The CVM approves new rules to regulate the investment funds and the concept of qualified investor

On December 17, 2014, the Brazilian Securities Commission ("CVM") issued (i) the CVM Rule no. 554, that modifies the concept of "qualified investor", creates the category of "professional investors" and removes minimum investment requirements from the other rules issued by CVM ("CVM Rule 554/14"); and (ii) the CVM Rule no. 555 ("CVM Rule 555/14"), that regulates the formation, management and operation of, and reporting by, investment funds, in substitution of CVM Rule no. 409, of 18 August 2004, as amended. 

CVM Rule 554/14 

In general, the CVM Rule 554/14 brings the following changes with effects on all rules issued by the CVM that make reference to the current concept of "qualified investors": 

(i)             Qualified investors. The following persons will be considered "qualified investors": (a) "professional investors", as per the new concept described below; (b) legal entities and individuals owning financial investments in an amount greater than R$1,000,000.00 (one million Reals) (replacing the R$300,000.00 (three hundred thousand Reals) established in the current regulation); (c) in relation to its own investments, individuals that have been approved in technical qualification examinations or have certifications approved by the CVM as requirements to be independent investment agents, portfolio administrators, securities analysts and consultants; and (d) investments clubs, provided that its portfolio is managed by one or more investors that are qualified investors.  

(ii)           Professional investors. The following persons will be deemed "professional investors": (a) persons and entities that routinely act in the financial markets, i.e., financial institutions and other institutions authorized to operate by the Central Bank of Brazil, insurance companies and savings companies, open and closed-ended pension entities, independent agents, portfolio administrators, securities analysts and consultants authorized by the CVM; (b) investment funds; (c) non-resident investors; (d) investment clubs, provided that the portfolio is managed by a securities portfolio manager authorized by the CVM; and (e) legal entities and individuals owning financial assets in an amount greater than R$10,000,000.00 (ten million Reals). 

(iii)          Investment funds. All investment funds will be deemed "professional investors", not only those targeting exclusively professional or qualified investors. However, it is important to highlight that, for the purposes of the CVM Rule 555/14, only the investment funds targeted exclusively at qualified investors and professional investors will be deemed "qualified investors" or "professional investors", respectively; therefore, subject to the rules related to concentration and diversification limits. 

(iv)          Public Social Security Regimes (RPPS). The specific social security regimes created by the Union, the States, the Federal District or Cities and Towns will be deemed "professional investors" and "qualified investors" solely if they are recognized as such, pursuant to specific regulation of the Social Security Ministry (Minist?rio da Previd?ncia Social). 

The CVM Rule 554/14 amended the CVM Rule no. 539, of 13 November 2013 ("CVM Rule 539/13"), that regulates the duty to check the suitability of investment products according to investors profiles, in order to introduce in such the concepts of "qualified investors" and "professional investors", according to the parameters established above. 

In addition, the CVM Rule 554/14 amends the other rules published by the CVM that deal with, or make reference to, the current concept of "qualified investors", replacing them by the new concepts described above, excluding any and all rules requiring a minimum investment or a minimum par value per security in case of investment in securities regulated by the CVM. 

Among the changes described above, we highlight the amendment to the CVM Rule no. 476, of 16 January 2009, as amended ("CVM Rule 476/09"). Currently, the CVM Rule 476/09 contemplates a minimum investment in the primary market in the amount of R$1,000,000.00 (one million Reals) in securities subject to public distribution with restricted placement efforts. In the secondary market, however, such securities may currently be traded in lots of any amount. In accordance with the changes introduced by the CVM Rule 554/14, the public distributions with restricted placement efforts shall be targeted solely at "professional investors", however, negotiation in the secondary market will be allowed between "qualified investors"[1]

Both CVM Rule 554/14 and CVM Rule 539/13 will enter into force on 1 July 2015. 

CVM Rule 555/14 

In general, the provisions of the CVM Rule 555/14 propose to value electronic means of communication, rationalize the volume and ensure more transparency in the disclosure of information in relation to investment funds, prevent practices that, as understood by the CVM, may affect the independence of administrators or portfolio managers in the exercise of their activities, improve regulations concerning how to calculate and charge performance fees, provide flexibility to the rules for investment in certain financial assets, in particular offshore, incorporating practices that are already adopted by the market and addressing issues that have already been clarified by CVM Board decisions and circular letters of the Authority for Relations with Institutional Investors (Superintend?ncia de Rela??es com Investidores Institucionais - SIN). 

Main modifications 

Among the innovations brought by the CVM Rule 555/14, the following are highlighted: 

(i)             Valuing virtual correspondence and provision of information on the internet. The CVM Rule 555/14 allows documents to be electronically sent or provided to shareholders and permits them to address issues electronically, provided that this is expressly contemplated by the bylaws of the fund.  

(ii)           Key aspects of open-ended funds. The CVM Rule 555/14 establishes new rules applicable to open-ended funds: (a)Transfer of shares. In addition to the cases in which transfers or disposals of open-ended fund shares are currently allowed, the CVM Rule 555/14 allows transfer and assignments of open-ended fund shares the following cases: (a.1) arbitration award; (a.2) dissolution of conjugal partnership or common-law marriage that results in the division of property; and (a.3) alterations in the management or portability of pension plans; (b)Mandatory Redemption Open-ended funds can adopt a mandatory redemption of shares, provided that: (b.1) the bylaws or the shareholders general meeting authorize and clearly determines the terms and conditions under which this procedure is to take place; (b.2) is performed in an equitable, simultaneously and proportionally manner between all shareholders; and (b.3) no exit fee is charged; and (c)Prospectus- Waiver. The CVM Rule 555/14 waives the need a prospects for open-ended funds and it transfers the material information provided therein to the term of adhesion and risk awareness or a new virtual disclosure documents with information from the Fund (Formul?rio de Informa??es Complementares do Fundo). 

(iii)          Distribution of L?mina. It is expressly forbidden to use the name "L?mina" in documents that do not meet fully the requirements of the CVM Rule 555/14, being mandatory the distribution of the l?mina together with any marketing materials of open-ended funds not targeted exclusively to "qualified investors", except in the cases expressly provided for in the CVM Rule 555/14. 

(iv)          Attributions of portfolio managers and administrators. The CVM Rule 555/14 includes clarifications on the division of responsibilities between administrators and portfolio managers, explaining issues relating to the authority to represent the fund in several circumstances and determining which obligations and veto are applicable to one or the other, as applicable. Among other, are deemed attributions of the portfolio manager: (a) to trade on behalf of the fund the financial assets, to hire intermediaries involved in the transactions on behalf of the fund, as well as execute, where appropriate, any and all agreements or documents relating to trading and buying such financial assets, representing the fund in this regard for all legal purposes; (b) to send to the administrator copies of the documents executed on behalf of the fund, without prejudice to sending other documents and information to allow the administrator to correctly comply with its legal and regulatory obligations towards the fund; and (c) to exercise voting rights applicable to the financial assets comprising the portfolio of the fund and perform all other actions required in connection therewith. 

Additionally, the CVM Rule 555/14 establishes requirements for the engagement of more than one portfolio manager by investment funds, namely: (a) joint and several liability for the acts of common management; (b) each portfolio manager shall have limitedauthority to give orders to the custodian of the fund, being restricted to the specifics of each portfolio manager, when applicable; and (c) the administrator shall have authorization to act as arbitrator in the event of any conflict. 

(v)            Engagement of the market-maker. The CVM Rule 555/14 provides that the administrator can engage a market maker on behalf of the fund, provided that: (a) the engagement and termination of this service are disclosed as material fact; and (b) the market maker is duly registered with the marketing authorities and is not administrator, manager or a related party of the fund. 

(vi)          Treatment of custody fee. In response to comments from participants of the public hearing, the CVM has decided not to include the custody fee into the management fee, and the CVM Rule 555/14 established that: (a) the maximum percentage of the custody fee shall be expressly provided in the Bylaws; (b) the increase on such percentage is subject to approval by the shareholders general meeting of the fund; and (c) the effective custody fee shall be disclosed on the form of "Performance Demonstration of the Fund" (Formul?rio de Demonstra??o de Desempenho do Fundo). 

(vii)        New calculation methodology for the performance fee: the "adjustment method". In addition to recognizing the two methods already used by the market to calculate and charge the performance fee[2], the CVM Rule 555/14 permits the use of a third methodology: the "adjustment method". Generally speaking, the "adjustment method" will consist of adopting the "assets method" for all investments preceding the last time the performance fee was charged, and solely for investments made thereafter individual adjustments will be made. For this purpose, the value of the shares as of the day of, or day following, actual availability in the issue of shares will be used, always before deducting the provision for payment of the performance fee, and individual adjustments should be made in order to correct any benefit or loss in relation to the other shares in the fund. 

(viii)       Other changes in relation to calculating and charging the performance fee. (a)Share resetting: As a general rule, the CVM Rule 555/14 contains a prohibition in relation to the procedure known in the market as "resetting", whereby the value of share as adjusted in accordance with the benchmark is reset at the end of a period in relation to which a performance fee is charged. In this sense, specific procedures are established to ensure that the value of the shares in the fund at the time of calculating the performance fee is compared to the value of the basis share, as adjusted in accordance with the benchmark for the period elapsed since the last time the performance fee was charged; (b)Negative benchmark: In respect to the funds that are not targeted exclusively to "qualified investors", the CVM Rule 555/14 contemplates specific rules for calculating the performance fee in case the portfolio of the fund appreciates but the relevant benchmark has a negative performance (i.e., the value of the shares is higher than the value of the basis shares/high water-mark, but the value of the shares, as adjusted in accordance with the benchmark, is lower than it). In such case, the performance fee will be calculated on the difference between the value of the shares and the value of the basis shares/high water-mark, as adjusted in accordance with the benchmark, provided that the performance fee amount is at all times restricted to the difference between the value of the shares and the value of the basis shares/high water-mark; and (c)Carrying forward the provision for performance fee: the CVM Rule 555/14 allows the administrator and the portfolio manager not to allocate the performance fee provisioned in a period and charge it in the next period, provided that this is expressly contemplated by the fund regulation, the fund is targeted solely at "qualified investors" and the value of the shares is higher than the value of the basis shares/high water-mark. In case of a fund that is not targeted solely at "qualified investors", this procedure will only be permitted if the performance fee is calculated and charged in accordance with the "adjustment method". 

(ix)          End of rebate for funds of funds. In relation to funds of funds, the CVM Rule 555/14 includes a provision expressly prohibiting the administrator, portfolio manager or their related parties from receiving any compensation, benefit or advantage that could affect their independence in the exercise of their activities, directly or indirectly through related parties.  

It is appropriate to bear in mind that pursuant to the CVM Rule 555/14 the above mentioned prohibition is not applied to (a) funds of funds investing more than 95% of their net assets in a single investment fund; and (b) investments funds targeted solely at "professional investors", provided that the totality of investors execute specific acknowledgement terms, according to the form provided for in the CVM Rule 555/14. 

(x)        Financialassets located offshore. The CVM Rule 555/14 provides details of the requirements and rules for investments in financial assets located offshore. In this sense, these assets must meet at least one of the following conditions: (a) be registered in the registration system, object bookkeeping of assets, custody object or central deposit, in all cases, by institutions authorized in their home countries and supervised by recognized local authority; or (b) having its existence diligently checked by the administrator or by the custodian of the Fund, as defined in the bylaws of the fund, provided that such assets are recorded or held in custody, in both cases, by duly authorized entities according to the CVM Rule 555/14.  

Funds are only allowed to use offshore derivatives contracts if such transactions comply with at least one of the following conditions: (a) are recorded in registration systems, subject to proper bookkeeping, held in custody or registered in a clearing system, in all cases, by duly authorized systems in their countries of origin supervised by recognized local authority; (b) are informed to the local authorities; (c) are traded on exchanges, electronic platforms or settled through a central counterparty; or (d) have, as counterparty, financial institution that complying with Basel Accords, is classified as low credit risk and is supervised by a recognized local authority. 

Moreover, the fund that invests in funds or offshore investment vehicles must comply with the following conditions: (a) the administrator, directly or through the custodian of the fund, should make sure of the custodian or the register and transfer agent of the offshore investment vehicle has infrastructure, processes and adequate internal controls to perform the activities as provided in the CVM Rule 555/14; (b) the portfolio manager must ensure that the investment fund or offshore investment vehicle complies with all the requirements expressly provided for in the CVM Rule 555/14, including those when it, directly or indirectly, has influence on investment decisions of funds or other offshore investment vehicles.  

(xi)          Amendments in the limits for investment in certain financial assets. The CVM Rule 555/14 contemplates the possibility for funds that are not targeted solely at "qualified investors" to be permitted to invest up to 20% of their net worth in investment funds targeted solely at "qualified investors" or funds of funds targeted solely at "qualified investors". Within the 20% limit referred above, up to 5% (five percent) of the net assets of the fund can be invested in (a) non-standardized receivablesinvestment funds ("FIDC-NP") or fund of funds that invest in FIDC-NP; and (b) shares of investment funds, or funds of funds, registered according to the CVM Rule 555/14 target exclusively at "professional investors". 

Additionally, the CVM Rule 555/14 provides that investment funds may invest up to 20% of their net worth in offshore financial assets. There will be no such limit, being the investors allowed to invest 100% of the net assets of the fund in offshore financial assets, in: (a) funds classified as "Fixed Income - Foreign Debt" (Renda Fixa - D?vida Externa); (b) funds targeted exclusively to "professional investors"; and (c) funds target exclusively at "qualified investors", provided that, among other requirements, the bylaws of the funds established that at least 67% of the net worth is to be composed of offshore financial assets and has detailed information about the assets that the Fund to intends to acquire. For the other funds targeted at "qualified investors" not referred above, the limit to offshore investments is 40%. 

(xii)        New classification of investment funds. The CVM Rule 555/14 simplifies the fund classification so that there are only four classes of funds, namely, "Fixed Income" (Renda Fixa), "Equities" (Renda Vari?vel), "Multimarket"(Multimercado) and "Foreign Exchange" (Cambial) funds, expressly authorizing the adoption of multiple sub classifications provided for in the CVM Rule 555/14 (i.e. Simple (Simples), Indexed (Refenciado), Foreign Debt (D?vida Externa), Short Term (Curto Prazo), Long Term (Longo Prazo) and Offshore Investments (Investimento no Exterior)).

(xiii)      Creation of a "Fixed Income Simple Fund". The CVM Rule 555/14 creates the so-called "Simple Fund", with a restricted investment policy. The key characteristics of such fund are (a) 95% of the portfolio is invested in (a.1.) federal government bonds (a.2) fixed income securities issued or guaranteed by financial institutions with a credit risk assigned by the portfolio manager equivalent to the sovereign risk, or (a.3) REPO agreements backed by federal government bonds or securities issued or guaranteed by institutions duly authorized by the Central Bank of Brazil, with credit risk at least equivalent to sovereign risk, when the assets are backed by private entities; (b) they use derivatives exclusively for hedging purposes; (c) organized as open-ended funds; (d) preferably use of electronic distribution, documents and communications; and (e) adoption by the portfolio manager of investment strategies to protect the fund from losses and volatility. 

(xiv)       Key aspects of funds targeted solely at "qualified investors". The CVM Rule 555/14 indicates that funds targeted solely at "qualified investors": (a) if closed-ended, are exempted from preparing and publishing a prospectus, notice of launch and end of the relevant public offerings of shares; and (b) can provide guarantees in agreements or negotiable instruments, provide acceptance and assume joint obligations, in transactions directly or indirectly related to the portfolio of the Fund, provided that no less than 2/3 of their shareholders agree therewith. 

(xv)         Key aspects of funds targeted solely at "professional investors". As long as expressly provided in the respective bylaws, funds targeted exclusively to "professional investors" are exempted from many requirements of CVM Rule 555/14, such as compliance with specific rules to calculate the performance rate and concentration and diversification limits, among others. 

In addition to "professional investors", the CVM Rule 555/14 admits as investors of funds target exclusively at "professional investors": (a) employees or members of the administration or management bodies of the fund or its related institutions, as long as expressly authorized by the director responsible for the institution before the CVM; and (b) investors related to "professional investors" for family or corporate relationship, provided that at least 90% of the shares of fund are held by such investors.

(xvi)       Fund transformation. The CVM Rule 555/14 brings express restrictions in relation to fund transformations, which will only be permitted when the investment policies of the funds involved are compatible. In addition, the prior authorization of the CVM will be required for transformation: (a) from an open-ended fund into a closed-ended fund, (b) from an investment club into an open-ended or closed-ended investment fund and vice-versa, and (c) from a fund regulated by a specific CVM rule into a fund regulated by the CVM Rule 555/14 and vice-versa. 

(xvii)     Other matters. The CVM Rule 555/14 also innovates in relation to the following matters: (a) in case a fund is closed for investment in exceptional illiquidity events, it will only be mandatory to call a shareholders general meeting if the fund stays closed for more than five consecutive days, (b) in the case of funds intended solely for "professional investors", the administrator is authorized to restrict new applications only to new investors; (c) expressly provides for payment of shares in closed-end funds targeted exclusively to "qualified investors" through capital calls made by the administrator; and (d) the administrator will be allowed to disclose the value of the shares and the net assets of an open-ended fund in a frequency that is compatible with the liquidity of the fund, provided that this is expressly contemplated by the relevant fund regulation.

Transitional Provisions 

CVM Rule 555/14 shall enter into force on July 1, 2015, and the investment funds which are in operation on July 1, 2015 will have until January 4, 2016 to adjust to the new rules.

Changes in the funds regulations promoted by managers seeking to include privileges and/or expand concentration limits previously established will depend on approval of the shareholders general meeting, in accordance with the funds regulations. If there is no sufficient quorum to set up the shareholders general meeting, the manager will be allowed to make such changes, with due regard to certain rules regarding shareholders general meeting callings and effective decisions.

In the case of investment funds and investment funds to "qualified investors" or "professional investors", despite the need to adjust to new rules, the shareholders who no longer fit in their respective categories will be allowed to stay and make additional investments, provided that they have joined the fund prior to the date in which the CVM Rule 555/14 enters in force, in accordance with the criteria for admission and permanence previously existing.

For the investment funds operating on the date that the CVM Rule 555/14 becomes effective, it will be allowed the maintenance of the previously existing performance fee until the first collection after the adjustments of the funds regulations.

In case of noncompliance with the limits of type of assets or of issuers on the effective date of the amendments, the maintenance of the financial assets in the fund portfolio will be allowed until the maturity date or regarding financial assets without maturity, for a maximum of one hundred and eighty (180) days from the validity of the adjusted fund regulation. In such case, the investment funds will not be allowed to make new investments that aggravate the excesses until they comply with the standard of the CVM Rule 555/14.

Managers and portfolios managers will have a period of one hundred and eighty (180) days from July 1, 2015 to terminate the rebate of funds of funds.