Circular Letter CVM/SIN 03/2021

SECURITIES COMMISSION OF BRAZIL
Rua Sete de Setembro, 111/2-5th and 23-34th Floors – Center – Rio de Janeiro - RJ – ZIP: 20050-901 – Brazil Tel.: (21) 3554-8686 - www.cvm.gov.br Circular Letter No. 3/2021/CVM/SIN Rio de Janeiro, March 8, 2021

To administrators and managers of investment funds regulated by CVM Instruction No. 555 ("Instruction").

Subject: Monitoring of compliance with risk factor concentration limits for investment funds according to their classes defined in the Instruction.

Dear Sirs,

This Circular Letter aims to guide administrators and managers of investment funds regarding the adequate monitoring of the compliance of the funds they administer or manage with the risk factor concentration limits established in Section V of the Instruction and their respective regulations, with special attention to the continued compliance of the investment fund with its respective class as delimited in Section VI of the Instruction.

We have identified in our prudential supervision routine of the fund industry risks associated with inadequate or incomplete controls and processes for monitoring the risk factor concentration limits that characterize the class of each fund, by administrators and/or managers, with the potential for funds to adopt investment strategies that lead to exposure to risk factors different from those defined in their mandates and disclosed to investors, including the possibility of non-compliance with the limits of their class, according to definitions in Section VI of the Instruction.

I) Frequency and methodology for monitoring the fund's compliance with risk factor concentration limits.
The measures taken by administrators and managers on this topic begin with the definition of the fund's class, even during its structuring phase, and must be taken continuously throughout the entire operational trajectory of the fund, on a daily basis, through the definition, execution, and monitoring of controls and processes that guarantee its permanent compliance. Respecting the processes and methodology of each administrator, we understand that the following steps constitute the minimum recommended to ensure adequate monitoring of the topic:

• Identification of the risk factors of each asset and derivative traded by the funds administered and registration of this information in the control systems.
• Parameterization of these systems with the portfolio concentration limits on the fund's main risk factors (defined jointly with the manager) in a manner consistent with the fund's class and its limits provided for in Section V of the Instruction, as well as with other limits provided for in the regulation.

SECURITIES COMMISSION OF BRAZIL
Rua Sete de Setembro, 111/2-5th and 23-34th Floors – Center – Rio de Janeiro - RJ – ZIP: 20050-901 – Brazil Tel.: (21) 3554-8686 - www.cvm.gov.br

• Verification, even if automated, of the operations carried out by the manager to ensure adherence to the risk factors previously defined for the fund and that they do not exceed the limits provided for the class and the regulation.
• Daily consolidation of the fund's portfolio exposure by risk factor, considering derivatives by their notional exposure value, to monitor adherence to the parameters and limits previously defined.
• In case of identification of non-compliance, potential or effective, of the fund, the administrator must immediately inform the manager and the CVM (if effective) and take measures to bring the fund into compliance in the best interest of the unitholders.

II) Interaction between administrator and manager.
As provided in Article 104 of the Instruction, it is the manager's responsibility to evaluate the compliance of the fund's classification before carrying out operations, and the administrator's responsibility to monitor this adherence up to a maximum deadline of 1 (one) day.
We understand that a key point for the adequate functioning of this monitoring is the constant and agile interaction between administrator and manager, who, within their respective spheres of regulatory responsibilities and competencies, share responsibility for the continued compliance of the fund's portfolio, aiming for a better understanding of the management strategies and the fund's investment policy. It is therefore recommended that processes or protocols be defined to ensure the efficiency of this continuous communication, whether for prudential purposes or for addressing situations of effective non-compliance.

III) Other guidelines related to the topic.
III.1) Directional position and main risk factor.
In the understanding of this technical area, the concept of the main risk factor is not necessarily linked to the directional exposure (net exposure) generated by the fund's portfolio assets and derivatives, but rather to the risk factor that is the predominant element in the management of the fund and whose variation produces the greatest effects on the market value of the fund's portfolio, as defined in paragraph 5 of Article 104 of the Instruction. As an example, funds that adopt a long biased or long and short strategy and simultaneously hold bought and sold positions in the equity market (via stock lending or derivatives), resulting in a final neutral or lightly exposed directional position in terms of beta with reference indices, must still consider, for the purpose of measuring their main risk factor, the exposure to the "equities" risk factor produced by these positions, recognizing that the price variation of the different equities held or sold reflects on the value of their portfolio independently, even if a potential correlation between these assets can be considered. This recognition of the predominance of the "equities" risk factor for the examples cited above does not prevent, of course, that the fund administrator considers eventual correlations and netting of positions when providing sensitivity information (Question 15) of the Monthly Profile document sent to the CVM.

III.2) Equity class funds with leveraged exposures in markets other than the equity market.
We guide administrators and managers of investment funds to pay special attention to the monitoring of equity class funds that may, on a recurring basis, adopt leveraged strategies through the use of derivatives that generate exposures of great magnitude in foreign exchange, interest rate, and other markets distinct from the equity market, to the point of characterizing the risk associated with the price variation of equities admitted to trading in the organized market as that which potentially produces the greatest effect on the market value of the fund's portfolio, and thus characterizing it as its main risk factor, as delimited by Article 115 of the Instruction.

SECURITIES COMMISSION OF BRAZIL
Rua Sete de Setembro, 111/2-5th and 23-34th Floors – Center – Rio de Janeiro - RJ – ZIP: 20050-901 – Brazil Tel.: (21) 3554-8686 - www.cvm.gov.br

In this sense, we clarify that compliance with the objective limits provided in paragraph 1 of Article 115 of the Instruction does not eliminate the need for continued compliance with the conceptual limit defined in the caput of the same article, which states that "they must have as their main risk factor the price variation of equities admitted to trading in the organized market." Thus, the degree of freedom granted in item II of paragraph 1 of the same article cannot be interpreted as permission to violate the concept defined in the caput, even if the fund's regulation and other documents do not define limits for leverage and/or restrictions on the use of derivatives, or if the fund's portfolio is within the leverage limit provided for in the fund's documents, if applicable. The exercise reflected above for investment funds classified as Equity must be respected and observed, under the same conditions, for funds categorized in the other classes contained in the Instruction that provide for concentration in a specific risk factor (in this case, Fixed Income and Foreign Exchange).

Sincerely,
Digitally signed by
DANIEL WALTER MAEDA BERNARDO
Superintendent of Institutional Investors Supervision