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Gustavo Rabello

TozziniFreire Advogados, São Paulo

gjrabello@tozzinifreire.com.br

 

Daiane Nunes

TozziniFreire Advogados, São Paulo

dainunes@tozzinifreire.com.br

 

Brazil was relatively unaffected by Covid-19 when several European countries began to struggle with the impacts of the pandemic. It was not before late March that the country started to close its doors and businesses in an attempt to impose mass isolation on more than 200 million people. The country has now reached almost 1,000 deaths a day. We expect to reach the peak soon, before the numbers start to decrease. It has been paramount to monitor the weaknesses and risks related to Brazilian investment funds, but also to follow up on opportunities that arise, not only for existing investments but also for future trends.

With unpredictable conditions, no one knows how long the crisis will last or its effects in the economy. The focus now is to evaluate its various effects, including the direct interference in the credit capacity of different companies and investment portfolios, the devaluation of shares, the difficulty in proceeding redemptions and concerns about fundraising for new structures or additional capital calls.

These ramifications have triggered reflections on the obligations of participants in this industry, from investors to service providers (eg, portfolio managers, custodians and intermediaries), and the immediate actions that should be taken to mitigate losses. The Brazilian regulators have been quite active in this field and have been issuing, almost on a weekly basis, new regulations in order to smooth the path for the industry through this (hopefully) temporary situation.

In spite of the disastrous impact of the crisis worldwide, it is possible to identify good opportunities and a new modus operandi for society in general, which has been nicknamed the ‘new normal’. Faster and cheaper credit has been granted by financial technology companies ('Fintechs') and they have been more disruptive every day, attracting a considerable number of clients that come from traditional banks. Services related to the life sciences industry, fast delivery of foods and goods, medical products and education technology, among others, have been surviving and even growing. Shortly before the pandemic, the asset management industry was booming and the number of such institutions grew exponentially over the past five years. This also reflects the capital flowing between investors, funds, Fintechs and so on.  

Impact on market participants and investment funds

In liquid and open-ended credit funds, with a short redemption period, there was a wave of requests for redemption, due to a fear of future losses and search for immediate liquidity by investors. In March, for instance, with local businesses starting to shut their doors, almost BRL 100bn (approximately US$20bn) was redeemed by concerned investors. Funds with longer redemption terms showed greater stability and a much smaller level of redemption.

In relation to structured (or alternative) funds, usually constituted as closed-ended funds and with redemption only admitted at the end of the fund’s term or in its early liquidation, there are concerns about those close to their maturity, because the liquidity framework can be compromised.

The valuation of invested companies may be affected, which interferes with credit pricing and ratings. This could make access to credit financing more expensive for such companies.

As a consequence, the default rate has been increasing, and some businesses have closed for good. Part of the challenge, however, has been addressed by actions and financial aid announced by the government and institutions, such as debt renegotiations, emergency credit lines granted by public and private sectors, and financing for payrolls. Such measures will help to mitigate effects of the economic downturn and reduce the unemployment levels.

Local regulators, in particular the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários or CVM), have taken an active role by issuing new rules and deliberations to mitigate the negative effects of the pandemic, such as flexible deadlines, distribution of proceeds and permission to conduct general meetings online. In situations where there is no palliative measure expressly issued, the capital markets regulators have been flexible to analyse on a case-by-case basis, respecting the discretion of the competent authorities.

Communication among participants must be regular, transparent and consistent, as applicable, especially in the case of funds that already face or are about to face adverse conditions, such as liquidity restrictions. For this purpose, technology is once again fulfilling a fundamental role by facilitating communication and bringing people together. In this context, we have been able to see online meetings and gatherings being performed efficiently, with more participants than when such meetings took place physically. The CVM has issued rules allowing, for instance, publicly listed companies to hold meetings partially or exclusively online. The same principle has been extended to general quota-holders meetings of investment funds as well as meetings of holders of several types of securities and notes carrying regular ordinary and extraordinary meetings.[I1].

Turning to the real estate industry, there has been a significant drop in sales of shopping malls and in the liquidity of investments of real estate funds that invest in malls. An avalanche of contractual renegotiations of tenancies is taking place, and business owners have been requesting waivers from rentals and other applicable costs. All the parties involved have been quite open to discussions. The 'new normal' has changed the way people work in their offices; spaces have been modified and reorganised. Construction sites are considered essential activities and therefore it seems that new projects have kept going.

Market participants have been alerted to the need to provide, in related documents, information about the risks arising from Covid-19, as well as other epidemics or pandemics that may arise. This requires the revision of investment fund documents, especially for those conducting public offerings of quotas, in order to adjust rules regarding terms, liquidity conditions, risk factors, and so on.

Moreover, the participants must ensure that the contingency plans covered by their internal policies are sufficient and constantly being improved and observed, with demonstration of control and full capacity to perform activities, whether related to portfolio management, operations or corporate governance duties, in a comprehensive and secure manner, despite temporary difficulties or limitations. With the increase in home working, online cybersecurity concerns and policies should also be modernised. Labour regulations will need to be updated in order to cover larger numbers of days working from home, and this are likely to be incorporated into our routines after Covid-19.

Moreover, it is about time that institutional investors took an active role and fully exercised their fiduciary duty. This is an opportunity to finally implement the concept of stewardship of investments by institutional investors in Brazil, specifically pension funds, which have a fiduciary duty on the management of the resources that are trusted to them by their beneficiaries. The stewardship guidelines, described in a stewardship code issued by the Association of Capital Market Investors, intend to encourage more active management of assets by institutional investors. They include guidelines for monitoring their activities and an evaluation of their environmental, social and governance (ESG) impact, in addition to the exercise of voting rights at general meetings. The Association of Pension Funds of Brazil also created guidelines for selecting asset managers that are vested with ESG principles.

Identification of good opportunities

There is no doubt the pandemic will end one day, though it is not possible to fully predict its consequences. With this in mind, investors are looking out for the best opportunities on a longer-term basis. Assets in different classes could be devalued and this would bring the expectation for good results after prices return to normal levels, when market conditions are re-established and we have better predictability and asset price stability.

This scenario has a very positive outlook for private equity (PE) and venture capital (VC) funds, for example, with fundraising in Brazil and abroad. There is a lot of potential for PE and VC funds in Brazil. Securitisation of receivables was experiencing massive growth before the pandemic. If we add the ESG criteria to evaluate how such companies will be dealing with the resources they raise in this period, we may see even better long-term results. ESG will be a paramount element whenever companies raise capital to reduce cashflow difficulties. In the end, they will have a chance to leave this crisis in better shape, vested with ESG principles.

This could be the perfect time for Brazil to wake up to impact investing, following the example of other regions with developed impact investment focused on ESG elements. This is a moment where small, medium and large companies will be more dependent than ever on capital markets to raise resources for their long-term survival.

ESG investing has been gaining traction, and it is in tune with the present dialogue about choosing investment targets not only for expected profit, but also for their positive impact for society on some scale. It is in this context that new investment initiatives -- aimed at information technology, health innovation, social improvement and climate change -- emerge. Good opportunities will emerge as various societal problems become more visible during the pandemic and demand attention and correction, making room for young companies to come up with answers.

It is for such reasons that foreign and local asset managers have been quite active in relation to Brazilian assets and have been structuring new investment funds, adapted to these future perspectives and strategies, in order to enable the required fundraising, capital calls and investment. There are no asset classes being left behind. That means that equity, hedge, fixed income and venture capital funds have all been active. Distressed assets have also become a trend, as levels of defaulted debts increase, and there is an ocean of opportunities in Brazil in this sector.

As a result, in addition to providing returns to investors, investment funds may have a fundamental role in helping the economy to resume.

All of these requirements challenge market participants to change their outlook and attitudes towards portfolio allocations, not only with regard to decisions only seeking profits, but also with all applicable formalities, and thus appear more firm, consistent and prepared for other possible adversities.

The world is starting to become prepared for the 'new normal'. In the midst of the shock of the pandemic, we open the doors to a new model of life, work and investments, because the future will always hold good surprises.

 

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