CADE is 240 days. However, for complex transactions, this can be extended by 60 days, upon request of the parties, or 90 days, through a reasoned decision by CADE’s Tribunal. If CADE does not comply with such terms, the merger filing is tacitly approved. One should note that merger filings that fall under the fast-track procedure have been approved by CADE in less than 30 days, on average.
Private equity funds under CADE’s new antitrust regime
The merger review process of transactions involving investment funds is not a new subject to CADE and raises important challenges. Indeed, the focus of the antitrust authority is to identify who is taking the commercial decisions of the different funds and at what degree relevant information of the invested companies are shared.
As anticipated, CADE has been looking for criteria that would clarify whether investment funds’ transactions should be subject to merger control review. This is not a simple task. On one hand, the revoked regime did not provide legal certainty in this regard. On the other, those transactions are, in many cases, carried out by investment vehicles located outside Brazil, which are part of complex corporate structures.
As a result, one challenging question faced by both the authorities and practitioners when assessing whether a given transaction triggers the need of an antitrust filing in Brazil was how to define the concept of economic group applying to investment funds for the purposes of assessing the turnover threshold established in the Antitrust Law.
This question, although simple at a first glance, was never properly answered under the revoked antitrust regime. In some cases, CADE decided to look to the quotaholders of the funds; in others, the concern seemed to be within the portfolio companies, while the manager always played an important role in the analysis. The relevant influence was always the focus of the analysis.
However, following the approval of the new Antitrust Law – which remains silent in this regard – CADE had the chance to address the controversial discussion by means of the creation of a new and more objective disposition. This is the context in which CADE’s Resolution No. 2, of 29 May 2012 (CADE Resolution 2/2012) was amended. At that time, CADE decided to adopt an approach whereby the concept of an economic group of investment funds was defined as broadly as possible.
Investment fund economic groups
For the purpose of defining the concept of economic groups in general, and not only as regards investment funds, CADE Resolution 2/2012 establishes as follows:
Article 4, §1º: An economic group, for the purpose of the turnover thresholds established in Article 88 of the Antitrust Law, should be understood as follows:
- companies that are under a joint control, internal or external; and
- companies in which any of the companies considered in item ‘I’ above hold, directly or indirectly, at least 20% of the voting or total corporate capital.
With respect to investment funds, CADE’s Resolution 2/2012 defines as follows:
Article 4, §2º: As to the investment funds, the following entities shall be considered as part of the same economic group, cumulatively:
- funds that are under the same management;
- the manager;
- the quotaholders that hold directly or indirectly more than 20% of the quotas of at least one of the funds in item ‘I’; and
- the companies that belong to the funds’ portfolio in which the equity stake, directly or indirectly held by the fund, is equal to or greater than 20% of the voting or total corporate capital.
Criticised by some practitioners for its conservative approach, the rule decided to consider as part of the same economic group not only the portfolio companies and quotaholders, but also the manager and funds under the same management.
One could see this as a straightforward concept not linked to a control test, but to an objective percentage threshold. There is a presumption that a 20 per cent stake, even when not providing voting rights, is sufficient to raise antitrust issues, in a clear signal that CADE is also concerned with potential effects driven by minority passive investments, and not only those leading to a factual influence.
The turnover thresholds and private equity groups
Once the economic group of an investment fund is defined, the second challenge is to assess the exact turnover of this group in order to conclude whether any of the turnover thresholds established in the Antitrust Law are met.
In practical terms, as private equity transactions are usually performed by investment vehicles or funds created for the specific purpose of holding the investment to be made, such entities tend to have no turnover. Therefore, one should consider cumulatively, as part of the turnover of the group:
- the joint turnover of the quotaholders in Brazil that hold directly or indirectly 20 per cent of the quotas;
- the joint turnover of the portfolio companies in Brazil in which the equity stake held by the fund is of at least 20 per cent directly or indirectly;
- the turnover of the manager in Brazil; and
- the joint turnover of the funds under the same management in Brazil, if any.
One should note that, regarding the quotaholders and portfolio companies, 100 per cent of their turnovers must be considered, irrespective of the percentage held. This means, for example, that if the interest of an investment fund in the portfolio company is of 20 per cent, 100 per cent of its turnover shall be considered for the purposes of the filing threshold.
If such entities, individually or jointly considered, reach the turnover threshold established in the Antitrust Law, a filing may be required, depending on the turnover of the other group involved.
Acquisition of minority interest by private equity firms
Rather than take control, private equity groups take more minority stakes in companies as they face up to the shortage of bank debt available to finance full takeovers, and this situation also brings challenges for antitrust authorities worldwide, including Brazil.
While under the revoked regime, a control test (voting and veto rights) was always performed to assess the need for a filing in Brazil; the new regime moved this analysis to a more objective and straightforward approach.
In fact, and in accordance with the Antitrust Law, a corporate transaction would trigger the need for a filing in Brazil not only when leading to acquisition of control but also when meeting the de minimis rules, a new concept brought by CADE Resolution 2/2012.
Indeed, according to de minimis rules, if the private equity group is not a competitor of the target or operates in vertically related markets, a filing would be required only when the investment is higher than 20 per cent, in the case of a first investment; or in every increase of 20 per cent (acquired from one individual seller). On the other hand, where the private equity group is a competitor of the target or operates in vertically related markets, a filing would be required only when the investment is higher than 5 per cent, in case of a first investment; or in every increase of 5 per cent.
For the purposes of defining whether the private equity group competes or not with the target, one should follow the ‘economic group rule’ established in CADE Resolution 2/2012 and consider:
- the quotaholders that hold directly or indirectly 20 per cent of the quotas;
- portfolio companies in which the equity stake held by the fund is of at least 20 per cent, directly or indirectly;
- the manager; and
- funds under the same management.
Finally, CADE’s approval of private equity deals would be required when:
- the transaction entails direct or indirect effects in Brazil;
- either the target of the transaction or the private equity fund or the economic group to which they belong have at least a 750 million reais turnover in Brazil and the other party and the economic group to which it belongs have at least a 75 million reais turnover in Brazil (for the fiscal year preceding the transaction);
- the transaction leads to acquisition of control of the target; or
- the transaction fulfils the de minimis rule of 20 per cent or 5 per cent, as the case may be, irrespective of control rights.
Public consultation proceeding – brief overview
The current understanding of economic group for investment funds is now under discussion, as CADE issued a public consultation to review the merger control rules, which narrows down the controversial concept, considering the experience acquired in the past two years. There has been some market pressure to review the existing rules, as the investors have been contesting the hurdles established by CADE, which include the disclosure of unnecessary information for the purposes of the antitrust analysis and flooding the authorities with numerous filings that would not require, in theory, CADE’s review because of their simplicity.
The proposed amendment to the concept of economic group for investment funds would no longer take account of the manager and the funds that are under the same management, nor of the quotaholders of funds that are not involved in the transaction.
A quick assessment of the second year of the Antitrust Law
More than two years into the implementation of the Antitrust Law, a quick analysis of the filings submitted in this period may help to give a better sense of which kind of transaction involving private equities is falling under CADE’s merger control role.
From a total of 650 transactions submitted to CADE’s review in the first two years of the new regime, at least 103 involved private equity funds (both national and international ones), accounting for near 16 per cent of the total number.5 The positive aspect, though, is that approximately 95 per cent of the transactions involving private equity deals were cleared under the fast-track procedure in fewer than 30 days. With the amendments proposed in the public consultation, such numbers are expected to change, with CADE becoming even more efficient in its analysis.
The statistics also show that real estate seems to be the hot market for private equity firms in Brazil, as illustrated in chart 1, below:
Chart 1: private equity transactions by sector of activity
Sector of activity
(Source: CADE website, accessed in May 2014.)
While the majority of the precedents do not include any detailed discussion with respect to the need of submitting private equity deals to CADE’s analysis; on a few occasions, CADE reinforced the conservative approach it has taken for the purposes of defining the economic group or analysing minority equity interests, as detailed in Chart 2, below:
Chart 2: CADE past cases – the Antitrust Law
CADE reiterates that the manager, irrespective of his role within the fund, shall be considered as part of the economic group of private equity firms.
CADE confirms that its Resolution 2/2012 (concept of economic group and minority equity interest) does not demand a control test for the purposes of assessing if a filing is required for a given transaction.
CADE acknowledges the transaction, which involved the acquisition of minority equity interest (less than 20%) by an investment fund that competes or has related activities with the target.
(Source: CADE website, accessed in May 2014.)
Part of the market argues that the rules applying to investment funds, particularly those related to the economic group concept and turnover threshold, are very restrictive, flooding the authorities with numerous filings that would not require, in theory, CADE’s review as they don’t have any potential to raise antitrust concerns. According to these critics, besides the cost burden this places on private equity firms, CADE’s staff could be focusing on other relevant matters.
CADE, however, stands by its regulations, arguing that the Antitrust Law revised the filing thresholds, not only increasing the amounts involved, but also requiring a minimum turnover threshold to the second group involved, thus reducing the number of filings subjected to its review, in comparison to the revoked regime. Moreover, the efficiency of CADE in this first two years of the new antitrust regime seems to have eliminated any concern the market had with respect to the possibility of the prior approval affecting the closing of simple transactions, indeed, some fast-track cases have been approved in less than 20 days.
CADE may have already identified concerns in at least two sectors. Indeed, following the analysis of numerous filings affecting the educational and health sectors in Brazil in the past year, CADE realised that private equity groups may be behind such acquisitions, consolidating the markets through sophisticated corporate structures, difficult to be identified.
This may be a signal that CADE is heading in the right direction, and that it is better to keep a restrictive approach as part of an antitrust policy, since it must preserve consumer welfare. The precise answer, though, in terms of the effectiveness of this policy, is still pending and will demand time, patience and scrutiny. In addition and partially in line with the market understanding, as referred, CADE has recently put under public consultation proceeding a proposal to amend the applicable rules to investment funds, which are currently awaiting CADE’s comments. Such rules, once implemented, will change the way CADE assess the economic group of investment funds, streamlining the antitrust review.
Controversies aside, the message is to reinforce that Brazil is indeed a safe country for investments and that, in the event a private equity transaction may demand an antitrust approval, CADE is committed to review it in as short a time as possible and eliminate any possible concern since its beginning.
- www.investopedia.com/terms/p/privateequity.asp, accessed May 2013.
- When the bill to reform the revoked Antitrust Law was under discussion by the Brazilian Congress, it included a proposed disposition excluding certain transactions from obligatory approval by CADE, namely: ‘transactions and exchanges of shares, quotas or other securities, by parties themselves or through third parties, of a temporary nature, or equity shares acquired for purposes of resale, provided that the acquirers:
do not hold the power to determine, directly or indirectly, or the capacity to influence the competitive behavior of the acquired company; or
only exercise the right to vote with the exclusive objective of preparing for disposal, in whole or in part, of their assets or these equity stakes, a disposal that must occur within the regulatory time
limit.’If this disposition was to be approved by the Brazilian Congress, the situations listed above that
would not be considered merger filings would have had a direct impact on the deals entered into by
private equity funds. The final text, though, excluded the mentioned disposition.
- In accordance with the Ordinance MJ/MF issued on 30 May 2012.
- This number may vary, since certain corporate structures that may involve private equity firms are protected by CADE confidentiality rules.