For several years, Chile has been trying to brand itself as a financial services centre for Latin America. In spite of the economy’s small size, compared with Brazil and Mexico, international financial services firms and investors have positively endorsed its sound economic principles in the last decade.
But the asset management (AM) is governed by a highly fragmented and complex set of regulations, which is hindering Chile’s development as a financial services centre. Therefore, international asset managers seeking to distribute their products in Chile have to overcome several regulatory and tax hurdles. In order to lower these barriers, the Chilean Government is introducing a bill in Congress which would improve the country’s attractions as an AM centre by introducing a single, clear set of rules. Below, we describe the current AM regulatory framework in Chile and the new bill’s main measures.
Background to the Chilean fund industry
Approximately 30 years ago, in 1976, the Government approved the Mutual Fund statute (D.L. Nº 1.328), which was the first formal attempt to create a regulatory framework. As the country’s capital markets have evolved since then, this statute has been amended several times, notably following the 1981 introduction of the new retirement and private pension fund scheme. This pension system, based on mandatory contributions managed by third parties, greatly contributed to strong growth in the domestic investment industry.
Under this new retirement system, pension funds entrusted highly regulated private managers (AFPs) to manage the contributions made by Chilean employees. The new system generated rapid growth in the domestic capital market, demanding new and more sophisticated investment mechanisms and products. In response to this sophistication, the legislator passed several statutes targeting special investment needs, namely the Foreign Capital Investment Fund, Law 18,657 (in 1987) and the Private Investment Funds Law 18,815 (in 1989). All of these statutes became the pillars of the investment fund industry in Chile, spurring fast growth in the local investment industry. As of 2011, according to the Chilean securities regulator (SVS) , the local AM industry has the following characteristics:
Details of the new regulation
In order to continue promoting the Chilean investment fund industry, streamline the structure and simplify the regulations, the Chilean Ministry of Finance has significantly revised the regulations applicable to asset managers and investment funds. On 5 October 2011, the Government introduced a bill that substantially reshapes the regulatory framework applicable to asset managers and investment funds. Called the ‘Third party funds and portfolio management statute’, the bill is commonly referred to as the new ‘Investment Funds Law’. It must still be discussed and approved by Congress before becoming law.
Some highlights of this bill, as it stands today, are:
Distinction between types of fund
The bill clearly distinguishes between two types of funds that are subject to supervision and registration with the SVS. These are: (i) Mutual Funds, which are mainly characterised by the ease of redemption; and (ii) Investment Funds, which do not allow redemption of the investment. A separate category of fund, not subject to registration and supervision of the SVS, is Private Investment Funds, which cannot have more than 50 investors.
The distinction – based on how an investment is redeemed – acknowledges and follows the traditional distinction between closed-end and open-end funds in the US. Since both mutual funds and investment funds (other than private investment funds) are subject to registration with the SVS, they can be also listed on the local stock exchanges or traded over-the-counter in a secondary market.
Distinction between types of manager
The bill also distinguishes two types of management: (i) Investment Funds Management, and (ii) Portfolio Management. If passed, the proposed bill will be the single source of regulations for both types of management activity. As of today, the fund management role is separately regulated by the law applicable to the specific type of fund. The three main categories are: (i) Mutual Fund Managers, regulated under the mutual fund statute (DL 1328); (ii) Investment Funds Managers, regulated under the investment fund statute (Law 18815); and (iii) FICE and FICER managers, regulated under the foreign investors fund statute (Law 18657). Additionally, the Chilean Capital Markets Statute (Law 18045) has some provisions applicable to fund management
Fund manager requirements
Fund managers must be formed as stock corporations (Sociedad Anonima), which should be registered and subject to the supervision of the SVS. This is the same requirement currently imposed on asset managers. It is also a requirement, subject to the SVS qualification, that those directly involved in the AM activity and key decision-makers must be deemed sufficiently qualified for such purposes.
Duty of care
There is also a duty of care that managers must observe. Therefore, managers cannot legally delegate the management function. But the bill does allow managers to subcontract with third parties. For example, a US asset manager could set up a local manager, subcontracting services from the head office.
Exchange-traded product features
The bill also preserves some of the necessary features required to issue exchange-traded products (the most commonly known are the ETFs). These are provisions recently introduced to the current Mutual Fund Statute in 2010 (e.g. contributions and redemptions can be paid in kind with securities traded in Chilean or foreign exchanges).
From a tax standpoint, under the bill, capital gain realised upon the sale or redemption of the fund quotas continues to have the same tax treatment as stocks in a publicly traded stock corporation (‘Sociedad Anonima abierta’). In the case of Private Investment Funds, the proposed tax treatment is the same as the one currently applicable to privately traded stock corporations (‘Sociedad Anonima cerrada’). Therefore, capital gains taxation would be subject to the requirements and limitations in the current income tax law.
Due to Chile’s two-tier tax system, dividends typically carry a tax credit equivalent to the corporate income tax rate paid upon the profits distributed, so that when an investment fund distributes profits derived from investments subject to this type of taxation, a tax credit would be available to investors under the bill.
The tax treatment and exemptions set forth in the current Income Tax Law articles 104, 106 and 107 would continue to apply under the bill, which also grants full tax exemption to non-resident investors on capital gains realised upon redemption, or sale of the quotas, and distributions providing a fund holds at least 80% of its investments in non-Chilean assets or securities — and the fund’s investment guidelines state this fact. If these requirements were not met, the gain or distribution would be subject to a 10% tax. In general, tax ramifications should be carefully considered.
Regarding the management fee paid to the fund manager, Chilean VAT at a 19% rate is generally applicable, but under the bill the portion of management services fees that could be attributed to foreign investors would be VAT-exempt. This is an important exemption, since VAT imposed on management services to foreign investors could not be recovered, as they are not Chilean VAT taxpayers and it becomes a cost.
SVS registration threshold
The bill also introduces the concept of ‘portfolio management services and portfolio manager’. When the portfolio manager meets any of the definitions set forth in the statute, it has to register with the SVS and becomes subject to SVS supervision. The level at which the bill requires registration is having more than 500 investors, or managing 50 or more portfolios exceeding US$500,000.
While the Chilean Congress is still debating the bill, its main measures create a single regulatory and tax framework. This will not only facilitate the development of the investment fund and asset management industry, but also provide investor safeguards through a strong and clear attribution of supervision powers to the Chilean regulator.
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