The Brazilian Investment Market*
On October 2, 2023, the Brazilian Securities Commission’s (CVM) much-expected Resolution No. 175 (Resolution 175) came into force. The resolution modernizes the regulatory framework for investment funds in Brazil by regulating and setting force practices that have been adopted throughout sophisticated international markets, while consolidating local market practices and previous decisions rendered by the CVM’s board.
The new framework is expected to be a “game changer” for investors in the world’s fourth largest investment funds market1, with approximately BRL 7.4tn assets under management (comprising open-ended and closed-ended funds) 2.
In this article, we explore the background to Resolution 175 and key procedures in the new framework, and examine the implications for investment funds.
The Brazilian Investment Market*
On October 2, 2023, the Brazilian Securities Commission’s (CVM) much-expected Resolution No. 175 (Resolution 175) came into force. The resolution modernizes the regulatory framework for investment funds in Brazil by regulating and setting force practices that have been adopted throughout sophisticated international markets, while consolidating local market practices and previous decisions rendered by the CVM’s board.
The new framework is expected to be a “game changer” for investors in the world’s fourth largest investment funds market1, with approximately BRL 7.4tn assets under management (comprising open-ended and closed-ended funds) 2.
In this article, we explore the background to Resolution 175 and key procedures in the new framework, and examine the implications for investment funds.
On September 20, 2019, the Brazilian Federal Government enacted Federal Law No. 13,879 (Economic Liberty Act) which modified Brazil’s Civil Code to formally and statutorily govern investment funds in the country, whilst establishing a basic legal framework for the industry. With the enactment of the Economic Liberty Act, CVM was tasked with the mission to draft a new regulatory framework for investment funds that would set a legal course for investors and fund services providers regarding their liabilities before the investment fund and the CVM.
Since 2019, investors have therefore eagerly awaited two specific provisions previously disclosed and stipulated by the Brazilian government through the Economic Liberty Act. These were pending express regulations from the CVM that would make Brazil “step up its game” and effectively join the international community when speaking about investment funds. The regulations specifically were regarding:
- investors’ limitation of liability to the value of their subscribed quotas (interests in the fund which confer participation in the fund);
- the civil insolvency regimen for investment funds.
Brazilian-formed investment funds have distinct characteristics when compared to investment structures and/or investment funds in other jurisdictions. Local funds lack legal personality and are therefore not considered legal entities3. They may be formed as a closed or open-ended pool of funds, in the form of a “special nature” unincorporated pool of assets (condomínio de natureza especial).
This means that, pursuant to its sui generis legal nature/classification and prior to Resolution 175 and the Economic Liberty Act, investors of Brazilian-formed investment funds were subject to an unlimited liability regimen in case of any outstanding claims, liabilities, obligations and/or overdue charges and expenses of the investment fund that might have been incurred during its term of duration.
In other words, the “corporate limited liability veil”, which normally protects and safeguards investors and quota holders of investment funds formed in foreign jurisdictions, would not be applicable to Brazilian investment funds, due to the fact that (i) local-formed investment funds are not considered legal entities and/or corporations with legal personality and (ii) there was no legal provision (until the Economic Liberty Act) that expressly protected investors and quota holders from said unlimited liability.
On December 23, 2022, after a considerable two-year hiatus, which involved lengthy public hearings with the Brazilian capital markets players and experts, the CVM published Resolution 175. Although it will have a significant impact on Brazil’s investment market, it is important to highlight that while the quota holders’ limitation of liability is now permitted pursuant to Brazilian law, it is not mandatory. The investment fund’s bylaws must expressly dictate such limitation and stipulate that the class of quotas in question is subject to the limited liability regimen by means of the inclusion of the suffix “limited liability” in the fund’s name. This is to distinguish the limited liability class of quotas from other classes of quotas that were not subjected to the limited liability regimen (within the same investment fund structure).
Additionally, Resolution 175 has set forth a procedure for whenever a class of quotas or investment fund’s net equity is negative, and said class is subject to the limited liability regimen. In this instance, the fiduciary administrator must proceed with carrying out the following acts:
- First, to suspend and temporarily cancel: (a) the class’ rights (if any) to redeem any quotas; (b) ongoing amortizations of quotas; (c) new and/or ongoing subscriptions of quotas; and (d) requests by quota holders to redeem quotas;
- second, to communicate: (a) to the investment fund’s investment manager that the class of quotas net equity is negative; and (b) to the capital markets through filing of a material fact (fato relevante) for disclosure purposes; and
- third, within 20 days from said verification: (a) prepare (with the investment manager’s support) a plan of action (i.e., contingency plan) to deal with the class of quotas’ negative net equity; and (b) call the quota holders to convene at a meeting to render a decision with regard to the contingency plan prepared by the fiduciary administrator and the investment manager4.
At the quota holders’ meeting, in case the investors decide not to approve the contingency plan proposed by the fiduciary administrator and the investment manager, the quota holders must decide on the following possibilities:
- cover and pay up for the class’ negative net equity, by the deployment of additional capital, with own or third-party funds, in amounts and terms aligned with the class;
- spin-off, merger or amalgamation of the class of quotas to another investment fund, to which a formal proposal has been analyzed previously by the investment fund’s service providers (i.e., fiduciary administrator and the investment manager);
- liquidate the class of quotas with negative net equity, provided that there are no pending and outstanding obligations to be fulfilled with its remaining equity and assets; or
- make the fiduciary administrator file a judicial insolvency statement (i.e., bankruptcy statement) of the class of quotas with negative net equity.
In case the quota holders decide to file a judicial insolvency statement of the class of quotas with negative net equity, the fiduciary administrator will proceed with the disclosure and filing of a material fact to the Brazilian capital markets and proceed with necessary acts to cancel the class’ functioning and maintenance registration before the CVM.
Despite the Economic Liberty Act and Resolution 175 setting forth “governance and legal entity aspects” to investment funds, investment funds in Brazil will not be subject to Federal Law No. 11,101 (dated February 9, 2005) regarding a special regimen for bankruptcy and extrajudicial/judicial restructuring (“Bankruptcy and Restructuring Act”).
Pursuant to the Bankruptcy and Restructuring Act, only corporate legal entities that act as business enterprises (sociedades empresárias) may be subject to the special legal regimen regarding bankruptcy and extrajudicial/judicial restructuring. Therefore, this excludes investment funds due to the fact that they do not fall within this legal category or classification.
Investment funds will be subject to a simpler civil insolvency (insolvência civil) proceeding following the provisions of the Brazilian Civil Code and Law 5,869/73, where the relevant competent jurisdiction or court will be commissioned with the task of mainly processing creditors’ requests and proceeding with the liquidation of the class’ assets, if there are any outstanding and pending debts against it. This is seen as a point of concern, especially considering that civil insolvency matters are expected to be judged by judicial circuits which are not specialized in business matters (as is generally the case in restructuring and/or bankruptcy matters involving corporations in Brazil).
These novelties will prove to be fundamental for both local and international investors when deciding to deploy capital in emerging markets like Brazil. Investors’ equity, in theory, will be safeguarded from third-party claims should the resources and assets from the fund prove to be insufficient to pay off all debts and liabilities connected with it and its relevant service providers.
With the new regulations and the limitation of investors’ liability coming into effect, relevant aspects will have to be observed by those doing business with Brazilian investment funds. For example, the credit risk analysis of local investment funds involved in business transactions, particularly involving structured and/or leveraged funds, is now duly recommended. This is something that was not required prior to the Economic Freedom Law and Resolution 175, considering that funds did not have investors’ limitation of liability.
In addition, given its innovative nature, special attention should be paid to the role of the Brazilian courts in interpreting and applying this new legal feature. This will ensure that the limitation is in fact applied and there is no undue liability for the fund's service providers – the investment manager and the administrator – to the extent such service providers have discharged their fiduciary duties in rendering services to their administered and managed investment funds.
Attorneys affiliated with Cleary Gottlieb do not practice Brazilian law. Any views expressed herein are not and should not be construed as legal advice and should be discussed with Brazilian counsel.
Built with Shorthand