Research

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.

1. Registration. 
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
such rights.

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.