Data & Intelligence
New Brazilian Regulations Promote Important Changes for Private Equity Funds (“FIPs”) in Brazil
Posted On: 25 Oct 2016 | By Antonio Felix de Araujo Cintra, partner at TozziniFreire Advogados
On August 30 this year the Brazilian Securities Commission (“Comissão de Valores Mobiliários” or “CVM”) enacted Instruction CVM No. 578 (“Instruction 578”) to govern the formation, operation and management of private equity funds in Brazil. Instruction 578 revoked and replaced Instruction CVM No. 391, as amended, as well as several other regulations on the matter and is now the main regulation concerning private equity funds formed in Brazil.
Instruction 578 was enacted after a long consultation process conducted by the CVM, during which it published an initial draft and asked for comments and suggestions from the market. The draft received several comments from important Brazilian organizations such as ABVCAP and ANBIMA, as well as comments from market players, law firms and individuals.
With the final wording of Instruction 578, the CVM showed that it took a real interest in the comments it received from the public and enacted new rules that we hope will facilitate the activities of fund administrators, portfolio managers and investors in Brazil. The purpose of this article is solely to summarize some of the main innovations in the rules and not to enter into all the details of Instruction 578, which would require a much lengthier work.
One of the difficulties under the previous regulations was that the rule provided for the “automatic” registration of the FIP but the CVM did not have in place a system able to confirm immediately the registration. This problem generally caused most fund managers to wait until they received a registration letter from the CVM. Such process brought some uncertainty to the registration process.
Under the new system the registration will also be granted automatically once the relevant documents are filed with the CVM, but until the CVM implements a system for automatic registration the registration will be effective 10 business days after the filing (unless the CVM replies earlier with requests for amendments or clarifications on the documents).
2. Eligible assets.
The main change in the rules regarding the types of assets that a FIP may invest in is the authorization for FIPs (i) to invest in non-convertible debentures and (ii) to invest in quotas of limited-liability companies (usually referred to in Brazil as “Limitadas” or “Ltdas”).
The investment in non-convertible debentures is limited to 30% of the subscribed capital of the FIP (except for both Infrastructure FIPs and Research, Development and Innovation FIPs, which are not subject to the 30% limitation). This new rule will certainly provide flexibility for the managers of the FIPs and the controlling shareholders of the invested companies, which are now allowed to negotiate and structure the investments more freely investment structures that contemplate a debt and equity mix.
The other important type of asset that FIPs may now purchase is quotas of Ltdas. This is a good innovation of the new regulations, because Ltdas, due to their simplicity and lower operational cost, are the preferred type of company chosen by startups. The purpose of the CVM was precisely to enable FIPs to invest in new businesses and for that reason only Ltdas with gross revenues lower than or equal to R$16 million may receive such investments. Once a Ltda reaches the R$16 million threshold it will have to be converted into a corporation (“SA”) and adopt all governance rules required from any company invested by FIPs.
It is important to note that the existing requirement that a FIP must participate in the decision taking processes of the invested companies is applicable to the two new classes of assets described in the preceding paragraphs. Therefore, the terms and conditions of the debentures will have to contain specific provisions granting rights to the debenture holders to have an influence in the management and strategies of the issuer. The same requirement applies in the case of Ltdas, which articles of association will have to assure certain rights to the FIP to enable it to exert some influence in the management of the company.
In addition, another innovation is that Instruction 478 allows a FIP, provided it meets some requirements, to transfer funds to the invested company as advances for future capital increases (a transaction usually know in Brazil by its acronym “AFAC”). This is a very common alternative for Brazilian shareholders to provide emergency funds to a company, which are interest free and must be later incorporated into the company’s corporate capital.
3. Influence in management
Another innovation brought by Instruction 478 is the determination of certain instances where a FIP is not required to have influence in the management and strategies of the invested company. This may happen when either (i) the investment of the FIP in the relevant company is reduced to less than half of the original investment and represents less than 15% of the capital of the invested company or (ii) the accounting value of the investment has been reduced to zero and the majority of the investors agree in a general meeting to give up
Moreover, a FIP is not required to have influence in the company if it invests in companies listed in a special access segment of a stock exchange the rules of which require the listed companies to adopt governance rules stricter than those required by law. As general rule, this type of investment is limited to 35% of the subscribed capital of the FIP.
4. Investments abroad.
As a general rule, a FIP is allowed to invest up to 20% of its subscribed capital in assets located abroad (provided that the assets have the same economic nature of the assets in which the FIP is allowed to invest in Brazil). On the other hand, Multi-Strategy FIPs which accept only investments of professional investors (as defined under the relevant regulations), may invest up to 100% of their subscribed capital in non-Brazilian assets. As a reference, professional investors are currently defined as investors that have at least R$ 10 million invested in financial assets.
5. Types of funds
One of the main innovations of Instruction 578 is that it has consolidated a number of different rules and divided FIPs in five different categories: (i) Seed Capital; (ii) Emerging Companies; (iii) Infrastructure, (iv) Resarch, Development and Innovation and (v) Multi-Strategy.
The following items contain a very brief summary of the main features each type of FIP:
(i) FIP–Seed Capital (“FIP – Capital Semente”): which sole purpose is to invest in companies having annual gross revenues of less than R$ 16 million. It may invest in Ltdas., which are not required to be adopt special governance rules;
(ii) FIP – Emerging Companies (“FIP – Empresas Emergentes”): for investments in companies having annual gross revenues of less than R$ 300 million, which may be subject to less strict governance rules than the ones generally applied for companies
invested by FIPs;
(iii) FIP–Infrastructure and FIP – Research Development and Innovation (FIP – Infraestrutura and FIP – Produção Econômica Intensiva em Pesquisa, Desenvolvimento e Inovação): for investments of companies which develop infrastructure projects or are involved in the economic production in research, development and innovation in energy, transportation, water and sanitation, irrigation, and other priority areas defined by the Federal Government. Such FIPs may invest 100% of their subscribed capital in non-convertible debentures issued by the invested companies;
(iv) FIP–Multi-Strategy (FIP Multiestrategia): are FIPs that do not fit into any of the previous types. They have no restrictions as to their investments and may even make the same investments made by the special purpose FIPs mentioned above.
6. Classes of quotas
The by-laws (Regulamento) of a FIP may attribute to one or more classes of quotas different economic-financial rights in connection with both the determination of the administration and management fees and the order of preference in the payment of income, amortizations or the liquidation balance of the fund. FIPs that are open exclusively to professional investors may attribute other economic-financial rights in addition of the ones mentioned in the preceding sentence.
Moreover, the by-laws of a FIP may have one or more classes of quotas that give special political rights in connection with the matters specified therein.
7. Administrator and manager
The main innovation with respect to the management of FIPs is the clarification of the different roles played by the administrator and the manager of the fund.
The main obligations of the Administrator continue to be the ones more related to the operational aspects of the fund, such as keeping the shares register, organizing the general meetings of investors, hiring a custodian for the assets of the fund and generally making sure that the fund is always in compliance with its bylaws.
The Manager’s role, on the other hand, is mainly related the management of the investments of the FIP. In this capacity, the Manager has, among other duties, to prepare and disclose the investors any researches and studies made in connection with the investments and divestments of the FIP, to sign shareholders’ agreements on behalf of the FIP, and to exercise effective influence in the management and
strategies in the investment companies.
The issues discussed above do not cover all changes implemented by CVM in the regulations governing FIPs, which, as mentioned before, represent a major review of the rules. There are several other details that will have to be adjusted for the FIPs to become compliant with the new rules. One should note that FIPs existing before the enactment of Instruction 578 will have 12 months, as of the publication of the new rules, to adapt their by-laws to Instruction 578, unless they start a new public offering of quotas, in which case the
adjustments will have to be made at the time of the offering.
Simultaneously with Instruction 578, the CVM enacted also Instruction CVM No. 579, which provides for criteria that FIPs must use in its accounting statements. Although also very important, the analysis of Instruction 579 falls out of the scope of this article.
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Rashad Kaldany | Executive Vice-President and Growth Markets, CDPQ
David Rubenstein | Co-Founder and Managing Director, The Carlyle Group