How the Brazilian authorities are trying to tackle Covid-19 consequences in the financial system

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Kenneth Ferreira
TozziniFreire Advogados, São Paulo
kferreira@tozzinifreire.com.br

Natasha Wiedmann
TozziniFreire Advogados, São Paulo
nwiedmann@tozzinifreire.com.br

Introduction

To tackle the effects of the Covid-19 pandemic on the financial system, the Brazilian National Monetary Council (Conselho Monetário Nacional or CMN) approved Resolutions Nos 4,782 and 4,783 in an extraordinary meeting. Both were published on 16 March 2020 by the Central Bank of Brazil (Banco Central do Brasil or BCB) and aim to facilitate the renegotiation of credits for the benefit of companies and families. It also approved Resolution No 4,797, published on 6 April 2020, which temporarily prohibits financial institutions and further institutions authorised to operate by the BCB from distributing profits and increasing the remuneration of managers.

The federal government published Provisional Measure No 930 (MP) on 30 March 2020. It gives added legal protection to the Collegiate Board of Directors and the employees of the BCB when designing policies to tackle with the Covid-19 pandemic and to mitigate risk-management models of payment arrangements, especially considering crisis scenarios.

More details on the measures are provided below.

Resolution No 4,782

This resolution establishes temporary criteria for the characterisation of credit operation restructuring for risk-management purposes.

Financial institutions are required to maintain a risk and capital management structure. According to CMN rules,^[1] these institutions are obliged to characterise an asset as ‘problematic’ in the following cases: (1) when it considers that the customer no longer has the financial capacity to honour their obligation; (2) when the financial institution, regardless of any regulatory requirement, recognises a significant deterioration of the credit quality of the customer; (3) when there is a restructuring of the credit operation that implies the concession of advantages to the client due to the deterioration of their credit quality; (4) when the institution requires the bankruptcy or similar procedure against the counterparty; or (5) when the counterparty files or undergoes any kind of judicial measure that limits, delays or prevents the fulfilment of its obligations under the agreed conditions.

When characterising an asset as problematic, the financial institution must establish an estimate of the expected loss. This estimate must be reflected in the provisioning and capital availability of the institution. Resolution No 4,782 exempts banks from classifying as problematic those assets submitted to restructuring, as of items (1) to (5), until 30 September 2020, unless such assets were already classified as such on the date the resolution came into force, or if there is evidence that the counterparty does not have financial capacity to honour the new agreed conditions. It also allows for the immediate reversal of the characterisation of the exposure of a problematic asset carried out in cases in which the institution believed that the counterparty no longer had the capacity to honour their obligation.

Resolution No 4,783/2020

Since 2013, financial institutions in Brazil have been required to maintain minimum capital levels, in accordance with the parameters of the so-called Basel III. In addition to the minimum capital requirements, additional principal capital (APC) was instituted, whereby institutions must maintain an additional buffer for the conservation of their own capital to face countercyclical movements or systemic risk.

Resolution No 4,783 decreased the percentage of the APC from 2.5 per cent to 1.25 per cent until 31 March 2021. It also determined a gradual increase of this percentage until it returns to 2.5 per cent level on 1 April 2022. According to a note published by the BCB, this measure would increase capital in the national financial system by R$56bn, increasing the credit capacity by about R$637bn.

Resolution No 4,797/2020

This resolution temporarily prohibits financial institutions and further institutions authorised to operate by the BCB from distributing profits and increasing the remuneration of managers. According to the resolution, the following are expressly forbidden until 30 September 2020:

• payment of interest on equity and dividends above the mandatory minimum established in the bylaws;

• share buybacks, except if carried out through stock exchanges or an organised over-the-counter market, as long as they are kept in treasury for later sale, up to the limit of five per cent of the issued shares, including the shares registered in the Treasury as of the date the resolution starts producing effects, and upon the BCB’s authorisation;

• decrease in share capital, when legally possible;

• increase in the fixed or variable remuneration of directors and members of the board of directors, including bonuses, profit sharing and any deferred remuneration instalments and other performance-related compensation; and

• the anticipation of payments described in the aforementioned items.

The prohibitions apply to all payments to be made from 6 April until 30 September 2020, as well as those calculated on base dates within this period. In addition, the amounts retained as a result of the imposed prohibitions cannot be regarded as a future obligation or be linked in any way to future dividend payments.

Provisional Measure No 930/2020

More protection to BCB directors

The MP establishes that, except in cases of fraud, the members of the Collegiate Board of Directors and the employees of the BCB will not be liable for acts performed in the exercise of their duties, except by respective correctional or disciplinary bodies.

This provision is temporary and is applicable for as long as the effects of the actions, assistance lines and programmes adopted by the BCB to deal with the Covid-19 crisis remain. It does not waive any criminal responsibility.

The aim of this measure is to avoid situations in which these state agents, responsible for the execution of relevant public policies, which invariably demand a certain level of intervention in the economy, answer judicially or extrajudicially for having adopted the measures required by the legislation or necessary according to their discretionary technical and reasoned judgment. The intention is to provide an environment for the aforementioned persons in which they feel comfortable and have the required calmness to adopt technically appropriate measures to tackle with the effects of the crisis.

Payments schemes and payments services

The MP also aims to promote improvements in the legislation relating to the provision of payment services, within the scope of payment arrangements that are part of the Brazilian payment system (SPB) and are governed by Law No 12,865 of 9 October 2013.

The most critical issue related to payment arrangements are the risk-management models of these arrangements. The Brazilian market has some peculiarities, especially in credit card arrangements, due, also, to the context in which this instrument appeared in Brazil, the replacement of checks and periods of very high inflation. This context led to the incorporation of some practices that were consolidated over time, such as payment terms for participants entitled to receive the money that are longer than the international average and the existence of a large financial volume of transactions in instalments. These particularities result in the existence of relevant risk exposure among the participants in the payment arrangement’s chain.

Thus, considering this scenario, the MP established that the funds received by payment arrangements participants: (1) do not communicate with other assets and rights of the payment arrangement participants, being intended for the settlement of payment transactions in the context of the payment arrangement in question; (2) are not subject to judicial constriction acts for the settlement of debts of the participants in the arrangements, except for the fulfilment of obligations to settle payment transactions between participants in the payment arrangement in question; (3) may not be subject to credit assignment or pledged, unless the proceeds of the respective transaction are used to settle or ensure the settlement of payments between participants in the payment arrangement, until receipt by the receiving end user; and (4) are not subject to collection under special regimes applied to institutions authorised to operate by the BCB, judicial or extrajudicial restructuring, bankruptcy, judicial liquidation or any other similar regime that may affect the participants in the payment arrangement.

In the case of anticipation of payments to the receiving end user by a participant in the payment arrangement, the participant will have the right to receive the funds originally intended for the receiving end user. This provision provides greater certainty in the anticipation of receivables transactions, which are current practice in the Brazilian payments industry.

The MP also allows the payment arrangement regulation to authorise the redirection of financial flows in situations in which one of the members of the settlement chain is subject to special regimes applicable to institutions that are authorised to operate by the BCB or to other insolvency regimes.

Moreover, the MP also determines that the rules on funds maintained in payment accounts and the new regulation on funds received by participants in payment arrangements are applicable to participants and payment arrangements institutors, even in cases where the payment arrangements are not part of the SPB. This provides more guarantees for the popular economy, as it extends the protection given to funds maintained in payment accounts and the payment flow between the participants of the payment scheme even though they do not integrate the SPB.

Finally, the MP establishes that assets and rights allocated by the institutors and by participants in the payment arrangements in order to guarantee the settlement of payment transactions: (1) constitute separate assets, which cannot be subject to arrest, search and seizure or any other act of judicial constriction, except for the fulfilment of the obligations assumed within the scope of the arrangement; and (2) are not subject to collection under the special regimes of institutions authorised to operate by the BCB, judicial and extrajudicial recovery, bankruptcy, judicial liquidation or any other recovery or dissolution regime to which the participant of the payment arrangement is submitted.

The measures ensure that the flow of payments in the payment arrangement chain is maintained, even if a certain arrangement participant paralyses its activities due to solvency problems, thus ensuring that the money paid by a cardholder continues to reach the participant entitled to receive the money. By protecting this payment flow, the exposure between the participants of the arrangement is substantially decreased, without adding costs and without impacting competition aspects, as it aims to grant the same treatment to any participant, regardless of their size.

The need to provide for guarantees is due to the possibility of default by end users, which typically represents a small fraction of payments. The measure will guarantee adequate protection to an asset that is intended for the soundness and solidity of payment arrangements.

The MP takes into consideration the uncertainties regarding the effects of Covid-19 on the national economy, in order to ensure greater certainty in the payment arrangement obligation chain and to make the use of receivables by the participant entitled to receive the money safer and at lower costs. At the same time, it aims at dealing with risky situations, in order to ensure the soundness of payment arrangements and institutions.

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