New Modalities of Credit Derivative Transactions in Brazil

Co-written by Adriana M Gödel Stuber

Under the terms of Resolution nº 2933, of February 28, 2002, the Brazilian Monetary Council authorizes the financial and other institutions accredited with the Brazilian Central Bank (Banco Central do Brasil - Bacen) to carry out certain credit derivative transactions according to terms and conditions to be established by Bacen.

According to the regulations in force, the financial and other institutions authorized to act as the receiver of credit risks are the multi-service, commercial and investment banks; the Federal Savings Banks; loan, finance and investment companies; real estate loan and leasing companies. In the specific case of leasing companies, the transaction may only occur if the underlying asset relates to credits deriving from leasing transactions.

The parties involved in this kind of transaction are the party transferring the risk and the party receiving the risk. The first acquires, by means of a credit derivative contract, the protection against a certain credit risk by making the mutually agreed payment. The second assumes, under the same credit derivative contract, the risk inherent in the respective underlying asset and undertakes to pay the mutually agreed compensation to the party transferring the risk if any event foreseen in the contract occurs.

Therefore, credit derivatives are the contracts wherein the parties bargain credit risk of transactions without the underlying asset being transferred at the time of transaction.

According to the Brazilian Monetary Council and Bacen, "underlying asset" is any credit deriving from loan, financing and leasing transactions; credit instruments; securities; guarantees; sureties; credit derivatives and other instruments and financial or commercial agreements subject to a credit risk that are negotiated and performed domestically. As a general rule, the party transferring the risk must necessarily hold the credit risk. Nevertheless, there is in exception to this general rule. Such rule does not apply if the transaction involves in underlying asset that trades usually on organized markets and whose pricing can be confirmed.

If the underlying asset is in portfolio, the credit risk transfer party will make available to Bacen all records that attest to the existence of risk of the underlying asset at the time the credit derivative is contracted. The risk transfer amount is limited to the value of the underlying asset. Additionally, it is expressly...