The above-mentioned Resolution raised various doubts and discussions in the market since it has been published on October 31 2013. Some of our clients showed concern especially with the definitions and methods to be applied for the “prudential adjustments”. (Note: These adjustments are deductions to be made to the common equity capital).
On December 18 2014 Resolution 4,389 was published and it brought various amendments and more detailed definitions. Besides, it extended the implementation date of Resolution 4,277/13 to June 30 2015 (before it was January 1 2015, as per Resolution 4,349/14).
In a nutshell some of the novelties of Resolution 4,389 are:
- Article 1: Some more detailed definitions on the nature of financial instruments have been presented, as follows:
- Securities for trading and available for sale (Circular Letter 3,068/01);
- Derivative instruments (Circular Letter 3,082/02) and
- Other marked-to-market financial instruments.
- Article 2: The Brazilian Central Bank (BCB) segregated in two different topics the “mark-to-market procedures” and the “independent price verification procedures” (IPV). We understand that this was done because now the BCB has detailed the minimum IPV contents on § 3. They must consider:
- The complexity of the financial instruments and the nature of its markets;
- Independent data source and
- Consistency with the Accounting figures.
The BCB has made clearer that the financial institution has to be capable of demonstrating the independency of the mark-to-market from the IPV procedures. The regulation states that the mark-to-market procedures have to be organizationally segregated from the Treasury unity. Our interpretation is that both mark-to-market and IPV processes have to be segregated from Treasury, however both could be performed by the same area, provided there are independent processes in place.
- Article 8: This was the article, which presented the majority of the relevant amendments and details, which we believe were the ones subject to more profound discussions with the BCB. It deals with the “prudential adjustments”:
- On §1 there is now the option of skipping the prudential adjustments for those actively and frequently traded instruments, which prices are captured from independent sources and reflect their actual realization values;
- Besides, on §2 the 7 prudential elements have been detailed, with the specification of their nature;
- 6 clarified that stress scenarios or forced liquidation of assets scenarios should not be considered for the computation of the prudential adjustments. Our understanding is that these scenarios exercises are indeed linked to Resolution 4,090/12, which deals with liquidity risk management;
- 7 explains that before making prudential adjustments one should assess the relevance and liquidity of the financial instruments portfolios. This assessment belongs to the financial institution;
- 10 brings along the option to check if when computing the risk-weighted assets (RWA), as per resolution 4,193/13, the elements of the prudential adjustments have been already sufficiently considered.
Our assessment of this regulation, even after the amendments and details presented by Resolution 4,389/14 is that it still requires a great deal of subjectivity. The prudential adjustments derive from conceptual definitions and there is still no standardized data and/or information for a great number of instruments in the market. We believe that as time goes by and the BCB starts its assessments of the market practices the financial institutions will enhance their practice and concepts.