Questions and Answers on Resolution CMN No. 4,926 of June 24, 2021 and Resolution BCB No. 111 of July 6, 2021: Classification in the Trading Book or Banking Book

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QUESTIONS AND ANSWERS
Resolution CMN No. 4,926, of June 24, 2021
Resolution BCB No. 111, of July 6, 2021.
CLASSIFICATION IN THE TRADING BOOK OR BANKING BOOK

1) Must all instruments measured at fair value with corresponding adjustments recognized in the period's income be classified in the trading book?
No. For classification in the trading book, an instrument must meet the set of conditions set forth in Article 26¹ of Resolution No. 4,557, of February 23, 2017, and in Articles 5 and 6 of Resolution BCB No. 111, of July 6, 2021. Therefore, daily measurement at fair value producing adjustments recognized in counterpart to an appropriate revenue or expense account, in the institution's period income, is not a sufficient condition to determine the classification of an instrument in the trading book.

2) Can the trading book contain instruments that do not have the purpose of trading or that present a legal impediment to sale or that are not measured daily at fair value, with the resulting adjustments recognized in income?
No. The trading book may only contain instruments that simultaneously meet the following conditions: have the purpose of trading, do not present a legal impediment to sale, and are measured daily at fair value, with the resulting adjustments recognized in income.

3) Can the trading book contain instruments that are measured daily at fair value, with the resulting adjustments recognized in a separate equity account?
No. Among the necessary conditions for classification in the trading book is the requirement that instruments classified therein be measured daily at fair value, with the resulting adjustments recognized in income.

4) Under what conditions may an institution request the Central Bank of Brazil (BCB) for a classification different from that provided for in Article 6 of Resolution BCB No. 111, of 2021?
The mechanism provided for in Article 8 of Resolution BCB No. 111, of 2021, allows the institution to request BCB authorization to classify in the banking book an operation based on an instrument contained in Article 6 of Resolution BCB No. 111, of 2021, and applies to the following situations: (i) the instrument does not present a legal impediment to its sale, is measured daily at fair value, with the resulting adjustments recognized in income, but the institution believes that the purpose of the operation in question does not correspond to any of those listed in Article 5, item I, of said Resolution BCB; or (ii) the instrument is measured daily at fair value, with the resulting adjustments recognized in income, but presents a legal impediment to its sale.

5) Can a Rural Product Note (CPR) or a Bank Credit Note (CCB) of an individual be included in the trading book?
CPRs, CCBs, and similar instruments cannot be classified in the trading book. These instruments must necessarily be classified in the banking book, in accordance with item IV of Article 4 of Resolution BCB No. 111.

6) Must all derivative financial instruments be classified in the trading book?
No. Derivative financial instruments, in general, must be classified according to the purpose for which they were contracted, except for embedded options and automatic options, which must always be classified in the trading book, in accordance with item VI of Article 6 of Resolution BCB No. 111, of 2021. It is noteworthy, however, that those related to interest rate exposures, when used for hedging positions in the banking book, may be classified in the banking book, in accordance with § 3 of Article 6 of Resolution BCB No. 111, of 2021.

7) Is there any impediment for derivative financial instruments intended for hedging banking book instruments to be classified in this same book?
There is no impediment to the classification in the banking book of derivative financial instruments whose purpose is to hedge banking book instruments, except for embedded options and automatic options, which must always be classified in the trading book, in accordance with item VI of Article 6 of Resolution BCB No. 111. It is noteworthy, however, that those related to interest rate exposures, when used for hedging positions in the banking book, may be classified in the banking book, in accordance with § 3 of Article 6 of Resolution BCB No. 111, of 2021.

8) Can committed operations whose purpose is the liquidity management of a financial institution be classified in the banking book?
Yes. A committed operation that has as its purpose liquidity management may be classified in the banking book, in accordance with the exception provided for in § 1 of Article 6 of Resolution BCB No. 111, of 2021.

9) Must embedded options and automatic options necessarily be classified in the trading book?
Embedded options and automatic options, as a general rule, must be classified in the trading book. However, if such instruments present exposure to interest rate risk, their classification in the banking book is permitted provided that, upon initial recognition, the instrument does not meet the conditions of Article 5 of Resolution BCB No. 111, of 2021. In this case, the institution must observe the provisions of Article 8 of Resolution BCB No. 111, of 2021.

10) What is the expected periodicity and frequency for monitoring the emergence in the banking book of net short exposures to credit risk or equity risk from individual instruments, upon their initial accounting recognition?
In line with Article 12 of Resolution BCB No. 111, of 2021, institutions must continuously manage and monitor banking book exposures so as to identify any instrument that, upon its initial accounting recognition, individually, has the potential to create a net short exposure to credit risk or equity risk in this book.

11) How should the treatment be for a share of an investment fund held entirely (“exclusive fund”) by a financial institution?
Individual equity positions related to a share of an investment fund held entirely (“exclusive fund”) by a financial institution, subject to consolidation in accordance with Resolution No. 4,280, of October 31, 2013, must be classified as if they were held directly by the financial institution.

11A) What elements would characterize the expectation of acquisition at the time of financial settlement of the subscription, as referred to in item III of Article 5 of Resolution BCB No. 111, of 2021?
An institution that has secured the commitment to subscribe to an offering of securities or financial assets to the issuing entity will characterize its expectation of acquisition at the time of financial settlement of the subscription when the total demand formally identified in the stage of collecting expressions of interest by market agents is less than the total volume established for the offering. Expressions of interest from the institution itself, which do not have as motivation any of the purposes referred to in item I of Article 5 of Resolution BCB No. 111, of 2021, so formally evidenced, do not meet the provisions of item III of Article 5 of said Resolution and may be considered for the computation of the total demand mentioned above.

Example
A company wishes to carry out a public offering for the issuance of debentures in the amount of R$ 100 million, with bank “X” acting in the structuring of the operation and having secured the subscription commitment to the company. During the process, the bank, based on its credit analysis, determines its interest in acquiring R$ 30 million. Thus, at the time of bookbuilding, the bank places its purchase offer of R$ 30 million. Concurrently, other investors demonstrate interest in acquiring R$ 20 million. Considering the secured subscription commitment and that the demand from investors was lower than the total volume of the issuance, at the time of financial settlement, the bank will have to acquire the remaining R$ 50 million. Given the different origins and purposes of each amount acquired by the bank, R$ 30 million will be classified in the banking book and R$ 50 million will be classified in the trading book.

DIFFERENT CLASSIFICATION AND RECLASSIFICATION

12) Which institutions may request, on an extraordinary basis, BCB authorization, as provided for in Article 8 of Resolution BCB No. 111, of 2021, for a specific operation to be classified differently from that provided for in Article 6 of said Resolution BCB, upon its initial accounting recognition?
Only institutions classified in S1, S2, or S3 may request the BCB authorization, provided for in Article 8 of Resolution BCB No. 111, of 2021, for classification different from that contained in Article 6 of said Resolution BCB.

13) Which institutions may request, on an extraordinary basis, BCB authorization, as provided for in Article 9 of Resolution BCB No. 111, of 2021, for a specific operation to be reclassified to another book, at a time subsequent to its classification upon initial accounting recognition?
Only institutions classified in S1, S2, or S3 may request, on an extraordinary basis, BCB authorization for the reclassification of a specific operation, as provided for in Article 9 of Resolution BCB No. 111, of 2021.

14) In accordance with item II of Article 5 of Resolution BCB No. 111, all instruments that, upon their initial accounting recognition, may result in a net short exposure to credit risk or equity risk in the banking book must be classified in the trading book. In such a situation, is it possible to classify only the net short exposure in the trading book or must the entire instrument be classified there?
It is not permitted to classify in the trading book only the net short exposure generated in the banking book by the new instrument, if it were classified in the banking book. It is necessary that the instrument as a whole be classified in the trading book upon its initial accounting recognition.

15) Does the classification in the trading book of the instrument that, upon its initial accounting recognition, may result in a net short exposure to credit risk or equity risk in the banking book, provided for in Article 5, item II, of Resolution BCB No. 111, of 2021, constitute a reclassification or an internal risk transfer – IRT?
The situation mentioned does not constitute either a reclassification or an internal risk transfer.

16) Is the mechanism provided for in Article 8 of Resolution BCB No. 111, of 2021 applicable to financial instruments that meet the provisions of Article 5 and are not listed in Article 6?
No. In accordance with the caput of Article 8 of Resolution BCB No. 111, of 2021, the Central Bank of Brazil may authorize classification different from that provided for in Article 6 of said Resolution.

TRADING DESK STRUCTURE

17) Must instruments classified in the banking book be managed in the trading desk structure referred to in Articles 25-A and 25-B of Resolution No. 4,557, of 2017²?
No, because the trading desks referred to in Articles 25-A and 25-B of Resolution No. 4,557, of 2017, are restricted to those that manage only instruments subject to market risk, as defined in Article 25 of said Resolution.

18) Are institutions classified in S3 required to establish a trading desk structure?
Only those institutions classified in S3 that request the establishment of a dedicated trading desk, for the recording of internal risk transfers between books, are required to establish a trading desk structure, in accordance with item VIII of Article 59³ of Resolution No. 4,557, of 2017.

19) Are institutions classified in S3 required to establish the synthetic trading desk referred to in Article 19 of Resolution BCB No. 111?
Only those institutions classified in S3 that request the establishment of a dedicated trading desk, for the recording of internal risk transfers between books, are required to establish a trading desk structure, which includes the synthetic trading desk, in accordance with item VIII of Article 59⁴ of Resolution No. 4,557, of 2017.

20) Are institutions classified in S4 required to establish a trading desk structure?
No. Institutions classified in S4 are exempt from establishing a trading desk structure, in accordance with item XII of Article 60⁵ of Resolution No. 4,557, of 2017.

21) Can the synthetic trading desk referred to in Article 19 of Resolution BCB No. 111, of 2021, contain other positions not related to foreign currencies and commodities allocated in the banking book?
No. The synthetic trading desk, which must be established for the purpose of calculating the market risk capital requirement, may only contain positions related to foreign currencies and commodities allocated in the banking book. Additionally, the synthetic trading desk is exempt from the need for traders or linked trading books, in accordance with the sole paragraph of Article 19 of Resolution BCB No. 111, of 2021.

22) Is it possible for the same trader to be responsible for managing positions in the trading book and in the banking book?
Yes. There is no impediment for the same trader to be responsible for managing positions in the trading book and in the banking book. However, the positions under their management in the banking book cannot be managed in the trading desk structure⁶ referred to in Chapter III of Resolution BCB No. 111, of 2021.

22A) Is the possibility of reclassification of a specific operation to the banking book or to the trading book provided for in Article 9 of Resolution BCB No. 111, of 2021, applicable to those operations whose classification in a specific book was carried out based on the criteria established by Circular No. 3,354, of 2007? The mechanism provided for in Article 9 of Resolution BCB No. 111, of 2021, does not apply to operations whose classification was carried out based on the criteria established by Circular No. 3,354, of 2007. The provisions of Article 9 of Resolution BCB No. 111, of 2021, are only admissible for those operations that had their classification, upon their initial accounting recognition, carried out based on the criteria established in Chapter III of said normative.

INTERNAL RISK TRANSFERS

23) May all segments request the recognition of the effect of internal risk transfers for capital requirement purposes, as provided for in Chapter V of Resolution BCB No. 111, of 2021?
No. Only institutions classified in S1, S2, or S3 may request this recognition.

24) Is it necessary for the institution to request BCB approval for each of its internal risk transfers?
Resolution BCB No. 111, of 2021, does not provide for the need for BCB approval for each internal risk transfer to have its effects recognized for capital requirement purposes. However, it is necessary that the dedicated trading desk in which such inter-book operations will be registered has been previously authorized by the BCB, in accordance with Article 27-A⁷ of Resolution No. 4,557 of CMN.

25) Which instruments must the dedicated trading desk, referred to in Article 22 of Resolution BCB No. 111, of 2021, register?
The dedicated trading desk – whose BCB authorization is a necessary condition for internal risk transfers between books to have their effects recognized for capital requirement purposes – must register only internal risk transfers between books and their related external hedges.

26) Until what date will the effects for capital requirement purposes of internal risk transfers between books of institutions that do not have a BCB-approved dedicated trading desk be recognized?
Internal risk transfers between books of institutions that do not have a BCB-approved dedicated trading desk will only have their effects for capital requirement purposes recognized until December 1, 2022, in accordance with § 4 of Article 27-A of Resolution No. 4,557, of 2017, with wording given by Resolution CMN No. 4,926, of 2021.

27) Are institutions that use internal risk transfers in their internal risk management process, but do not request the recognition of their effects for capital requirement purposes, subject to the determinations of Chapter V of Resolution BCB No. 111, of 2021?
No. The determinations of Chapter V apply only to institutions seeking to recognize the effects of internal risk transfers for capital requirement purposes.

28) Can the external hedge referred to in § 1 of Article 21 of Resolution BCB No. 111, of 2021, be constituted by multiple transactions?
Yes. The external hedge referred to in § 1 of Article 21 of Resolution BCB No. 111, of 2021, may be constituted by a set of transactions, provided that this set of transactions is:
I - classified in the trading book;
II - constituted by transactions with counterparties external to the prudential conglomerate; III - equivalent to an opposite operation to that of the related internal risk transfer, which transferred exposures to credit risk or equity risk from the banking book to the trading book; and IV - duly recognized as protection for the initial risk exposure of the banking book. Furthermore, this same set of transactions must also meet the determinations of §§ 2 and 3 of Article 21 of Resolution BCB No. 111, of 2021.

29) Do the reports mentioned in Article 18 of Resolution BCB No. 111, of 2021, have a minimum weekly periodicity, like those listed in Article 16, item IV?
No. The reports mentioned in Article 18 do not have a minimum periodicity and must adapt to the profile of the respective trading desk. Thus, if intraday activity in a certain trading desk is relevant, it is expected that the reports be prepared with less periodicity, so that the behavior intended to be monitored is timely communicated to the appropriate instances of the institution.

Version Control

Version Reference Changes
1.0 December 2021 -
2.0 July 2022 Inclusion 11A and 22A

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¹ The wording of Article 26 of Resolution No. 4,557, of 2017, will be amended by Resolution CMN No. 4,926, of June 24, 2021, effective as of March 1, 2022.
² Resolution CMN No. 4,926, of June 24, 2021, will include Articles 25-A and 25-B in Resolution No. 4,557, of 2017, effective as of March 1, 2022.
³ The wording of Article 59 of Resolution No. 4,557, of 2017, will be amended by Resolution CMN No. 4,926, of June 24, 2021, effective as of March 1, 2022.
⁴ The wording of Article 59 of Resolution No. 4,557, of 2017, will be amended by Resolution CMN No. 4,926, of June 24, 2021, effective as of March 1, 2022.
⁵ The wording of Article 60 of Resolution No. 4,557, of 2017, will be amended by Resolution CMN No. 4,926, of June 24, 2021, effective as of March 1, 2022.
⁶ In accordance with Article 25-B of Resolution No. 4,557, of 2017, each trading desk must manage exclusively instruments subject to market risk.
⁷ Resolution CMN No. 4,926, of June 24, 2021, will include Article 27-A in Resolution No. 4,557, of 2017, effective as of March 1, 2022.