CMN Resolution No. 4389 — Amends Resolution No. 4,277 of October 31, 2013, Establishing Minimum Procedures for Pricing Financial Instruments Valued at Market Value

The Central Bank of Brazil, pursuant to Article 9 of Law No. 4,595 of December 31, 1964, makes public that the National Monetary Council, in a session held on December 18, 2014, in view of the provisions of Article 4, item VIII, of the aforementioned Law, Articles 2, item VI, 8, and 9 of Law No. 4,728 of July 14, 1965, Article 20 of Law No. 4,864 of November 29, 1965, Articles 7 and 23, item I, of Law No. 6,099 of September 12, 1974, Article 1, item II, of Law No. 10,194 of February 14, 2001, and Article 6 of Decree-Law No. 759 of August 12, 1969,

RESOLVES:

Article 1. Resolution No. 4,277 of October 31, 2013, shall enter into force with the following alterations:

“Article 1. ........................................................

Sole Paragraph. The financial instruments referred to in the main text include:

I - securities and marketable securities classified in the categories “trading securities” and “available-for-sale securities”, in accordance with Circular No. 3,068 of November 8, 2001;

II - financial derivative instruments, as referred to in Circular No. 3,082 of January 30, 2002; and

III - other financial instruments valued at market value, regardless of their classification in the trading portfolio, established in Resolution No. 3,464 of June 26, 2007.” (NR)

“Article 2. The minimum requirements referred to in Article 1 include the adoption of systems and controls that must be guided by criteria of prudence and reliability.

§ 1. ............................................................
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IV - pricing procedures;

V - independent verification procedures;

VI - the processes for identifying financial instruments that meet the conditions for admissibility referred to in § 1 of Article 8;

VII - the procedures for considering the hedge strategies referred to in § 8 of Article 8; and

VIII - procedures for incorporating the adjustments referred to in Article 8 of this Resolution.

§ 2. The independent verification procedures provided for in item V of § 1 consist of the regular verification of the accuracy of prices, indices, rates, and other data used in the pricing process, observable in the market or resulting from premises established by the institution, and the identification and correction of errors or biases in pricing methodologies, and must also:
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§ 3. To ensure the accuracy of prices, indices, and rates used in the pricing process, the independent verification procedures provided for in item V of § 1 must consider, at a minimum:

I - the complexity of the financial instruments and the nature of the markets in which they are traded;

II - the independence of data sources; and

III - consistency with the values used in the calculation of monthly balance sheets and other financial statements.

§ 4. The institution must be able to prove the independence between the pricing and verification procedures provided for in items IV and V of § 1.

§ 5. The institution must use the results of the independent verification procedures in the revision of pricing methodologies.” (NR)

“Article 6. ........................................................
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Sole Paragraph. The periodic reviews referred to in item VII must be carried out at least annually or whenever there is a relevant change in the premises, parameters, or model results, in order to ensure their accuracy and adequacy.” (NR)

“Article 7. ........................................................

I - be approved by a unit independent of the areas responsible for trading desks; and

II - be submitted to an evaluation regarding the validity of the premises, mathematical methods, and information systems employed, carried out by a unit independent of the areas responsible for development.” (NR)

“Article 8. ........................................................

§ 1. It is admitted that, for financial instruments valued at market value, provided they are traded actively and frequently and whose prices are based on independent information sources, in which the price adequately reflects the estimated net realizable value of the financial instrument, the adjustments mentioned in the main text need not be made.

§ 2. The evaluation referred to in the main text must consider, at a minimum, the following elements:

I - settlement costs of positions, which refer to the difference between the estimated net realizable value and the average value of firm buy and sell offers, when available, or estimated by adopting a pricing technique or model;

II - credit risk spread, which consists of the differential over the risk-free rate or reference value attributable to the credit quality of the issuer or counterparty;

III - effective costs of deploying and raising funds, which refer to costs associated with margin replenishment, reinvestments, or refinancing;

IV - prepayment risk and waiver risk, which refer to costs associated with the possibility of exercising options, even if not contractually provided;

V - future administrative costs, which refer to the costs of maintaining the financial instrument management structure when its time in the portfolio exceeds the expected;

VI - operational risks, which refer to the possibility of losses caused by the factors listed in Article 2 of Resolution No. 3,380 of June 29, 2006, directly related to the pricing process of financial instruments; and

VII - model risks, which refer to the possibility of losses attributable to uncertainties in the specification of pricing models and the parameters used.

§ 3. The adjustments resulting from the evaluation provided for in this article must be deducted from Principal Capital when not recognized in accounting records in accordance with the accounting regulation applicable to financial institutions authorized to operate by the Central Bank of Brazil.

§ 4. The policies and procedures referred to in § 1 of Article 2 must be compatible with accounting practices and regulations and specify the nature of the adjustments that are accounted for and those that are deducted from Principal Capital.

§ 5. Additionally, for the purpose of adjustments to Principal Capital, the institutions referred to in Article 1 must consider the following elements, without prejudice to others considered relevant:

I - time required to settle positions held or to offset, in whole or in part, the risks arising through hedge operations;

II - volatilities in buy and sell offer prices;

III - availability of independent quotes;

IV - average and volatility of trading volumes, including during stress periods;

V - market concentrations;

VI - time the positions remain in the portfolio;

VII - relevance of positions subjected to model-based marking methods in the pricing process; and

VIII - model risks not included in the evaluation provided for in item VII of § 2.

§ 6. In the procedures for evaluating the need for adjustments referred to in the main text, stress scenarios or the need for immediate liquidation of the entire positions must not be considered as premises.

§ 7. The evaluation of the need for prudential adjustments referred to in the main text must consider the relevance and liquidity of positions in financial instruments valued at market value, observing the following criteria:

I - relevance and liquidity must be defined by the institution according to consistent and verifiable criteria;

II - the analysis of the relevance of financial instruments must consider, at a minimum, the size of the respective position in the institution relative to the total in the markets in which they are traded and relative to the total exposure in the institution itself; and

III - the analysis of the liquidity of financial instruments must consider the following aspects, without prejudice to others considered relevant:

a) their nature and complexity;

b) the liquidity conditions of the markets in which they are traded; and

c) the institution’s ability to trade them under current market conditions, considering the size of the position and the time necessary to settle it.

§ 8. The evaluation of the adjustments mentioned in the main text may consider the hedge strategies adopted by the institutions.

§ 9. The evaluation of the need for adjustments referred to in the main text must be carried out consistently and with a frequency compatible with the nature of the operations, the complexity of the products, and the changes in the relevance and liquidity of positions in financial instruments valued at market value.

§ 10. It is admitted that, in the evaluation of the need for adjustments provided for in the main text, the institution consider the extent to which the elements mentioned in this article are already reflected in the calculation of the RWA amount provided for in Resolution No. 4,193 of March 1, 2013, and in the coverage of interest rate risk referred to in Article 13 of the said Resolution.

§ 11. In specific cases where the institution evaluates that the risks associated with the elements mentioned in this article are already adequately incorporated in the calculation of the RWA amount, the results of this evaluation must be demonstrated in detail.” (NR)

“Article 10. If the impropriety or inconsistency in the evaluation of the need for adjustments in the value of financial instruments and in the calculation of their amount is found, in accordance with this Resolution, the Central Bank of Brazil may determine, at any time, the revision of the adjustment and, when appropriate, its accounting recognition.” (NR)

“Article 11. This Resolution enters into force on June 30, 2015.” (NR)

Article 2. This Resolution enters into force on the date of its publication.

          Alexandre Antonio Tombini  
                President of the Central Bank of Brazil