Foreign investors should be aware of Brazil’s unique national payments structure, developed in response to specific historical factors.
In this paper we place particular emphasis on an area that foreign entrants to Brazil’s financial markets are unlikely to be familiar with – the country’s unique clearing and settlement arrangements.
Fund transfers, payment mechanisms and post-trade clearing and settlement are not typically a primary consideration when entering a new market. They are often described as “financial plumbing,” but in the words of one former US banking regulator, “they are more like the central nervous system.”
The global financial volatility of recent years has only increased awareness of how essential it is for different elements of the financial system to work together; this is an area that firms looking to operate in Brazil cannot afford to ignore.
Brazil’s historical origins
Many of the unique features of Brazil’s current financial architecture have their origin in the 1990s, when Brazil was going through a period of very high inflation. As a result, regulatory attention was focused on reducing the length of settlement cycles. During the following decade, attention shifted toward reducing settlement risk and potential contagion arising from institutional failure.
Settlement risk or “Herstatt risk” – named for a German bank that failed in 1974 – is the risk that a financial institution may fail to complete both legs of a transaction, leaving its counterparty exposed to a sudden loss. A number of legal and structural reforms were made in response to these concerns, including the Brazilian Central Bank (Banco Central do Brasil or BCB) being given the power to nominate certain clearing and settlement systems as systemically important.
Systemically important platforms are required to settle transactions in central bank funds, on a delivery versus payment (DVP) basis. In practice, bond, equity, foreign exchange and derivatives platforms – including the majority of over-the-counter (OTC) trading systems – are all designated as being systemically important.
Structurally, the BCB established a real-time gross settlement system, known as the Reserves Transfer System (Sistema de Transferência de Reservas or STR), to settle transactions using accounts held at the central bank itself. Payment messages are sent to STR via the National Financial System Network (Rede do Sistema Financeiro Nacional or RSFN).
In addition, the BCB advised the National Congress on The Payment Systems Law of 2001, which took several further steps to reduce settlement risk. These steps included permitting multilateral netting by clearing houses and safeguarding assets posted as collateral from judicial seizure and the reach of bankruptcy law.
The Brazilian Central Bank sits at the center of a network of clearing and settlement systems
As a result of these reforms, Brazil’s national payment system today is characterized by the extensive use of straight-through processing.
All large value and other systemically important fund transfers are settled in same-day funds, and typically do so within a few minutes of being initiated. Interbank fund transfers are settled irrevocably on a real-time basis.
The architecture utilized to make this to happen is centered on STR. This forms the hub of Brazil’s payment systems and functions in conjunction with a variety of other clearing and settlement platforms, connected via the RSFN. All systemically important interbank transfers are settled directly through STR.
Some other settlements take place via SITRAF – a privately operated fund transfer system that effectively shares a platform with STR.
Two other clearinghouses also provide interbank clearing and netting: SILOC, for deferred transfers, and COMPE for checks. In both cases, settlement is made through STR. The efficiency of this structure means that transfers between Brazilian retail and commercial bank accounts are now among the fastest in the world.
Most retail banking payments are settled on the same day they are initiated, and electronic transfers from checking accounts are typically completed in less than one minute. In the financial markets, most transactions settle either on the day a trade is made, or one day later (T+1).
Federal government bond transactions are cleared and settled through two systems. The most important is SELIC, which handles OTC transactions on a real-time gross settlement basis and is operated by the BCB itself.
Deals transacted on the stock exchange (BM&F BOVESPA) are cleared and netted off by its own Debt Securities Clearinghouse and settled jointly with the STR. The Debt Securities Clearinghouse is one of four multilateral netting systems owned and operated by BM&F BOVESPA.
The others are the FX Clearinghouse, for transactions involving the US dollar and Brazilian real; the Derivatives Clearinghouse, for swaps and futures; and the Equity and Corporate Bond Clearinghouse (former CBLC), which mainly handles equities. Each uses the RSFN to arrange settlement in conjunction with STR. Corporate bonds and derivatives traded off the main exchange are cleared and settled through CETIP, a publicly owned organization focused on OTC activity.
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3 Sistema de Transferência de Fundos (Funds Transfer System).
4Sistema de Liquidação Diferida das Transferências Interbancárias de Ordens de Crédito (Deferred Settlement System for Interbank Credit Orders).
5Centralizadora da Compensação de Cheques e Outros Papéis (Central clearinghouse for checks)
6 Sistema de Liquidação Diferida das Transferências Interbancárias de Ordens de Crédito (Deferred Settlement System for Interbank Credit Orders).