Investment Funds 2020 Comparisons

Last Updated February 17, 2020

Contributed By Baker McKenzie

Law and Practice

Authors



Baker McKenzie is the most award-winning firm in Latin America and has the widest geographical coverage of the region. The team is multidisciplinary and the firm's professionals are specialists in their clients' industries. The team of experts is technically and commercially top-skilled; it is trained to anticipate risks in a permanently changing and globalised business environment. The firm's global network allows it a unique best-practices and knowledge exchange with the most influential business centres in the world, incentivises it to maintain international service standards and allows it to reduce the burden of management for clients and improve the quality and cost effectiveness of the service received. The firm's innovation centres represent a strategic investment to maintain its work at the forefront of the legal services industry. Through the firm's corporate social responsibility programmes, it inspires firm colleagues to make a difference, and collaborates with clients who share the same commitment to social justice. Baker McKenzie is widely renowned for its diversity and equality policies.

Retail funds represent approximately 70% of all the investments in the Colombian capital markets. Both open-end and close-end funds have increased in size and number. Funds with an investment focus on debt instruments have offered returns of around 10% per annum. Local private equity funds on the contrary have been facing difficult challenges. On the one hand, institutional investors are not convinced they should continue to invest in the product as the number of funds that have completed a successful investment-divestment cycle is very limited. This, coupled with the fact that local private equity funds compete with foreign private equity funds for the same bucket or investment limits of institutional investors, has made it more difficult for local fund managers to compete with international fund managers. After all, the size and diversification of investments that an international fund manager may offer has proved a more compelling investment case for institutional investors in Colombia.

Alternative investment funds comprise private equity funds (PEFs) and real estate funds (similar to REITs). Hedge funds are not a specific kind of fund in Colombia and would be generally categorised and subject to the same regulations as retail funds.

Both PEFs and real estate funds are regulated vehicles that can only be set up by a management company that must be a broker-dealer, trust company or management investment company (sociedad administradora de inversión). Each type of entity requires a licence and is subject to the oversight of the Colombian Financial Superintendency (SFC). The management company may hold a dual role of management company and investor manager. However, investment management may be delegated to a professional fund manager (similar to a general partner in the international private equity fund industry). Professional fund managers are unregulated entities usually organised in the form of simplified corporations or corporations.

Participants’ interest in PEFs are called units and qualify as securities. If the investors in the alternative investment funds are Colombian institutional investors (such as pension funds or insurance companies), the units must be listed in the National Registry of Securities (RNVE, according to its initialism in Spanish) and material information disclosure requirements to the market at large would apply. If not listed, no such material information needs to be disclosed to the market at large.

Alternative investment funds are closed-end funds that would only allow redemption of the investment by the investors at expiry of the fund term, unless there are partial divestments of fund assets.

The managing company must meet certain administrative and back office criteria to be able to set up an alternative investment fund, including sufficient administrative, infrastructure, technology and operative capabilities to allow it to manage the alternative investment fund-qualified personnel exclusively dedicated to such management, and adequate internal controls. Such criteria are assessed by the regulator.

The creation of a PEF does not require prior approval from the SFC. However, funds by-laws, once approved by the board of directors of the management company, must be filed with the SFC and allow a 16-day period for the SFC to object to such by-laws. If there are no objections, the PEF shall be deemed automatically authorised. Once there is an agreement between the professional fund manager and the management company to set up a fund, the process of drafting the fund’s by-laws and the negotiation with the investors for a first closing may take between six and nine months. In this process the SFC is likely to require a meeting with the management company to understand the business plan, diligence conducted on the professional manager and target investors and investments.

The process of setting up a PEF is not particularly expensive and there is a body of precedents and market practice that has simplified the process of reaching an agreement with respect to the fund’s by-laws.

On the contrary, the creation of a real estate investment fund would be subject to the prior authorisation of the SFC. Certain information must be provided to the SFC, which includes the same documentation required for a PEF, including the fund’s by-laws. The process may be lengthier and given that PEFs may invest in real estate, many management companies and fund managers choose PEFs over real estate investment funds.

The applicable regulation establishes that the fund's assets constitute a segregate estate, entirely distinct from that of the managing company and of other funds established by such managing company. The specific regulation on PEFs contains the same principle, but adds that such assets are also segregated from those of the GP and the investors.

Aside from specific funds in which the investor controls a PEF or a real estate investment fund controlled by the professional fund manager, the authors would see no reason and there are no precedents for disregarding the segregate estate to claim liability from the investors. Investors' liability is then generally limited to their contributions or, if available, undrawn commitments.

Private equity funds must (i) disclose to the financial regulator all of their organisation documents 15 days before their incorporation (although the fund does not need an express authorisation from the regulator); (ii) report any modifications to their regulations within 30 business days after such modifications are approved; and (iii) keep relevant financial information, regulations and management reports available to investors.

If the private equity fund is listed in the RNVE, disclosure of material information to the market at large will be applicable.

The first wave of funds that were created between 2008 and 2012 and the more recent debt funds have secured commitments from institutional investors (pension funds and insurance companies). However, the investment pace and appetite of institutional investors for local alternative investment funds has waned, mainly for two reasons: there are a limited number of funds that have completed their exit cycle and thus investors have no clear evidence of whether PEFs, in particular, have been a successful product; and, on the other hand, local PEFs compete with international PEFs for the same basket of allowed investments to institutional investors and given the ticket sizes and track record of international investment funds, institutional investors may lean towards investing in offshore funds with experienced general partners (GPs).

The second pool of investors is comprised of family officers and large corporates, which may choose to channel their investments through PEFs given the beneficial tax treatment.

Local fund managers would generally use simplified stock corporations to undertake their roles as professional managers.

On the contrary, international fund managers may opt for a dual fund manager structure where they have a local simplified stock corporation to undertake more day-to-day fund manager activities such as searching for investments and conducting diligence, and using an offshore manager where actual decisions are taken.

Any individual or legal entity (excluding SFC-licensed entities other than institutional investors) may invest in an alternative investment fund. However, the minimum amount of the commitment or investment is equal to 600 minimum statutory wages (approximately USD159,600).

Institutional investors have a very detailed regime of permitted investments and a set of buckets, one of which is alternative investments.

Private equity funds require a minimum initial investment of no less than 600 minimum statutory wages (approximately USD159,600) per investor and a minimum of two investors. Private equity funds must hire a professional manager and a managing company. Private equity funds may only invest ⅓ of their equity in securities listed in the RNVE.

Managing companies may only be regulated entities organised under the laws of Colombia.

Professional fund managers may be foreign companies (or individuals).

There is a requirement for a daily valuation of the investments to determine the value of fund units, which must be conducted by price providers licensed by the SFC and that are local entities.

Given that private equity funds and real estate funds seldom invest in listed securities, there is no need to use the services of a custodian. When they do invest in local listed securities, custodians must be licensed by the SFC and therefore are local entities (usually a trust company).

Foreign professional fund managers must appoint an individual in charge of representing the professional manager, on a permanent basis, in Colombia. There are local regulatory requirements that PEF managers must meet if they intend to receive commitments or contributions from institutional investors (eg, pension funds and insurance companies). The fund manager must show that it has at least five years of experience in the management of and/or investment in the type of underlying assets in which the fund will invest. This experience may be evidenced by the fund manager itself, its officers or its parent.

These funds do not need to obtain regulatory approval, although they must remit to the financial regulator all of their organisation documents 15 days before their incorporation. However, the negotiations between the fund manager, the management company and institutional investors may take from eight months to a year. This time would be reduced significantly if the negotiation of commitments or contributors is with other types of investors.

Only the professional fund managers or the managing companies of the corresponding alternative fund (or any other stockbroker, trust company or investment management company, on behalf of the managing company) may market the fund. The fund should describe the marketing rules in its regulations. Investors should sign a certificate whereby they confirm having received the regulations of the private equity fund and understand the risks of their investment, as well as the nature and operation of the private equity fund.

Alternative funds may be marketed to individuals and legal entities alike in Colombia, regardless of whether they qualify as professional investors. Only certain SFC-licensed entities may invest in private equity funds and real estate funds, such as institutional investors (eg, pension fund managers and insurance companies).

However, if funds are marketed to non-professional investors, there are certain profiling and advisory duties that would apply.

Other than the entry ticket, there are no special restrictions for investors to invest in a private equity fund. Investors are generally protected by the regulations on financial consumers and stock market investors protection rules. Managing companies will be subject to a self-regulatory regime and the supervision of the self-regulatory authority in Colombia (AMV, according to its initialism in Spanish).

The distribution of funds gives rise to professional advisory services. The regulation requires advisers to consider the clients’ and products’ profiles and match the most appropriate product for the client’s profile. In advising a client, no adviser may state that a specific result or level of performance is guaranteed.

Colombian regulations acknowledge two types of customers: professional investors and client investors. Client investors (that is, non-sophisticated investors) have the right to receive advisory services from regulated entities. However, Colombian regulations allow client investors to waive their right to receive a professional recommendation regarding simple assets, but such waiver is not possible with respect to complex assets.

Classification is made by each licensed entity based on (i) the complexity of the structure of the product, (ii) related risks and the capacity to analyse such risks, (iii) available information on the product, (iv) exit limitations, (v) complexity on the formulas for calculating yields, and (vi) the inclusion of conditions to the equity protection mechanisms.

Investors are protected by fiduciary duties that burden the management company and fund managers, including a duty of care, a duty of loyalty and the duty to afford equal treatment to all investors in the same legal position. This, of course, would not prevent the fund from issuing different types of units for different investors, which would allow for different rights or obligations.

As alternative funds do not require prior express approval to operate and are not highly regulated, considering the professional and sophisticated nature of their investments, it is not common for a fund manager to approach the regulator on a regular basis. Nevertheless, the Colombian regulator is generally approachable, especially in the organisation and incorporation phase of regulated entities and funds. Furthermore, the SFC has made a practice of requiring the management company to make a presentation on the scope of the fund, the type of fund manager chosen by the management company, the diligence conducted by the management company to choose or accept a fund manager and a complete assessment of potential conflicts.

Restrictions on Types of Investment

The investment policy of all types of alternative investment funds must be clearly established at the outset in the by-laws of the fund.

For PEFs, up to two thirds of the investors' contributions must be directly invested in assets other than securities listed in the RNVE. Furthermore, PEFs may purchase debt instruments issued by a public-private partnership (PPP) concessionaire, and may grant loans to such projects, in which case the two-thirds limitation does not apply.

Additionally, real estate-focused PEFs may invest all of the contributions to purchase the authorised assets in this industry, whereas real estate funds must invest at least 75% of their assets in real estate assets or assets whose underlying assets are real estate.

The Need for a Custodian

Management companies must retain the services of SFC-licensed custodians (only certain trust companies) to act as custodians of listed securities in which the fund may invest. However, both private equity funds and real estate funds seldom invest in securities and thus the role of the custodians is limited. Other types of assets, such as non-listed shares, may be held directly by the management company.

The Need for a Price Supplier

The units in real estate funds and private equity funds must be priced daily. As a general rule, the fund will need to retain a price supplier to provide such daily valuations. PEFs will be excused from using an SFC-licensed price supplier if the price supplier does not have an approved methodology for the valuation of the assets in which the fund invests. In this event, the services of a non-licensed third-party expert may be retained or the valuation may be assumed by the fund manager directly.

The daily valuation is very relevant to the fund industry because units can only be issued at the value of the unit at the time of the issuance, meaning that issuance of units at a premium or with a discount with respect to the applicable valuation are not permitted. However, the daily valuation is not binding for secondary market transactions.

Money Laundering

Because management companies are SFC-licensed entities, they must have in place an anti-money laundering and counter-terrorism financing (AML/CTF) system that they must apply both with respect to receiving funds or commitments from the investors, or when making investments and divestments. In practice, know-your-customer proceedings associated to specific assets in which the fund will be invested are trusted to the professional manager.

Insider Dealing

There is no specific set of rules applicable to insider dealing in connection with PEFs or real estate funds. However, if dealing with listed securities, insider dealing may qualify as a crime and even if the transactions do not entail listed securities, then there may be civil and administrative fines that may result from improper use of privileged information by the management company, the fund manager or their officers and employees.

Conflicts of Interest

The investors must appoint an oversight committee in charge of verifying compliance with the fund’s by-laws and to resolve conflict of interest situations. At least one of the members of the oversight committee must be independent not only from the fund manager and the management company but also from the investors.

Real Estate Funds

Real estate funds may not undertake leveraging transactions on a value exceeding 100% of their net worth. Furthermore, if the fund is to undertake leveraged investments, the minimum contribution or commitment from the investor would be of 200 monthly minimum legal wages (approximately USD53,200).

Private Equity Funds

Private equity funds may issue bonds as well as debt. However, if they decide to issue bonds, no distributions or redemptions will be allowed while the bonds issuance is outstanding.

Leveraged transactions where the borrower is the private equity fund are not unusual but neither are they the norm. In terms of a security package, it is not yet common for lenders to take a security interest on commitments from the investors but there is nothing that would prevent that under Colombian laws.

The most relevant issue in fund finance is the know-your-customer requirements that demand regulated lenders such as banks to identify the beneficial owners of the fund, which is information that some fund managers are not willing to disclose out of contract or practice.

Alternative funds are not taxpayers; therefore, any tax burden derived from the fund activities relies on the investors. Investors in alternative funds pay taxes on a cash basis (as opposed to the accrual basis, which is the general rule). This means that no taxation is triggered when the alternative fund derives any income or profit. The tax event is deferred until distribution to the investors.

However, after the enactment of the December 2019 tax reform, the tax deferral was limited to alternative funds (i) listed on the stock exchange or (ii) funds not owned more than 50% by the same beneficial owner, economic group or family of funds in which the beneficial owners, economic group or family have control over the fund distributions.

Retail funds (fondos de inversión de colectiva) are regulated vehicles that can only be set up by a management company that must be a broker-dealer, trust company or management investment company (sociedad administradora de inversión), each a type of entity that requires a licence and is subject to the oversight of the SFC. The funds themselves are segregated pools of assets, different from those owned or otherwise managed by the management company.

The management company will hold three roles: administration activities (representing the portfolio fund before authorities, investors and third parties), fund manager (making investment and divestment decisions) and distribution of the fund. Both the roles of fund manager and fund distribution may be outsourced to other management companies.

Participants’ interest in retail funds are called fund units and qualify as securities if the fund is closed-ended, in which case the units may or may not be registered with the RNVE. If the fund is open-ended, the units will not qualify as securities.

If the investors in closed-end portfolio funds are Colombian institutional investors (such as pension funds or insurance companies), the units must be listed in the RNVE and material information disclosure requirements to the market at large would apply. If not listed, no such material information needs to be disclosed to the market at large.

A management company may choose to create umbrella funds to manage under common rules different funds with different investment scope.

Setting up a management company is a lengthy process and is subject to minimum capital requirements and approval from the SFC that may take from one to two years.

Once a management company has been created, the managing company must meet certain administrative and back office criteria to be able to set up an investment fund, including sufficient administrative, infrastructure, technology and operative capabilities to allow them to manage the investment fund, qualified personnel exclusively dedicated to such management, and adequate internal controls.

The approval process is regulated and requires the filing of certain documentation, such as the investment fund's by-laws (modelo de reglamento), as well as other documentation regarding the corporate approvals required to establish the investment fund and a description of the investment fund's potential operations and investments.

The process generally takes up to four months, as of the initial documentation filing. The process may involve follow-on questions by the SFC, which may delay the approval, depending on the type of queries and the answers provided. The approval procedure entails no cost before the public authorities.

Applicable regulation establishes that the fund's assets constitute a separate pool of assets entirely distinct from that of the managing company and of other investment funds established by such management company. Investors' liability is limited to their share of the assets or results of the fund.

General principles regarding disclosure or reporting include the undertaking for the managing company to act with transparency, ensuring the delivery of correct, impartial, timely, precise, pertinent and useful information. No false, incomplete or inexact information shall be delivered to investors. All information shall be provided in a simple and intelligible manner to investors. Any limitations on investors' rights shall be highlighted in bold and an easily readable font.

Among others, information items should address all aspects inherent to the investment fund should be delivered via the by-laws, information prospectus and technical information letter. These items shall be made available online by the managing company, as well as in written form in its offices and of those of any investment fund promoters. Account statements and accountability reports must also be disclosed to investors.

If the funds are listed in the RNVE, then material information must be disclosed to the market at large, similar to what would happen with a listed company.

Retail funds have become an option for the public in general during the last ten years and not only for professional investors. Lately, very low ticket options in retail funds have become an attractive option for different financial entities. Big players such as insurance companies and pension funds also see in retail funds an option for treasury and liquidity management, although they are not deemed as an option to create big earnings in the long term.

However, retail investor appetite remains low, relative to other economies with deeper and more liquid financial markets. However, investment funds have increased in number of clients and managed funds by 10%, in both cases, during the past five years. Retail investors are generally individuals looking for a return on their savings.

See 3.1.1 Fund Structures. There are only two possible types of investment funds that management companies may set up: single funds and umbrella funds.

There are no special restrictions on the types of investors that can invest in a retail fund, whether individuals or legal entities. However, not all entities subject to the oversight of the SFC may invest in a retail fund (eg, banks cannot invest in retail funds, but pension funds and insurance companies may do so).

No investor may hold more than 10% of the units of an open-end retail fund and no investor may hold more than 80% of a closed-end retail fund.

Institutional investors (eg, pension funds and insurance companies) have limited buckets of the amounts they may invest in these types of funds.

The regulatory regime is primarily contained in Decree 2,555 of 2010, issued by the Colombian government, as amended from time to time. Additionally, the SFC issues regulatory letters that are mandatory for management companies, which are always under the surveillance of the SFC, including Title VI of Part III of Regulation No 29 of 2014, as amended from time to time.

The regulatory regime applicable to retail funds in Colombia is established in the rules relating to investment funds. In particular, investment limitations are established in each type of particular investment fund, as described in 3.4 Operational Requirements.

Non-local service providers may not participate in the formation or management of local funds. Funds that invest in listed securities must use the services of SFC-licensed custodians and must use the services of an SFC-licensed price supplier for the valuation of the fund's units. There is little room for non-local service providers in the operation of the fund other than in an advisory capacity.

Non-local service providers may not participate in the formation or management of local funds. Please see 3.3.2 Requirements for Non-local Service Providers.

Please see 3.1.2 Common Process for Setting up Investment Funds.

Marketing of investment funds – whether retail or other – may only be carried out by management companies or pooled accounts (omnibus accounts) managed by such management companies. Marketing of investment funds may only be carried out via the following channels: the sales team of the management company directly, regulated network use agreements and regulated corresponding agreements. Marketing activities are subject to fiduciary duties in favour of customers. Local regulation also contains investor attention standards that must be followed when undertaking these activities.

Retail funds may be marketed to both client investors and professional investors.

Investors are generally protected by the regulations on financial consumers and stock market investors protection rules. Managing companies will be subject to a self-regulatory regime and the AMV.

The distribution of funds gives rise to professional advisory services. The regulation requires advisers to consider the clients’ and products’ profiles and match the most appropriate product for the client’s profile. In advising a client, no adviser may state that that specific result is guaranteed.

Colombian regulations acknowledge two types of customers: professional investors and client investors. Client investors (that is, non-sophisticated investors) have the right to receive advisory services from regulated entities. Colombian regulations allow client investors to waive their right to receive a professional recommendation regarding simple assets, but such waiver is not possible with respect to complex assets.

Classification is made by each licensed entity based on (i) the complexity of the structure of the product, (ii) related risks and the capacity to analyse such risks, (iii) available information on the product, (iv) exit limitations, (v) complexity on the formulas for calculating yields, and (vi) the inclusion of conditions to the equity protection mechanisms.

Retail funds must (i) prepare and deliver to their investors an account statement on a quarterly basis, (ii) issue a fact sheet and update it on a monthly basis, and (iii) provide management reports to their investors.

Investors are protected by fiduciary duties that burden the management company and fund managers, including a duty of care, a duty of loyalty and the duty to afford equal treatment to all investors in the same legal position. This, of course, would not prevent the fund from issuing different types of units for different investors, which would allow for different rights or obligations.

The Colombian regulator is generally approachable and face-to-face meetings are possible.

The investment policy of all types of investment funds must be clearly established at the outset in the investment fund agreement. Depending on the specific industry or focus of each type of investment fund, there are different investments they may undertake, which are determined by the activity carried out by each fund. There are certain types of funds that have specific regulations, such as:

  • MMF – their portfolio shall be exclusively composed of listed securities, which are rated by an authorised rating agency with investment grade, except for notes issued or guaranteed by the Republic of Colombia, the Central Bank or the Deposit Insurance Corporation (Fogafin);
  • index funds – their portfolio must replicate – either by direct purchase or through investments in exchange-traded derivatives – securities indices, whether local or foreign, by purchasing some or all the assets composing such index; and
  • real estate investment funds – no less than 75% of their portfolio must be composed of real estate-related assets, as defined in the regulation.

Whenever the portfolio assets are listed securities, regardless of the type of investment fund, the managing company must hold such listed securities through a custodian. Such custodians must be trust companies, authorised and supervised by the SFC.

All valuation procedures must follow the guidelines established in the applicable regulation issued by the SFC. Insider dealing and market abuse are subject to general securities market regulation on the matter, which must be observed by both the managing company and the general partner, as well as money laundering and short selling.

Retail funds may not undertake leveraging transactions on a value exceeding 100% of their net worth. They may undertake regular borrowing transactions such as short sales, leverage repos, credits, certain derivatives and margin accounts. If a retail fund is to enter into leveraged transactions, the minimum contribution of each investor must be at least equal to 200 monthly minimum legal wages (approximately USD53,200).

Investors in retail funds are taxed on the profit obtained by the fund. Income tax is collected exclusively through withholding tax on a monthly basis. The method to determine the profit varies depending on the type of underlying investment. With regard to dividends, the withholding tax is 10% when such dividends were taxed as profits at the corporate level. If such dividends were not taxed, the withholding tax rate is 25%. Other streams of income are taxed at a 14% withholding tax rate. If the investor is located in a tax haven, a 25% rate is applicable. A reduced 5% rate is applicable to derivatives with fixed-income underlying assets.

Losses can be offset against profits of the following months with certain limitations. An excess of withholding tax can also be credited within the next 12 months.

The regulation applicable to PEFs was overhauled by means of Decree 1984 of 2018 entered into force on October 2018, but provided for a six-month period for PEFs to adjust their by-laws. The main modifications introduced referred to good governance standards and managing conflicts of interest. In addition, rules on notes issuance by PEFs were adopted, as well as novel regulations on insolvency of PEFs.

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Law and Practice in Colombia

Authors



Baker McKenzie is the most award-winning firm in Latin America and has the widest geographical coverage of the region. The team is multidisciplinary and the firm's professionals are specialists in their clients' industries. The team of experts is technically and commercially top-skilled; it is trained to anticipate risks in a permanently changing and globalised business environment. The firm's global network allows it a unique best-practices and knowledge exchange with the most influential business centres in the world, incentivises it to maintain international service standards and allows it to reduce the burden of management for clients and improve the quality and cost effectiveness of the service received. The firm's innovation centres represent a strategic investment to maintain its work at the forefront of the legal services industry. Through the firm's corporate social responsibility programmes, it inspires firm colleagues to make a difference, and collaborates with clients who share the same commitment to social justice. Baker McKenzie is widely renowned for its diversity and equality policies.