CVM issues official letter to managers and administrators of investment funds regulated by CVM Instruction 555

The Securities and Exchange Commission of Brazil ("CVM") published, on March 8, 2021, Circular Letter No. 3/2021/CVM/SIN ("Official Letter") with the purpose of providing guidance to investment fund managers and administrators on the appropriate monitoring of the compliance of funds with the limits on concentration in risk factors established in CVM Instruction No. 555.

In order to avoid that the funds may adopt investment strategies that lead to an exposure to risk factors different from those disclosed to investors, including with the possibility of non-compliance with the limits of their class, CVM recommends:

I) Periodicity and methodology for monitoring the compliance of the fund with the limits of concentration in risk factors.

CVM understands that the following steps are the minimum recommended to ensure adequate monitoring:

- Identification of the risk factors of each asset and derivative traded by the managed funds and registration of this information in the control systems.

- Parameterization of these systems with the limits of concentration of the portfolio in the main risk factors of the fund (defined jointly with the manager) in a manner consistent with the class of fund and its limits foreseen in CVM Instruction 555, as well as with other limits foreseen in the regulations.

- Verification, even if automated, of the operations carried out by the manager in order to guarantee adherence with the risk factors previously defined for the fund and that they do not exceed the limits foreseen for the class and the regulations.

- Daily consolidation of the exposure of the fund portfolio by risk factor, considering the derivatives by their notional value of exposure, to monitor adherence to previously defined parameters and limits.

- In the case of identification of potential or effective non-compliance of the fund, the administrator should immediately inform the manager and the CVM (if effective) and endeavor for its compliance in the best interest of the quota holders.

II) Interaction between administrator and manager.

According to CVM Instruction 555, it is the responsibility of the manager to evaluate compliance with the framework of the fund before executing operations and the administrator to monitor this compliance up to the maximum period of 1 (one) day.

In CVM's understanding, for the adequate functioning of the monitoring it is necessary to have a constant and agile interaction between the administrator and the manager who, within their respective spheres of attributions and regulatory competences, share the responsibility for the continuous classification of the fund portfolio, aiming at a better understanding of the management strategies and the investment policy of the fund, and thus it is recommended that processes or protocols be defined to guarantee the efficiency of this continuous communication, be it prudential or for the addressing of situations of effective non-compliance.

III) Other related guidance.

III.1) Directional position and main risk factor.

In the understanding of the technical area of the CVM, the concept of principal risk factor is not necessarily linked to the directional exposure (net exposure) generated by the assets and derivatives of the fund portfolio, but to the risk factor that is the preponderant element in the management of the fund and whose variation produces the greatest effects on the market value of the fund portfolio.

The CVM mentioned, by way of example, funds that adopt a long biased or long and short strategy and hold both long and short positions in the variable income market (via stock borrowing or derivatives), resulting in a neutral or little exposed final directional position in terms of beta with reference indexes. Such funds should consider, even so and for purposes 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 shares held or sold reflects on the value of their portfolio independently, although a potential correlation between these assets can be considered.

The recognition of the preponderance of the risk factor "equities" for the examples cited above does not impede that the administrator of the fund consider eventual correlations and netting of positions in the rendering of the 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 equities.

CVM advises fund managers and administrators to pay special attention to the monitoring of Equity class funds that may adopt, on a recurrent basis, leveraged strategies through the use of derivatives that generate large exposures in the foreign exchange and interest rate markets, as well as other markets distinct from the stock market, to the point of mischaracterizing the risk associated with the variation in the prices of shares admitted to trading in the organized market as the one that potentially produces the greatest effect on the market value of the fund portfolio and, therefore, mischaracterizing it as its main risk factor.

In this sense, the CVM clarifies that the compliance with the objective limits set forth in CVM Instruction No. 555 does not eliminate the need for continued compliance with the conceptual limit defined, and that as provided in the rule "The main risk factor for funds classified as "Equities" must be the variation in the prices of shares admitted for trading in the organized market".

Although the CVM Instruction no. 555 allows that the surplus resources of the portfolio may be invested in any other modalities of financial assets, as long as certain limits of concentration are observed, this degree of liberty should not be interpreted as an allowance for non-compliance with the main concept, even if the regulations and other documents of the fund do not define limits for leverage and/or restrictions for the use of derivatives or that the portfolio of the fund is within the leverage limit foreseen in the documents of the fund, if applicable.

Finally, it is worth emphasizing that the recommendations for investment funds classified as Equity funds should be respected and observed, under the same conditions, for funds categorized in the other classes listed in CVM Instruction 555 that provide for concentration on specific risk factors (in this case, Fixed Income and Foreign Exchange).

Please click here to access the full content of the Official Letter. For further information, please contact our Capital Markets team at our office ([email protected].br).