The Brazilian Securities Commission (CVM) has enacted a new regulatory framework that will potentially reshape the investment funds industry in Brazil. The new regulatory framework brings Brazil closer to the most attractive countries for investment funds.
The long-awaited new regulatory framework for investment funds in Brazil was issued by the CVM on December 23, 2022, under CVM Rule No. 175 (RCVM 175).
The new rule, consistent with the innovations from Law No. 13,874, of 2019 (Economic Freedom Law), introduces a regulatory modernization to a major industry that became sophisticated over the last decades and further consolidates important rulings from the CVM concerning the investment funds industry.
The RCVM 175 is comprised of a general part of rules applicable to all investment funds, and of different schedules, each of which regulates different types of funds in detail. The RCVM 175 was released with two different schedules – the first one concerning Financial Investment Funds (FIF) (formerly by CVM Rule555), and the second one for Receivables Investment Funds (FIDC) (formerly regulated by CVM Rule 356). The schedules for another specific funds, such as real estate funds and private equity, and venture capital funds, are expected to be released by the CVM in early 2023.
The main innovations from RCVM 175 can be summarized as follows:
Limited liability
Now, RCVM 175 brings the possibility of limited liability to all types of investment funds, an innovation brought by the Economic Freedom Law. The limited liability funds will have to add “limited liability” to their corporate names, and quota holders of funds without limited liability will have to bear losses of the fund in case of negative net asset value, in addition to being liable for losses in connection with services rendered by services providers of the funds in bad-faith or fraud.
Multiple classes of quotas, sub-classes, and segregated portfolio
Segregated portfolio. Following the Economic Freedom Law, the RCVM 175 allows the existence of different classes of quotas and attributes to each class different rights and obligations. The funds with different class quotas must create a segregated portfolio of assets for each class, which is a new concept to the Brazilian funds industry, albeit largely used in other countries. It is expected the use of funds with segregated portfolios comes with reduction in costs and efficiency for both service providers and investors.
Classification. Because of the taxation of income and capital gains of investment funds in Brazil varies according to the fund classification pursuant to tax rules, the RCVM 175 provides that the fund may issue multiple classes of quotas, provided that all of such classes are under the same taxation regime. There was a clear concern from the CVM regarding a potential misalignment between RCVM 175 and the current tax regime for investment funds in case of the rule had allowed different classes of quotas under different tax regimes – which is subject to further review of the tax rules applicable to investment funds.
Subclasses of quotas. The RCVM 175 has introduced the concept of sub-classes of quotas. The characteristics possible to be attributed to the sub-classes of quotas include amortization and redemption, administration and management fees, and distribution of profits. The new rule did not authorize the coexistence of open-ended and closed-ended sub-classes within the same fund.
Services providers
The RCVM 175 has emphasized the relevance of the fund administrator and the fund manager, further defining both as "essential service providers". The rule brings additional responsibilities to fund managers when acting as structuring advisers to the formation of receivables funds (FIDC), and when they carry out due diligence reviews over the portfolio of receivables to be acquired by the FIDC. The CVM has also ruled on the lack of joint liability between fund administrators and fund managers, except when working on liquidity management activities as detailed below.
Social and environmental funds
The CVM showed special attention to the ESG agenda and added to RCVM 175 minimum criteria that investment funds should meet to be characterized and labeled as ESG funds. Funds that do not seek to effectively bring social and environmental criteria as an outcome of their investments cannot be labeled as ESG funds.
Crypto assets
RCVM 175 brings a definition to crypto assets, which have been added to the list of eligible assets to be purchased and traded by investment funds. However, such crypto assets must be subject to trade in Brazil or abroad in institutions authorized by financial regulators – hence ensuring a regulated trading environment for such assets. Underlying tokens of financial assets and securities are not yet considered crypto assets under RCVM 175.
Carbon credits
RCVM 175 has also added carbon credits to the list of eligible assets to be purchased and traded by investment funds. For the moment, the CVM has authorized investments exclusively in carbon credits currently existing under Brazilian regulation, such as the Decarbonization Credits (Créditos de Descarbonização, or CBIO), which must be registered in financial settlement and registration systems accredited with the CVM and the Brazilian Central Bank or traded in organized markets accredited with the CVM.
Governance
RCVM 175 aims at speeding up the decision-making process at the fund level. This gives more flexibility to fund by-laws to regulate new matters, such as payment in kind, issuance of new quotas of closed-end funds, preferred rights on the issuance of quotas, and the creation of a side pocket to the management of exceptional circumstances of illiquidity.
Liquidity management
Another important point of RCVM 175 is the attribution of joint responsibility between the fund administrator and the fund manager, now characterized as “essential services providers”, under the performance of activities related to liquidity management. The joint responsibility arises from the complementarity of such activities between both players, who must ultimately protect the best interest of the quota holders. Nevertheless, for matters other than liquidity management, the fund administrator and the fund manager remain with the power to attribute different responsibilities and duties to each other within the scope of their activities.
Non-disclosure of portfolio
The RCVM 175 has come up with a rule that allows funds not to disclose their portfolios within a window of 180 days. Many fund managers complained at the CVM that the disclosure of their portfolios under shorter terms had prejudiced their allocation and investment strategies. Such non-disclosure is automatic and does not require prior approval from the CVM, as opposed before RCVM 175. The effects of this rule will be monitored by the CVM and are subject to further amendments pursuant to the CVM’s conclusions.
Insolvency
The new rules on insolvency for investment funds are one of the most awaited innovations by the Brazilian funds industry after the creation of such possibility by the Economic Freedom Law. Pursuant to the brand new insolvency rules, in case the net asset value of the fund becomes negative, the quota holders may resolve how to address such a scenario, including declaring insolvency. The insolvency may also be requested by the fund administrator under specific circumstances. If the fund has different classes of quotas – and consequently segregated portfolios, the insolvency will fall exclusively upon the class of quotas of which net asset value became negative.
Foreign Investments
The CVM has made it more flexible for local investment funds to invest abroad. RCVM 175 now authorizes local funds to invest abroad up to 100% of their net asset value, as opposed to a limit of 20% prior to the new rule.
Insider Trading
The RCVM 175 has created a new set of rules in connection with the use of insider information.
Receivables Funds (FIDC)
Another huge improvement from RCVM 175 is the possibility to market Receivables Funds (FIDC) to retail investors, which until the new rule could only be targeted at qualified investors (e.g., individuals or legal entities with over BRL 1 million invested in financial products and securities). The Receivables Funds (FIDC) targeted at retail investors must comply with a higher standard of features to protect such investors from the risks associated with such type of investment. Unfortunately, RCVM 175 does not allow the acquisition of receivables abroad.
Effectiveness, transition period, and repeals
Effectiveness
General rule
Most of the rules of RCVM 175 will become effective on April 3, 2023, however, some other rules will become effective on the following specific dates.
Specific dates
The rules regarding maximum placement fees will become effective on October 1, 2023.
The rules regarding limits of credit exposure for Financial Investment Funds (FIF) will become effective on October 1, 2023.
The rules regarding the creation of different classes and sub-classes of quotas will become effective on April 1, 2024.
Transition period
Except for the Receivables Funds (FIDC), the existing investment funds, on April 3, 2023, must update their by-laws to conform to RCVM 175 by December 31, 2024. The Receivables Funds (FIDC) must update its by-laws to conform to RCVM 175 by December 31, 2023.
Repeals
RCVM 175 consolidated into a single rule a span of rules in connection with different types of investment funds. As a result, RCVM 175 repealed CVM Rule 356 and CVM Rule 444 (FIDC), CVM Rule 472 (Real Estate Funds), CVM Rule 555 (Hedge Funds), and CVM Rule 578 (PE and VC Funds), among others.
