Brazil: Brazilian Market Index Investment Funds May Invest In International Exchange Traded Funds (ETF)?

Last Updated: 13 November 2012
Article by Walter Stuber

On November 12, 2012, the Supervision of Relations with Institutional Investors (Superintendência de Relações com Investidores Institucionais) of the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) issued Directive Release (Ofício-Circular) CVM/SIN/No. 5/2012, dated November 7, 2012, addressed to the administrators of Brazilian Market Index Investment Funds (Index Funds), also known abroad as Exchange Traded Funds (ETFs), governed by CVM Instruction No. 359, of January 22, 2002 (CVM Instr. 359/2002), about domestic Index Funds that invest in International ETFs.

By force of CVM Instr. 359/2002, domestic Index Funds cannot invest in units (cotas) of ETFs incorporated in other jurisdictions.

The Index Fund is organized as an open-end joint ownership, whose resources are intended for investment in securities portfolio that seek to replicate the variations and profitability of a reference index for an indefinite period of time. For this purpose, reference index means a specific market index recognized by CVM, with which the investment policy of the Index Fund is associated.

Payment and redemption of fund units may only be made by a tender of securities that compose the reference index, pro rata to such composition. The fund bylaws may specify minimum or maximum lot of securities for the purpose of issuance or redemption of units, based on the theoretical portfolio of the reference index.

The Index Fund will maintain at least 95% of its resources invested in securities or other variable income assets authorized by CVM, in the same proportion in which they appear in the reference index, or in positions purchased in the reference index futures market, so as to reflect the variations and profitability of such index. The total margin guarantees required of the Index Fund in transactions involving derivatives may not exceed 20% of the fund´s net asset value. The Index Fund may enter into swap agreements with third parties containing a mark-to-market settlement provision, covering the difference in profitability between the fund and the reference index.

Funds in excess of the minimum investment specified in the preceding paragraph (95%) may be invested in: (i) governmental securities issued by the Brazilian Treasury of the Central Bank of Brazil (Banco Central do Brasil – Bacen); (ii) fixed-income securities issued by financial institutions; (iii) units of a financial investment fund (fundo de investimento financeiro – FIF); (iv) repurchase transactions, in accordance with the regulations issued by the Brazilian Monetary Council (Conselho Monetário Nacional – CMN); and (v) derivatives transactions made on a stock exchange, commodities and futures exchange or organized over-the-counter market solely to manage the risks incidental to the fund´s portfolio or the securities therein, subject to the limit of 20% of the fund´s net asset value mentioned in the preceding paragraph.

To enable the incorporation of an Index Fund with the proposal of investing in units of ETFs incorporated in other jurisdictions, in fact specific waivers would be required to comply with certain provisions of the applicable regulations, beyond those which the CVM Board has been granted in the case of Index Funds that has been registered with CVM since 2008. These provisions are the following: (i) the Index Fund must have the possibility to acquire units of ETFs of other jurisdictions; (ii) the Index Fund must be authorized to pay and redeem units in Brazilian currency without any limitation whatsoever; and (iii) the fund bylaws must contain a provision allowing the collection of entry and exit fees to be passed along to the unitholder requesting investment/redemption of units the costs arising from the creation or destruction, respectively, of the basket of indices of the Index Fund.

There was a consultation filed by a market participant in this regard, which will be commented below. As a result of this consultation, the Supervision of Relations with Institutional Investors has submitted the matter to the CVM Board. The CVM Board sought to assess the relevance, timeliness and convenience in the analysis, to be conducted on a case by case basis, of registration applications from Index Funds that replicate international indices, and obtains the above-mentioned waivers to comply with the provisions of CVM Instr. 359/2002.

In the consultation, the Index Fund object of waivers would count with the following features and warranties: (1) the indices and international index funds invested would be compatible with the Brazilian regulatory requirements. Therefore, no leveraged index funds, back index funds or synthetic replication-based index funds would be allowed by the CVM Board; and (2) the Index Fund will be exclusively destined to individuals or legal entities with financial investments above R$ 1 million each.

After the analysis of the consultation and based on the arguments presented thereon, the CVM Board concluded that it is convenient to evaluate, on a case by case basis, the possibility to grant waivers to the compliance with the provisions of CVM Instr. 359/2002, for the purpose of incorporation, registry, issuance, distribution and trading of units of domestic Index Funds, based on indices of other jurisdictions, provided that they observe the features and warranties discussed above.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Walter Stuber
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