Circular No. 3902 — Procedures for Bilateral Margin Requirements on Derivatives

CIRCULAR NO. 3,902, OF MAY 30, 2018

Establishes procedures for compliance with the requirement for bilateral collateral margin in transactions with financial derivative instruments carried out in the country or abroad by financial institutions and other institutions authorized to operate by the Central Bank of Brazil, not settled through an entity that acts as a central counterparty.

The Collegiate Board of the Central Bank of Brazil, in a session held on May 30, 2018, based on art. 9 of Law No. 4,595, of December 31, 1964, and art. 28 of Resolution No. 4,662, of May 25, 2018,

RESOLVES:

Art. 1 This Circular establishes procedures for compliance with the requirement for bilateral collateral margin in transactions with financial derivative instruments carried out in the country or abroad by financial institutions and other institutions authorized to operate by the Central Bank of Brazil, not settled through an entity that acts as a central counterparty, as provided for in Resolution No. 4,662, of May 25, 2018.

Art. 2 For the purposes of calculating the collateral margins referred to in this Circular, only bilateral agreements for the clearing and settlement of obligations that meet the following conditions must be considered:

I - the agreement must be formalized in a contractual instrument that meets the following requirements:

a) the contract supporting the coverage of the exposure related to the agreement must have full legal effect in all jurisdictions where it must or may produce effects; and

b) the rights and obligations arising from the use of the agreement must be provided for in the contract, except those arising directly from the law; and

II - the agreement must establish the circumstances that imply early maturity, as well as the methodology for the calculation, clearing, and settlement of the obligations subject to it.

§ 1 In the event that the agreements provide for early maturity due to default by one of the parties, the situations that characterize default must be stipulated.

§ 2 Without prejudice to the provisions of § 1, the following situations must be considered as characterizing default: declaration of insolvency and the decree of intervention, bankruptcy, extrajudicial liquidation, or another resolution regime by the competent authorities.

§ 3 It is prohibited to stipulate clauses establishing that, after maturity, calculation, and settlement of obligations, the performing counterparty does not pay or limits the immediate payment of the final amount due, if the defaulting counterparty is the creditor.

Art. 3 The minimum initial margin (MIM) must be calculated based on the sum of the gross initial margin (MIB) of the covered operations that are not subject to the agreements referred to in art. 2 of this Circular with the sum of the net initial margins associated with these agreements, according to the following formula:

MIM = MIB + ∑ MILNetting,n (from n=1 to N), where:

I - N is the number of agreements mentioned in the caput, entered into between the covered institution and its covered counterparty; and

II - MILNetting,n is the net initial margin of the operations subject to the n-th agreement entered into and maintained by the covered institution and its covered counterparty.

§ 1 The gross initial margin (MIB) corresponds to the sum of the multiplication between the notional value of each covered operation and its respective weighting factor, considering the class of derivatives and the maturity term associated with the operation, as established below:

I - 2% (two percent), in the case of credit derivatives with a remaining maturity term of less than 2 years;

II - 5% (five percent), in the case of credit derivatives with a remaining maturity term between 2 and 5 years;

III - 10% (ten percent), in the case of credit derivatives with a remaining maturity term greater than 5 years;

IV - 15% (fifteen percent), in the case of commodity derivatives;

V - 15% (fifteen percent), in the case of equity derivatives;

VI - 6% (six percent), in the case of foreign currency derivatives and gold derivatives;

VII - 1% (one percent), in the case of interest rate derivatives with a remaining maturity term of less than 2 years;

VIII - 2% (two percent), in the case of interest rate derivatives with a remaining maturity term between 2 and 5 years;

IX - 4% (four percent), in the case of interest rate derivatives with a remaining maturity term greater than 5 years; and

X - 15% (fifteen percent), in the case of other derivatives.

§ 2 In the case of derivatives with non-linear characteristics, the MIB must be calculated based on the multiplication between the notional value, the variation of the derivative's price relative to the variation of the underlying asset's price (delta), and the factors indicated in the items of § 1, according to the class of derivatives and their maturity terms.

§ 3 In the case of an operation classified in more than one of the classes of derivatives listed in the items of § 1, the highest weighting factor must be used.

§ 4 The MILNetting,n must be calculated according to the following formula:

MILNetting,n = 0.4 x MIBNetting,n + 0.6 x NGRn x MIBNetting,n, where:

I - the MIBNetting,n represents the gross initial margin of the n-th agreement, calculated according to the methodology described in § 1; and

II - the NGRn, for the n-th agreement mentioned in the caput, must be calculated by the covered institution through the following procedures:

a) for each part "p" of the n-th agreement, the covered institution must compute the ratio:

NGRn,p = Max(∑ MtMi,p,0 from i=1 to Kn) / ∑ Max(MtMi,p,0) from i=1 to Kn, where:

1. "p" takes the value 1 to indicate the covered institution and takes the value 2 to indicate its covered counterparty;

2. Kn is the number of covered operations that make up the n-th agreement mentioned in the caput;

3. MtMi,p is the market value of operation "i" for part "p"; and

4. Max( ) is the maximum function, whose value consists of the highest value of its arguments.

b) in the event that the situation occurs in which, for some part "p" of the n-th agreement, the denominator of the ratio referred to in item "a" is null, the covered institution must consider that NGRn=1; and

c) in any case other than that provided for in item "b", the covered institution must consider that the value of NGRn is the highest value among the ratios computed in item "a", according to the following formula:

NGRn = Max(NGRn,1, NGRn,2).

§ 5 For the purposes of calculating the MIM to be delivered by the covered institution, the types of derivative operations in which the institution does not offer credit risk to its counterparty, such as option contracts in which said institution acts as the buyer of the option, must not be considered in the calculation of the MIB and the MIBNetting,n.

§ 6 For the purposes of calculating the MIM to be received by the covered institution, the types of derivative operations in which the institution does not incur credit risk from its counterparty, such as option contracts in which said institution acts as the seller of the option, must not be considered in the calculation of the MIB and the MIBNetting,n.

§ 7 The types mentioned in §§ 5 and 6 must be considered in the calculation of the NGR, for the purposes of calculating the MIM to be delivered by the covered institution and for the purposes of calculating the MIM to be received by the covered institution.

Art. 4 The minimum variation margin (MVM) to be maintained by the covered institution in favor of its covered counterparty is equal to the absolute value of the sum of the market values of the covered operations that have a negative market value for the covered institution.

Art. 5 The MVM to be maintained by the covered counterparty in favor of the covered institution is equal to the sum of the market values of the covered operations that have a positive market value for the covered institution.

Art. 6 In the case of covered operations subject to the same bilateral agreement for the clearing and settlement of obligations, according to the requirements established in art. 2, the MVM may be calculated considering the net market value of the operations subject to the same agreement, for the purposes of the calculations of the minimum margins mentioned in arts. 4 and 5.

Art. 7 For the purposes of this Circular, the collateral margin may be constituted based on the receipt or delivery of the following financial instruments:

I - demand deposits and savings deposits held at the covered institution receiving the collateral;

II - time deposits, interbank deposits, financial letters, real estate credit letters, agribusiness credit letters, and certificates of structured operations issued by the covered institution receiving the collateral and custodied at the institution itself or in its favor by third parties;

III - federal public bonds accepted by the Central Bank of Brazil in intraday rediscount operations;

IV - bonds and securities issued by the European Union, the European Central Bank, or the other entities listed in art. 2, § 1, item IV of Resolution No. 4,662, of 2018;

V - bonds and securities issued by central governments of foreign jurisdictions and their respective central banks, provided that the external risk classification of the issuance, conferred by a credit rating agency registered or recognized in Brazil by the Securities and Exchange Commission (CVM), is equal to or greater than AA- or equivalent classification;

VI - shares included in relevant stock exchange indices recognized by the supervisory authority of the jurisdiction in which they are located, or securities convertible into them;

VII - gold as a financial asset;

VIII - credit instruments issued by non-financial entities that have shares in relevant stock exchange indices subject to government regulation and supervision and whose external risk classification of the issuance, conferred by a credit rating agency registered or recognized in Brazil by the Securities and Exchange Commission (CVM), is equal to or greater than the national scale classification of brAAA or equivalent; and

IX - investment fund shares, provided that the following conditions are met:

a) the market value of the shares must be evaluated and disclosed at least daily;

b) the redemption or negotiation of the shares can be carried out daily;

c) the fund's investments must be restricted to the instruments listed in items I to VIII of the caput and to shares of other investment funds that satisfy the provision of item "e" of this item;

d) the fund must be administered by an entity supervised by the Securities and Exchange Commission (CVM) or must be subject to one of the foreign jurisdictions listed in art. 2, § 1, items II and III of Resolution No. 4,662, of 2018; and

e) the provisions of items "a" to "d" of this item must apply to the shares of investment funds that make up the assets of the investment fund holding the shares.

§ 1 The external risk classification referred to in item V of the caput must be the one with the highest degree of risk, if there is more than one classification available.

§ 2 For the purposes of the provisions of the caput, the following financial instruments may not be used:

I - whose payment obligation is guaranteed by the counterparty delivering the instruments itself or by an entity linked to it, with which consolidated financial statements are prepared;

II - whose credit risk presents a relevant positive correlation with the credit risk of the entity delivering the instruments;

III - whose market value presents a relevant negative correlation with the credit risk of the entity delivering the instruments; and

IV - whose market value presents a relevant negative correlation with the market value of the derivative portfolio.

§ 3 The financial instruments listed in items II to IX of the caput, to be admitted as collateral margins, must be subject to:

I - registration or centralized deposit in an entity that carries out activities of registration or centralized deposit of financial assets or securities, authorized by the Central Bank of Brazil or by the Securities and Exchange Commission (CVM); or

II - registration, custody, or centralized deposit in a financial market infrastructure regulated and supervised by a competent authority in its jurisdiction when issued or custodied abroad.

Art. 8 The covered institution must proceed to replace the financial instrument used as collateral margin on the business day following the day on which the instrument ceases to meet the eligibility criteria established in this Circular.

Art. 9 For the purposes of compliance with the requirement for initial and variation margins, the adjusted values of the market values of the financial instruments referred to in art. 7 must be considered, according to the following formula:

VA = VM x (1 – HC – HFX), where:

I - VM the market value of the financial instrument;

II - HC the standardized adjustment factor associated with the nature of the financial instrument; and

III - HFX the standardized adjustment factor associated with the mismatch between the reference currency for the settlement of obligations related to the covered operation and the currency in which the financial instrument referred to in art. 7 is denominated or indexed.

§ 1 The value of the standardized adjustment factor (HC) referred to in item II of the caput must be equivalent to, at minimum:

I - 0% (zero percent), for the financial instruments referred to in art. 7, items I and II;

II - 0.5% (half percent), for the financial instruments referred to in art. 7, items III, IV, and V, when the effective remaining maturity term is less than or equal to 1 year;

III - 2% (two percent), for the financial instruments referred to in art. 7, items III, IV, and V, when the effective remaining maturity term is greater than 1 year and less than or equal to 5 years;

IV - 4% (four percent), for the financial instruments referred to in art. 7, items III, IV, and V, when the effective remaining maturity term is greater than 5 years;

V - 15% (fifteen percent), for the financial instruments referred to in art. 7, items VI, VII, and VIII; and

VI - the highest of the applicable HC values for the assets that make up the investment fund portfolio, in the case of the financial instruments referred to in art. 7, item IX.

§ 2 In the event of impossibility of identifying the assets mentioned in § 1, item VI, the value of HC must be equivalent to, at minimum, 15% (fifteen percent).

§ 3 The value of the standardized adjustment factor HFX must be equal to:

I - 8% (eight percent), if there is a mismatch between the reference currency for the settlement of obligations related to the covered operation and the currency in which the financial instrument referred to in art. 7 is denominated or indexed; or

II - 0% (zero percent), in the absence of the mismatch referred to in item I.

§ 4 The market value of the structured operation certificate must be limited to the portion related to the protected nominal value, as provided for in Resolution No. 4,263, of September 5, 2013.

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

Otávio Ribeiro Damaso
Director of Regulation

This text does not replace the published in the DOU of 6/4/2018, Section 1, p. 20/21, and in Sisbacen.