Circular No. 3106 — Regulates the execution of credit derivative operations under Resolution 2,933 of February 28, 2002

CIRCULAR NO. 003106

Dispenses on the execution of credit derivative operations governed by Resolution 2,933 of February 28, 2002.

The Collective Board of Directors of the Central Bank of Brazil, in a session held on April 10, 2002, based on Article 1 of Resolution 2,933 of February 28, 2002,

DECIDED:

Article 1. Establish the following modalities of credit derivatives eligible for execution by the institutions referred to in Article 1 of Resolution 2,933 of February 28, 2002:

I - "credit" swap, when the risk-receiving counterparty is remunerated based on a protection rate;

II - "total return" swap, when the risk-receiving counterparty is remunerated based on the cash flow of receipt of charges and counterpayments linked to the underlying asset, as provided in Article 1, § 3rd, item II, of Resolution 2,933 of 2002.

Sole Paragraph. The following are prohibited:

I - the execution of options linked to these modalities;

II - the execution of credit derivative operations between controlling, affiliated, or controlled legal or natural persons, including the companies referred to in Articles 3 and 18 of Resolution 2,723 of May 31, 2000, with the wording given by Resolution 2,743 of June 28, 2000;

III - the reception of the credit risk of the persons referred to in item II; and

IV - the execution of credit derivative operations whose cash flows are not in the same currency or indexer as the underlying asset.

Article 2. For the purposes of this Circular, the following are defined as:

I - "swap" operations: those executed between the risk-transferring counterparty and the risk-receiving counterparty for settlement on a future date, which imply, upon the occurrence of one or more credit deterioration events, the restoration, total or partial, of the reference value established in the contract in favor of the risk-transferring counterparty;

II - credit deterioration events (credit events): those facts, defined between the parties in the contract, related to the underlying asset or its obligors that, regardless of their motivation, cause the payment, by the risk-receiving counterparty, of the protection contracted by the risk-transferring counterparty.

Article 3. Operations executed in accordance with this Circular by the risk-transferring counterparty, provided that it is directly the holder of the underlying asset or indirectly through a credit derivative operation, may, at the institution's discretion, be considered in the calculation of the Required Equity Value (PLE), as provided in Resolution 2,099 of August 17, 1994, and subsequent amendments, based on the degree of transfer of the credit risk of the underlying asset.

§ 1st. For the purposes of this Article, the transfer of credit risk of the underlying asset is considered effective when:

I - the contract establishes as credit events, at minimum, the following situations:

a) declaration of bankruptcy or civil insolvency of the obligors of the underlying asset;

b) request for preventive bankruptcy agreement by the obligors of the underlying asset;

c) judicial or extrajudicial liquidation of the obligors of the underlying asset;

d) restructuring of the obligors' liabilities, when this represents a loss in value or deterioration of the credit quality of the underlying asset;

e) change of control, merger, or incorporation of the obligors, when this represents a loss in value or deterioration of the credit quality of the underlying asset;

f) moratorium by the obligors of the underlying asset;

g) default of the underlying asset;

h) compulsory advance payment of the underlying asset, in the event of contractual provision;

i) repudiation or judicial challenge of the underlying asset;

II - the underlying asset is legally transferable, in cases where the credit derivative contract so provides upon the occurrence of the credit event;

III - there is no co-obligation of the risk-transferring counterparty regarding the portion of the underlying asset subject to the operation;

IV - there is no clause allowing unilateral cancellation of the contract by the risk-receiving counterparty, except in the event of non-payment by the risk-transferring counterparty of the remuneration established in Article 1, items I and II;

V - there is no clause allowing the risk-receiving counterparty to fail to promptly pay the amount due to the risk-transferring counterparty upon the occurrence of the credit event.

§ 2nd. With a view to using the prerogative referred to in the main text, the weighting factor, in percentage value, to be applied to the protection amount of the underlying asset for the purpose of calculating the PLE must be obtained based on the following formula:

FP = (PRP x FPP)/PRA + [1- (PRP/PRA)] x FPA, where:

FP = weighting factor, in percentage value, applicable to the protection amount of the underlying asset;

PRP = remaining term of the credit derivative (in business days);

FPP = weighting factor of the protection, in percentage value, equal to 50%.

PRA = remaining term of the underlying asset (in business days);

FPA = weighting factor, in percentage value, related to the underlying asset, according to the Asset Classification Table as provided in Article 2, § 1st, of the Regulation Annex IV to Resolution 2,099 of 1994, and subsequent amendments.

§ 3rd. The exposure to the risk of the underlying asset that exceeds the protection amount must be weighted by its original factor according to the Asset Classification Table as provided in Article 2, § 1st, of the Regulation Annex IV to Resolution 2,099 of 1994, and subsequent amendments.

§ 4th. In the event that a clause stipulating minimum values or percentages of loss of the underlying asset for total or partial restoration to be executed is established, additional PLE earmarking equivalent to the stipulated minimum value or percentage must be proven.

Article 4. It is incumbent upon the risk-transferring counterparty, observing the current regulations on exposure limits per client:

I - to benefit from the credit derivative operation, in proportion to the transferred risk, provided that it is directly the holder of the underlying asset or indirectly through a credit derivative operation, observing the minimum requirements established in Article 3, § 1st, regarding the obligors of the underlying asset;

II - to consider the credit derivative operation, in proportion to the transferred risk, within the exposure limit related to the risk-receiving counterparty.

Article 5. The risk-receiving counterparty is exposed to the risk of the underlying asset in proportion to the risk assumed, observing the provisions of the Regulation Annex IV to Resolution 2,099 of 1994, and subsequent amendments.

Sole Paragraph. The risk-receiving counterparty must, regarding the exposure to risk referred to in the main text:

I - observe the current regulations regarding exposure limits per client; and

II - constitute specific provisions calculated according to the same criteria established by Resolution 2,682 of December 21, 1999.

Article 6. In addition to the provisions of Article 6 of Circular 3,082 of January 30, 2002, it is mandatory to disclose, in explanatory notes to financial statements, information containing, at minimum, the following aspects related to credit derivative operations:

I - institution's policy, objectives, and strategies;

II - volumes of credit risk received and transferred (book value and market value), total and for the period;

III - effect (increase/reduction) on the calculation of the PLE value;

IV - amount and characteristics of credit operations transferred or received during the period due to the triggering events provided in the contract; and

V - segregation by type (credit swap and total return swap).

Article 7. Institutions must maintain, available to the Central Bank of Brazil, adequately documented, their policy and procedures for executing credit derivative operations, as well as the established exposure limits, regardless of the condition of risk receiver or transmitter.

Article 8. The execution of a credit derivative contract, whose cumulative amount of operations with the same counterparty is equal to or greater than 10% (ten percent) of the Reference Equity (RE) value of any of the institutions acting as counterparties in the contract, must be communicated to the Central Bank of Brazil.

Sole Paragraph. The communication referred to in this Article must be directed to the component of the Department of Registration and Information of the Financial System (Decad) to which the institution classified in the condition referred to in the main text is subject, within five business days counted from the date of execution of the contract.

Article 9. The institution must inform Decad of the name of the director responsible for the practice of credit derivative operations, in accordance with Article 3 of Resolution 2,933 of 2002.

Article 10. This Circular enters into force on the date of its publication.

Brasília, April 10, 2002.

Sérgio Darcy da Silva Alves
Director