Circular Letter CVM/SMI 04/2021

30/08/2021 SEI/CVM - 1333345 - Circular Letter https://sei.cvm.gov.br/sei/controlador.php?acao=documento_imprimir_web&acao_origem=arvore_visualizar&id_documento=1403206&infra_sistema=… 1/4 SECURITIES AND EXCHANGE COMMISSION OF BRAZIL (CVM) Rua Sete de Setembro, 111/2-5th and 23-34th Floors, Center, Rio de Janeiro/RJ – ZIP: 20050-901 – Brazil - Tel.: (21) 3554-8686 Rua Cincinato Braga, 340/2nd, 3rd and 4th Floors, Bela Vista, São Paulo/ SP – ZIP: 01333-010 – Brazil - Tel.: (11) 2146-2000 SCN Q.02 – Bl. A – Ed. Corporate Financial Center, S.404/4th Floor, Brasília/DF – ZIP: 70712-900 – Brazil - Tel.: (61) 3327-2030/2031 www.cvm.gov.br Circular Letter No. 4/2021-CVM/SMI Rio de Janeiro, August 27, 2021. To Directors Responsible for Resolution CVM No. 35/2021 at Intermediaries Subject: Best practices for intermediaries to carry out procedures for the compulsory liquidation of open positions held by clients, especially in future settlement markets.

Dear Directors,

1. This Circular Letter aims to bring recommendations to intermediaries regarding measures that must be adopted to ensure that their procedures for the compulsory liquidation of open positions held by clients, especially in future settlement markets, meet the requirements set forth in Resolution CVM No. 35/2021 (RCVM 35).

I - INTRODUCTION

2. This SMI has observed, in recent years, the growth in the volume traded by natural person investors in future settlement markets, more specifically in the mini-contracts for the US dollar and IBOVESPA.

3. Article 31 of RCVM 35 provides that intermediaries must conduct their activities with good faith, diligence, and loyalty towards their clients (Article 31, caput), and they are prohibited from privileging their own interests or those of persons linked to them to the detriment of their clients' interests (Article 31, sole paragraph).

4. Regarding intermediaries that receive orders from their clients through electronic systems for direct market access trading, Article 16 of RCVM 35 provides that the intermediary must maintain a pre-operational risk management control system, including the establishment and monitoring of operational limits (Article 16, § 1st, item II, initial part), and that such risk management control system must allow for the monitoring, control, and adoption of measures aimed at adjusting orders that exceed the operational limits established by the intermediary for each client (Article 16, § 2nd).

5. Article 33, item I, of RCVM 35 also provides that the intermediary must safeguard the integrity and regular functioning of the market, including regarding client selection and the requirement of guarantees.

II - DILIGENCE OF INTERMEDIARIES REGARDING PROCEDURES FOR THE COMPULSORY LIQUIDATION OF OPEN POSITIONS HELD BY CLIENTS

6. The intermediary, when proceeding with the compulsory liquidation of an open position held by one of its clients, safeguarding the integrity and regular functioning of the market, must also observe the best interest of its client, thereby balancing the command of Article 33, item I, with that of Article 31, sole paragraph, both of RCVM 35.

7. In this regard, the opening of positions by the client must be preceded by confirmation of sufficient funds to guarantee the position to be opened, in accordance with Article 33, item I, of RCVM 35.

8. Once the position is opened in the client's name, the intermediary's risk management control systems must adequately monitor this client's exposures throughout the trading session, especially due to the volatility of the asset price, in accordance with Article 16, §1st, item II, of RCVM 35.

9. And, upon identifying, at a certain moment during the trading session, a reduction in funds deposited as guarantees in the client's name, or even changes in asset prices, the intermediary must act, (i) either to prevent an increase in positions above the guarantees allocated in the client's name, (ii) or to terminate or reduce positions held by the client, compulsorily, both to comply with Article 16, §1st, item II, of RCVM 35.

10. In order to achieve these objectives, intermediaries must adopt certain measures, cumulatively or alternatively, depending on the particularities of each situation, among them: (i) requirement of deposit of additional funds during the trading session; (ii) blocking of new operations that are not for the reduction or termination of open positions; or (iii) compulsory termination or reduction of positions held by the client.

11. It should be noted that there are different costs associated with each of these measures, and that compulsory termination of positions, especially by the risk area, normally entails the charging of additional values (for example: "fees", "fines", "tariffs", etc.) with amounts and calculation criteria that exceed the values that would be charged in operations commanded by the client themselves, as disclosed by each intermediary.

12. In the understanding of this SMI, and as a best practice, the intermediary must (i) communicate to the client, immediately and clearly, that the guarantees provided by him have reached a risk limit predefined by the intermediary. This limit must be LOWER than the compulsory liquidation limit and must be calibrated to give the client a reasonable time to react, either to provide new guarantees or to reduce the risks of their positions; (ii) communicate to the client, in advance and with transparency, that the intermediary may, with high probability, carry out the compulsory liquidation of open positions held by the client, if the client themselves does not take measures to reduce the risk of their positions or provide new guarantees; and, furthermore, (iii) inform the client about the additional costs involved, which will comply with both Article 33, item I, by the requirement of guarantees, and Article 31, sole paragraph, by the best interest of the client, both of RCVM 35.

13. What this SMI understands does not comply with the two mentioned commands is when the intermediary allows the opening of positions by the client, with guarantees that the intermediary considered sufficient at first, however, immediately afterwards, the intermediary compulsorily terminates this same position:
    a) without there having been a significant reduction in the guarantees allocated by the client; or

30/08/2021 SEI/CVM - 1333345 - Circular Letter https://sei.cvm.gov.br/sei/controlador.php?acao=documento_imprimir_web&acao_origem=arvore_visualizar&id_documento=1403206&infra_sistema=… 2/4 b) without there having been a change in the asset price that results in a significant increase in the client's risk exposure; or c) when the risk criteria and models used by the intermediary to accept the order differ significantly from those used to monitor the client's position.

14. This is because, under this condition, the intermediary is not safeguarding the integrity and regular functioning of the market, as it terminates positions of its client, who held guarantees to support the operations, in situations where the prices of the assets would not have undergone changes.

15. Moreover, in this hypothesis, the intermediary is not observing the best interest of the client, as the compulsory liquidation will, as a consequence, result in the charging of additional costs that exceed the costs of operations if commanded by the client themselves, these additional costs directed towards the intermediary's own interest, in addition to the undue opportunity costs imposed on clients in this situation.

16. Thus, the SMI understands that the intermediary must make available clear, complete, precise, and easily accessible information regarding the investor's assets, risks, and guarantees, thereby contributing to diligent asset management also by the investor, especially to allow the investor to monitor the risks emanating from their open positions in future settlement markets.

17. Likewise, intermediaries must maintain procedures for defining and managing pre-operational and operational limits of their clients, with objective criteria that encompass, but are not limited to, transactions carried out, open positions, guarantees deposited, daily movements, and the financial capacity of each client.

18. In these terms, compulsory liquidation is a control tool optional for use by intermediaries, whose objective is to mitigate the risks represented by open positions in the name of their clients, considering the client's risk as a whole and not only asset by asset, and that the eventual use of this tool does not depend on prior communication to the client, provided that the provisions of RCVM 35 are observed, in line with the guidelines presented in this Circular Letter.

III - CONCLUSION

19. In the context of best practices recommended to intermediaries for risk management, the duty of good faith, provided for in Article 31, caput, of RCVM 35, will also be materialized by the prior and wide disclosure of clear, complete, precise, and easily accessible information through client interaction channels, regarding:
    a) operational and pre-operational limits, including regarding how they can be viewed and managed by clients and the possibilities and tools for updating these limits, used by intermediaries; b) progression of the risk of loss of guarantees, with the provision of channels that allow the investor to monitor the progression of the use of the guarantees provided, especially the attainment of previously established levels of asset loss, lower than those that would legitimize compulsory liquidation by intermediaries; c) percentage of guarantee consumption from which it is OPTIONAL for the intermediary, at any time, to activate the compulsory liquidation procedure; d) percentage of guarantee consumption from which the intermediary MUST communicate to the client that the compulsory liquidation procedure may be activated at any time, if the client does not immediately replenish their guarantees or reduce the risk of their positions. This percentage must necessarily be SMALLER than that stipulated in item (c) above and must be calibrated in a way to give the investor adequate time to react; e) tariffs incident on compulsory liquidation operations in the securities market, calculated based on clear, complete, transparent, and fully accessible criteria to investors and that allow them to replicate the calculations performed by intermediaries for the charging, individualized for each client; and f) possibility of the asset position in the client's name being legitimately compulsorily liquidated by the intermediary, if the total risk of the client is compromised, even if from the point of view of the asset to be liquidated the risks and guarantees are compatible.

20. The provision, by the intermediary's interaction channels with its clients, of didactic material of easy comprehension, which allows for full understanding, especially by retail clients, of the compulsory liquidation mechanisms and their costs adopted by the intermediary, in the search for due transparency in the relationship with its clients, is also recommended, for which it is expected that the intermediary comply with RCVM 35, in line with the guidelines and best practices for carrying out compulsory liquidation procedures presented in this Circular Letter.

21. Acting thus, what is expected is that the intermediary acts in a sound and diligent manner, in the best interest of the client and safeguarding the integrity and regular functioning of the market, adopting procedures for the compulsory termination of positions held by its clients, especially in future settlement markets, imposing additional costs on its clients only when any of the following two conditions arises:
    a) significant reduction in the guarantees allocated by the client; or b) expressive change in the asset price and the risk of the positions held by the client.

Sincerely,

Document electronically signed by Francisco José Bastos Santos, Superintendent, on 27/08/2021, at 02:01, based on Article 6 of Decree No. 8.539, of October 8, 2015.
The authenticity of the document can be checked on the site https://sei.cvm.gov.br/conferir_autenticidade, informing the verification code 1333345 and the CRC code 79E1D91D.
This document's authenticity can be verified by accessing https://sei.cvm.gov.br/conferir_autenticidade, and typing the "Verification Code" 1333345 and the "CRC Code" 79E1D91D.
Reference: Process No. 19957.008410/2020-80 SEI Document No. 1333345