Circular Letter CVM/SIN 06/2020: Interpretation of Regulatory Provisions Applicable to Investment Funds

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

Circular Letter No. 6/2020/CVM/SIN
Rio de Janeiro, March 26, 2020

To
Investment fund administrators registered with the CVM

Subject: Interpretation of regulatory provisions applicable to investment funds

Dear Sirs,

1. Introduction
   We refer to questions raised by market participants to this Superintendence regarding the best interpretation to be given to occurrences of portfolio misalignment; the use of opening or closing shares in investment funds regulated by CVM Instruction 555; the holding of general meetings of investment funds in the context of the COVID-19 pandemic; and the manner in which information and documents should be exchanged between fund service providers.

2. Portfolio Misalignments
   Initially, reference is made to the provisions contained in Articles 104 and 105 of CVM Instruction No. 555, which deal with the duties of fund administrators and managers regarding compliance with portfolio composition and concentration limits and risk factors established in said Instruction and in the fund regulations, daily monitoring, communication of misalignments, and processes for realigning fund portfolios.

In this regard, we remind you that the materialization of scenarios of high market volatility in which funds trade the financial assets comprising their portfolios may provoke, in the interpretation of this technical area, eventual misalignments characterized as passive, and thus, subject to the dictates of Article 105 of the Instruction.

We recall, in this particular aspect, that Article 105 provides that the manager is not subject to penalties applicable to portfolio misalignments "resulting from exogenous facts and beyond their will, which cause unpredictable and significant (...) changes in the general conditions of the capital markets", but "provided that such misalignment does not exceed the maximum period of 15 (fifteen) consecutive days and does not imply a change in the tax treatment granted to the fund or to the fund's unitholders".

At this point, considering that, in circumstances where the continuity of unpredictability and relevance of changes in the "general conditions of the capital markets" makes compliance with the regulatory period for realignment unfeasible, the interpretation of this technical area is that there would be no just cause for the adoption of sanctioning measures by the Autarchy, with regard to the period during which the elements characterizing passive misalignment and the effective unfeasibility of realignment persist, taking into account both by the administrator and by the fund manager the extent and duration of the "exogenous facts" that led to the misalignment, and from when they no longer impose unpredictable and significant changes in the general market conditions that lead to the maintenance of the fund's misalignment situation, as provided in the regulation.

Without prejudice to the above, even in this context, it is evident that it is not appropriate for the manager to make investment decisions that might worsen the fund's misalignment situation.

It is also worth noting that the actual period during which the fund remains misaligned depends not only on the cooling of the exceptional conditions that caused it, but also on other structural factors associated with the fund's portfolio, such as, for example, the liquidity of the assets in the misaligned portfolio.

In this context, the technical area will evaluate each case within the framework of the reporting mechanism to the CVM already established by Article 105, Sole Paragraph, of the Instruction, regarding cases of misalignment, as is already the practice, to conclude whether the measures adopted by the manager, during their fund management activities, and by the administrator, as responsible for portfolio monitoring and communications to the CVM regarding misalignments, were compatible with what was required by the circumstances and in compliance with their duty of diligence.

On the other hand, even if the portfolio alignment period is not explicitly defined in other regulations associated with other types of investment funds, and this Superintendence understands that subsidiary application regarding the 15-day realignment period is not applicable, we understand that the rationale explained above should also be applied to other types of funds, in the sense that any portfolio misalignment caused by abrupt changes in market conditions should be considered passive in nature, and the realignment period considered reasonable will depend on the duration of the exceptionality, the nature and liquidity structure of the portfolio, and the best diligence adopted by the manager, in line with their fiduciary duties, to promote the solution of the problem.

3. Temporary Substitution of Opening Share Calculation with Closing Shares in Investment Funds Regulated by CVM Instruction 555
   As has been the subject of questions to this Superintendence, some fund administrators have faced operational difficulties in maintaining the calculation of opening shares for funds that admit this possibility, given the high market volatility currently. This option is currently provided for in Article 16 of CVM Instruction 555, as transcribed below:

Art. 16. In the issuance of fund shares, the value of the share of the day or the day following the application date must be used, as provided in the regulations.

§ 1st The fund regulations may establish that the value of the day's share will be calculated based on the net asset value of the previous day, duly updated by 1 (one) day, when it concerns investment funds:
I – classified, in the manner of Art. 109, as "Fixed Income"; or II – registered as "Exclusive" or "Pension", in the manner of Arts. 130 and 131, respectively.

For investment funds that offer intraday liquidity, the opening value appears as an important measure, providing the unitholder who wishes to redeem their shares with an estimated value since the beginning of the day, thus enabling the processing of redemption and application requests on the same day of the investor's request.

Thus, since it is a type of fund typically structured for applications and redemptions on D+0 and processed throughout the day, it is understandable that, in moments of extreme market volatility in which the fund operates, operational difficulties faced by some administrators persist in calculating the fund's opening shares, either due to the more severe impact that imposed operational contingencies may have on a routine very sensitive to processing time; or because, in a scenario of high market volatility in which the fund operates and maintains its positions, the very task of calculating this share becomes more difficult.

Thus, the Superintendence understands that it is admissible that, for funds with said operational difficulty, it be permitted, exceptionally and during the period in which the most acute moment of contingencies associated with the adverse, extreme, and unpredictable market scenario passes, the fund may substitute the use of the opening share with the conventional system of payments for applications and redemptions based on the closing share, provided that the fund discloses a relevant fact with the objective of informing the fund's unitholders about the temporary operational restriction to which it is subject.

4. General Meetings of Investment Funds in the Context of the COVID-19 Pandemic
   As is known, Article 66 of CVM Instruction No. 555 regulates the hypotheses in which ordinary and extraordinary general meetings of investment funds regulated by it must be convened. Similarly, Article 26 of CVM Instruction No. 356 provides for investment funds in credit rights; Article 18 of CVM Instruction No. 472, for real estate investment funds; and Article 24 of CVM Instruction No. 578, for investment funds in participations; without prejudice to the analogous provisions in the regulation of other types of investment funds regulated by the CVM.

Preliminarily, we recall the issuance of CVM Deliberation 848, which, among other matters, fixed, on an extraordinary basis, new deadlines for compliance with various periodic obligations required of investment funds, including regarding the subject matter treated here.

In this regard, since these are events that may go against the determinations of the Ministry of Health and the recommendations of the World Health Organization regarding the gathering of people, especially in enclosed environments and difficult to control for virus contamination, the interpretation of the technical area is that, under current circumstances, it is justified, in light of the public interest, the cancellation or postponement of general meetings, whether convened or not, in cases where it is not possible to hold the conclave remotely, virtually, or by means of formal consultation, observing the extended deadlines subject to the recent CVM Deliberation No. 848.

In the same sense, we understand that the same treatment applies to real estate receivable certificates ("CRI") and agribusiness certificates ("CRA"), given that such certificates are also impacted similarly as seen in the fund industry, in that securitizing companies (or fiduciary agents, as the case may be) must also hold general meetings under certain circumstances.

In the same manner here, it is appropriate to admit, in the current exceptional health situation, that securitizing companies (and, as the case may be, fiduciary agents) promote and hold virtual and remote general meetings, or even exceptionally adopt formal consultation dynamics, to deal with this scenario and preserve, with priority, the health and physical integrity of those involved. Or, when this is not possible, postpone the meetings, observing the extended deadlines subject to the recent CVM Deliberation 848.

5. Exchange of Documents Between Service Providers
   Similarly, it has been questioned about the manner in which the exchange of documents should occur between managers, administrators, banks, brokers, among others, within the scope of an investment fund, especially regarding the necessity or eventual obligation that they occur in physical or presential form, given the scenario of restrictions for face-to-face meetings or contact between people maintained in the context of the COVID-19 pandemic.

At this point, the Superintendence understands, regarding the regulation applicable to activities associated with the investment fund (especially, administration, management, custody, and distribution of fund shares), that there is no rule that requires the transmission of information or documents necessarily in any specific format, let alone physical form or requiring the presence or physical contact, direct or indirect, between people in general.

6. Provisioning of Credit Rights in FIDC
   The CVM has received various inquiries regarding the best interpretation of the rules of CVM Instruction 489 that deal with the accounting of credit rights held in the portfolio of FIDCs, especially regarding provisioning. In this context, the question arises whether delays in the payment of a credit or the need for its renegotiation necessarily impose the realization of a provision on this asset.

Regarding this point, the perception of the technical area is that CVM Instruction 489 does not require that a provision be constituted for each event of delay or renegotiation of the payment conditions of a given credit right, but rather and only, in cases where a change in the perspective of expected loss on the asset appears. Therefore, the SIN understands that the interpretation that the constitution of provisions in these cases is mandatory is not appropriate.

Without denying that delays in the payment of a credit or the need for its renegotiation can be considered evidence of a worsening in the quality of that credit held in the portfolio, thus leading to a need to record a provision for the due update of this new level of credit risk associated with the asset, nothing prevents the administrator of an FIDC from not making such a provision, whenever they conclude that the delay or renegotiation in question does not represent, per se, evidence in the reduction of the recoverable value of the asset, but emerges as a consequence of abnormal, exceptional, and temporary market situations.

However, it is worth reiterating that, just as a payment delay may not entail the constitution of a provision, it is also the administrator's duty not to delay its constitution when the facts and circumstances indicate a significant deterioration in the recovery capacity of the credits in question.

Sincerely,

Digitally signed by
DANIEL WALTER MAEDA BERNARDO
Superintendent of Institutional Investor Relations