CVM Explanatory Note 20/80

CVM EXPLANATORY NOTE NO. 20/80.

CVM INSTRUCTION NO. 14, of October 17, 1980, which defines stock exchange operations involving call and put options on shares and establishes the requirements for their execution.

The current stage of development of the Brazilian stock market has demanded the emergence of mechanisms capable of attracting new participants and providing other investment alternatives. Among these mechanisms are options trading, whose basic economic function is to allow investors to allocate risks associated with share ownership more efficiently, thereby contributing to greater liquidity in the securities market.

The options market allows, through the combination of various positions, conditions for transferring risks, as a way to adjust the needs of a particular investor, thereby providing, alongside great flexibility, greater security to those less inclined to take risks.

Indeed, some investors who would not be attracted to invest in the stock market, given the risks involved, might agree to participate through options purchase operations, since these would represent the application of a small part of their assets, much smaller than that allocated in the case of a direct purchase.

On the other hand, investors who hold large positions in shares may be encouraged to remain in the market, even in its less favorable phases, if they have the possibility of using the options instrument to transfer the risks associated with this retention.

The practice of options trading in the Brazilian securities market constitutes a requirement of this same market, having even preceded the issuance of formal regulations by the CVM.

Its development, however, has demanded the creation of operational alternatives, in order to diversify the possible investment strategies, using this mechanism.

Thus, the regulation of these operations is imposed as a way to meet the requests of an increasingly sophisticated market, within the objective of promoting its self-sustained and orderly development.

By defining stock exchange options operations and establishing the requirements for their execution, the CVM was concerned with some points considered fundamental, aiming at the orderly development of the securities market, and the preservation of its reliability and regularity as a whole, leaving to the self-regulatory bodies the responsibility for the effective implementation of the relevant norms and regulations.

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Indeed, the self-regulatory entity, due to its proximity to the market and better knowledge of its activities, has greater sensitivity to evaluate and regulate them, being able to take more sensitive, agile, and effective action.

According to these assumptions, CVM INSTRUCTION NO. 014/80, now presented, defines general and didactic rules, with stock exchanges responsible for detailing the norms and regulations to be observed in options trading in their trading floors, which must, however, be submitted previously to the CVM for approval.

Additionally, it should be noted that the administration of the options market is the responsibility of the stock exchanges, and any changes to the acts and regulations initially established by the exchanges must be justified subsequently to the CVM, which will monitor the exercise of this self-regulatory power.

Thus, according to the principles of self-regulation, INSTRUCTION NO. 014/80 delegates to stock exchanges the fixing and administration of adequate guarantees to ensure the use of the options instrument only by those who have sufficient assets to assume the risks involved.

Note that, unlike other similar operations existing in the market, the risk of not honoring assumed commitments affects only the option writer. This is because, to the holder of an option, it belongs the right to exercise it or not, whereas the writer, regardless of their will, may be obliged to deliver or purchase, at any time, during the validity period of the option, the underlying shares corresponding to it, as it refers, respectively, to a call or put option on shares. Thus, given that, between the moment an option is written and its exercise by the holder, the prices in the spot market for the underlying shares may undergo significant variations, which could lead the writer to be uncovered if they do not want or cannot satisfy the assumed commitments, when such variations cause them great losses, it is necessary that they deposit guarantees for their operation.

It is also important to clarify that the levels of guarantees have the purpose of controlling the degree of leverage of the market or a specific security, allowing the necessary adjustments for the regular functioning of this market. Such a measure will, likewise, be the responsibility of the stock exchanges, with the regulatory body exercising residual competence.

As previously cited, the maintenance of the efficiency and reliability of the securities market is a fundamental condition to ensure its development.

Within this line, the present Instruction defines some requirements to be observed by stock exchanges and brokerage firms, considered indispensable to achieving this objective, such as:
a) the indication by the brokerage firm of an administrator, of high hierarchical level (director, managing partner, or owner of an individual company), to directly supervise the compliance with all norms and

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procedures related to options, as well as to facilitate the relationship between the intermediary and the market.

Mandatory training for professionals participating in this market, mainly for those who may come to recommend options transactions to clients, including, furthermore, the obligation to assess, through examination, the individual performance of each participant.

The adoption of a standard contract to be signed between the brokerage firm and its client, at the time of opening the current account for options operations, and a document, with detailed information on the objectives and risks of options transactions, to be delivered, obligatorily, to the client upon signing said contract.

The establishment in stock exchanges of a regulation and evaluation committee for the options market, which aims to improve, monitor, and enforce the norms regarding this market. The creation of this committee provides the opportunity for people not members of the stock exchange boards of directors to also collaborate in the improvement of stock exchange activities, by providing subsidies originating from studies or specific works.

Thus, the objectives of INSTRUCTION NO. 014/80, outlined in this Explanatory Note, are coherent with the basic philosophy of securities market regulation, in which the goal is to ensure the requirements of safety, reliability, and efficiency indispensable to its development, and, in particular, to establish greater responsibility of the community in the elaboration and compliance with the norms that regulate the options market, avoiding the need for regulatory body intervention.

Originally signed by
JORGE HILÁRIO GOUVÊA VIEIRA
President