Prior to the mid-1990s, changes in the payment system in Brazil were motivated by the need to cope with high inflation rates. During that time, the Brazilian payment system achieved significant technological progress, especially aimed at enhancing the speed of processing financial transactions. In the reform recently carried out by the Central Bank of Brazil (BCB), the focus has shifted to risk management.
The launch of the STR (Reserves Transfer System) in April 2002 marked the beginning of a new phase for the Brazilian payment system. The STR, developed and operated by the BCB, is an RTGS system composing 147 participants: 141 banks that own reserve accounts, five clearing houses that utilize special settlement accounts at the Central Bank of Brazil, and the STN (National Treasury Secretariat).
The Brazilian payment system’s reform, however, goes beyond the STR. To reduce systemic risk, legal changes were also made. Law 10,214, enacted in March 2001, is the main legal instrument for the Brazilian payment system. It sets forth among other things that:
- It is up to the Central Bank of Brazil to define which systems are systemically important;
- multilateral netting of obligations is allowed in the environment of clearing and settlement systems;
- in systemically important systems, the respective clearing houses must act as central counterparties and adopt mechanisms and safeguards that ensure certainty of settlement of operations that are carried out;
- assets posted as collateral to clearing houses cannot be seized even by judicial order;
- the bankruptcy law does not affect the fulfillment by a participant of its obligations to a clearing or settlement system, which will be brought to completion and settled in accordance with the system regulation.
The functioning of clearing and settlement systems is regulated by the Central Bank of Brazil, mainly as set forth in the annex to Circular 3.057. The main points of this are that:
- it is mandatory that the systemically important settlement systems promote the final settlement of net results directly in accounts held at the Central Bank of Brazil;
- settlement systems defined as systemically important include all those that settle operations with securities and other financial assets, including foreign currencies and financial derivatives, as well as the funds transfer systems that process transfers with values higher than R$10m or carry daily turnovers higher than R$5bn;
- the maximum settlement lag is: a) at the end of day for systemically important funds transfer systems; b) one business day for spot operations with securities (except stocks); and c) three business days for operations with stocks carried out on stock exchanges. The settlement deadline in other situations is established by the Central Bank of Brazil, which examines each particular case;
- a clearinghouse should keep Net Worth compatible to its risk exposure, observing a minimum limit of R$30m for system considered systemically important and R$5m for system that is not;
- minimum standards for risk management are specially established for central counterparties.
The Brazilian payment system has a high degree of automation, with increasing use of electronic means to transfer funds and settle obligations, and nearly 100 per cent of all securities are dematerialized. Straight-through processing is used in almost all financial market segments. STR is the central system of the Brazilian payment system:
- firstly, by legal disposition, all banking financial institutions are obligated to deposit their available funds in accounts held at the Central Bank of Brazil (reserves accounts);
- secondly, according to Central Bank of Brazil’s Circular 3,057, net positions stemming from systemically important clearing system have to be settled in reserves accounts;
- finally, by disposition of the Central Bank of Brasil (Circular 3,101), all funds transfers between reserves accounts, as well as between reserves accounts and clearinghouse’s settlement accounts, have to be made through STR.
Intraday funds transfers can be settled through either STR or SITRAF (Funds Transfer System). The latter is a hybrid settlement system, which modus operandi is similar to the one used by the new CHIPS system in the United States. Depending on its value, cheques are settled through STR in bilateral basis (cheques with values larger than $100,000), or in a specific settlement system (COMPE – Centralizer Clearing for Cheques). Similar procedures are used for inter-bank credit transfers related do ‘bloquetos de cobrança’, which is a standardized document that allows bills to be paid in any branch of any bank. For ‘bloquetos de cobrança’, the referential value is around $200, and a specific system is used to settle transfers which value is lower than the referential value (SILOC – Deferred Settlement System for Inter-bank Credit Orders), together with another kind of credit transfer, the so called DOC. TECBAN Clearing house is used to settle credit transfers related to the ‘Banco24Horas’, which is a shared ATM network. COMPE, SILOC and TECBAN are multilateral clearing systems (COMPE and SILOC settle on T+1 and TECBAN on T or T+1, depending on the time at which the funds transfer is initiated).
For securities settlement systems, the Brazilian payment system presents certain segmentation. SELIC (Special System for Settlement and Custody), operated by the BCB, is a central securities depository (CSD) and a DVP model 1 settlement system for federal government securities (the settlement of financial and security legs takes place simultaneously throughout the day, operation-by-operation). BM&F Securities is a DVP model 3 multilateral settlement system for government securities (both outright transactions and repurchase agreements are usually settled in T+1). Transactions with stocks, carried out normally in the Sao Paulo Stock Exchange, are settled by the CBLC (Brazilian Clearing and Depository Corporation), which also acts as a CSD. CBLC settles on T+3 in accordance with DVP model 3. CETIP (Clearing House for Custody and Settlement) is a CSD mainly for corporate bonds, and a securities settlement system as well. Both CBLC and BM&F Securities act as central counterparty.
The BM&F (Brazilian Mercantile & Futures Exchange) operates two other settlement systems, one for derivatives and other for inter-bank foreign exchange transactions. These two systems are multilateral net settlement systems, where settlement is on T+1 for derivatives, and normally on T+2 for foreign exchange transactions. BM&F is also a central counterparty for these two systems.
The Central Bank of Brazil considers, among the settlement systems previously mentioned, all but TECBAN, COMPE and SILOC as systemically important. For the smooth functioning of the Brazilian payment system in the real-time settlement environment the Central Bank of Brazil is particularly important beacuse:
- it can activate STR´s optimization routine should a gridlock situation arise;
- it extends a fully collateralized (with treasury securities), unlimited and free of charge intraday credit facility to banks holding reserve accounts;
- it offers liquidity-saving facilities whereby a SELIC participant bank pledges the securities related to DVP transactions as collateral in intraday credit liquidity with the Central Bank in order to obtain funds to settle the securities transactions, including treasury auctions. Both operations occur at the same time, but they are settled on a gross basis. Reverse associated operations are also possible; that is, the bank settles the collateralized intraday credit with funds received from the securities sale at the SELIC.
Another important feature of the the Brazilian payment system is that balances at the end of day are used to verify banks’ compliance with reserve requirements, so these funds can be freely used throughout the day to settle obligations.
In general, the central counterparties in Brazil have adopted the following risk management mechanisms. For minimizing the possibility of participant failure, a minimum capital requirement and operational and technological skills are demanded. For mitigating the settlement risk originated from the default of a participant, the central counterparty considers the risk exposure assessment by the portfolio concept, the stressing tests, the individual margin requirement, the liquidity and credit lines, the intraday risk evaluation capacity and margin call, and the DVP and PVP mechanisms. For mitigating the risk that exceeds the individual safety network, the central counterparty adopts a settlement fund and if necessary its own capital.
As part of the Brazilian payment system reform, a proprietary messaging protocol has been introduced together with a new private TCP-IP network named RSFN – Rede do Sistema Financeiro Nacional (National Financial System Network). All messages are standardized, encrypted and formatted with XML syntax. These many infrastructure advancements in the Brazilian payments systems are expected to foster greater innovation throughout the financial markets in the years to come.