Resolution CMN No. 4277 — Establishes Minimum Requirements and Prudential Adjustments for Market-Valued Financial Instruments

The Central Bank of Brazil, in accordance with Article 9 of Law No. 4,595 of December 31, 1964, makes public that the National Monetary Council, in a session held on October 31, 2013, based on Article 4, item VIII, of the aforementioned Law, in Articles 2, item VI, 8, and 9 of Law No. 4,728 of July 14, 1965, in Article 20 of Law No. 4,864 of November 29, 1965, in Law No. 6,099 of September 12, 1974, in Law No. 10,194 of February 14, 2001, and in Article 6 of Decree-Law No. 759 of August 12, 1969,

R E S O L V E D:

CHAPTER I

OF THE OBJECT AND SCOPE OF APPLICATION

Art. 1 This Resolution provides for minimum requirements to be observed in the process of pricing financial instruments valued at market price and regarding the adoption of prudential adjustments by multiple banks, commercial banks, investment banks, exchange banks, savings banks, by the National Bank for Economic and Social Development (BNDES), and by institutions comprising a conglomerate composed of at least one multiple, commercial, investment, exchange, or savings bank.

CHAPTER II

OF RESPONSIBILITIES AND CONTROLS

Art. 2 The systems and controls established by the institutions referred to in Art. 1 for the purpose of pricing financial instruments covered by this Resolution must be guided by criteria of prudence and reliability.

§ 1 The systems and controls referred to in the caput must include clearly documented and updated policies and procedures, encompassing, at a minimum:

I - the definition of responsibilities of each area involved in the pricing process;

II - the continuous review of market information sources;

III - guidelines on the use of data not observable in the market, which reflect the premises used by the institution in the pricing process;

IV - independent pricing and verification procedures; and

V - procedures for the incorporation of prudential adjustments, as provided in Art. 4 of this Resolution.

§ 2 The procedures provided for in item IV of § 1 consist of the regular verification of the accuracy of prices, indices, rates, and other data, 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:

I - be carried out, at least monthly, by a unit independent of those responsible for the trading desks; and

II - employ a degree of accuracy appropriate to the objective of the pricing.

Art. 3 The systems referred to in Art. 2 must be integrated with the institution's other risk management processes.

Sole Paragraph. The structure responsible for the pricing process must report to a member of the executive board independently of the areas responsible for the trading desks.

CHAPTER III

OF PRICING METHODOLOGIES

Art. 4 The pricing processes covered by this Resolution must use market valuation methodologies or model-based pricing methodologies.

§ 1 Market valuation presupposes the pricing, at least daily, of financial instruments that have price quotes, indices, and rates immediately available for non-forced transactions and originating from independent sources.

§ 2 Model-based pricing presupposes pricing, at least daily, and involves the use of mathematical methods that use market benchmarks and data not observable in the market in the production of their estimates.

Art. 5 The pricing process must, whenever possible, use market valuation, using quotes based on criteria of prudence, relevance, and reliability.

Art. 6 Model-based pricing may be adopted when the relevance or availability of market benchmarks are insufficient for the exclusive use of market valuation methodologies, observing the following conditions:

I - use of pricing methodologies widely accepted in the market, whenever available;

II - the use of model-based valuation methodology must be consistent and verifiable;

III - respect for the criteria established in Art. 5 in all market benchmarks and other data used in model-based valuation;

IV - the adequacy of market benchmarks and other data used in model-based valuation for each instrument must be reviewed regularly;

V - knowledge, by the institution's board of directors and Board of Directors, if any, of the financial instruments subject to model-based valuation methodology and the materiality of uncertainties generated by this approach for risk management and performance purposes;

VI - knowledge, by those responsible for the institution's risk management, of the limitations of the models employed and their effects on pricing results;

VII - submission of the models used to periodic reviews that assess the adequacy of their premises and results in relation to values available in the market; and

VIII - adoption of a degree of conservatism higher than that required for market valuation methodologies.

Art. 7 When developed by the institution itself, the pricing methodology provided for in Art. 6 must:

I - be approved by units independent of the areas responsible for the trading desks, when these are also responsible for the development of pricing models; 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 the development and approval of the models.

CHAPTER IV

OF PRUDENTIAL ADJUSTMENTS

Art. 8 The institutions referred to in Art. 1 must establish and maintain procedures for assessing the need for adjustments in the value of the financial instruments covered by this Resolution, regardless of the pricing methodology adopted and observing criteria of prudence, relevance, and reliability.

§ 1 The assessment referred to in the caput must consider, at a minimum, the following elements:

I - costs of liquidating positions;

II - credit risk spread;

III - effective costs of investing and raising funds;

IV - prepayment risk and waiver risk;

V - future administrative costs;

VI - operational risks; and

VII - model risks, when applicable;

§ 2 The adjustments resulting from the assessment provided for in this article must be deducted from Core Capital when not recognized in the calculation of the value of financial instruments for accounting purposes, considering consistent and verifiable criteria.

§ 3 Additionally, for the purpose of adjustments to Core Capital, the institutions referred to in Art. 1 must consider, at a minimum, the following elements:

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

II - volatilities in bid and ask prices;

III - availability of independent quotes;

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

V - market concentrations;

VI - holding period of positions in the portfolio;

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

VIII - model risks not included in the assessment provided for in item VII of § 1.

CHAPTER V

OF GENERAL PROVISIONS

Art. 9 The pricing methodologies provided for in Art. 4, even if developed externally, and the assessment of the need for prudential adjustments provided for in Art. 8 are the exclusive responsibility of the institution.

Art. 10. The Central Bank of Brazil is authorized to establish criteria and adopt complementary measures necessary for the execution of the provisions of this Resolution.

Art. 11. This Resolution enters into force on July 1, 2014.

Alexandre Antonio Tombini
President of the Central Bank of Brazil