CVM Circular Letter CVM/SIN 02/2015

SECURITIES AND EXCHANGE COMMISSION OF BRAZIL
Seven of September Street, 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/CVM/SIN No. 2/2015
Rio de Janeiro, June 9, 2015

To/To the Responsible Directors
Investment Fund Administrator Institutions
Subject: Liquidity Risk Management of Investment Funds

Dear Sirs/Madams,

Since the issuance of CVM Instruction No. 522/12 (“ICVM 522”), the administrator and manager of an investment fund constituted in the form of an open-end condominium must adopt the policies, practices, and internal controls necessary to ensure that the fund’s portfolio liquidity is compatible with (i) the deadlines provided for in its bylaws for the payment of redemption requests; and (ii) the fulfillment of its obligations.

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

It should be noted that despite Article 65-B, caput, of CVM Instruction No. 409/04 (“ICVM 409”) not containing an express reference to the asset portfolio manager, in the understanding of this technical area, the liquidity management of a fund is a task to be performed jointly by the administrator and manager, given that it requires coordination between liability controls (administrator) and asset controls (manager).

In light of the above, based on the regulation applicable to investment funds, combined with the experience gathered by this technical area in supervisory activities related to the matter, we hereby publish this Circular Letter, whose main purpose is to provide guidance on procedures that we consider should be observed within the scope of liquidity management of investment funds.

In this sense, without diminishing the importance of other procedures, we point out three points that we consider especially important, namely:

a) The liquidity management of a fund begins even before its constitution, during the planning of its target audience, its objectives, strategy, and investment policy, and, consequently, the conditions for share subscription and redemption payments;

b) The internal controls of administrators must be prepared to calculate the liquidity of the funds' portfolios at any time, and with precision. Moreover, it must be possible to consistently estimate the expected cash outflows (which in turn must consider not only the

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

payment of requested redemptions, but also all operational expenses of the fund, as well as provisions related to derivative transactions); and

c) The stress tests applied to the portfolios of investment funds, in accordance with Article 65-B, §2, of ICVM 409, should not simply consider a predefined historical horizon of activity, but rather simulate the volatility that may occur regarding the liquidity of assets, as well as the impacts caused by the fund's liabilities, including redemption requests, during periods of crisis. In the event that the fund does not have a history reaching a period of true stress, an alternative is to use as a reference the impacts in terms of liquidity, both from the perspective of assets and liabilities, experienced by similar funds during moments of stress, or even to consistently and verifiably simulate conditions that represent a true test of liquidity compatibility between assets and liabilities. It is also worth noting that, from the perspective of liabilities, the stress test must consider the impact of potential concentration of shareholders.

Still regarding the stress test, we inform that a report developed jointly by the Advisory on Analysis and Research – ASA – of the CVM and by this Superintendence of Institutional Investor Relations - SIN, titled INDICATOR OF REDEMPTION IN STRESS SITUATIONS, follows attached. This report provides detailed information regarding an analytical tool developed for the supervision of liquidity risk management in investment funds.

We clarify that although it is a model that is being effectively used in the supervisory routine, it is part of a continuously evolving work conducted by ASA and this SIN. The learning so far is that, even in an initial version, the tool is proving to be quite useful for monitoring the liquidity risk of the investment fund industry. Thus, we reinforce the encouragement to visit the report and highlight that any criticisms and suggestions will be very welcome.

Finally, with the aim of illustrating the result of the monitoring carried out so far by the supervision team on the liquidity stress tests to which the asset portfolios of investment funds are subjected, we highlight below the results of two tests analyzed, considering the first result positive and the second result concerning:

Case 1 - Even with a redemption deadline of D+0, the liquidity index in a stress scenario (here defined as stressed liquid assets, as provided in CVM Instruction No. 512/11, divided by Net Asset Value) of the fund (8.7094%) is higher than the worst redemption since 2008 (LVaR in stress of -7.0138%). In other words, the administrator is able to demonstrate that in a liquidity stress scenario for both assets and liabilities, the fund's situation is compliant with Article 65-B of CVM Instruction No. 409/04. It is also worth mentioning that in normal situations, the liquidity index of this fund is 3.8 times larger than its LVaR.

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

Case 2 - The current liquidity of the fund corresponds to approximately 4% of its net asset value and the largest redemption occurred in the last 12 months corresponds to 2.73% of NAV; by the characteristics presented, the administrator considers that the fund does not present liquidity risks. In this case, we consider that the use of a 12-month history, without the test covering a period that truly covers a stress situation for the fund's assets and liabilities, is not compliant with Article 65-B, § 2, of ICVM 409.

Sincerely,

FRANCISCO JOSÉ BASTOS SANTOS
Superintendent of Institutional Investor Relations