UNITED STATES
SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549

 

FORM 20-F

(Mark One)

 

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

OR

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2019

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from                           to                           .

 

OR

 

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Date of event requiring this shell company report                                  

 

Commission file number: 001-39155

 

XP Inc.
(Exact name of Registrant as specified in its charter)

 

Not applicable 

(Translation of Registrant’s name into English)

 

Cayman Islands
(Jurisdiction of incorporation or organization)

 

Av. Chedid Jafet, 75, Torre Sul, 30th floor,
Vila Olímpia – São Paulo
Brazil 04551-065

+55 (11) 3075-0429
(Address of principal executive offices)

 

Bruno Constantino Alexandre dos Santos, Chief Financial Officer 

Tel: +55 (11) 3075-0429 

Av. Chedid Jafet, 75, Torre Sul, 30th floor,

Vila Olímpia – São Paulo

Brazil 04551-065 

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

Copies to:

 

Manuel Garciadiaz

Byron B. Rooney

Davis Polk & Wardwell LLP

450 Lexington Avenue

New York, NY 10017

Phone: (212) 450-4000

Fax: (212) 450-6858

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of each class 

Trading Symbol 

Name of each exchange on which registered 

Class A common shares, par value US$0.00001 per share XP The NASDAQ Global Select Market  

 

 

 

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

None

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

The number of outstanding shares as of December 31, 2019 was 354,181,346 Class A common shares and 197,618,980 Class B common shares.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes          No

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

Yes          No

 

Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes          No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

 

Yes           No (not required)

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer Accelerated Filer Non-accelerated Filer Emerging growth company

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.

 

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this annual report:

 

     U.S. GAAP

 

     International Financial Reporting Standards as issued by the International Accounting Standards Board

 

     Other

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

 

Item 17           Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes           No

 

 

 

Table of Contents  

XP INC.

 

TABLE OF CONTENTS

 

 

Page

 

PART I 6
ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 6
A.   Directors and senior management 6
B.   Advisers 6
C.   Auditors 6
ITEM 2.  OFFER STATISTICS AND EXPECTED TIMETABLE 6
A.   Offer statistics 6
B.   Method and expected timetable 6
ITEM 3.  KEY INFORMATION 6
A.   Selected financial data 6
B.   Capitalization and indebtedness 11
C.   Reasons for the offer and use of proceeds 11
D.   Risk factors 11
ITEM 4.  INFORMATION ON THE COMPANY 44
A.   History and development of the company 44
B.   Business overview 48
C.   Organizational structure 100
D.   Property, plants and equipment 101
ITEM 4A.  UNRESOLVED STAFF COMMENTS 102
ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS 102
A.   Operating results 102
B.   Liquidity and capital resources 122
C.   Research and development, patents and licenses, etc. 125
D.   Trend information 125
E.   Off-balance sheet arrangements 125
F.   Tabular disclosure of contractual obligations 126
G.   Safe harbor 126
ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 126
A.   Directors and senior management 126
B.   Compensation 136
C.   Board practices 136
D.   Employees 138
E.   Share ownership 139
ITEM 7.  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 139
A.   Major shareholders 139
B.   Related party transactions 143
C.   Interests of experts and counsel 144
ITEM 8.  FINANCIAL INFORMATION 144
A.   Consolidated statements and other financial information 144
B.   Significant changes 147
ITEM 9.  THE OFFER AND LISTING 147
A.   Offering and listing details 147
B.   Plan of distribution 147
C.   Markets 147
D.   Selling shareholders 147
E.   Dilution 147
F.   Expenses of the issue 147
ITEM 10.  ADDITIONAL INFORMATION 147
A.   Share capital 147
B.   Memorandum and articles of association 147
C.   Material contracts 157
D.   Exchange controls 157
E.   Taxation 157

 

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F.   Dividends and paying agents 161
G.   Statement by experts 161
H.   Documents on display 161
I.   Subsidiary information 162
ITEM 11.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 162
ITEM 12.  DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 165
A.   Debt securities 165
B.   Warrants and rights 165
C.   Other securities 165
D.   American Depositary Shares 165
PART II 166
ITEM 13.  DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 166
A.   Defaults 166
B.   Arrears and delinquencies 166
ITEM 14.  MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 166
A.   Material modifications to instruments 166
B.   Material modifications to rights 166
C.   Withdrawal or substitution of assets 166
D.   Change in trustees or paying agents 166
E.   Use of proceeds 166
ITEM 15.  CONTROLS AND PROCEDURES 166
A.   Disclosure controls and procedures 166
B.   Management’s annual report on internal control over financial reporting 167
C.   Attestation report of the registered public accounting firm 167
D.   Changes in internal control over financial reporting 167
ITEM 16.  [RESERVED] 167
ITEM 16A.  Audit committee financial expert 167
ITEM 16B.  Code of ethics 168
ITEM 16C.  Principal accountant fees and services 168
ITEM 16D.  Exemptions from the listing standards for audit committees 169
ITEM 16E.  Purchases of equity securities by the issuer and affiliated purchasers 169
ITEM 16F.  Change in registrant’s certifying accountant 169
ITEM 16G.  Corporate governance 169
ITEM 16H.  Mine safety disclosure 175
PART III 176
ITEM 17.  FINANCIAL STATEMENTS 176
ITEM 18.  FINANCIAL STATEMENTS 176
ITEM 19.  EXHIBITS 176

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PRESENTATION OF FINANCIAL AND OTHER INFORMATION

 

All references to “U.S. dollars,” “dollars” or “$” are to the U.S. dollar. All references to “real,” “reais,” “Brazilian real ,” “Brazilian reais ,” or “R$” are to the Brazilian real , the official currency of Brazil. All references to “IFRS” are to International Financial Reporting Standards, as issued by the International Accounting Standards Board, or the IASB.

 

Financial Statements

 

XP was incorporated on August 29, 2019, as a Cayman Islands exempted company with limited liability duly registered with the Cayman Islands Registrar of Companies. Until the contribution of XP Brazil shares to it prior to the consummation of our initial public offering of Class A common shares completed on December 13, 2019 (the “initial public offering”), XP had not commenced operations and had only nominal assets and liabilities and no material contingent liabilities or commitments.

 

We maintain our books and records in Brazilian reais , the presentation currency for our financial statements and also the functional currency of our operations in Brazil. Our annual consolidated financial statements were prepared in accordance with IFRS, as issued by the IASB. Unless otherwise noted, our statement of financial position information presented herein as of December 31, 2019 and 2018 and the statements of income for the years ended December 31, 2019, 2018 and 2017 is stated in Brazilian reais , its reporting currency. Our consolidated financial information contained in this annual report is derived from our audited consolidated financial statements as of December 31, 2019 and 2018 and statements of income for the years ended December 31, 2019, 2018 and 2017, together with the notes thereto.

 

This financial information should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements, including the notes thereto, included elsewhere in this annual report.

 

Our fiscal year ends on December 31. References in this annual report to a fiscal year, such as “fiscal year 2019,” relate to our fiscal year ended on December 31 of that calendar year.

 

Our historical financial statements included elsewhere in this annual report reflect the Share Split conducted following the Share Contribution and prior to the consummation of our initial public offering.

 

Corporate Events

 

Our Incorporation

 

We are a Cayman Islands exempted company incorporated with limited liability on August 29, 2019 for purposes of effectuating our initial public offering. At the time of our incorporation, XP Controle, Itaú, GA Bermuda and DYNA III held 2,036,988,542 shares (prior to giving effect to the Share Split, as defined herein) of XP Brazil, which are all of the shares of XP Brazil. All references to “XP Brazil” refer to XP Investimentos S.A., our Brazilian principal non-operating holding company whose consolidated financial statements are included elsewhere in this annual report.

 

Itaú Transaction and 2022 Acquisition

 

In connection with the Itaú Transaction entered into on May 11, 2017, Itaú Unibanco shall purchase in 2022, subject to certain conditions precedent (including regulatory approval from the Central Bank), the equivalent of 12.5% of XP’s total outstanding capital stock (pre-public offering), which stock is currently held by XP Controle, GA Bermuda and DYNA III, for a certain and adjusted price previously agreed in the relevant share purchase agreement relating to the Itaú Transaction.

 

Our Corporate Reorganization

 

On November 29, 2019, XP Controle, Itaú, GA Bermuda and DYNA III contributed all of their shares in XP Brazil to us. In return for this contribution, we issued new Class B common shares to XP Controle, new Class A common shares and Class B common shares to Itaú, new Class A common shares and Class B common shares to

 

 

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GA Bermuda and new Class A common shares to DYNA III in a one-to-one exchange for the shares of XP Brazil contributed to us. In addition and following the Share Contribution, we implemented a four-to-one reverse share split (or consolidation), effective as of November 30, 2019, which we refer to herein as the Share Split.

 

As of the date of this annual report, we had a total of 551,800,326 common shares issued and outstanding, 197,618,980 of these shares were Class B common shares beneficially owned by XP Controle, GA Bermuda and Itaú and 354,181,346 of these shares were Class A common shares beneficially owned by Itaú, GA Bermuda and DYNA III and by other investors.

 

The following chart shows our corporate structure as of the date hereof:

 

 

 

Please read the information in the section entitled “Business—Our Corporate Structure” for a more thorough description of the operations of our material operating subsidiaries.

 

Financial Information in U.S. Dollars

 

Solely for the convenience of the reader, we have translated some of the real amounts included in this annual report from Reais into U.S. dollars. You should not construe these translations as representations by us that the amounts actually represent these U.S. dollar amounts or could be converted into U.S. dollars at the rates indicated. Unless otherwise indicated, we have translated real amounts into U.S. dollars using a rate of R$4.0307 to US$1.00, the commercial purchase rate for U.S. dollars at December 31, 2019 as reported by the Central Bank.

 

Special Note Regarding Non-GAAP Financial Measures

 

This annual report presents our Floating Balance, Adjusted Gross Financial Assets, Adjusted EBITDA and Adjusted Net Income information for the convenience of the investors.

 

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We present Floating Balance because we believe this measure helps to understand the effect on our balance sheet from uninvested cash balances from retail clients’ investment accounts at XP companies. We calculate Floating Balance as the sum of securities trading and intermediation (liabilities), minus securities trading and intermediation (assets). It is a metric that our management tracks internally and that investors and analysts typically want to calculate. Unlike the portions of Retail AUC invested by clients in equities, fixed income, mutual funds and almost all our other asset classes, Floating Balance is accounted for on our balance sheet, resulting in a net increase in our liabilities, and is a source of funds that we allocate to securities and financial instruments, which generates interest revenues for us. Given the size of our current AUC and the pace of our growths, Floating Balance, despite being historically only in the range of 1% to 2% of total AUC, is material and therefore helps explain the variation of the assets and liabilities in our balance sheet.

 

We present Adjusted Gross Financial Assets because we believe this metric captures the liquidity that is in fact available to us, net of the portion of liquidity that is related to our Floating Balance (and therefore attributable to clients). We calculate Adjusted Gross Financial Assets as the sum of (1) Cash and Financial Assets (comprised of Cash plus Securities – Fair value through profit or loss, plus Securities – Fair value through other comprehensive income, plus Securities – Evaluated at amortized cost, plus Derivative financial instruments, plus Securities purchased under agreements to resell), less (2) Financial Liabilities (comprised of the sum of Securities loaned, Derivative financial instruments, Securities sold under repurchase agreements and Private pension liabilities), and (3) less Floating Balance. It is a measure that we track internally on a daily basis, and it more intuitively reflects the effect of the operational profits we generate and the variations between working capital assets and liabilities (cash flows from operating activities), investments in fixed and intangible assets (cash flows from investing activities) and inflows and outflows related to equity and debt securities in our capital structure (cash flows from financing activities). Our management treats all securities and financial instrument assets, net of financial instrument liabilities, as balances that compose our total liquidity, with sub line items (such as, for example, “securities at fair value through profit and loss” and “securities at fair value through other comprehensive income”) expected to fluctuate substantially from quarter to quarter as our treasury manages and allocates our total liquidity to the most suitable financial instruments.

 

We present Adjusted EBITDA because we believe this measure can provide useful information to investors and analysts regarding the operational results of the business, EBITDA being a fairly common metric that market participants are familiar with, in particular when understanding and analyzing service companies. Despite having two subsidiaries that are financial institutions in Brazil, we believe our business is primarily an asset light services and fees business. Accordingly, we track internally Adjusted EBITDA as a measure of profits before the impact of income taxes, net of non-cash charges of depreciation and amortization, and before the impact of our capital structure (which comprises interest expenses from debt and interest revenues from cash and liquidity available), since we believe the latter is ultimately a corporate finance choice of the equity holders and unrelated to the capacity of the business to generate operational results. We calculate Adjusted EBITDA as net income, plus income tax, plus depreciation and amortization, plus interest expense on debt, minus interest revenue on Adjusted Gross Financial Assets.

 

We present Adjusted Net Income because we believe this measure can provide useful information to investors and analysts regarding the net results of the business, excluding one-time revenues or expenses related to transactions or events that are not reflective of our core operating performance. We calculate Adjusted Net Income as net income, plus Itaú Transaction and deal related expenses, plus IPO process related expenses, plus our Share Based Plan expenses, minus one-time tax claim recognition (2010-2017) plus/minus taxes.

 

The non-GAAP financial measures described in this annual report are not a substitute for the IFRS measures of earnings. Additionally, our calculation of Adjusted EBITDA and Adjusted Net Income may be different from the calculation used by other companies, including our competitors in the financial services industry, and therefore, our measures may not be comparable to those of other companies. Adjusted EBITDA does not reflect historical cash expenditures or future requirements for capital expenditures or contractual commitments.

 

Market Share and Other Information

 

This annual report contains data related to economic conditions in the market in which we operate. The information contained in this annual report concerning economic conditions is based on publicly available information from third-party sources that we believe to be reasonable. Market data and certain industry forecast data used in this annual report were obtained from internal reports and studies, where appropriate, as well as estimates,

 

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market research, publicly available information (including information available from the United States Securities and Exchange Commission website) and industry publications. We obtained the information included in this annual report relating to the industry in which we operate, as well as the estimates concerning market shares, through internal research, a report dated September 2019 by management consulting company Oliver Wyman commissioned by us, public information and publications on the industry prepared by official public sources, such as the Brazilian Central Bank, the Brazilian Institute of Geography and Statistics ( Instituto Brasileiro de Geografia e Estatística ), or the IBGE, the Institute of Applied Economic Research ( Instituto de Pesquisa Econômica Aplicada ), or the IPEA, as well as private sources, such as B3, ANBIMA, Nielsen, consulting and research companies in the Brazilian financial services industry, the Brazilian Economic Institute of Fundação Getulio Vargas ( Instituto Brasileiro de Economia da Fundação Getulio Vargas ), or FGV/IBRE, among others.

 

Industry publications generally state that the information they include has been obtained from sources believed to be reliable, but that the accuracy and completeness of such information is not guaranteed. Although we have no reason to believe any of this information or these reports are inaccurate in any material respect and believe and act as if they are reliable, neither we, the selling shareholders, the underwriters, nor their respective agents have independently verified it. Governmental publications and other market sources, including those referred to above, generally state that their information was obtained from recognized and reliable sources, but the accuracy and completeness of that information is not guaranteed. In addition, the data that we compile internally and our estimates have not been verified by an independent source. Except as disclosed in this annual report, none of the publications, reports or other published industry sources referred to in this annual report were commissioned by us or prepared at our request. Except as disclosed in this annual report, we have not sought or obtained the consent of any of these sources to include such market data in this annual report.

 

Calculation of Net Promoter Score

 

Net Promoter Score, or NPS, is a widely known survey methodology that measures the willingness of customers to recommend a company’s products and services. It is used to gauge customers’ overall satisfaction with a company’s products and services and their loyalty to the brand, and it is typically based on customer surveys. NPS measures satisfaction using a scale of zero to 10 based on a customer’s response to the following question: “How likely is it that you would recommend XP to a friend or colleague?” Responses of nine or ten are considered “Promoters.” Responses of seven or eight are considered neutral. Responses of six or less are considered “Detractors.” The NPS, a percentage expressed as a numerical value, is calculated by subtracting the percentage of respondents who are Detractors from the percentage who are Promoters and dividing that number by the total number of respondents, which means that the higher the number, the higher the measure of customer satisfaction. The NPS calculation gives no weight to customers who decline to answer the survey question. The NPS calculation as of a given date reflects the average of the answers in the previous 6 months, e.g. the NPS as of December 2018 reflects the average of answers from July 2018 to December 2018. Our NPS score as calculated by us as of December 2017, December 2018 and December 2019 was 58, 64 and 73, respectively.

 

Rounding

 

We have made rounding adjustments to some of the figures included in this annual report. Accordingly, numerical figures shown as totals in some tables may not be an arithmetic aggregation of the figures that preceded them.

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This annual report on Form 20-F contains statements that constitute forward-looking statements. Many of the forward-looking statements contained in this annual report can be identified by the use of forward-looking words such as “anticipate,” “believe,” “could,” “expect,” “should,” “plan,” “intend,” “estimate” and “potential,” among others.

 

Forward-looking statements appear in a number of places in this annual report and include, but are not limited to, statements regarding our intent, belief or current expectations. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. Such statements are subject to risks and uncertainties, and actual results may differ materially from those expressed or implied in the forward-looking statements due to of various factors, including, but not limited to, those identified under the section entitled “Risk Factors” in this annual report. These risks and uncertainties include factors relating to:

 

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· general economic, financial, political, demographic and business conditions in Brazil, as well as any other countries we may serve in the future and their impact on our business;

 

· fluctuations in interest, inflation and exchange rates in Brazil and any other countries we may serve in the future;

 

· competition in the financial services industry;

 

· our ability to implement our business strategy;

 

· our ability to adapt to the rapid pace of technological changes in the financial services industry;

 

· the reliability, performance, functionality and quality of our products and services and the investment performance of investment funds managed by third parties or by our asset managers;

 

· the availability of government authorizations on terms and conditions and within periods acceptable to us;

 

· our ability to continue attracting and retaining new appropriately-skilled employees;

 

· our capitalization and level of indebtedness;

 

· the interests of our controlling shareholders;

 

· changes in government regulations applicable to the financial services industry in Brazil and elsewhere;

 

· our ability to compete and conduct our business in the future;

 

· the success of operating initiatives, including advertising and promotional efforts and new product, service and concept development by us and our competitors;

 

· changes in consumer demands regarding financial products, customer experience related to investments and technological advances, and our ability to innovate to respond to such changes;

 

· changes in labor, distribution and other operating costs;

 

· our compliance with, and changes to, government laws, regulations and tax matters that currently apply to us;

 

· other factors that may affect our financial condition, liquidity and results of operations; and

 

· other risk factors discussed under “Risk Factors.”

 

Forward-looking statements speak only as of the date they are made, and we do not undertake any obligation to update them in light of new information or future developments or to release publicly any revisions to these statements in order to reflect later events or circumstances or to reflect the occurrence of unanticipated events.

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

A. Directors and senior management

 

Not applicable.

 

B. Advisers

 

Not applicable.

 

C. Auditors

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

A. Offer statistics

 

Not applicable.

 

B. Method and expected timetable

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A. Selected financial data

 

The following tables set forth, for the years and as of the dates indicated, our summary financial and operating data. This information should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements, including the notes thereto, included elsewhere in this annual report.

 

The summary statements of financial position as of December 31, 2019 and 2018 and the statements of income for the years ended December 31, 2019, 2018, 2017 and 2016 have been prepared in accordance with IFRS, as issued by the IASB. Share and per share data in the table below has been retroactively adjusted to give effect to reverse share split.

 

Income Statement Data

 

    For the Year Ended
December 31,
    2019   2019   2018   2017   2016
    (US$)(1)   (R$)
    (in millions, except earnings per share)
Gross revenue and income(2)     1,369       5,518       3,216       2,065       1,347  
Sales tax(3)     (97 )     (390 )     (258 )     (158 )     (95 )
Total revenue and income     1,272       5,128       2,958       1,907       1,252  
Operating costs and expenses                                        
Operating costs     (398 )     (1,606 )     (941 )     (580 )     (376 )
Selling expenses     (38 )     (155 )     (96 )     (33 )     (24 )
Administrative expenses     (469 )     (1,891 )     (1,177 )     (650 )     (471 )
Other operating expenses, net     38       153       (31 )     (8 )     (6 )
Interest expense on debt     (21 )     (84 )     (72 )     (61 )      
Income before income tax     383       1,544       641       576       374  
Income tax expense     (113 )     (455 )     (175 )     (152 )     (130 )
Net income for the year     270       1,089       465       424       244  
Net income attributable to:                                        
Owners of the Parent company     268       1,080       461       414       189  
Non-controlling interest     2       9       4       10       55  
Basic earnings per shares – R$(4)     0.5241       2.1125       0.9358       0.8535       0.5440  
Diluted earnings per shares – R$(4)     0.5238       2.1115       0.9358       0.8535       0.5440  

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(1) For convenience purposes only, amounts in reais for the year ended December 31, 2019 and 2018 have been translated to U.S. dollars using an exchange rate of R$4.0307 to US$1.00, the commercial purchase rate for U.S. dollars as of December 31, 2019 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate.

 

(2) The sum of (i) Revenues from services rendered; and (ii) Income from financial instruments, in each case gross of taxes and contributions on revenue.

 

(3) The sum of (i) Sales taxes and contributions on revenue; and (ii) Taxes and contributions on financial income.

 

(4) The basic and diluted earnings per share have been retroactively adjusted to give effect to reverse share split which occurred on November 30, 2019.

 

Balance Sheet Data

 

    As of December 31,
    2019   2019   2018
    (US$)(1)   (R$)
    (in millions)
Assets    
Cash     27       110       68  
Securities purchased under agreements to resell     2,354       9,490       6,571  
Securities trading and intermediation     125       505       898  
Other securities and derivative financial instruments(2)     7,793       31,411       8,834  
Property and equipment     35       142       99  
Intangible assets     137       553       505  
Other assets(3)     350       1,410       749  
Total assets     10,823       43,623       17,724  
Liabilities                        
Securities sold under repurchase agreements     3,880       15,638       6,641  
Securities trading and intermediation     2,261       9,115       5,307  
Securities loaned and derivative financial instruments(4)     1,303       5,251       2,251  
Borrowings, lease liabilities, and debentures(5)     365       1,472       876  
Private pension liabilities     933       3,759       16  
Other liabilities(6)     305       1,231       542  
Total liabilities     9,047       36,467       15,633  
Total equity     1,775       7,156       2,092  
Total liabilities and equity     10,823       43,623       17,724  

 

(1) For convenience purposes only, amounts in reais for the year ended December 31, 2019 have been translated to U.S. dollars using an exchange rate of R$4.0307 to US$1.00, the commercial purchase rate for U.S. dollars as of December 31, 2019 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

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(2) The sum of (i) Fair value through profit or loss – Securities; (ii) Fair value through profit or loss – Derivative financial instruments; (iii) Fair value through other comprehensive income – Securities; and (iv) Evaluated at amortized cost – Securities.

 

(3) The sum of (i) Evaluated at amortized cost – Accounts receivable; (ii) Evaluated at amortized cost – Other financial assets; (iii) Other assets; and (iv) Deferred tax expenses.

 

(4) The sum of (i) Securities loaned; and (ii) Derivative financial instruments.

 

(5) The sum of (i) Borrowings; (ii) Lease liabilities; and (iii) Debentures.

 

(6) The sum of (i) Accounts payable; (ii) Other financial liabilities; (iii) Social and statutory obligations; (iv) Taxes and social security obligations; (v) Provisions and contingent liabilities; (vi) Other liabilities; and (vii) Deferred tax liabilities.

 

Non-GAAP Financial Measures

 

This annual report presents our Floating Balance, Adjusted Gross Financial Assets, Adjusted EBITDA and Adjusted Net Income and their respective reconciliations for the convenience of investors, which are non-GAAP financial measures. A non-GAAP financial measure is generally defined as a numerical measure of historical or future financial performance, financial position, or cash flow that purports to measure financial performance but excludes or includes amounts that would not be so adjusted in the most comparable GAAP measure. For further information on why our management chooses to use these non-GAAP financial measures, and on the limits of using these non-GAAP financial measures, please see “Presentation of Financial and Other Information—Special Note Regarding Non-GAAP Financial Measures.”

 

Floating Balance

 

    For the Year Ended
December 31,
    2019   2019   2018
    (US$)(1)   (R$)
    (in millions)
(+) Securities trading and intermediation (Liabilities)     2,261       9,115       5,307  
(-) Securities trading and intermediation (Assets)     (125 )     (505 )     (898 )
Floating Balance     2,136       8,610       4,408  

 

(1) For convenience purposes only, amounts in reais for the year ended December 31, 2019 have been translated to U.S. dollars using an exchange rate of R$4.0307 to US$1.00, the commercial purchase rate for U.S. dollars as of December 31, 2019 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

Adjusted Gross Financial Assets

 

    For the Year Ended
December 31,
    2019   2019   2018
    (US$)(1)   (R$)
    (in millions)
Cash and Financial Assets                        
(+) Cash     27       110       68  
(+) Securities – Fair value through profit or loss     5,568       22,443       6,291  
(+) Securities – Fair value through other comprehensive
income
    649       2,616       696  
(+) Securities – Evaluated at amortized cost     562       2,267       155  
(+) Derivative financial instruments (Assets)     1,013       4,085       1,692  
(+) Securities purchased under agreements to resell     2,354       9,490       6,571  
Financial Liabilities                        
(-) Securities loaned     (502 )     (2,022 )     (1,260 )
(-) Derivative financial instruments (Liabilities)     (801 )     (3,229 )     (991 )
(-) Securities sold under repurchase agreements     (3,880 )     (15,638 )     (6,641 )
(-) Private pension liabilities(2)     (933 )     (3,759 )     (16 )
Subtotal     4,060       16,363       6,565  
(-) Floating Balance     (2,136 )     (8,610 )     (4,408 )
Adjusted Gross Financial Assets     1,924       7,753       2,157  

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(1) For convenience purposes only, amounts in reais for the year ended December 31, 2019 have been translated to U.S. dollars using an exchange rate of R$4.0307 to US$1.00, the commercial purchase rate for U.S. dollars as of December 31, 2019 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

(2) Relates to balances of retail clients invested in pension funds through XP VP. Those balances are identified in the financial statements as “Securities—Fair value through profit or loss,” with a corresponding balance in “Private Pension Liabilities.”

 

Adjusted EBITDA

 

    For the Year Ended
December 31,
    2019   2019   2018   2017
    (US$)(1)   (R$)
    (in millions)
Net Income     270       1,089       465       424  
(+) Income Tax     113       455       175       152  
(+) Depreciation and Amortization     23       91       53       27  
(+) Interest Expense on Debt     21       84       72       61  
(-) Interest Revenue on Adjusted Gross Financial Assets(2)     (37 )     (150 )     (104 )     (99 )
Adjusted EBITDA     390       1,569       662       565  

 

(1) For convenience purposes only, amounts in reais for the year ended December 31, 2019 have been translated to U.S. dollars using an exchange rate of R$4.0307 to US$1.00, the commercial purchase rate for U.S. dollars as of December 31, 2019 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “Item 3. Key Information—A. Selected financial data—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

(2) Calculated as the average interest rate over the period (the CDI rate), multiplied by the average Adjusted Gross Financial Assets. The historical annual CDI rates are set forth in the table in “Item 5. Operating and Financial Review and Prospects—A. Operating results—Brazilian Macroeconomic Environment.” However, the calculation of this adjustment is performed on a daily basis.

 

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Adjusted Net Income

 

    For the Year Ended
December 31,
    2019   2019   2018   2017
    (US$)(1)   (R$)
    (in millions)
Net Income     270       1,089       465       424  
(+) Itaú Transaction and deal related expenses(2)                 39       6  
(+) Share-Based Plan     2       8              
(+) IPO expenses(3)     5       22              
(-) One-time tax claim recognition (2010-2017)(4)     (18 )     (71 )            
(-/+) Taxes     6       25       (13 )     (2 )
Adjusted Net Income     266       1,074       491       428  

 

(1) For convenience purposes only, amounts in reais for the year ended December 31, 2019 have been translated to U.S. dollars using an exchange rate of R$4.0307 to US$1.00, the commercial purchase rate for U.S. dollars as of December 31, 2019 as reported by the Central Bank. These translations should not be considered representations that any such amounts have been, could have been or could be converted at that or any other exchange rate. See “Item 3. Key Information—A. Selected financial data—Exchange Rates” for further information about recent fluctuations in exchange rates.

 

(2) Expenses of R$6 million in 2017 related to the potential IPO process that was discontinued after the Itaú Transaction, including legal, auditing, advisory and travel, among others. In 2018, expenses of R$39 million related to the payment of fees and expenses in respect of the closing of the Itaú Transaction.

 

(3) Expenses of R$22 million in 2019 related to the IPO. We incurred in a total amount of R$44 million regarding other offering expenses out of, which R$22 million was recognized directly in income statement and the amount of R$22 million in equity as transaction cost in the our consolidated financial statements, included elsewhere in this annual report.

 

(4) Income of R$71 million in 2019 related to the recognition of PIS/COFINS credits.

 

Exchange Rates

 

The Brazilian foreign exchange system allows the purchase and sale of foreign currency and the international transfer of reais by any person or legal entity, regardless of the amount, subject to certain regulatory procedures.

 

The real depreciated against the U.S. dollar from mid-2011 to early 2016. In particular, during 2015, due to the poor economic conditions in Brazil, including as a result of political instability, the real depreciated at a rate that was much higher than in previous years. Overall in 2015, the real depreciated 47.0%, reaching R$3.9048 per US$1.00 on December 31, 2015. In 2016, the real fluctuated significantly, primarily as a result of Brazil’s political instability, appreciating 16.5% to R$3.2585 per US$1.00 on December 31, 2016. In 2017, the real depreciated 1.5% against the U.S. dollar, ending the year at an exchange rate of R$3.3074 per US$1.00. In 2018, the real depreciated 17.1% against the U.S. dollar, ending the year at an exchange rate of R$3.8742 per US$1.00 mainly due to the result of lower interest rates in Brazil as well as uncertainty regarding the results of the Brazilian presidential elections, which were held in October 2018. The real /U.S. dollar exchange rate reported by the Central Bank was R$4.0307 per US$1.00 on December 31, 2019, which reflected a 4.0% depreciation in the real against the U.S. dollar in 2019. There can be no assurance that the real will not depreciate or appreciate further against the U.S. dollar. The Central Bank has previously intervened in the foreign exchange market to attempt to control instability in foreign exchange rates. We cannot predict whether the Central Bank or the Brazilian government will continue to allow the real to float freely or will intervene in the exchange rate market by re-implementing a currency band system or otherwise. The real may depreciate or appreciate substantially against the U.S. dollar in the future. Furthermore, Brazilian law provides that, whenever there is a serious imbalance in Brazil’s balance of payments or there are serious reasons to foresee a serious imbalance, temporary restrictions may be imposed on remittances of foreign capital abroad. We cannot assure you that the Brazilian government will not place restrictions on remittances of foreign capital abroad in the future.

 

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The following table sets forth, for the periods indicated, the high, low, average and period-end exchange rates for the purchase of U.S. dollars expressed in Brazilian reais per U.S. dollar. The average rate is calculated by using the average of reported exchange rates by the Central Bank on each business day during a monthly period and on the last day of each month during an annual period, as applicable. As of April 28, 2020, the exchange rate for the purchase of U.S. dollars as reported by the Central Bank was R$5.5683 per US$1.00.

 

Year   Period-end   Average(1)   Low(2)   High(3)
2014     2.6556       2.3541       2.1968       2.7397  
2015     3.9042       3.3381       2.5748       4.1942  
2016     3.2585       3.4827       3.1187       4.1552  
2017     3.3074       3.1919       3.0504       3.3756  
2018     3.8742       3.6552       3.1380       4.1873  
2019     4.0307       3.9456       3.6513       4.2596  

 

Source : Central Bank.

 

(1) Represents the average of the exchange rates on the closing of each business day during the year.

 

(2) Represents the minimum of the exchange rates on the closing of each business day during the year.

 

(3) Represents the maximum of the exchange rates on the closing of each business day during the year.

 

   

Period-end 

 

Average(1) 

 

Low(2) 

 

High(3) 

October 2019     4.0035       4.0864       3.9786       4.1734  
November 2019     4.2234       4.1547       3.9780       4.2596  
December 2019     4.0307       4.1089       4.0307       4.2255  
January 2020     4.2689       4.1489       4.0207       4.2689  
February 2020     4.4987       4.3410       4.2381       4.4987  
March 2020     5.1987       4.8839       4.4883       5.1987  
April 2020 (through April 28, 2020)     5.5683       5.3142       5.0779       5.6510  

 

Source : Central Bank.

 

(1) Represents the average of the exchange rates on the closing of each business day during the month.

 

(2) Represents the minimum of the exchange rates on the closing of each business day during the month.

 

(3) Represents the maximum of the exchange rates on the closing of each business day during the month.

 

B. Capitalization and indebtedness

 

Not applicable.

 

C. Reasons for the offer and use of proceeds

 

Not applicable.

 

D. Risk factors

 

Our business, results of operations, financial condition or prospects could be adversely affected if any of these risks occurs, and as a result, the trading price of our common shares could decline. The risks described below are those known to us and those that we currently believe may materially affect us.

 

Certain Risks Relating to Our Business and Industry

 

If we cannot make the necessary investments to keep pace with rapid developments and change in our industry, the use of our services could decline, reducing our revenues.

 

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The financial services market in which we compete is subject to rapid and significant changes. This market is characterized by rapid technological change, new product and service introductions, evolving industry standards, changing client needs and the entrance of nontraditional competitors. In order to remain competitive and maintain and enhance customer experience and the quality of our services, we must continuously invest in projects to develop new products and features. These projects carry risks, such as cost overruns, delays in delivery, performance problems and lack of client adoption. There can be no assurance that we will have the funds available to maintain the levels of investment required to support our projects, and any delay in the delivery of new services or the failure to differentiate our services or to accurately predict and address market demand could render our services less desirable, or even obsolete, to our clients.

 

In addition, the services we deliver are designed to process highly complex transactions and provide reports and other information concerning those transactions, all at high volumes and processing speeds. Any failure to deliver an effective and secure service, or any performance issue that arises with a new service could result in significant processing or reporting errors or other losses. As a result of these factors, our development efforts could result in increased costs and/or we could also experience a loss in business that could reduce our earnings or could cause a loss of revenue if promised new services are not timely delivered to our clients or do not perform as anticipated. We also rely in part, and may in the future rely in part, on third parties, for the development of, and access to, new technologies. Our future success will depend in part on our ability to develop or adapt to technological changes and evolving industry standards. We cannot predict the effects of technological changes on our business. If we are unable to develop, adapt to or access technological changes or evolving industry standards on a timely and cost-effective basis, our business, financial condition and results of operations could be materially adversely affected.

 

Furthermore, our competitors may have the ability to devote more financial and operational resources than we can to the development of new technologies and services that provide improved functionality and features to their existing service offerings. If successful, their development efforts could render our services less desirable to clients, resulting in the loss of clients or a reduction in the fees we could generate from our service offerings.

 

Substantial and increasingly intense competition within our industry may harm our business.

 

The financial services market is highly competitive. Our growth will depend on a combination of the continued growth of financial services and our ability to increase our market share. Our primary competitors include traditional financial services providers such as affiliates of financial institutions and well-established financial services companies in Brazil. We also face competition from non-traditional financial services providers that have significant financial resources and develop different kinds of services.

 

Many of our competitors have substantially greater financial, technological, operational and marketing resources than we do. Accordingly, these competitors may be able to offer more attractive fees to our current and prospective clients, especially our competitors that are affiliated with financial institutions. If competition causes us to reduce the fees we charge for our services, we will need to aggressively control our costs in order to maintain our profit margins and our revenues may be adversely affected. Moreover, we may not be successful in reducing or controlling costs and our margins may be adversely affected. In particular, we may need to reduce the fees we charge in order to maintain market share, as clients may demand more customized and favorable pricing from us. In addition, we may incur increased costs from incentive payments made to IFAs in order to gain or maintain market share. We may also decide to terminate client relationships which may no longer be profitable to us due to such pricing pressure. Competition could also result in a loss of existing clients, and greater difficulty in attracting new clients. One or more of these factors could have a material adverse effect on our business, financial condition and results of operations. For further information regarding our competition, see “Item 4. Information About the Company—B. Business overview—Competition.”

 

Client attrition could cause our revenues to decline and the degradation of the quality of the products and services we offer, including support services, could adversely impact our ability to attract and retain clients and partners.

 

We experience client attrition resulting from several factors, including, among others, client business closures, transfers of accounts to our competitors and lack of client satisfaction with our platform and overall user experience, including the reliability, performance, functionality and quality of our products and services. We cannot predict the level of attrition in the future and our revenues could decline as a result of higher than expected attrition, which could have a material adverse effect on our business, financial condition and results of operations. In addition, our growth to date has been partially driven by the growth of our clients’ businesses. Should the rate of growth of our clients’ business slow or decline, this could have an adverse effect on our results of operations. Furthermore, should we not be successful in selling additional solutions to our active client base, we may fail to achieve our desired rate of growth.

 

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Moreover, our clients expect a consistent level of quality on our platform and in the provision of our products and services. The support services that we provide are also a key element of the value proposition to our clients. Also, increased market volatility may result in unexpected losses in equities, derivatives and other products which may lead to questions regarding the accuracy of our suitability procedures. If the reliability, performance or functionality of our products and services is compromised or the quality of those products or services is otherwise degraded or questioned, or if we fail to continue to provide a high level of support, we could lose existing clients and find it harder to attract new clients and partners. If we are unable to scale our support functions to address the growth of our client and partner network, the quality of our support may decrease, which could adversely affect our ability to attract and retain clients and partners.

 

Our investment services to our retail clients subject us to additional risks.

 

We provide investment services to our retail clients, including through IFAs. The risks associated with these investment services include those arising from possible conflicts of interest, unsuitable investment recommendations, inadequate due diligence on the issuer or the provider of the security, inadequate disclosure and fraud. Realization of these risks could lead to liabilities for client losses, regulatory fines, civil penalties and harm to our reputation and business.

 

We do not have long-term contractual arrangements with most of our institutional brokerage clients, and our trading volumes and revenues could be reduced if these clients stop using our platform and solutions.

 

Our business largely depends on certain of our institutional brokerage clients using our solutions and trading on our platforms. A limited number of such clients can account for a significant portion of our trading volumes, which in turn, results in a significant portion of our transaction fees. Most of our institutional brokerage clients do not have long-term contractual arrangements with us and utilize our platform and solutions on a transaction-by-transaction basis and may choose not to use our platform at any time. These institutional brokerage clients buy and sell a variety of products within various asset classes using traditional methods, including by telephone, e-mail and instant messaging, and through other trading platforms. Any significant loss of these institutional brokerage clients or a significant reduction in their use of our platform and solutions could have a substantial negative impact on our trading volumes and revenues, and materially adversely affect our business, financial condition and results of operations.

 

Our institutional brokerage business depends on our key dealer clients providing us with liquidity and supporting our marketplaces by transacting with our other institutional and wholesale clients.

 

Our institutional brokerage business relies on its key dealer clients to provide liquidity on our trading platforms by posting prices on our platform and responding to client inquiries and this business has historically earned a substantial portion of its revenues from such dealer clients. Increased market volatility and market declines can cause our key dealer clients to experience reduced liquidity or to decrease their use of our platform. Market knowledge and feedback from these dealer clients have been important factors in the development of many of our offerings and solutions. In addition, these dealer clients also provide us with data via feeds and through the transactions they execute on our trading platforms, which is an important input for our market data offerings.

 

Our dealer clients also buy and sell through traditional methods, including by telephone, e-mail and instant messaging, and through other trading platforms. Some of our dealer clients have developed electronic trading networks that compete with us or have announced their intention to explore the development of such electronic trading networks, and many of our dealer clients are involved in other ventures, including other trading platforms or other distribution channels, whether as trading participants and/or as investors. In particular, some of our dealer clients or their affiliates, as is typical for a large number of major banks, have their own single bank or other competing trading platform and frequently invest in such businesses and may acquire ownership interests in similar businesses, and such businesses may also compete with us. These competing trading platforms may offer some features that we do not currently offer or that we are unable to offer, including customized features or functions and solutions that are fully integrated with some of their other offerings. Accordingly, there can be no assurance that such dealer clients’ primary commitments will not be to one of our competitors or that they will not continue to rely on their own trading platforms or traditional methods instead of using our trading platforms.

 

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Although we have established and maintain significant long-term relationships with our key dealer clients, we cannot assure you that all of these relationships will continue or will not diminish. Any reduction in the use of our trading platforms by our key dealer clients for any reason, including increased market volatility, and any associated decrease in the pool of capital and liquidity accessible across our marketplaces, could reduce the volume of trading on our platform, which could, in turn, reduce the use of our platform by their counterparty clients. In addition, any decrease in the number of dealer clients competing for trades on our trading platforms, could cause our dealer clients to forego the use of our platform and instead use platforms that provide access to more competitive trading environments and prices. The occurrence of any of the foregoing may have a material adverse effect on our business, financial condition and results of operations.

 

A significant part of our business depends on the B3

 

The B3 is the only public stock exchange in Brazil and a significant volume of our trading activities is conducted through the B3, for which we pay the B3 clearing, custody and other financial services fees. We cannot assure you that the B3 will not impose restrictions on trading, request additional guarantees or margin requirements, increase existing fees or introduce new fees, among other measures. The occurrence of any of the foregoing may have a material adverse effect on our business, financial condition and results of operations.

 

XP CCTVM depends in part on the performance of its IFAs. If XP CCTVM is unable to hire, retain and qualify such IFAs, our business may be harmed.

 

XP CCTVM, one of our principal operating subsidiaries and securities broker, has a broad network of IFAs, and our business depends in part on such IFAs. Pursuant to CVM Instruction No. 497, IFAs may carry out the following activities on behalf of a broker dealer: (1) prospecting and acquiring customers; (2) receiving and registering orders and transmitting such orders to the appropriate trading or registration systems; and (3) providing information on the products offered and the services provided by XP CCTVM. XP CCTVM’s reliance on IFAs creates numerous risks.

 

As of December 31, 2019, XP CCTVM had approximately 6,400 individual IFAs organized into approximately 640 IFA entities, which were responsible for serving approximately 28% of XP CCTVM’s active clients. In addition, XP CCTVM’s 20 largest IFA entities comprised 1,807 individual IFAs and were responsible for serving approximately 9.3% of XP CCTVM’s active clients.

 

Pursuant to Article 15 of CVM Instruction No. 497, XP CCTVM is liable for the acts of its IFAs. As a result, XP CCTVM may be subject to claims, lawsuits, arbitration proceedings, government investigations and other legal and regulatory proceedings seeking to hold XP CCTVM liable for the actions of IFAs. We cannot give any assurances as to the outcome of any such claims, lawsuits, arbitration proceedings, government investigations or other legal or regulatory proceedings. Any claims against XP CCTVM, whether with or without merit, could be time-consuming, result in costly litigation, be harmful to its reputation and to “XP” brand, require significant management attention and divert significant resources, and the resolution of one or more such proceedings may result in substantial damages, settlement costs, sanctions, consent decrees, injunctions, fines and penalties that could adversely affect XP CCTVM’s business, financial condition and results of operations. In addition, no assurances can be given that these IFAs’ interests will continue to be aligned with the interests of XP CCTVM, that there will be no commercial disagreements between the IFAs and XP CCTVM, that such IFAs will not compete with XP CCTVM or that they will not engage in improper conduct (i.e. churning) in their role as IFAs. In Brazil, there is increased competition between financial institutions seeking to attract IFAs to increase their client base, assets under custody and business possibilities. No assurances can be given that XP CCTVM will be able to remain an attractive player to such IFAs or to retain such agents in its business platform. Furthermore, many clients have their commercial relationship directly with the IFA of their choice and trust and not with the employees of XP CCTVM. Accordingly, the loss of IFAs may result in loss of clients and assets under custody, which would affect XP CCTVM’s business.

 

Furthermore, the independent contractor status of the IFAs may be challenged in the courts of Brazil. For example, XP CCTVM has in the past been involved in, and successfully challenged, a number of legal proceedings claiming that IFAs should be treated as its employees rather than as independent contractors, and there can be no assurance that we will be successful in challenging any future claims. Changes to foreign, federal, state, and local laws governing the definition or classification of independent contractors, or judicial decisions regarding independent contractor classification, could require classification of IFAs as employees. If, as a result of legislation or judicial decisions, XP CCTVM is required to classify IFAs as employees, XP CCTVM would incur significant additional expenses for compensating IFAs, potentially retroactively to the past five years and including expenses associated with the application of wage and hour laws (including minimum wage, overtime, meal and rest period requirements), vacation, 13 th monthly salary, FGTS, severance, employee benefits, social security contributions, taxes, and penalties (including collective moral damages).

 

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Moreover, on July 1, 2019, the CVM issued Public Hearing Release SDM No. 03/19 ( Edital de Audiência Pública SDM nº 03/19 ), or SDM 3/19, which aims to initiate discussions with financial market entities and IFAs in connection with potential amendments to CVM Instruction No. 497. Such amendments could include terminating the exclusivity provision set forth in CVM Instruction No. 497, among others. Although we cannot predict the impact of such potential amendments, they could result in increased competition for clients and qualified IFAs and reduced oversight of IFAs, and allow IFAs to work with other platforms or competitors, which may adversely affect us.

 

Poor investment performance could lead to a loss of assets under management and a decline in revenues.

 

Distributing investment fund quotas managed by third parties or by our asset managers represents a relevant part of our business, which income is a percentage of the management and/or performance fee related to such funds. Moreover, a portion of our consolidated income is derived from management and performance fees collected by our three principal asset managers, XP Gestão, XP Advisory and XP Vista. Poor investment performance by the investment funds managed by third parties or by our asset managers for a number of reasons, including the overall market declines and increased volatility due to the COVID-19 pandemic, could hinder our growth and reduce our revenues because (1) existing clients might withdraw funds in favor of better performing products or fixed income products, such as government debt, which would result in lower investment advisory and other fees; (2) our ability to attract capital from existing and new clients might diminish; and (3) the negative investment performance will directly reduce our managed assets and revenues base, which may have a material adverse effect on our business, financial condition, results of operations and the price of our Class A common shares.

 

Unauthorized disclosure, destruction or modification of data, through cybersecurity breaches, computer viruses or otherwise or disruption of our services could expose us to liability, protracted and costly litigation and damage our reputation.

 

Our business involves the collection, storage, processing and transmission of customers’ personal data, including names, addresses, identification numbers, bank account numbers and trading and investment portfolios data. An increasing number of organizations, including large clients and businesses, other large technology companies, financial institutions and government institutions, have disclosed breaches of their information technology systems, some of which have involved sophisticated and highly targeted attacks, including on portions of their websites, networks or infrastructure, or those of third parties who provide services to them. We could also be subject to breaches of security by hackers. Threats may derive from human error, fraud or malice on the part of employees, third-party service providers or IFAs, or may result from accidental technological failure. Concerns about security are increased when we transmit information. Electronic transmissions can be subject to attack, interception or loss. Also, computer viruses and malware can be distributed and spread rapidly over the internet and could infiltrate our systems or those of our associated participants, which can impact the confidentiality, integrity and availability of information, and the integrity and availability of our products, services and systems, among other effects. Denial of service or other attacks could be launched against us for a variety of purposes, including interfering with our services or creating a diversion for other malicious activities. These types of actions and attacks could disrupt our delivery of products and services or make them unavailable, which could damage our reputation, force us to incur significant expenses in remediating the resulting impacts, expose us to uninsured liability, subject us to lawsuits, fines or sanctions, distract our management or increase our costs of doing business.

 

In 2013 and 2014, XP CCTVM suffered security breaches, through which an individual improperly accessed a small portion of our customer records and obtained certain non-material customer registration information, such as name, address and email, and subsequently publicly disclosed such information in January 2017. The security breaches were identified and immediately remedied, did not result in the imposition of penalties or fines from the relevant regulatory authorities, and did not materially impact us. We assisted all affected customers and mitigated their damages.

 

In the scope of our activities, we share information with third parties, including thousands of IFAs, commercial partners, third-party service providers and other agents, who collect, process, store and transmit sensitive data, and we may be held responsible for any failure or cybersecurity breaches attributed to these third parties insofar as they

 

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relate to the information we share with them. The loss, destruction or unauthorized modification of data by us or such third parties or through systems we provide could result in significant fines, sanctions and proceedings or actions against us by governmental bodies or third parties, which could have a material adverse effect on our business, financial condition and results of operations. Any such proceeding or action, and any related indemnification obligation, could damage our reputation, force us to incur significant expenses in defense of these proceedings, distract our management, increase our costs of doing business or result in the imposition of financial liability.

 

Our encryption of data and other protective measures may not prevent unauthorized access or use of sensitive data. A breach of our system or that of one of our associated participants may subject us to material losses or liability, including fines. A misuse of such data or a cybersecurity breach could harm our reputation and deter clients from using our products and services, thus reducing our revenues. In addition, any such misuse or breach could cause us to incur costs to correct the breaches or failures, expose us to uninsured liability, increase our risk of regulatory scrutiny, subject us to lawsuits, and result in the imposition of material penalties and fines under state and federal laws or regulations.

 

We cannot assure you that there are written agreements in place with every third-party or that such written agreements will prevent the unauthorized use, modification, destruction or disclosure of data or enable us to obtain reimbursement from such third-parties in the event we should suffer incidents resulting in unauthorized use, modification, destruction or disclosure of data. Any unauthorized use, modification, destruction or disclosure of data could result in protracted and costly litigation, which could have a material adverse effect on our business, financial condition and results of operations.

 

Cybersecurity incidents are increasing in frequency and evolving in nature and include, but are not limited to, installation of malicious software, unauthorized access to data and other electronic security breaches that could lead to disruptions in systems, unauthorized release of confidential or otherwise protected information and the corruption of data. Given the unpredictability of the timing, nature and scope of information technology disruptions, there can be no assurance that the procedures and controls we employ will be sufficient to prevent security breaches from occurring and we could be subject to manipulation or improper use of our systems and networks or financial losses from remedial actions, any of which could have a material adverse effect on our business, financial condition and results of operations.

 

Once Law No. 13,709/2018 ( Lei Geral de Proteção de Dados, or the LGPD) comes into force in August 2020, cybersecurity incidents and data breach or leakage events may subject us to the following penalties: (1) warnings, with the imposition of a deadline for the adoption of corrective measures; (2) a one-time fine of up to 2% of gross sales of the company or a group of companies or a maximum amount of R$50,000,000 per violation; (3) a daily fine, up to a maximum amount of R$50,000,000 per violation; (4) public disclosure of the violation; (5) the restriction of access to the personal data to which the violation relates, until corrective measures are implemented; and (6) deletion of the personal data to which the violation relates. As of the date of this annual report, a new bill pending ratification by the Brazilian house of representatives and the Brazilian president will, if passed, delay the coming into force of the LGPD to January 1, 2021.

 

Our business depends on well-regarded and widely known brands, including “XP Investimentos,” “Clear,” “Rico,” “XP Asset Management,” “Infomoney,” “XP Educação,” “XP Seguros” and “XP Investments,” and any failure to maintain, protect, and enhance our brands, including through effective marketing and communications strategies, would harm our business.

 

We have developed well-regarded and widely known brands, including “XP Investimentos,” “Clear,” “Rico,” “XP Asset Management,” “Infomoney,” “XP Educação,” “XP Seguros” and “XP Investments,” that have contributed significantly to the success of our business. Maintaining, protecting, and enhancing our brands are critical to expanding our client base, and other third-party partners, as well as increasing engagement with our products and services. This will depend largely on our ability to remain widely known, maintain trust, be a technology leader, and continue to provide high-quality and secure products and services. Any negative publicity about our industry or our company, the quality, reliability and performance of our products and services, our suitability, risk management and continuity policies and processes, changes to our products and services, our ability to effectively manage and resolve client complaints, our privacy and security practices, litigation, regulatory activity, and the experience of clients with our products or services, for example as a result of overall market declines and increased market volatility due to the COVID-19 pandemic, could adversely affect our reputation and

 

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the confidence in and use of our products and services. Harm to our brands can arise from many sources, including failure by us or our partners to satisfy expectations of service and quality, inadequate protection of personal information, compliance failures and claims, litigation and other claims, third-party trademark infringement claims, administrative proceedings at the applicable national trademark offices, employee misconduct, and misconduct by our associated participants, partners, service providers, or other counterparties. If we do not successfully maintain well-regarded and widely known brands, our business could be materially and adversely affected.

 

We have been from time to time in the past, and may in the future be, the target of incomplete, inaccurate, and misleading or false statements about our company, our business, and our products and services that could damage our brands and materially deter people from adopting our services. For example, over the past several years, certain persons or entities have fraudulently used the “XP” brand and/or presented themselves as part of or affiliated with the “XP” brand as IFAs carrying out activities on our behalf. Negative publicity about our company or our management, including about our product quality, reliability and performance, changes to our products and services, privacy and security practices, litigation, regulatory enforcement, and other actions, as well as the actions of our clients and other users of our services, even if inaccurate, could cause a loss of confidence in us.

 

In addition, we believe that promoting our brands in a cost-effective manner is critical to achieving widespread acceptance of our products and services and to expand our base of clients. Our brand promotion activities may not generate customer awareness or increase revenue, and even if they do, any increase in revenue may not offset the expenses we incur in building our brands. If we fail to successfully promote and maintain our brands or if we incur excessive expenses in this effort, our business could be materially and adversely affected.

 

The introduction and promotion of new services, as well as the promotion of existing services, may be partly dependent on our visibility on third-party advertising platforms, such as Google, Facebook or Instagram. Changes in the way these platforms operate or changes in their advertising prices or other terms could make the maintenance and promotion of our products and services and our brands more expensive or more difficult. If we are unable to market and promote our brands on third-party platforms effectively, our ability to acquire new clients would be materially harmed.

 

An increase in volume on our systems or other errors or events could cause them to malfunction.

 

Most of our trade orders to buy or sell securities or invest in the broad range of asset classes we offer are received and processed electronically. This method of trading is heavily dependent on the integrity of the electronic systems supporting it. While we have never experienced a significant failure of our trading systems, heavy stress placed on our systems during peak trading times could cause our systems to operate at unacceptably low speeds or fail altogether, such as in periods of increased market volatility. Any significant degradation or failure of our systems or the systems of third parties involved in the trading process (e.g., online and Internet service providers, the systems of the B3, record keeping and data processing functions performed by third parties, and third-party software), even for a short time, could cause customers to suffer delays in trading. In addition, systems errors, including as a result of human error, could occur. These delays or errors could cause substantial losses for customers and could subject us to claims from these customers for losses or other regulatory penalties or other sanctions or increased settlement disbursements. There can be no assurance that our network structure will operate appropriately in the event of a subsystem, component or software failure or error. Furthermore, we cannot assure you that we will be able to prevent an extended systems failure in the event of a power or telecommunications failure, an earthquake, terrorist attack, epidemics or pandemics such as COVID-19, fire or any act of God. Any systems failure that causes interruptions in our operations could have a material adverse effect on our business, financial condition and results of operations.

 

We rely on a number of external service providers for certain key market information and data, technology, processing and supporting functions.

 

We rely on a number of external service providers for certain key market information and data, technology, processing and supporting functions, such as Microsoft, SAP and Oracle, among others. These include trading platform, portfolio management and asset allocation services, account opening and management systems, communication systems, registration systems, data control systems, information security systems, anti-fraud systems, trading surveillance systems, exchanges, clearinghouses and others which are of critical importance for us in order to provide our services to our clients in a satisfactory manner. These service providers may face technical, operational and security risks of their own, including risks similar to those that we face as described herein. Any

 

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significant failures by them, including improper use or disclosure of our confidential customer, employee or company information, could interrupt our business, cause us to incur losses and harm our reputation. Particularly, we have contracted with Bloomberg, Reuters and certain other institutions to allow our clients to access real-time market information data, which are essential for our clients to make their investment decisions and take certain actions (such as making trades). Any failure of such information providers to update or deliver the data in a timely manner as provided in the agreements could lead to potential losses of our clients, which may in turn affect our business operations and reputation and may cause us to incur losses.

 

We cannot assure you that the external service providers will be able to continue to provide these services to meet our current needs in an efficient and cost-effective manner, or that they will be able to adequately expand their services to meet our needs in the future. Some external service providers may have assets and infrastructure that are important to the services they provide us that are located in or outside Brazil, and their ability to provide these services is subject to risks from unfavorable political, economic, legal or other developments, such as social or political instability, changes in governmental policies or changes in the applicable laws and regulations of the jurisdictions in which their assets and operations are located.

 

An interruption in or the cessation of service by any external service provider as a result of system failures, capacity constraints, financial constraints or problems, unanticipated trading market closures or for any other reason and our inability to make alternative arrangements in a smooth and timely manner, if at all, could have a material adverse effect on our business, financial condition and results of operations.

 

Further, disputes might arise in relation to the agreements that we enter into with our service providers or the performance of the service providers thereunder. To the extent that any service provider disagrees with us on the quality of the products or services, terms and conditions of the payment or other provisions of such agreements, we may face claims, disputes, litigations or other proceedings initiated by such service provider against us. We may incur substantial expenses and require significant attention of management in defending against these claims, regardless of their merit. We could also face damages to our reputation as a result of such claims, and our business, financial condition, results of operations and prospects could be materially and adversely affected.

 

We may not be able to ensure the accuracy of the third-party product information on our platform, and we have limited control over the performance of third-party financial products we offer.

 

We offer certain third-party financial products. The acceptance and popularity of our platform is partially premised on the reliability and performance of the relevant underlying products and information on our platform. We rely on the relevant third-party providers of the relevant products for the authenticity of their underlying products and the comprehensiveness, accuracy and timeliness of the related financial information. While the products and information from these third-party providers have been generally reliable, there can be no assurance that the reliability can be maintained in the future. If these third-party providers or their agents provide inauthentic financial products or incomplete, misleading, inaccurate or fraudulent information, we may lose the trust of existing and prospective investors. In addition, if our investors purchase the underlying products that they discover on our platform and they suffer losses, they may blame us and attempt to hold us responsible for their losses, even though we have made risk disclosures before they invest. Our reputation could be harmed and we could experience reduced user traffic to our platform, which would adversely affect our business and financial performance.

 

Furthermore, as investors access the underlying products through our platform, they may have the impression that we are at least partially responsible for the quality and performance of these products. Although we have established standards to screen product providers before distributing their products on our platform, we have limited control over the performance of the third-party financial products we offer. In the event that an investor is dissatisfied with underlying products or the services of a products provider, we do not have any means to directly make improvements in response to user complaints. If investors become dissatisfied with the underlying products available on our platform, our business, reputation, financial performance and prospects could be adversely affected.

 

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We rely upon our systems and upon third-party data center service providers to host certain aspects of our platform and content, and any systems failure due to factors beyond our control or any disruption to, or interference with, our use of third-party data center services, could interrupt our service, increase our costs and impair our ability to deliver our platform, resulting in customer dissatisfaction, damaging our reputation and harming our business.

 

We utilize data center hosting facilities from third-party service providers to make certain content available on our platform. Our primary data centers are located in the cities of Barueri and Santana do Parnaíba, in the State of São Paulo, Brazil (which are located approximately 5 miles apart). Our operations depend, in part, on our providers’ ability to protect their facilities against damage or interruption from natural disasters, power or telecommunications failures, criminal acts and similar events. The occurrence of spikes in user volume, traffic, natural disasters, acts of terrorism, vandalism or sabotage, or a decision to close a facility without adequate notice, or other unanticipated problems at our providers’ facilities could result in lengthy interruptions in the availability of our platform, which would adversely affect our business.

 

In addition, we depend on the efficient and uninterrupted operation of numerous systems, including our computer systems, software, data centers and telecommunications networks, as well as the systems of third parties. Our systems and operations or those of our third-party providers, could be exposed to damage or interruption from, among other things, fire, natural disaster, power loss, telecommunications failure, unauthorized entry and computer viruses. We do not maintain insurance policies specifically for property and business interruptions. Defects in our systems or those of third parties, errors or delays in the processing of transactions, telecommunications failures or other difficulties could result in:

 

· loss of revenues;

 

· loss of clients;

 

· loss of client data;

 

· loss of licenses or authorizations with the CVM, the Central Bank, the Superintendency of Private Insurance ( Superintendência de Seguros Privados ), or SUSEP, and/or any other applicable authority;

 

· loss of our membership to the B3 and/or loss of access to the trading facilities of the B3;

 

· fines imposed by applicable regulatory authorities and other issues relating to non-compliance with applicable financial services or data protection requirements;

 

· a failure to receive, or loss of, Central Bank authorizations to operate as a financial services provider in Brazil;

 

· fines or other penalties imposed by the Central Bank, as well as other measures taken by the Central Bank, including intervention, temporary special management systems, the imposition of insolvency proceedings, and/or the out-of-court liquidation of XP CCTVM and any of our subsidiaries to whom licenses may be granted in the future;

 

· harm to our business or reputation resulting from negative publicity;

 

· exposure to fraud losses or other liabilities;

 

· additional operating and development costs; and/or

 

· diversion of technical and other resources.

 

We are subject to risks in using prime brokers and custodians.

 

Our asset management division and its managed funds depend on the services of prime brokers, administrators and custodians to settle and report securities transactions. In the event of the insolvency of a prime broker, administrator or custodian, our funds might not be able to recover equivalent assets in whole or in part, as they will rank among the prime broker’s, the administrator’s and the custodian’s unsecured creditors in relation to assets that the prime broker, administrator or custodian borrows, lends or otherwise uses. In addition, cash held by our funds with the prime broker, administrator or custodian will not be segregated from the prime broker’s, administrator’s or custodian’s own cash, and the funds will therefore rank as unsecured creditors in relation thereto.

 

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If we lose key personnel, our business, financial condition and results of operations may be adversely affected.

 

We are dependent upon the ability and experience of a number of key personnel, including Guilherme Dias Fernandes Benchimol, one of our founders and our chief executive officer, as well as a high-profile public figure and the face of the XP brand, and other members of senior management, who have substantial experience with our operations, the financial services industry and the markets in which we offer our products and services. Many of our key personnel have worked for us for a significant amount of time or were recruited by us specifically due to their industry experience. It is possible that the loss of the services of one or a combination of our senior executives or key managers, including our chief executive officer, could have a material adverse effect on our business, financial condition and results of operations.

 

The ability to attract, recruit, develop and retain qualified employees and continue to strengthen our existing infrastructure and systems is critical to our success and growth. If we are not able to do so, our business and prospects may be materially and adversely affected.

 

Our business functions at the intersection of rapidly changing technological, social, economic and regulatory developments that require a wide-ranging set of expertise and intellectual capital. In order for us to successfully compete and grow, we must attract, recruit, develop and retain the necessary personnel who can provide the needed expertise across the entire spectrum of our intellectual capital needs. While we have a number of our key personnel who have substantial experience with our operations, we must also develop our personnel to provide succession plans capable of maintaining continuity in the midst of the inevitable unpredictability of human capital. However, the market for qualified personnel is competitive, and we may not succeed in recruiting additional personnel or may fail to effectively replace current personnel who depart with qualified or effective successors. We must continue to hire additional personnel to execute our strategic plans. Our effort to retain and develop personnel may also result in significant additional expenses, which could adversely affect our profitability. We cannot assure you that our qualified employees will continue to be employed by us or that we will be able to attract and retain qualified personnel in the future. Failure to retain or attract key personnel could have a material adverse effect on our business, financial condition and results of operations.

 

In addition, in order to manage our growth effectively, we must continue to strengthen our existing infrastructure, develop and improve our internal controls, create and improve our reporting systems, and timely address issues as they arise. These efforts may require substantial financial expenditures, commitments of resources, developments of our processes, and other investments and innovations. Furthermore, we encourage employees to quickly develop and launch new features for our products and services. As we grow, we may not be able to execute as quickly as smaller, more efficient organizations. If we do not successfully manage our growth, our business will suffer.

 

We are subject to various risks associated with the securities industry, any of which could have a materially adverse effect on our business, cash flows and results of operations.

 

We are subject to uncertainties that are common across the securities industry. These uncertainties include:

 

· the volatility of domestic and international financial, bond and stock markets, and the markets for funds and other asset classes, in particular in the current context of the COVID-19 pandemic;

 

· extensive governmental regulation;

 

· litigation;

 

· intense competition;

 

· poor performance of investment products that our advisors recommend or sell or that are otherwise sold or distributed on our platform;

 

· substantial fluctuations in the volume and price level of securities; and

 

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· dependence on the solvency of various third parties.

 

As a result, our revenues and earnings may vary significantly from quarter to quarter and from year to year. In addition, lower price levels of securities may result in reduced volumes of securities, options and futures transactions, with a consequent reduction in our commission revenues. In periods of low retail and institutional brokerage volume and reduced investment banking activity, profitability is impaired because certain expenses remain relatively fixed. Sudden sharp declines in market values of securities and the failure of issuers and counterparties to perform their obligations can result in illiquid markets which, in turn, may result in our having difficulty selling securities. In the event of a market downturn, our business could be adversely affected in many ways, potentially for a prolonged period of time, for example as a result of the impact of overall market declines and increased market volatility due to the COVID-19 pandemic on our equity and equity funds’ position and on the fair value of our AUC, which could lead to reduced demand for the asset class. Our revenues are likely to decline in such circumstances and, if we are unable to reduce expenses at the same pace, our profit margins would erode, which could have a material adverse effect on our business, financial condition and results of operations.

 

We derive a significant portion of our revenues from one of our operating subsidiaries.

 

A significant portion of our revenues is derived from one of our principal operating subsidiaries, XP CCTVM. For the years ended December 31, 2019, 2018 and 2017, the average net revenue of XP CCTVM represented approximately 66.7% of our total consolidated net revenue for such periods. We expect that we will continue to depend on XP CCTVM for a significant portion of our revenues for the foreseeable future, and any decrease in the revenue of XP CCTVM or any other event significantly affecting XP CCTVM may have a material adverse effect on our financial condition and results of operations.

 

Our holding company structure makes us dependent on the operations of our subsidiaries.

 

We are a Cayman Islands exempted company with limited liability. As a holding company, our corporate purpose is to invest, as a partner or shareholder, in other companies, consortia or joint ventures in Brazil, where most of our operations are located, and outside Brazil. Accordingly, our material assets are our direct and indirect equity interests in our subsidiaries, and we are therefore dependent upon the results of operations and, in turn, the payments, dividends and distributions from our subsidiaries for funds to pay our holding company’s operating and other expenses and to pay future cash dividends or distributions, if any, to holders of our Class A common shares, and we may have tax costs in connection with any dividend or distribution. In addition, the payments, dividends and distributions from our subsidiaries to us for funds to pay future cash dividends or distributions, if any, to holders of our Class A common shares, could be restricted under financing arrangements that we or our subsidiaries may enter into in the future and we and such subsidiaries may be required to obtain the approval of lenders to make such payments to us in the event they are in default of their repayment obligations. Furthermore, we may be adversely affected if the Brazilian government imposes legal restrictions on dividend distributions by our Brazilian subsidiaries and exchange rate fluctuation will affect the U.S. dollar value of any distributions our subsidiaries make with respect to our equity interests in those subsidiaries.

 

On April 6, 2020, in response to the ongoing uncertainty relating to the economic effects of the COVID-19 pandemic, the Central Bank issued CMN Resolution No. 4,797/2020, or CMN Resolution No. 4,797. CMN Resolution No. 4,797 prohibits financial institutions and other institutions authorized to operate by the Central Bank, including XP CCTVM and Banco XP, to, until September 30, 2020, make dividend distributions beyond the minimum legal requirement or the minimum threshold established in such institutions’ bylaws. CMN Resolution No. 4,797/2020 also temporarily prohibits financial institutions from making other related payments, pay interest on equity, effect stock repurchases, and effect capital stock reductions. We do not expect the temporary prohibitions established by CMN Resolution No. 4,797 to have a material impact on our business, financial condition or results of operations.

 

For further information, see “—Certain Risks Relating to Brazil—Exchange rate instability may have adverse effects on the Brazilian economy, us and the price of our Class A common shares,” “—Certain Risks Relating to Brazil —Economic uncertainty and political instability in Brazil may harm us and the price of our Class A common shares” and “Item 8. Financial Information—A. Consolidated statements and other financial information—Dividends and Dividend Policy.”  

 

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We are exposed to fluctuations in foreign currency exchange rates and enter into derivatives transactions to manage our exposure to exchange rate risk.

 

We hold certain funds in non-Brazilian real currencies, and will continue to do so in the future, and our offshore operating subsidiaries generate revenue in non-Brazilian real currencies. Accordingly, our financial results are affected by the translation of these non- real currencies into reais . In addition, to the extent that we need to convert future financing proceeds into Brazilian reais for our operations, any appreciation of the Brazilian real against the relevant foreign currencies would materially reduce the Brazilian real amounts we would receive from the conversion, and any depreciation of the Brazilian real against the relevant foreign currencies could increase the amounts in Brazilian reais that we are require to convert into the relevant foreign currencies in order to service such relevant foreign currency financings. No assurance can be given that fluctuations in foreign exchange rates will not have a significant impact on our business, financial condition, results of operations and prospects. We may also have foreign exchange risk on any of our other assets and liabilities denominated in currencies, or with pricing linked to currencies, other than our functional currency, including certain contract assets. Fluctuations in the Brazilian real versus any of these foreign currencies may have a material adverse effect on our financial position and results of operations, for example as a result of overall market declines and increased market volatility due to the COVID-19 pandemic.

 

In addition, we enter into derivatives transactions to manage our exposure to exchange rate risk. Such derivatives transactions are designed to protect us against increases or decreases in exchange rates, but not both. If we have entered into derivatives transactions to protect against, for example, decreases in the value of the real and the real instead increases in value, we may incur financial losses. Such losses could materially and adversely affect us.

 

XP CCTVM is subject to liquidity risks.

 

XP CCTVM is subject to liquidity risks. Liquidity is the ability to meet current and future cash flow needs on a timely basis at a reasonable cost. XP CCTVM requires sufficient liquidity to meet customer and clearinghouse deposit maturities/withdrawals, payments on debt obligations as they become due and other cash commitments under both normal operating conditions and other unpredictable circumstances causing industry or general financial market stress. XP CCTVM’s access to funding sources in amounts adequate to finance its activities on terms that are acceptable to it could be impaired by factors that affect it specifically or the financial services industry or economy generally. To the extent XP CCTVM is unable to maintain adequate levels of liquidity, it may not be able to meet its payment obligations, which may have a material adverse effect on our business, financial condition and results of operations.

 

In addition, XP CCTVM invests funds held in customer accounts in fixed income financial instruments and securities that meet certain liquidity conditions. To the extent customers withdraw a substantial amount of their funds held in such customer accounts for other uses, XP CCTVM might experience liquidity constraints, requiring it to rapidly sell financial assets at a discounted price, and may be unable to obtain funding and default on its payment obligations to market counterparties and other customers, which may cause XP CCTVM to incur losses, and consequently harm our image and reputation and have a material adverse effect on our business, financial condition and results of operations.

 

We have identified material weaknesses in our internal control over financial reporting and, if we fail to remediate such deficiencies (and any other ones) and to maintain effective internal controls over financial reporting, we may be unable to accurately report our results of operations, meet our reporting obligations and/or prevent fraud.

 

The material weaknesses identified relate to our insufficient processes necessary to comply with the reporting and compliance requirements of IFRS and the U.S. Securities and Exchange Commission, or the SEC. Specifically:

 

· we identified material weaknesses related to managing access to our systems, data and end-user computing (EUC) controls; and

 

· we identified material weaknesses related to the recognition and measurement of revenues, which could result in a material misstatement of our revenues if not timely identified by us.

 

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These material weaknesses did not result in a misstatement to our consolidated financial statements.

 

We have adopted a remediation plan with respect to the material weaknesses identified above which includes the implementation of new processes and procedures, including additional levels of review to improve our internal controls procedures, implementation of new software solutions, training our staff and enhanced our documentation. Other additional measures are already being adopted in connection with the project preparing the company for the upcoming reporting under Section 404 of the Sarbanes-Oxley Act in 2020. Some of these measures have already been implemented and we will be working extensively on implementing the remaining measures through 2020. For further information, see “Item 15. Controls and Procedures—D. Changes in internal control over financial reporting.” However, we cannot assure you that our efforts will be effective or prevent any future material weakness or significant deficiency in our internal controls over financial reporting.

 

In connection with the preparation of our consolidated financial statements for the year ended December 31, 2019, we did not identify any additional material weaknesses in our internal control over financial reporting.

 

We are subject to the Sarbanes-Oxley Act, which requires, among other things, that we establish and maintain effective internal controls over financial reporting and disclosure controls and procedures. Under the current rules of the SEC we are required to perform system and process evaluation and testing of our internal controls over financial reporting to allow management to assess the effectiveness of our internal controls. Our testing may reveal deficiencies in our internal controls that are deemed to be material weaknesses or significant deficiencies and render our internal controls over financial reporting ineffective. We expect to incur additional accounting and auditing expenses and to spend significant management time in complying with these requirements. If we are not able to comply with these requirements in a timely manner, or if we or our management identifies additional material weaknesses or significant deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses, the market price of our Class A common shares may decline and we may be subject to investigations or sanctions by the SEC, the Financial Industry Regulatory Authority, Inc., or FINRA, or other regulatory authorities.

 

In addition, these obligations also require substantial attention from our senior management and could divert their attention away from the day-to-day management of our business. These cost increases and the diversion of management’s attention could materially and adversely affect our business, financial condition and operation results.

 

Requirements associated with being a public company in the United States require significant company resources and management attention.

 

We are subject to certain reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, and the other rules and regulations of the SEC and Nasdaq. We are also subject to various other regulatory requirements, including the Sarbanes-Oxley Act. We expect these rules and regulations to increase our legal, accounting and financial compliance costs and to make some activities more time-consuming and costly. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantial costs to maintain the same or similar coverage. New rules and regulations relating to information disclosure, financial reporting and controls and corporate governance, which could be adopted by the SEC, Nasdaq or other regulatory bodies or exchange entities from time to time, could result in a significant increase in legal, accounting and other compliance costs and make certain corporate activities more time-consuming and costly, which could materially affect our business, financial condition and results of operations. These rules and regulations may also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers.

 

These obligations also require substantial attention from our senior management and could divert their attention away from the day-to-day management of our business. Given that most of the individuals who now constitute our management team have limited experience managing a publicly traded company and complying with the increasingly complex laws pertaining to public companies, initially, these new obligations could demand even greater attention. These cost increases and the diversion of management’s attention could materially and adversely affect our business, financial condition and results of operations.

 

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Our business is subject to complex and evolving regulations and oversight related to our provision of financial products and services and to costs and risks associated with other increased or changing laws and regulations affecting our business, including developments in data protection and privacy laws, which could harm our business, financial condition and results of operations.

 

As a financial services institution in Brazil, our business is subject to Brazilian laws and regulations relating to financial services in Brazil, comprising Federal Law No. 4,595/64, Federal Law No. 6,385/76 and related rules and regulations issued by the Central Bank, the CVM, the B3 and ANBIMA, among others. In addition, our insurance business is subject to various laws and regulations in Brazil, such as Federal Law No. 4,595/64, Decree Law No. 73/66 and certain other rules and regulations issued by the National Private Insurance Council ( Conselho Nacional de Seguros Privados ), or CNSP, and SUSEP, among others.

 

The laws, rules, and regulations that govern our business include or may in the future include those relating to banking, deposit-taking, cross-border and domestic money transmission, foreign exchange, payments services (such as payment processing and settlement services), consumer financial protection, tax, anti-money laundering and terrorist financing and escheatment (rules relating to unclaimed property). These laws, rules, and regulations are enforced by multiple authorities and governing bodies in Brazil, including the Central Bank and the CMN. In addition, as our business continues to develop and expand, we may become subject to additional rules and regulations, which may limit or change how we conduct our business.

 

We are subject to anti-money laundering and terrorist financing laws and regulations in multiple jurisdictions that prohibit, among other things, involvement in transferring the proceeds of criminal or terrorist activities. We could be subject to liability and forced to change our business practices if we were found to be subject to, or in violation of, any laws or regulations impacting our ability to maintain a bank account in the countries where we operate, including the United States, or if existing or new legislation or regulations applicable to banks in the countries where we maintain a bank account, including the United States, were to result in banks in those countries being unwilling or unable to establish and maintain bank accounts for us.

 

If any person in the Cayman Islands knows or suspects or has reasonable grounds for knowing or suspecting that another person is engaged in criminal conduct or money laundering or is involved with terrorism or terrorist financing and property and the information for that knowledge or suspicion came to their attention in the course of business in the regulated sector, or other trade, profession, business or employment, the person will be required to report such knowledge or suspicion to (i) the Financial Regulatory Authority (“FRA”) of the Cayman Islands, pursuant to the Proceeds of Crime Law (2019 Revision) of the Cayman Islands if the disclosure relates to criminal conduct or money laundering, or (ii) a police officer of the rank of constable or higher, or the FRA, pursuant to the Terrorism Law (2018 Revision) of the Cayman Islands, if the disclosure relates to involvement with terrorism or terrorist financing and property. Such a report shall not be treated as a breach of confidence or of any restriction upon the disclosure of information imposed by any enactment or otherwise.

 

Certain of our subsidiaries are subject to regulation in the United States, such as our subsidiary, XP Investments US, LLC, which is registered with the SEC and FINRA as a broker-dealer and XP Advisory US, Inc., which is registered with the SEC as an investment advisor. We do not believe that we or any of our subsidiaries engage in any financial services activities in the United States that would require a license from any U.S. federal or state banking authorities or other financial regulators, except those licenses and registrations that have already been obtained. If we are found to have engaged in a banking or other financial services business in the United States without an appropriate registration or license, we could be subject to liability, or forced to cease doing such business, change our business practices, or to obtain the appropriate license or registration. If we or any of our subsidiaries obtain additional licenses or registrations in the United States, we could be subject to compliance with additional applicable laws and regulations, including anti-money laundering and terrorist financing laws and regulations, which could adversely affect our business, financial condition, or results of operations.

 

Although we have a compliance program focused on applicable laws, rules, and regulations (which currently is principally focused on Brazilian law) and are continually investing in this program, we may nonetheless be subject to fines or other penalties in one or more jurisdictions levied by federal, state or local regulators, as well as those levied by foreign regulators. In addition to fines, penalties for failing to comply with applicable rules and regulations could include significant criminal and civil lawsuits, forfeiture of significant assets, or other enforcement actions, including loss of required licenses or approvals in a given jurisdiction. We could also be required to make changes to our business practices or compliance programs as a result of regulatory scrutiny. In addition, any perceived or actual failure to comply with applicable laws, rules, and regulations could have a significant impact on our reputation as a trusted brand and could cause us to lose existing clients, prevent us from obtaining new clients,

 

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require us to expend significant funds to remedy problems caused by breaches and to avert further breaches, and expose us to legal risk and potential liability, and we could be (1) required to pay substantial fines and disgorgement of our profits; (2) required to change our business practices; or (3) subjected to insolvency proceedings such as an intervention by the Central Bank, as well as the out-of-court liquidation of XP CCTVM, and any of our subsidiaries to whom authorizations may be granted in the future. Any disciplinary or punitive action by our regulators or failure to obtain required operating authorizations could seriously harm our business and results of operations.

 

In addition, the Brazilian regulatory and legal environment exposes us to other compliance and litigation risks that could materially affect our results of operations. These laws and regulations may change, sometimes significantly, as a result of political, economic or social events. Some of the federal, state or local laws and regulations in Brazil that affect us include: those relating to consumer products, product liability or consumer protection; those relating to the manner in which we advertise, market or sell products; labor and employment laws, including wage and hour laws; tax laws or interpretations thereof; bank secrecy laws, data protection and privacy laws and regulations; and securities and exchange laws and regulations. For instance, data protection and privacy laws are developing to take into account the changes in cultural and consumer attitudes towards the protection of personal data (including as a result of the LGPD). There can be no guarantee that we will have sufficient financial and personnel resources to comply with any new regulations or successfully compete in the context of a changing regulatory environment.

 

The laws regulating privacy rights and data protection have considerably evolved over recent years, providing for more restrictive provisions on the means through which processing of personal data by organizations is regulated. As of August 2018, when the LGPD was enacted, practices involving the processing of personal data were ruled by certain sectorial laws, such as the Consumer Defense Code (Law No. 8,078/1990) and the Brazilian Civil Rights Framework for the Internet (Law No. 12,965).

 

On August 14, 2018, the President of Brazil approved the LGPD, a comprehensive personal data protection law establishing general principles and obligations that apply across multiple economic sectors and contractual relationships. The LGPD establishes detailed rules for the collection, use, processing and storage of personal data and will affect all economic sectors, including the relationship between customers and suppliers of goods and services, employees and employers and other relationships in which personal data is collected, whether in a digital or physical environment. The obligations established by LGPD will become effective starting in August 2020 (24 months from the date of its publication in August 2018), by which date all legal entities will be required to adapt their data processing activities to these new rules. Once LGPD becomes effective, the penalties and fines for violations include: (1) warnings, with the imposition of a deadline for the adoption of corrective measures; (2) a one-time fine of up to 2% of gross sales of the company or a group of companies or a maximum amount of R$50,000,000 per violation; (3) a daily fine, up to a maximum amount of R$50,000,000 per violation; (4) public disclosure of the violation; (5) the restriction of access to the personal data to which the violation relates, until corrective measures are implemented; and (6) deletion of the personal data to which the violation relates. Any additional privacy laws or regulations enacted or approved in Brazil or in other jurisdictions in which we operate could seriously harm our business, financial condition or results of operations. As of the date of this annual report, a new bill pending ratification by the Brazilian house of representatives and the Brazilian president will, if passed, delay the coming into force of the LGPD to January 1, 2021.

 

We are subject to regulatory activity and antitrust litigation under competition laws.

 

We are subject to scrutiny from governmental agencies under competition laws in countries in which we operate. Some jurisdictions also provide private rights of action for competitors or consumers to assert claims of anticompetitive conduct. Other companies or governmental agencies may allege that our actions violate antitrust or competition laws, or otherwise constitute unfair competition. Contractual agreements with clients or companies, as well as our unilateral business practices, could give rise to regulatory action or antitrust investigations or litigation. Some regulators may perceive our business to have such significant market power that otherwise uncontroversial business practices could be deemed anticompetitive. Any such claims and investigations, even if they are unfounded, may be expensive to defend, involve negative publicity and substantial diversion of management time and effort, and could result in significant judgments against us.

 

In order to obtain antitrust regulatory approvals from Brazil’s Administrative Council for Economic Defense ( Conselho Administrativo de Defesa Econômica , or CADE), and the Central Bank for the Itaú Transaction, we entered into agreements with CADE and the Central Bank pursuant to which we agreed to certain restrictions on our ability to acquire interests in financial investment platforms.

 

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Pursuant to our agreement with CADE, we agreed, among other measures, to: (1) adopt equal treatment practices in our relationships with suppliers of financial products; (2) refrain from entering into exclusive relationships with financial advisors (except as permitted by applicable regulations); (3) facilitate transferability of clients’ financial products to competing platforms; and (4) maintain a “no fee” policy for specific types of financial products. A breach by us of any of the aforementioned measures could result in financial penalties, antitrust investigations and the revision of the agreement with CADE.

 

Pursuant to our agreement with the Central Bank, we agreed, among other measures, to: (1) refrain from acquiring any interest in financial investment platforms; (2) prohibit Itaú Unibanco S.A. from exercising any influence over our business and operational decisions and strategies; and (3) refrain from selling any interest in our capital stock to any Itaú Unibanco S.A. group company. A breach by us of any of the aforementioned measures could result in financial penalties.

 

We are subject to anti-corruption, anti-bribery, anti-money laundering and sanctions laws and regulations.

 

We operate in jurisdictions that have a high risk of corruption and we are subject to anti-corruption, anti-bribery anti-money laundering and sanctions laws and regulations, including the Brazilian Federal Law No. 12,846/2013, or the Clean Company Act, the United States Foreign Corrupt Practices Act of 1977, as amended, or the FCPA, and the Bribery Act 2010 of the United Kingdom, or the Bribery Act. Each of the Clean Company Act, the FCPA and the Bribery Act impose liability against companies who engage in bribery of government officials, either directly or through intermediaries. We have a compliance program that is designed to manage the risks of doing business in light of these new and existing legal and regulatory requirements. Violations of the anti-corruption, anti-bribery, anti-money laundering and sanctions laws and regulations could result in criminal liability, administrative and civil lawsuits, significant fines and penalties, forfeiture of significant assets, as well as reputational harm.

 

Regulators may increase enforcement of these obligations, which may require us to adjust our compliance and anti-money laundering programs, including the procedures we use to verify the identity of our clients and to monitor our transactions and transactions made through our platform. Regulators regularly reexamine the transaction volume thresholds at which we must obtain and keep applicable records, verify identities of customers, and report any change in such thresholds to the applicable regulatory authorities, which could result in increased costs in order to comply with these legal and regulatory requirements. Costs associated with fines or enforcement actions, changes in compliance requirements, or limitations on our ability to grow could harm our business, and any new requirements or changes to existing requirements could impose significant costs, result in delays to planned product improvements, make it more difficult for new customers to join our network and reduce the attractiveness of our products and services.

 

Changes in tax laws, tax incentives, benefits or differing interpretations of tax laws may adversely affect our results of operations.

 

Changes in tax laws, regulations, related interpretations and tax accounting standards in Brazil, the United States, the United Kingdom, Portugal, or Switzerland (countries where we operate), or the Cayman Islands may result in a higher tax rate on our earnings, which may significantly reduce our profits and cash flows from operations. For example, in January 2019, the corporate income tax, or IRPJ, aggregate rate applicable to XP CCTVM was reduced from 45% to 40% on net profits. The aggregate income tax rate applied to financial institutions in Brazil (more specifically, to banks of any nature, which does not include XP CCTVM) was increased to 45% as of March 1, 2020. In addition, our financial condition and results of operations may decline if certain tax incentives are not retained or renewed. For example, Brazilian Law No. 11,196 currently grants tax benefits to companies that invest in research and development, provided that some requirements are met, which significantly reduces our annual corporate income tax expense. If the taxes applicable to our business increase or any tax benefits are revoked and we cannot alter our cost structure to pass our tax increases on to clients, our financial condition, results of operations and cash flows could be adversely affected. Our activities are also subject to a Municipal Tax on Services ( Imposto Sobre Serviços ), or ISS. Any increases in ISS rates could also harm our profitability.

 

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Furthermore, Brazilian governmental authorities at the federal, state and local levels are considering changes in tax laws in order to cover budgetary shortfalls resulting from the recent economic downturn in Brazil. If these proposals are enacted they may harm our profitability by increasing our tax liabilities, increasing our tax compliance costs, or otherwise affecting our financial condition, results of operations and cash flows. Tax rules in Brazil, particularly at the local level, can change without notice. We may not always be aware of all such changes that affect our business and we may therefore fail to pay the applicable taxes or otherwise comply with tax regulations, which may result in additional tax assessments and penalties for our company.

 

At the municipal level, the Brazilian government enacted Supplementary Law No. 157/16, which imposed changes regarding the ISS collection applied to the rendering of part of our services. These changes created new obligations, as ISS will now be due in the municipality in which the acquirer of our services is located rather than in the municipality in which the service provider’s facilities are located. This obligation took force in January 2018, but has been delayed by Direct Unconstitutionality Action No. 5835, or ADI, filed by taxpayers. The ADI challenges the constitutionality of Supplementary Law No. 157/16 before the Supreme Court, arguing that the new legislation would adversely affect companies’ activities due to the increase of costs and bureaucracy related to the ISS payment to several municipalities and the compliance with tax reporting obligations connected therewith. As a result, the Supreme Court granted an injunction to suspend the enforcement of Supplementary Law No. 157/16. As of the date of this annual report, a final decision on this matter is currently pending.

 

On February 18, 2020, it was announced that the Cayman Islands has been placed on the list of non-cooperative jurisdictions published by the European Union, or EU, for tax purposes. The Cayman Islands government issued a press release on February 18, 2020 affirming that the jurisdiction introduced appropriate legislative changes on February 7, 2020 relating to the EU’s criteria, but that the listing appears to stem from such legislation not being enacted by February 4, 2020, which was the date of the EU’s Code of Conduct Group meeting to advise the EU Finance Ministers prior to the Finance Ministers’ decision regarding the listing on February 18, 2020. The Cayman Islands government press release states that the Cayman Islands remains fully committed to cooperating with the EU, and will continue to constructively engage with them with the view to be delisted as soon as possible. It is unclear as to whether the Cayman Islands being placed on such list will have a significant, or any, effect on us.

 

Moreover, we are subject to tax laws and regulations that may be interpreted differently by tax authorities and us. The application of indirect taxes, such as sales and use tax, value-added tax, or VAT, provincial taxes, goods and services tax, business tax and gross receipt tax, to businesses such as ours is complex and continues to evolve. We are required to use significant judgment in order to evaluate applicable tax obligations. In many cases, the ultimate tax determination is uncertain because it is not clear how existing statutes apply to our business. One or more states or municipalities, the federal government or other countries may seek to challenge the taxation or procedures applied to our transactions, which could impose the charge of taxes or additional reporting, record-keeping or indirect tax collection obligations on businesses like ours. New taxes could also require us to incur substantial costs to capture data and collect and remit taxes. If such obligations were imposed, the additional costs associated with tax collection, remittance and audit requirements could have a material adverse effect on our business and financial results. As each EU member state may implement its own laws and regulations in connection with the listing, the tax and other implications to us and our shareholders may differ on a country-by-country and investor-by-investor basis.

 

The costs and effects of pending and future litigation, investigations or similar matters, or adverse facts and developments related thereto, could materially affect our business, financial position and results of operations.

 

We are, and may be in the future, party to legal, arbitration and administrative investigations, inspections and proceedings arising in the ordinary course of our business or from extraordinary corporate, tax or regulatory events, involving our clients, suppliers, customers, investors, as well as competition, government agencies, tax and environmental authorities, particularly with respect to civil, tax and labor claims. Indemnity rights that we seek to negotiate in certain transactions may not cover all claims that may be asserted against us, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Also, we currently are, and may in the future be, party to one or more securities class actions regarding our registration statement on Form F-1 in connection with our initial public offering and other related reports. Furthermore, there is no guarantee that we will be successful in defending ourselves in pending or future litigation or similar matters under various laws. Should the ultimate judgments or settlements in any pending or future litigation or investigation significantly exceed any amounts we are able to recover under any indemnity arrangements, such judgments or settlements could have a material adverse effect on our business, financial condition and results of operations and the price of our Class A common shares. Further, even if we adequately address issues raised by an inspection conducted by an agency or successfully defend our case in an administrative proceeding or court action, we may have to set aside significant financial and management resources to settle issues raised by such proceedings or to those lawsuits or claims, which could adversely affect our business.See “Item 8. Financial Information—A. Consolidated statements and other financial information—Legal Proceedings.”

 

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We may not be able to successfully manage our intellectual property and may be subject to infringement claims.

 

We rely on a combination of contractual rights, trademarks and trade secrets to establish and protect our proprietary technology. Third parties may challenge, invalidate, circumvent, infringe or misappropriate our intellectual property, including at the administrative or judicial level, or such intellectual property may not be sufficient to permit us to take advantage of current market trends or otherwise to provide competitive advantages, which could result in costly redesign efforts, the discontinuance of certain service offerings or other competitive harm. Others, including our competitors, may independently develop similar technology, duplicate our services or design around our intellectual property, and in such cases, we could not assert our intellectual property rights against such parties. Further, our contractual arrangements may not effectively prevent disclosure of our confidential information or provide an adequate remedy in the event of unauthorized disclosure of our confidential information. We may have to litigate to enforce or determine the scope and enforceability of our intellectual property rights, trade secrets and know-how, which is expensive, could cause a diversion of resources and may not prove successful. Also, because of the rapid pace of technological change in our industry, aspects of our business and our services rely on technologies developed or licensed by third parties, and we may not be able to obtain or continue to obtain licenses and technologies from these third parties on reasonable terms or at all. The loss of intellectual property protection, the inability to obtain third-party intellectual property or delay or refusal by relevant regulatory authorities to approve pending intellectual property registration applications could harm our business and ability to compete. With respect to trademarks, loss of rights may result from term expirations, owner abandonment and forfeiture or cancellation proceedings before the Brazilian Patent and Trademark Office ( Instituto Nacional da Propriedade Industrial , or the INPI). In addition, if we lose rights over registered trademarks, we would not be entitled to use such trademarks on an exclusive basis and, therefore, third parties would be able to use similar or identical trademarks to identify their products or services, which could adversely affect our business.

 

We may also be subject to costly litigation in the event our services and technology infringe upon or otherwise violate a third party’s proprietary rights. Third parties may have, or may eventually be issued, patents that could be infringed by our services or technology. Any of these third parties could make a claim of infringement against us with respect to our services or technology, and we have been subject to such claims in the past. We may also be subject to claims by third parties for breach of copyright, trademark, license usage or other intellectual property rights. Any claim from third parties may result in a limitation on our ability to use the intellectual property subject to these claims or could prevent us from registering our brands as trademarks. Additionally, in recent years, individuals and groups have been purchasing intellectual property assets for the sole purpose of making claims of infringement and attempting to extract settlements from companies like ours. Even if we believe that intellectual property related claims are without merit, defending against such claims is time-consuming and expensive and could result in the diversion of the time and attention of our management and employees. Claims of intellectual property infringement also might require us to redesign affected services, enter into costly settlement or license agreements, pay costly damage awards, change our brands, or face a temporary or permanent injunction prohibiting us from marketing or selling certain services or using certain brands. Even if we have an agreement for indemnification against such costs, the party providing such indemnification may be unwilling or unable to comply with its indemnification obligations. If we cannot or do not license the infringed technology on reasonable terms or substitute similar technology from another source, our revenues and earnings could be adversely impacted.

 

Our use of open source software could negatively affect our ability to sell our solutions and subject us to possible litigation.

 

Our solutions incorporate and are dependent to some extent on the use and development of open source software and we intend to continue our use and development of open source software in the future. Such open source software is generally licensed by its authors or other third parties under open source licenses and is typically freely accessible, usable and modifiable. Pursuant to such open source licenses, we may be subject to certain conditions, including requirements that we offer our proprietary software that incorporates the open source software for no cost, that we make available source code for modifications or derivative works we create based upon, incorporating or using the open source software and that we license such modifications or derivative works under the terms of the particular open source license. If an author or other third party that uses or distributes such open source software were to allege that we had not complied with the conditions of one or more of these licenses, we

 

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could be required to incur significant legal expenses defending against such allegations and could be subject to significant damages, enjoined from the use or sale of our solutions that contained or are dependent upon the open source software and required to comply with the foregoing conditions, which could disrupt the distribution and sale of some of our products and services. Litigation could be costly for us to defend, have a negative effect on our financial condition and results of operations or require us to devote additional research and development resources to change our platform. The terms of many open source licenses to which we are subject have not been interpreted by courts. As there is little or no legal precedent governing the interpretation of many of the terms of certain of these licenses, the potential impact of these terms on our business is uncertain and may result in unanticipated obligations regarding our solutions and technologies.

 

Any requirement to disclose our proprietary source code, termination of open source license rights or payments of damages for breach of contract could be harmful to our business, financial condition or results of operations, and could make it easier for our competitors develop products and services that are similar to or better than ours.

 

In addition to risks related to license requirements, use of open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties, controls on the origin or development of the software, or remedies against the licensors. Many of the risks associated with usage of open source software cannot be eliminated and could adversely affect our business.

 

Although we believe that we have complied with our obligations under the various applicable licenses for open source software, it is possible that we may not be aware of all instances where open source software has been incorporated into our proprietary software or used in connection with our solutions or our corresponding obligations under open source licenses. We do not have open source software usage policies or monitoring procedures in place. We rely on multiple software programmers to design our proprietary software and we cannot be certain that our programmers have not incorporated open source software into our proprietary software that we intend to maintain as confidential or that they will not do so in the future. To the extent that we are required to disclose the source code of certain of our proprietary software developments to third-parties, including our competitors, in order to comply with applicable open source license terms, such disclosure could harm our intellectual property position, competitive advantage, financial condition and results of operations. In addition, to the extent that we have failed to comply with our obligations under particular licenses for open source software, we may lose the right to continue to use and exploit such open source software in connection with our operations and solutions, which could disrupt and adversely affect our business.

 

We may face challenges in expanding into new geographic regions outside of Brazil.

 

We may face challenges in connection with our expansion through XP Investments and certain of our other subsidiaries into new geographic regions outside of Brazil, and we will face challenges associated with entering markets in which we have limited or no experience and in which we may not be well-known. Offering our services in new geographic regions requires substantial expenditures and takes considerable time, and we may not recover our investments in new markets in a timely manner or at all. For example, we may be unable to attract a sufficient number of clients, fail to anticipate competitive conditions or fail to adapt and tailor our services to different markets. In addition, the ongoing economic uncertainty and political instability in the countries in which we operate may adversely affect us.

 

The development of our products and services globally exposes us to risks relating to staffing and managing cross-border operations; increased costs and difficulty protecting intellectual property and sensitive data; tariffs and other trade barriers; differing and potentially adverse tax consequences; increased and conflicting regulatory compliance requirements, including with respect to privacy and security; lack of acceptance of our products and services; challenges caused by distance, language, and cultural differences; exchange rate risk; and political instability. Accordingly, our efforts to develop and expand the geographic footprint of our operations may not be successful, which could limit our ability to grow our business.

 

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Any acquisitions, partnerships or joint ventures that we make or enter into could disrupt our business and harm our financial condition.

 

Acquisitions, partnerships and joint ventures are part of our growth strategy. From time to time, we pursue strategic acquisitions, such as our recent acquisitions of Clear Corretora de Títulos e Valores Mobiliários S.A., or Clear, in 2015, Rico Corretora de Títulos e Valores Mobiliários S.A., or Rico, in 2017, and XP Vista in 2018. We evaluate, and expect in the future to evaluate, potential strategic acquisitions of, and partnerships or joint ventures with, complementary businesses, services or technologies. We may not be successful in identifying acquisition, partnership and joint venture targets. In addition, we may not be able to successfully finance or integrate any businesses, services or technologies that we acquire or with which we form a partnership or joint venture, and we may lose clients as a result of any acquisition, partnership or joint venture. In addition, we may be unable to realize the expected benefits, synergies or developments that we may initially anticipate. Furthermore, the integration of any acquisition, partnership or joint venture may divert management’s time and resources from our core business and disrupt our operations.

 

Certain acquisitions, partnerships and joint ventures we make may prevent us from competing for certain clients or in certain lines of business and may lead to a loss of clients. For example, in order to obtain antitrust regulatory approvals from CADE and the Central Bank in connection with the Itaú Transaction, we entered into agreements with CADE and the Central Bank pursuant to which we agreed to certain restrictions on our ability to acquire interests in financial investment platforms.

 

In addition, we may spend time and money on projects that do not increase our revenue or profitability. To the extent we finance any acquisition or investment in cash, it would reduce our cash reserves, and to the extent the purchase price is paid with our common shares, it could be dilutive to our shareholders. To the extent we finance any acquisition or investment with the proceeds from the incurrence of debt, this would increase our level of indebtedness and could negatively affect our liquidity, credit rating and restrict our operations. Our competitors may be willing to pay more than us for acquisitions or investments, which may cause us to lose certain opportunities that we would otherwise desire to complete. Moreover, we may face contingent liabilities in connection with our acquisitions and joint ventures, including, among others, (1) judicial and/or administrative proceeding or contingencies relating to the company, asset or business acquired, including civil, regulatory, tax, labor, social security, environmental and intellectual property proceedings or contingencies; and (2) financial, reputational and technical issues, including with respect to accounting practices, financial statement disclosures and internal controls, as well as other regulatory or compliance matters, all of which we may not have identified as part of our due diligence process and that may not be sufficiently indemnifiable under the relevant acquisition or joint venture agreement. We cannot assure you that any acquisition, partnership, investment or joint venture we make will not have a material adverse effect on our business, financial condition and results of operations.

 

Our insurance policies may not be sufficient to cover all claims.

 

Our insurance policies may not adequately cover all risks to which we are exposed. A significant claim not covered by our insurance, in full or in part, may result in significant expenditures by us. Moreover, we may not be able to maintain insurance policies in the future at reasonable costs or on acceptable terms, which may adversely affect our business and the trading price of our Class A common shares.

 

Our risk management policies and procedures may not be fully effective in mitigating our risk exposure in all market environments or against all types of risks, which could expose us to losses and liability and otherwise harm our business.

 

We operate in a dynamic industry, and we have experienced significant change in recent years, including undertaking certain acquisitions and conducting our initial public offering, and the emergence of new risks within the industries in which we operate or may operate in the future. Accordingly, our risk management policies and procedures may not be fully effective in identifying, monitoring and managing our risks. Some of our risk evaluation methods depend upon information provided by others and public information regarding markets, clients or other matters that are otherwise inaccessible by us. In some cases, however, that information may not be accurate, complete or up-to-date. If our policies and procedures are not fully effective or we are not always successful in capturing all risks to which we are or may be exposed, we may suffer harm to our reputation or be subject to litigation or regulatory actions that could have a material adverse effect on our business, financial condition and results of operations.

 

We offer financial services and other products and services to a large number of clients, and we are responsible for vetting and monitoring these clients and determining whether the transactions we process for them are legitimate. When our products and services are used in connection with illegitimate transactions, and we settle those funds to clients and are unable to recover them, we suffer losses and liability. These types of illegitimate, as well as unlawful, transactions can also expose us to governmental and regulatory sanctions, including outside of Brazil (for example,

 

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U.S. anti-money laundering and economic sanctions violations). Our risk management policies, procedures, techniques, and processes may not be sufficient to identify all of the risks to which we are exposed, to enable us to mitigate the risks we have identified, or to identify additional risks to which we may become subject in the future. Furthermore, if our risk management policies and processes contain errors or are otherwise ineffective, we may suffer large financial losses, we may be subject to civil and criminal liability, and our business may be materially and adversely affected.

 

Holding large and concentrated positions may expose us to losses.

 

Concentration of risk may reduce revenues or result in losses in our institutional and retail investment business, our market-making activities and our underwriting businesses in the event of unfavorable market conditions, failed executions or settlements with respect to transactions that we underwrite, or in instances in which market conditions are more favorable to our competitors. We commit substantial amounts of capital to these businesses, which often results in our taking large positions in the securities of a particular issuer or issuers in a particular industry, country or region, and any losses in these large positions may have a material adverse effect on our financial condition and results of operations.

 

We may not be able to secure financing on favorable terms, or at all, to meet our future capital needs.

 

We have funded our operations since inception in part through equity financings, bank credit facilities and other financing arrangements. In the future, we may require additional capital to respond to business opportunities, refinancing needs, challenges, acquisitions, or unforeseen circumstances and may decide to engage in equity or debt financings or enter into credit facilities for other reasons, and we may not be able to secure any such additional debt or equity financing or refinancing on favorable terms, in a timely manner, or at all. Any debt financing obtained by us in the future could also include restrictive covenants relating to our capital-raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. Our credit facilities contain restrictive covenants, including customary limitations on the incurrence of certain indebtedness and liens. Our ability to comply with these covenants may be affected by events beyond our control, and breaches of these covenants could result in a default under our credit facilities and any future financing agreements into which we may enter. If not waived, defaults could cause our outstanding indebtedness under our credit facilities and any future financing agreements that we may enter into under these terms to become immediately due and payable. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to grow or support our business and to respond to business challenges could be significantly limited. See “Item 5. Operating and Financial Review and Prospects—B. Liquidity and capital resources—Indebtedness.”

 

Some of our clients reach us on digital media platforms, leading to our difficulties in maintaining all the communication records.

 

Under the relevant laws and regulations of Brazil (including CVM Rule No. 505), we are generally required to keep the records of our communications with customers concerning our services for at least a period of 5 years, including from IFAs. To ensure all of our users and customers are best served, we occasionally provide customer service on popular digital media platforms in a similar way as other market participants in both our industry and other various industries. However, we cannot solve all the difficulties arising therefrom because the digital media platforms usually do not have functions that telephone or email operation systems use for the long-term storage of communication records, which, such difficulties, if questioned by the CVM, could have a material adverse effect on our business, financial condition and results of operations.

 

If we are not able to respond to changes in user preferences for our financial products and services and provide a satisfactory user experience on our platform, or our existing and new products and services do not maintain or achieve sufficient market acceptance, we will not be able to maintain and expand our user base and increase user activities, and our financial results and competitive position will be harmed.

 

We believe that our user base is the cornerstone of our business. Our ability to maintain and expand our user base depends on a number of factors, including our ability to offer suitable financial products and services for our users, and our ability to provide relevant and timely products and services to meet changing user needs at a reasonable cost. If we are unable to respond to changes in user preference and deliver satisfactory and distinguishable user experience at a reasonable cost, our users may switch to competing platforms or, in relevant cases, obtain the relevant products and services directly from their providers. As a result, user access to and user activity on our platform will decline, our products and services will be less attractive to our users, and our business, financial performance and prospects will be materially and adversely affected.

 

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We have devoted significant resources to, and will continue to emphasize, upgrading and marketing our existing financial products and services and enhancing their market awareness. We also incur expenses and expend resources upfront to develop, acquire and market new financial products and services that incorporate additional features, improve functionality or otherwise make our products more desirable to clients. New financial products and services must achieve high levels of market acceptance in order for us to recoup our investment in developing, acquiring and bringing them to market.

 

Our existing and new financial products and services could fail to attain sufficient market acceptance for many reasons, including:

 

· investors are not willing to deploy their funds in a timely or efficient manner;

 

· we may fail to predict market demand accurately and provide products and services that meet this demand in a timely fashion;

 

· users may not like, find useful or agree with, any changes;

 

· there may be defects, errors or failures on our platform;

 

· there may be negative publicity about our financial products and services or our platform’s performance or effectiveness;

 

· if new financial products and services or changes to our platform do not comply with Brazilian laws, regulations or rules applicable to us;

 

· there may be competing products and services introduced or anticipated to be introduced by our competitors; and

 

· there may be changes in our clients preferences towards low risk investments within traditional banks due to the market declines and increased volatility caused by the COVID-19 pandemic, which could decrease our net inflows from both new and existing clients.

 

If our existing and new financial products and services do not achieve adequate acceptance in the market, our competitive position, financial condition and results of operations could be adversely affected.

 

Our balance sheet includes significant amounts of intangible assets. The impairment of a significant portion of these assets would negatively affect our business, financial condition and results of operations.

 

As of December 31, 2019, our balance sheet includes intangible assets that amount to R$553 million. These assets consist primarily of identified intangible assets associated with our acquisitions. We also expect to engage in additional acquisitions, which may result in our recognition of additional intangible assets. Under current accounting standards, we are required to amortize certain intangible assets over the useful life of the asset, while certain other intangible assets are not amortized. On at least an annual basis, we assess whether there have been impairments in the carrying value of certain intangible assets. If the carrying value of the asset is determined to be impaired, then it is written down to fair value by a charge to operating earnings. An impairment of a significant portion of intangible assets could have a material adverse effect on our business, financial condition and results of operations.

 

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Certain Risks Relating to Brazil

 

The Brazilian federal government has exercised, and continues to exercise, significant influence over the Brazilian economy. This involvement as well as Brazil’s political and economic conditions could harm us and the price of our Class A common shares.

 

The Brazilian federal government frequently exercises significant influence over the Brazilian economy and occasionally makes significant changes in policy and regulations. The Brazilian government’s actions to control inflation and other policies and regulations have often involved, among other measures, increases or decreases in interest rates, changes in fiscal policies, wage and price controls, foreign exchange rate controls, blocking access to bank accounts, currency devaluations, capital controls and import and export restrictions. We have no control over and cannot predict what measures or policies the Brazilian government may take in the future. We and the market price of our Class A common shares may be harmed by changes in Brazilian government policies, as well as general economic factors, including, without limitation:

 

· growth or downturn of the Brazilian economy;

 

· interest rates and monetary policies;

 

· exchange rates and currency fluctuations;

 

· inflation;

 

· liquidity of the domestic capital and lending markets;

 

· import and export controls;

 

· exchange controls and restrictions on remittances abroad and payments of dividends;

 

· modifications to laws and regulations according to political, social and economic interests;

 

· fiscal policy, monetary policy and changes in tax laws;

 

· economic, political and social instability, including general strikes and mass demonstrations;

 

· labor and social security regulations;

 

· energy and water shortages and rationing;

 

· public health crises, such as the ongoing COVID-19 pandemic;

 

· commodity prices; and

 

· other political, diplomatic, social and economic developments in or affecting Brazil.

 

Uncertainty over whether the Brazilian federal government will implement reforms or changes in policy or regulation affecting these or other factors in the future may affect economic performance and contribute to economic uncertainty in Brazil, which may have an adverse effect on our activities and consequently our results of operations, and may also adversely affect the trading price of our Class A common shares. Recent economic and political instability has led to a negative perception of the Brazilian economy and higher volatility in the Brazilian securities markets, which also may adversely affect us and our Class A common shares. See “—Economic uncertainty and political instability in Brazil may harm us and the price of our Class A common shares” and “Item 5. Operating and Financial Review and Prospects—A. Operating results—Brazilian Macroeconomic Environment.”

 

Economic uncertainty and political instability in Brazil may harm us and the price of our Class A common shares.

 

Brazil’s political environment has historically influenced, and continues to influence, the performance of the country’s economy. Political crises have affected and continue to affect the confidence of investors and the general public, which have historically resulted in economic deceleration and heightened volatility in the securities offered by companies with significant operations in Brazil.

 

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The recent economic instability in Brazil has contributed to a decline in market confidence in the Brazilian economy as well as to a deteriorating political environment. In addition, various ongoing investigations into allegations of money laundering and corruption being conducted by the Office of the Brazilian Federal Prosecutor, including the largest such investigation, known as “ Operação Lava Jato ,” have negatively impacted the Brazilian economy and political environment. The potential outcome of these investigations is uncertain, but they have already had an adverse impact on the image and reputation of the implicated companies, and on the general market perception of the Brazilian economy. We cannot predict whether the ongoing investigations will result in further political and economic instability, or if new allegations against government officials and/or executives of private companies will arise in the future.

 

A failure by the Brazilian government to implement necessary reforms may result in diminished confidence in the Brazilian government’s budgetary condition and fiscal stance, which could result in downgrades of Brazil’s sovereign foreign credit rating by credit rating agencies, negatively impact Brazil’s economy, lead to further depreciation of the real and an increase in inflation and interest rates, adversely affecting our business, financial condition and results of operations.

 

Any of the above factors may create additional political uncertainty, which could harm the Brazilian economy and, consequently, our business, and could adversely affect our financial condition, results of operations and the price of our Class A common shares.

 

Inflation and certain measures by the Brazilian government to curb inflation have historically harmed the Brazilian economy and Brazilian capital markets, and high levels of inflation in the future would harm our business and the price of our Class A common shares.

 

In the past, Brazil has experienced extremely high rates of inflation. Inflation and some of the measures taken by the Brazilian government in an attempt to curb inflation have had significant negative effects on the Brazilian economy generally. Inflation, policies adopted to curb inflationary pressures and uncertainties regarding possible future governmental intervention have contributed to economic uncertainty and heightened volatility in the Brazilian capital markets.

 

According to the National Consumer Price Index ( Índice Nacional de Preços ao Consumidor Amplo , or IPCA), which is published by the Brazilian Institute for Geography and Statistics ( Instituto Brasileiro de Geografia e Estatística , or IBGE), Brazilian inflation rates were 4.3%, 3.7% and 2.9% as of December 31, 2019, 2018 and 2017, respectively. Brazil may experience high levels of inflation in the future and inflationary pressures may lead to the Brazilian government intervening in the economy and introducing policies that could harm our business and the trading price of our Class A common shares. In the past, the Brazilian government’s interventions included the maintenance of a restrictive monetary policy with high interest rates that restricted credit availability and reduced economic growth, causing volatility in interest rates. For example, the official interest rate in Brazil decreased from 14.25% as of December 31, 2015 to 4.50% as of December 31, 2019, as established by the COPOM. On February 7, 2018, the COPOM reduced the SELIC rate to 6.75% and further reduced the SELIC rate to 6.50% on March 21, 2018. The COPOM reconfirmed the SELIC rate of 6.50% on May 16, 2018 and subsequently on June 20, 2018. As of December 31, 2018, the SELIC rate was 6.50%. The COPOM reconfirmed the SELIC rate of 6.50% on February 6, 2019, but reduced the SELIC rate to 6.00% on August 1, 2019, further reduced the rate to 5.00% on October 30, 2019 and further reduced the rate to 4.50% on December 12, 2019. On February 5, 2020, the COPOM reduced the SELIC rate to 4.25% and further reduced the rate to 3.75% on March 18, 2020. As of April 28, 2020, the SELIC rate is 3.75% Conversely, more lenient government and Central Bank policies and interest rate decreases have triggered and may continue to trigger increases in inflation, and, consequently, growth volatility and the need for sudden and significant interest rate increases, which could negatively affect us and increase our indebtedness.

 

Exchange rate instability may have adverse effects on the Brazilian economy, us and the price of our Class A common shares.

 

The Brazilian currency has been historically volatile and has been devalued frequently over the past three decades. Throughout this period, the Brazilian government has implemented various economic plans and used various exchange rate policies, including sudden devaluations, periodic mini-devaluations (during which the

 

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frequency of adjustments has ranged from daily to monthly), exchange controls, dual exchange rate markets and a floating exchange rate system. Although long-term depreciation of the real is generally linked to the rate of inflation in Brazil, depreciation of the real occurring over shorter periods of time has resulted in significant variations in the exchange rate between the real , the U.S. dollar and other currencies. The real depreciated against the U.S. dollar by 32.0% at year-end 2015 as compared to year-end 2014, and by 11.8% at year-end 2014 as compared to year-end 2013. The real /U.S. dollar exchange rate reported by the Central Bank was R$3.9048 per U.S. dollar on December 31, 2015 and R$3.2591 per U.S. dollar on December 31, 2016, which reflected a 16.5% appreciation in the real against the U.S. dollar during 2016. The real /U.S. dollar exchange rate reported by the Central Bank was R$3.308 per U.S. dollar on December 31, 2017, which reflected a 1.5% depreciation in the real against the U.S. dollar during 2017. The real/U.S. dollar exchange rate reported by the Central Bank was R$3.8742 per US$1.00 on December 31, 2018, which reflected a 17.1% depreciation in the real against the U.S. dollar during 2018. The real/U.S. dollar exchange rate reported by the Central Bank was R$4.0307 per US$1.00 on December 31, 2019, which reflected a 4.0% depreciation in the real against the U.S. dollar during 2019. As of April 28, 2020, the exchange rate for the purchase of U.S. dollars as reported by the Central Bank was R$5.5683 per US$1.00.

 

A devaluation of the real relative to the U.S. dollar could create inflationary pressures in Brazil and cause the Brazilian government to, among other measures, increase interest rates. Any depreciation of the real may generally restrict access to the international capital markets. It would also reduce the U.S. dollar value of our results of operations. Restrictive macroeconomic policies could reduce the stability of the Brazilian economy and harm our results of operations and profitability. In addition, domestic and international reactions to restrictive economic policies could have a negative impact on the Brazilian economy. These policies and any reactions to them may harm us by curtailing access to foreign financial markets and prompting further government intervention. A devaluation of the real relative to the U.S. dollar may also, as in the context of the current economic slowdown, decrease consumer spending, increase deflationary pressures and reduce economic growth.

 

On the other hand, an appreciation of the real relative to the U.S. dollar and other foreign currencies may deteriorate the Brazilian foreign exchange current accounts. We and certain of our suppliers purchase services from countries outside Brazil, and thus changes in the value of the U.S. dollar compared to other currencies may affect the costs of services that we purchase. Depending on the circumstances, either devaluation or appreciation of the real relative to the U.S. dollar and other foreign currencies could restrict the growth of the Brazilian economy, as well as our business, results of operations and profitability.

 

Infrastructure and workforce deficiency in Brazil may impact economic growth and have a material adverse effect on us.

 

Our performance depends on the overall health and growth of the Brazilian economy. Brazilian GDP growth has fluctuated over the past few years, with growth of 3.0% in 2013 but decreasing to 0.5% in 2014, a contraction of 3.5% in 2015, a contraction of 3.3% in 2016, a growth of 1.1% in 2017, a growth of 1.1% in 2018 and a growth of 1.1% in 2019. Growth is limited by inadequate infrastructure, including potential energy shortages and deficient transportation, logistics and telecommunication sectors, general strikes, the lack of a qualified labor force, and the lack of private and public investments in these areas, which limit productivity and efficiency. Additionally, despite the business continuity and crisis management policies currently in place, travel restrictions or potential impacts on personnel due to the COVID-19 pandemic may disrupt our business, our IFAs and the expansion of our client base. Any of these factors could lead to labor market volatility and generally impact income, purchasing power and consumption levels, which could limit growth and ultimately have a material adverse effect on us.

 

Developments and the perceptions of risks in other countries, including other emerging markets, the United States and Europe, may harm the Brazilian economy and the price of our Class A common shares.

 

The market for securities offered by companies with significant operations in Brazil is influenced by economic and market conditions in Brazil and, to varying degrees, market conditions in other Latin American and emerging markets, as well as the United States, Europe and other countries. To the extent the conditions of the global markets or economy deteriorate, the business of companies with significant operations in Brazil may be harmed. The weakness in the global economy has been marked by, among other adverse factors, lower levels of consumer and corporate confidence, decreased business investment and consumer spending, increased unemployment, reduced income and asset values in many areas, reduction of China’s growth rate, currency volatility and limited availability of credit and access to capital. Developments or economic conditions in other emerging market countries have at times significantly affected the availability of credit to companies with significant operations in Brazil and resulted in considerable outflows of funds from Brazil, decreasing the amount of foreign investments in Brazil.

 

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Crises and political instability in other emerging market countries, the United States, Europe or other countries, including increased international trade tensions and protectionist policies, could decrease investor demand for securities offered by companies with significant operations in Brazil, such as our Class A common shares. In June 2016, the United Kingdom had a referendum in which the majority voted to leave the European Union (so-called “Brexit”). The announcement of Brexit caused significant volatility in global stock markets and currency exchange rate fluctuations. The United Kingdom formally left the European Union on January 31, 2020, at which point a transition period began. The United Kingdom is expected to continue to follow certain European Union rules during the transition period; however, the ongoing process of negotiations between the United Kingdom and the European Union will determine the future terms of the United Kingdom’s relationship with the European Union, including access to European Union markets, either during the transitional period or more permanently. We have no control over and cannot predict the effect of the United Kingdom’s exit from the European Union nor over whether and to which effect any other member state will decide to exit the European Union in the future. These developments, as well as potential crises and forms of political instability arising therefrom or any other as of yet unforeseen development, may harm our business and the price of our Class A common shares.

 

The COVID-19 pandemic is expected to have a negative impact on global, regional and national economies, and we would be materially adversely affected by a protracted economic downturn.

 

The current COVID-19 pandemic is expected to have a negative impact on global, regional and national economies and to disrupt supply chains and otherwise reduce international trade and business activity. Reflecting this, the COVID-19 pandemic has already in February, March and April 2020 caused the levels of equity and other financial markets to decline sharply and to become volatile, and such effects may continue or worsen in the future. This may in turn further impact the stock market and REIT markets in Brazil, which are directly related to a substantial proportion of our operations, given that changes in fair value of the related assets and liabilities are recognized in our income statement. The market declines and volatility could negatively impact the value of such financial instruments causing us to incur losses as well as result in the postponement or cancellation of several public offering and mergers and acquisitions thereby reducing our issuer services advisory fees, among others. The economic slowdown and market downturn could also negatively impact specific portfolios through negative ratings migration and higher than expected losses, potentially leading clients to redirect investments away from us and to more traditional financial institutions, as well as reduced management fees from our asset management businesses, which are required to meet certain criteria to earn performance fees.

 

The market volatility resulting from the COVID-19 pandemic has already caused a number of planned public stock offerings and merger and acquisition transactions in Brazil to be postponed or cancelled, which we expect will have a negative effect on our revenues in our Issuer Services business. The current COVID-19 pandemic and its potential impact on the global economy may affect our ability to meet our financial targets. While it is too early for us to predict the impacts on our business or our financial targets that the expanding pandemic, and the governmental responses to it, may have, we would be materially adversely affected by a protracted downturn in local, regional or global economic conditions.

 

Any further downgrading of Brazil’s credit rating could reduce the trading price of our Class A common shares.

 

We may be harmed by investors’ perceptions of risks related to Brazil’s sovereign debt credit rating. Rating agencies regularly evaluate Brazil and its sovereign ratings, which are based on a number of factors including macroeconomic trends, fiscal and budgetary conditions, indebtedness metrics and the perspective of changes in any of these factors.

 

The rating agencies began to review Brazil’s sovereign credit rating in September 2015. Subsequently, the three major rating agencies downgraded Brazil’s investment-grade status:

 

· Standard & Poor’s initially downgraded Brazil’s credit rating from BBB-negative to BB-positive and subsequently downgraded it again from BB-positive to BB, maintaining its negative outlook, citing a worse credit situation since the first downgrade. On January 11, 2018, Standard & Poor’s further downgraded Brazil’s credit rating from BB to BB-negative.

 

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· In December 2015, Moody’s placed Brazil’s Baa3’s issue and bond ratings under review for downgrade and subsequently downgraded the issue and bond ratings to below investment grade, at Ba2 with a negative outlook, citing the prospect of a further deterioration in Brazil’s debt indicators, taking into account the low growth environment and the challenging political scenario.

 

· Fitch downgraded Brazil’s sovereign credit rating to BB-positive with a negative outlook, citing the rapid expansion of the country’s budget deficit and the worse-than-expected recession. In February 2018, Fitch downgraded Brazil’s sovereign credit rating again to BB-negative, citing, among other reasons, fiscal deficits, the increasing burden of public debt and an inability to implement reforms that would structurally improve Brazil’s public finances. Brazil’s sovereign credit rating is currently rated below investment grade by the three main credit rating agencies. Consequently, the prices of securities offered by companies with significant operations in Brazil have been negatively affected. A prolongation or worsening of the current Brazilian recession and continued political uncertainty, among other factors, could lead to further ratings downgrades. Any further downgrade of Brazil’s sovereign credit ratings could heighten investors’ perception of risk and, as a result, cause the trading price of our Class A common shares to decline.

 

Certain Risks Relating to Our Class A Common Shares

 

An active trading market for our common shares may not be sustainable. If an active trading market is not maintained, investors may not be able to resell their shares at or above the offering price and our ability to raise capital in the future may be impaired.

 

Although our Class A common shares are listed and being traded on Nasdaq, an active trading market for our shares may not be maintained. If an active market for our Class A common shares is not maintained, it may be difficult for you to sell shares you have purchased without depressing the market price for the shares or at all. An inactive trading market may also impair our ability to raise capital to continue to fund operations by selling shares and may impair our ability to acquire other companies or technologies by using our shares as consideration.

 

XP Controle owns 64.61% of our outstanding Class B common shares, which represents approximately 54.79% of the voting power of our issued share capital, and, subject to the provisions of the Shareholders’ Agreement, control all matters requiring shareholder approval. This concentration of ownership and voting power limits your ability to influence corporate matters.

 

As of December 31, 2019, XP Controle controlled our company and did not hold any of our Class A common shares, but beneficially owned 23.14% of our issued share capital through its beneficial ownership of 64.61% of our outstanding Class B common shares, respectively, and consequently, 54.79% of the combined voting power of our issued share capital. Our Class B common shares are entitled to 10 votes per share and our Class A common shares are entitled to one vote per share. Our Class B common shares are convertible into an equivalent number of Class A common shares. As a result, XP Controle, subject to the provisions of the Shareholders’ Agreement, controls the outcome of all decisions at our shareholders’ meetings, and is able to elect a majority of the members of our board of directors. XP Controle is also able to direct our actions in areas such as business strategy, financing, distributions, acquisitions and dispositions of assets or businesses. For example, XP Controle may cause us to make acquisitions that increase the amount of our indebtedness or outstanding Class A common shares, sell revenue-generating assets or inhibit change of control transactions that may benefit other shareholders. The decisions of XP Controle on these matters may be contrary to your expectations or preferences, and they may take actions that could be contrary to your interests. They are, subject to the provisions of the Shareholders’ Agreement, able to prevent any other shareholders, including you, from blocking these actions. In addition, for so long as they beneficially own more than two-thirds of our issued share capital, XP Controle will also have the ability to unilaterally amend XP’s Memorandum and Articles of Association, which may be amended only by special resolution of shareholders (requiring a two-thirds majority vote of those shareholders attending and voting at a quorate meeting).

 

So long as XP Controle beneficially owns a sufficient number of Class B common shares, even if it beneficially owns significantly less than 50% of our outstanding share capital, it will be able to effectively control our decisions.

 

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We have granted the holders of our Class B common shares preemptive rights to acquire shares that we may sell in the future, which may impair our ability to raise funds.

 

Under our Memorandum and Articles of Association and the Shareholders’ Agreement, the holders of our Class B common shares, XP Controle, Itaú and GA Bermuda, are entitled to preemptive rights to purchase additional common shares in the event that there is an increase in our share capital and additional common shares are issued, upon the same economic terms and at the same price, in order to maintain their proportional ownership interests, which are approximately 23.14%, 46.05% and 13.60% of our outstanding shares, respectively. The exercise by holders of our Class B common shares of their preemptive rights may impair our ability to raise funds, or adversely affect the terms on which we are able to raise funds, as we may not be able to offer to new investors the quantity of our shares that they may desire to purchase. For more information, see “Item 10. Additional Information—B. Memorandum and articles of association—Preemptive or Similar Rights.”

 

Class A common shares eligible for future sale may cause the market price of our Class A common shares to drop significantly.

 

The market price of our Class A common shares may decline as a result of sales of a large number of our Class A common shares in the market or the perception that these sales may occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

 

As of December 31, 2019, we had outstanding 354,181,346 Class A common shares and 197,618,980 Class B common shares. Subject to the lock-up agreements described below, the Class A common shares sold in our public offering are freely tradable without restriction or further registration under the Securities Act by persons other than our affiliates within the meaning of Rule 144 of the Securities Act.

 

Our shareholders or entities controlled by them or their permitted transferees are able to sell their Class A common shares in the public market from time to time without registering them, subject to certain limitations on the timing, amount and method of those sales imposed by regulations promulgated by the SEC. If any of our shareholders, the affiliated entities controlled by them or their respective permitted transferees were to sell a large number of their Class A common shares, the market price of our Class A common shares may decline significantly. In addition, the perception in the public markets that sales by them might occur may also cause the trading price of our Class A common shares to decline.

 

Sales of substantial amounts of our Class A common shares in the public market, or the perception that these sales may occur, could cause the market price of our Class A common shares to decline. This could also impair our ability to raise additional capital through the sale of our equity securities. Under our Articles of Association, we are authorized to issue up to 5,500,000,000 shares, of which 551,800,326 common shares are outstanding. We cannot predict the size of future issuances of our shares or the effect, if any, that future sales and issuances of shares would have on the market price of our Class A common shares.

 

Our Memorandum and Articles of Association and the Shareholders’ Agreement contain, anti-takeover provisions that may discourage a third-party from acquiring us and adversely affect the rights of holders of our Class A common shares.

 

Our Memorandum and Articles of Association and the Shareholders’ Agreement contain, certain provisions that could limit the ability of others to acquire our control, including a provision that grants authority to our board of directors to establish and issue from time to time one or more series of preferred shares and to determine, with respect to any series of preferred shares, the terms and rights of that series. These provisions could have the effect of depriving our shareholders of the opportunity to sell their shares at a premium over the prevailing market price by discouraging third parties from seeking to obtain our control in a tender offer or similar transactions.

 

If securities or industry analysts do not publish research, or publish inaccurate or unfavorable research, about our business, the price of our Class A common shares and our trading volume could decline.

 

The trading market for our Class A common shares depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrade our Class A common shares or publish inaccurate or unfavorable research about our business, the price of our Class A common shares would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our Class A common shares could decrease, which might cause the price of our Class A common shares and trading volume to decline.

 

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We may not pay any cash dividends in the foreseeable future.

 

The declaration, payment and amount of any future dividends will be made at the discretion of our board of directors and will depend upon, among other things, the results of operations, cash flows and financial condition, operating and capital requirements, and other factors as our board of directors considers relevant. In addition, our holding company structure makes us dependent on the operations of our subsidiaries. See “—Certain Risks Relating to Our Business and Industry—Our holding company structure makes us dependent on the operations of our subsidiaries.” There is no assurance that future dividends will be paid, and if dividends are paid, there is no assurance with respect to the amount of any such dividend. See “Item 8. Financial Information—A. Consolidated statements and other financial information—Dividends and Dividend Policy.” and “Item 10. Additional Information—B. Memorandum and articles of association—Dividends and Capitalization of Profits.”

 

Our dual class capital structure means our shares will not be included in certain indices. We cannot predict the impact this may have on the trading price of our Class A common shares.

 

In 2017, FTSE Russell, S&P Dow Jones and MSCI announced changes to their eligibility criteria for inclusion of shares of public companies on certain indices to exclude companies with multiple classes of shares of common stock from being added to such indices. FTSE Russell announced plans to require new constituents of its indices to have at least five percent of their voting rights in the hands of public stockholders, whereas S&P Dow Jones announced that companies with multiple share classes, such as ours, will not be eligible for inclusion in the S&P 500, S&P MidCap 400 and S&P SmallCap 600, which together make up the S&P Composite 1500. MSCI also opened public consultations on their treatment of no-vote and multi-class structures and temporarily barred new multi-class listings from its ACWI Investable Market Index and U.S. Investable Market 2500 Index; however, in October 2018, MSCI announced its decision to include equity securities “with unequal voting structures” in its indices and to launch a new index that specifically includes voting rights in its eligibility criteria. We cannot assure you that other stock indices will not take a similar approach to FTSE Russell, S&P Dow Jones and MSCI in the future. Under the announced policies, our dual class capital structure would make us ineligible for inclusion in any of these indices and, as a result, mutual funds, exchange-traded funds and other investment vehicles that attempt to passively track these indices will not invest in our stock. It continues to be somewhat unclear what effect, if any, these policies will have on the valuations of publicly traded companies excluded from the indices, but in certain situations they may depress these valuations compared to those of other similar companies that are included. Exclusion from indices could make our Class A common shares less attractive to investors and, as a result, the market price of our Class A common shares could be adversely affected.

 

The dual class structure of our common stock has the effect of concentrating voting control with XP Controle, our controlling shareholder; this will limit or preclude your ability to influence corporate matters.

 

Each Class A common share entitles its holder to one vote per share and each Class B common share entitles its holder to ten votes per share, so long as the total number of votes of the issued and outstanding Class B common shares represents at least 10% of the voting share rights of the Company. The beneficial owners of our Class B common shares currently consist of XP Controle, Itaú and GA Bermuda, with XP Controle holding 64.61% of the Class B common shares. Due to the ten-to-one voting ratio between our Class B and Class A common shares, our controlling shareholder, XP Controle, controls a majority of the combined voting power of our common shares and therefore is able to, subject to the provisions of the Shareholders’ Agreement, control all matters submitted to our shareholders so long as the total number of the issued and outstanding Class B common shares is at least 10% of the voting share rights of the Company.

 

In addition, our Memorandum and Articles of Association provide that at any time when there are Class A common shares in issue, additional Class B common shares may only be issued pursuant to (1) a share split, subdivision of shares or similar transaction or where a dividend or other distribution is paid by the issue of shares or rights to acquire shares or following capitalization of profits; (2) a merger, consolidation, or other business combination involving the issuance of Class B common shares as full or partial consideration; or (3) an issuance of Class A common shares, whereby holders of the Class B common shares are entitled to purchase a number of Class B common shares that would allow them to maintain their proportional ownership and voting interests in XP (following an offer by us to each holder of Class B common shares to issue to such holder, upon the same economic terms and at the same price, such number of Class B common shares as would ensure such holder may maintain a proportional ownership and voting interest in XP pursuant to our Memorandum and Articles of Association).

 

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In light of the above provisions relating to the issuance of additional Class B common shares, as well as the ten-to-one voting ratio of our Class B common shares and Class A common shares, holders of our Class B common shares in many situations maintain control of all matters requiring shareholder approval. This concentrated control limits or precludes your ability to influence corporate matters for the foreseeable future. For a description of our dual class structure, see “Item 10. Additional Information—B. Memorandum and articles of association—Voting Rights.”

 

We are a Cayman Islands exempted company with limited liability. The rights of our shareholders, including with respect to fiduciary duties and corporate opportunities, may be different from the rights of shareholders governed by the laws of U.S. jurisdictions.

 

We are a Cayman Islands exempted company with limited liability. Our corporate affairs are governed by our Memorandum and Articles of Association and by the laws of the Cayman Islands. The rights of shareholders and the responsibilities of members of our board of directors may be different from the rights of shareholders and responsibilities of directors in companies governed by the laws of U.S. jurisdictions. In particular, as a matter of Cayman Islands law, directors of a Cayman Islands company owe fiduciary duties to the company and separately a duty of care, diligence and skill to the company. Under Cayman Islands law, directors and officers owe the following fiduciary duties: (1) duty to act in good faith in what the director or officer believes to be in the best interests of the company as a whole; (2) duty to exercise powers for the purposes for which those powers were conferred and not for a collateral purpose; (3) directors should not properly fetter the exercise of future discretion; (4) duty to exercise powers fairly as between different sections of shareholders; (5) duty to exercise independent judgment; and (6) duty not to put themselves in a position in which there is a conflict between their duty to the company and their personal interests. Our Memorandum and Articles of Association have varied this last obligation by providing that a director must disclose the nature and extent of his or her interest in any contract or arrangement, and following such disclosure and subject to any separate requirement under applicable law or the listing rules of the Nasdaq, and unless disqualified by the chairman of the relevant meeting, such director may vote in respect of any transaction or arrangement in which he or she is interested and may be counted in the quorum at the meeting. Conversely, under Delaware corporate law, a director has a fiduciary duty to the corporation and its stockholders (made up of two components) and the director’s duties prohibits self-dealing by a director and mandates that the best interest of the corporation and its shareholders take precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the shareholders generally. See “Item 10. Additional Information—B. Memorandum and articles of association—Principal Differences between Cayman Islands and U.S. Corporate Law.”

 

We may need to raise additional capital in the future by issuing securities or may enter into corporate transactions with an effect similar to a merger, which may dilute your interest in our share capital and affect the trading price of our Class A common shares.

 

We may need to raise additional funds to grow our business and implement our growth strategy through public or private issuances of common shares or securities convertible into, or exchangeable for, our common shares, which may dilute your interest in our share capital or result in a decrease in the market price of our common shares. In addition, we may also enter into mergers or other similar transactions in the future, which may dilute your interest in our share capital or result in a decrease in the market price of our Class A common shares. Any fundraising through the issuance of shares or securities convertible into or exchangeable for shares, or the participation in corporate transactions with an effect similar to a merger, may dilute your interest in our capital stock or result in a decrease in the market price of our Class A common shares.

 

As a foreign private issuer, we have different disclosure and other requirements than U.S. domestic registrants.

 

As a foreign private issuer, we are subject to different disclosure and other requirements than domestic U.S. registrants and non-emerging growth companies. For example, as a foreign private issuer, in the United States, we are not subject to the same disclosure requirements as a domestic U.S. registrant under the Exchange Act, including the requirements to prepare and issue quarterly reports on Form 10-Q or to file current reports on Form 8-K upon the occurrence of specified significant events, the proxy rules applicable to domestic U.S. registrants under Section 14 of the Exchange Act or the insider reporting and short-swing profit rules applicable to domestic U.S. registrants under Section 16 of the Exchange Act. In addition, we rely on exemptions from certain U.S. rules which permit us to follow Cayman Islands legal requirements rather than certain of the requirements that are applicable to U.S. domestic registrants.

 

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We follow Cayman Islands laws and regulations that are applicable to Cayman Islands companies. However, Cayman Islands laws and regulations applicable to Cayman Islands companies do not contain any provisions comparable to the U.S. proxy rules, the U.S. rules relating to the filing of reports on Form 10-Q or 8-K or the U.S. rules relating to liability for insiders who profit from trades made in a short period of time, as referred to above.

 

Furthermore, foreign private issuers are required to file their annual report on Form 20-F within 120 days after the end of each fiscal year, while U.S. domestic issuers that are accelerated filers are required to file their annual report on Form 10-K within 75 days after the end of each fiscal year. Foreign private issuers are also exempt from Regulation Fair Disclosure, aimed at preventing issuers from making selective disclosures of material information, although we will be subject to Cayman Islands laws and regulations having, in some respects, a similar effect as Regulation Fair Disclosure. As a result of the above, even though we are required to file reports on Form 6-K disclosing the limited information which we have made or are required to make public pursuant to Cayman Islands law, or are required to distribute to shareholders generally, and that is material to us, you may not receive information of the same type or amount that is required to be disclosed to shareholders of a U.S. company.

 

We are a “controlled company” within the meaning of the rules of the Nasdaq corporate governance rules and, as a result, qualify for, and rely on, exemptions from certain corporate governance requirements. You will not have the same protections afforded to shareholders of companies that are subject to such requirements.

 

XP Controle beneficially owns 64.61% of our Class B common shares, representing 54.79% of the voting power of our outstanding share capital. As a result, we are a “controlled company” within the meaning of the corporate governance standards of the Nasdaq corporate governance rules. Under these rules, a company of which more than 50% of the voting power in the election of directors is held by an individual, group or another company is a “controlled company” and may elect not to comply with certain corporate governance requirements. For example, controlled companies, within one year of the date of the listing of their common shares:

 

· are not required to have a board that is composed of a majority of “independent directors,” as defined under the rules of such exchange;

 

· are not required to have a compensation committee that is composed entirely of independent directors; and

 

· are not required to have a nominating and corporate governance committee that is composed entirely of independent directors.

 

We currently rely on these exemptions. As a result, the majority of the directors on our board are not independent. In addition, none of the committees of our board consist entirely of independent directors. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all of the corporate governance requirements of the Nasdaq.

 

As a foreign private issuer, we rely on exemptions from certain Nasdaq corporate governance standards applicable to U.S. issuers, including the requirement that a majority of an issuer’s directors consist of independent directors. This may afford less protection to holders of our Class A common shares.

 

Section 5605 of the Nasdaq equity rules requires listed companies to have, among other things, a majority of their board members be independent, and to have independent director oversight of executive compensation, nomination of directors and corporate governance matters. As a foreign private issuer, however, we are permitted to follow, and we do follow, home country practice in lieu of the above requirements. See “Item 10. Additional Information—B. Memorandum and articles of association—Principal Differences between Cayman Islands and U.S. Corporate Law.”

 

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We may lose our foreign private issuer status which would then require us to comply with the Exchange Act’s domestic reporting regime and cause us to incur significant legal, accounting and other expenses.

 

In order to maintain our current status as a foreign private issuer, either (a) more than 50% of our Class A common shares must be either directly or indirectly owned of record by non-residents of the United States or (b)(i) a majority of our executive officers or directors may not be U.S. citizens or residents; (2) more than 50% of our assets cannot be located in the United States; and (3) our business must be administered principally outside the United States. If we lose this status, we would be required to comply with the Exchange Act reporting and other requirements applicable to U.S. domestic issuers, which are more detailed and extensive than the requirements for foreign private issuers. We may also be required to make changes in our corporate governance practices in accordance with various SEC and Nasdaq rules. The regulatory and compliance costs to us under U.S. securities laws if we are required to comply with the reporting requirements applicable to a U.S. domestic issuer may be significantly higher than the costs we will incur as a foreign private issuer.

 

Our shareholders may face difficulties in protecting their interests because we are a Cayman Islands exempted company.

 

Our corporate affairs are governed by our Memorandum and Articles of Association, by the Companies Law (as amended) of the Cayman Islands, or the Companies Law, and the common law of the Cayman Islands. The rights of shareholders to take action against our directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as that from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less exhaustive body of securities laws than the United States. In addition, some U.S. states, such as Delaware, have more fulsome and judicially interpreted bodies of corporate law than the Cayman Islands.

 

While Cayman Islands law allows a dissenting shareholder to express the shareholder’s view that a court sanctioned reorganization of a Cayman Islands company would not provide fair value for the shareholder’s shares, Cayman Islands statutory law does not specifically provide for shareholder appraisal rights in connection with a court sanctioned reorganization (by way of a scheme of arrangement). This may make it more difficult for you to assess the value of any consideration you may receive in a merger or consolidation (by way of a scheme of arrangement) or to require that the acquirer gives you additional consideration if you believe the consideration offered is insufficient. However, Cayman Islands statutory law provides a mechanism for a dissenting shareholder in a merger or consolidation to apply to the Grand Court of the Cayman Islands for a determination of the fair value of the dissenter’s shares if it is not possible for the company and the dissenter to agree on a fair price within the time limits prescribed.

 

Shareholders of Cayman Islands exempted companies (such as us) have no general rights under Cayman Islands law to inspect corporate records and accounts or to obtain copies of lists of shareholders. Our directors have discretion under our Memorandum and Articles of Association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

 

Subject to limited exceptions, under Cayman Islands’ law, a minority shareholder may not bring a derivative action against the board of directors. Class actions are not recognized in the Cayman Islands, but groups of shareholders with identical interests may bring representative proceedings, which are similar.

 

United States civil liabilities and certain judgments obtained against us by our shareholders may not be enforceable.

 

We are a Cayman Islands exempted company and substantially all of our assets are located outside of the United States. In addition, the majority of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside of the United States. As a result, it may be difficult to effect service of process within the United States upon these persons. It may also be difficult to enforce in U.S. courts judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors who are not resident in the United States and the substantial majority of whose assets are located outside of the United States.

 

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Further, it is unclear if original actions predicated on civil liabilities based solely upon U.S. federal securities laws are enforceable in courts outside the United States, including in the Cayman Islands and Brazil. Courts of the Cayman Islands may not, in an original action in the Cayman Islands, recognize or enforce judgments of U.S. courts predicated upon the civil liability provisions of the securities laws of the United States or any state of the United States on the grounds that such provisions are penal in nature. Although there is no statutory enforcement in the Cayman Islands of judgments obtained in the United States, courts of the Cayman Islands will recognize and enforce a foreign judgment of a court of competent jurisdiction if such judgment is final, for a liquidated sum, provided it is not in respect of taxes or a fine or penalty, is not inconsistent with a Cayman Islands’ judgment in respect of the same matters, and was not obtained in a manner which is contrary to the public policy of the Cayman Islands. In addition, a Cayman Islands court may stay proceedings if concurrent proceedings are being brought elsewhere.

 

Judgments of Brazilian courts to enforce our obligations with respect to our Class A common shares may be payable only in reais.

 

Most of our assets are located in Brazil. If proceedings are brought in the courts of Brazil seeking to enforce our obligations in respect of our Class A common shares, we may not be required to discharge our obligations in a currency other than the real . Under Brazilian exchange control laws, an obligation in Brazil to pay amounts denominated in a currency other than the real may only be satisfied in Brazilian currency at the exchange rate, typically as determined by the Central Bank, in effect on the date the judgment is obtained, and such amounts are then typically adjusted to reflect exchange rate variations and monetary restatements through the effective payment date. The then-prevailing exchange rate may not afford non-Brazilian investors with full compensation for any claim arising out of or related to our obligations under the Class A common shares.

 

Our Class A common shares may not be a suitable investment for all investors, as investment in our Class A common shares presents risks and the possibility of financial losses.

 

The investment in our Class A common shares is subject to risks. Investors who wish to invest in our Class A common shares are thus subject to asset losses, including loss of the entire value of their investment, as well as other risks, including those related to our Class A common shares, us, the sector in which we operate, our shareholders and the general macroeconomic environment in Brazil, among other risks.

 

Each potential investor in our Class A common shares must therefore determine the suitability of that investment in light of its own circumstances. In particular, each potential investor should:

 

· have sufficient knowledge and experience to make a meaningful evaluation of our Class A common shares, the merits and risks of investing in our Class A common shares and the information contained in this annual report;

 

· have access to, and knowledge of, appropriate analytical tools to evaluate, in the context of its particular financial situation, an investment in our Class A common shares and the impact our Class A common shares will have on its overall investment portfolio;

 

· have sufficient financial resources and liquidity to bear all of the risks of an investment in our Class A common shares;

 

· understand thoroughly the terms of our Class A common shares and be familiar with the behavior of any relevant indices and financial markets; and

 

· be able to evaluate (either alone or with the help of a financial adviser) possible scenarios for economic, interest rate and other factors that may affect its investment and its ability to bear the applicable risks.

 

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There can be no assurance that we will not be a passive foreign investment company for any taxable year, which could subject United States investors in our Class A common shares to significant adverse U.S. federal income tax consequences.

 

Under the Internal Revenue Code of 1986, as amended, or the Code, we will be a passive foreign investment company, or PFIC, for any taxable year in which, after the application of certain look-through rules with respect to subsidiaries, either (1) 75% or more of our gross income consists of “passive income;” or (2) 50% or more of the average quarterly value of our assets consists of assets that produce, or are held for the production of, “passive income.” Passive income generally includes dividends, interest, certain non-active rents and royalties, and capital gains. Based on our current operations, income, assets and certain estimates and projections, including as to the relative values of our assets, including goodwill, which is based on the expected price of our Class A common shares, we do not expect to be a PFIC for our 2019 taxable year. However, there can be no assurance that the Internal Revenue Service, or the IRS, will agree with our conclusion. In addition, whether we will be a PFIC in 2019 or in any future year is uncertain because, among other things, (1) we hold and expect to continue to hold a substantial amount of cash, which is categorized as a passive asset; and (2) our PFIC status for any taxable year will depend on the composition of our income and assets and the value of our assets from time to time (which may be determined, in part, by reference to the market price of our Class A common shares, which could be volatile). Accordingly, there can be no assurance that we will not be a PFIC for any taxable year.

 

If we are a PFIC for any taxable year during which a U.S. investor holds Class A common shares, we generally would continue to be treated as a PFIC with respect to that U.S. investor for all succeeding years during which the U.S. investor holds Class A common shares, even if we ceased to meet the threshold requirements for PFIC status. Such a U.S. investor may be subject to adverse U.S. federal income tax consequences, including (1) the treatment of all or a portion of any gain on disposition as ordinary income; (2) the application of a deferred interest charge on such gain and the receipt of certain dividends; and (3) compliance with certain reporting requirements. A “mark-to-market” election may be available that will alter the consequences of PFIC status if our Class A common shares are regularly traded on a qualified exchange. For further discussion, see “Item 10. Additional Information—E. Taxation—U.S. Federal Income Tax Considerations.”  

 

ITEM 4. INFORMATION ON THE COMPANY

 

A. History and development of the company

 

We are a Cayman Islands exempted company incorporated with limited liability on August 29, 2019 for purposes of effectuating our initial public offering. At the time of our incorporation, XP Controle, Itaú Unibanco S.A. (the predecessor-in-interest to ITB Holding Brasil Participações Ltda.), G.A. Brasil IV Fundo de Investimento em Participações (the predecessor-in-interest to GA Bermuda) and DYNA III held 2,036,988,542 shares (prior to giving effect to the Share Split) of XP Investimentos S.A., or XP Brazil, which are all of the shares of XP Brazil, our Brazilian principal non-operating holding company whose consolidated financial statements are included elsewhere in this annual report.

 

On November 29, 2019, XP Controle, Itaú, GA Bermuda and DYNA III contributed all of their shares in XP Brazil to us. In return for this contribution, we issued new Class B common shares to XP Controle, new Class A common shares and Class B common shares to Itaú, new Class A common shares and Class B common shares to GA Bermuda, and new Class A common shares to DYNA III in a one-to-one exchange for the shares of XP Brazil contributed to us, or the Share Contribution. In addition and following the Share Contribution, we implemented a four-to-one reverse share split (or consolidation), effective as of November 30, 2019, or the Share Split.

 

On December 10, 2019, the registration statement on Form F-1 (File No 333-234719) relating to our initial public offering of our class A common shares was declared effective by the SEC. On December 10, 2019, we commenced our initial public offering. On December 13, 2019 we closed our initial public offering, pursuant to which we issued and sold 42,553,192 Class A common shares and certain selling shareholders sold an additional 40,834,045 Class A common shares for an aggregate amount of 83,387,237 Class A common shares for an aggregate price of US$2,251,455,399 (R$9,044 million). We did not receive any proceeds from the sale of Class A common shares by the selling shareholders.

 

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We have a total of 551,800,326 common shares issued and outstanding, 197,618,980 of these shares are Class B common shares beneficially owned by XP Controle, Itaú and GA Bermuda, and 354,181,346 of these shares are Class A common shares beneficially owned by Itaú, GA Bermuda, DYNA III and by other investors.

 

Our group is currently composed of 25 entities, 16 of which are incorporated in Brazil and 9 of which are incorporated in other countries. The numbers of total revenue and income presented below eliminate the effects of intercompany transactions. Our material operating subsidiaries are:

 

XP Investimentos Corretora de Câmbio, Títulos e Valores Mobiliários S.A., or XP CCTVM

 

XP CCTVM is a Brazilian broker-dealer entity and the core entity of the group, with the highest concentration of the group’s employees. All retail clients of XP Investimentos (including XP Direct and through our IFA network), Clear and Rico brands onboard and access all the products in our investment platform through XP CCTVM. In addition, it provides brokerage and issuer services to institutional and corporate clients. XP CCTVM had assets of R$5,336 million (representing 44.3% of our combined assets) as of December 31, 2017, R$14,050 million (representing 73.5% of our combined assets) as of December 31, 2018 and R$29,316 million (representing 60.9% of our combined assets) as of December 31, 2019. XP CCTVM recorded total revenue and income of R$1,380 million during 2017 (representing 72.4% of our consolidated total revenue and income), R$1,967 million during 2018 (representing 66.5% of our consolidated total revenue and income) and R$3,322 million during 2019 (representing 74.3% of our consolidated total revenue and income).

 

XP Gestão de Recursos Ltda., or XP Gestão

 

XP Gestão, founded in 2005, was the first asset management firm within the group. It manages mutual funds focused on stocks and macro strategies, which are distributed to our retail clients via XP CCTVM and to institutional clients. XP Gestão had assets of R$75 million (representing 0.6% of our combined assets) as of December 31, 2017, R$105 million (representing 0.5% of our combined assets) as of December 31, 2018 and R$146 million (representing 0.3% of our combined assets) as of December 31, 2019. XP Gestão recorded total revenue and income of R$70 million during 2017 (representing 3.7% of our consolidated total revenue and income), R$71 million during 2018 (representing 2.4% of our consolidated total revenue and income) and R$175 million during 2019 (representing 3.9% of our consolidated total revenue and income).

 

XP Advisory Gestão de Recursos Ltda., or XP Advisory

 

XP Advisory is a Brazilian asset management firm focused on single client mandates, including managing exclusive funds and managed portfolios for our high-net-worth retail clients via XP CCTVM. XP Advisory had assets of R$8 million (representing 0.1% of our combined assets) as of December 31, 2017, R$19 million (representing 0.1% of our combined assets) as of December 31, 2018 and R$18 million (representing 0.1% of our combined assets) as of December 31, 2019. XP Advisory recorded total revenue and income of R$11 million during 2017 (representing 0.6% of our consolidated total revenue and income), R$21 million during 2018 (representing 0.7% of our consolidated total revenue and income) and R$35 million during 2019 (representing 0.8% of our consolidated total revenue and income).

 

XP Vista Asset Management Ltda., or XP Vista

 

XP Vista, acquired in 2018, is a Brazilian asset management firm focused on managing passive mutual funds that track market indexes, and mutual and investment funds focused on fixed income, credit, real estate, infrastructure and other alternative strategies, which are distributed to our retail clients (via XP CCTVM) and institutional clients. XP Vista had assets of R$12 million (representing 0.1% of our combined assets) as of December 31, 2018 and R$41 million (representing 0.1% of our combined assets) as of December 31, 2019. XP Vista recorded total revenue and income of R$20 million during 2018 (representing 0.7% of our consolidated total revenue and income) and R$93 million during 2019 (representing 2.1% of our consolidated total revenue and income).

 

XP Corretora de Seguros Ltda., or XP Seguros

 

XP Seguros, founded in 2008, is a Brazilian insurance broker focused on providing pension plans, both from our insurance company and from third-party insurance companies, and life insurance products from third-party

 

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insurance companies. XP Seguros provides such products to our retail clients through our platform. XP Seguros had assets of R$20 million (representing 0.2% of our combined assets) as of December 31, 2017, R$48 million (representing 0.2% of our combined assets) as of December 31, 2018 and R$127 million (representing 0.3% of our combined assets) as of December 31, 2019. XP Seguros recorded total revenue and income of R$27 million during 2017 (representing 1.4% of our consolidated total revenue and income), R$61 million during 2018 (representing 2.1% of our consolidated total revenue and income) and R$130 million during 2019 (representing 2.9% of our consolidated total revenue and income).

 

XP Investments US, LLC, or XP Investments

 

XP Investments, founded in 2010, is a broker-dealer registered with the SEC and FINRA, as well as an interdealer broker member with the NFA. With offices in New York and Miami, its key businesses include providing securities brokerage services for institutional and retail investors (most of which are Brazilian) and interdealer brokerage services for institutional traders. XP Investments had assets of R$152 million (representing 1.3% of our combined assets) as of December 31, 2017, R$253 million (representing 1.3% of our combined assets) as of December 31, 2018 and R$407 million (representing 0.8% of our combined assets) as of December 31, 2019. XP Investments recorded total revenue and income of R$132 million during 2017 (representing 6.9% of our consolidated total revenue and income), R$206 million during 2018 (representing 7.0% of our consolidated total revenue and income) and R$302 million during 2019 (representing 6.7% of our consolidated total revenue and income).

 

XPE Infomoney Educação Assessoria Empresarial e Participações Ltda., or XP Educação

 

XP Educação, founded in 2003, focuses on our digital content services, including developing and selling financial education courses and events online and in person to retail clients. XP Educação had assets of R$10 million (representing 0.1% of our combined assets) as of December 31, 2017 and R$40 million (representing 0.2% of our combined assets) as of December 31, 2018 and R$117 million (representing 0.2% of our combined assets) as of December 31, 2019. XP Educação recorded total revenue and income of R$10 million during 2017 (representing 0.5% of our consolidated total revenue and income), R$57 million during 2018 (representing 1.9% of our consolidated total revenue and income) and R$112 million during 2019 (representing 2.5% of our consolidated total revenue and income).

 

Acquisitions and New Lines of Business

 

Spiti

 

On September 2, 2019, we incorporated Spiti Análise Ltda. (formerly known as Lírios Participações Ltda.), our Brazilian subsidiary, to act as a provider of independent research reports to retail clients.

 

XP Portugal

 

In September 2019, we incorporated Chamaleon Bravery, Unipessoal, LDA, or XP Portugal. XP Portugal is an investment advisory company. We expect XP Portugal to become operational in the second half of 2020. As of the date of this annual report, we are in the process of obtaining the applicable regulatory approvals, as required by the Portuguese Securities and Exchange Commission ( Comissão do Mercado de Valores Mobiliários ), or CMVM.

 

Banco XP

 

On October 11, 2019, the Central Bank authorized Banco XP to operate as a multi-purpose bank, with both commercial and investment banking activities, as well as to carry out transactions in the foreign exchange markets. On that same date, the share capital of Banco XP was increased from R$10 million to R$100 million. Banco XP began its operations on November 2019 on a reduced scale, offering pledged asset loans (Resgate Express and Limite Express) and foreign exchange related services only to its employees. In January 2020, Banco XP started offering such services to XP CCTVM’s IFA network, and on February 19, 2020, to all XP CCTVM clients.

 

XP Vida e Previdência

 

On December 11, 2017, we incorporated XP Controle 5 Participações S.A., a life insurance and private pension plans provider in Brazil. On September 5, 2018, the SUSEP granted XP Controle 5 Participações S.A. the Portaria No. 7200 authorization to operate as an insurance company in Brazil, and XP Controle 5 Participações S.A. changed its legal name to XP Vida e Previdência S.A.. In an effort to support our expansion strategy, XP VP increased its capital to R$17.5 million on September 24, 2018, to R$22.5 million on July 24, 2019 and to R$27.5 million on December 30, 2019.

 

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Following a transition period during which XP VP tested and integrated its systems and processes, XP VP began its operations in April 2019.

 

Rico

 

On August 10, 2017, following the approval of the Central Bank, we completed the acquisition of Rico Corretora de Títulos e Valores Mobiliários S.A., or Rico, for an aggregate purchase price of approximately R$405 million. At the time of the acquisition, Rico had approximately R$10.9 billion in assets under custody and approximately 129,000 clients. The Rico acquisition was in line with our growth strategy to accelerate the expansion of our retail customer base and the further positioning of our complementary brands, namely XP Investimentos, Clear and Rico, and was a key driver of the expansion of our business. On October 4, 2018, following the approval of the Central Bank, the entity Rico merged into XP CCTVM, but it remains as a brand. For further information on the marketing and positioning of our brands, see “Item 4. Information on the Company—B. Business overview.”

 

2016 Corporate Reorganization

 

During 2016, XP Brazil, through a series of transactions with G.A. Brasil IV Fundo de Investimento em Participações (the predecessor-in-interest to GA Bermuda), conducted a corporate reorganization with the objective of simplifying the organization of the group and eliminating non-controlling interests. This transaction resulted in the increase of share capital and capital reserve by R$98.4 million and R$245.4 million, respectively. As part of the reorganization, XP Brazil legally merged with a new holding entity, resulting in the creation of a deferred income tax asset of R$122.1 million recorded in capital reserve in equity, relating to the previously generated tax-deductible goodwill at one of the subsidiaries that was rolled up as part of the reorganization.

 

Recent Developments

 

Private Equity Asset

 

On January 7, 2020, we incorporated XP PE Gestão de Recursos Ltda., our Brazilian subsidiary, to act as private equity asset management.

 

Visa Agreement

 

On March 4, 2020, XP Brazil entered into an agreement with Visa as its issuing brand of debit and credit cards, which will be launched by the company during 2020. The initiative marks our entrance in the card segment in Brazil and it is aligned with the strategy on creating a full-service platform by adding new financial products to benefit our clients. Since last year, we established a squad focused on the product design, which is now working closely with Visa to bring a differentiated offer to our customers, that will enjoy Visa’s large number of services and other new and revolutionary benefits to be launched with the “XP Visa Infinite Card.”

 

Resignation of Director

 

On April 6, 2020, Geraldo Travaglia Filho tendered his resignation as a member of our board of directors and as a member of our audit committee, effective as of April 30, 2020. His successor, Ricardo Baldin, will be nominated for election for a two-year term at our annual general meeting scheduled to take place on April 30, 2020.

 

Corporate Information

 

Our legal and commercial name is XP Inc. Our principal executive offices are located at Av. Chedid Jafet, 75, Torre Sul, 30th floor, Vila Olímpia – São Paulo, Brazil 04551-065. Our telephone number at this address is +55 (11) 3075-0429. We are registered under the laws of the Cayman Islands as an exempted company with limited liability. We have appointed XP Investments US, LLC, with offices at 55 West 46th Street, 30 Floor, New York, NY 10036, as our agent to receive service of process with respect to any action brought against us in the United States under the federal securities laws of the United States or of any state in the United States.

 

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Investors should contact us for any inquiries through the address and telephone number of our principal executive office. Our principal website is www.xpinc.com. The information contained in, or accessible through, our website is not incorporated into this annual report or the registration statement of which it forms a part. In addition, the SEC maintains a website at http://www.sec.gov, from which you can electronically access the this annual report and the registration statement and its materials.

 

B. Business overview

 

Our Mission

 

Our mission is to transform the financial markets in Brazil to improve the lives of people in our country, which is the 6th largest economy in the world with over 200 million people and a GDP of nearly US$2 trillion. We believe the financial services industry in Brazil is generally inefficient, expensive by international standards and provides poor client experiences, because it is dominated by five traditional financial institutions with US$1.5 trillion in assets that account for approximately 93% of retail assets under custody, or AUC, according to a report by Oliver Wyman published in 2019, and 80% of all consumer loans and 79% of all deposits, according to the Central Bank of Brazil.

 

We believe this concentration has enabled the incumbents to secure a large profit pool and restrict the market in Brazil by: (1) providing a more narrow selection of financial products than typically found in larger markets, such as the United States and Europe; (2) promoting inefficient financial products, such as savings accounts called Poupança, which provide investors with very low returns, at times below the inflation rate, and come with highly restrictive and punitive redemption options; (3) charging relatively high fees with low yields since the clients are captive and the products made available are often limited only to those created and controlled by each bank; and (4) providing poor customer service due to a low prioritization of the client experience, limited market competition, and a lack of alternative choices available to consumers.

 

We are dedicated to disrupting this market and improving people’s lives by providing them with access to more financial products and services through multiple channels, at lower fees, with a strong emphasis on financial education and high-quality services delivered through a highly differentiated client-centric approach and innovative technology solutions.

 

Introduction to XP

 

XP is a leading, technology-driven financial services platform and a trusted provider of low-fee financial products and services in Brazil. We have developed a mission-driven culture and a revolutionary business model that we believe provide us with strong competitive advantages in our market. We use these to disintermediate the legacy models of traditional financial institutions by educating new classes of investors, democratizing access to a wider range of financial services, developing new financial products and technology applications to empower our clients, and providing what we believe is the highest-quality customer service and client experience in the industry in Brazil. We believe we have established ourselves as the leading alternative to the traditional banks, with a large and fast-growing ecosystem of retail investors, institutions, and corporate issuers, built over many years that accounted for 1.7 million active clients and R$159 billion in net in-flows of new money for the year ended December 31, 2019, up 91% year-over-year and 134% year-over-year, respectively. Based on data from sources indicated below, we believe we are:

 

· #1 Ranked Financial Investment Brand in Brazil – with an NPS of 73 as of December 2019, the highest score in our market based on company filings according to a third party analyst research report;

 

· #1 Independent Financial Investment Platform in Brazil – with 3% market share of the R$7.9 trillion market for total AUC as of December 31, 2018, according to a report by Oliver Wyman commissioned by us;

 

· #1 Independent Digital Platform for Investors in Brazil – with three digital portals XP, Rico and Clear serving clients directly. XP has the largest number of followers on Instagram (over 940,000 as of the date of this annual report) among investment firms in Brazil, and our three brands combined accounted for 59% of Google searches for investment keywords and 41% of responses to “the first brand in investments” according to Google Analytics and a consumer survey, respectively, as of December 2019;

 

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· #1 Independent Financial Investment Network in Brazil – with a range of proprietary XP Advisory Services and approximately 6,400 IFAs who on-board new clients onto the XP Platform;

 

· #1 Financial Media Portal in Latin America – with approximately 9 million monthly unique visitors to our Infomoney website as of December, 2019. Approximately 75% of our website traffic in this period was originated organically by viewers without being driven from a related site or advertisement according to third-party traffic data from Similarweb; and

 

· #1 Financial Services Event in Latin America – with over 30,000 attendees at our annual EXPERT conference held in July 2019, which we believe ranks as the largest investment services event in Latin America and one of the largest in the world based on an internal analysis of third party data.

 

Our Founding & Evolution

 

We were founded in 2001 as a small, independent financial advisor partnership dedicated to improving the lives of people in our country. In order to build our business from the ground up, while competing against the traditional banks, we dedicated ourselves to the search for new ways to compete and to leverage next-generation technologies that enable us to differentiate ourselves and provide the operating efficiencies to scale. Over the years, we have been able to consistently innovate, develop our technology solutions, and evolve our proprietary business model in several integrated phases that have complemented each other and compounded our capabilities. We believe this evolution has enabled us to instill trust in the XP brand and begin a revolution in the way financial services are sold in Brazil. These integrated evolutionary phases include:

 

(1) Providing Financial Education and Empowerment – We began our evolution by providing financial education courses to empower new classes of first-time and early-stage investors teaching them how to invest and how to access new types of financial products and services that they may not have had access to before through traditional financial institutions. These educational courses began to build trust in XP and became an effective client acquisition model by converting students into empowered clients.

 

(2) Democratizing Access to Financial Products and Services – We developed an open product platform which provided our clients with a much wider selection of financial products than the traditional banks provide to their customers. This platform included a more diverse selection of financial investment products, such as equity and fixed income securities, mutual and hedge funds, structured products, life insurance and pension plans, and real estate trusts, and a wider choice of issuers that include XP, our product partners and our competitors. The breadth of our open platform was a significant market innovation, that enhanced our brand further, and provided clients with new opportunities for risk-taking and investment returns. We believe it remains substantially differentiated when compared to the relatively closed platforms of the traditional banks.

 

(3) Scaling of Our Ecosystem of Users, Distribution & Media Content – We expanded our ecosystem of users, distribution channels, and proprietary digital content and marketing. As our retail customer base and AUC volumes grew, we attracted new issuers of financial products, corporate clients and institutional traders into our fast-growing ecosystem of clients. We complemented our distribution by scaling our network of IFAs located across Brazil who solicit new customers, provide them access to our wide selection of financial products and technology applications, and help us onboard them as XP clients. These IFAs are our strategic business partners who share our entrepreneurial spirit and mission to democratize financial services in Brazil and benefit from the competitive advantages provided by our platform and technology. To support this expansion while continuously building trusted relationships in the market, we expanded our proprietary marketing initiatives and digital media content. We continued to build our educational course offerings, created what we believe is the largest investment conference in the world, developed the largest financial information online portal in Latin America, and developed a range of social media and digital influencer programs to promote our services and brand.

 

(4) Diversification and Enhancement of Our Direct Digital Channels and Brands – We expanded our distribution significantly by leveraging our growing ecosystem to (1) grow and enhance XP Direct , our primary digital portal for investors, and (2) develop new digital channels, such as Rico , our digital portal brand for self-directed investors, and Clear , our digital portal and online trading platform brand for retail active traders. We also enhanced these direct portals further by leveraging our technology platform, fast-growing data lake, and artificial intelligence capabilities to provide more sophisticated functionality and offer more advanced data analytics tools through more intuitive and convenient user interfaces, or UX.

 

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(5) Empowerment of the Client Journey – We leveraged the significant technology DNA in our company, comprising our innovation and development teams and agile software development methods to develop a suite of new products, services and technology applications that engage and serve our clients across their financial journeys. We launched an advanced suite of cloud-based and mobile technology applications, with sleek advanced UX and easy user experience, that complement our advisory services and provide powerful functionality across the user journey, enabling our clients and partners to better manage their various accounts, trading activities, analytics, and data queries. We have also begun to expand our solutions into adjacent and complementary financial services that our clients use. For example (1) we began to provide our ecosystem with pension insurance in March 2019, and by December 2019 we had already captured approximately 10% market share of the new money inflows for this service in Brazil in that period; and (2) we received our bank license for Banco XP from the Central Bank of Brazil on October 11, 2019, which enables us to offer a range of complementary digital banking products and services to our clients, including asset-back margin finance. Since February 19, 2020, Banco XP offers pledged asset loans ( Resgate Express and Limite Express ) and foreign exchange related services to all XP CCTVM clients.

 

The following graphic illustrates how we have successfully scaled across channels and grown our client base as we evolved our business over time.

 

 

The Revolutionary XP Model

 

Our revolutionary XP Model has been developed over the course of our evolution and enables us to go to market in a very different way from the legacy models of the large traditional financial institutions. We believe our model provides us with a unique value proposition for our clients and partners, and it has begun to change the way investment services are accessed and sold in Brazil. Our differentiated approach incorporates a unique combination of proprietary capabilities, services and technologies to deliver a highly customized and integrated client experience, with significant operating efficiency advantages that have enabled us to scale and grow profitably. As illustrated in the following graphic, the key components of our model include: (1) a mission driven culture; (2) a self-reinforcing ecosystem; (3) a superior products and services platform; and (4) differentiated, advanced technology platform.

 

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· A Mission-Driven Culture – our culture remains central to XP and we remain vigilant in preserving and nurturing it, so that it can continue to guide our firm by promoting (1) a strong collaborative environment within our company; (2) a clear focus on our mission to improve people’s lives by empowering them as investors; (3) a zero-fee pricing philosophy wherever possible; (4) a strong, long-term client-centric focus which we prioritize ahead of maximizing short-term gains; and (5) an energetic entrepreneurial spirit with a commitment to innovation and the continuous pursuit of improvement.

 

· A Self-Reinforcing Ecosystem – we have developed a valuable ecosystem of clients, distribution channels and media content that are a powerful lead-generation engine, continuously reinforce each other and help promote XP’s products and services as they grow. These include:

 

· User Base of Clients – which includes our: (1) over 1.7 million retail clients who buy and sell the financial products on our platform, benefitting from our ecosystem because they can access a much broader portfolio of financial products, from hundreds of different providers, and get help finding the product that is right for them, all in a user-friendly way, with exceptionally low fees; and (2) over 400 institutional and corporate issuer clients (out of which over 200 are located in Brazil and over 200 are located outside Brazil), such as fund managers, private banks, corporate treasuries and insurance companies, who provide additional liquidity and unique financial products for our platform. These issuers benefit from our ecosystem because they are provided with dedicated strategic advisory services that enable them to access a much broader pool of capital, from our retail investors, at an overall lower cost.

 

· Omni-Channel Distribution Network – which enables us to reach clients and deliver our products and services through a range of proprietary brands and channels, that includes: (1)  XP Direct our fast-growing full-service offering for mass-affluent clients; (2)  Rico our online-only solution for self-directed investors; and (3)  Clear our digital portal and electronic trading platform for retail active traders. We also reach clients through our proprietary, and efficient distribution network of approximately 6,400 IFA partners, who are located in approximately 640 offices in 138 cities across

 

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Brazil, which collectively represent 86% of Brazilian GDP. Together, they form the largest independent financial advisor network in the country. Our IFA partners benefit from our suite of financial products, education tools, and the IFA-specific applications that we developed to help them build and grow their businesses, and we benefit from their abilities to reach and cultivate new clients.

 

· Proprietary Media & Digital Content – which helps us democratize access to financial content in Brazil, empower Brazilians on how to make investment decisions more independently, and attract, retain and monetize clients. This lead-generation ecosystem of platforms includes: (1)  Infomoney the largest investment portal in Latin America with approximately 9 million monthly unique visitors as of December 30, 2019 ; (2) XP Educação a leading online financial education portal in Brazil; (3)  XP Research digital platform with over 600,000 monthly unique visitors; (4)  EXPERT the largest investment event in Latin America with approximately 30,000 attendees in 2019; (5) our Digital Influencers program, with over 3 million followers on social media; and (6)  Leadr an investment-focused social media network with over 730,000 downloads and over 150,000 monthly active users. We believe this content is highly differentiated in Brazil, is a powerful driver of growth, and provides us with low CAC.

 

· A Superior Product and Services Platform – we primarily provide our clients with two types of offerings, our financial advisory services and our open financial product platform. We have developed both of these solutions to provide our clients with significant differentiation and a superior value proposition versus the legacy offerings of the traditional banks. These include:

 

· Suite of XP Advisory Services – which are comprised of several services, such as (1)  XP Investimentos for our retail clients in Brazil; (2)  XP Private for our high-net-worth clients; (3)  XP Investments for our international clients; and (4)  XP Issuer Services , for our corporate and institutional clients.

 

· Open Product Platform – which is our open product platform that provides our clients with the broadest access to over 600 investment products in the market without the protectionist barriers, conflicts and closed-loop restrictions of the traditional banks. These include investment products from XP, our partners and our competitors, such as equity and fixed income securities, mutual and hedge funds, structured products, life insurance, pension plans, real-estate investment funds (REITs) and others.

 

· VIP Customer Service – which is our premier customer service program and support organization, designed to provide our clients and partners with the highest quality client service. We train our customer service personnel to (1) understand the daily activities and processes across the client journey in order to help resolve customer issues more effectively; (2) prioritize positive client experiences and long-term relationships above short-term performance results; and (3) leverage and promote our advanced technologies to serve our clients more efficiently.

 

· A Differentiated, Advanced Technology Platform – we have developed a powerful, integrated suite of proprietary technology assets, technology applications, and technology development resources that enable us to differentiate XP in the market, manage all of our solutions, conduct all of our activities and operate with low-cost advantages and efficiencies. These include:

 

· XP Genius – which is our powerful, integrated, cloud-based technology platform built with a modular architecture that efficiently leverages a range of micro-services to help (1) connect our various portals, systems, technologies and environments; (2) power our solutions and applications across our organization; (3) manage our large, valuable and rapidly growing pools of proprietary data; (4) conduct our big data analytics and artificial intelligence initiatives; (5) provide us with proprietary information and market insights; and (6) extend our reach and capabilities into new areas.

 

· XP Innovation Teams – which is a dedicated innovation development program, comprised of approximately 585 people, who develop and support our solutions by using agile software development methods and leveraging the significant technology and data assets in our company. These include 9 XP Tribes , comprised of 2-3 managers each, that help guide and support our development priorities across numerous projects, and 50 XP Squads , comprised of an autonomous integrated team of 8-10 developers and business experts, that collaborate to create new technologies and solutions or improve our current offerings.

 

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· XP Technology Apps – which is an advanced suite of cloud-based and mobile technology applications, that complement our advisory services and provide powerful functionality across the user journey, enabling our clients and partners to better manage their various accounts, trading activities, and data queries. Our apps are integrated with our powerful data bases and analytics tools and are designed to be powerful, yet simple, attractive, and easy to use, with sleek user interfaces, or UX, that are comparable to some of the top consumer technology products in the world.

 

Our Operations

 

We operate an asset-light, highly scalable business model that emphasizes operational efficiency and profitability. We leverage the XP Model to serve a diverse group of retail and institutional clients in local and international markets, with offices in Brazil, New York, Miami, London and Geneva. We currently serve over 1.7 million active retail clients who have an investment account with us. Approximately 28% of our clients are served by one of our IFA partners and approximately 72% of our clients are self-served, primarily utilizing an account through one of our websites, or have an investment adviser through XP Direct. As of December 31, 2019, our average AUC per client account was approximately R$240,000.

 

We generate our revenues primarily by (1) providing our existing clients with a growing range of financial products and services in which to invest their existing AUC already on our platform; (2) attracting additional money onto our platform from existing investors to grow our total AUC; and (3) attracting new clients and money inflows onto our platform across a variety of channels to increase our total AUC. As shown in the following chart, we generate a significant amount of our revenues from existing clients and AUC, which is recurring and predictable in nature.

 

% of Retail Revenue From New Clients vs Existing Clients

 

 

Depending on the mix of products and services, we generate numerous forms of income from our AUC, including advisory fees, commissions, distribution fees from product manufacturers and asset management fees across various solution categories such as retail, institutional, issuer services, digital content and other. As a result of our business model and market position, we benefit from high visibility in most of our revenues and from a low correlation to macro-economic conditions. We have established a track record of delivering strong financial performance, even during difficult macroeconomic conditions in Brazil. For example, while Brazil GDP growth decelerated materially from 2014 to 2019 in one of the worst recessions in Brazilian history, our total AUC grew at a CAGR of 94% during the same period.

 

Our technology-driven business model is asset-light and highly scalable. This enables us to generate scale efficiencies from increases in total AUC. We conduct the majority of our business online and through mobile applications and emphasize operational efficiency and profitability throughout our operations. These operating

 

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efficiencies enable us to generate strong cash flow in various market conditions, allowing us to continue investing in the growth of our business. Our business requires minimal capital expenditures to facilitate organic growth, with expenditures amounting to 3.1% and 4.6% of net revenues for the years ended December 31, 2019 and 2018, respectively. Additionally, our strong balance sheet serves as a substantial competitive advantage relative to other independent financial services providers in Brazil, enabling us to underwrite, develop and distribute new financial products and services, and capture inorganic opportunities, such as our acquisitions of Infomoney in 2011 and Rico in 2018.

 

In 2019, we reported R$409 billion in AUC, R$5,518 billion in gross revenue, R$5,128 billion in net revenue, R$1,089 million in net income, and R$1,074 million in Adjusted Net Income, a year-over-year increase of 103%, 72%, 73%, 134% and 119%, respectively, versus 2018.

 

Our Market

 

Brazil is a large and attractive market for financial services and financial technology solutions. The country has the 6 th largest population and the 9 th largest economy in the world with 210 million people and a GDP of US$2.06 trillion in 2019. As shown in the graph below, Brazil GDP growth decelerated materially from 2014 to 2019 in one of the worst recessions in Brazilian history. During this period, we established a track record of delivering strong financial performance, even during difficult macroeconomic conditions, and grew our total AUC at a CAGR of 94%. Brazil emerged from its recession in 2018 and is now expected to enter a more positive macroeconomic environment for the first time in several years, which we believe will create favorable tailwinds for our business.

 

 

Key Market Challenges

 

We believe the Brazil financial services industry faces several important market challenges that create market inefficiencies and opportunities for disruption, including:

 

· Highly Concentrated Market – In Brazil, the financial services market continues to be controlled by a few traditional financial institutions. According to a report by Oliver Wyman published in 2019, five banks, Itaú Unibanco, Bradesco, Banco do Brasil, Caixa Economica Federal and Santander, collectively accounted for 93% of the R$8.6 trillion in investment AUC. According to the latest information from the Brazilian Central Bank, these same five banks collectively accounted for: (1) 80% of the R$2.6 trillion in all deposits; (2) 99% of the R$599 billion in mortgages; (3) 79% of the R$231 billion in credit card outstanding balances; (4) 93% of the R$810 billion in open Pension Funds; (5) 61% of the R$4.7 trillion in institutional asset management funds; (6) 84% of the R$1.8 trillion in personal loans; and (7) 78% of the R$1.5 trillion in corporate credit balances. We believe this concentration has created material market inefficiencies which provide significant opportunities for disruption, disintermediation, and new business models.

 

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· Bureaucratic, Asset-Heavy Infrastructures – The legacy models of the traditional banks are based on asset-heavy infrastructures such as large networks of physical bank branches, large bureaucratic organizations with hundreds of thousands of personnel and processes, and older, segregated technology platforms. We believe these cumbersome infrastructures encourage the traditional banks to focus more on (1) managing the internal burdens of their operations; (2) pushing their in-house products over alternatives from third-party providers; and (3) preserving the status quo.

 

· Narrow Selection of Financial Products – The concentration of traditional financial institutions in Brazil provide their customers with more limited access to financial products than typically found in larger and more developed markets, such as the United States and Europe. These banks have closed-loop product platforms which significantly restricts the selection of investment products made available to their customers typically to those that were created in-house by each bank or have significant embedded costs to drive promotion. We believe these practices tend to drive high fees and/or low cost of funding for the traditional banks, but severely limit choice for investors.

 

· Promotion of Inefficient Financial Products In Brazil the traditional banks continue to promote inefficient financial products, such as self-issued time deposits, or CDBs, and savings accounts called Poupan ç a , which provide a large number of the mass population of investors with very low returns and punitive redemption options, often at an attractive margin to the bank. Poupan ç a or other cash accounts account for 20% of all investment assets in Brazil, according to Oliver Wyman, despite paying relatively low interest rates, often lower than the base Selic interest rate in Brazil, and occasionally even lower than the inflation rate, as shown in the graph below. We believe the continued promotion of these products is not in the best interests of investors, but they continue to generate high fees for the traditional banks.

 

 

Source : Séries temporais – Banco Central do Brasil

 

· High-Costs and Spreads We believe overall fees and spreads for financial products in Brazil are too high and are driven by (1) the closed platforms of the incumbent banks who often limit their customer’s selection of financial products to those created and controlled by each bank; (2) the promotion of inefficient financial products that pay very low yields, such as Poupan ç a; and (3) the high, asset-heavy infrastructure costs of the incumbent banks.

 

· Poor Customer Service We believe the incumbent banks and other service providers generally provide poor customer service in Brazil based on market surveys, given the lack of market competition and alternative choices available to their clients. We believe these factors drive the prioritization of near-term results over long-term client relationships and discourage the banks from (1) focusing on their client’s day-to-day needs; (2) serving the entire customer experience; and (3) looking for new ways to add value.

 

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· Underpenetrated Debt Capital and Other Financial Markets – We believe the debt capital markets in Brazil are significantly underpenetrated for the issuance of fixed income products and corporate bonds, particularly when compared to larger markets such as the United States and Europe. The incumbent banks control the majority of the debt market and typically steers clients to bank issued term loans or limited fixed income products that are sold to their asset management businesses, which we believe limits the amount of available credit in the market and fosters an environment for higher costs due to limited competition. Similarly, other lending products, commonly found in larger markets, such as home equity loans, are very limited in Brazil.

 

Key Market Trends

 

· Favorable and Highly-Aligned Regulatory Initiatives – The Central Bank of Brazil, or BCB, is actively promoting what it calls financial democratization policies that seek to provide easier access to financial markets, long-term low interest rates and better financial services. We believe these regulatory initiatives provide a favorable regulatory environment that are closely aligned and complement our mission to improve people’s lives by transforming the financial markets in Brazil. The Central Bank, has implemented an active regulatory agenda, called BC# which is focused on addressing structural issues of the National Financial System by fostering technological innovation. The Central Bank has defined four dimensions for its agenda, including:

 

· Inclusion – which it defines as “to ensure non-discriminatory access to the market for all those wishing to participate: small and large businesses entrepreneurs, investors and borrowers, both domestic and foreign clients.” Initiatives in this dimension involve (1) fostering the expansion of credit cooperatives; (2) simplifying and modernizing foreign exchange and international trade regulation (convertibility of the real); (3) local capital market development; and (4) enlarging access to microcredit;

 

· Competitiveness – which it defines as “to promote adequate pricing through fostering competitive access to financial markets.” Initiatives in this dimension involve (1) innovation and preparing the financial system for a technological and inclusive future (e.g. instant payments, open banking, and cyber risk management); (2) improving the management of international reserves; and (3) increasing market efficiency (e.g. market infrastructure and reserve requirements).

 

· Transparency – which it defines as “to improve the market and the BCB information availability and quality, and strengthen the transparency of information regarding financial markets – such as financial services and credit earmarking rules.” Initiatives in this dimension involve (1) improving conditions for rural and mortgage loans; (2) strengthening BCB’s relationship with Congress and foreign investors; and (3) Enhancing transparency and communication of BCB’s actions, including monetary policy decisions.

 

· Education – which it defines as “to promote the citizens’ financial awareness – and, ultimately, their participation in the financial markets – as well as to strengthen the habit of saving.” Initiatives in this dimension involve providing scalable financial education solutions to school students, indebted individuals and low-income citizens.

 

· Increasing Demand for Financial Education & Information – As interest rates and yields on traditional savings product have decreased, we believe there are a growing number of people interested in learning (1) the basics of financial freedom and empowerment; (2) how to access the financial markets more effectively; and (3) more sophisticated financial management strategies. We have seen the number of financial education students increase significantly in the market and believe the demand for financial media content has grown materially in the last few years across a number of channels.

 

· Increasing Demand for Financial Products – As more customers claim their financial freedom from the traditional banks, and yields on other bank products remain stagnant, we believe the market will see a

 

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steady increase in the demand for more types of financial products and more choices of issuers across different asset classes and risk appetites. We believe there will also continue to be an increasing interest from institutions and corporates for more product issuing opportunities and product structuring services. We believe this is a long-term trend as the Brazilian market expands to close the product selection gap with other large markets, such as the United States and Europe. Nevertheless, overall market declines and increased volatility may reduce the desirability of our products and services to both new and existing clients, such as in connection with the ongoing COVID-19 pandemic.

 

· Increasing Demand for Technology to Manage Financial Services – Similar to other trends in commerce, customers in Brazil are increasingly looking to conduct their financial journeys through digital channels, via online portals, cloud-based platforms and mobile technology applications, instead of in bank branches. In addition, as customers engagement increases, they are also demanding access to more sophisticated analytical tools and technology applications, such as comparison engines, risk management tools, and electronic trading platforms, through digital channels that can enable these features at low costs and high efficiency.

 

· Increasing Demand for Better UX Experiences – As customers engage in more digital channels, they are increasingly demanding sleeker, more powerful and more convenient user interfaces, or UX, similar to the consumer technology products and software applications that they interact with in other areas of their daily lives. We believe these digital customers will increasingly demand technology applications that provide intuitive, easy-to-use, yet powerful features, that can integrate and utilize all of their data, and empower them to do more across their client journeys, versus just siloed applications with one or two functions.

 

· Increasing Number of Independent Financial Advisors – the career market for registered IFAs is growing rapidly in Brazil as the traditional banks continue to close branches and reduce costs from their large legacy operations. Many top financial services professionals who previously worked in these banks are looking to become IFAs. The total number of IFAs in Brazil has grown from over 5,000 in 2015 to over 9,000 by 2019 according to a report by Oliver Wyman published in 2019.

 

· Increasing Demand for Turn-Key Solutions and Applications for IFAs Many of these IFAs are looking for new platforms, that provide the product suites, business management tools and technology applications that they can use to start their businesses, attract new customers and manage their operations more effectively.

 

· Disintermediation of Investments, Credit and Market Equitization – Greater access to information and technology are making Brazilians increasingly aware and inclined to look for alternatives outside the traditional retail banks for investment products and services. Brazil is in the early stages of this process, with 93% of all retail AUC still inside the five incumbent banks according to a report by Oliver Wyman. Large corporates in Brazil have also been diversifying their funding sources away from Brazil’s largest banks, as the three Government-owned banks, Banco do Brasil, Caixa and BNDES, have reduced their corporate loan portfolios by R$372 billion in aggregate from December 2014 to June 2019, while Itaú Unibanco, Bradesco and Santander Brasil have kept their respective corporate loan books relatively unchanged during this same period. In addition, equities as an asset class is still incredibly underpenetrated among retail investors, with only 1% of Brazilians having an active brokerage account.

 

· Market Volatility in Connection with the COVID-19 Pandemic – As a consequence of the market volatility in connection with the COVID-19 pandemic, a number of planned public stock offerings and merger and acquisition transactions in Brazil have been postponed or cancelled, which we expect will have a negative effect on our revenues in our Issuer Services business. In addition, our retail business may be affected, as asset management businesses (such as ours) must meet certain criteria for performance fees, and we expect that the current market performance will result in reduced management fees in comparison to 2019. Moreover, new and existing clients may choose to redirect investments away from us toward more traditional banks in a flight to safety.

 

Addressable Market Opportunities

 

We believe our XP Model will benefit from these key market trends and the favorable macroeconomic environment in Brazil, and has positioned us to continue to penetrate, grow and expand our large addressable market

 

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opportunity in Brazil, which was expected to reach nearly R$8.6 trillion in investment AUC and adjacent markets by the end of 2019, according to a report by Oliver Wyman. Given our leadership, scale, brand, and competitive advantages provided by our XP Model , we believe we will benefit from and continue to be a catalyst for:

 

· Continued Growth of the Investment AUC Addressable Market – According to a report by Oliver Wyman published in 2019, the total addressable market of investment AUC in Brazil was R$7.9 trillion in 2018, up 105% since 2011, representing a CAGR of 11% that is roughly expected to continue at least up to 2024, as shown in the following graph.

 

Evolution Of Investment Assets

R$ Tn, Nominal Values

 

 

· Continued Shift of AUC from Banks to Independent Investment Firms – According to the Oliver Wyman report, banks in Brazil currently control approximately 93% of retail investment AUC and independent investment firms control approximately 7%, of which we believe XP accounts for the significant majority. Oliver Wyman estimates that the market share of investment AUC for independent investment firms will grow from 7% in 2018 to 25% in 2024. We believe this is a long-term trend that is still in the early stages. A similar shift away from banks has been observed in other markets across the globe, including the United States, where independent investment firms controlled 87% of mutual funds distributions in 2017, also according to Oliver Wyman, as shown in the following graphs.

 

Evolution Of Investment Assets Market Share

 

 

 

1. For banks, it includes both retail and private banking branches as well as online banking; it excludes networks of IFA belonging to the groups. Considers mutual funds’ assets distribution.

 

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Source : ANBIMA, Valor, Infomoney survey May/2017, Financial Times, Platforum. Oliver Wyman analysis

 

· Shift from Fixed Income to More Effective Products – Within the growth of AUC, we believe there is a long-term mix shift trend from lower yielding fixed income products to higher potential yielding products such as equities, managed funds, and structured products, such as derivatives. The share of fixed income as a percentage of total investment AUC dropped from 22% in 2016 to 19% in 2018 as shown in the following graph. These products have higher margins for investment platforms, positively affecting our profitability. In addition, these products tend to require more sophisticated advisory services given their inherently higher risk and complexity, which benefits firms, such as XP, that offer valuable financial planning and investment advisory services with a superior customer experience.

 

Evolution Of Investment Assets By Product Type

R$ Tn, Nominal Values

 

 

· Continued Expansion of Our Addressable Market into New Areas – We have made significant progress in disrupting the investment services of traditional banks, which can be among the hardest to penetrate, due to the difficulty in gaining customer trust, and have one of the highest switching costs in the financial services industry, due to the expense and tax impact of moving accounts. According to a report by Oliver Wyman published in 2019, we believe the total addressable revenue pool including adjacent markets that could be complementary to XP, such as insurance brokerage, credit and debit cards and other loans currently is R$487 billion, as shown in the following graphic.

 

Estimated Market Size (Revenues; FY 2018) 

R$ Bn, Nominal Values

 

 

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Note: Insurance Brokerage are the commissions paid by insurance companies to the brokers distributing their products; Debit/Credit Cards include (1) MDR fees; (2) net interest income after provisions for rotativo , installments and overdraft; (3) annual fees on cards; (4) discounting of receivables; and (5) POS rental/sales; Other Loans include net interest income after provision for payroll, auto and personal loans plus mortgages (non-earmarked) and corporate loans.

 

Our Competitive Strengths

 

Over the last 19 years, we have developed a differentiated set of capabilities and attributes in our business that we believe provide us with meaningful strategic advantages and have helped us to disintermediate the legacy models of traditional financial institutions. We believe these competitive strengths form the foundations of our business and drive value creation for our shareholders.

 

Mission-Driven Culture

 

Our culture remains central to XP and we believe it is the core strength of our company, enabling us to attract talent, unify our people, maintain the mindset to innovate and disrupt, guide our go-to-market-approach, develop powerful relationships with our clients and establish our identity in the marketplace. We remain vigilant in preserving and nurturing it, so that it can continue to guide our firm. We believe the key strengths of our culture are:

 

· A Collaborative Partnership Model that fosters a collaborative environment within our company and an ownership mentality across our organization, which have enabled employees at all levels to remain focused and well aligned despite our rapid growth and expansion;

 

· Our Mission to Empower – which helps us maintain a clear and consistent message internally to our employees and partners and externally to the market, that our primary focus is to empower our clients and improve their lives by providing them with better access to investment opportunities;

 

· A Zero-Fee Pricing Philosophy – that seeks to eliminate expensive and unnecessary bank fees and charges, such as custodial, account maintenance and transfer services fees, which provides us with comparative marketing advantage and constantly reminds us to remain efficient;

 

· A Client-Centric Focus – that prioritizes transparency in our services, high-quality customer service and positive client experiences above short-term performance results, which helps us build a loyal customer base and long-term relationships that can be seen in our client cohorts and retention data; and

 

· An Entrepreneurial Spirit – that keeps us focused on the continuous pursuit of innovation across our firm to improve our operations and our client experiences. This fosters an energetic, meritocratic environment that attracts the most innovative financial and technological talent in the country to work or partner with us, which has helped us remain creative and avoid complacency.

 

Revolutionary XP Model

 

Our model incorporates a unique combination of proprietary capabilities, services and technologies to deliver a highly differentiated and integrated client experience, that have enabled us to differentiate from our competitors. In addition, the XP Model has given several strategic and operating advantages, including:

 

· First-Disruptor Leadership Since our founding in 2001, XP has established itself as a trusted provider of low-cost brokerage, investment advisory, and asset management services in Brazil, the largest independent investment platform and leading alternative to the banks;

 

· Trusted Brand We have built a valuable, trusted brand in Brazil and received an NPS of 73 in December 2019, which is the highest score in the financial services industry;

 

· Highly Efficient Financial Model We believe our technology driven business model provides us with significant scale and operating efficiencies, including:

 

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· Large Scale and Recurring Revenue We have significant scale with R$409 billion in AUC and R$5.5 billion in last twelve-month gross revenue as of December 31, 2019. Our business also has a significant component of highly recurring revenue. We believe these help provide our business with a level of predictability and defensibility;

 

· Attractive LTV / CAC – Our business has an attractive client LTV (as defined herein) due to our wallet share gains, revenue yield and low churn, driven by strong client relationships, our focus on the client experience, our increasing suite of solutions, and the structural high switching costs inherent in investment services. Our model also has relatively low acquisition costs per client due to our efficient marketing driven by our primarily digital business model, our self-reinforcing ecosystem, and our omni-channel distribution network. As of December 2019, the LTV / CAC ratio for our XP branded solutions was approximately 13x. We calculate LTV based on the following key assumptions: (1) 14.2% per annum as the discount rate; (2) a 10 year fixed projection period; and (3) the average churn observed in the last 12 months’ monthly cohorts of clients;

 

· Asset-Light, Low Cost Structure – Our technology-driven business model is asset-light and highly scalable. We conduct the majority of our business online and through mobile applications and emphasize operational efficiency and profitability throughout our operations. The asset-light nature of our business model requires minimal capital expenditures to facilitate growth, with expenditures amounting to 3.1% and 4.6% of net revenues for the years ended December 31, 2019 and 2018 respectively;

 

· Strong Free Cash Flow Generation – Our business model operating efficiencies enables us to generate strong cash flow in various market conditions, and enables us to continue investing in the growth of our existing business;

 

· Network Effects As we grow our business, we believe our model demonstrates distinct self- reinforcing network effects that help compound our growth; and

 

· Powerful Combination of Attributes The success of XP is due to the combination of capabilities, trusted brand, size and scalability of the XP Model that have been developed and nurtured over time.

 

Leadership and Structure

 

· Experienced Management Team with Strong Track Record of Success – Our management team is comprised of our founders, who have help guide the success of XP over the last 19 years, and new partners who have joined the company along the way from a variety of successful backgrounds in the financial services, technology and consumer services industries. This team has an established track record of delivering strong financial performance, even during difficult macroeconomic conditions in Brazil. For example, while Brazil GDP growth decelerated materially from 2014 to 2019 in one of the worst recessions in Brazilian history, our total AUC grew at a CAGR of 94%.

 

· Meritocratic Partnership Structure – We believe our partnership model is key to our long-term value creation. As of December 31, 2019, our partnership was made up of approximately 373 shareholders of XP Controle, our controlling shareholder, and who are directors, officers and employees of the Company and/or its subsidiaries. In December 2019, we implemented our new partnership model, pursuant to which existing or new partners may be entitled to share based compensation based on individual performance. For further information, please see “Item 6. Directors, Senior Management and Employees—B. Compensation—Long-Term Incentive Plan.”

 

Our Growth Strategies

 

Despite our success to date, we believe our business is still in the early days of driving the disintermediation of traditional financial institutions in Brazil and offering better alternatives to their legacy models and practices. We believe there is a large addressable market opportunity remaining in our core business and significant market share to win from the incumbent banks that still control over 93% of the retail investment AUC in Brazil. We intend to leverage our competitive strengths and continue to enhance the strategic advantages we have created through the XP Model in order to continue to grow and expand our business. We intend to pursue these strategies organically,

 

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through our in-house initiatives and development capabilities provided by of XP Innovation Squads , and inorganically, by selectively making acquisitions of strategic assets such our acquisitions of Rico and Infomoney . Most importantly, we intend to remain focused on our core mission of improving people’s lives by empowering them to become investors and entrepreneurs, and we will nurture our mission-driven culture so that it can continue to guide our firm. Based on these principles, we plan to continue growth our firm by:

 

· Penetrating Our Base – We will continue to seek a greater share of the total AUC and trading volumes from our clients, who often keep assets in different accounts and may use the services of several firms, and we will seek to sell additional products and services to our clients. We believe that our strong value proposition and client-centric approach will continue to enhance our client loyalty and enable us to grow our share of wallet from our current customer base.

 

· Expanding Our Ecosystem – We believe the self-reinforcing ecosystem provides a strong and highly differentiated advantage to XP, enabling us to reach, engage and empower clients across numerous channels. We intend to expand our ecosystem by:

 

· Growing our Client Base We will continue to grow our base of active retail clients, which reached 1.7 million as of December 31, 2019, up 91% year-over-year, as well as our base of institutional trading partners and corporate issuers who provide additional liquidly and products to our platform;

 

· Expanding Our Omni-Channel Distribution Network We intend to drive more users to our various online portals and expand our network of approximately 6,400 IFA partners, which we believe provide a competitive advantage in promoting the XP brand and signing new clients. We intend to grow these channels by (1) Cross-promoting our brands through our proprietary media; (2) helping our existing IFA partners succeed and expand their businesses; (3) promoting the entrepreneurial opportunities of IFA careers in Brazil; and (4) signing new IFA relationships onto the XP platform. We believe that these channels will also continue to grow as (1) the investment market in Brazil continues to democratize and open up to new investors; and (2) traditional financial institutions continue to close branches, continue to cut costs, and their employees look for new career opportunities; and

 

· Growing our Proprietary Digital Content We believe this proprietary content (1) helps build familiarity and trust with XP; (2) helps educate Brazilians and makes them more proficient in financial products and services; and (3) helps convert students and audiences into new or more empowered clients or business partners. We will also continue to expand the reach, audience base and student base of our portals to attract, engage and empower prospective clients. We believe there is a significant opportunity to create and penetrate new media channels to cultivate existing relationships and attract new clients and partners. For example, we developed and launched our social media network, Leadr in 2019 and we already reached over 736,000 downloads.

 

· Expanding Our Solutions – We believe there is a significant opportunity to leverage our trusted brand, high NPS scores, and strong client-experience across the XP Model to (1) offer our clients and partners additional financial services solutions with a similar value proposition; and (2) disrupt the legacy models of traditional financial institutions in new areas. We could expand our solutions organically by leveraging the powerful development resources of our XP Innovation Squads , or we could selectively pursue investments and acquisitions that meet our criteria. We intend to expand our solutions by:

 

· Growing Our XP Platform Offering While we believe our open product platform is key competitive advantage versus the limited, closed-loop platforms of the traditional financial institutions, we believe there is a significant opportunity to continue to build on this strength and provide our clients with greater selection and investment opportunities by (1) developing new investment products; and (2) incorporating new investment products from our partners and competitors;

 

· Growing Our XP Advisory Services Similar to our product platform, we will look for opportunities to expand our suite of advisory services. For example, we launched XP Investments and opened offices in New York, Miami, London and Geneva, to provide new services for Brazilian clients looking to invest outside of Brazil and international investors looking to invest in Brazil;

 

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· Developing New Investment Solutions We have begun to leverage our capabilities to develop solutions in new adjacent areas of the financial services industry. For example, we developed a proprietary Pension Insurance solution that was complementary to some of our wealth management services and entered in March 2019 the R$1.8 trillion pension insurance market, which has been growing since 2011 at a rate of 15% per annum according to Oliver Wyman. By December 2019, we captured 7% of the net inflows in the pension insurance market, and reached approximately R$2 billion in AUC and over 6,000 active clients. We have also created a proprietary debt capital markets, or DCM, function to help foster the development of the fixed income markets in Brazil, which relative underdeveloped given the traditional bank control of credit in the marketplace. Our DCM function has already help numerous new issuers of fixed income securities access new pools of capital, and we believe represents the largest independent DCM business in Brazil. We believe there may be other similar opportunities for us to pursue in the future;

 

· Entering into New Financial Sectors – We believe there may be incremental opportunities to disintermediate the legacy models of traditional financial institutions in other financial sectors beyond investments, which may require new licenses and platforms, but tend to be easier to penetrate and have much lower switching costs versus the investment services industry. For example, some new sector opportunities could include (1) insurance brokerage; (2) debit/credit cards; and (3) other loans. According to a report by Oliver Wyman, we believe the total addressable revenue pool including these adjacent markets that could be complementary to XP is R$487 billion. In October 2019, we received our Digital Bank license from the Central Bank of Brazil, enabling us to provide a broader suite of financial services; and

 

· Entering into New Geographies We remain focused primarily on penetrating the large financial services market opportunity in Brazil. However, we have selectively opened a few small offices in the United States, the United Kingdom and Switzerland, to provide our Brazilian clients with access to international financial markets, and provide international clients with investment opportunities in Brazil. As new opportunities develop, we could selectively expand into new markets, where we can leverage our expertise in financial education and financial empowerment to create new classes of investors and disintermediate bank services in other highly concentrated markets.

 

Our Products and Services

 

We sell a wide range of products and services in various combinations to our clients that we believe are unmatched in their breadth and functionality in Brazil. We have developed these solutions to provide our clients with significant differentiation and a superior value proposition versus the legacy offerings of traditional banks. These include: our (1) XP Educação; (2) XP Advisory Services; and (3) our Open Product Platform.

 

XP Educação Products

 

XP Educação is the largest financial education service in Brazil, providing seminars, classes and learning tools to help teach individuals a range of topics, from the basics of investing to more sophisticated techniques and advanced investment strategies. We sell these courses to help educate investors in Brazil, which we believe is an effective way to build familiarity and trust with XP and an efficient way to help convert students into new or more empowered buyers of financial products and services. As of December 2019, we offered over 140 educational programs and 3 online MBA certification courses and had served over 126,000 students.

 

XP Advisory Services

 

Our XP Advisory Services leverage our in-house experts to advise our clients on a range of investment activities and our proprietary capabilities, expertise and systems to execute transactions on their behalf. For example, these services include:

 

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  Name 

Type 

Description 

Users 

XP Investimentos Domestic Financial Services Advisory services in Brazil to our mass-affluent clients and selected institutional clients Mass-
Affluent
XP Private Domestic and International Financial Services A unique and personalized wealth management experience for high-net-worth clients, which combines the robustness of a large global institution with the flexibility of a family office. XP Private provides a specialized manager with tailored solutions for each client and wealth planning development of on and offshore structures designed to protect, preserve and grow a clients’ net worth. High Net
Worth
XP Investments International Financial Services Access to international markets for our high-net worth customers and institutional clients, and access to the Brazilian market to foreign institutional investors. XP Investments is a FINRA registered firm with offices in New York and Miami, and an FCA registered firm, with offices in London and Geneva

Mass-
Affluent

 

High Net
Worth

 

XP Issuer Services Product Structuring and Issuing Product structuring and capital markets services for our corporate clients and issuers of fixed income products

Issuers

 

Corporate

 

 

Open Product Platform

 

We offer our client and partners the XP Platform, which is an open product platform that provides our clients with the broadest access to investment products in the market, ranging from our own XP-branded products to those of our partners and our competitors. We believe the open nature of our product platform is highly differentiated in the market and a key driver of the early success of XP. Traditional financial institutions in Brazil tend to favor a closed-loop model which significantly restricts the selection of investment products made available to their customers to those that were created in-house or have significant embedded costs to drive promotion. For example, these products include:

 

Name 

Type 

Description 

Clients 

Brokerage
Securities
Investment Products

Over 300 equity securities and futures, such as:

 

·     Equities, iShares (ETFs) and Brazilian Depository Receipts (BDRs);

 

·     Dollar, Ibovespa and rate futures; and

 

·     Commodities, such as feeder cattle, coffee, soy; corn, ethanol, oil and gold.

 

·     Retail

 

·     Institutions

 

Fixed Income Securities Investment Products

Over 50 fixed income securities, including:

 

·     Bank Issuances: LCI, LCA, CDB, LF, LC;

 

·     Private Credit: Debentures, CRI, CRA, FIDC; and

 

·     Government Securities.

 

·     Retail

 

·     Institutions

 

Mutual and Hedge Funds Investment Products

·     Over 15 XP Asset Management Funds

 

·     Over 400 third-party funds curated by XP from over 120 asset managers; and

 

·     Over 20 international funds.

 

·     Retail

 

·     Institutions

 

 

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Name 

Type 

Description 

Clients 

Structured
Products
Investment Products

Derivatives and synthetic instruments including:

 

·     Derivatives – Structures set up with options, using the margin as security. Can be done with Index, Dollar, Shares, Interest, feeder cattle and corn commodities; and

 

·     COE (Structured Operations Certificate) – Instruments combining fixed and variable income elements, with returns linked to assets indices such as exchange, inflation, shares and international assets. These products appear as one single (synthetic) asset for the client, facilitating monitoring of performance and single taxation, and can have lower costs compared with investing in assets/derivatives separately.

·     Retail

 

·     Institutions

 

Pension Plans and Life Insurance Investment Products

XP branded solutions and distribution of over 58 funds from 37 leading independent insurers and asset managers, including:

 

·       Pension and social security funds; and

 

·     Life and travel insurance products of the main independent providers, with similar characteristics to those offered in more developed markets.

·     Retail

 

·     Institutions

 

Wealth Management Services Investment Products A suite of asset organization, succession planning and other services. ·     Retail
Other Investment Products Investment Products

·     Real Estate funds of corporate assets logistics, retail and receivables; and

 

·     Equity and debt capital markets solutions.

·     Retail

 

·     Institutions

 

Our Marketing, Sales & Distribution

 

We market our brands and value-proposition through our proprietary media and we sell our products and services through our omni-channel distribution network and online portals, which are part of our self-reinforcing ecosystem that continuously promotes XP’s products and services. We believe the primarily digital, technology-enabled nature of our media and our distribution is a significant differentiator for our business and a key competitive advantage.

 

Proprietary Media & Digital Content

 

Our media and digital content is an ecosystem of portals and initiatives that aim to democratize access to financial content in Brazil. It is composed of six key initiatives: InfoMoney, XP Educação, XP Research, EXPERT, XP Influencers and Leadr. As we empower Brazilians on how to make investment decisions more independently, we help attract, retain and monetize our clients. We attract clients by providing multiple, ongoing touch points, which we believe help build brand awareness, trust and a greater familiarity and comfort level with investing. These initiatives provide us with a strong organic flow of prospective clients and a highly efficient source of customer acquisition. With millions of users navigating through our platforms monthly, we leverage big data analytical tools and artificial intelligence technology to help create an increasingly personalized experience that helps retain clients. Our content also helps our clients navigate and evolve through their journey as investors, which we believe helps them optimize their asset allocations over time.

 

· Infomoney – acquired in 2011, Infomoney is the largest investment-related website in Latin America and the 11 th largest on a global scale, with approximately 9 million monthly unique visitors as of December 31, 2019, and appearing as a top 10 result in Google searches for an average of approximately 50,000 keywords, during 2019.

 

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· XP Educação – a key part of our mission since our founding, XP Education is a leading financial education portal in Brazil, with over 126,000 students. XP Educação provides seminars, classes and learning tools to help investors, entrepreneurs and executives to evolve through their respective journeys and according to their specific needs.

 

 

· XP Research – our proprietary investment research group has over 25 specialists serving retail clients in Portuguese and institutional clients in English. This group produces a wide range of content, which includes insights into fixed income, equities, funds, REITs, asset allocation, economics, and politics, among others. Our digital research retail platform is free and has over 600,000 unique monthly visitors that come to our website, which utilizes a robust SEO strategy to attract new viewers.

 

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· EXPERT – our annual conference for clients, IFAs, and partners has become the largest investment event in Latin America. In 2019, we had approximately 30,000 attendees, over 180 sponsors, over 140 journalists in attendance, and over 940 news articles written about our event. EXPERT includes a roster of world-renowned speakers, including former U.S. President Bill Clinton in 2018 and former Federal Reserve Chairman Ben Bernanke and Olympic medalist Michael Phelps in 2019. Due to the recent COVID-19 pandemic, the 2020 EXPERT was cancelled. Nevertheless, given that EXPERT is one of the most important events for gathering XP clients and all our ecosystem, we are currently planning to organize an innovative and digital event for 2020.

 

 

· Digital Influencers – a proprietary program that promotes celebrity investment experts online and also includes content from senior XP executives who discuss our mission and culture. Our influencers have over 3 million followers on Instagram, LinkedIn, YouTube and Twitter. We also have over 3 million additional follower profiles in our database from other sources. For example, our stock trading podcast, Stock Pickers , is among the largest podcasts in Brazil. We believe this proprietary network of influencers help listeners become more knowledgeable and comfortable with investments, creates greater brand awareness for our solutions, and enhances our connectivity with prospective clients and existing customers.

 

· Leadr – our free investment-focused social media network, available as an Android or IOS app, with over 736,000 downloads that communicate, research, socialize ideas and trade directly from their accounts. Leadr was designed to help foster the growth of the Brazilian investment market by gathering content and users related to the financial market. It creates a social environment where people can create their profiles, follow other people, create posts, interact with one another, share news, investment ideas, questions and use the $money tag to share stocks, commodities, indices and cryptocurrencies they are talking about with their live quotes. Our XP Research content is linked to the Leadr portal and brings additional organic flow to our network.

 

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Omni-Channel Distribution Network

 

We onboard and serve our clients though our omni-channel distribution network, which enables us to deliver our products and services through a range of proprietary channels designed to provide different levels of service and functionality. These include:

 

· XP Direct – our full-service website for the mass-affluent clients, which provides access to all of our products and more sophisticated functionality.

 

 

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· Rico – our online-only solution for self-directed investors, which provides powerful, yet convenient and easy-to-use investment services, decision-making tools and custom-designed educational software applications. These are delivered through a simple, attractive and intuitive online portal that is supported by a dedicated marketing and digital media program.

 

 

· Clear – A part of XP since 2014, Clear was first to offer zero brokerage fees in Brazil. Clear’s goal is to provide its clients, both professional and novice investors, with the best investment experience at a low cost. One of Clear’s main highlights is an intuitive and simple Home Broker application that allows the user to invest in various asset classes in the equities and futures market such as options, stocks, ETFs and futures contracts, among others. Clear is a 100% digital service, with innovative collateral management tools and proprietary front ends designed for retail active traders, and is integrated with the best trading platforms available in the market.

 

 

· IFA Network – our proprietary distribution network of approximately 6,400 IFA partners, who solicit new clients and help us onboard them as XP clients. These IFAs are located in approximately 640 offices in 138 cities across the country and form the largest independent financial advisor network in Brazil, which is a competitive advantage for XP. We believe our IFA partners choose to work with XP for a number of reasons including, (1) our deep understanding and appreciation of the IFA business model and our

 

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promotion of IFA careers given our origins as an IFA; (2) our dedicated suite of technology tools designed to help IFAs manage their businesses more effectively; (3) our trusted brand and reach across Brazil; and (4) our proprietary market information which can help IFAs reach and sell their services to customers more effectively. We ask our IFA partners to evaluate us on a monthly basis, and recorded an average score of 8.8 out of 10 for the six months ended December 31, 2019.

 

Our Technology

 

Our technology is a significant competitive advantage for XP. We have developed a powerful, integrated suite of data-driven technology systems, applications, and development resources that enable us to differentiate XP in the market, manage all of our solutions, conduct all of our activities and operate with low-cost advantages and efficiencies. We are leveraging the significant technology DNA in our company, our innovation and development teams, and agile software development methods to develop a suite of new products, services and technology applications that engage and serve our clients across their financial journeys.

 

XP Genius Platform

 

Our core technology is XP Genius , which is an integrated, cloud-based technology platform with a modular architecture that is highly scalable and secure, and hosted in two fully redundant hot site data centers that operate with real time data synchronization. XP Genius enables us to:

 

· connect our various systems, micro-services, technologies and environments, enabling us to expand our capabilities modularly, while maintaining an efficient architecture and software code base;

 

· power our solutions and applications across our organization with integrated data harmonized code;

 

· manage our large, valuable and rapidly growing central database of proprietary data with the ability to access information in our data lake in real time;

 

· conduct our big data analytics and artificial intelligence initiatives, such as our online customer behavior monitoring and our machine learning techniques to identify deviations in customer information; and

 

· provide us with proprietary information and market insights from across our integrated ecosystem.

 

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XP Innovation Development Teams

 

We have also built a dedicated innovation development program, called XP Innovation , which is comprised of approximately 585 people, up from approximately 350 people in December 2018 and approximately 150 people in December 2017. These dedicated technology resources develop and support our solutions by using agile software development methods and leveraging our significant technology and data assets. These include 9 XP Tribes , comprised of 2-3 managers each, that help guide and support our development priorities across numerous projects, and 50 XP Squads , comprised of autonomous integrated teams of 8-10 people, including a product owner and business expert, a UX specialist, a technology leader and several developers, that collaborate to create new technologies and solutions or improve our current offerings. These teams operate like 50 different start-up companies inside XP with a focus on the total customer experience, conducting client interviews, prototyping, behavior analysis and user tests. One of the most visible external example of our technology capabilities is the suite of technology applications that we provide to our clients and partners.

 

 

XP Technology Apps

 

We complement and enrich our XP Advisory services and XP Platform of products by developing and offering a differentiated suite of proprietary XP Apps , including cloud-based and mobile technology applications and tools, that are designed to be powerful, yet simple, attractive, and easy to use, with sleek user interfaces, or UX, that are comparable to the look and convenience of some of the top consumer technology products in the world. We combine some of the powerful technical capabilities of XP Genius , with the large amount of proprietary data that flows through our systems, and the agile software development methods of our technology innovation XP Tribes and XP Squads to generate functionality and market insights that are value-added for our clients. As a result, XP Apps enable users to incorporate a range of activities across their customer experience journeys, such as managing their accounts, executing trades, performing custom analytics, and creating custom reports.

 

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Bull

 

Bull is our free, cloud-based trading platform designed for retail and institutional traders, that includes powerful data visualization, custom simulations, analytics, and advance graphics tools that can be used from any internet connected device, such as desktop, tablet, mobile phone, and smart watch. The user can analyze the main flows of the market, time and schedule trades, and conduct various forms of charting and volume and pricing analysis. In addition, the user has access to several trading tools such as Chart Trading and DOM , that can be used to run various market and performance simulations and execute trading quickly and efficiently.

 

 

Rede

 

Rede is an IFA management solution application developed for a desktop environment, that was designed to help an IFA run its business. It provides a comprehensive suite of CRM, account management and investing tools that enable IFAs to: (1) access their customer’s information; (2) manage their customer relationships; (3) monitor their clients’ financial activity; (4) develop the best investment strategies for their clients based on key performance metrics; and (5) communicate with clients across a range of platforms.

 

 

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HUB

 

HUB is an IFA management solution application, similar to Rede, but designed to help an IFA run its business on-the-go through a mobile application. HUB also provides a comprehensive suite of tools for IFAs that enable them to: (1) access client information in real time; (2) manage their CRM application and organize their schedules and meetings on the go; (3) monitor client activity, net funding and upcoming maturities; (4) quickly define and chart investment strategies remotely; and (5) communicate with clients across a range of platforms and third party applications.

 

 

WebCambio

 

WebCambio a customized digital wire transfer application that provides our clients with foreign exchange and remittance services. This platform integrates with the best automation services in the market, offers (1) online FX quotes and closing prices; (2) convenient transaction controls; (3) transparent transaction and tax calculations; (4) fast currency settlement; (5) simplified contract signing; and (6) integration with XP account equity guarantees and other benefits.

 

 

XP Mobile

 

XP Mobile is a suite of mobile apps for various XP websites, including XP Investimentos , Clear, Rico and XP Educação available in the Apple AppStore and GooglePlay store. XP Investimentos and Rico apps had an average rating of 4.7 as of the date of this annual report.

 

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Our Support Functions

 

In order to provide, fulfill and support our products, services and platforms, we have built a robust yet efficient operations organization that leverages our technology to onboard our clients, provide high-quality customer support, and conduct our fraud prevention and risk management. These support functions include:

 

Our Customer Onboarding

 

Our client onboarding process is primarily a digital experience and highly efficient. Prospective clients must register on a web based platform and enter their basic identification information, such as a name, date of birth, and government ID number, as well as their residential address and financial data, such as monthly income and total assets. This process is highly efficient and compliant with Brazilian banking regulation and international anti-money laundering and know-your-customer best practices. All information registered by our prospective clients is verified and validated through third-party data services that integrate automatically with our systems through our API applications. On average, this validation procedure takes less than 10 minutes to be completed and for prospective clients to be informed whether their application was successful or not. Today, we believe 80% to 85% of prospective clients are automatically approved and have their accounts opened through this process.

 

Once a client account is opened, the client is able to login to the platform and respond to the suitability questionnaire. Based on their answers, clients will be informed about their investment profile classification and the products suitable to their profiles. Once the suitability process is completed, clients are able to browse the website, get information of all types of investments available, transfer money to their XP accounts and proceed with investments.

 

Our Customer Support

 

Our customer support organization serves our clients across multiple brands and channels providing support online or by phone through our efficient automated technology tools, client relationship personnel and help desk personnel. Our customer support organization professionals are highly trained and have the appropriate market certifications to interact with clients about our financial products and services. Our customer support personnel are also encouraged to continue to enhance their training and raise their qualification levels through in-house courses and additional financial certifications.

 

For customers of our XP-branded services, such as those that reach us through XP Direct or our IFA network, we provide dedicated support depending on the customer profile. For example, depending on the client profile, our first level of support may be a dedicated advisor, who maintains a close relationship with the client, understands their needs and offers solutions to any questions they have or issues they want to resolve. Our second level of support may be our centralized help desk personnel that are available to answer any operational and technical questions about a client’s account via telephone, chat and email. For customers of our Rico and Clear branded online services, our first level of support may be our automated technology tools, such as our self-help tools and chatbots. Our second level of support may be our specialized help desk personnel, who can be reached online, through email and dedicated communication tools, such as online chats and a dedicated WhatsApp application, as well as via telephone.

 

We closely measure our clients’ satisfaction and overall happiness with our services, across all of our brands, through quality indicators and surveys such as NPS and CSAT. These metrics are directly linked with our internal customer support personnel evaluation and compensation, which we believe reinforces our team alignment and commitment to proving high-quality customer service. We are also highly focused on delivering a highly positive overall client experience and are continuously investing in this area. We have a specific team of professionals that are dedicated to coordinating client experience improvement projects across each point of customer contact throughout our company. For example, this team has implemented various programs designed to reinforce our customer centricity mindset, such as:

 

· XP Tour – a guided tour that any client or prospect can attend to visit our main offices. During the tour, people can interact with our professionals, learn more about XP’s history and participate in pilot testing for new products and technology applications;

 

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· Fale com Guilherme , or Talk to Guilherme – an open channel where anyone can send a suggestion, complaint or request directly to Guilherme Dias Fernandes Benchimol, our CEO; and

 

· Nossa! – a proprietary Wow! program, where any employee can suggest, design and create a unique experience for any client.

 

Our Fraud Prevention and Risk Management

 

Our fraud prevention and risk management operations are primarily managed by three different groups that are staffed with more than 70 employees dedicated to auditing and mitigating our company risk exposure. This team is comprised of highly qualified personnel that come from a variety of backgrounds in other areas, such as telecommunications, credit card issuing, merchant acquiring, banking and the stock market. They are completely independent from our business functions and report directly to our Chief Risk Officer. These groups include:

 

· Corporate Risk – This group is focused on identifying, classifying and mitigating operational, reputational, environmental and strategic risks, including any potential internal fraud.

 

· Financial Risk – This group is focused on monitoring our financial positions and managing our exposure to liquidity risk, market risk, and credit risk; and

 

· Fraud Prevention – This group is comprised of fraud experts, data scientist, database administrators, investigators, and regulator staff, who focus on managing our antifraud strategy and ensuring the legitimacy of client transactions. Their work entails (1) detecting and preventing potential external fraud with different models of client authentication, such as user logins; (2) managing our transaction verification services; (3) monitoring financial advisors activities; (4) employee and partner fingerprinting; (5) managing our data tokenization and token management technology; and (6) managing our biometric facial recognition technology, among others.

 

Competition

 

The Brazilian financial services industry is highly competitive and fast-changing. The markets for our solutions continue to evolve and are competitive in the asset classes, products and geographies in which we operate. We face competition to acquire customers from a variety of traditional and non-traditional financial institutions. Our primary competitors include traditional financial institutions, including Itaú Unibanco, Bradesco, Caixa, Banco do Brasil and Santander. Our other competitors include other financial services companies, such as Guide, Modal, Genial, Easyinvest, Nova Futura, Inter DTVM and BTG Digital. We also compete with a range of other providers in some specific categories, such as asset management firms, insurance companies, investment banking firms, institutional brokerage firms, private banking and wealth management firm and digital banks.

 

The most significant competitive factors in this business line are price, as well as the quality, reliability, security and ease of our platform and solutions. We believe that our comprehensive products and services and geographic reach increasingly differentiate us from other market participants.

 

For information on risks relating to increased competition in our industry, see “Item 3. Key Information—D. Risk factors—Risks Relating to Our Business and Industry—If we cannot make the necessary investments to keep pace with rapid developments and change in our industry, the use of our services could decline, reducing our revenues.” and “Item 3. Key Information—D. Risk factors—Risks Relating to Our Business and Industry—Substantial and increasingly intense competition within our industry may harm our business.”

 

Seasonality

 

We have experienced in the past, and expect to continue to experience, seasonal fluctuations in our revenues. Historically, our revenues have been strongest during the second and the last quarter of each year as a result of performance fees of mutual funds from both our own asset management business as well as third-party funds distributed through our platform. Adverse events that occur during those periods could have a disproportionate effect on our results of operations for the entire fiscal year. In addition, we are also impacted by the number of business days in each quarter, which affects our trading and brokerage businesses. As a result of quarterly fluctuations caused by these and other factors, comparisons of our results of operations across different fiscal quarters may not be accurate indicators of our future performance.

 

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Regulatory Overview

 

We are subject to government authorizations in the jurisdictions in which we operate and conduct our activities.

 

Our Regulatory Position

 

Two of our subsidiaries, XP CCTVM and Banco XP S.A., or Banco XP, perform activities that are subject to regulation in Brazil by the Central Bank. As required by the applicable Brazilian regulation, both must possess authorizations from the Central Bank in order to operate, as follows:

 

· XP CCTVM is authorized by the Central Bank to (1) be constituted and operate as a securities broker; (2) carry out operations in the foreign exchange market; and (3) receive direct or indirect foreign investments of up to 100% of its capital stock.

 

· Banco XP is authorized by the Central Bank to operate as a multi-purpose bank. On October 10, 2019, the board of officers of the Central Bank granted Banco XP’s authorization to operate as a multi-purpose bank, with both commercial and investment bank activities, as well as to carry out transactions in the foreign exchange market. The authorization was published in the National Official Gazette ( Diário Oficial da União ) on October 11, 2019. On November 13, 2019, the Central Bank authorized direct or indirect foreign investments in Banco XP of up to 100% of its capital stock.

 

Four of our subsidiaries, XP CCTVM, XP Gestão, XP Advisory and XP Vista, perform activities that are subject to regulation in Brazil by the CVM. As required by the applicable Brazilian regulation, they are authorized to operate by the CVM, as follows:

 

· XP CCTVM is authorized to provide securities portfolio management services and securities custody services; and

 

· each of XP Gestão, XP Advisory and XP Vista is authorized to provide securities portfolio management services.

 

Two of our subsidiaries, XP Investments and XP Advisory US, Inc., or XP Advisory US, perform activities that require registration with and regulation by appropriate regulatory authorities in the United States, as follows:

 

· XP Investments is (1) registered as a securities broker-dealer with the SEC and in twenty-six U.S. states and territories; (2) registered with the U.S. Commodity Futures Trading Commission, or the CFTC, as an introducing broker; and (3) a member of the Financial Industry Regulatory Authority, or FINRA, and the National Futures Association, or the NFA, self-regulatory organizations overseen by the SEC and the CFTC, respectively; and

 

· XP Advisory US became registered as an investment adviser with the SEC on January 30, 2019. XP Advisory US was previously registered as an investment adviser in the state of Florida.

 

One of our subsidiaries, Sartus Capital Ltd., or Sartus UK, performs advisory services as an appointed representative acting as an agent for New Europe Advisers Ltd., or NEA, which is duly authorized and regulated by the Financial Conduct Authority, or the FCA, subject to the terms and conditions set forth in the Appointed Representative Agreement signed on April 28, 2016. On June 28, 2019, we sent a notice of termination of the Appointed Representative Agreement to New Europe Advisers Ltd., became effective on September 30, 2019, in order to concentrate our efforts in the private and wealth management business in Switzerland through our Swiss subsidiary, XP Private (Europe) SA.

 

XP Private (Europe) SA performs activities under the supervision of the Association Romande des Intermédiaires Financiers , or the ARIF, a self-regulatory organization (SRO), which is overseen by the Swiss Financial Market Supervisory Authority (FINMA). As required by the applicable regulation, in order to provide securities portfolio management services XP Private (Europe) SA became a member of ARIF on September 5, 2016.

 

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One of our subsidiaries, XP Investments UK LLP, performs activities that are subject to regulation by the Financial Conduct Authority. As required by the applicable regulation, it is authorized and regulated by the FCA and has sufficient permissions to carry out its business, including operating as an Organised Trading Facility (OTF).

 

One of our subsidiaries, XP Portugal, performs activities that are subject to regulation by the CMVM, including operating as an investment advisory company. As required by the applicable regulation, it has applied to the CMVM for the authorization to operate, which is currently pending.

 

Two of our subsidiaries, XP Corretora de Seguros Ltda., or XP CS, and XP VP, perform activities that are subject to regulation by SUSEP. As required by the applicable regulation, both have applied for authorizations to operate from SUSEP, which current status is as follows:

 

· XP CS, our insurance broker dealer, is authorized to operate as an insurance brokerage; and

 

· XP VP, our insurance company, is authorized to operate life insurance and private pension plans.

 

Regulatory Environment in Brazil

 

Our main subsidiaries in Brazil are subject to extensive regulation, such as those applicable to banks (in the case of Banco XP), securities and foreign exchange brokers (in the case of XP CCTVM), securities portfolio managers (in the case of XP Gestão, XP Advisory and XP Vista), securities analysts (such as Spiti Análise Ltda.) insurance companies and insurance brokers (in the case of XP VP and XP CS, respectively).

 

We offer various financial and capital markets services; in particular, we conduct activities related to banking, underwriting, brokerage services, portfolio management and insurance.

 

Legislation Applicable to Financial Institutions and Portfolio Managers in Brazil

 

The current Brazilian banking and financial institutional system was established by Law No. 4,595 of December 31, 1964, as amended, or the Banking Law.

 

The Banking Law laid out the structure of the national financial system, which is made up of the CMN, the Central Bank of Brazil, Banco do Brasil S.A., the National Bank for Economic and Social Development – BNDES, or the BNDES, and other public or private financial institutions. While the following entities do not fall under the purview of the Banking Law, they play key roles in the financial system: the CVM, SUSEP, the National Superintendency of Pension Plans ( Superintendência Nacional de Previdência Complementar ), or PREVIC; the CNSP, and the National Council for Pension Plans ( Conselho Nacional de Previdência Complementar ), or CNPC.

 

Law No. 4,728 of July 14, 1965, as amended, or Law No. 4,728/65, regulates Brazilian capital markets through setting standards and various other mechanisms. Further, pursuant to Law No. 6,385 of December 7, 1976, as amended, or Law No. 6,385/76, the distribution and issuance of securities in the market, trading of securities and settlement and/or clearance of securities transactions all require prior authorization by the CVM. The banking and capital markets regulatory framework in Brazil is further supplemented by the regulation issued by CMN, CVM and the Central Bank, and self-regulation policies, such as those issued by various associations, over-the-counter organized markets and securities exchanges, that govern their members and participants, (for example, B3, the Brazilian Association of Financial and Capital Markets Entities, or ANBIMA and the Brazilian Association of Investment Analysts, or APIMEC). The incorporation and operation of financial institutions in Brazil depend on prior authorization from the Central Bank (and a decree from the Brazilian Executive Branch when the capital stock of such institutions is held by foreign investors – Decree No. 10,029, of September 26, 2019, authorized the Central Bank to approve foreign investments in financial institutions, but such decree has yet to be regulated by the CMN and the Central Bank), and are also subject to oversight from the CVM when they participate in the Brazilian capital markets (such as XP CCTVM).

 

Financial institutions in Brazil can operate under various forms – such as commercial banks, investment banks, credit, financing and investment companies, cooperative banks, leasing companies, securities brokerage companies, securities distributor companies, real estate credit companies, mortgage companies, among others – all of which are regulated by different rules issued by the CMN, the Central Bank, and, if such financial institutions participate in capital markets activities, the CVM. In addition, like financial institutions, stock exchanges are also subject to CMN, the Central Bank, and the CVM approval and regulation as well in accordance with Law No. 4,728/65.

 

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Pursuant to Banking Law, CMN Resolution No. 4,122 of August 2, 2012, as amended, or CMN Resolution No. 4,122, and CMN Resolution No. 1,655 of October 26, 1989, financial institutions must seek approval from the Central Bank, and, in certain cases, the CVM when appointing managers (including directors, officers and members of certain statutory boards, such as fiscal councils). According to Law No. 4,728/65, for securities brokerage firms (such as XP CCTVM), managers are subject to further restrictions and are prohibited from working for or fulfilling any administrative, advisory, tax or decision-making positions at entities listed on the Brazilian stock exchange. In addition, managers of XP CCTVM are prohibited from filling managerial functions in other brokerage firms authorized to carry out foreign exchange transactions pursuant to CMN Resolution No. 1,770, of November 28, 1990.

 

According to CMN Resolution No. 2,723 of May 31, 2000, with the exception of (1) equity interests typically held in proprietary investment portfolios by investment banks, development banks, development agencies ( agências de fomento ) and multiservice banks ( bancos múltiplos ); and (2) temporary equity interests not categorized as permanent assets ( ativos permanentes ) by the financial institution, financial institutions must receive prior authorization from the Central Bank to hold capital interest of other companies. In order to receive authorization, the financial institutions’ activities must justify the need to hold capital interest for other companies; however, should the financial institutions participate in underwriting activities falling under certain exceptions established by the CMN, they will not need to provide justification.

 

In addition, as a principle, according to the Banking Law, Brazilian financial institutions are banned from granting loans or cash advances to their managers (officers, directors, and members of advisory boards, as well as their relatives). Certain exceptions to such restrictions are set forth in CMN Resolution No. 4,693 of October 29, 2018.

 

Furthermore, XP CCTVM and XP VP are required to maintain certain levels of regulatory capital, as determined by the Central Bank and SUSEP, respectively. For further information, see note 33(i) to our consolidated financial statements and note 23 to our unaudited interim condensed consolidated financial statements included elsewhere in this annual report.

 

Securities Brokerage Firms

 

Securities trading in stock exchange markets shall be carried out exclusively by securities brokerage firms (such as XP CCTVM) and certain other authorized institutions. Brokerage firms are part of the national financial system and are subject to regulation by and the oversight of the CMN, the Central Bank and the CVM. Securities brokerage firms must be authorized by the Central Bank to trade on the stock exchange market. Among other roles, securities brokerage firms and certain other authorized institutions can act as underwriters in the public offering of financial instruments and may participate in the foreign exchange trades in any foreign exchange market, subject to certain limitations, as set forth in Central Bank regulations.

 

Brokerage firms are regulated by CMN Resolution No. 1,655 of October 26, 1989, as amended, or CMN Resolution No. 1,655, which allows brokerage firms to participate, among others, in the following activities: (1) trading in stock exchanges; (2) underwriting; (3) intermediating public offerings; (4) managing investment portfolios; and (5) intermediating foreign currency trades. In addition to CMN Resolution No. 1,655, brokerage firms are subject to regulations from the CVM.

 

Under the rules set forth by the Central Bank, brokerage firms (such as XP CCTVM) cannot execute transactions that may result in loans, facilities or cash advances to their clients, including through synthetic transactions (such as assignment of rights), with the exception of margin transactions and other limited transactions.

 

Moreover, brokerage firms can neither charge commissions in connection with trades during primary distribution, nor purchase real property, except for their own use or as payment under “bad debts” (in which case, the asset must be sold within a year).

 

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Third-Party Funds Management

 

XP Gestão, XP Advisory, and XP Vista are asset managers licensed to operate by, and subject to the rules and oversight of, the CVM, pursuant to Law No. 6,385/76 and CVM Instruction No. 558 of March 26, 2015, as amended, or CVM Instruction No. 558.

 

CVM Instruction No. 558 defines asset/portfolio management activities as professional activities directly or indirectly related to the operation, maintenance and management of securities portfolios, including the investment of funds in the securities market on behalf of clients.

 

CVM Instruction No. 558 provides for two categories of asset managers: (1) trustee administrator and/or (2) portfolio manager, XP Gestão, XP Advisory and XP Vista, are registered as portfolio managers. To be authorized by the CVM to engage in such activity, legal entities that operate as asset managers must (1) have a registered office in Brazil; (2) have securities portfolio management as a corporate purpose and be duly incorporated and registered with the National Register of Legal Entities – CNPJ; (3) have one or more officers duly certified as asset managers as approved by CVM to take on liability for securities portfolio management, pursuant to CVM Instruction No. 558; (4) appoint a compliance officer and a risk management officer; (5) be controlled by reputable shareholders (direct and indirect), who have not been convicted of certain crimes detailed in article 3, VI of CVM Instruction No. 558; (5) who is not unable or suspended from occupying a position in financial institution or other entities authorized to operate by the CVM, the Central Bank, SUSEP or PREVIC, and have not been banned from asset management activities by judicial or administrative decisions; (6) put in place and maintain personnel and IT resources appropriate for the size and types of investment portfolio it manages; and (7) execute and provide the applicable forms to the CVM so as to prove its capacity to carry out such activities, pursuant to CVM Instruction No. 558. Under CVM Instruction No. 558, asset management must, among other requirements, conduct their activities in good faith, with transparency, diligence and loyalty with respect to their clients and perform their duties with the aim of achieving their investment objectives. This same regulation requires asset managers to maintain a website, with extensive current information, including, but not limited to (1) an updated annual filing form ( formulário de referência ); (2) a code of ethics; (3) rules, procedures and a description of internal controls in order to comply with CVM Instruction No. 558; (4) a risk management policy; (5) a policy of purchase and sale of securities by managers, employees and the company; (6) a pricing manual for assets from the securities portfolios managed by such asset manager, even if the manual has been developed by a third party; and (7) a policy of apportionment and division of orders among the securities portfolios.

 

Moreover, under CVM Instruction No. 558, asset management firms are forbidden from (1) making public assurances of profitability levels based on the historical performance of portfolio and market indexes; (2) modifying the basic features of the services they provide without following the prior appropriate procedures under the asset management agreement and regulations; (3) making promises as to future results of the portfolio; (4) contracting or granting loans on behalf of their clients, subject to certain exceptions set out in regulation; (5) providing a surety, corporate guarantee, acceptance or becoming a joint obligor in any other form, with respect to the managed assets; (6) neglecting, under any circumstances, the rights and intentions of the client; (7) trading the securities from the portfolios they manage with the purpose of obtaining brokerage revenues or rebates for themselves or third parties; or (8) subject to certain exceptions set out in the regulation, acting as a counterparty, directly or indirectly, to clients.

 

IFAs

 

The activity of IFAs ( agentes autônomos de investimentos ) is regulated by CVM Instruction No. 497 of June 3, 2011, as amended, or CVM Instruction No. 497, and Comment Letter No. 4/2018-CVM/SMI. Pursuant to such rules, IFAs are individuals, acting as agents and representatives for an institution integrating securities distribution systems, registered with the CVM to conduct client development and attraction, to receive and register orders and transmit such orders to the appropriate trading or registration systems and to provide information on the products offered and on the services provided by the institution that hired them. Although they are individuals, CVM Instruction No. 497 allows IFAs to carry out their activities through an unlimited liability partnership ( sociedades simples ) or sole proprietorship ( firma individual ), incorporated for this specific purpose, which must also be registered with the CVM. The IFAs must be engaged by an institution integrating the securities distribution system.

 

In carrying out its services, the IFA must act with integrity, good faith and professional ethics, applying the care and diligence expected from a professional in its position, with respect to clients and its employer.

 

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As set forth in CVM Instruction No. 497, IFAs (or the legal entities incorporated by them) are prohibited from certain activities, including, but not limited to:

 

· receiving from or giving to clients or on behalf of clients, for any reason, and as remuneration for the rendering of any services, money, bonds or securities or other assets; acting as an attorney-in-fact or representative of clients before institutions that are part of the securities distribution system, for any purpose; and

 

· contracting with clients or performing, even if free of charge, services related to securities portfolio management, consultancy or analysis of securities.

 

In addition, the following provisions of CVM Instruction No. 497 are noteworthy:

 

· IFAs must work exclusively for one principal and may only act for one intermediary, with the exception of the distribution of quotas of investment funds by IFAs;

 

· agents shall be transparent with their clients regarding details of their employer and its contractual relationship with the investor;

 

· IFA acting through a legal entity ( pessoa jurídica ) may not accept partners that are not accredited as IFAs; and

 

· agents must not delegate to third parties, in whole or in part, obligations under their contract with their employer.

 

The brokerage firms are responsible for verifying their respective IFAs and for overseeing their activities and compliance with the applicable law. They may even be held responsible for malpractice or misconduct by such agents acting in their capacities as such.

 

On July 1, 2019, the CVM issued Public Hearing Release SDM No. 03/19, or Release SDM 3/19, which may result in significant changes in CVM Instruction No. 497, such as: (1) providing authorization for IFAs incorporated as corporations, limited liability partnerships and/or other partnerships; (2) abolishing or creating exceptions to the exclusivity rule that IFAs are subject to; and (3) amending transparency rules in connection with the activities of IFAs, in particular the disclosure of compensation received by IFAs (which is currently not required to be disclosed to investors). According to Release SDM 3/19, suggestions from the general public were to be provided by August 30, 2019. We cannot predict what actual changes may arise from such process. Please see “Item 3. Key Information—D. Risk factors—Certain Risks Relating to Our Business and Industry—XP CCTVM depends in part on the performance of its IFAs. If XP CCTVM is unable to hire, retain and qualify such IFAs, our business may be harmed.”

 

Multi-purpose Banks

 

According to CMN Resolution No. 2,099 of August 17, 1994, Brazilian multi-purpose banks (such as Banco XP) are subject to extensive and continuous regulatory scrutiny by Brazilian authorities. Multi-purpose banks conduct at least two types of banking activities, provided that at least one of such activities falls into either the category of commercial or investment banking. Banking regulation is enforced by the relevant government entities and regulators with the goal of controlling credit availability and reducing or increasing consumption.

 

Certain controls are temporary in nature and may vary from time to time in accordance with the relevant government’s or regulator’s credit policies, including:

 

· minimum capital requirements;

 

· compulsory reserve requirements;

 

· lending limits and other credit restrictions; and

 

· accounting and statistical requirements.

 

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The following rules are applicable to multi-purpose banks, such as Banco XP:

 

· they shall ensure the adequacy of products and services for customers’ needs, interests and objectives, as well as the integrity, reliability, security and confidentiality of transactions, services and products;

 

· they may not own real estate other than the property they occupy, unless they take possession of real estate in satisfaction of a debt or when expressly authorized by the Central Bank, subject to certain CMN rules. Moreover, the total amount of fixed assets must be limited to 50.0% of the institution’s regulatory working capital;

 

· they shall comply with the principles of selectivity, guarantee, liquidity and risk diversification;

 

· financial institutions are prohibited from granting loans or advances without an appropriate agreement formalizing such debt;

 

· financial institutions may not grant loans to, or guarantee the transactions of, their affiliates, except in certain limited circumstances (see “—Transactions with Affiliates” below);

 

· the registered capital and total net assets of financial institutions must be compatible with the rules governing share capital and minimum capitalization enforced by the Central Bank for each type of financial institution; and

 

· financial institutions shall maintain internal policy and procedures governing their relationships with clients and users of their products and services.

 

In recent years, CMN has issued rules with the intention of modernizing financial services and retail banking. On September 26, 2019, CMN issued Resolution 4,753, which, effective as of January 1, 2020, replaces and consolidates a series of sparse CMN Resolutions dealing with the opening of bank accounts, which were issued over the years due to changes made to enable the creation of new products and services for specific public/clients, such as the rules applicable to “simplified accounts”, governed by Resolution No. 3,211, of June 30, 2004, and the CMN Resolution 4,480 of April 25, 2016, as amended, which regulated the opening and closing of bank deposit accounts by Brazilian residents through the exclusive use of electronic means and set forth terms and conditions applicable thereto. In addition, pursuant to CMN Resolution 4,479 of April 25, 2016, CMN created exemptions to requirements applicable to physical bank branches for bank accounts opened through electronic means. CMN Resolution 4,753 amended and consolidated many of these disparate rules enacted over the years, effective as of January 1, 2020.

 

Aiming to enable the use of more modern and efficient technology for the purpose of attracting new customers through electronic service channels, a process known as digital onboarding , CMN Resolution No. 4,753 removed from the regulatory framework several existing restrictions arising from the adoption of procedures relating to physical handling of documents, such as the requirement that the identification and location details of the client should be physically checked, as contained in Article 32 of Resolution No. 2,025, of 1993. The Central Bank acknowledged that there currently are more efficient and secure ways of verifying data by electronic means, which reduces administrative costs.

 

The integration of modern technology such as Application Programming Interfaces, or APIs, big data and blockchain/DLT, has incentivized the CMN and the Central Bank to develop new rules in connection with Agenda BC+. The regulatory framework tends to evolve accordingly. With this aim in mind, regulatory authorities are striving to create technological solutions that would plug the gaps from traditional inefficiencies in the banking system. The regulators have expressed significant interest in the benefits and efficiencies that such technology may bring to the banking industry and to its financial inclusion strategies.

 

According to CMN Resolution No. 4,658 of April 26, 2018, as amended by CMN Resolution No. 4,752, of September 26, 2019, financial institutions and other institutions authorized to operate by the Central Bank must implement cybersecurity policies in order to ensure the integrity of their data systems. Under the Resolution, which regulates cybersecurity policies and the requirements for contracting data processing, storage and cloud computing services, covered institutions are required to appoint an officer who will be responsible for implementing and overseeing cybersecurity policy, and to adopt procedures and controls to prevent and respond to cybersecurity incidents.

 

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The Cybersecurity Regulation also requires relevant institutions to provide an annual report to the Central Bank disclosing any cybersecurity incidents, as well as remediation efforts. In addition, communication to the Central Bank is required should any third-party service providers be hired for data processing, storage and cloud computing services. When services are rendered abroad, there are additional requirements for contracting, including the existence of a cooperation agreement between the Central Bank and the supervisory authority of the foreign country, or, absent such cooperation agreement, such contracting is subject to the prior approval of the Central Bank.

 

This year, the Ministry of Economy, the Central Bank, the CVM and SUSEP publicly announced their intention to implement a regulatory sandbox model in Brazil. The implementation of such a regulatory regime is expected to promote the development of more inclusive and higher quality products and services and to foster constant innovation in the financial, security and capital markets.

 

Securities Analysts

 

The activity of securities analysts ( analista de valores mobiliários ) is regulated by CVM Instruction No. 598, of May 3, 2018, and by CVM Circular Letter No. 2/2019/CVM/SIN, of March 1, 2019. Pursuant to such rules, securities analysts are individuals or legal entities that, on a professional basis, prepare analyst reports for publication, disclosure or distribution to third parties, even if limited to certain clients. For purposes of CVM Instruction No. 598, “analyst reports” mean any texts, follow-up reports, studies or analyses regarding specific securities or issuers that may assist or influence investors in the investment decision process.

 

Securities analysts must be registered before a certifying entity duly authorized by CVM. Currently, the certification of securities analysts is carried out by APIMEC, which also serves as a self-regulatory entity for securities analysts.

 

In carrying out its services, securities analysts must act with integrity, good faith and professional ethics, and the analysts reports must be prepared by the analyst applying the care and diligence expected from a professional in its position.

 

As set forth in CVM Instruction No. 598, securities analysts (both individuals and legal entities) are prohibited from certain activities, including, but not limited to:

 

· issue analyst reports aiming to obtain, for itself or for third parties, unfair advantages;

 

· omit information about conflicts of interest in analyst reports;

 

· trade, on behalf of itself or of third parties, securities covered by the analysts reports or derivatives backed in such securities for a period of 30 days prior to and 5 days after the disclosure of the analyst report about such securitiy or its issuer;

 

· trade, on behalf of itself or of third parties, securities covered by the analyst reports or derivatives backed in such securities in the opposite direction of the recommendations or conclusions expressed in the analyst reports for (i) 6 months as of the disclosure of such report; or (ii) until the disclosure of a new report about the same issuer or security, if such disclosure occurs within the 6 months period mentioned above;

 

· participate, directly or indirectly, (i) in any activity related to the public offering of securities, including sales efforts involving products or services related to the capital markets and efforts for prospecting new clients or jobs; (ii) in the structuring of financial products and securities; and (iii) in any activity related to M&A financial consulting; and

 

· disclose the analyst reports or their content, even partially, to persons that are not part of the analyst team, in particular the issuer or the securities the subject of the analyst report before its publication, disclosure or distribution through the proper channels.

 

Securities analysts operating as legal entities are responsible for declaring in a clear and highlighted manner, whenever applicable, in all analysts reports that are published, disclosed or distributed, situations that may impact the report’s impartiality or that are or may be a conflict of interest.

 

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Among others, CVM Instruction No. 598 considers that a conflict of interest may exist whenever the securities analyst entity, its controlled entities, controlling shareholders or entities under common control (i) have a relevant equity participation in the issuer covered by the analyst report, and vice-versa; (ii) have relevant financial and commercial interests over the issuer or the securities covered by the analyst report; (iii) are involved in the acquisition, selling or intermediation of securities covered by the analyst report; and (iv) are paid for other services rendered to the issuer covered by the report or its related parties.

 

Main Regulatory Entities

 

National Financial System

 

The main regulatory authorities in the Brazilian financial system are the CMN, the Central Bank and the CVM. In addition, most Brazilian investment banks, brokerage firms, securities distributers and asset managers are associated with and subject to the self-regulatory rules issued by ANBIMA.

 

In addition, trading segments managed by B3 are self-regulated and supervised by BSM – Supervisão de Mercados , or BSM, a non-profit organization that forms part of the B3 group.

 

We present below a summary of the main duties and powers of each regulatory agent, ANBIMA and BSM.

 

CMN

 

CMN is the main monetary and financial policy authority in Brazil, responsible for creating financial, credit, budgetary and monetary rules.

 

According to Banking Law, the CMN’s main responsibilities are to oversee the regular organization, operation and inspection of entities that are subject to the Banking Law, as well as the enforcement of applicable penalties. In addition, Law No. 4,728/65 delegates to the CMN the power to set general rules for underwriting activities for resale, distribution or intermediation in the placement of securities, including rules governing the minimum regulatory capital of the companies that contemplate the underwriting for resale and distribution of instruments in the market and conditions for registration of the companies or individual firms which contemplate intermediation activities in the distribution of instruments in the market. The CMN has the power to regulate credit transactions involving Brazilian financial institutions and Brazilian currency, supervise the foreign exchange and gold reserves of Brazil, establish saving and investment policies in Brazil and regulate the Brazilian capital markets. The CMN also oversees the activities of the Central Bank, the CVM and SUSEP. Other CMN responsibilities include:

 

· coordinating monetary, credit, budget and public debt policies;

 

· establishing policies on foreign exchange and interest rates;

 

· seeking to ensure liquidity and solvency of financial institutions;

 

· overseeing activities related to the stock exchange markets;

 

· regulating the structure and operation of financial institutions;

 

· granting authority to the Central Bank to issue currency and establish reserve requirement levels; and

 

· establishing general guidelines for the banking and financial markets.

 

The Central Bank

 

The activities of financial institutions are subject to limitations and restrictions. The Central Bank is responsible for (1) implementing those CMN policies that are related to monetary, credit and foreign exchange control matters; (2) regulating Brazilian financial institutions in the public and private sectors; and (3) monitoring and regulating foreign investments in Brazil. The President of the Central Bank is appointed by the President of Brazil (subject to ratification by the Senate) for an indefinite term.

 

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Banking Law delegated to the Central Bank the responsibility of permanently overseeing companies that directly or indirectly interfere in the financial and capital markets, controlling such companies’ operations in the foreign exchange market through operational proceedings and various modalities, and supervising the relative stability of foreign exchange rates and balance of payments. In addition, Law No. 4,728/65 states that the CMN and the Central Bank shall exercise their duties related to the financial and capital markets with the purpose of, among other things, facilitating the public’s access to information related to bonds or securities traded in the market and on the companies that issue them, protecting investors against illegal or fraudulent issuances of bonds or securities, preventing fraud and manipulation modalities intended to create artificial conditions of the demand, supply or pricing of bonds or securities distributed in the markets and ensuring the observance of equitable commercial practices by all of those professionals who participate in the intermediation of the distribution or trading of bonds or securities. The Central Bank has authority over brokerage firms, financial institutions, companies or individual firms performing underwriting for resale and distribution of bonds or securities, and maintains a record on, and inspects the transactions of, companies or individual firms that carry out intermediation activities in the distribution of bonds or securities, or which conduct, for any purposes, the prospecting of popular savings in the capital market.

 

Other important responsibilities of the Central Bank are as follows:

 

· controlling and approving the organization, operation, transfer of control and corporate reorganization of financial institutions and other institutions authorized to operate by the Central Bank;

 

· managing the daily flow of foreign capital and derivatives;

  

· establishing administrative rules and regulation for the registration of foreign investments;

 

· monitoring remittances of foreign currency;

 

· controlling the repatriation of funds (in case of a serious deficit in Brazil’s payment balance, the Central Bank may limit remittances of profits and prohibit remittances of capital for a limited period);

 

· receiving compulsory collections and voluntary deposits in cash from financial institutions;

 

· executing rediscount transactions and granting loans to banking financial institutions and other institutions authorized to operate by the Central Bank;

 

· intervening in the financial institutions or placing them under special administrative regimes, and determining their compulsory liquidation; and

 

· acting as depositary of the gold and foreign currency.

 

CVM

 

The CVM is a federal authority responsible for implementing the CMN’s policies related to the Brazilian capital market and for regulating, developing, controlling and inspecting the securities market.

 

The main responsibilities of the CVM are the following:

 

· regulating the Brazilian capital markets, in accordance with Brazilian corporation law and securities law;

 

· setting rules governing the operation of the securities market;

 

· defining the types of financial institutions that may carry out activities in the securities market, as well as the kinds of transactions that they may perform and services that they may provide in such market;

 

· controlling and supervising the Brazilian securities market through, among others:

 

(1) the approval, suspension and de-listing of publicly held companies;

 

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(2) the authorization of brokerage firms to operate in the securities market and public offering of securities;

 

(3) the supervision of the activities of publicly held companies, stock exchange markets, commodities and future markets, financial investment funds and variable income funds;

 

(4) the requirement of full disclosure of relevant events that affect the market, as well as the publication of annual and quarterly reports by publicly held companies;

 

(5) the imposition of penalties; and

 

· permanently supervising the activities and services of the securities market, as well as the dissemination of information related to the market and the amounts traded therein, to market participants.

 

The CVM has jurisdiction to regulate and supervise financial investment funds and derivatives markets, a role previously fulfilled by the Central Bank. Pursuant to Law No. 10,198 of February 14, 2001, as amended, and Law No. 10,303 of October 31, 2001, the regulation and supervision of both financial mutual funds and variable income funds and of transactions involving derivatives were transferred to the CVM. In compliance with the Brazilian legislation, the CVM is managed by a President and four officers, all of whom are appointed by the President of the Republic (and approved by the Senate). The persons appointed to the CVM shall have strong reputations and be recognized as experts in the capital markets sector. CVM officers are appointed for a single term of office of five years, and one-fifth of the members shall be renewed on an annual basis.

 

All decisions issued by the CVM and by the Central Bank in administrative proceedings on the topics of the national financial system and the foreign exchange market are subject to appeal before the Appeals Council of the National Financial System, which is composed of members appointed by public authorities and members of the private sector.

 

The CVM is also responsible for determining and regulating the performance of IFAs. Due to the relevance of the IFAs and our subsidiaries, we highlight below the relevant regulatory frameworks such entities are subject to.

 

Pension and Insurance

 

SUSEP and CNSP

 

In Brazil, the regulation of insurance, co-insurance, retrocession, capitalization, supplementary pension schemes and brokerage is carried out by CNSP and SUSEP.

 

SUSEP is an independent agency in charge of implementing and conducting the policies established by CNSP and the supervision of the insurance, co-insurance, retrocession, capitalization, supplementary pension schemes and brokerage. SUSEP neither regulates nor supervises (1) the supplementary pension entities that are regulated by the SPC; and (2) the operators of private healthcare assistance plans, which are regulated by ANS. With the enactment of Supplementary Law No. 126 on January 15, 2007, the CNSP and SUSEP are also responsible for the regulation of the Brazilian reinsurance market.

 

CNSP is made up of one representative of each one of the following bodies: Ministry of Social Security, the Central Bank, Ministry of Economy, Ministry of Justice, the CVM and the superintendent of SUSEP – Private Insurance Authority.

 

The supplementary insurance and pension sectors in Brazil are subject to overlapping regulations. Decree-Law No. 73 of November 21, 1966, as amended, sought to centralize the legislation and inspection activities in the sector by creating the National Private Insurance System – SNSP, composed of (1) CNSP; (2) SUSEP; (3) insurance companies duly authorized to operate in the private insurance market; (4) the reinsurance companies; and (5) duly qualified and/or registered insurance brokers. CNSP is linked to the Ministry of Economy and its main roles include: establishing the guidelines and rules for the private insurance policy in Brazil; regulating the incorporation, organization, operations, and inspection of insurers, reinsurers, supplementary open pension funds, and capitalization companies, as well as establishing capital thresholds for such entities; establishing the general characteristics of insurance and reinsurance contracts; establishing general guidelines for insurance, reinsurance, supplementary open pension funds, and capitalization operations; establishing general accounting and statistical rules, as well as legal, technical, and investment limits for the operations of insurers, reinsurers, supplementary open pension funds, and capitalization companies; and regulating insurance and reinsurance broker activities and profession.

 

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SUSEP’s main roles include: processing application requests of incorporation, organization, operations, and inspecting insurers, reinsurers, supplementary open pension funds, and capitalization companies; issuing instructions and circular letters in connection with the regulation of insurance, reinsurance, supplementary open pension funds, and capitalization operations, in accordance with CNSP guidelines; setting forth the conditions of insurance plans to be used by the insurer market; approving limits for the operations of supervised companies; authorizing the use and release of assets and amounts given in guaranty for technical provisions and discretionary capital; inspecting and implementing the general accounting and statistical rules set forth by CNSP; inspecting the operations of supervised companies; and conducting the liquidation of supervised companies.

 

Self-Regulatory Entities

 

ANBIMA

 

ANBIMA is a private self-regulatory association of investment banks, asset managers, securities brokers and investment advisers, which, among other responsibilities, establishes rules as well as codes of best practices for the Brazilian capital market, including punitive measures in case of noncompliance with its rules.

 

BSM

 

BSM supervises these markets and monitors operations, orders and trades executed in trading environments, supervises market participants and, if necessary, imposes penalties against those who infringe regulations.

 

Working in close collaboration with CVM and the Central Bank, BSM acts to ensure that institutions and their professionals comply with market regulations, by:

 

· conducting market surveillance – BSM monitors all orders and trades in B3’s markets in order to identify signs of irregularities;

 

· auditing – BSM audits all B3 participants to ensure their compliance with the regulations and to identify possible violations of market rules;

 

· imposing punitive processes and other enforcement actions – when violations of regulations occur, BSM adopts guidance, persuasion or disciplinary measures such as letters of recommendation, letters of censure or administrative sanctioning proceedings, in accordance with the severity of the violation that has been identified; in addition, BSM can, in connection with administrative sanctioning proceedings, apply penalties to or enter into Terms of Commitment ( termo de compromisso ) with the accused;

 

· providing compensation for loss – BSM analyzes and adjudicates complaints presented to the Investor Compensation Mechanism (MRP), which awards damages of up to R$120,000 to investors harmed by a B3 participant’s inappropriate activity; and

 

· facilitating market development – BSM develops education initiatives, rule enhancements and institutional relationships with market participants, regulatory bodies and international organizations.

 

APIMEC

 

APIMEC is a private self-regulatory association authorized by CVM to perform the certification and self-regulation of securities analysts (both individuals and legal entities), establishing rules, procedures and best practices that must be followed by securities analysts, under penalty of punitive measures in case of noncompliance with its rules.

 

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Other Rules

 

Adequacy of Capital and Limits of Exposure and Other Solvency Rules

 

The financial institutions are subject to an extensive set of rules issued by the CMN and the Central Bank related to capital amounts, exposure limits and other solvency rules that follow principles recommended by the Basel Committee, especially in view of the systemic risks associated with the relationship and activity of the financial institutions. As such, the CMN and the Central Bank sought to guarantee the solvency of the financial system and mitigate systemic risks.

 

With this aim, CMN Resolution No. 2,099 of August 17, 1994, as amended, or CMN Resolution No. 2,099, established minimum capital and net equity requirements for various types of financial institutions. For example, the CMN set a minimum capital amount and net equity amount of R$1.5 million for brokerage firms providing firm guarantee of underwriting of securities, in the manner operated by XP CCTVM, and R$17.5 million for multi-purpose banks, such as Bank XP after all due approvals from the Central Bank.

 

In accordance with the Basel Committee principles, other relevant rules for financial institutions are CMN Resolution Nos. 4,192 and 4,193, which set out the methodology for calculating the reference capital and the ascertainment of the minimum requirements for the reference capital, the main capital and additional capital. Said resolutions are complemented by various Central Bank circulars and circular letters, among which is Central Bank Circular No. 3,644 of March 4, 2013.

 

CMN Resolution No. 4,557 of February 23, 2017, or CMN Resolution No. 4,557, unifies and expands Brazilian regulation on risk and capital management for Brazilian financial institutions and other institutions authorized to operate by the Central Bank. The rule is also an effort to incorporate recommendations from the Basel Committee on Banking Supervision into Brazilian regulation. The rule states that risk management must be conducted through an unified effort by the relevant entity (i.e., not only must risks be analyzed on an individual basis, but financial institutions and other institutions authorized to operate by the Central Bank must also control and mitigate adverse effects caused by the interaction of different risks). It also strengthens the rules and requirements related to risk management governance and expanded on the competence requirements and duties of the risk management officer.

 

The rule sets out different structures for risk and capital management, which are applicable for different risk profiles set out in the applicable regulation. Consequently, less sophisticated financial institution can have a simpler risk management structure, while institutions with more complexity must follow stricter protocols.

 

Insurance companies are also subject to an extensive set of laws and regulations governing solvency, notably CNSP Resolution No. 321/2015 and Circular SUSEP No. 517/2015, which outline minimum regulatory capital parameters, prudential accounting adjustments, limitations on collateral assets supporting insurance reserves ( ativos garantidores ) and other related rules.

 

An insurance company’s minimum regulatory capital may vary from time to time in light of periodic risk-based calculations required by such regulations. Factors such as the risk profile of the insurance portfolio, credit risk of clients, general market-related risks and other indicators may result in the increase or decrease of regulatory capital over time, with corresponding effects of requiring additional capital or releasing capital, as the case may be. Insurance companies have limited control over the variation of such factors, and therefore may be required from time to time to make capital contributions exceeding their projections.

 

The aforementioned rules also contemplate the creation of various levels of internal and external controls overseeing solvency, such as auditing by independent actuaries, establishing internal audit committees for companies exceeding certain financial thresholds, limiting acceptable assets for purposes of covering insurance reserves, requiring monthly reporting to the insurance regulator, among other requirements.

 

Internal Compliance Procedures

 

All financial institutions shall maintain internal guidelines and procedures to control their financial, operational and managerial information systems and shall comply with all the applicable legislation. CMN Resolution No. 4,595 of August 28, 2017, states that Brazilian financial institutions and other institutions authorized to operate by the Central Bank shall implement and maintain a compliance policy compatible with the nature, size, complexity, structure, risk profile and business model of the institution.

 

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According to CMN Resolution No. 2,554 of September 24, 1998, the executive officers of the financial institution are responsible for implementing an efficient structure of internal control, by defining responsibilities and control procedures and establishing corresponding objectives and procedures throughout all levels of the institution. The executive officers are also responsible for verifying compliance with all internal procedures. The internal audit department of a financial institution reports directly to the executive officers or directors of the institution, as applicable.

 

Laws on Insolvency of Financial Institutions in Brazil

 

Financial institutions are subject to the procedures set out by Law No. 6,024 of March 13, 1974, as amended, or Law No. 6,024/74, and Decree-Law No. 2,321 enacted on February 25, 1987, as amended, which set out the provisions applicable to intervention, temporary administration or extrajudicial liquidation by the Central Bank, as well as to bankruptcy proceedings.

 

Temporary Administration

 

As per the Decree-Law No. 2,321, the Central Bank may assume the temporary administration of a Brazilian financial institution in certain situations, determining the temporary special administration regime.

 

The Central Bank is the authority empowered to determine this sort of regime, which shall take place (1) in case the financial institution (i) performs recurring practices against the economic and financial policies provided in federal law; (ii) faces a shortage of assets; (iii) fails to comply with the compulsory banking reserve rules; (iv) has a reckless or fraudulent management, or (2) in case of the existence of any of the reasons for an intervention by the Central Bank, as provided for in Law No. 6,024/74.

 

The administration of the financial institution subject to this temporary administration will be carried out by a directive board named by the Central Bank, with ordinary management powers. The financial institution administrators and members of the board of auditors have their mandates immediately terminated. The directive board is expected to issue one or more reports to the Central Bank based on which the regulatory authority shall decide on the actions to be taken in relation to the financial institution.

 

The temporary administration regime ceases (1) if the Federal Government takes control over the financial institution; (2) in case the financial institutions go through a corporate restructuring, merger, spin-off, amalgamation or transfer of its controlling interest; (3) in case of normalization of the situation of the finance institution, at Central Bank’s discretion; or (4) with the Central Bank decision for its extrajudicial liquidation.

 

Intervention and Extrajudicial Liquidation

 

Intervention and extrajudicial liquidation occur when a financial institution is in a precarious financial condition or upon the occurrence of triggering events that may impact its creditors’ situation. Such measures are imposed by the Central Bank in order to avoid the entity’s bankruptcy.

 

Intervention

 

Law No. 6,024/74 granted the Central Bank the power to appoint a liquidator to intervene in the transactions or liquidate any financial institution other than public financial institutions controlled by the Federal Government. The intervention may be ordered at Central Bank’s discretion, if the following is verified:

 

· due to mismanagement, the financial institution has suffered losses exposing creditors to risk;

 

· the financial institution has consistently violated Brazilian banking laws or regulation; or

 

· such intervention constitutes a viable alternative to the liquidation of the financial institution.

 

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Effective the date on which it is ordered, the intervention will automatically trigger the following: (1) suspension of the enforceability of payable obligations; (2) suspension of the maturity of previously contracted and imminently due obligations; and (3) the freezing of deposits already existing on the date of its determination. The intervention shall cease (1) if the interested parties, presenting the necessary guarantees, at the Central Bank’s discretion, undertake to continue the company’s economic activities; (2) at the Central Bank’s discretion, the entity’s situation has been normalized; or (3) if extrajudicial liquidation or bankruptcy of the entity is ordered.

 

The intervention may also be ordered upon request of the management of the financial institution. Any intervention period may not exceed six months, and may be extended once, by up to six additional months, by the Central Bank. The intervention procedure shall terminate if the Central Bank determines that the factors that motivated the intervention have been eliminated or upon the presentation of adequate guarantees by interested parties. On the other hand, the Central Bank may order the extrajudicial liquidation of the institution or authorize the intervener to request the bankruptcy thereof. According to Law No. 6,024/74, the intervention may be converted in a bankruptcy proceeding, currently governed by Law No. 11,101 of February 9, 2005 (which is the Law governing the Bankruptcy and Receivership of Companies, referred hereinafter as the LFRJE), if, among others, the assets of the institution under intervention are not enough to cover at least 50% of the amount of its outstanding unsecured credit.

 

Extrajudicial Liquidation

 

In accordance with Law No. 6,024/74, extrajudicial liquidation is an administrative procedure ordered by the Central Bank (not applicable to the financial institutions controlled by the Federal Government) being enforced by a liquidator appointed by the Central Bank.

 

This measure aims to terminate the activities of a troubled financial institution, removing it from the Brazilian national financial system, liquidating its assets and paying its liabilities, as in an extrajudicially decreed bankruptcy.

 

The Central Bank will order the extrajudicial liquidation of the financial institution if:

 

· the economic or financial situation of the institution is at risk, particularly when the institution fails to comply with its obligations in a timely manner, or upon occurrence of an event that indicates a state of insolvency according to LFRJE’s rules;

 

· management seriously violates the banking laws, rules or regulation;

 

· the institution suffers a loss that subjects its unprivileged and unsecured creditors to severe risk; or

 

· upon revocation of the authorization to operate, the institution fails to initiate, within 90 days, its ordinary liquidation, or, if initiated, the Central Bank verifies that the pace of the liquidation may harm the institution’s creditor.

 

Extrajudicial liquidation may also be ordered upon the request of a financial institution’s management, if its bylaws entitle it to do so or upon request by the intervener, with an indication of the causes of the request.

 

The decree of extrajudicial liquidation shall trigger the following: (1) suspend the actions or foreclose on rights and interests relating to the collection of the entity being liquidated, so that no other actions or executions may be brought during the liquidation; (2) accelerate the obligations of the entity being liquidated; (3) stall the statute of limitations with respect to the obligations assumed by the institution; (4) trigger the penal clauses provided in unilateral agreements that became due by virtue of the extrajudicial liquidation; (5) ratably deduct interest, against the estate, until the date when the debts are paid in full; and (6) preclude claims for monetary correction of any passive currencies or pecuniary penalties for infringement of criminal or administrative laws.

 

Extrajudicial liquidation procedures may be terminated (a) if the financial institution is declared bankrupt or (b) by decision of the Central Bank upon the following events: (1) full payment of the unsecured creditors; (2) change of corporate purpose of the institution to an economic activity that is not part of the CMN; (3) transfer of the controlling interest of the financial institution; (4) conversion into ordinary liquidation; (5) exhaustion of the assets owned by the financial institution upon its full realization and distribution of the proceeds among the creditors, even if full payment of the credits did not occur; or (6) acknowledgement by the Central Bank that the remaining assets are illiquid or of difficult disposal.

 

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Repayment of Creditors in an Extrajudicial Liquidation or Bankruptcy

 

In November 1995, the CMN created the Credits Guarantee Fund, or the FGC, according to CMN Resolution No. 2,197, of August 31, 1995, most recently amended and superseded by CMN Resolution No. 4,222, of May 23, 2013, in order to guarantee the payment of funds deposited with financial institutions in the event of intervention, extrajudicial liquidation, bankruptcy or other states of insolvency. The FGC is mainly funded by mandatory contributions from all Brazilian financial institutions that work with customer deposits.

 

The FGC is a deposit insurance system that guarantees, pursuant to CMN Resolution No. 4,688 of September 25, 2018, as amended, a maximum amount of R$250,000 of deposit and certain credit instruments held by a customer against a financial institution (or against member financial institutions of the same financial group) and a maximum amount of R$1.0 million per creditor against the set of all consolidated financial institutions every four years. The liability of the participating institutions is limited to the amount of their contributions to the FGC, with the exception that in limited circumstances if FGC payments are insufficient to cover insured losses, the participating institutions may be asked for extraordinary contributions and advances. The payment of unsecured credit and customer deposits not payable under the FGC is subject to the prior payment of all secured credits and other credits to which specific laws may grant special privileges.

 

In addition, Law No. 9,069 was enacted in 1995, sets forth that compulsory deposits maintained by financial institutions with the Central Bank are immune to actions by a bank’s general creditors for the repayment of debts.

 

Transactions with Affiliates

 

The Banking Law (paragraph 4, article 34), as amended by Law No. 13,506 of November 13, 2017, or Law No. 13,506, prohibits financial institutions from conducting credit transactions with related parties, except in certain specific circumstances as provided below. Pursuant to CMN Resolution No. 4,693 of October 29, 2018, the following persons are considered related parties of a financial institution for the purpose of such restriction:

 

(a) its controlling shareholders (individuals or legal entities), pursuant to Article 116 of Law No. 6,404/76;

 

(b) its officers and members of statutory or contractual bodies;

 

(c) spouses, partners and blood relatives up to the second degree of individuals specified in items (a) and (b);

 

(d) its individual shareholders with stakes equal to or greater than 15% in its capital, or Qualified Equity Interest; and

 

(e) its legal entities:

 

i. with Qualified Equity Interest in the financial institutions’ capital stock;

 

ii. in which capital, directly or indirectly, the financial institution holds Qualified Equity Interest;

 

iii. in which the financial institution holds effective operational control or relevance in the deliberations, regardless of the equity interest held; and

 

iv. with a common officer or board member in relation to the financial institution.

 

The following credit transactions with related parties are exempt from the prohibition referred to above: (1) transactions carried out under market-compatible conditions, without additional benefits or privileges when compared to transactions granted to other clients of the same profile of the respective institutions; (2) transactions with companies controlled by the Federal Government, in the case of federal public financial institutions; (3) credit transactions whose counterparty is a financial institution that is part of the same prudential conglomerate, provided that they contain a contractual subordination clause, subject to the provisions of item V of art. 10 of the Banking Law, in the case of banking financial institutions; (4) interbank deposits; (5) obligations assumed between related parties as a result of liability imposed on clearinghouse participants or providers of clearing and settlement services authorized by the Central Bank or by the CVM; and (6) other cases authorized by CMN Resolution No. 4,693.

 

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According to CMN Resolution No. 4,693, as of April 1, 2019, all financial institutions must adopt internal policies regulating transactions with related parties.

 

Brazilian Law No. 7,492 enacted on June 16, 1986, which regulates crimes against the Brazilian financial system, criminalized the extension of credit by a financial institution to certain related parties mentioned in the Banking Law, which are any of its controlling individuals or entities, directors or officers, members of statutory or contractual bodies and certain of their family individual members or legal entities with a qualified interest in the financial institution, as well as any legal entity with qualified interest in the financial institution or in which the financial institution has a qualified interest, either direct or indirect, under common effective control or with common officers or directors.

 

Punitive Sanctions

 

Legal violations under Brazilian banking and/or securities laws may lead to administrative, civil and criminal liability. Offenders may be prosecuted under all three legal theories separately, before different courts and regulatory authorities, and face different sanctions with respect to the same legal offense.

 

Law No. 13,506, Central Bank Circular No. 3,857 of November 14, 2017, and CVM Instruction No. 607 of June 18, 2019, regulate administrative sanctioning proceedings as well as the various penalties, consent orders, injunctive measures, fines and administrative settlements imposed by the Central Bank and the CVM.

 

Law No. 13,506 is noteworthy, as it:

 

(1) sets fines imposed by the Central Bank of up to R$2 billion or 0.5% of the entity’s revenue, arising from services and financial products provided in the year prior to the violation;

 

(2) limits fines imposed by the CVM to the greater of the following amounts: R$50 million, twice the value of the irregular transaction, three times the amount of the economic gain improperly obtained or loss improperly avoided, or twice the damage caused by the irregular conduct. Repeat offenders may be subject to treble the amounts above;

 

(3) provides for the suspension, disqualification and prohibition from engaging in certain activities or transactions in the banking or securities market for a period of up to twenty years;

 

(4) temporarily bans offending individuals from serving in any managerial capacity for financial institutions;

 

(5) imposes coercive or precautionary fines of up to R$100,000 per day, subject to a maximum period of 30 days in punitive fines;

 

(6) defines the scope of the Central Bank’s regulatory authority;

 

(7) prohibits the offending institutions themselves from participating in the markets;

 

(8) provides for a penalty of “public admonition” in place of “warning”, imposed by the Central Bank;

 

(9) empowers the Central Bank to enter into cease-and-desist commitments;

 

(10) empowers the Central Bank and the CVM to enter into administrative agreements;

 

(11) provides the CVM with the authority to ban the accused from contracting with official Brazilian financial institutions and participating in public bidding processes for a period of up to five years; and

 

(12) redefines related party transactions.

 

Penalties may be aggregated, and are calculated based on the following factors:

 

(1) gains obtained or attempted to be gained by the offender;

 

(2) economic capability to comply;

 

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(3) severity of the offense;

 

(4) actual losses;

 

(5) any recurrence of the offense; and

 

(6) the offender’s cooperativeness with the investigation.

 

Law No. 7,492 provides a legal framework to hold controlling shareholders, officers and managers of a financial institution criminally liable. The regime under Law No. 7,492 also covers interventionists, liquidators and real estate managers, in the context of interventions, extrajudicial liquidation or bankruptcy, respectively. Those found criminally liable under Law No. 7,492 will be subject to detention and/or pecuniary fines.

 

Law No. 6,385 also imposes imprisonment and/or fines for banking or securities infractions. For example, those liable for market manipulation and insider trading are subject to sentences of up to eight and five years, respectively, plus fines of up to three times the illicit benefit gained.

 

Regulation Against Money Laundering and Bank Secrecy in Brazil

 

Law No. 9,613 of March 3, 1998, as amended by Law No. 12,683 of July 9, 2012 and Law No. 13,506 of November 13, 2017, or the Anti-Money Laundering Law, plays a major regulatory role in the oversight of banking and financial and insurance activities in Brazil. The Anti-Money Laundering Law sets forth the rules and the penalties to be imposed upon persons engaging in activities that constitute “laundering” or the concealing of property, rights and assets. Such regulation further prohibits individuals from using the financial system for the aforementioned illicit acts.

 

Pursuant to the Anti-Money Laundering Law, banks (such as Banco XP), securities brokers (such as XP CCTVM), securities distributors, asset managers (such as XP Gestão, XP Advisory and XP Vista), leasing companies, credit card companies, insurance companies and insurance brokers (such as XP VP and XP CS, respectively), among others, must: (1) identify and maintain up-to-date records of their clients, for a period of at least five years; (2) keep up-to-date records of all transactions, for a period of at least five years, in Brazilian and foreign currencies, involving securities, bonds, credit, financial instruments, metals or any asset that if converted into cash exceed the amount set forth by the competent authorities, and which shall be in accordance with the instruction issued by these authorities; (3) keep up-to-date records of all transactions, for a period of at least five years, in Brazilian and foreign currency, involving securities, bonds, credit, instruments, metals, or any asset that if converted into cash exceed the applicable minimum amount set forth by the relevant authorities, such transactions must be in accordance with guidance on amount, timing and counterparties from the relevant authorities; (4) adopt AML internal control policies and procedures that are compatible with the size of the company; (5) register and maintain up-to-date records with the appropriate regulatory agency (i.e., COAF, CVM and/or SUSEP); (6) comply with COAF’s requests and obligations; (7) pay special attention to any transaction that, in light of the provisions set forth by competent authorities, may indicate the existence of a money laundering crime; (8) report all transactions referred to in items ii, iii and vii to COAF within twenty-four hours, while abstaining from notifying their customers of such report; and (9) confirm to the applicable regulatory agency (i.e., COAF, CVM and/or SUSEP) that no offending transactions have occurred.

 

In accordance with Circular Letter No. 3,461 enacted by the Central Bank on July 24, 2009, as amended, or Central Bank Circular Letter No. 3,461, financial institutions are required to (1) maintain updated client registration data (including declarations regarding the purposes and nature of the transactions and verification of the of clients’ statuses as politically prominent persons); (2) adopt preventative internal policies and procedures; (3) record transactions involving amounts in national or foreign currencies, securities, metals or any other assets that may be converted to cash, including specific records for the issuance or reloading of amounts in the form of prepaid cards; (4) maintain records of all financial services provided and all financial transactions carried out with clients or on their behalf as well as consolidated information that allows for verification of the flow of funds, the economic activity and financial capacity of the client, the origin of funds and end beneficiaries of the transactions; (5) maintain records of transactions carried out by individuals or legal entities that involve the same groups of companies, in an amount greater than R$10,000.00 over the course of a calendar month or transactions that reveal patterns of activity that indicate a scheme to prevent identification; (6) review transactions or proposals that may indicate criminal activities; (7) maintain records of all transfers of funds related to (i) deposits, electronic transfers, checks, among

 

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others, and (ii) issuance of checks, payment orders, among others, in amounts greater than R$1,000.00; (8) maintain records of issuances or loading of credit cards that allow the identification of transactions in amounts greater than R$100,000.00 or which reveal patterns of activity that indicate a scheme to prevent identification; (9) maintain records of transaction activities in amounts greater than R$100,000.00 in cash or which reveal patterns of activity that indicate a scheme to prevent identification; and (10) notify the relevant authority of any transaction that may be deemed suspicious by the financial institution.

 

SUSEP Circular No. 445/2012 imposes similar internal controls and monitoring requirements upon insurance and capitalization companies, complementary pension companies, ( entidades abertas de previdência complementar ), cooperative companies ( sociedades cooperativas ), including those authorized to provide reinsurance services, in particular, (1) the monitoring of transactions involving politically prominent persons, terrorism and money laundering; (2) the prevention, monitoring and detection of suspicious transactions; (3) the registration of transactions with clients and beneficiaries, third parties and related parties; and (4) the validation of compliance mechanisms by internal auditing. Companies subject to this regulation are also required to appoint one of their Officers as head of compliance and register such individual in accordance with the Anti-Money Laundering Law and SUSEP Circular No. 445/2012.

 

Along the same lines, CVM Instruction No. 301 of April 16, 1999, as amended, or CVM Instruction No. 301, establishes, among other obligations, that persons who engage in, on a permanent or occasional basis, as a main or ancillary activity, cumulatively or not, the custody, issuance, distribution, settlement, trade, intermediation, consultancy or management of bonds or securities, and independent audit within the scope of the stock exchange market must adopt rules, procedures and internal controls in accordance with previously and expressly established procedures to confirm the registration information of its clients, keep such information updated and monitor the transactions carried out thereby, so as to prevent the use of the account by third parties and identify the end beneficiaries of the transactions, such entities shall also identify and closely monitor the business relations maintained with politically exposed person. Under CVM Instruction No. 301, the following should be monitored: (1) transactions in amounts incompatible with the transacting parties’ professional occupation, income, and/or equity/financial position; (2) repeated transactions between the same parties, through which one or all of the parties involved has registered consistent gains or losses; (3) transactions indicating a material discrepancy between the volume and/or frequency of the business of the parties involved; (4) transactions that may involve identity deception of the parties involved and/or their beneficiaries; (5) transactions that may indicate insubordinate acts committed by agents against their principals; (6) transactions reflecting a sudden and objectively unjustified change in the operations of the persons involved; (7) transactions carried out with the purpose of generating loss or gain for which there is no objective economic basis; (8) transactions with the participation of individuals residing, or entities organized, in countries that either do not follow or insufficiently follow the recommendations from the Financial Action Group against Money Laundering and Terrorism Financing – GAFI; (9) transactions settled in cash, if and where permitted; (10) private transfers, without apparent reason, of funds and securities; (11) transactions reflecting a complexity and risk profile incompatible with the technical qualification of the client or its agent; (12) deposits or transfers made by third parties in order to settle client transactions or in order to provide collateral in transactions in future settlement markets; (13) payments made to third parties, in any form, by means of settlement of transactions or redemption of amounts deposited as collateral, registered in the client’s name; (14) situations in which it is not possible to maintain current their client registration information; (15) situations and transactions in which it is not possible to identify the end beneficiary; (16) situations in which it is not possible to conduct the aforementioned diligence process; (17) transactions with individuals considered to be Politically Exposed Persons; (18) the business relationship maintained with Politically Exposed Persons, non-resident investors (especially when incorporated as trusts) and private banking; (19) the proposals of new relationships and operations with Politically Exposed Persons, including those from countries with which Brazil has a large volume of financial and commercial transactions, common borders or ethnic, linguistic or political proximity; (20) clients that have become, since the beginning of the relationship with the institution or have already initially been considered to be Politically Exposed Persons, and apply the treatment of items (18) and(19) above; and (21) the origin of the resources involved in the transactions of clients and beneficiaries identified as Politically Exposed Persons.

 

On March 3, 1998, the Federal Government created the Council of Control of Financial Activities, or the COAF, within the scope of the Ministry of Finance. COAF’s purpose is to verify, examine, identify and apply administrative penalties to any suspicious or unlawful activities related to money laundering in Brazil, without prejudice to the jurisdiction of other bodies and entities. COAF’s full commission is composed of a president appointed by the President of the Republic, by means of the appointment of the Ministry of Finance and by a representative of each one of the following bodies and entities: (1) the Central Bank; (2) the CVM; (3) the Ministry of Foreign Relations; (4) SUSEP; (5) the Federal Revenue Office; (6) the Federal Police Department; (7) the Brazilian Intelligence Agency; (8) the Comptroller General; and (9) the National Treasury Attorney-General’s Office. The term of office for each member is three years, with the option of reelection.

 

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The financial institutions shall inform COAF (without informing its client) of certain transactions that present the characteristics established in the Central Bank Circular Letter No. 3,461, CVM Instruction No. 301 and Circular SUSEP No. 445/2012.

 

The same obligation is imposed upon asset managers (such as XP Gestão, XP Advisory and XP Vista), and insurance companies and insurance brokers (such as XP CS and XP VP).

 

Bank Secrecy

 

Brazilian financial institutions, by virtue of Supplementary Law No. 105 of January 10, 2001, are also subject to strict secrecy rules on transactions, and are required to preserve the confidential nature of its assets and liabilities transactions and of the services provided to their clients. The only circumstances under which the information regarding clients, services or transactions of the financial institutions may be disclosed to third parties are as follows: (1) disclosure of confidential information with the express consent of the interested parties; (2) exchange of information between financial institutions for data registration purposes, including through risk assessment centers, subject to the rules issued by the CMN and the Central Bank; (3) the supply, to credit protection entities, of information included in the register of issuers of rubber checks and debtors, subject to the rules issued by the CMN and the Central Bank; (4) disclosure of the occurrence or suspicion of unlawful criminal or administrative acts, among others; (5) reporting of information addressed by article 11, paragraph 2, of Law No. 9,311, of October 24, 1996; (6) reporting of information in accordance with the conditions foreseen in articles 2, 3, 4, 5, 6, 7 and 9 of Supplementary Law No. 105 of January 10, 2001; and (7) reporting of financial and payment data related to credit operations and completed or ongoing payment obligations from individuals or legal entities to database administrators for the purpose of credit history formation.

 

Politically Exposed Persons

 

Pursuant to Central Bank Circular Letter No. 3,461, SUSEP Circular No. 445/2012 and CVM Instruction No. 301, those financial institutions and other institutions authorized to operate by the Central Bank, SUSEP and CVM are required to obtain sufficient information from their clients to identify any Politically Exposed Persons from their client base and monitor their transactions accordingly.

 

Central Bank Circular Letter No. 3,461, SUSEP Circular No. 445/2012 and CVM Instruction No. 301 define Politically Exposed Persons as any government agent, who in the last five years, have held or is holding, in Brazil or in foreign territories relevant government positions, jobs or public office, as well as their representatives, family members and other closely related persons.

 

Central Bank Circular Letter No. 3,461, SUSEP Circular No. 445/2012 and CVM Instruction No. 301 establish that the internal procedures developed and implemented by the financial institutions subject to such regulation must be structured to enable the identification of Politically Exposed Persons and the origin of the funds for such clients’ transactions.

 

Internal Auditors

 

On June 29, 2017, the CMN issued Resolution No. 4,588 establishing the rules governing internal audits at financial institutions and others authorized to operate by the Central Bank. Pursuant to the resolution, financial institutions and others authorized to operate by the Central Bank must implement and maintain internal audit functions compatible with the nature, size, complexity, structure, risk profile and business model of the respective institution. Such activity must be the responsibility of a discrete unit in the institution or institutions that are part of its financial conglomerate, directly subordinated to the board of directors or by an independent auditor provided that such independent auditor is not in charge of the institution’s financial statements or any other activity that may create a conflict of interest.

 

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Independent Auditors in Brazil

 

Pursuant to CMN Resolution No. 3,198 of May 27, 2004 as amended, or CMN Resolution No. 3,198, all financial institutions must be audited by independent auditors. The financial institutions may only hire independent auditors registered with the CVM and certified as experts in banking analysis by the Central Bank. After such auditors have issued opinions auditing the financial statement of a certain financial institution for up to five consecutive fiscal years, the Auditor’s team including managers, supervisors or any members with managerial positions, must be replaced.

 

Similarly, pursuant to CVM Instruction No. 308 of May 14, 1999, if the audited company has a permanent audit committee, the term limit of five consecutive years provided above may be increased to ten years.

 

The independent auditors and the audit committee, if applicable, must notify the Central Bank, within three business days, of the existence or evidence of error or fraud, such as:

 

· lack of compliance with rules and regulations, which could affect the business of the audited entity;

 

· fraud of any amount conducted by the management of the institution;

 

· relevant fraud conducted by employees of the institution or of third parties; and

 

· relevant errors in the accounting records of the audited entity.

 

Audit Committee

 

CMN Resolution No. 3,198 requires financial institutions and other institutions authorized by the Central Bank to operate in Brazil, as well as for clearinghouses and clearance and custody service providers that (1) present reference equity equal to, or greater than, R$1 billion; (2) manage third-party funds in amounts equal to, or greater than, R$1 billion; or (3) have deposits and funds under management in a total amount equal to, or greater than, R$5 billion, to maintain an audit committee ( comitê de auditoria ).

 

The Brazilian legislation, in certain circumstances, allows the creation of a single audit committee for the operating companies (as XP CCTVM and Banco XP S.A.) of an economic group.

 

Ombudsman

 

Pursuant to CMN Resolution No. 4,433 of July 23, 2015, financial institutions (such as XP CCTVM and Banco XP) and other entities authorized to operate by the Central Bank are required to create an Ombudsman to establish an independent communication channel between the institutions and their clients, while observing strict compliance with consumer protection legislation and seeking improvement and enhancement of products, consumer services and other services. The Ombudsman shall be the responsibility of an appointed officer (who can also be the ombudsman himself, however, such person shall not be in charge of any other activity in the financial institution) and shall be compatible with the activities of the institution, as well as the complexity of its operations. Those institutions that are part of a financial conglomerate shall be authorized to implement a single Ombudsman to assist the entire conglomerate.

 

The following are the ombudsman department’s responsibilities: (1) receiving, recording, instructing, analyzing and providing formal and adequate attention to claims from clients and users of products and services of financial institutions; (2) providing clarification regarding the status of a claim and information as to when a response is expected to be given; (3) sending a final answer by the date on which a response is required; (4) keeping the board of directors or, if one does not exist, the financial institution’s board of executive officers, informed of the problems and shortcomings detected in the performance of its duties and the results of the actions taken by the financial institution’s officers to resolve them; and (5) preparing and sending to the internal audit department, to the audit committee (if one exists), and to the board of directors (or if one does not exist, to the board of executive officers of the financial institution), at the end of each fiscal semester, a quantitative and qualitative report on the ombudsman department’s activities and its performance.

 

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The financial institutions must report and keep up-to-date information on the officer in charge of the Ombudsman. Such officer shall prepare a semiannual report (on June 30 and December 31 of each year) and whenever a material event is determined, in accordance with the Central Bank’s instructions. In addition, Brazilian law allows for the creation of a single ombudsman department structure for a group of related companies, such that a single ombudsman department can be responsible for all financial institutions that are part of the same group. Any financial institution carrying out leasing transactions, however, shall create its own segregated ombudsman structure.

 

Insurance companies (such as XP VP) are likewise required by local insurance regulations (CNSP Resolution No. 279/2013) to have an Ombudsman with a substantially similar purpose and responsibilities as those described above.

 

Whistleblowing/Hotline

 

Pursuant to CMN Resolution No. 4,567 of April 27, 2017, financial institutions (such as XP CCTVM and Banco XP) are required to have a whistleblower hotline ( canal de denúncias ), through which their employees, clients, contractors and/or suppliers may anonymously report situations involving potential illicit activities of any nature related to the financial institution. Accordingly, financial institutions are required to appoint a responsible department for forwarding all reported events to the appropriate departments for further handling. This department is also required to prepare reports semi-annually detailing, at minimum, the following information relating to each reported event: (1) number of reported events and their nature; (2) the relevant departments that handled them; and (3) the average timeframe and relevant measures adopted to solve them. Such reports must be (1) approved by the board of directors of the financial institution or, absent the board of directors, by its officers; and (2) made available to the Central Bank for at least 5 years.

 

Foreign Investment in National Financial Institutions

 

In accordance with Article 192 of the Constitution, Article 52, II, of the Brazilian Transitory Constitutional Rulings enacted in 1988, or ADCT, and Article 1, second paragraph, of Circular No. 3,317 of the Central Bank, dated as March 29, 2006, foreign investors (regardless of being an individual or entity and irrespective of their nationality) are prevented from controlling, acquiring or increasing equity interest held in a Brazilian financial institution, directly or indirectly, unless there is a bilateral international treaty or such foreign acquisition or increase is in the interest of the Brazilian government. Until September 26, 2019, the interest of the Brazilian government for such foreign acquisition of voting or non-voting equity interest in financial institutions was determined by specific Presidential Decree and in accordance with Article 5 of Circular No. 3,317. On September 26, 2019, the Brazilian President enacted Decree No. 10,029, transferring to the Central Bank the authority to approve foreign investments in Brazilian financial institutions, eliminating the necessity of specific presidential decree on a case-by-case basis. Decree 10,029 is yet to be regulated by the CMN and the Central Bank, after which, pursuant to paragraph 1, article 1, thereof, the acquisition of voting or non-voting equity interest in a Brazilian financial institution by foreign investors, held directly or indirectly, will depend only on the Central Bank’s prior approval. On November 13, 2019, the Central Bank authorized direct or indirect foreign investments in XP CCTVM and Banco XP of up to 100% of their respective capital stock.

 

Furthermore, a Presidential Decree of December 9, 1996, declared that it is in the interest of the Brazilian government to allow foreign investors to acquire non-voting shares issued by Brazilian financial institutions that are traded on a stock exchange. Such Decree is generally applicable to all Brazilian financial institutions.

 

Corporate Interest Held by Financial Institutions in Nonfinancial Companies

 

Pursuant to CMN Resolution No. 2,723 of May 31, 2000, as amended, or CMN Resolution No. 2,723, financial institutions may only directly or indirectly hold equity in legal entities (incorporated locally or abroad) that supplement or subsidize the financial institutions’ activities, provided they obtain prior authorization from the Central Bank and that the invested entity does not hold, directly or indirectly, equity of the referred financial institution. However, this requirement for authorization does not apply to (1) equity interests typically held in the investment portfolios of investment banks, development banks, development agencies ( agências de fomento ) and multiservice banks with investment or development portfolios; and (2) temporary equity interests not registered as permanent assets of the financial institution.

 

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Regulation of Branches and Subsidiaries

 

As provided by CMN Resolution No. 2,723, the Central Bank requires authorization for operations of foreign branches or subsidiaries of Brazilian financial institutions, including compliance with the following rules: (1) the institution must have been in operation for at least six years; (2) the institution must be in compliance with operational limits currently in force; (3) the institution’s paid-up capital and net worth must meet the minimum requirements established in Exhibit II to CMN Resolution No. 2,099 plus an amount corresponding to 300.0% of the minimum paid-up capital and net worth required by Central Bank regulation for the installation of commercial banks; and (4) the Brazilian financial institution must present the Central Bank with a study on the economic and financial viability of the subsidiary, branch or investment.

 

In addition, the Central Bank will only grant such authorization if it has access to information, data and documents relating to the operations and accounting records of such subsidiary financial institutions abroad. In addition, the failure by a Brazilian bank to comply with the requirements of CMN Resolution No. 2,723 would cause the deduction of a designated percentage of the assets of such branch or subsidiary from the net worth of such bank for the purpose of calculating such bank’s compliance with the capital adequacy requirements of the Central Bank, on top of the other penalties imposed pursuant to the applicable regulation, including the cancellation of the Central Bank’s authorization.

 

CMN Resolution No. 4,122 sets forth the Central Bank requirements and procedures for approving the establishment, authorization to operate, cancellation of authorization, changes of control and corporate reorganizations of Brazilian financial institutions. Such resolution further requires the Central Bank’s approval for the election and confirmation of directors, executive officers and members of the audit committee as set forth in the company’s bylaws.

 

In addition, under the terms of CMN Resolution No. 2,723, the Central Bank’s prior authorization is also required: (1) in order to allocate new funds to branches or subsidiaries abroad; (2) for capital increases, directly or indirectly, of subsidiaries abroad; (3) in order to increase equity interests, directly or indirectly, in subsidiaries abroad; and/or (4) in order to merge with or spin-off from, directly or indirectly, subsidiaries abroad. These requirements are only applicable if such subsidiary is a financial institution or similar entity.

 

Legislation Applicable to Insurance Brokerage Firms in Brazil

 

XP VP, is a Brazil-based insurance company formed in 2018 and licensed by SUSEP to operate in the life and private pension lines, focusing primarily on the distribution of its products to individuals through XP’s proprietary digital platform. As a local insurer, XP Seguros is subject to the insurance laws and regulation generally applicable to life and private pension carriers in Brazil.

 

  XP CS is an insurance brokerage company focused on life and pension insurance brokerage, duly licensed by SUSEP to operate in the insurance market as per SUSEP Circular Letter No. 510 of January 22, 2015, and registered with SUSEP under No. 10.0628468. Therefore, it is subject to the applicable legislation and regulation applicable to insurance brokers.

 

Insurance companies such as XP Seguros and XP VP are required to be duly licensed by SUSEP in order to operate in any given insurance field and are subject to the local legal and regulatory framework governing their operations, governance, solvency, products, accounting, actuarial standards and other technical aspects of their business. By engaging in the insurance business, XP Seguros is subject to a number of regulatory risks, such as (a) changes in solvency and minimum capital regulation, which could result in the need for increased capital to cover new solvency requirements and/or in the divestment of certain classes of assets; (b) changes in product regulation, which could materially alter the way in which the company’s products are created, sold or operated in general; (c) intervention and/or liquidation proceedings by SUSEP in the event of solvency-sensitive scenarios, which could lead to material deviations or interruptions to the company’s ordinary course of business and/or regulatory sanctions upon the company and its management; and (d) incurrence of fines and other penalties (such as temporary suspension of activities or license cancellation) imposed by SUSEP for perceived breaches of applicable regulation, among others.

 

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Insurance brokerage firms such as XP CS must obtain SUSEP registration and authorization for their operations, pursuant to the rules in force and in accordance with Law No. 4,594 of December 29, 1964, as amended, or Law No. 4,594/64 and Decree-Law No. 73/66. The insurance broker, whether an individual or legal entity, is the intermediary legally authorized to solicit and promote insurance contracts accepted by the current legislation, between the insurance companies and individuals or public or private legal entities. Only duly qualified insurance brokers pursuant to Law No. 4,594/64 that have signed the insurance proposal shall be paid the brokerage fees related to each insurance modality, based on the respective tariffs, including in case of adjustment to the issued premium.

 

It is not mandatory that an insurance brokerage company sells its insurance through intermediation. Such companies may seek clients directly. However, when a direct sale of insurance occurs, a fee must be paid to FUNENSEG. The Brazilian legislation does not establish a minimum brokerage fee in such cases.

 

Under the applicable regulation, insurance brokerage companies, such as XP CS, are obligated to prove technical certification of all their employees and workers who directly participate in the regulation and settlement of insurance claims, customer service, and direct sales of insurance, capitalization and open supplementary pension products. Such certification shall be provided by an institution of recognized technical capacity, duly accredited by SUSEP.

 

Insured persons and insurance firms can pursue civil action against insurance brokers for losses incurred as a result of intentional malfeasance or negligence caused by brokerage activity. In case of non-compliance with the regulatory rules, in addition to the legal sanctions, insurance brokers and managers are subject to fines, temporary suspension from the exercise of the profession or registration cancellation.

 

Regulation Applicable to the Controlled Companies Outside Brazil

 

XP Investments – United States of America

 

XP Investments, whose marketing name is XP Investments, is registered as a securities broker-dealer with the SEC and in twenty-six U.S. states and territories, and is a member of FINRA, a self-regulatory organization, or SRO, subject to SEC oversight. Consequently, XP Investments and its personnel are subject to extensive requirements under the Exchange Act, state securities laws and SEC and FINRA rules, including requirements relating to, among other things, sales and trading practices, recordkeeping, anti-money laundering, financial and other reporting, supervision, misuse of material non-public information and the conduct and qualifications of certain personnel. SEC-registered broker-dealers are also subject to capital requirements, which mandate that they maintain minimum levels of capital (“net capital”) and effectively require that a significant portion of a broker-dealer’s assets be kept in relatively liquid form. SEC and FINRA rules also require notification when a broker-dealer’s net capital falls below certain predefined criteria, limit the ratio of subordinated debt to equity in a broker-dealer’s regulatory capital composition and constrain the ability of a broker-dealer to expand its business or distribute capital under certain circumstances.

 

XP Investments is also registered with the CFTC as an introducing broker and is a member of the NFA, an SRO that regulates certain CFTC-registrants. CFTC-registered introducing brokers are subject to expansive requirements under the Commodity Exchange Act and CFTC and NFA rules, including requirements relating to, among other things, sales practices, regulatory capital, anti-money laundering, financial reporting, supervision and recordkeeping.

 

The violation of laws, rules or regulation that govern the activities of an SEC-registered broker-dealer or CFTC-registered introducing broker could result in administrative or court proceedings, censures, fines, penalties, disgorgement, suspension or expulsion from a certain jurisdiction, SRO or market, the revocation or limitation of licenses, the issuance of cease-and-desist orders or injunctions or the suspension or disqualification of the entity and/or its officers, employees or other associated persons.

 

XP Private – Switzerland

 

XP Private (Europe) S.A., or XP Private Geneva is an independent asset management firm duly authorized to conduct its activities in Switzerland, pursuant to the rules issued by the Swiss Financial Market Supervisory Authority, or FINMA, and to the applicable legislation.

 

The authorization of XP Private Geneva does not contemplate professional management of investment funds portfolio in Switzerland.

 

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FINMA is the independent regulator of financial markets in Switzerland with the aim of protecting creditors, investors and insured persons. Its supervises banks, insurance companies, stock exchanges, investment funds, their managers and administrators. FINMA also regulates insurance distributors and intermediaries.

 

XP Private Geneva is a member of the ARIF, a nonprofit self-regulatory entity recognized by FINMA. Its objective is to assist in the prevention and combat of money laundering, inform its members and require them to comply with the Federal Money Laundering Law and Terrorism Financing Act of October 10, 1997.

 

XP Investments UK LLP and Sartus UK – United Kingdom

 

XP Investments UK LLP is a brokerage firm headquartered at New Penderel House 4th Floor 283-288 High Holborn London WC1V 7HP, United Kingdom, authorized by the FCA on April 10, 2017.

 

Sartus UK is an appointed representative of NEA acting as an agent of NEA, which is duly authorized and regulated by the FCA.

 

As an appointed representative, Sartus UK is not directly authorized by the FCA to provide regulated products and services in the United Kingdom. However, it is permitted to carry out certain regulated activities as an appointed representative of NEA. NEA is responsible for ensuring that such regulated activities are carried out in accordance with the relevant regulatory requirements. Consequently, Sartus UK is required to operate its business in accordance with the regulatory requirements applicable to NEA.

 

The permissions detailed above do not cover the discretionary management of portfolios of individuals and legal entities or the investment fund (also known as collective investments schemes) portfolios in the United Kingdom and the European Union.

 

On June 28, 2019, we sent a notice of termination of the Appointed Representative Agreement to NEA, which became effective on September 30, 2019, in order to concentrate our efforts in the private and wealth management business in Switzerland through XP Private (Europe) SA.

 

C. Organizational structure

 

We are a Cayman Islands exempted company incorporated with limited liability on August 29, 2019 for purposes of effectuating our initial public offering. At the time of our incorporation, XP Controle, Itaú Unibanco S.A. (the predecessor-in-interest to ITB Holding Brasil Participações Ltda.), G.A. Brasil IV Fundo de Investimento em Participações (the predecessor-in-interest to GA Bermuda) and DYNA III held 2,036,988,542 shares (prior to giving effect to the Share Split) of XP Brazil, which are all of the shares of XP Brazil, our Brazilian principal non-operating holding company whose consolidated financial statements are included elsewhere in this annual report.

 

The table below is a list of the Company’s subsidiaries, joint ventures and associated companies:

 

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Direct and indirect interest 

Name 

Principal activities 

Country 

Investment type 

2019 

2018 

2017 

        (%)
XP Investimentos S.A. Holding Brazil Directly 100.00% 100.00% 100.00%
XP Investimentos Corretora de Câmbio, Títulos e Valores Mobiliários S.A. Broker-dealer Brazil Indirectly 100.00% 100.00% 100.00%
XP Investments US, LLC Broker-dealer USA Indirectly 100.00% 100.00% 100.00%
XP Investments UK LLP Inter-dealer broker and Organized Trading Facility (OTF) UK Indirectly 100.00% 100.00% 99.90%
Sartus Capital LTD Investment advisor UK Indirectly 100.00% 100.00% 100.00%
XP Private (Europe) SA Investment advisor UK Indirectly 100.00% 100.00% 100.00%
XP Vida e Previdência S.A. Private pension and insurance Brazil Indirectly 100.00% 100.00%
Banco XP S.A. Multipurpose bank Brazil Indirectly 100.00%
Xperience Market Services LLC Non-operational USA Indirectly 100.00%
Chameleon Bravery Unipessoal LDA Investment Advisor (pending regulatory approval) Portugal Indirectly 100.00%
XP Holding Investimentos S.A. Financial Holding Brazil Indirectly 100.00%
XP Controle 3 Participações S.A. Financial Holding Brazil Indirectly 100.00% 100.00% 100.00%
XPE Infomoney Educação Assessoria Empresarial e Participações Ltda. Digital Content services Brazil Indirectly 99.99% 99.70% 96.69%
Tecfinance Informática e Projetos de Sistemas Ltda. Rendering of IT services Brazil Indirectly 99.76% 99.73% 99.73%
XP Corretora de Seguros Ltda. Insurance Broker Brazil Indirectly 99.99% 99.82% 99.81%
XP Gestão de Recursos Ltda. Asset management Brazil Indirectly 93.70% 92.80% 91.65%
XP Finanças Assessoria Financeira Ltda. Investment consulting service Brazil Indirectly 99.99% 99.99% 99.95%
Infostocks Informações e Sistemas Ltda. Mediation of information systems Brazil Indirectly 99.99% 99.99% 99.99%
XP Advisory Gestão Recursos Ltda. Asset management Brazil Indirectly 99.57% 99.52% 99.52%
XDEX Intermediação Ltda. Intermediary and service agency Brazil Indirectly 99.99%
XP Holding International LLC International financial holding USA Indirectly 100.00% 100.00% 100.00%
XP Advisory US Investment advisor USA Indirectly 100.00% 100.00% 100.00%
XP Holding UK Ltd International financial holding UK Indirectly 100.00% 100.00% 100.00%
XP Vista Asset Management Ltda. Asset management Brazil Indirectly 99.42% 99.60%
XP Controle 4 Participações S.A. Insurance holding Brazil Indirectly 100.00% 100.00%
Leadr Serviços Online Ltda. Social media Brazil Indirectly 99.99%
Spiti Análise Ltda. Research (pending regulatory approval) Brazil Indirectly 99.99%
             

For more details about our organizational structure please see “Item 4. Information on the Company—C. Organizational structure” and refer to notes 5 to our consolidated financial statements.

 

D. Property, plants and equipment

 

Intellectual Property

 

We rely on a combination of trademark, domain names and trade secret laws, as well as employee and third-party non-disclosure, confidentiality and other types of contractual arrangements to establish, maintain and enforce our intellectual property rights, including with respect to our proprietary rights related to our products and services. In addition, we license technology from third parties.

 

As of December 31, 2019, we did not own any Brazil-issued patents or copyrights. We own a number of trademarks including XP, XP Investimentos, XP Private, RICO, CLEAR, INFOMONEY, and TECFINANCE, and other valuable trademarks and designs covering various brands, products, programs and services, including EXPERT, LEADR, EXPLICA ANA, and PRIMO RICO. We also own a number of domain names registered in Brazil, including “xp.com.br,” “leadr.com.br,” “rico.com.br,” “clear.com.br” and “infomoney.com.br”, and abroad such as “xpi.us.”

 

As of the date December 31, 2019, our application to register the trademark “XP Inc.” in the United States is pending approval by the relevant authority.

 

Properties

 

Our corporate headquarters are located in Rio de Janeiro, and our principal executive offices, which include the majority of our product development, sales, marketing, and business operations, are located in São Paulo. Our principal executive offices consist of approximately 169,950 square feet of space under a lease that expires in December 2027. We also have offices in several other locations, including offshore in the United States of America, the United Kingdom and Switzerland, and believe our facilities are sufficient for our current needs.

 

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As of December 31, 2019, we had a services agreement with a data center service provider for the provision of data services to us from its data centers in the cities of Barueri and Santana do Parnaíba, in the State of São Paulo, Brazil (which are located approximately 5 miles apart). We believe that our facilities are suitable and adequate for our business as presently conducted, however, we periodically review our facility requirements and may acquire new space to meet the needs of our business or consolidate and dispose of facilities that are no longer required.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements as of December 31, 2019, 2018 and 2017 and the notes thereto, included elsewhere in this annual report, as well as the information presented under “Item 3. Key Information—A. Selected financial data.”

 

The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of events may differ materially from those expressed or implied in such forward-looking statements as a result of various factors, including those set forth in “Cautionary Statement Regarding Forward-Looking Statements” and “Item 3. Key Information—D. Risk factors.”

 

A. Operating results

 

Overview

 

XP is a leading, technology-driven financial services platform and a trusted provider of low-fee financial products and services in Brazil. We have developed a mission-driven culture and a revolutionary business model that we believe provide us with strong competitive advantages in our market. We use these to disintermediate the legacy models of traditional financial institutions by educating new classes of investors, democratizing access to a wider range of financial services, developing new financial products and technology applications to empower our clients, and providing what we believe is the highest-quality customer service experience in the industry in Brazil. We believe we have established ourselves as the leading alternative to the traditional banks, with a large ecosystem of retail investors, institutions, and corporate issuers in local and international markets, with offices in Brazil, New York, Miami, London and Geneva.

 

Our revolutionary XP Model has been developed over the course of our evolution and enables us to go to market in a very different way from the legacy models of the large traditional financial institutions. We believe our model provides us with a unique value proposition for our clients and partners and has enabled us to instill trust in the XP brand and begin to change the way investment services are sold in Brazil. This proprietary approach incorporates a unique combination of capabilities, services and technologies to deliver a highly differentiated and integrated client experience, with significant operating efficiency advantages that have enabled us to scale and grow profitably.

 

Our technology-driven business model is asset-light and highly scalable. This enables us to generate scale efficiencies from increases in total AUC. We conduct most of our business online and through mobile applications and emphasize operational efficiency and profitability throughout our operations. These operating efficiencies enable us to generate strong cash flow in various market conditions, allowing us to continue investing in the growth of our business. Our business requires minimal capital expenditures to facilitate growth, with expenditures amounting to 3.1% of net revenues for the year ended December 31, 2019.

 

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Key Business Metrics

 

The following table sets forth our key business metrics as of and for the years indicated. These supplemental business metrics are presented to assist investors to better understand our business and how it operates.

 

    As of and for the Year
Ended December 31,
    2019   2018   2017
Client Activity Metrics (unaudited)            
Retail – AUC (in R$ billions)     409       202       126  
Retail – active clients (in thousands)     1,702       892       539  
Retail – gross total revenues (in R$ millions)     3,676       2,351       1,485  
Institutional – gross total revenues (in R$ millions)     802       484       345  
Issuer Services – gross total revenues (in R$ millions)     507       178       106  
Digital Content – gross total revenues (in R$ millions)     112       54       29  
Other – gross total revenues (in R$ millions)     420       150       99  
Company Financial Metrics                        
Gross revenue and income (in R$ millions)     5,518       3,216       2,065  
Total revenue and income (in R$ millions)     5,128       2,958       1,907  
Gross Margin (%)(1)     68.7 %     68.2 %     69.6 %
Adjusted EBITDA (in R$ millions)(2)     1,569       662       565  
Adjusted Net Income (in R$ millions)(2)     1,074       491       428  
Adjusted Net Margin (%)(3)     20.9 %     16.6 %     22.4 %

 

(1) Calculated as total revenue and income less operating costs, divided by total revenue and income.

 

(2) For a reconciliation of our Adjusted EBITDA and Adjusted Net Income, see “Summary Financial Information—Non-GAAP Financial Measures.”

 

(3) Calculated as Adjusted Net Income divided by total revenue and income.

 

The following table sets forth additional business metrics as of and for the years indicated, related to Retail AUM (as defined herein). These supplemental business metrics are presented to assist investors to better understand our business and how it operates.

 

    As of and for the
Year Ended
December 31,
    2019   2018   2017
Retail – AUM (in R$ billions)     44.7       25.7       14.4  
Mutual and Hedge Funds     21.6       14.8       7.7  
Hedge Funds (Fundo de Investimento Multimercado)     9.8       7.8       4.4  
Equity Funds (Fundo de Investimento em Ações)     3.2       2.1       1.1  
Fixed Income Funds (Fundo de Investimento Renda Fixa)     8.5       4.9       2.1  
Other Funds     0.1       0.0        
Exclusive Funds     11.3       5.5       3.5  
Pension Funds     4.6       1.4       1.0  
Investment Clubs     1.4       0.6       0.4  
Managed Portfolios     5.8       3.3       1.8