Circular Letter CVM/SIN 10/2018: Liquidity Management of Investment Funds

COMISSÃO DE VALORES MOBILIÁRIOS
Rua Sete de Setembro, 111/2-5º e 23-34º Andares – Centro – Rio de Janeiro - RJ – CEP: 20050-901 – Brasil Tel.: (21) 3554-8686 - www.cvm.gov.br Circular Letter No. 10/2018/CVM/SIN Rio de Janeiro, September 17, 2018

To
Directors Responsible for the Administration and Management of Investment Funds

Subject: Liquidity Management of Investment Funds

Dear Sirs,

CVM Instruction No. 555/14 establishes, in its Article 91, that the administrator and the manager of an investment fund must jointly adopt the policies, procedures, and internal controls necessary so that the liquidity of the fund's portfolio is compatible with (1) the deadlines set forth in the regulations for the payment of redemption requests; and (2) the fulfillment of the fund's obligations.

Furthermore, the aforementioned policies, practices, and controls must take into account, at a minimum, (i) the liquidity of the assets; (ii) the obligations, including expected margin deposits and other known guarantees and unavailability; (iii) the expected redemption values under ordinary conditions, calculated with consistent and verifiable statistical criteria; and (iv) the degree of dispersion of share ownership.

On the other hand, the Financial Stability Board ("FSB") Report on the Brazilian regulation of investment funds from 2017 (Brazil Peer Review) suggested that the CVM:

should (a) consider allowing post-event liquidity risk management tools to be deployed at short notice without the approval of investors; and (b) assess the adequacy of existing liquidity risk management tools and consider whether to broaden the range of such tools available to investment funds

In particular regarding the second recommendation of the FSB concerning the theme of liquidity management, it is suggested that the CVM assess whether the ordinary liquidity management tools currently provided for in the regulation of investment funds would be sufficient for the adequate exercise, by the manager, of their fiduciary duties on the subject.

In particular, that report mentioned:

In addition, it should be noted that some liquidity risk management tools found in other jurisdictions are not currently available in Brazil. These include swing pricing, anti-dilution levies, short term borrowings and redemption gates. Making these tools available in Brazil has the potential to provide fiduciary administrators greater flexibility to manage liquidity risk in the manner most appropriate to the type of investment fund and investors in question.

Thus, and without prejudice to ongoing studies at the CVM regarding the recommendations made in the report, this Superintendence deems it opportune and necessary to clarify the interpretation of this technical area for certain provisions of the Instruction, particularly regarding the liquidity management measures admitted, in the interpretation of the technical area, by the present domestic regulatory framework.

The Superintendence understands that the use of the swing pricing tool is not permitted nor would it be desirable, given the challenges associated with (i) transparency in the imputation of costs to the investor in these circumstances, (ii) the complexity of understanding by the average Brazilian investor regarding the application of the mechanism, and (iii) the fact that, for systemic protection purposes, the already admitted exit fees would offer similar mitigation, with greater transparency and simplicity than swing pricing and with the same expected effects of discouraging the first mover advantage.

On the other hand, it is the technical area's interpretation that short-term borrowings would leverage the fund precisely in situations of stress, would aggregate counterparty risk not foreseen in regulations nor known to investors, would amplify the risk of wealth transfer between fund shareholders, and, finally, would incentivize lenient behavior by the fund's administrator and manager regarding liquidity management, which must already estimate stress scenarios for the determination of the amount of liquid assets in the portfolio. For these reasons, in the technical area's assessment, such a tool would offer unnecessary disadvantages compared to the closure of the fund for redemptions already provided for in Article 39 of CVM Instruction 555.

Regarding the so-called anti-dilution levies, understood as the direct attribution to the investor of transaction costs associated with an investment or redemption, this Superintendence understands that there is no regulatory restriction on their use, although, in fact, it is not a practice in the Brazilian fund industry. Formally, such fees must be characterized as entry or exit fees, as applicable, and as provided for, respectively, in items XLV and XLVI of Article 2 of CVM Instruction 555, and thus, the criteria for their application and their calculation methodology, if applicable, must be detailed in the fund's regulations.

Finally, although redemption gates cannot be used as an ordinary liquidity management tool for funds intended for the general public, we remind you of the provision of Article 125, IV, of Instruction 555, which allows funds intended exclusively for qualified investors to "establish deadlines for share conversion and for the payment of redemptions different from those provided for in this Instruction"; as well as the provision of Article 39, I, of the same Instruction, which states that, in the case treated therein, it is possible to deliberate on the "reopening or maintenance of the closure of the fund for redemption," a provision that would also accommodate the implementation of redemptions through windows, if so deliberated by the shareholders in the assembly.

Sincerely,

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