The publication of Regulation No. 7/2023 (RRGA) on December 29 2023 by the Portuguese Securities Market Commission (CMVM) helped to clarify several practical dilemmas encountered by private equity players and resolve several questions and omissions that arose under the previous regulation. The RRGA regulates the asset management regime (RGA) approved by Decree-Law No. 27/2023, which entered into force on May 28 2023.
The publication of the RRGA followed the expiry of a 180-day period allotted for the management entities of collective investment undertakings and the collective investment undertakings governed by the General Regime for Collective Investment Undertakings (RGOIC) to comply with the RGA.
In the same manner that the RGA consolidated the regulation of collective investment undertakings into a single decree, the RRGA has amalgamated into a single regulation the regulatory regime applicable to the asset management sector. Consequently, it has repealed CMVM Regulation No. 2/2015, which regulated the RGOIC, and CMVM Regulation No. 3/2015, which regulated the Legal Regime of Venture Capital, Social Entrepreneurship, and Specialised Investment, approved by Law No. 18/2015 of March 4 (RJCR).
The RRGA has resolved some of the interpretative issues attributable to the regulatory fragmentation that existed under the previous regime. A prime example concerns the costs and charges of closed-end private equity funds (Private Equity Funds), which will be examined in this article.
A hot topic in several jurisdictions
There has been a divergence of interpretations between the regulator and the regulated entities regarding which charges can, should, or should not be borne by Private Equity Funds. This topic, which is gaining national traction, has been widely discussed in other jurisdictions, such as the US, where, in September 2023, the Securities and Exchange Commission (SEC) implemented the most significant changes to the regulation applicable to Private Equity Funds since 2010. Among the hot topics within these amendments is the determination of which costs should be borne by these funds.
In Portuguese law, the issue of Private Equity Funds costs and charges was regulated in Article 32 of the RJCR, which presented a list (of illustrative nature, given the use of the term “namely”) that was considered, in practical terms, by the CMVM as exhaustive regarding the charges of such funds. This list included:
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The remuneration of the management entity, custodians, and auditor;
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Costs associated with investments and divestments, including the expenses related to these transactions;
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Costs associated with the application of surplus cash;
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Costs related to documentation to be made available to participants and the convening of meetings of participants; and
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Costs for legal, financial, and tax consultants of Private Equity Funds.
The previous regulation on private equity (CMVM Regulation No. 3/2015) did not address this topic, and the regulation concerning other collective investment undertakings (CMVM Regulation No. 2/2015) merely provided a method for calculating the current expense ratio and the disclosure requirements related to these issues, specifically in the constitutive documents of the collective investment undertakings and in the periodic information to be provided to participants.
In alignment with the RGA’s emphasis on enhanced self-regulation, rather than promulgating a list of what must be considered as the charges of the Private Equity Funds (be it exhaustive or illustrative), the RGA stipulates in Article 69(1) that “the management company shall not charge or allocate to the collective investment undertaking, nor to its participants, undue costs that are not provided for in the respective constitutive documents.”
Furthermore, Article 69(2) asserts that “the costs and charges that can be allocated to the collective investment undertaking shall be appropriate to its sound and prudent management.” Correspondingly, the RRGA specifies in Article 10(1) that “the costs and charges of the CIU [collective investment undertaking] are consistent with its investment policy.”
Analysis of the new legislation
The above legislative liberalisation broadens the scope (relative to the RJCR’s explicit or implicit numerus clausus) of costs and charges that may, or must, be allocated to Private Equity Funds, thus opening the possibility, in theory, of allocating any costs or charges to the undertakings, with the caveat that these must be appropriate to the fund’s sound and prudent management, and consistent with its investment policy. From this, it seems necessary to clarify a long-standing question regarding whether the costs for entities subcontracted by the management companies, hired for the benefit of a specific Private Equity Fund, can, or should, be allocated to the Private Equity Funds. It appears a positive response is warranted, while preserving the subjectivity of interpretation concerning the aforementioned requirements.
In any case, with great power comes great responsibility. The shift towards greater self-regulation, as seen with the enactment of the RGA and its corresponding regulations, diverges from the more ‘heteronomous regulation’ features of the RJCR. This transition, while alleviating some of the interpretative challenges previously posed by the CMVM, introduces a new kind of uncertainty for regulated entities:
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On the one hand, they gain clarity on what to expect and the boundaries of their actions; but
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On the other hand, this broader interpretative scope and subsequent self-regulation concerning costs and charges grant management entities greater freedom and independence in determining which costs and charges should be borne by the Private Equity Funds.
However, without the constraints previously in place, this freedom comes with the risk that the CMVM, in response, may adopt a different interpretation of these definitions and frameworks, potentially leading to supervisory and disciplinary consequences.
In defining these limits, it can be particularly enlightening to consider how other regulators have understood (or not) what constitutes permissible Private Equity Funds. For instance, the SEC, in its regulatory amendments, has identified certain practices as prohibited, including:
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Charging or allocating to the private fund fees and expenses relating to a private fund portfolio investment held by multiple funds on a non-pro rata basis, unless the charge or allocation is fair and equitable under the circumstances and the private fund adviser first distributes a written notice describing the allocation and how it is fair and equitable; or
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Reducing the amount of a private fund adviser’s (or a related person’s) clawback by actual, potential, or hypothetical taxes, unless the adviser discloses in writing the aggregate dollar amounts of the adviser clawback, before and after any such reduction, within 45 days of the end of the quarter in which the clawback occurs.
On a positive note, the approach adopted by the CMVM regarding costs and charges was overly restrictive. Therefore, the authors view the understanding promoted by the RGA and the RRGA in a favourable light, in so far as, within certain basic parameters, the management company is sovereign in determining which expenses it considers should be borne by the Private Equity Funds. However, this determination should be meticulously deliberated and conducted within strict legal criteria, previously defined by the management company in the constitutive documents to be submitted to the CMVM at the commencement of each fund’s activities.
Finally, although the RRGA came into effect on January 1 2024, management companies and collective investment undertakings covered by the RRGA have a grace period of 180 days from its effective date to comply with its provisions. It is therefore conceivable that the CMVM may issue guidelines in the future to clarify some of the topics discussed above.