I. Background

With the spread of the COVID-19 pandemic, the global economy was brought into an abrupt and devastating halt. Without the stimulus of business activity, businesses—whether small, medium or large—have incurred heavy losses, forcing most enterprises to find creative ways to generate at least some activity, or worse, to close down.

The Securities and Exchange Commission (“SEC”) reacted swiftly to mitigate impacts and other risks brought about by the pandemic by releasing SEC Memorandum Circular No. 23, Series of 2020 (“Rules on CDV”), which aims to aid in averting credit and liquidity crisis and to prepare organizations for any further adverse development brought about by the COVID-19 pandemic.

II. A CDV, Defined

A Corporate Debt Vehicle (“CDV”) is a closed-end investment company that offers its shares and/or units of participation to any number of Qualified Buyers and/or non-Qualified Buyers not exceeding 19 persons in the Philippines during any 12-month period. The Rules on CDV has adopted the definition of a Qualified Buyer under the Securities Regulation Code (“SRC”) and its Implementing Rules and Regulation.

Similarly, the Rules on CDV has adopted the definition of large and medium-sized enterprises from SRC Rule 68. Under the Rules on CDV and SRC Rule 68, a corporation is classified as a large and/or medium-sized enterprise when it has met any of the following criteria: 

If the CDV is a parent company, the foregoing amounts shall be based on the consolidated figures. The CDV must have a primary objective of investing in portfolios of corporate debt papers of large corporations and medium-sized enterprises operating or deriving income in the Philippines, or any company guaranteed by a large or medium-sized domestic corporations, by the Philippine government and/or its agencies, or by multilateral agencies.

III. Minimum Requirements and Registration of a CDV

Like any other investment company, the establishment of the CDV starts with the filing of the CDV’s Corporate Papers, (i.e., Articles of Incorporation and By-laws which contain the mandatory provisions prescribed under the Rules on CDV), SEC Form ICA-CDV, as well as paying the filing fees to the SEC. Further, a notarized simplified Prospectus and Product Sheet must be approved by the SEC prior to the commencement of the offer. 

General Requirements

Under the Rules on CDV, a CDV must have a minimum subscribed and paid-up capital of PhP50 Million. However, if the CDV is one of or part of a group of investment companies to be created or already in existence to be managed or under management by the same Fund Manager with a track record of at least five years, the subscribed and paid-up capital shall not be lower than PhP1 Million provided that the CDV shall submit an affidavit stating that the Fund Manager is operating for at least five years.

The original incorporators of a newly-incorporated CDV are not allowed to sell, transfer, convey, encumber or otherwise dispose of their securities within 12 months from the registration of the CDV, unless such persons are related to an existing fund or Fund Manager with a track record of at least five years. Further, all of members of the Board of Directors are required to be Filipinos.

IV. Issuances of CDV

Shares Product Features

Under Section 8.1 of the SRC, securities must be registered first with the SEC before it issold or offered for sale or distribution within the Philippines. Nevertheless, Section 10 of the SRC provides for transactions which are exempt from registration, such as the sale to any number of Qualified Buyers under Section 10(l) and not exceeding 19 persons during any 12-month period under Section 10(k).

Hence, the sales of CDVs to any number of Qualified Buyers and/or non-qualified buyers not exceeding 19 persons in the Philippines during any 12-month period are exempt from the registration requirement under Section 8.1 of the SRC. Notwithstanding its exemption, the conduct by any person in the purchase, sale, distribution of such securities, settlement and other activities shall comply with the provisions of the SRC and any applicable rules. An example of which is that every share or evidence of participation, given to an investor, must clearly indicate the terms and conditions of the CDV.

As previously mentioned, a CDV is a closed-end company/fund, hence the subscription of shares in the CDV may only be done through an initial public offering (“IPO”). It also worthy to note that despite not being required to be registered as a security, a Prospectus is still required to be submitted to the SEC for approval, as will be discussed below. Relevantly, the CDV may offer several shares or unit classes, which is managed as separate asset pools, with the same investment objectives.

Another feature of CDVs is that the redemption of the shares may only be made at maturity. In this regard, the CDV may pay out the value of the underlying investments of each share or unit in a class upon maturity of said underlying investments. Notwithstanding the foregoing, a CDV may make periodic distribution of income to investors of the fund on a pro-rata basis. The distribution of income shall be made only from cash received from interest income earned after deduction of applicable taxes and expenses. For CDV issuing units of participation, it shall be exempt from SEC Memorandum Circular No.11, Series of 2008 or any amendments thereto.

Finally, considering that the investments are held to maturity, the accounting business model of the corporate debt portfolio shall follow the Hold-to-Collect Business Model. The business model for the corporate debt portfolio is amortized cost, in which the contractual cash flows under the instruments represent Solely Payments for Principal and Interest.

Requirements Prior to the Commencement of the Offer

A notarized Simplified Prospectus and Product Highlight Sheet must be submitted to and approved by the SEC prior to the commencement of the offer, the contends of which are specified under the Rules on CDV.  

The new rules define a Prospectus as a document intended to provide investors and any party to the offer with key information and disclosures to facilitate better understanding of the Fund. As a minimum requirement, several disclosures must be made in the Simplified Prospectus, such as the business background of the Investment Company/CDV, a description of the features of the securities to be offered, including the characteristics of each share or unit class, if any, rights, privileges and restrictions, as well as payment dates and probable yields for each class, the date of commencement of the offering of the CDV, as well as the commencement/ offering date of each unit/share class, if any, and the tenure and maturity of the CDV, as well as the tenure and maturity of each unit/share class, if any.

In the event that an application aims to establish more than one fund, a separate application must be submitted for each fund.

Distribution of Shares

Once the Prospectus has been approved by the SEC and the corresponding filing fees paid, the securities may be offered through an initial offering. The distribution shall be performed only by a registered Mutual Fund Distributor and Certified Investment Solicitor.

The first tranche of the approved shares or units of the CDV, which may be issued in tranches at more than one instance, must be issued within six months from approval of the SEC. Subsequent tranches shall be issued within three months from the submission of the Current Report and Updated Simplified Prospectus.

At least 30 days prior to the offering or sale of the securities of the subsequent tranches, the CDV is must inform the SEC through a Current Report of the material changes in the Simplified Prospectus previously approved or confirmed by the Commission, submit and reflect such changes in the Simplified Prospectus on file with the Commission, and update those being distributed to prospective investors, including the relevant information in the website and other selling or advertising materials.

V. Permissible Investments and Limitations

Permissible Transactions

The Rules on CDV likewise impose several obligations on the Investment Company and/or the Fund Manager to ensure that the proceeds from the issuance of CDV securities are invested in corporate debts of large corporations and medium-sized enterprises and are used in accordance with the investment policies and objectives provided in the Prospectus. However, pending the deployment of the CDV in accordance with its investment objectives, the proceeds may be invested in deposits and money market instruments. Moreover, the Investment Company and/r the Fund Manager must make certain that he issuer of the corporate debt security is regulated by the relevant regulatory authority, and that the remaining term of corporate papers where the fund invests must not exceed the term of the CDV offered. In case of unit or share class, the corporate papers where the CDV invests shall not also exceed the term of such unit or share class.

The Investment Company, operating as a CDV, may borrow, on a temporary basis, for the purpose of meeting redemptions and bringing requirements provided that the borrowing period should not exceed one month and the aggregate borrowing shall not exceed 10% of the net assets of the CDV.

Investment Limitation

The value of a CDV’s investments in Corporate Debt issued by a single enterprise must not exceed 25% of the fund’s Net Asset Value and 50% in single group entities. However, the single issuer limit may be increased to 30% if either the Corporate Debt or the issuer is assessed by any domestic or global rating agency with the highest credit rating, or may be waived if the CDV has a capital protection feature in which the return of the investor’s capital is guaranteed at a predetermined date in the future, with some returns, if any.

Additionally, the investment limit shall be computed based on the total proceeds of securities sold within the initial offering period. Nevertheless, in case of any additional launch of new share or unit class and issuance of securities thereunder by the CDV after the maturity of one share or unit class, the computation of the investment limit shall be based on the total proceeds of securities sold by the remaining classes and those of the new share or unit class.

Other Prohibitions

An Investment Company, as a CDV, is also prohibited from investing in the securities it is issuing and investing in corporate debts of corporations in which any of its directors or officers or directors or officers of its investment advisor(s), manager(s), or distributor(s) are members.

The total operating expenses of the CDV shall not exceed 10% of its average investment fund or net worth as shown in its previous audited financial statements covering the immediately preceding year. Like any other entity under the regulatory and supervisory powers of the SEC, CDVs must comply with mandatory reportorial requirements.