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Guide to 13 March 2014 Economics Research http://www.credit-suisse.com/researchandanalytics Brazil Local Markets

Guide to

13 March 2014 Economics Research

http://www.credit-suisse.com/researchandanalytics

Brazil Local Markets

Economics Brazil

Research Analysts Nilson Teixeira +55 11 3701 6288 nilson.teixeira@credit-suisse.com

Paulo Coutinho +55 11 3701 6353 paulo.coutinho@credit-suisse.com

Iana Ferrao +55 11 3701 6345 iana.ferrao@credit-suisse.com

Leonardo Fonseca +55 11 3701 6348 leonardo.fonseca@credit-suisse.com

Daniel Lavarda +55 11 3701 6352 daniel.lavarda@credit-suisse.com

We acknowledge the significant assistance from Pâmela Borges, Felipe Leon and Túlio Sousa in the preparation of this report.

Leon and Túlio Sousa in the preparation of this report. This report, in its eighth year,

This report, in its eighth year, provides international investors with a summary of Brazil’s fixed-income market and describes in a nutshell the bonds and derivatives available, the institutions and market players involved, and the taxes levied on the different products. It also presents an overview of the LOCuS system, which Credit Suisse clients can access to obtain financial market data and real-time quotes.

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS.

CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS

BEYOND INFORMATION Client-Driven Solutions, Insights, and Access

Table of Contents 13 March 2014 Summary 4 1. Introduction   5 2. Financial System

Table of Contents

13 March 2014

Summary

4

1. Introduction

 

5

2. Financial System

 

7

3. Exchange Rate

 

8

4. Interest Rates

 

12

4.1. Selic Rate

 

12

4.2. CDI Rate

13

4.3. Basic Financial Rate

14

4.4. Reference Rate

14

4.5. Long-Term Interest Rate

15

5. Inflation Indexes

17

5.1. IBGE Indexes

 

17

5.2. FGV Indexes

18

6. Brazil’s Public-Sector Debt

20

6.1. Overview

 

20

6.2. Domestic Public Securities

21

6.3. Secondary Market

27

7. Private-Sector Securities

29

7.1. CDBs and RDBs

 

29

7.2. Corporate Bonds

31

7.3. Agricultural

Cash Forward

Contract Bonds (CPRs)

33

7.4. Certificates

of Real Estate

Receivables (CRIs)

34

7.5. Banking Credit Notes (CCBs)

38

7.6. Receivables-Backed

Investment Funds (FIDCs)

38

7.7. Judicial Requisitions to Treasury for Budget Appropriation

and Payment of Money Judgments (Precatórios)

40

7.8.

Treasury

Bills (LFs)

41

8. Derivatives and Swaps

 

43

8.1

Futures and Options

43

8.2.

Swaps

55

9. Taxation of Foreign Investments in Brazil

59

9.1. Income Tax

 

59

9.2. Tax on Financial Transactions (IOF)

61

13 March 2014 Appendix A: Financial System Entities 62 Regulatory and Oversight Entities Other Important

13 March 2014

Appendix A: Financial System Entities

62

Regulatory and Oversight Entities Other Important Entities

62

64

Appendix B: Requirements for Foreign Investors

67

Appendix C: Form for Foreign Investor’s Registration with the CVM

68

Appendix D: Brazil Local Markets in LOCuS

71

Introduction Brazil in LOCuS List of Web Sites

71

72

80

13 March 2014 Summary This Guide to FI Markets in Brazil explains in detail the

13 March 2014

Summary

This Guide to FI Markets in Brazil explains in detail the operations of Brazil’s fixed-income financial market. It describes the main financial assets and instruments traded locally (bonds and derivatives) as well as the applicable taxes. It also contains important information on the main institutions that regulate and oversee the local financial system. Among the assets and financial instruments presented, we highlight the following:

federal public securities, the main public debt bonds traded on the local market, whether fixed-rate or linked to a floating interest rate or inflation index; information is also provided on auctions of public debt securities;

private bonds, especially certificates and receipts issued by financial institutions (Certificates of Deposit (CDBs), Non-Transferable Certificates of Deposit (RDBs), and Treasury Bills (LFs)) and by companies in general (bonds);

assets backed by credit receivables, especially Banking Credit Notes (CCBs) and specific receivables such as Certificates of Real Estate Receivables (CRIs); there is also a description of Receivables-Backed Investment Funds (FIDCs), which raise capital for the acquisition of receivables to be traded on the market in the form of fund shares;

precatórios, which are judicial requisitions to treasuries for budget appropriation and payment of money judgments against public entities; these instruments are classified as receivables, and the attached rights can be assigned to a third party by the respective holders;

derivatives, the main financial derivatives traded on the securities, futures, and commodities exchange and on over-the-counter markets; these derivatives include swaps involving interest rates, exchange rates, and inflation indexes as well as option contracts.

For each of these assets, we provide the yield calculations and data on volumes, secondary-market liquidity, and timetables of issuances and maturities.

This guide is divided into nine sections and four appendices. The first section presents a general overview of the participation of foreign investors in the Brazilian fixed-income market. The second presents the main institutions that comprise the Brazilian financial system and their roles, described in further detail in Appendix A. The following section presents Brazil’s foreign exchange market and describes the main currency trading platforms and the PTAX exchange rate calculated by the central bank and used as a benchmark for settlement of onshore and offshore contracts indexed to the USD. In the fourth section, we present the main interest rates used in the domestic markets, especially the Selic basic interest rate, used to guide monetary policy, and the Certificate of Interbank Deposit (CDI) rates. The fifth section contains an overview of the main inflation indexes used in Brazil. A more extensive discussion of these indexes can be found in the Brazil Inflation Guide, first published on June 25, 2009. The main features of public and private fixed-income securities are presented in detail in sections six and seven, respectively. Section eight presents the main derivatives and swaps of interest, currency, and inflation rates traded on the local market. Taxation matters are addressed in section nine. In Appendices B and C we present the main procedures a foreign investor needs to follow in order to qualify to trade in the local market. Finally, Appendix D contains a guide to the pages on Brazilian fixed-income markets within the LOCuS system, which can be accessed by Credit Suisse clients.

1. Introduction 13 March 2014 The flow of foreign portfolio investments into the main emerging

1. Introduction

13 March 2014

The flow of foreign portfolio investments into the main emerging economies has grown significantly in recent years (Exhibit 1). Historically, foreign investors’ financial investments in Brazil have been heavily concentrated in equities. Nevertheless, the share of foreign investments in fixed-income securities has increased since the mid-2000s (Exhibit 2). We believe this movement will continue in the coming years, owing mostly to the continued wide gap between domestic and international interest rates and the withdrawal in June 2013 1 of the 6% Tax on Financial Transactions (IOF) levied on these investments since October 2010.

Exhibit 1: Net Foreign Portfolio Inflow into Debt Instruments

USD bn

Chile   71

Chile  71

 

71

Indonesia 1      

Indonesia 1 1

     
Brazil  

Brazil 

 
Turkey 2 50

Turkey 2 2

50

Mexico 1   37 47 20 11   25 23 15 10

Mexico 1 1

 

37

47

20 11
20
11
 
25 23 15 10
25
23
15
10
 
16 14
16
14

30

 

32

 

8

10

9

11

13

11

 

1

7

1 7 2 0   8 6 5 5

2

1 7 2 0   8 6 5 5
1 7 2 0   8 6 5 5

0

 

8

8

6

5

5
5
3
3

-4

2009

2010

2011

2012

2013

2008

1 Cum. 12 months through September. 2 Cum. 12 months through November. Source: IMF, Credit Suisse

Exhibit 2: Breakdown of Stock of Foreign Portfolio Investments in Brazil

% of total, USD bn

450 100 Equities (%) 90 400 80 350 70 300 60 250 50 200 40
450
100
Equities (%)
90
400
80
350
70
300
60
250
50
200
40
150
Fixed Income (%)
30
100
20
Portfolio Size
50
10
(USD bn, LHS)
0
0
Nov-02
Sep-04
Jul-06
May-08
Mar-10
Jan-12
Nov-13
Source: Central Bank of Brazil, Credit Suisse

The share of domestic federal securities debt (DPMFi) held by foreigners in Brazil continues to rise, although current levels are somewhat lower than in other emerging markets (Exhibit 3). The higher share of foreign investors in government securities has a positive impact on the domestic debt profile. Compared to local investors, foreigners are usually more prone to invest in fixed-income securities with much longer maturities. Hence, the increase in the participation of foreign investors has contributed to an extension in the maturities of government debt.

In addition to their impact on the maturity profile, foreign investors help increase liquidity in the secondary market, particularly for instruments still sparsely used in Brazil, notably bonds backed by credit receivables.

1 For securities traded in Brazil. Securities traded abroad with maturities of less than one year are subject to the IOF at 6%.

13 March 2014 Exhibit 3: Share of Domestic Public Debt of EM Countries Held by

13 March 2014

Exhibit 3: Share of Domestic Public Debt of EM Countries Held by Foreign Investors

% of total

18

16

14

12

10

8

6

4

2

0

Brazil 16.1
Brazil
16.1

Jan-08

Jan-10

Jan-12

Dec-13

26

24

22

20

18

16

14

12

10

8

Turkey 21.5
Turkey
21.5

Jan-07

Jan-09

Jan-11

Jan-12

Dec-13

40 Mexico 36.9 35 30 25 20 15 10 5 Jan-07 Jan-09 Jan-11 Jan-12 Dec-13
40
Mexico
36.9
35
30
25
20
15
10
5
Jan-07
Jan-09
Jan-11
Jan-12
Dec-13

Source: Treasuries, Credit Suisse

In the past few years, the Brazilian government has announced a set of measures to encourage long-term financing. The measures were structured in two main parts: tax incentives for long-term corporate bonds earmarked for investment projects and the creation of a fund to stimulate the liquidity of those bonds in the secondary market (although this fund has not yet become operational). Through those measures, households and foreign investors purchasing local corporate bonds that meet certain criteria became exempt from income taxes and the IOF tax 2 .

2 In October 2010, the government increased the IOF levied on foreign investments in fixed-income securities traded in Brazil, including infrastructure bonds, to 6%. The government reduced to 0% first the IOF on infrastructure bonds (in December 2011) and, later, the IOF on all private securities traded in the country (in June 2013).

13 March 2014 2. Financial System The basic features of Brazil’s financial system were established

13 March 2014

2. Financial System

The basic features of Brazil’s financial system were established through a series of institutional reforms that started in 1964/65 with the creation of the National Monetary Council (CMN) and the Central Bank of Brazil and ended in 1976 with the creation of the Brazilian Securities Commission (CVM).

Additional measures to restructure the financial system involved regulations to separate proprietary trading from asset management (information barriers), the introduction of compliance departments within financial institutions, the creation of a credit risk center, new directives to control market risks and interest rate risk (already applicable to foreign- currency transactions), and the reform of securities market legislationwhich increased the participation of minority shareholders in company decisions and introduced corporate governance practices.

Exhibit 4 illustrates the institutions operating in the Brazilian financial system and agencies in charge of oversight and regulation. The role of the major regulatory and oversight agencies is explained in detail in Appendix A.

Exhibit 4: Regulatory and Oversight Agencies

Operating Institutions

Central Bank

Securities Commission (CVM)

FinancialFinancial InstitutionsInstitutions

Full-service banks



Commercial banks



Savings and loan associations



Credit unions



Investment banks





Development banks



Credit, finance, and investment companies



Asset Management

Mutual funds





Investment clubs



Foreign investors' portfolios





Consortium managers



InMaturityediaries

Commodities and futures exchange





Stock exchanges



Brokerage firms / securities dealers





Leasing companies



Foreign exchange brokers



Autonomous investment agents





Settlement and Custody Systems

Selic



Cetip



Other settlement and custody systems



Source: Brazilian Securities Commission (CVM), Credit Suisse

13 March 2014 3. Exchange Rate The Brazilian exchange rate system is a dirty float

13 March 2014

3. Exchange Rate

The Brazilian exchange rate system is a dirty float system. The central bank actively buys and sells dollars both in the spot and derivative markets. According to the monetary authority, the interventions in the FX market aim to cover a lack of liquidity and ensure that the market functions properly. To make the system more transparent, the central bank intervenes in the market through primary dealers 3 , disclosing information to the market on weekly basis, generally on Wednesdays 4 .

In 2005, the National Monetary Council (CMN, Appendix A) concluded the process of unifying Brazil’s FX markets. Under the new regime, the differences in legislation and the commercial 5 and tourism 6 rates were eliminated. Virtually all exchange rate transactions must be registered with the central bank; however, unification of the FX markets significantly simplified transactions involving foreign currencies and reduced red tape, especially for offshore remittances.

Under the previous system, each type of transaction required a different set of documents. With the unification of the markets, the documents necessary for FX transactions ceased to be classified by type. Moreover, the financial institution carrying out the transaction is responsible for submission of all necessary documentation, except in certain situations.

Spot Market

The spot FX market has a daily average turnover of around USD 3bn. Spot trades can be made on the São Paulo Securities, Commodities, and Futures Exchange (BM&FBovespa, Appendix A), on the over-the-counter (OTC) market, or at foreign exchange clearinghouses. All trades must be registered in the Central Bank Information System (SISBACEN, Appendix A).

The spot dollar market of the BM&FBovespa was created in February 2006. It is a trading system that allows parties interested in buying and selling dollars to make bids through a broker or a bank, which are responsible for sending accepted orders to traders at the BM&FBovespa for execution. Although this market provides more transparency and safety in trading, it has very low liquidity, in part due to the costs involved in settlement services. Before the emergence of the BM&FBovespa spot dollar system, transactions in the spot dollar market were carried out only in the interbank FX market, between brokerage firms and banks authorized to operate by the central bank.

3 The central bank currently intervenes in the FX market via 14 previously selected financial institutions (primary dealers). The dealers are chosen every six months, and at least two institutions must swap functions in each period. The number of dealers may also change between periods. The central bank uses the following five criteria for selecting dealers:

1. information provided to the central bank (weight of 30%), used by the central bank to determine how each institution operates in the FX market;

2. imports and exports (25%), volume of FX transactions linked to imports and exports traded by the institution;

3. financial FX (20%), the volume of financial FX transactions carried out by the institution;

4. USD-linked securities and reverse FX swaps (20%), volume of public debt bonds adjusted for currency gains/losses and currency coupon swaps traded by the institution; and

5. interbank market (5%), volume traded by the institution in the FX interbank market.

4 The Treasury also buys dollars in the market to cover external debt obligations. The Treasury’s purchase

operations are made using Banco do Brasil.

5 This segment was used for: (i) exports/imports; (ii) federal, state, and municipal governments; (iii) foreign

investments in Brazil and loans to residents; and (iv) payments for services.

6 The floating FX rate segment was for tourism transactions, contributions to associations, donations, inheritances, retirement and pension benefits, maintenance of residents and health treatment.

13 March 2014 PTAX Rate The PTAX is the official exchange rate used for settlement

13 March 2014

PTAX Rate

The PTAX is the official exchange rate used for settlement of financial contracts indexed to the dollar. It is used as a benchmark for USD-linked onshore and offshore contracts (for instance dollar future contracts and dollar-linked rates, such as non-deliverable forward (NDF) contracts settled in USD, and bonds).

The central bank is responsible for calculating and publishing the PTAX rate. The PTAX is the arithmetic average of the rates obtained in four daily consultations of exchange dealers. Consultations are carried out at around 10:00 a.m., 11:00 a.m., 12:00 noon, and 1:00 p.m. (local time). The exchange rate for each consultation corresponds to the average of rates effectively quoted by the dealers, excluding in each case the two highest and two lowest 7 . The results are released after each survey, and the PTAX rate is released around 1:00 p.m. (local time).

Government Intervention

As a response to the post-crisis BRL appreciation, the government implemented measures aiming to reduce excessive volatility of the local currency. However, the majority of these measures have been reverted since June 2012, following the significant depreciation of the BRL in 2Q12 (from BRLUSD 1.80 in March to 2.05 in June) and in 2013 (BRLUSD 2.45 in August). The main interventions in the FX market during this period were (Exhibit 5):

Taxation of foreign investment in fixed income: The Tax on Financial Transactions (IOF, described in more detail in Chapter 9) was charged on investments by non- residents in fixed-income securities traded in Brazil. The rate, which increased from 0% to 2% in October 2009 and from 2% to 6% in October 2010, applied to the purchase of BRL by foreign investors. The regulation also required a “simultaneous FX transaction” if the investor decided to migrate from an equity, futures, or commodities investment to a fixed-income asset. In this case, the investor would have to pay the IOF tax as well. The IOF was reduced to 0% in June 2013.

Taxation of foreign investment in equities: The IOF of 2% was imposed on non- residents’ investments in equities, including American Depositary Receipts (ADRs), in October 2009. In November 2009, the levy on investments in ADRs was reduced to 1.5%. The IOF rate on investments in equities traded in Brazil was reduced from 2% to 0% in December 2011 and on ADRs, from 1.5% to 0.0% in December 2013.

Establishment of mandatory reserves for banks’ short FX positions: In January 2011, the reserve requirement was implemented on 60% of the short positions in dollars that exceed the lower of USD 3.0 billion and the institution's Tier-1 capital. The reserves are deposited at the central bank in local currency and are not remunerated. The upper limit was lowered to USD 1.0 billion in July 2011. In June 2013, the government cancelled the reserve requirements for banks’ short positions in dollars entirely.

Taxation of foreign loans: In March 2011 the Tax on Financial Transactions (IOF) was charged on external loans with maturities of less than one year. The levy was extended to loans with maturities of less than two years in April 2011, three years in March 2012, and finally to five years later in March 2012. The IOF was maintained only for loans with maturities of less than two years in June 2012. The threshold was later reduced to one year in December of the same year.

7 This methodology went into effect in July 2011. The PTAX rate according to the former methodology was the average (volume-weighted) FX rate of transactions in the spot FX market with settlement two days after the transaction (T+2). This calculation was made after purging transactions whose volume exceeded 5% of the volume traded in the day. The rate was announced after the market close (5:30 p.m., local time) and was based on only one daily survey.

13 March 2014  Taxation of short positions in financial derivatives: In July 2011, the

13 March 2014

Taxation of short positions in financial derivatives: In July 2011, the IOF was imposed at the rate of 1% on increases in short positions in financial derivatives whose settlement value is influenced by movements in the FX rate (e.g., USD options, futures, and forward-rate agreements (FRAs). The 1% IOF was also levied on domestic investors to prevent increases in short dollar positions. Specifically, a new acquisition or sale of an exchange derivative resulting in an increase in short position or decrease in long position greater than USD 10 million in one day was subjected to the 1% IOF on the notional value of the transaction. The government withdrew this measure in June 2013.

In sum, the government’s intervention measures aimed at controlling FX rates, still in place as of February 2014, are:

IOF levy of 6.0% on external loans with maturities of less than one year; and

IOF levy of 6.38% on credit card transactions abroad, on payments in foreign currency made with debit cards, on foreign currency withdrawals abroad, on purchases of travelers checks, and on the addition of foreign currency to prepaid cards.

Exhibit 5: Interventions in FX Market 13 March 2014 OCTOBER 19: Increase in Tax on

Exhibit 5: Interventions in FX Market

13 March 2014

OCTOBER

OCTOBER

19: Increase in Tax on Financial Transactions (IOF) rate on foreign inflows for equities and fixed - income

investments from 0% to 2%.

NOVEMBER

 

18: Reduction in IOF rate on foreign investment in ADRs from 2% to 1.5%.

 

OCTOBER

04: Increase of IOF on investments in fixed income, from 2% to 4%. Investments in

04: Increase of IOF on investments in fixed income, from 2% to 4%. Investments in equities remain subject to the IOF of 2%.

07: Simultaneous FX transactions for foreigners that transfer their investments from the securities, futures, and commodities exc han ge to

other investments in the financial and capital markets, such as fixed - income securities.

18: New increase in IOF tax rate on inflows for the purchase of fixed - income securities, from 4% to 6%.

 

JANUARY

06: Imposition of reserve requirements on banks' short dollar positions.

Reserve requirement applies to 60% of short positions in dollars exceeding lesser of USD 3.0 billion and the institution's Tier - 1

capital. Reserves are deposited with central bank in local currency and will not be remunerated.

10: Brazil’s Sovereign Fund permitted by its bylaws to deal in the FX market.

13: Resumption of central bank’s reverse swap auctions, taking long FX positions in derivatives markets.

25: Resumption of Maturity auction facilities by central bank in FX market.

MARCH

28: IOF rate on credit card transactions abroad raised from 2.38% to 6.38%.

29: IOF levy of 6% on foreign financing with maturity of less than one year.

29: IOF levy of 6% on foreign financing with maturity of less than one year.

APRIL

06: IOF levy of 6% on foreign loans is extended to transactions with maturity of up to 2 years.

JULY

 

08: Reduction in limit for reserve requirements on banks' short position in dollars.

Minimum deposit charged on 60% of short dollar positions that exceed lesser of USD 1.0 billion and bank's regulatory capital. Deposit

must be made in cash and will not be remunerated.

27: IOF levy of 1% imposed on increases in short positions in financial derivatives whose settlement value is affected by FX rate ch anges.

The levy will apply only to net short positions above USD 10.0 million.

27: Legal framework established for IOF levy on derivatives market. Government permitted to raise IOF rate to up to 25% of value of

transactions in derivatives market.

DECEMBER

01: IOF rate on investments in stocks and bonds of infrastructure companies reduced to 0%.

 

MARCH

01: IOF levy of 6% on foreign loans extended to transactions with maturities of up to 3 years.

02: Maximum period of advance payments by exporters limited to 360 days; transactions must be financed by importer of goods.

12: IOF levy of 6% on foreign financing extended to transactions maturing within 5 years.

12: IOF levy of 6% on foreign financing extended to transactions maturing within 5 years.

JUNE

14: Maturity of loans subject to IOF levy reduced from 5 to 2 years.

28: Rules on advance payment transactions extended to financial institutions and other companies.

 

DECEMBER

04: Maximum period for advance payment of export transactions extended from 1 to 5 years.

05: Maturity of loans subject to IOF levy reduced from 2 years to 1 year.

 

JANUARY

30: IOF levy on foreign investment in shares of real estate investment funds reduced from 6% to 0%.

JUNE

04: IOF levy on foreign investments in fixed income reduced from 6% to 0%.

12: IOF levy on increases in short positions in financial derivatives whose settlement value is affected by FX rate changes reduc ed from

1% to 0%.

1% to 0%.

25: Cancellation of reserve requirements on banks’ short position in dollars.

JULY

 

03: Elimination of maximum Maturity ( 5 years) for prepayment of export transactions.

DECEMBER

24: IOF levy on foreign investment in ADRs reduced from 1.5% to 0%.

27: IOF levy on payments in foreign currency made with debit cards, on foreign currency withdrawals abroad, on purchases of trave ler s

checks, and on the addition of foreign currency to prepaid cards increased from 0.38% to 6.38%.

Source: Central Bank of Brazil, Ministry of Finance, Credit Suisse.

13 March 2014 4. Interest Rates Interest rates in Brazil (for example, the Selic basic

13 March 2014

4. Interest Rates

Interest rates in Brazil (for example, the Selic basic interest rate and the Certificate of Interbank Deposit (CDI) rate) are expressed mainly in compound annualized terms, based on a year of 252 business days. They differ from the US standard compounding method, which uses a 360-day year (Exhibit 6).

Exhibit 6: Counting of Days for Interest Rates in Brazil

Business Days (1) / 252 Exponential

business days

i e = (1+ i a )

252 - 1

i e effective rate in the period

i a effective annual rate

(1) Does not accrue on weekends or holidays

Calendar Days 360 / Linear
Calendar Days 360 / Linear

Calendar Days 360 / Linear

Calendar Days 360 / Linear

i e =

i a

d

360

effective rate in the period effective annual rate

d days between date 1 and date 2

i a

i e

Source: Credit Suisse

4.1. Selic Rate

The Special Settlement and Custody System (Selic) is an electronic system run by the central bank for registration, settlement, and custody of transactions involving public securities. All Selic transactions are settled immediately; debits and credits are made directly to each institution’s reserves account at the central bank.

The Selic rate is the average of rates for one-day financing transactions backed by federal public bonds, carried out in the Selic system in the form of repurchase (repo) operations8. The interest rates for the transactions used to calculate the Selic rate reflect the liquidity conditions in the bank reserves market. These interest rates are not influenced by counterparty risk in the buyback transactions since all trades are backed by federal public securities.

The Selic rate is also the basic interest rate used as a benchmark for monetary policy. The Selic rate is set by the Monetary Policy Committee (Copom) at its eight regular meetings held each year. The Copom defines not only the target for the Selic rate but also the Committee’s “bias.” If a negative or positive bias is adopted, the central bank governor can alter the Selic rate target at any time between Copom meetings, provided this change follows the direction of the announced bias. Using a bias has become unnecessary in recent years, however, as inflation and volatility have both decreased significantly. The bias has been neutral since March 2003.

The establishment of the target induces banks operating in the Selic system to carry out one-day buyback transactions around the target, since the daily activity of the central bank tends to offset surpluses or shortfalls in bank reserves, bringing the target close to the rate effectively negotiated.

8 Sales of bonds with a buyback commitment assumed by the seller and a resale commitment assumed by the buyer.

13 March 2014 4.2. CDI Rate The CDI rate is the average rate of one-day

13 March 2014

4.2. CDI Rate

The CDI rate is the average rate of one-day transactions backed by fixed-rate Certificates of Interbank Deposit (CDIs), registered and settled by the Cetip clearinghouse (Appendix A). Its calculation takes into account only one-day trades between institutions of different financial groups.

The majority of CDI trades are made for a period of one day (overnight) and are referred to as “DI Over.” A repo based on the CDI rate takes place when two institutions agree on an interest rate and close the deal electronically (Exhibit 7). The Cetip transfers ownership of the CDI to the purchasing institution and creates a credit that impacts the selling institution’s reserve account at the central bank on the same day (T). On the next day (T+1), the transaction is reversed, and the purchaser receives its reserve funds, plus the previously agreed interest rate (“DI Over” rate). In October 2013 a new methodology was adopted to calculate the DI Over rate. Under the new methodology all CDI transactions recorded and cleared by the Cetip are used to obtain the DI rate weighted by volume. According to the former methodology the 5% upper and lower tails were excluded from the computation.

Exhibit 7: CDI Settlement

T End of T Buyer Seller

T

End of T
End of T
T End of T Buyer Seller

Buyer

Seller

Buyer Seller

T+1

CDI
CDI
$
$
Interest
Interest
End of T+1
End of T+1
$ + Interest CDI
$
+
Interest
CDI
$

$

CDI
CDI
CDI $

CDI

CDI $

$

Source: Credit Suisse

Even though the central bank does not operate directly in this market, the CDI rate tends to be very similar to the Selic rate (Exhibit 8).

Exhibit 8: Effective Selic Rate and DI Rate

Basis points, p.a.

0.205 0.185 0.165 Effective Selic Rate 0.145 0.125 0.105 0.085 DI Rate 0.065 Dec-03 Dec-04
0.205
0.185
0.165
Effective Selic Rate
0.145
0.125
0.105
0.085
DI Rate
0.065
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13

Source: Central Bank of Brazil, Credit Suisse

13 March 2014 4.3. Basic Financial Rate The basic financial rate (TBF) was created to

13 March 2014

4.3. Basic Financial Rate

The basic financial rate (TBF) was created to be used as a benchmark rate for transactions within the financial system with maturities above 60 days. The TBF rate is the average of rates paid on Certificates of Deposit (CDBs) and/or Non-Transferable Certificates of Deposit (RDBs) 9 with maturities of 30 to 35 days. These transactions are weighted by their respective volumes and involve only trades of the 30 largest institutions on a given day, by volume of their issues of CDBs and RDBs. In the calculation of the weighted average, the two highest and the two lowest rates surveyed and the securities purchased by institutions from the same conglomerate are removed from the sample. The TBF rate is used mainly as the basis for calculating the Reference Rate (TR).

4.4. Reference Rate

The Reference Rate of Interest (TR) was created in 1991 as a reference rate for future inflation built into nominal market interest rates. The idea behind the TR is to strip out the expected real interest rate from the nominal interest rate represented by the TBF. The difference between these two rates points to the expected inflation for the period.

The TR rate is published daily by the central bank and is valid until the same day of the following month. The calculation of the TR is based mainly on the TBF (average of CDB and RDB rates), to which a reduction factor is applied. The TR reduction factor is a function of the TBF, and the parameters of its formula are periodically updated by the central bank (Exhibit 9).

Exhibit 9: Formulas for Calculation of TR

TR =

1 + TBF R
1 + TBF
R

- 1

Where:

R = TR reduction factor

TBF = Basic Financial Rate on the

reference day

B = function of the TBF rate

R = 1.005 + B TBF

TBF (% p.a.)

B*

TBF > 16

0.48

15

< TBF ≤ 16

0.44

14

< TBF ≤ 15

0.40

13

< TBF ≤ 14

0.36

10.5 ≤ TBF < 13

0.32

10 ≤ TBF ≤ 10.5

0.31

9.5 ≤ TBF < 10

0.26

9 ≤ TBF < 9.5

0.23

* The rule for deMaturityining the B factor is defined by

Central Bank Resolutions 3446 and 3356/07.

Source: Central Bank of Brazil, Credit Suisse

The TR rate is mainly used as the basic rate for the Brazilian savings and loan system, which finances housing construction. Yields on savings deposits are split into two components:

I. basic remuneration, at the Reference Rate (TR), and

II. additional remuneration, corresponding to:

0.5% p.m., when the Selic basic interest rate is higher than 8.5% p.a.;

70% of the annual Selic rate, when the Selic is less than or equal to 8.5% p.a.

9 Please refer to section 7.1.

13 March 2014 Until May 2012, the additional remuneration was 0.5% p.m., regardless of the

13 March 2014

Until May 2012, the additional remuneration was 0.5% p.m., regardless of the Selic rate. The change to the taxation rules governing returns on savings deposit accounts occurred to prevent funds from migrating from government bonds and other securities indexed to the Selic rate to savings deposits (the Monetary Policy Committee (Copom) set the Selic rate below 8.50% in June 2012).

The continued reduction in the Selic basic interest rate in recent years has helped raise the competitiveness of savings deposits versus other financial investments, mainly because the investments are exempt from income tax, which varies between 15.0% and 22.5% for most types of investment (Exhibit 10).

Exhibit 10: Passbook Savings and DI Over Rates % p.a. 30 25 CDI rate 20
Exhibit 10: Passbook Savings and DI Over Rates
% p.a.
30
25
CDI rate
20
15
10
Savings yield
5
Dec-01
Dec-03
Dec-05
Dec-07
Dec-09
Dec-11
Dec-13

Source: Central Bank of Brazil, Credit Suisse

4.5. Long-Term Interest Rate

The Long-Term Interest Rate (TJLP) was created in November 1994 to stimulate long- term investments, which were previously less feasible due to the absence of a market for long-term credit in the country. At present, the TJLP is the main rate for credit lines from the Brazilian Development Bank 10 (BNDES) and from the Workers’ Support Fund (FAT). The TJLP can theoretically be used in any transaction in the financial markets, but that rarely occurs.

The Long-Term Interest Rate is effective for a calendar quarter and is calculated based on the following parameters:

(i)

the inflation target, prorated for 12 months as of the first month in which the rate is effective, based on the annual targets set by the Brazilian Monetary Council (CMN); and

(ii)

the risk premium, which embeds an international real interest rate and a component reflecting Brazil’s country risk in a medium- and long-term perspective.

The rate is set by the CMN and published by the last day of the quarter immediately preceding the date on which it is to take effect (Exhibit 11).

10 As of December 2012, the total volume of BNDES loans was equivalent to 10.7% of GDP and the total volume of all bank loans in the country was equivalent to 53.5% of GDP.

13 March 2014 Exhibit 11: Long-Term Interest Rate (TJLP) and Target for Selic Rate %

13 March 2014

Exhibit 11: Long-Term Interest Rate (TJLP) and Target for Selic Rate

% p.a. 30 25 Selic 20 15 10 TJLP 5 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09
% p.a.
30
25
Selic
20
15
10
TJLP
5
Dec-01
Dec-03
Dec-05
Dec-07
Dec-09
Dec-11
Dec-13

Source: Central Bank of Brazil, Credit Suisse

13 March 2014 5. Inflation Indexes There are several price indexes in Brazil, mainly due

13 March 2014

5. Inflation Indexes

There are several price indexes in Brazil, mainly due to the country’s history of high inflation. We discuss all of these indexes at length in our “Inflation Guide: Inflation indexes in Brazil,” published on June 25, 2009.

The Broad Consumer Price Index (IPCA) is the index most closely followed by market agents, due to its status as the standard price index of the inflation-targeting regime. Another factor that heightened the importance of the IPCA versus other indexes was the growth in government bonds linked to the IPCA (NTN-Bs), compared to growth in the market for government bonds linked to other inflation indexes, such as IGP-M (NTN-Cs).

Despite the greater importance of the IPCA, market agents also follow the other price indexes, in particular the General Price Indexes (IGPs) and the CPI put out by the Institute of Economic Research Foundation (Fipe). These indexes differ in their underlying baskets of goods and services, household target as a function of income brackets, and geographical locations. In the case of the IGPs, producer inflation has higher weight in the index than consumer inflation.

5.1. IBGE Indexes

The Brazilian Statistics Bureau (IBGE) publishes three important inflation indexes each month: IPCA, IPCA-15, and INPC. The indexes follow the same method of calculation but differ in terms of the data collection period and the composition of the basket of products and services.

IPCA

The IPCA reflects prices on a nationwide basis (data collected in nine major metropolitan areas, plus the cities of Goiânia and Brasília), for goods and services used by households with monthly income between 1 and 40 times the monthly minimum wage 11 . The change in the index is calculated on the basis of the weighted arithmetic average of the price groups, and the weighting is variable according to past inflation.

The most frequently analyzed breakdown of the IPCA is between market prices and administered prices. Around 25% of the IPCA is composed of goods and services whose prices are administered directly or indirectly by the government; the remainder is represented by market prices. Recent inflation analyses have also made the distinction between food and other items in the inflation index more relevant.

IPCA-15

The IPCA-15 index is calculated using the same methodology of the IPCA. The difference is the period of the price surveys (sampling period). The IPCA-15 uses the prices collected from the 16th day of the previous month to the 15th day of the current month, while the IPCA is collected from the first through the last day of the month (Exhibit 12). Given that the IPCA-15 is released before the IPCA, it has become a good method for determining the trend of the IPCA.

11 From USD 339 to USD 13,560 as of February 2013.

13 March 2014 Exhibit 12: Period of Data Collection and Publication of IPCA-15 and IPCA

13 March 2014

Exhibit 12: Period of Data Collection and Publication of IPCA-15 and IPCA

Index

IPCA (Broad Consumer Price Index)

IPCA-15 (Broad Consumer Price Index, mid-month)

 
  From the 1st to From the 16th day of the

From the 1st to

  From the 1st to From the 16th day of the

From the 16th day of the

Survey

the 30th day of

month before the reference

period

the reference

month to the 15th day of the

month

reference month

Approximate

Approximate    
 
Approximate    
 

monthly

of the following month

of the reference month

release date

Source: Brazilian Statistics Bureau (IBGE), Credit Suisse

5.2. FGV Indexes

The General Price Indexes (IGPs) are published by the Getúlio Vargas Foundation (FGV). They combine prices surveyed in various production chains, ranging from basic agricultural prices to inputs in the construction sector. The IGPs are made up of three sub- indexes: the Producer Price Index (PPI), the Consumer Price Index (CPI) and the National Construction Cost Index (INCC, Exhibit 13).

Exhibit 13: Composition of General Price Indexes

% of total

CPI Represents the value added by the retail sector and consumer services 30% to gross
CPI
Represents the value
added by the retail sector
and consumer services
30%
to gross domestic
60%
expenditure (GDE)
10%
INCC
Represents the value

added by the construction

industry to GDE

PPI

Represents the value

added by production,

transportation, and

wholesale trade to

GDE

Source: Getúlio Vargas Foundation (FGV), Credit Suisse

The FGV releases three general price indexes during the month: IGP-10, IGP-M, and IGP- DI, which use the same calculation methodology and differ only in their collection period (Exhibit 14).

13 March 2014 Exhibit 14: Survey Periods and Publication of IGPs Index IGP-10 IGP-M IGP-DI

13 March 2014

Exhibit 14: Survey Periods and Publication of IGPs

Index

IGP-10

IGP-M

IGP-DI

Survey

Survey
Survey
Survey

period

From the 11th day of the

From the 21st day of the

From the 1st to the 30 th

month before the reference

month before the reference

day of the reference

month to the 10th day of the

month to the 20th day of

month

reference month

the reference month

Approximate

Approximate
Approximate
Approximate

monthly

release date

of the reference month

of the reference month

of the following month

Source: Getúlio Vargas Foundation (FGV), Credit Suisse

The IGP-M is one of the most widely used indexes, mainly since it is published before the end of the reference month, while the results of most indexes are not reported until the following month. The IGP-M is the only IGP index that collects partial data every ten days, called “previews.” The announcement of the partial results for the 10- and 20-day periods enables analysts to anticipate changes in the overall IGP-M index. The IGP-M previews measure the change in prices in 10- and 20-day periods over a fixed comparison base (Exhibit 15).

Exhibit 15: Calculation of IGP-M and IGP-M Previews

Month 1 Month 2 Month 3 21 30 1 20 21 30 1 10 20
Month 1
Month 2
Month 3
21
30
1
20
21
30
1
10
20
Average B
Average A
Average C
1 st IGP-M proxy in month 3 = Average C / Average B
Average D
2 nd IGP-M proxy in month 3 = Average D / Average B
Month 3 IGP-M = Average A / Average B

Source: Getúlio Vargas Foundation (FGV), Credit Suisse

13 March 2014 6. Brazil’s Public -Sector Debt 6.1. Overview The improvement in solvency indicators

13 March 2014

6. Brazil’s Public-Sector Debt

6.1. Overview

The improvement in solvency indicators and the active role of the Brazilian Treasury have contributed to a significant change in the debt profile and to an increase in the average time to maturity of domestic federal public securities debt (DPMFi), namely:

increase in the shares of fixed-rate securities and inflation-linked securities in total debt;

reduction in the shares of Selic-floaters and USD-linked securities 12 (Exhibit 16).

Exhibit 16: Breakdown of Domestic Federal Debt Securities (DPMFi)

% of total FX 2.7 1.3 0.9 1.1 0.7 0.6 0.6 5.2 10.8 22.3 22.4
% of total
FX
2.7
1.3
0.9
1.1
0.7
0.6
0.6
5.2
10.8
22.3
22.4
Selic
28.6
31.5
33.4
35.5
37.0
37.4
40.0
53.9
59.9
Inflation
63.2
29.6
28.1
26.3
57.0
28.6
22.5
29.3
62.9
56.6
15.5
14.9
43.3
Fixed-rate
13.5
41.2
5.9
37.9
38.3
37.3
36.1
33.7
32.2
27.9
7.0
20.1
12.5
14.8
12.5
7.8
2.2
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

Source: Brazilian Treasury, Credit Suisse

In theory, the new profile would make the public debt less risky by reducing the share that is directly exposed to exchange rate fluctuations and monetary policy cycles. In addition to the change in debt profile, the average time to maturity also rose (Exhibit 17) 13 . Accordingly, the country has also experienced a reduction in the portion of debt maturing in the next 12 months and an increase mainly in the stock of debt maturing within three years (Exhibit 18). From 2011 to 2013, however, the stock of debt maturing within one year increased slightly, while the stock of debt maturing in one to three years declined. This movement is explained by the Treasury’s more aggressive policy of swapping Selic- linked securities for fixed-rate securities, which typically have shorter maturities.

12 The exposure of the DPMFi to the dollar is different from the debt profile due to dollar swap contracts, whereby the central bank receives an amount equivalent to the FX gain/loss (plus a fixed interest rate) and pays the CDI interest rate. 13 The Treasury calculates the average maturity of securities as the weighted average of the tenors of the various flows (intermediate coupons and principal), with the weightings corresponding to the present value of each payment. The average life is calculated as the average of the remaining tenor of the securities, weighted only by the present value of the principal. In other words, the calculation of the average life is less conservative than the calculation of the average maturity.

Exhibit 17: Average Time to Maturity and Duration of DPMFi Months 60 Average time to

Exhibit 17: Average Time to Maturity and Duration of DPMFi

Months 60 Average time to maturity 45 30 Average duration 15 0 Oct-97 Oct-01 Oct-05
Months
60
Average time to maturity
45
30
Average duration
15
0
Oct-97
Oct-01
Oct-05
Oct-09
Oct-13

Source: Central Bank of Brazil, Brazilian Treasury, Credit Suisse

13 March 2014

Exhibit 18: Profile of DPMFi Maturities

BRL trillion and % of total

0.4 0.5 0.6 0.6 0.7 0.8 1.0 1.1 1.2 1.3 1.4 1.6 1.8 1.9 2.0

37

29

37

39

35

37

39

42

 

36

41

36

 

40

   
 

37

41

36

33

44

28
28
30
30
27
27
25
25
25
25
22
22
25
25
26
26

1999 2001

2003

2005 2007

2009 2011

 

2013

More

than 3

years

1 to 3

years

Up to

1 year

Source: Brazilian Treasury, Credit Suisse

Brazil’s external securities debt as a percentage of total securities debt has dropped significantly since 2006, in part owing to the external debt bond buy-back program (initiated in January 2006, Exhibit 19). The Brazilian Treasury no longer uses external debt bond issuances as a source of funding, but rather for operational purposes. According to the Treasury, the main aim of the new external debt issuances is to build a sovereign yield curve in the international market in both USD and BRL, to serve as a benchmark for private-sector issuances.

Exhibit 19: Breakdown of Public Securities Debt

% of GDP

52.2

50.1

   

46.1

46.3

44.9

45.0

45.7

44.2

46.1

46.0

41.7

43.2

42.5

43.0

43.6

42.2

6.1

4.1

4.4

3.1

2.4

2.0

2.1

2.0

2006

2007

2008

2009

2010

2011

2012

2013

DPFMi

DPFe

Source: Brazilian Treasury, Credit Suisse

6.2. Domestic Public Securities

Since 2002, the Brazilian Treasury has been the only entity responsible for issuances of public debt, both domestic and external. In the past, the central bank was responsible for the issuance of external debt and shared the responsibility for domestic debt issuances with the Treasury. Since then, the central bank has been responsible only for repo operations, by managing a stock of securities originally issued by the Treasury. Currently, the Treasury issues fixed-rate bonds with maturities of up to 20 years and inflation-linked securities for up to 40 years (Exhibit 20). In the external market, the Treasury has already issued fixed-rate securities in BRL maturing within 35 years (maturity in 2045).

13 March 2014 Exhibit 20: Features of Domestic Public Debt Securities Security LFT NTN-B LTN

13 March 2014

Exhibit 20: Features of Domestic Public Debt Securities

Security

LFT

NTN-B

LTN

NTN-F

NTN-C**

Index

Selic

IPCA

Fixed-rate

Fixed-rate

IGP-M

Coupon

no coupon

per semester

no coupon

per semester

per semester

Interest (%, p.a.)

-

6

-

10

6

Average time to maturity* (months)

26.6

95

18.6

40.6

84

Outstanding* (BRL bn)

440.5

605.8

547.7

200

66.0

Daily average volume** (BRL mn)

5.1

4.2

15.6

2.5

-

Still issued?

*As of August 2013. ** NTN-C 010131: interest of 12% p.a

**In 2013, YTD through August

Source: Central Bank of Brazil, Brazilian Treasury, Credit Suisse

Almost all of Treasury’s primary issuances are made via public auctions. At the end of each month, the Treasury publishes a timetable with the dates of the auctions for the following month as well as the total maturities and the maximum volume of securities that will be offered. Banks, brokerage firms, and other institutions registered in the Selic system can take part in the auctions, which are executed in the Central Bank Information System (SISBACEN, Appendix A). Settlement is on the day after the effective date of the operation (T+1).

The terms of the auctions depend on the type of securities offered. IPCA-Linked National Treasury Bills (NTN-Bs) and Selic Floater Treasury Bills (LFTs) are sold through a uniform-price auction, with a single sale price (or cutoff price). The other securities are sold in multiple-price auctions 14 (also known as discriminatory auctions), with payment based on the offered bid. Settlement takes place on the following business day and can be made in cash or in other securities, according to the features of the securities being traded. The Treasury follows a relatively stable timetable of primary issuances, with regular auctions on Tuesdays, Wednesdays, and Thursdays, depending on the type of security offered 15 (Exhibit 21). These regular auctions always take place from 12:00 noon to 1:00 p.m. (local time).

Exhibit 21: Features of Auctions of Public Securities*

as of December 2013

Security

NTN-B

LFT

LTN

NTN-F

Frequency

2 weeks

 

4 weeks

1 week

2 weeks

Auction type

 

Uniform

Uniform

Discriminatory

Discriminatory

(single-price)

(multiple-price)

(multiple-price)

2 steps?

Weekday

Tuesday (1 st step, sale)

Wednesday (2 nd step, exchange)

Thursday

Thursday

Thursday

Settlement

Cash

Securities

Cash/Securities

Cash

Cash

* As of December 2013

Source: Brazilian Treasury, Credit Suisse

14 In the discriminatory auction, each buyer offers his bid, which may or may not be accepted by the

15

Treasury. Thus, in this case, the sale prices may be different among the various buyers.

In accordance with the 2013 Annual Financing Plan (PAF 2013), the Treasury will concentrate issuances mainly in fixed-rate securities (LTNs and NTN-Fs) and IPCA inflation-linked securities (NTN-Bs).

13 March 2014 In addition to the auctions described above, the Treasury also holds other

13 March 2014

In addition to the auctions described above, the Treasury also holds other kinds of auctions aiming to spread out maturities, lengthen tenors, change compositions, and stimulate secondary market liquidity. In exchange auctions, for example, the Treasury receives only other public securities as payment for the issuance, and in buyback auctions the Treasury repurchases previously issued securities. These auctions take place at a lower frequency (Exhibit 22) than the regular ones and have lower liquidity, sometimes ending with no deal.

Exhibit 22: Frequency of Exchange and Buyback Auctions*

Security

Exchange

Early redemption

LTN

Quarterly

-

NTN-F

Variable

Monthly

LFT

Quarterly

-

NTN-B

Monthly

Monthly

* As of December 2013

Source: Brazilian Treasury, Credit Suisse

On the following pages, we present a description of the main public securities issued and traded in the local market.

LTN (Fixed-Rate, Zero-Coupon)

Issuer: Brazilian Treasury

Adjustment of nominal value: Not adjusted

Index: Fixed-rate

Redemption of principal: At maturity

Nominal value on reference date: BRL 1,000.00

Number of days in year: 252 business days

Interest rate: 0% (sold at discount)

Time to maturity: Liquidity date (inclusive) until maturity date (exclusive)

Interest: No payment of interest

Negotiation: Yield-to-maturity (YTM)

Average Time to Maturity (Months) 20 19.6 15.2 15 10 7.0 5
Average Time to Maturity (Months)
20
19.6
15.2
15
10
7.0
5

Monthly Average of Issuances (BRL bn)

 

18.2

17.8

 

14.8

   

16.2

11.6

11.3

   
6.3

6.3

6.3
 
 

2008

2010

2011

2012

2013

Dec-07 Dec-09 Dec-11 Dec-13 2007 2009 Liquidity / Daily Average (BRL mn) 0.1 0.1 1.2
Dec-07
Dec-09
Dec-11
Dec-13
2007
2009
Liquidity / Daily Average (BRL mn)
0.1
0.1
1.2
2 to 3 years
1.3
0.3
0.4
1.8
1 to 2 years
1.3
6.6
0.1
0.6
1.1
1.1
4.8
2.3
1.1
1.6
1.0
0.6
0.1
3.0
Up to 1 year
2.9
0.8
1.6
1.4
1.1
1.2
1.0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Pricing
Unit Price from Yield
Yield from Unit Price
YTM: Yield-to-maturity (252 business days)
252
NV: Nominal value (BRL 1,000.00)
NV
bd
NV
UP =
bd
UP: Unit price (market price for 1 security)
YTM =
-1
) 252
(
1+ YTM
UP
bd: Business days between settlement date (inclusive) and maturity date (exclusive).

Source: Brazilian Treasury, Credit Suisse

13 March 2014 LFT (Selic-Floater Bond) Issuer: Brazilian Treasury Adjustment of nominal value: Adjusted by

13 March 2014

LFT (Selic-Floater Bond)

Issuer: Brazilian Treasury

Adjustment of nominal value: Adjusted by the Selic factor

Index: Linked to Selic basic interest rate

Redemption of principal: At maturity

Nominal value on Reference date: BRL 1,000.00

Number of days in year: 252 business days

Interest rate: 0% (sold at discount)

Time to maturity: Liquidity date (inclusive) until maturity date (exclusive)

Interest: No payment of interest

Negotiation: Yield-to-maturity (YTM)

Maturity/Outstanding Volume (BRL bn)

112.2

113.0

     

84.0

 

34.3

 

11.8

11.8
112.2 1 1 3 . 0       84.0   34.3   11.8 2014 2015

2014

2015

2016

2017

2018

*As of December 2013

Liquidity / Daily Average (BRL mn)

Up to 1 year

Up to 1 year

Up to 1 year

1 to 2 years

more than 2 years

more than 2 years

 
666 1034
666
1034
 
402 294 388 348 443 450
402
294
388
348
443
450

130

264

529 217
529
217
518 155
518
155
367 186
367
186

840

171 380 370 158 195 174
171
380
370
158
195
174

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Nov-13

Average Time to Maturity (Months) 35 34.2 30 28.9 25 21.8 20 Dec-07 Dec-09 Dec-11
Average Time to Maturity (Months)
35
34.2
30
28.9
25
21.8
20
Dec-07
Dec-09
Dec-11
Dec-13

Issuances, Monthly Average (BRL bn)

7.1
6.8

Dec-11 Dec-13 Issuances, Monthly Average (BRL bn) 7.1 6.8 7.4 7.2 6.8 4.4 1.0 2007 2008

7.4

Dec-13 Issuances, Monthly Average (BRL bn) 7.1 6.8 7.4 7.2 6.8 4.4 1.0 2007 2008 2009

7.2

Dec-13 Issuances, Monthly Average (BRL bn) 7.1 6.8 7.4 7.2 6.8 4.4 1.0 2007 2008 2009

6.8

Issuances, Monthly Average (BRL bn) 7.1 6.8 7.4 7.2 6.8 4.4 1.0 2007 2008 2009 2010
Issuances, Monthly Average (BRL bn) 7.1 6.8 7.4 7.2 6.8 4.4 1.0 2007 2008 2009 2010

4.4

Monthly Average (BRL bn) 7.1 6.8 7.4 7.2 6.8 4.4 1.0 2007 2008 2009 2010 2011

1.0

Monthly Average (BRL bn) 7.1 6.8 7.4 7.2 6.8 4.4 1.0 2007 2008 2009 2010 2011

2007

2008

2009

2010

2011

2012

2013

Pricing

 
       

252

       

=

UNV

 

UNV

bd

UNV

=

NV ΔSELIC

Quote =

UP

UP

(

1

+ YTM

bd

) 252

YTM

=

UP

-

1

Δ SELIC is the BZSELCA

Index on Bloomberg

UNV

UNV: Adjusted nominal value (by the Selic rate factor)

 

NV: Nominal value on reference date (BRL 1,000.00)

 

YTM: Yield-to-maturity (annualized for 252 business days)

 

UP: Unit price (market price for 1 bond)

 

ΔSELIC: Cumulative daily Selic rate factor from

 

bd: Business days between settlement date (inclusive) and maturity date (exclusive).

Reference date (inclusive) to settlement date (exclusive)

 

Quote: Price as a percentage of Adjusted Nominal Value

 

Source: Brazilian Treasury, Credit Suisse

13 March 2014 NTN-B (IPCA inflation-linked bond) Issuer: Brazilian Treasury Adjustment of nominal value: Not

13 March 2014

NTN-B (IPCA inflation-linked bond)

Issuer: Brazilian Treasury

Adjustment of nominal value: Not adjusted

Index: Fixed-rate

Redemption of principal: At maturity

Nominal value on reference date: BRL 1,000.00

Number of days in year: 252 business days

Interest rate: 6% p.a.

Time to maturity: Liquidity date (inclusive) until maturity date (exclusive)

Interest: 29.56301410 per semester

Negotiation: Yield-to-maturity (YTM)

Maturity/Outstanding Volume (BRL bn)

77.6

82.6

86.4

       

60.9

50.6

 
 
 

2014

2015

2016

2017

2018

Average Time to Maturity (Months)

100

90

80

70

60

50

95.0 91.9
95.0
91.9
57.0
57.0
Dec-07 Dec-09 Dec-11 Dec-13 *As of December 2013 Liquidity / Daily Average (BRL mn) Issuances,
Dec-07
Dec-09
Dec-11
Dec-13
*As of December 2013
Liquidity / Daily Average (BRL mn)
Issuances, Monthly Average (BRL bn)
6.2
Up to 2 years
2 to 4 years
More than 4 years
5.6
4.7
4.8
4109
3.9
2.4
2.0
449
678
457
535
250
272
1121
1293
488
730
626
681
3406
2006
2007
2008
2009
2010
2011
2012
2013
2007
2008
2009
2010
2011
2012
2013
Pricing
1
n
Coupon
UNV
UP
IPCA 2
2
bd
bd n
i
UP =
+
Coupon =
-1 UNV
Quote =
(
1+ 6%
)
UNV = NV 
 PR
252
IPCA 1
UNV
i=1
(1 + YTM)
(1 + YTM) 252
Coupon : Interest paid every semester
YTM: Yield-to-maturity (annualized for 252 business days)
UNV: Adjusted nominal value (by the IPCA rate factor)
NV: Nominal value on reference date (BRL 1,000.00)
IPCA 2 : IPCA index number for the previous month
UP: Unit price (market price for 1 bond)
IPCA 1 : IPCA index number for the month prior to reference date
bd: Business days between settlement date (inclusive) and maturity
date (exclusive).
PR: Prorated adjustment of IPCA inflation forecast (% mom)
Quote: Price as a percentage of Adjusted Nominal Value

Source: Brazilian Treasury, Credit Suisse

13 March 2014 NTN-F (Fixed-Rate Bond) Issuer: Brazilian Treasury Adjustment of nominal value: Not adjusted

13 March 2014

NTN-F (Fixed-Rate Bond)

Issuer: Brazilian Treasury

Adjustment of nominal value: Not adjusted

Index: Fixed-rate

Redemption of principal: At maturity

Nominal value on reference date: BRL 1,000.00

Number of days in year: 252 business days

Interest rate: 10% p.a.

Time to maturity: Liquidity date (inclusive) until maturity date (exclusive)

Interest: 48.808848 per semester

Negotiation: Yield-to-maturity (YTM)

Average Time to Maturity (months)

46

40

34

28

22

42.8 39.4
42.8 39.4
42.8 39.4
42.8
39.4
42.8 39.4
42.8 39.4
42.8 39.4 22.8

22.8

Dec-07

Dec-09

Dec-11

Dec-13

Issuances, Monthly Average (BRL bn)

6.6

Dec-11 Dec-13 Issuances, Monthly Average (BRL bn) 6.6 4.5 3.5 3.3 2.3 1.9 2.2 2007 2008

4.5

Dec-11 Dec-13 Issuances, Monthly Average (BRL bn) 6.6 4.5 3.5 3.3 2.3 1.9 2.2 2007 2008

3.5

Dec-13 Issuances, Monthly Average (BRL bn) 6.6 4.5 3.5 3.3 2.3 1.9 2.2 2007 2008 2009

3.3

Dec-13 Issuances, Monthly Average (BRL bn) 6.6 4.5 3.5 3.3 2.3 1.9 2.2 2007 2008 2009

2.3

Issuances, Monthly Average (BRL bn) 6.6 4.5 3.5 3.3 2.3 1.9 2.2 2007 2008 2009 2010

1.9

2.2

Monthly Average (BRL bn) 6.6 4.5 3.5 3.3 2.3 1.9 2.2 2007 2008 2009 2010 2011
Monthly Average (BRL bn) 6.6 4.5 3.5 3.3 2.3 1.9 2.2 2007 2008 2009 2010 2011

2007

2008

2009

2010

2011

2012

2013

Liquidity / Daily Average (BRL mn)

1

Up to 1 year 1 to 2 years 2 to 3 years    

Up to 1 year

Up to 1 year 1 to 2 years 2 to 3 years    

1 to 2 years

Up to 1 year 1 to 2 years 2 to 3 years    

2 to 3 years

   
 

175

150 203 534
150
203
534

42

1778

 
26 208
26
208

408

513 23
513
23
143 296
143
296
 
 

123

12

428

   

31

 

132

 

2007

2008

 

2009

2010

2011

2012

2013

Pricing

 
 

Unit Price from Yield

 

Yield from Unit Price

n

Coupon NV bd i bd n + ( ) 252 ( ) 252 1+YTM 1+YTM
Coupon
NV
bd i
bd n
+
(
) 252
(
) 252
1+YTM
1+YTM

1

 

UP=

Coupon =

( 1+10% ) 2

- 1

NV

i=1

 

Coupon: Interest paid every semester

UP: Unit price (market price for 1 bond)

YTM: Yield-to-maturity (annualized for 252 business days)

bd: Business days between settlement date (inclusive) and maturity date (exclusive)

NV: Nominal value (BRL 1,000.00)

 

Source: Brazilian Treasury, Credit Suisse

13 March 2014 6.3. Secondary Market Despite the sizable stock of domestic debt, the liquidity

13 March 2014

6.3. Secondary Market

Despite the sizable stock of domestic debt, the liquidity of the secondary market is low. From 2009 to 2013, there was an increase in total liquidity, reversing the downward trend observed from 2004 to 2008 (Exhibit 23). The recent increase was due to the growth in trading of fixed-rate securities (NTN-Fs and LTNs) and IPCA-linked bonds (NTN-Bs).

Exhibit 23: Daily Average Trading Volume in Secondary Market

Per bond and total, BRL billion

20.2 Others LTN LFT 7.2 NTN-F NTN-C NTN-B 3.2 9.3 8.2 7.7 7.6 2.0 7.5
20.2
Others
LTN
LFT
7.2
NTN-F
NTN-C
NTN-B
3.2
9.3
8.2
7.7
7.6
2.0
7.5
6.3
3.9
5.9
5.7
3.4
3.0
4.7
4.1
0.7
6.7
6.2
4.4
3.7
3.1
0.8
0.8
1.1
7.7
1.2
2.5
1.6
1.7
0.6
0.6
1.0
0.6
3.5
2.5
1.9
2.0
1.1
1.2
0.9
1.0
1.0
1.2
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

Source: Central Bank of Brazil, Credit Suisse

The increase in volume was concentrated in securities with longer maturities. Part was driven by Provisional Decree 281 16 , published in February 2006, which exempted non- resident investors from paying income tax on the purchase of public securities. The measure affected mainly securities with longer maturities, especially above two years (Exhibit 24). The government made investments in fixed income securities by non- residents subject to the Tax on Financial Transactions (IOF) in October 2009 and increased the rate in 2010, but on a temporary basis; in early 2013, the tax rate on fixed- income portfolio inflows was once again reduced to zero.

Exhibit 24: Average Daily Trading Volume and Share of Securities Maturing in More Than Two Years in Secondary Market

Per linker, USD million Other 58.6 59.3 58.1 Fixed-rate 11.8 Inflation-linked 50.0 Selic 4.0 %
Per linker, USD million
Other
58.6
59.3
58.1
Fixed-rate
11.8
Inflation-linked
50.0
Selic
4.0
% of total
38.2
33.0
29.1
5.5
24.7
6.4
4.3
2.0
21.0
3.9
2.1
2.2
2.3
8.5
3.2
1.5
1.5 1.7
1.0
1.8
0.9 5.8
1.1
0.7
0.5
0.7
1.1
1.0
0.8 0.5
1.4
0.5
0.5
0.4
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

Source: Credit Suisse, Central Bank of Brazil

16 Converted into Law No. 11312 in June 2006.

13 March 2014 As an alternative to the daily average, another measure of liquidity in

13 March 2014

As an alternative to the daily average, another measure of liquidity in the secondary market is turnover, defined as the ratio between the total value traded in the past 12 months and the current debt stock. According to this criteria, there was also a sharp increase in the liquidity of NTN-Fs until 2010, which has reverted in recent years. Meanwhile, the liquidity of LTNs dropped significantly as the relative importance of these securities has been surpassed by the higher issuances of NTN-Fs (fixed-rate securities with longer maturities) and other securities, such as NTN-Bs. The turnover of NTN-Bs, in particular, has recovered since 2010, after a decrease between 2006 and 2008 (Exhibit 25).

Exhibit 25: Turnover of Public Debt Securities (Excluding Central Bank Portfolio)

% of outstanding volume 2006 2008 2010 2012 2013 318 299 284 269 238 212
% of outstanding volume
2006
2008
2010
2012
2013
318
299
284
269
238
212
205
178
166
155
147
125
116
90
79
79
42
39
35
33
18
14
7
3
4
NTN-B
LFT
NTN-F
NTN-C
LTN

Source: Credit Suisse, Central Bank of Brazil

13 March 2014 7. Private-Sector Securities The market of private fixed-income bonds has grown at

13 March 2014

7. Private-Sector Securities

The market of private fixed-income bonds has grown at a very strong pace in recent years, benefiting not only from the country’s macroeconomic stability but also from changes in the legislation that have enabled the development of new credit methods.

The private sector issues many types of securities in the domestic market, especially:

Certificates of Deposit (CDBs) and Non-Transferable Certificate of Deposit (RDBs), private securities debt (debentures/corporate bonds), Banking Credit Notes (CCBs), Certificates of Real Estate Receivables (CRIs), and Receivables-Backed Investment Funds (FIDC). The most significant are CDBs/RDBs and corporate bonds (Exhibit 26), even though the stock of the other securitiesespecially CCBs, CRIs (Exhibit 27), and FIDCshas been growing substantially in recent years.

Exhibit 26: Stock of CDB/RDBs and Corporate Bonds

Exhibit 27: Stock of CCBs and CRIs

BRL bn BRL bn Corporate bonds CCB CDB+RDB CRI 43 152 44 126 85 283
BRL bn
BRL bn
Corporate bonds
CCB
CDB+RDB
CRI
43
152
44
126
85
283
155
329
210
362
248
684
283
768
338
782
397
683
505
598
585
546
0.7
0.6
1.7
0.9
2.9
2.1
6.7
2.2
12.9
2.9
20.5
7.2
18.4
10.6
18.2
18.9
22.5
27.8
24.7
33.4
26.7
45.4

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Cetip, Brazilian Association of Financial Market Institutions (Andima), Credit Suisse

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Cetip, Credit Suisse

7.1. CDBs and RDBs

Certificates of Deposit (CDBs) and Non-Transferable Certificates of Deposit (RDBs) are private securities issued by financial institutions (commercial, development, investment, and full-service banks) with the aim of raising funds in the market for financing commercial credit operations, with negotiated rates and maturities. CDBs represent the vast majority of these two securities in the market (99%), especially since RDBs are not transferable, i.e., they cannot be traded in the secondary market, whereas CDBs do not have this restriction. This is the main reason why there is a low stock of RDBs vis-à-vis CDBs (Exhibits 28 and 29).

Exhibit 28: Stock of CDBs Exhibit 29: Stock of RDBs 13 March 2014 BRL bn

Exhibit 28: Stock of CDBs

Exhibit 29: Stock of RDBs

13 March 2014

BRL bn BRL bn 782 2.5 767 682 683 2.1 2.0 598 546 1.7 360
BRL bn
BRL bn
782
2.5
767
682
683
2.1
2.0
598
546
1.7
360
326
281
0.9
0.8
0.8
0.7
0.7
152
0.4
126
0.3

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Cetip, Credit Suisse

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Cetip, Credit Suisse

CDBs, like RDBs, may be fixed-rate or linked to an index (95% of the total in December 2013), while fixed-rate securities represent only 5% of the total (Exhibit 30). The composition of the stock of these securities has remained roughly constant in recent years. The CDB rate is calculated based on a year of 252 business days, as are the CDI and Selic rates.

Exhibit 30: Stock of CDBs and RDBs, by Index

BRL bn

Fixed-rate  770 7 8 2

 

770

782

Floating rate  684 29 19 684

 

684

29

19

684

 

30

19

599

15

547

 

362

654

739

763

665

26

 

329

 

584

 

283

21 308
21
308

22

521

21 262
21
262

340

 

152

143
143

9

127

8

119
119

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: Cetip, Credit Suisse

Trading in CDBs is done mainly on the over-the-counter (OTC) market and registered with the Cetip clearinghouse, with settlement on the same day (D+0) or on the next day (D+1). The liquidity of the secondary market of CDBs is very low (Exhibit 31), and the average volume of daily trades as a percentage of the total outstanding volume dropped from 52% in 2004 to 8.2% in 2010, increased to 16.1% in 2012, and declined again to 7.9% in 2013.

13 March 2014 Exhibit 31: Daily Trading Volume of CDBs in Secondary Market BRL mn

13 March 2014

Exhibit 31: Daily Trading Volume of CDBs in Secondary Market

BRL mn and % of total outstanding volume

668 Daily average (BRL mn) 52.0 Total value of trading as % of stock 384
668
Daily average (BRL mn)
52.0
Total value of trading
as % of stock
384
28.2
343
260
25.0
279
24.9
262
259
257
19.8
19.1
19.3
280
16.1
170
169
11.2
9.6
8.2
7.9
61
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

Source: Cetip, Credit Suisse

7.2. Corporate Bonds

Corporate debt bonds (locally referred to as debentures) are generally issued by large companies whose aim is to raise longer-term funds to finance projects and/or adjustments in their capital structure. These bonds can be issued only by companies formed as publicly or privately held joint stock corporations. However, only publicly traded companies can make issuances for general investors (public issuances), while unlisted companies can only issue securities to a restricted group of investors (private issuances).

Corporate bonds may pay periodic coupons, at fixed or floating rates or even linked to FX or inflation indexes (especially the IGP-M). In general, corporate bonds pay a risk premium in the form of a fixed spread or a percentage over the CDI interest rate, which reflects companies’ risk classification. Debenture contracts include special clauses that define types of guarantee, possibilities of repricing debts 17 , convertibility into shares, early redemption, etc. The bonds may be issued without a fixed period for the redemption of the principal amount (perpetual bonds).

The stock of corporate debt bonds in the domestic market has augmented significantly since 2005, but the composition of this expansion has changed greatly. In early 2009, the Brazilian Securities Commission (CVM) implemented rules for a new type of public offering of private securities such as non-convertible corporate bonds, commercial paper, and CCBs. These offerings are referred to as restricted efforts distributions (per CVM Directive 476 (“ICVM 476)), involve less paperwork, and can be made only to qualified investors. Issuances under this regulation do not need to be registered with the CVM until the end of the distribution process. Accordingly, the offering process has become much faster and should explain the significant rise in these distributions’ share of total bond issuances (Exhibit 32). There are also a few restrictions on this kind of offering. For instance, the number of investors the issuer can approach for the bookbuilding process is limited to 50, only 20 of those can participate in the offering, and the securities can only be traded 90 days after the initial purchase.

17 Repricing is a mechanism used by the issuing companies to periodically alter (in accordance with the clauses negotiated in the issuance) the terms agreed upon with the holders, to adjust the bonds to market conditions. If investors do not accept the new conditions proposed by the company, the company will have to acquire the bonds in advance.

Exhibit 32: Issuances of Corporate Bonds 13 March 2014 BRL bn Pubic offerings Restricted efforts

Exhibit 32: Issuances of Corporate Bonds

13 March 2014

BRL bn

Pubic offerings Restricted efforts distribution 72 80 69 36 59 50 48 42 40 5
Pubic offerings
Restricted efforts distribution
72
80
69
36
59
50
48
42
40
5
15
15
16
10
3
11
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

Source: Brazilian Association of Financial Market Institutions (Andima), Credit Suisse

Regarding the classification of bonds, the bulk available in the market is formed of book- entry bonds, linked to the DI interest rate and not convertible into shares of the issuing company, with a guarantee subordinated to the other creditors of the company (Exhibit 33).

Exhibit 33: Main Classifications and Features of Corporate Bonds

Form

% of total

Book-entry

Custody and book-entry processes carried out by a financial

institution duly authorized to operate by CVM

99.6

Registered

Registration and control of transfers made by issuing company

0.4

Convertibility

Non-convertible

Not exchangeable for other assets

99.9

Convertible

Exchangeable for shares of issuing company to settle the debt

0.0

Guarantee

Junior

No priority over other creditors of the company;

priority only for shareholders

54.8

Unsecured debt

No priority in disposal of company assets in the event of composition

with creditors

38.0

Collateral

Secured by assets of issuing company or third parties (pledge, lien,

or receivables)

5.9

 

Priority of bondholders to dispose of assets of issuing company in the event

Floating-rate

of bankruptcy; company may transfer assets without prior authorization of

1.3

creditors