Nicholas Pattman, Senior Associate and Philip Millward, Partner
Walkers Global (Latin America Group)
With mounting competition on the ground, Brazil-based fund managers are increasingly looking to attract international investors, giving rise to the rapid growth of the offshore Latin American asset base.
In March 2012, it will be 20 years since the Brazilian National Monetary Council (Conselho Monetário Nacional) introduced Resolution 1,912. Together with Resolution 1,787 enacted in 1991, it was instrumental in laying the foundations for Brazil’s investment funds industry. Rule 409 issued by the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários) in 2004 went further and introduced a consolidated set of rules applicable to the organisation and operation of mutual funds in Brazil. Since then, the industry in Brazil has continued to evolve and develop, not only in terms of AUM but also diversification of fund types. By the end of last year, AUM for the industry stood in excess of US$1 trillion.
One category of Brazilian investment funds, multimarket funds or multimercados (domestic funds with an investment policy that pursues diversification across several assets classes), have been permitted to gain exposure to international markets as part of their strategy since amendments made to Rule 409 in 2007 and 2008. The amendments permit multimercados to invest up to 20% of their assets overseas and 100% in the case of funds sold to qualified investors.
The amendments and consequent access to the global financial markets was long awaited and much demanded by local managers. However, initially the legislation was employed more as a means of accessing hedges at better rates rather than as an integral part of the overall strategy of local managers. Over time, as Brazilian investors venture beyond the relative risk-free environment of fixed income and managers expand their horizons beyond the confines of the financial markets in Brazil, so both continue to explore the opportunities that the regulations offer and with them the portfolio diversification that the foreign markets and their products can provide.
There are many structures that can be adopted by local managers wishing to invest in assets abroad in accordance with the regulations. One such structure employed is for the investment policy of the local fund to provide for the possibility of it using 20% or 100% of its assets, depending upon the criteria of the underlying investors, to subscribe for a specific class of shares issued by a portfolio within an existing or newly constituted segregated portfolio company (SPC) incorporated by the manager in the Cayman Islands and registered with the Cayman Islands Monetary Authority. The local fund essentially acts as a domestic feeder to a specified segregated portfolio within the SPC.
The Companies Law of the Cayman Islands permits any exempted company incorporated in the Cayman Islands to apply to the Registrar of Companies to be registered as an SPC. Once registered, the entity may create and operate one or more segregated portfolios with the benefit of statutory segregation of assets and liabilities between portfolios. The provisions of the Companies Law permitting exempted companies to register as SPCs have created opportunities for the introduction of innovative legal structures across a wide range of business areas of which investment funds is one such example.
The use of SPCs in an investment funds context, where managers look to harness a range of trading strategies, instruments and products through a single vehicle (strategies, instruments and products that by their nature have potential significant exposure and liability to third parties), is well documented and the benefit that having the ability to set up a statutory ‘ring-fence’ to protect against cross class liability issues relating to the assets and liabilities of the various segregated portfolios within a SPC is self-evident, especially where leverage or derivative strategies can be employed.
Furthermore, the advantages over traditional methods of creating legal divisions between accounts (such as setting up underlying special purpose vehicles and negotiating limited recourse provisions with third parties) include reduced complexity, time savings and cost efficiencies.
Amendments to the Companies Law in 2011 further refined Cayman Islands legislation dealing with SPCs, in particular removing the personal liability of directors who failed to identify the correct segregated portfolio participating in a transaction and replacing this with a pragmatic procedure to correct situations. It also includes specific provisions, subject to the constitutional documents of the SPC, for the termination of a redundant segregated portfolio which has no assets or liabilities and for the re-instatement of any segregated portfolio that has been terminated.
There is no doubt that 2012 will be an important year for the world economy, no less so for Brazil as it continues its integration into the global markets. As the country becomes an ever more prominent player on the international stage, many expect that its increasingly sophisticated investment funds industry will continue to look beyond its borders to the international markets. When it does so, the Cayman Islands and other international finance centres, with their tax neutrality, robust legal and regulatory frameworks and flexible corporate vehicles will serve as the natural bridge to the global markets and SPCs as one of the products that will act as an ideal platform for successful growth.
This article first appeared in LatAm Fund Manager (February 2012, Page 16 – 17). For more information, please visit www.latamfm.com.