Brazil: Financial Institutions Recovery Plans in Brazil

Last Updated: 7 July 2016
Article by Walter Stuber

Continuing the process of adoption in Brazil of the international standards of prudential regulation, on June 30, 2016 the Brazilian Monetary Council (Conselho Monetário Nacional – CMN) issued Resolution No. 4,502 (CMN Res. 4,502/2016), laying down minimum requirements to be observed in the preparation and implementation of recovery plans for financial institutions and other entities authorized to operate by the Central Bank of Brazil (Banco Central do Brasil – Bacen). This is an important step to incorporate to the Brazilian regulation the best international regulatory practices, in accordance to the recommendations of the Financial Stability Board

I. Introduction

According to CMN Res. 4,502/2016, systemically important institutions must comply with minimum requirements in the preparation and implementation of recovery plans, such as the identification of critical functions for the Brazilian Financial System (Sistema Financeiro Nacional - SFN), the production of stress scenarios and robust indicators, the definition of a clear and transparent governance, assessment of possible barriers to recovery and preparation of communication plans with key stakeholders.

Systemically important institutions are multiple banks, commercial banks, investment banks and saving banks whose Total Exposure-to-Gross Domestic Product (TE/GDP) ratio defined by Bacen on December 31 of the penultimate year in relation to the current year exceeds 10%[1].

These institutions must develop recovery plans annually and promote independent review every three years. Top management must closely monitor the whole process of preparing and leading its implementation whenever they deem necessary.

Currently, financial institutions are obliged to draw up contingency plans of capital and liquidity, and to conduct stress tests within the capital and risk management of credit, market and liquidity. It is expected that the adopted new rules make such exercises more comprehensive and robust, enabling effective planning recovery strategies by systemically important financial institutions and, ultimately, contributing to the strength, stability and proper functioning of the SFN.

The scope of the recovery plan will include: (i) all members of the same prudential conglomerate, in accordance with the Accounting Plan of the Institutions of the SFN (Plano Contábil das Instituições do Sistema Financeiro Nacional - Cosif); and (ii) the entities that perform critical functions or essential services (as defined below) belonging to a group integrated by an institution subject to the requirements established in CMN Res. 4,502/2016.

As foreseen in the timeline established by CMN Res. 4,502/2016, these institutions will have until December 31, 2017 to adapt to the new rules in a process of gradual transition, with intermediate steps which will allow Bacen to monitor closely the effective implementation of such plans.

Bacen may determine other financial institutions and similar entities not framed in the criterion established in CMN Res. 4,502/2016 to also present a recovery plan, if it deems that the institution plays a critical role. The deadline for submission of such recovery plan will be set by Bacen and may not be less than twelve months.

II. Recovery Plan's Content

The recovery plan must contain at least a detailed description of the following items: (i) critical functions and essential services performed by any entity included in the scope of the recovery plan; (ii) monitoring program; (iii) stress scenarios; (iv) recovery strategies and criteria and procedures for its operation; (v) communication plan; (vi) barriers and risks; and (vii) governance mechanisms.

Critical functions are activities, operations or services whose interruption would endanger the financial stability and the functioning of the real economy.

Essential services are activities, operations or services not classified as critical functions whose discontinuity might compromise the viability of the systematically important institutions.

The inclusion in the recovery plan of other activities, operations or services performed by any entity included in the scope of the recovery plan may be determined when Bacen understands that the discontinuance of the activity, operation or service can compromise the financial stability and the functioning of the real economy or the viability of the financial institution.

The adoption of the recovery strategies by the institution must be associated with the achievement of critical levels defined in the monitoring program and the materialization of the potential stress situation.

III. Monitoring Program

The monitoring program will include indicators and other quantitative and qualitative information which: (i) permit the appropriate monitoring of the risks incurred by the institution; (ii) reflect the magnitude and speed of change of the economic-financial situation and liquidity of the institution; (iii) allow the timely adoption of the recovery strategies; (iv) consider the horizon required for  the recovery strategies to take effect; and (v) consider the business model, the nature, complexity and risk profile of the institution. The monitoring program must establish critical levels for the most relevant indicators in order to monitor the risks and eventual implementation of the recovery plan. It shall monitor at least the following indicators: (i) those that demonstrate the actual or potential deterioration in the ability of the institution to meet its capital requirements; (ii) those that point to real or potential deterioration in the ability of the institution to meet its liquidity needs and financing; (iii) those that show the real or potential variation of result or of changes in the pattern of sources of income or expenditure; (iv) those that reflect the quality of active operations and its concentration on sectorial and geographical terms, as well as of counterparties; (v) those that reflect the concentration of funding sources, their level of stability and their costs; (vi) those  that signal activities or events that may significantly affect the image and the operational or financial continuity; (vii) those that point legal risks, contagion risks and the effectiveness of internal controls; and (viii) others determined by Bacen.

The institution will establish appropriate monitoring processes and systems of indicators, critical levels and other information included in the monitoring program and linked to the recovery plan. Bacen may request data on the indicators and other information of the monitoring program, in the form and periodicity to be defined by it.

IV. Stress Scenarios

The stress scenarios must be comprehensive and contemplate the events that could threaten business continuity and viability of the institution. They must contain at least chances of devaluation of assets, reduction of raising capacity, deteriorating the capacity to generate results, deteriorating the situation of liquidity, or resulting from instabilities of systemic or idiosyncratic nature, either domestic or foreign. In order to test the adequacy of the critical levels defined in the monitoring program, the feasibility and effectiveness of recovery strategies, the stress scenarios must include hypothesis of  infeasibility of the institution's business model. Bacen may determine the inclusion of additional stress scenarios in the recovery plan and the completion of stress tests that consider these scenarios. The deadline for the inclusion of scenarios and stress tests will be set by Bacen according to the complexity of the circumstances of each case.

V. Recovery Strategies

The recovery plan must provide for a comprehensive and robust set of recovery strategies in response to different stress scenarios. The institution will evaluate the inclusion at least of the following recovery strategies: (i) strengthening of capital and liquidity situation; (ii) sale of assets; (iii) debt refinancing; (iv) restructuring of liabilities; (v) access to financial support of entities belonging to the same group, if any; (vi) access to financial assistance of liquidity lines, if any, regardless of the nature of the source; (vii) changes in corporate or organizational structures, on operational strategy or business model of the institution; and (viii) maintenance of the supply of services rendered by third parties, which are required for operational continuity of the institution.

It must also contain the grounds of feasibility and an analysis of the expected impact of adoption of each recovery strategy individually and, when appropriate, of the joint adoption of more than one strategy. The grounds of the feasibility and the impact analysis should highlight the time required for the recovery strategies to take effect and the expected costs and benefits.

VI. Communication Plan

The communication plan aims to contribute to the effectiveness of the strategies set out in the recovery plan and will have to consider the appropriateness, adequacy and timeliness of communication with stakeholders throughout the process of implementation of the recovery plan.

VII. Barriers and Risks

The recovery plan must identify any barriers to the effectiveness of the recovery strategies and the risks associated with their implementation. When the institution forwards the recovery plan to Bacen, it must indicate the actions to be implemented to eliminate or mitigate the barriers and risks associated with their implementation. The deadlines associated with the adoption of these actions will be presented to Bacen on the occasion of the delivery of the recovery plan.

VIII. Governance Mechanisms

It is paramount to describe the necessary governance mechanisms for the implementation of the recovery plan. The drafting and review of the recovery plan must be integrated with information management processes, risk, capital and crisis management and with the institution's contingency and capital plans. Bacen may determine to the institution that the drafting processes of the recovery plan and its revisions be evaluated by a specific report of an independent auditor.

The recovery plan must be submitted for review by an independent unit of the areas responsible for its preparation. This review will have to: (i) involve the evaluation of the critical functions and essential services, the suitability and robustness of the monitoring program and the stress scenarios, the mapping of barriers and risks to the effectiveness of the recovery strategies, and other governance criteria and procedures associated with the operation of the plan; and (ii) be held every three years, at least, or whenever there is any change in the economic and financial setting, operating strategies, business model, organizational structure or processes linked to critical functions and essential services.

Furthermore, the recovery plan must be approved and reviewed by the Board of Officers (Diretoria) and by the Board of Directors (Conselho de Administração), if any[2], annually or whenever occurs a change in the economic and financial setting, operating strategies, business model, organizational structure or processes linked to critical functions and essential services.

The Board of Officers and the Board of Directors (if any) shall: (i) ensure the timely identification of those responsible for implementation of the recovery plan; (ii) have a comprehensive and integrated understanding of the critical functions and essential services, of the indicators and other information in the monitoring program, stress scenarios, recovery strategies, barriers and risks associated with the plan, ensuring their compatibility with the strategic planning of the institution; and (iii) ensure the development of feasible and effective recovery strategies, including those involving other companies of the same economic group.

In addition, the Board of Officers and the Board of Directors (if any) are responsible for the adoption of the strategies set out in the recovery plan. The specific responsibilities of each Officer and member of the Board of Directors (if any), must be detailed in the recovery plan. The Officer responsible for servicing the requirements established in CVM Res. 4,502/2016 (Officer in charge) must inform immediately to the Board of Officers and, when applicable, to the Board of Directors and the Audit Committee, whenever the above-mentioned indicators reach the critical levels established in advance.

IX. Final Considerations

The financial institutions and similar entities must: (i) indicate the Officer in charge; and (ii) send their recovery plans to Bacen annually, or whenever there is a relevant change, within 30 days after its approval by the Board of Officers and by the Board of Directors (if any).

The following must be timely communicated to Bacen: (i) the achievement of critical level established in the monitoring program; (ii) the materialization of a stress situation; (iii) the decision for the adoption of recovery strategy; and (iv) a reasoned decision for not adopting any of the recovery strategies, whenever happens any of the situations mentioned in items (i) or (ii) above. Bacen can fix a specific term to each mode of communication contemplated herein.

Bacen may, at its option: (i) determine adjustments to the contents of the recovery plan; and (ii) determine the total or partial execution of the recovery plan, in order to maintain the solidity, stability and proper functioning of the SFN[3].

The recovery plan must be submitted to Bacen until December 31, 2017, subject to the following schedule: (i) until October 31, 2016: indication of the Officer in charge; (ii) until December 31, 2016: presentation of the detailed description of the mechanisms of governance; (iii) until March 31, 2017: presentation of the detailed description of the critical functions and essential services; (iv) until June 30, 2017: presentation of the detailed description of the monitoring program and the stress scenarios; and (v) until  December 31, 2017: presentation of the detailed description of the recovery strategies and the criteria and procedures for its operation; and of the communication plan and the barriers and risks.

From July 1 of 2018, a brief description of the recovery plan must be available in the specific section of the institution's webpage that contains information relating to risk management, as defined by Bacen in accordance with the rules in force. The location of this information must be reported together with the published financial statements. The institution is waived to include strategic information in this brief description.

All the documents that support the servicing of the provisions of CMN Res. 4,502/2016 must be kept at the disposal of Bacen for a period of five years counted from the date of delivery of the recovery plan.

[1] The TE/GDP ratio is defined in accordance with Bacen Circular No. 3,768, of October 29, 2015. For determination of the TE/GDP ratio for 2016, the Total Exposure value must match the value of the total assets in the base date of December 31, 2014 registered in the individual balance sheet or in the balance sheet of the financial conglomerate, if the institution integrates a financial conglomerate, in accordance with Cosif. As of January 1st, 2017, any institution that fits the criterion set out in CMN Res. 4,502/2016 and exceeds the above-mentioned threshold (10%) shall prepare and submit to Bacen the recovery plan until December 31 of the year of the framework.

[2] Not all the institutions will have a Board of Directors. Some have only a Board of Officers.

[3] The implementation of the recovery plan does not prevent the adoption by Bacen of certain preventive prudential measures set forth in CMN Resolution No. 4,019, of September 29, 2011, concurrently or successively, which include: (i) adoption of additional operating controls and procedures; (ii) the degree of risk reduction of exposures; (iii) compliance with additional values to the Required Reference Equity (Patrimônio de Referência Exigido - PRE); (iv) compliance with more restrictive operating limits; (v) recovery of liquidity levels; (vi) limitation or suspension of: (a) increase in the directors' remuneration; (b) payments of portions of variable remuneration of the administrators; (c) distribution of results in amount above the minimum legal limits; (vii) restriction or suspension of: (a) practice of operating modes or certain species of operations, active or passive; (b) exploring new business lines; (c) acquisition of direct or indirect participation  in the capital of other financial or non-financial companies; (d) opening of new dependencies; (viii) disposal of assets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Walter Stuber
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