On September 16, 2013, the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) issued CVM Instruction No. 537 (CVM Instr. 537/2013), amending CVM Instruction No. 359, of January 22, 2002 (CVM Instr. 359/2002), that regulates the incorporation, administration and operation of the Brazilian Market Index Investment Funds (Index Funds), also known in Brazil and abroad as Exchange Traded Funds (ETFs).

The EFT 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 benchmark index for an indefinite period of time. For this purpose, benchmark index means a specific market index recognized by CVM, with which the investment policy of the EFT is associated.

The new rules allow managers of ETFs to use investment strategies that reflect the behavior of fixed income indices in the performance of the Fund. The indices accepted for the authorization of this kind of investment vehicle were restricted until this moment to indices based on asset portfolios of variable income.

Furthermore, CVM decided to set forth the criteria to be followed for determining the benchmark index, which will have to be used by the market participants in their applications for authorization for operation of ETFs. The approval of the benchmark index will consider at least the following criteria:

  1. the complete calculation methodology of the index must be made available free of charge and through the Internet, including its composition, the weights of each financial asset, the criteria of rebalancing and its frequency, and other parameters required for its replication. These weights can be published retrospectively after each rebalancing of the index, with the deadline date of the subsequent rebalancing;
  2. the calculation methodology of the index must include predetermined rules and objective criteria;
  3. the frequency of index rebalancing shall allow investors to replicate it;
  4. the index cannot be subject to retroactive adjustments;
  5. the chosen index must represent an investment goal clear and single, without conditions. Conditions are any clauses or rules that imply that under certain circumstances the performance of the index does not reflect the return of the theoretical portfolio of assets;
  6. index whose provider is a party related to the administrator or the manager is not acceptable;
  7. index whose provider receives potential payments issuers for its inclusion as a component is also not acceptable;
  8. the performance of the index must be public, have wide dissemination and easy access through the Internet; and
  9. indices representing multiples of other indices, the inverse of these indexes, or multiples of its inverse, are not acceptable.

CVM Instr. 537/2013 forbids the creation of ETFs with: (a) leveraged indices; (b) inverse indices, which reflect an opposite performance of the reference index; or (c) synthetic indices, designed to reflect the performance of the benchmark index by means of derivative contracts.

To reflect the variation and the return on the benchmark index, the EFT must keep at least 95% of its equity applied in1: (i) financial assets included in the benchmark index; and (ii) net position bought in futures contracts. The following financial assets are admitted: (a) securities or other financial assets whose initial public offering was subjected to registration at CVM or that have been distributed with restricted efforts; and (b) Government bonds issued by the National Treasury. Futures contracts should be traded on commodities and futures exchange and settled in clearing houses and clearing and settlement service providers that take the position of central counterparty.

Another novelty introduced by CVM Instr. 537/2013 is the so-called "cash creation", which is the possibility of the manager of the ETF to accept national currency (the Brazilian Real) for the payment and redemption of the units (cotas) of the Fund, provided that this possibility has been contemplated in the ETF´s regulation. Whenever there is such possibility, the portfolio established for the payment or redemption of units of the Fund may contain: (i) financial assets that comprise the benchmark index; (ii) national currency; (iii) parcel not exceeding 5% of the amount involved in the operation, including financial assets that are not part to the benchmark index; and (iv) parcel not exceeding 20% of the amount involved in the operation, including financial assets that are not part of the benchmark index, but are of the same kind of those and of different issues. This rule is only applicable in the case of ETFs that seek to reflect the variations and the profitability of fixed income indices.

Financial assets of the same kind are those who possess the same level of risk for a similar return expectation for presenting similarities as regards the remuneration, the issuer´s credit risk, the liquidity risk, and the maturity date.

To conclude the analysis of CVM Instr. 537/2013, this instruction still consolidates issues that were dealt with by CVM, through waivers of requirements of CVM Instr. 359/2002, when applications for authorization for operation of new ETFs were submitted by the market participants.

1In the case of ETFs that seek to reflect the variations and profitability of fixed income indices, financial assets that are not part of the benchmark index, but are of the same kind of those and of different issues, are admitted, limited to 20% of the net worth value of the Fund.

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.