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Brazilian Sovereign Fixed Income and Foreign

Exchange Markets

Handbook – First Edition

July 14, 2017

Please refer to page 20 of this report for important disclosures, analyst certifications and additional information. Itaú BBA does and seeks to do business with Companies covered in this research report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the sole factor in making their investment decision.

Itaú Corretora de Valores S.A. is the securities arm of Itaú Unibanco Group. Itaú BBA is a registered mark used by Itaú Corretora de Valores S.A.

Brazilian Sovereign Fixed Income and Foreign Exchange Markets


Brazilian Sovereign Fixed Income and Foreign Exchange Markets


July 17, 2017

Handbook (First Edition) – July 17, 2017

This is the first edition of the Itaú Unibanco Brazilian Sovereign Fixed Income and Foreign Exchange

Markets. In this report, we describe the federal debt and exchange rate markets in detail, providing a

reference guide for investors interested in understanding Brazilian markets’ idiosyncrasies. This edition

uses information available up to June 2017.

Contents

1. Basics

1.1. Interest rate compounding

1.2. Calendars

1.3. Major interest rate fixings

1.4. Major inflation indexes

2. Foreign exchange market

2.1. Overview

2.2. Spot FX market

2.3. US Dollar futures (DOL)

2.4. US Dollar forward points (FRP)

2.5. The Casado

2.6. USD onshore interest rates (Cupom Cambial)

2.7. FRA de Cupom (FRC)

3. Domestic federal debt market

3.1. Market at a glance

3.2. Overview

3.3. Products

3.4. Market structure

3.4.1. Primary market

3.4.2. Secondary market

3.5. Market participants

3.6. Countries and dependencies with favored taxation

3.7. Taxation

4. Regulatory requirements for investing in domestic markets

5. External federal debt market

5.1. Market at a glance

5.2. External strategy


6. Onshore interest-rate derivatives

Appendix A – Methodology for calculation of PTAX fixing

Appendix B – Computation of the Updated Nominal Value

Appendix C – Annual Financing Plan (PAF) across the years

Appendix D – References


1. Basics

1.1 Interest rate compounding

Contracts denominated in BRL whose underlying is an interest rate usually apply the 252 day count basis with

geometric compounding, as shown below:

𝑖𝑒 = (1 + 𝑖𝑎)𝑏𝑑

252 − 1

𝑏𝑑 = business days

𝑖𝑎 = quoted annual rate

𝑖𝑒 = effective rate in the period

The benchmark BRL interest rate term structure uses geometric compounding.

In contrast, the benchmark onshore USD interest rate curve (the Cupom Cambial) employs both arithmetic and

geometric discounting (see discussion in section 2.7).

1.2 Calendars

There are two basic calendars used for business days computation:

The schedule for the two benchmark floating interest rates (Selic and CDI) and the exchange rate fixing

(PTAX) takes into account only national holidays.

o We’ll refer to it as the “CDI calendar”.

Exchange traded contracts follow a different cash settlement and trading-day schedule.

o The major derivatives clearing house in Brazil, BM&F, is located in São Paulo state, being closed on

regional holidays.

o We’ll refer to this schedule as “BM&F calendar”.

The table below reports a list of Brazilian national and regional holidays, as disclosed by the clearings and the central

bank. The dates marked by an asterisk are subject to yearly variation.


There is a third calendar employed for FX-related trades. The settlement date on spot BRL/USD

transactions is determined in a CDI calendar combined with US national holidays.

o Typically, standard OTC contracts define a business day in this calendar by requiring that New York, São

Paulo city and Rio de Janeiro city all have regular bank activities.

Since the FX swaps offered by the central bank are registered at the BM&F, the rollover pace computations

in any given month must take into account the regional holidays presented in the table above.

1.3 Major interest rate fixings

Since 1999, Brazil implements an inflation targeting regime, substituting the previous FX crawling-peg

system.

The inflation target is set by the National Monetary Council (CMN).

The CMN is headed by the Finance Minister, and also includes the Central Bank Governor and the Minister of

Planning.

The pertinent inflation index for monetary policy is the IPCA (published by IBGE - the official statistics bureau).

The target is defined over the year-end headline CPI.

The main objective of the Brazilian Central Bank (BCB) is price stability.

Its most important monetary policy instrument is the reference Selic rate, set by the Monetary Policy Committee

(aka. Copom).

The BCB Governor and eight directors vote in the Copom meetings. The board gathers eight times per year

(roughly 45 days apart).

The BCB governor has Minister status and has no predefined mandate.

Date Holiday BM&F CETIP CDI PTAX

1-Jan New Year's Day N N N N

25-Jan São Paulo's Foundation N Y Y Y

27-Feb * Shrove Monday N N N N

28-Feb * Shrove Tuesday N N N N

1-Mar * Ash Wednesday (1/2 day) Y Y Y Y

14-Apr * Good Friday N N N N

21-Apr Tiradentes' Day N N N N

1-May Labour Day N N N N

15-Jun * Corpus Christi N N N N

9-Jul Constitutionalist Revolution N Y Y Y

7-Sep Independence Day N N N N

12-Oct Our Lady of Aparecida N N N N

2-Nov All Souls' Day N N N N

15-Nov Republic Day N N N N

20-Nov Black Awareness Day N Y Y Y

24-Dec Christmas Eve N Y Y Y

25-Dec Christmas Day N N N N

29-Dec * Last Business Day of Year N Y Y Y

* Valid dates for 2017.

Source: BM&F, CETIP, Itaú


Selic

The Selic overnight rate is the volume-weighted average rate of one-day repurchase agreements collateralized by

federal securities. Daily financing is considered on transactions with federal securities in the Special System for

Settlement and Custody (SELIC) custody system. Its target is set by the Central Bank at the Monetary Policy

Committee (Copom) meetings. Historically, the effective Selic rate is lower than the target set by the BCB, with an

average (since 2013) spread of 10bps. If for some reason BCB is not able to publish the Selic fixing on a particular

national business day, the previous available fixing will be repeated.

Bloomberg tickers:

Target Selic rate: BZSTSETA Index

Effective Selic rate: BZSELICA Index

CDI

The CDI rate is the average rate of one-day transactions backed by fixed-rate debt instruments issued by banks.

These instruments are known as Certificates of Interbank Deposit (CDIs) and are registered and liquidated at the

Cetip system. The majority of them are due in one business day (aka. DI-Over) and the transactions made

between two different financial conglomerates are used by Cetip to compute the CDI fixing rate.

Since Oct/07/2013, the CDI interest rate is no longer calculated as a trimmed average; rather, all operations that

take place on a given day enter the calculation, each weighted by its corresponding financial volume.

Bloomberg ticker:

Interbank fixing: BZDIOVRA Index

TJLP/TJP

Aiming at stimulating long-term investments in Brazil, the provisional measure number 684 created the Long-Term

Interest Rate (TJLP) on October 31, 1994. The TJLP has since been used as a benchmark rate for credit lines

from the Brazilian Development Bank (BNDES).

In March 2017, the National Monetary Council announced a new rate called TLP (Long-Term Rate) to replace the

TJLP. According to the provisional measure creating the TLP (PM 777 of April 26, 2017), the new framework will

gradually phase out the subsidy embedded in the old TJLP. However, by the publication date of the Handbook, the

provisional measure was pending final approval by the Congress.

The new TLP will change on a monthly basis (instead of the quarterly frequency for the old TJLP) and will combine

the variation of prices (IPCA) with a fixed interest rate based on the real yield of NTN-B bonds (5-year maturity).

The “fixed rate” of each credit operation will be the effective rate on the date of the contract hiring and will be

applied evenly for the entire financing period. To the “fixed rate” mentioned, it will be applied a reduction factor that

will linearly converge to one (1), in annual adjustments, during five years starting January 1, 2018. The first

reduction factor will be defined in a way that the fixed interest rate, summed with inflation expectations for the

subsequent next 12 months in the date the fixed rate was defined, results the same value as the effective TJLP in

January 1, 2018.

The current TJLP will be determined by the CMN until the outstanding TJLP-linked credit is fully redeemed. After

that, the TLP will be the sole BNDES benchmark interest rate.


Bloomberg ticker:

TJLP: BZTJLP Index

Example:

Assuming the following is true on January, 2018:

IPCA coupon 5-year yield (NTN-B): 5.0% p.a.

Expected IPCA 12 months forward (Focus): 4.0%

TJLP: 7.0% p.a.

Also, let α be the reduction factor valid for 2018. Based on the current text of the PM 777/2017, we would have the

following formula:

𝑇𝐿𝑃 = α (𝑁𝑇𝑁_𝐵5𝑌) + (𝐼𝑃𝐶𝐴𝐹𝑜𝑐𝑢𝑠) = 𝑇𝐽𝐿𝑃 = 7.0%

α (5.0%) + (4.0%) = 7.0%

Thus, under those assumptions, the reduction factor (α) for 2018 would be 0.6.

In this example, loans granted in January 2018 would have a fixed real interest rate of 3.0% - the assumed 5-year

real rate (5.0%) times the reduction factor derived above (0.6) – plus the IPCA, for the entire maturity of the loan.

From February 2018 onwards, the TLP would be 0.6 times the NTN-B yield prevailing at the market for each month

of the year, plus inflation. The reduction factor would go to 0.68 for new loans granted in 2019 and to 0.76 for 2020

loans, until it reaches 1.0 for operations contracted as of 2023.

1.4 Major inflation indexes

The Brazilian statistical bureau puts out the Broad Consumer Price Index (IPCA) and the mid-month inflation index

(IPCA-15). The former is closely monitored by the market, due to its status as the standard price index of the

inflation-targeting regime and the fact that linkers (NTN-Bs) are indexed to it.

The IPCA-15 index is calculated using the same methodology of the IPCA, but the sampling period is different (see

comparative table below). Markets use the mid-month index as a leading indicator for the IPCA. Other noteworthy

indexes are those published by the Getúlio Vargas Foundation (FGV).

Bloomberg tickers:

IPCA YoY: BZPIIPCY Index

IPCA-15 (preview) YoY: BZPIIPYO Index


Inflation targeting

At the inception of the Brazilian inflation-targeting regime (decree No 3,088/1999), the CMN had until the June 30th

of each year to set the target for the calendar-year two years hence.

On June 2017 the framework was changed in order to expand the inflation target setting horizon (decree

No 9,083/2017).

Starting on 2017, the CMN will set the IPCA target three years in advance (as opposed to two years).

According to the BCB, this new system improves the potency of monetary policy to anchor long-term

inflation expectations. In a note published on the central bank’s website, the central bank argues the expanded

horizon permits a greater disentangling of the CPI target decision from the current stage of the monetary cycle

when such goal is chosen.

The inflation targets already defined are:

o 2018: 4.50%

o 2019: 4.25%

o 2020: 4.00%

For each year, the tolerance limits remain +/- 1.5%.

Agency IndexComponent

indices

Income bracket

(in minimum

wages)

Coverage

area

Survey

periodRelease date Since

IPCA-15

9 metropolitan

regions + Brasília

and Goiânia

Middle of the

previous month -

middle of this

month

By the 25th of

the reference

month

2000

IPCA

INPC 1 to 5

IGP-10

11th of the previous

month - 10th of this

month

By the 20th of

the reference

month

1993

IGP-M

21st of the previous

month - 20th of this

month *

By the 30th of

the reference

month **

1989

IGP-DI Calendar month

By the 10th of

the following

month

1944

* 1st preview: 21st to 30th; 2nd preview: 21st to 10th

** 1st preview: by the 10th; 2nd preview: by the 20th

Source: BCB, Itaú

1979

FGV

IPA (60%)

IPC (30%)

INCC (10%)

1 to 33 for the IPC

(the remaining

components are not

consumer price

indices)

7 biggest

metropolitan

regions

NoneIBGE

1 to 40

10 metropolitan

regions + Brasília,

Goiânia and

Campo Grande

Calendar month

By the 15th of

the following

month


2. Foreign exchange market

2.1 Overview

In Brazil, spot US Dollar is traded in a Decentralized Multiple-Dealer Market. The Central Bank of Brazil (BCB)

executes the FX policy established by the National Monetary Council. Financial institutions can participate in the

market only with the central bank’s authorization.

Since January 1999, the BRL has traded under an administered floating exchange rate regime1.

The BCB’s mandate permits it to discretionarily intervene in the FX market and manage international

reserves.

The interventions aim to cover a lack of foreign currency liquidity and ensure the properly functioning of local

markets.

In order to cover external debt obligations, the National Treasury purchases USD in the market via the state-

owned Banco do Brasil.

Since April 2012, the Central bank has refrained from buying or selling US dollars directly in the spot market,

thus preserving the sizable amount of international reserves (USD 370 billion).

o Instead, it has employed USD swaps (NDFs settled onshore in BRL) to curb exchange rate volatility.

o Additionally, BCB can offer FX repo contracts (dubbed “USD credit line”) in order to provide liquidity.

The currency is fully deliverable onshore.

The FX market in Brazil opens from 9:00 AM to 18:00 AM, Brasilia time.

The quoting convention is BRL per US dollar (1 pip = 0.0001 BRL).

All FX trades must be registered in the Central Bank Information System (SISBACEN) and booked against a

financial institution authorized to deal FX by the BCB.

Spot currency can be traded over the counter or on the BM&F clearing house, but liquidity is higher in the

former.

Onshore BRL-settled NDFs are typically fixed one day prior to settlement based on the PTAX offer rate.

The PTAX rate, published daily by the BCB, is the fixing rate for the USD-linked instruments – bonds and

derivatives – settled onshore and offshore.

The Department of International Reserves Operations (Depin) is responsible for surveying spot (T+2)

exchange rate quotes with authorized FX dealers each working day2.

Offshore BRL trades are all non-deliverable.

Liquidity is concentrated in non-deliverable forwards (NDFs).

1 See Garcia M., Medeiros M. & Santos F. (2015) for an in-depth investigation of price discovery in Brazilian FX markets.

2 The current methodology for the calculation of the PTAX rate is reported in Appendix A.


2.2 Spot FX market

Banks and financial entities must receive an authorization from BCB in order to operate in the spot exchange rate

market.

All trades must be registered with the Central Bank (not necessarily at the moment they take place).

Mutual funds do not have authorization to trade spot foreign currency.

The bulk of liquidity is concentrated in the OTC market, either by phone via a broker or via the Casado trade (see

the discussion below).

On a typical business day, spot trading can take place from 9:00 through 16:30 Brasília time.

The standard operation is settled in T + 2, with business day counting as described in section 1.2.

Real-time tracking of USDBRL spot quotes is unavailable outside of BM&F (which is a small part of the FX

market).

For this reason, some investors monitor the difference between the DOL and the Casado (see discussion

below) rather than the published quotes of the spot.

2.3 US Dollar Futures (DOL)

The DOL is the BM&F contract code for the USDBRL future contracts. The code for a specific maturity is completed

by adding 3 characters specifying the month and the year3.

Example: DOLF17 = Contract for the USDBRL future due in the first business day in the month of January (character

“F”) of the year 2017.

Contract details, quoting conventions

The fixing for the contract is the PTAX FX rate published by the Central bank, one business day (CDI calendar)

prior to its maturity date (the first business day of the corresponding month).

The contract size is USD 50,000 and it is quoted as BRL per 1,000 US dollars (three decimal digits).

The margin accounts of the counterparties are adjusted daily in cash, according to the BM&F margin cash flow

values.

On the last business day of the week and on the day preceding a holiday, trading at BM&F ends at 16:00 Sao

Paulo time for US dollar futures, options, volatility and structured transactions.

Liquidity considerations

As a rule of thumb, liquidity is usually concentrated in the nearest maturity.

Around mid-month, the liquidity of the second nearest maturity (traded via the Structured US Dollar Rollover

– DR1) increases as market participants start to roll their positions.

3 The digit for the January contracts is “F”, for the February maturities “G” and March is represented by the letter “H”. The

remaining codes are: April (J), May (K), June (M), July (N), September (U), October (V), November (X) and December (Z).


The DR1 transaction is quoted as the forward points differential between the longer-dated DOL and the

nearest maturity (in BRL/1,000 USD units).

The bulk of demand for the DR1 contract come from participants who want to roll their outstanding positions,

but any two DOL maturities can be traded.

o The code for the DR1 includes six characters: three for identifying the maturity of first DOL contract and

three other characters for the second contract.

o For instance, a long position on the DR1G17H17 is converted by BM&F into a short position on the

February future (DOLG17) and a long position of equal size on the March contract (DOLH17).

At the FX fixing date, liquidity moves to the second nearest maturity. For instance, the contract with the

largest liquidity at January 31 2017, which is the fixing day for the DOL maturing in February (DOLG17), was

the DOLH17 (i.e. the March 2017 contract).

Importantly, according to BM&F rules, there is no price oscillation limit for the nearest DOL contract in the last

three trading sessions prior to its expiration date.

Since the settlement takes place at the prevailing PTAX rate, the DOL is free to “pursue” the spot FX rate on

the last three sessions of the month (see section 2.4).

Mark-to-market and margin cash flow

The margin cash flow for one future contract outstanding at the end of date 𝑡 is given by:

𝐴𝐷𝑡 = (𝑃𝐴𝑡 − 𝑃𝐴𝑡−1) × 𝑀

𝐴𝐷𝑡 = the daily settlement value, computed in BRL currency. The actual payment occurs on 𝑡 + 1, the next

business day in a BMF calendar

𝑃𝐴𝑡 = the closing price on day 𝑡 for the corresponding maturity

𝑃𝐴𝑡−1 = the trading price for positions initiated on 𝑡 or the closing price on day 𝑡 − 1 for positions entered prior to 𝑡

𝑀 = a multiplicative constant established by BM&F – currently, set to 50

On the expiration date, open positions are cash-settled by:

𝑉𝐿 = 𝑇𝐷𝑡−1 × 50,000

𝑉𝐿 = the cash-settlement value per contract, computed in BRL currency. Settlement takes place on the same day

as the expiration date.

𝑇𝐷𝑡−1 = the offered PTAX exchange rate as recorded on the last business day of the month prior to the expiration

month

Obs: given that the closing price is quoted in BRL/1,000 USD units and the multiplier is equal to 50, the notional of

each contract currently corresponds to USD 50,000.

2.4 US Dollar forward points (FRP)

The forward-points strategy allows market agents to hedge the PTAX-spot FX risk at BM&F. It was created by the

exchange precisely to overcome the FX fixing risk at the end of the month.

The structure is converted by BM&F into a DOL position at the PTAX exchange rate (times 1,000) plus a traded

forward point value (likewise quoted in BRL/1,000 USD).


There are two strategies available, depending on the chosen PTAX rate.

The FRP0 determines the FX future DOL contract price using the trading day PTAX:

𝑇𝑃𝑡𝑇 = 𝑃𝑇𝐴𝑋𝑡 × 1,000 + 𝐹𝑅𝑃0𝑅𝑎𝑡𝑒

𝑇𝑃𝑡𝑇 = the DOL contract traded price done at day 𝑡 for maturity date 𝑇

𝑃𝑇𝐴𝑋𝑡 = the PTAX rate published by BCB at trading date 𝑡

𝐹𝑅𝑃0𝑅𝑎𝑡𝑒 = the traded quote (BRL/1,000 USD)

The FRP1 strategy is converted into a DOL position in the next business day (BM&F calendar) at the

𝑃𝑇𝐴𝑋𝑡+1 plus the negotiated forward points:

𝑇𝑃𝑡+1𝑇 = 𝑃𝑇𝐴𝑋𝑡+1 × 1,000 + 𝐹𝑅𝑃1𝑅𝑎𝑡𝑒

𝑇𝑃𝑡𝑇 = the DOL contract traded price for maturity date 𝑇, computed at 𝑡 + 1

𝑃𝑇𝐴𝑋𝑡 = the PTAX published by BCB one business day after trade date.

𝐹𝑅𝑃1𝑅𝑎𝑡𝑒 = the traded quote (BRL/1,000 USD)

2.5 The Casado

The Casado strategy allows investors to trade the forward points between the FX spot rate and the most liquid DOL

contract.

One counterparty sells a DOL contract and buys spot USD and the other assumes the reverse position in both

the derivate and the spot legs.

The spot leg will usually settle at the BM&F FX clearing.

The Casado’s price will be relatively unchanged over the course of the session, whereas the FRP will vary until

the publication of the day’s PTAX.

Typically, market makers hedge FX flows firstly with the DOL and manage the mismatch risk through by trading

the Casado.

2.6 USD onshore interest rates (Cupom Cambial)

Since Brazil's restrictive FX regulations prohibit deposits in foreign currencies, the market turned to derivatives in

order to bypass this regulatory constraint. The USD onshore term structure is known as the Cupom Cambial curve

(or only the Cupom).

Dollar DI futures (DDI)

The calibration of the Cupom curve uses forward rate agreements in the Dollar DI futures (DDI).

Contract details and quoting conventions

Each contract is currently worth USD 50,000 at maturity – thus matching the notional of US Dollar futures.

The market convention is to quote DDI contracts in rate perspective.


Liquidity for individually traded contracts is very low; they’re usually traded as one short and one long position in

a FRA.

Mark-to-market and margin cash flow

In contrast to DI1 futures, the traded price is found by linear discounting as follows:

𝑇𝑃𝑡𝑇 =

100,000

(1 + 𝑅𝑡,𝑇𝐶 × 𝐶𝐷𝑡,𝑇)

𝑇𝑃𝑡𝑇 = the traded price

𝑅𝑡,𝑇𝐶 = the quoted DDI (linear) rate, expressed in actual days

𝐶𝐷𝑡,𝑇 = day count fraction in Actual/360 between trading date 𝑡 and maturity 𝑇

Since inside Brazil all bank accounts can only carry BRL, the margin cash flow computation must convert the

difference between closing and opening USD interest rates to the Brazilian currency.

Somewhat counter intuitively, the contract specifies the PTAX FX rate fixed on the previous business day to

make this conversion.

When the contract was first designed by the exchange, the PTAX rate was only available after closing of the spot

FX market. In order to avoid delays in end-of-day marking-to-market, BM&F refrained to use the same day

PTAX.

For positions entered at 𝑡, the margin cash flow is given by:

𝑀𝐶𝐹𝑡𝑇 = (𝐶𝑃𝑡

𝑇 − 𝑇𝑃𝑡𝑇) × 𝑃𝑇𝐴𝑋𝑡−1 × 𝑀

For outstanding positions, the previous settlement price is adjusted by a correction factor as follows:

𝑀𝐶𝐹𝑡𝑇 = (𝐶𝑃𝑡

𝑇 − (𝐶𝑃𝑡−1𝑇 × 𝐹𝐶𝑡)) × 𝑃𝑇𝐴𝑋𝑡−1 × 𝑀

where:

𝑀𝐶𝐹𝑡𝑇 = margin cash flow

𝐶𝑃𝑡𝑇 = closing price on trading day 𝑡 (transformed from rate to unitary price)

𝑃𝑇𝐴𝑋𝑡−1 = the PTAX FX rate set on the previous business day (CDI calendar)

𝑀 = points per contract multiplier; BM&F currently defines it as 0.5 for DDI contracts

𝑇𝑃𝑡𝑇 = trading price

𝐹𝐶𝑡 = correction factor given below:

𝐹𝐶𝑡 = ∏ (1 +

𝐷𝐼𝑡−𝑗

100)𝑚

𝑗=1

1/252

(𝑃𝑇𝐴𝑋𝑡−1

𝐶𝐷𝐼

𝑃𝑇𝐴𝑋𝑡−2∗ )


where:

𝑚 = is the number of CDI capitalization factors from 𝑡 − 1 (BM&F calendar) inclusive to 𝑡 exclusive; the product

notation above encompasses situations in which there are more than one CDI fixing published between

consecutive trading sessions (eg. when the BM&F closes for a regional holiday).

𝑃𝑇𝐴𝑋𝑡−1𝐶𝐷𝐼 = the PTAX published on the previous business day on a CDI calendar

𝑃𝑇𝐴𝑋𝑡−2∗ = the PTAX found by firstly moving backwards one business day in a BM&F calendar and then moving

backwards one business day in a CDI calendar

The definition of 𝑃𝑇𝐴𝑋𝑡−2∗ above matches the procedure used by the exchange to compute the correction factor

when there is a holiday in the BM&F calendar.

On regular business days (i.e., without adjacent holidays), we have 𝑃𝑇𝐴𝑋𝑡−1𝐶𝐷𝐼 = 𝑃𝑇𝐴𝑋𝑡−1 and 𝑃𝑇𝐴𝑋𝑡−2

∗ =

𝑃𝑇𝐴𝑋𝑡−2.

2.7 FRA de Cupom (FRC)

The market does not usually trade a single DDI future contract, but rather they’re quoted as forward rate agreements.

To avoid the distortion caused by the change of the previous day-PTAX to the trading day, the BM&F created

another future contract called FRA de Cupom.

Contract details and quoting conventions

The contracts are identified with the FRC code, followed by the digit codes that represent the month and year of

the contract.

With FRC, agents can trade the USD onshore forward rate from the next available DDI contract (aka the basis

month) to a desired maturity 𝑇2.

However, on the previous (BM&F calendar) business day to the last fixing day for the nearest DOL contract, the

basis month of the FRC becomes the second-available DDI maturity.

For instance, on mid-January 2017, the first available DOL was the February contract (DOLG17), whose

expiration date was on February 1, 2017.

Hence, the last FX fixing used in the DOLG17 contract was the PTAX rate as of January 31, 2017 (one

business day prior to expiration - BM&F calendar).

Until January 30, the basis month is the February (DDIG17); at this date, the basis month switches to the

March DDI contract (DDIH17).

Conversion to DDI positions

A long FRC for a given maturity 𝑇2 position will be converted by the exchange into a long position in the DDI due

in 𝑇2 and a short position in the basis month DDI.

The number of contracts for the long-dated leg is equal to the number of FRC contracts traded.

Given a position in 𝑞2 FRC contracts, traded at the 𝐶𝑓𝑟𝑐 FRC rate (“clean” Cupom), the preliminary number of

contracts 𝑞1̅ for the short-dated leg is:


𝑞1̅ =𝑞2

1 + (𝐶𝑓𝑟𝑐 ×(𝑛2 − 𝑛1)

36000)

𝑛2 = actual days from trading day to 𝑇2

𝑛1 = actual days from trading day to basis month maturity

𝑞1̅ = the preliminary quantity of short-dated contracts; the final quantity 𝑞1 is the integer closest

to 𝑞1̅

The short-dated leg is entered at the adjustment price prevailing on the day the operation is made. Thus, the

basis month contract will have a zero cash flow at the trading date.

The price for the long-dated DDI is given by:

𝐶2𝐷𝐷𝐼 = {[1 + 𝐶1

𝐷𝐷𝐼 ×𝑛1

36,000] × [1 + 𝐶𝑓𝑟𝑐 ×

𝑛2 − 𝑛1

36,000] − 1} ×

36,000

𝑛2

𝐶2𝐷𝐷𝐼 = price of the long-dated DDI contract (linear annualized rate)

𝐶1𝐷𝐷𝐼 = price of the short-dated leg

Short DDI payer

Long DDI receiver

Forward receiver

Diagram of a FRC receiver position

T1 T2t

Source: Itaú


3. Domestic federal debt market

3.1 Market at a glance

3.2 Overview

The Brazilian domestic federal public debt (henceforth DFPD) market is one of the largest in the EM space. As of

April 2017, the total amount outstanding of federal bonds in the domestic market is BRL 3,123 billion. All instruments

are BRL-denominated, and typically cleared at T + 1 (although other options are available). Linkers and floaters are

currently issued by the Treasury, whereas issuance of USD-linked bonds (NTN-D) was discontinued in 2002.

The bulk of public debt is domestic. As of April 2017, the share of the domestic debt is 96.26%.

The average duration of the federal debt is 6.3 years. For comparison with other sovereigns, the Treasury also

calculates the Average Term to Maturity of the public debt, currently at 4.6 years.

The Treasury has pursued a strategy of reducing the share of floaters on total debt, increasing that of fixed-rate

and IPCA-linked instruments.

LFT LTN NTN-F NTN-B NTN-C

Type Floater Fixed Rate Fixed Rate Linker Linker

Index Selic - - IPCA IGP-M

Amortization Bullet bond Bullet bond Bullet bond Bullet bond Bullet bond

Coupon

Interest - - 10% p.a. 6% p.a. 6% p.a.

Frequency - - Per semester Per semester Per semester

Short and Medium term

5 and 10 years

(Aug/2022, Aug/2026)

Long Term

20 and 40 years

(May/2035, May/2055)

Auction day Thursdays Thursdays Thursdays Tuesdays Off the run

Type of auction Dutch Yankee Yankee Dutch -

Amount Outstanding

(BRL billion)981 779 348 889 85

% of domestic debt 31.3% 24.9% 11.1% 28.4% 2.7%

Average Maturity (years) 3.6 1.5 4.1 7.9 5.2

Source: National Treasury (05/2017), Itaú

Local Instruments

Benchmarks

(on the run)

6 years

(Mar/2023, Sep/2023)

Short and Medium term

6, 12, 24 and 48 months

Long Term

6 and 10 years

(Jan/2023, Jan/2027)

-


3.3 Products

Pricing of federal bonds

The general expression for the unitary price (𝑃𝑈) of a bond is given by:

𝑃𝑈 =(𝑄𝑢𝑜𝑡𝑒 × 𝑉𝑁𝐴)

100

where

𝑄𝑢𝑜𝑡𝑒 = the present value of the bond’s cash flow

𝑉𝑁𝐴 = the updated nominal value. It is used to correct each bond’s cash flow by the corresponding index. The

𝑉𝑁𝐴 was set at BRL 1,000 on the corresponding base date4.

Fixed-rate

The fixed-rate instruments currently being issued by the national Treasury are the LTNs (short-term discounted bills)

and the NTN-Fs (longer-dated notes). Both instruments are redeemed only at maturity, having a par value of BRL

1,000. The LTN is a zero coupon instrument, whereas NTN-Fs pay fixed semiannual interest.

National Treasury Bill (LTN)

Face value: BRL 1,000.00

Tenors: 6-, 12-, 24- and 36-month maturities

Coupon: zero

Day count: business days/252

Amortization: bullet

Issuance frequency: weekly (Thu.)

4 For the NTN-B bonds, the base date is July/15/2000; for the LFTs it is July/01/2000.

15%

6.3

4.5

0%

5%

10%

15%

20%

25%

30%

35%

40%

0

1

2

3

4

5

6

7

8

9

Dec-07 Dec-09 Dec-11 Dec-13 Dec-15 May-17

Federal public debt maturity structure

Source: National Treasury, Itaú

Average term to maturityAverage maturity (duration)% maturing in 12 months (rhs)

Years

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Ma

y-0

4

Ma

y-0

5

Ma

y-0

6

Ma

y-0

7

Ma

y-0

8

Ma

y-0

9

Ma

y-1

0

Ma

y-1

1

Ma

y-1

2

Ma

y-1

3

Ma

y-1

4

Ma

y-1

5

Ma

y-1

6

Ma

y-1

7

Public debt composition


Exchange rate

Floating rate

Inflation linked

Fixed rate


Settlement: T + 1

Index: none

Pricing:

𝑄𝑢𝑜𝑡𝑒 =100

(1 + 𝑦𝑖𝑒𝑙𝑑)𝑏𝑑

252

National Treasury Note – Series F (NTN-F)

Face value: BRL 1,000.00

Tenors: 3-, 5- and 10-year maturities

Coupon: 10% pa, semiannual



Issuance frequency: typically every two weeks

Settlement: T + 1

Index: none

Pricing:

𝑐 = (1 + 10%)12 − 1

𝑄𝑢𝑜𝑡𝑒 = ∑ [100 × 𝑐

(1 + 𝑦𝑖𝑒𝑙𝑑)𝑏𝑑𝑡252

]𝑇

𝑡=1+

1

(1 + 𝑦𝑖𝑒𝑙𝑑)𝑏𝑑𝑇252

Inflation-linked

In late 2005, the National Treasury stepped up the IPCA-linked bonds issuance. Currently, the Treasury only issues

NTN-B bonds and the outstanding amount of IGP-M linkers is very low. In addition, it holds regularly NTN-B buyback

auctions in order to improve liquidity.

National Treasury Note – Series B (NTN-B)

Face value: BRL adjusted by inflation

Tenors: 3-, 5-, 10-, 20-, 30- and 40-year maturities

Coupon: 6% pa, semiannual



Issuance frequency: typically twice a month

Settlement: T + 1

Index: IPCA5

5 For details of the pro-rata IPCA accrual, refer to Appendix B.


Pricing:

𝑐 = (1 + 6%)12 − 1

𝑄𝑢𝑜𝑡𝑒 =100 × 𝑐

(1 + 𝑦𝑖𝑒𝑙𝑑)𝑏𝑑1252

+100 × 𝑐

(1 + 𝑦𝑖𝑒𝑙𝑑)𝑏𝑑2252

+ ⋯ +1

(1 + 𝑦𝑖𝑒𝑙𝑑)𝑏𝑑𝑇252

National Treasury Note – Series C (NTN-C)

Face value: BRL adjusted by inflation

Tenors: Apr-2021 and Jan-2031

Coupon: 2031: 12% pa; 2021: 6% pa (semiannual)



Issuance frequency: Bond no longer issued

Settlement: T + 1

Index: IGP-M

Floating-rate

The LFT bonds are indexed to the benchmark monetary policy rate. They’re typically traded with a premium over the

Selic, but sometimes can be quoted with a discount.

Letras Financeiras do Tesouro (LFT)

Face value: BRL, floats with

Tenors: up to 10 years

Coupon: zero



Issuance frequency: no longer issued

Settlement: T + 1

Index: Selic rate

Pricing:

𝑄𝑢𝑜𝑡𝑒 =100

(1 + 𝑦𝑖𝑒𝑙𝑑)𝑏𝑑

252

The table below reports the conventions for accurate pricing of Brazilian federal bonds.


Clearing and settlement

Settlement of transactions occurs on the trade date (T+0 or T+1).

Government bonds and notes are cleared and settled through the Selic System on a delivery-versus-payment

basis (DVP) against the same-day bank reserves (secondary market) or on the trade date plus one business day

(primary market).

Both types of settlement are electronic (or fully dematerialized).

All federal debt assets are identified through ISIN codes.

3.4 Market structure

3.4.1 Primary market

Since May 2002, in accordance with the Fiscal Responsibility Law, the National Treasury (STN) is the

sole issuer of federal government bonds.

Bond issuances are executed through BCB Ofpub (Oferta Pública – public offering in Portuguese) system,

but the decision process is managed within the Treasury.

The yearly Annual Borrowing Plan (PAF - in Portuguese), published by the STN, sets out the federal

financing strategy for the corresponding year.

o Based on this plan, the Treasury calibrates the monthly issuance of public debt, taking into account the

behavior of Brazilian markets observed so far.

o The expected results for the public debt indicators provided in the for the 2017 plan are given in the table

below6.

The Monthly Federal Public Debt Report reports the federal balance sheet on a monthly basis.

o It contains statistical indicators and comments about the previous month’s domestic debt auctions and

external debt operations.

6 Appendix C reports a timeline of the Annual Financing Plans’ expected results.

Variable Criteria LTN LFT NTN-B NTN-C NTN-F

Coupon (semester) Round - - 6 6 5

Inflation forecast Round - - 2 2 -

Accumulated Selic rate Round - 16 - 10 -

Flow of discounted payments Round - - 10 14 9

Accrual fraction Truncate - - 14 14 -

Accumulated price index Truncate - - 16 16 -

YTM (% p.a.) Truncate 4 4 4 4 4

UNV Truncate - 6 6 6 -

Price Truncate 6 6 6 6 6

Day exponential (bd/252) Truncate 14 14 14 14 14

Quotation (%) Truncate - 4 4 4 -

Financial value Truncate 2 2 2 2 2Source: National Treasury, Itaú

Conventions for pricing federal bonds (decimal places)


The Monthly Auction Calendar is presented on the last working day of the previous month.

o It describes the general characteristics of domestic debt auctions, such as the date and type of auction

(issuance, exchange or buyback), and establishes the maximum amount to be issued during the month.

Before each auction, a specific Administrative Order is released, providing information about the objective

and dates of the issuance, amount to be offered by bond, and maturity, among others.

The details of the auctions (e.g. the maturities offered) are released at the beginning of the reference

month. The size of the offering is announced only on the day of the auction.

The general characteristics of federal bonds currently being issued via competitive auctions were laid out in

the decree No 3,540 (July 2000).

The objective of fixed-rate bonds is to obtain funds and build an efficient domestic yield curve, through the

creation of benchmark maturities.

o LTNs create 6-, 12- and 24-motnh benchmarks;

o while NTN-Fs are used to construct the back end of the curve (3-, 5- and 10-year).

o Short LTNs (6- and 12-month) and longer-dated NTN-Fs (5- and 10-year) are issued on alternate weeks,

in order to stimulate the secondary market.

o Fixed-rate bonds mature on the first day of January, April, July and October in order to match the

maturity of DI futures negotiated at BM&F.

Likewise, linkers are issue with the double aims of funding the federal government and developing the real

yield curve.

o The IPCA-linked bonds (NTN-Bs) started to be issued in 2003, in substitution to the NTN-Cs (bonds

linked to the IGP-M index).

o The benchmark maturities are the 3-, 5-, 10-, 20-, 30- and 40-year.

o Inflation-linked instruments are offered on a lower frequency than fixed-rate ones (every two weeks).

Minimum Maximum

Stock (BRL billion)

FPD 3,112.9 3,450 3,650

Composition (%)

Fixed Rate 35.7 32 36

Inflation Linked 31.8 29 33

Floating Rate 28.2 29 33

Exchange Rate 4.2 3 7

Maturity Structure

% Maturing in 12 months 16.8 16 19

% of Amortization in 12 months 13.4 - -

Average Maturity (years) 4.5 4.2 4.4

Average Life (years) * 6.4 - -* Considers only cash flow from the remaining term of the principal redemption


2017 Guidelines

Federal Public Debt Expected Results

2016Indicators


o Linkers always mature on the 15th of May (bonds whose maturity year is an odd number) or August

(even-numbered years).

Floating-rate bonds (LFTs) are indexed to the overnight rate.

o There is no specific policy for floaters, as the Treasury focus on developing the abovementioned

markets.

o In 2017, the sole benchmark is the 6-year term, with the on-the-run maturities Mar-2023 and Sep-2023.

o Floaters mature on the 7th of March, June, September or December.

Primary issuance of debt is made via a dealer system.

Dealers are institutions accredited by the Treasury and the BCB to assist in the development of primary and

secondary bond markets.

o Primary dealers handle primary-market operations;

o Specialist dealers act on the secondary market.

There are a total of 15 accredited institutions, four of which operate only on the primary market, six only on

the secondary and five on both.

Financial institutions (banks, brokers, etc) registered in the SELIC system are eligible to participate in the

public auctions.

Institutions are evaluated at every 6-month period, according to their operations in BCB repo auctions and

the Treasury’s bond offerings.

Each dealer can place up to five bids per instrument.

The settlement of trades is done through the SELIC system, operated by the BCB. Clearance takes place on

the subsequent business day (T+1).

The auctions can be on a cash basis or on a bond exchange basis;

in the latter, the Treasury accepts public bonds in exchange for the ones being auctioned.

LTN and NTN-F auctions occur every week, on Thursdays.

NTN-Bs are offered every other Tuesday (two days before the 15th day and by the end of the month).

Apart from primary auctions, the Treasury also holds buyback auctions on a regular basis.

Buyback/Exchange auctions take place on Wednesdays.

Extraordinary buyback and/or traditional auctions to support local markets can also be called during periods

of stress.

o STN detaches a liquidity cushion equivalent to 3 months of federal debt service in its deposits with BCB.

o The total size of the Treasury’s account adds up to BRL 1 trillion (16% of GDP), and at the limit this

volume of reserves could be used to cover the Public Sector Borrowing Requirement in case of

prolonged market stress.

There are two main types of public bond auctions: (1) multiple-price auctions (Yankee auction) and (2)

single-price auctions (Dutch auction).

The auctions of fixed-rate instruments (LTN and NTN-F) are multiple-priced (i.e., each participant pays the

price she proposed)


o Dealers’ bids are sorted in decreasing order of price (or increasing order of rate);

o The cut-off price is established at the amount where demand equals supply (set at the Administrative

Order issued prior to each auction).

o Primary buyers base their bids on the basis (i.e. the spread between the bond’s yield and the

corresponding DI future rate).

Linkers (NTN-B) and floaters (LFT) are offered through a uniform-price mechanism.

o In these auctions, bonds with different maturities are offered simultaneously;

o The Treasury receives the buyers’ bids and then decides the cut-off price and the amount of each bond

to be sold.

o For linkers, dealers base their bids on yield to maturity.

In the day of the auction, bids are received from 11:00 AM through 11:30 AM (Brasilia time).

The results of the auction are disclosed on the same day, after noon.

3.4.2 Secondary market

Contrary to other EM markets, the convention is to trade bonds in yield (except for the LFTs) and to quote prices

of coupon-paying bonds without removing accrued interest (i.e. the “dirty price”).

Trading activity takes place mostly in the OTC market, but investors can also trade through the platform operated

by the BM&F (SISBEX).

The transactions are registered at the SELIC system.

The Brazilian Financial and Capital Markets Association (Anbima) surveys banks, financial brokers and resource

managers acting in the secondary market in order to find “fair” bond prices.

Anbima publishes daily indicative yield/price data for federal bonds7. It also tracks the domestic corporate bond

market.

In April 2017, the average daily turnover of local debt (LFT, LTN, NTN-B and NTN-F) was roughly BRL 27.5

billion.

Anbima maintains the IMA family of indexes, used by local funds as a performance benchmark.

Each index represents the evolution, at market prices, of a public bond portfolio. The general IMA index

corresponds to weighted average daily rate of return of three sub-indexes:

IMA-B: tracks the performance of NTN-B bonds;

IRF-M: tracks the performance of short fixed rate bonds (LTN and NTN-F);

IMA-S: tracks the performance of floating-rate bonds (LFT).

7 Latest data is available at Anbima’s Compare system.

http://www4.anbima.associados.rtm/templateanbima/curvas/compare.asp


3.5 Market participants

Participation of foreigner investors in the domestic market increased after the IOF tax rate was set to zero in

20138.

Non-residents’ participation in the domestic market declined from the historical highs reached in 2015 and is

currently around 13.6%

Financial institutions and mutual funds concentrate a major part of the liquidity in Brazilian money market. They

are the largest private holders of Selic-indexed debt. The T + 0 liquidity provided by many funds and the daily

announcement of funds’ quotes are one of the reasons these players allocate a substantial share of their

portfolios to LFTs.

In contrast, Pension funds tend to hold long-duration bonds, particularly linkers. They’re typically buy-and-hold

investors, who desire to match their liabilities with the bonds’ features.

A substantial share of foreigner ownership is composed of long-duration fixed rate bonds (NTN-Fs)

8 For details, we refer to section 3.6 (taxation).

0%

5%

10%

15%

20%

25%

Ma

y-0

7

Ma

y-0

8

Ma

y-0

9

Ma

y-1

0

Ma

y-1

1

Ma

y-1

2

Ma

y-1

3

Ma

y-1

4

Ma

y-1

5

Ma

y-1

6

Ma

y-1

7

Non-residents share of public debt


Non-residents (%)

IOF

: 0.0

%

IOF

: 6

.0%

IOF

: 2

.0%

IOF

: 0

.0%

IOF

: 1

.5%


3.6 Countries and dependencies with favored taxation

The article 24 of Law No 9.430/96 defines “favored taxation” as countries or jurisdictions in which there is no

income tax or the income tax is less than 20%. Investors from countries that are not considered tax havens by

the Finance Ministry are entitled to tax benefits.

The current list was updated by Normative Instruction 1,658/2016, which amended instruction 1037/2010.

The tables below report the updated “Black list” and the “Gray list”, respectively.

15%22%

9%

48%61%

31%

48%

14%

87%23%

39%

30%

35%

62%

3%

23%

0%

29%

2% 2% 1%7%

0%

10%

0%

20%

40%

60%

80%

100%

120%

Fin

ancia

lin

stitu

tio

ns

Mu

tua

lfu

nds

No

nre

sid

ents

Pensio

nfu

nds

Govt.

Insu

rance

Domestic debt holdings breakdown


Inflation linkedFixed rate

Floating rateOthers

0%

20%

40%

60%

80%

100%

120%

140%

2007 2009 2011 2013 2015 2017

Holders of domestic federal debt


Financial institutions Pension funds Government Others

Mutual funds Non-residentsInsurance

American Samoa Saint Kitts and Nevis Oman

Andorra French Polynesia Panama

Anguilla Gibraltar Pitcairn Islands

Antigua and Barbuda Granada Qeshm Island

Aruba Hong Kong Saint Helena Island

Ascension Island Ireland Saint Lucia

Bahamas Isle of Man Saint Martin

Bahrain Kiribati Saint Pierre and Miquelon

Barbados Labuan Saint Vincent and the Grenadines

Belize Lebanon San Marino

Bermudas Liberia Seychelles

British Virgin Islands Liechtenstein Singapore

Brunei Macau Solomon Islands

Campione D'Italia Madeira Swaziland

Cayman Islands Maldives Tonga

Channel Islands* Marshall Islands Tristan da Cunha

Cook Islands Mauritius Turks and Caicos Islands

Costa Rica Monaco United Arab Emirates

Curaçao Montserrat Islands United States Virgin Islands

Cyprus Nauru Vanuatu

Djibouti Niue Western Samoa

Dominica Norfolk Island* Jersey, Guernsey, Alderney and Sark

Source: Brazilian Finance Ministry, Itaú

Tax havens according to Brazilian law (Black list)

Countries and dependencies


3.7 Taxation

The fiscal treatment of non-resident investors comprises an income tax (according to the origin of the funds) and a

tax over financial operations (IOF).

Income Tax (IR)

Since 2006, yields originated from government bonds are subject to a 0% income tax for investor’s from

countries that are not classified as a tax haven by Brazilian authorities. Non-resident exclusive investment

funds shares with a minimum of 98% in government bonds are also exempt.

However, government bonds subject to a resale agreement (“operações compromissadas”) are not exempt

from income tax.

Investors from countries/regions with favored taxation (i.e. where there is not an income tax rate of 20% or

more) are subject to a withholding tax on yields according to the period of the investment (see the table

below).

Country Legal entities constituted as...

Austria a holding company that don't engage in substantive economic activities

Denmark a holding company that don't engage in substantive economic activities

Iceland an International Trading Company (ITC)

Malta an International Trading Company (ITC) and as an International Holding Company (IHC)

Netherlands a holding company that don't engage in substantive economic activities

Spain Entidad de Tenencia de Valores Extranjeros (ETVEs)

Switzerland holding, domiciliary, auxiliary, mixed, administrative companies*

Uruguay Sociedades Financeiras de Inversión (Safis) (2010)

USA a state Limited Liability Companies whose participation is composed of non-residents*** For other corporate forms included in the list refer to Normative Ruling nº 1.474/2014

** Only those not subject to federal income tax

Source: Brazilian Finance Ministry, Itaú

Privileged tax regimes (Grey list)

Investment types Period

Withholding Tax on Yields Days

Government Bonds

Private Bonds

Fixed Income Funds - Long Term*

Swaps

Structured Notes (COE)

≤ 180

181 - 360

361 - 720

> 720

22.5%

20.0%

17.5%

15.0%

Fixed Income Funds - Short Term*≤ 180

> 180

22.5%

20.0%

Stock Investment Funds, FIP, FIC-FIP and FIEE - 15%

Capital Gains (in stock exchanges and OTC market)

Stock or Stock Indexes

Other Derivatives

Day Trade

* In May and November, withholding income tax of 15% is levied as advance tax due upon redemption (aka. come-cotas )

Source: Anbima, Itaú

15%

15%

20%

Income Tax

Rates

Rates


Tax on Financial Operations (IOF): There are currently two different IOF tax charges on fixed income investors.

IOF on inflows of foreign resources to financial applications: since 2013 there is a 0% tax at the FX

settlement when the money enters the country to be invested in the Brazilian financial and capital markets.

Note that the IOF tax rate can be changed by the Executive Branch, from 0% to a ceiling of 25%.

Short-term IOF: Investments are subject to an IOF levy on redemptions, transfers or renegotiations that

occurs within 30 days of the acquisition of federal bonds by foreign investors. The tax rate is decreasing in

relation to the period as shown in the table.

Days Rate Days Rate

1 96% 16 46%

2 93% 17 43%

3 90% 18 40%

4 86% 19 36%

5 83% 20 33%

6 80% 21 30%

7 76% 22 26%

8 73% 23 26%

9 70% 24 20%

10 66% 25 16%

11 63% 26 13%

12 60% 27 10%

13 56% 28 6%

14 53% 29 3%

15 50% 30 0%Source: Brazilian Finance Ministry, Itaú

Short term IOF

redemptions within 1-month time


4. Regulatory requirements for investing in domestic markets

Representatives in Brazil

According to Brazilian legislation, non-resident investors must hire a representative in the country and a tax

representative:

The National Monetary Council established that before beginning activities, non-resident must:

Appoint a legal representative in the country;

Complete the form attached to Resolution 2,689; and

Register with the CVM (Brazilian SEC).

In addition, they are supposed to name their tax representative (usually the legal representative mentioned

above) and sign a bond and securities custody providing services agreement with an institution duly authorized

by the CVM.

The custodian bank provides investors through the secondary market of public debt, registering and settling

transactions (Delivery versus payment) on their behalf.

Mandatory registries

Before beginning operations, the investor must, through his representative, register in the CVM.

Resources entering the country must be registered at the Brazilian Central Bank Information System

(SISBACEN).

Each investor’s representative is responsible for recording Electronic Declaratory Registry (RDE) information and

keep the required documentation.

The RDE number and the update of its underlying information (e.g. investments, redemptions, revenues, capital

gains, transfers) are compulsory requirements for any resource movement abroad.

Non-resident investors also must acquire the Corporate Tax Registration (CNPJ), which is automatically obtained by

CVM at the Brazilian Inland Revenue Service (Brazilian IRS).


5. External federal debt market

5.1 Market at a glance

5.2 External strategy

Brazil doesn’t tap international markets for its financing needs. The Treasury’s goal is actually to build the sovereign

USD/EUR curves to serve as benchmarks for pricing external corporate issuance by Brazilian companies.

By 2005, the Treasury became the sole responsible for international market operations. So, the management of the

domestic and external public debt was fully integrated. The Treasury then started to build an offshore BRL yield

curve, so as to complement the domestic one.

Overall, the current strategy aims at:

Reduce the share of foreign exchange debt;

Develop the BRL external yield curve; and

Improve the USD sovereign curve by repurchasing off-the-run terms and reopening issuance of the selected

benchmarks (see table above).

The Treasury places and repurchases external bonds in order to improve the efficiency of the Brazilian offshore yield

curves (USD, EUR and BRL). The Treasury selected two benchmarks in the USD yield curve: the Global 6.00% 2026

and the Global 5.625% 2047. These are issued according to market conditions and early redemption of older bonds

which no longer play the role of reference tenors.

Type % per year Payments

Jan-2018 Sinkable No 22/07/2005 USD Fixed 8.000% Jan / Jul 4.5 Yes No

Oct-2019 Bullet No 06/10/2004 USD Fixed 8.875% Jan / Jul 1.5 Yes No

Jan-2019 Bullet No 06/01/2009 USD Fixed 5.875% Jan / Jul 2.3 Yes Yes

Jan-2020 Bullet No 19/01/2000 USD Fixed 12.750% Jan / Jul 1.0 No No



Apr-2024 Bullet No 07/03/2001 USD Fixed 8.875% Apr / Oct 2.2 No No

Apr-2024 Bullet No 30/07/2003 USD Fixed 8.875% Apr / Oct 0.8 Yes No


Feb-2025 Bullet No 31/01/2005 USD Fixed 8.750% Feb / Aug 2.3 Yes No

Apr-2026 Bullet Yes 10/03/2016 USD Fixed 6.000% Apr / Oct 2.5 Yes Yes

May-2027 Bullet No 04/06/1997 USD Fixed 10.125% May / Nov 3.0 No Yes

Mar-2030 Bullet No 24/02/2000 USD Fixed 12.250% Mar / Sep 1.6 No No

Jan-2034 Bullet No 12/01/2004 USD Fixed 8.250% Jan / Jul 2.5 Yes No

Jan-2037 Bullet No 10/01/2006 USD Fixed 7.125% Jan / Jul 3.0 Yes No



Feb-2047 Bullet Yes 21/07/2016 USD Fixed 5.625% Feb / Aug 1.5 Yes Yes

Apr-2021 Bullet Yes 27/03/2014 EUR Fixed 2.875% Apr 1.0 Yes No

Jan-2022 Bullet - 06/09/2006 BRL Fixed 12.500% Jan / Jul 3.0 Yes No

Jan-2024 Bullet - 07/04/2012 BRL Fixed 8.500% Jan / Jul 3.2 Yes No

Jan-2028 Bullet - 07/02/2007 BRL Fixed 10.250% Jan / Jul 4.9 Yes NoSource: National Treasury, Bloomberg, Itaú

External Bonds

CouponIssue

Ammount

(billion)

CACOptional

redemption?Globals

Maturity

Type

Benchmark?

(FY2017)

Issuance

DateCurrency


6. Onshore interest-rate derivatives

DI1 futures

Futures over the CDI fixing rate play a pivotal role in pricing Brazilian federal debt securities. Being one of the most

liquid markets in EM space, DI1 futures play a role analogous to that of Overnight Indexed Swaps (OIS) in other

LatAm markets.

Market: Futures exchange (BM&F).

Type: zero-coupon interest rate future.

Participants express their view on the path of the interbank rate from the entry date through maturity by

receiving/paying a fixed rate vs. the CDI (floating rate).

Underlying: the CDI rate (uncollateralized interbank overnight rate).

Contract size: BRL 100,000 future value.

Round-lot: 5 contracts.

Quotation: given as percentage annualized rate (base 252).

Quote specification: three decimal places.

Tick size:

From the 1st to the 3

rd contract month: 0.001 of an interest rate point;

from the 4th to the 12

th contract month: 0.005 of an interest rate point; and

longer-dated maturities: 0.01 of an interest rate point.

Authorized maturities:

the next 12 months from the trading date are available;

after that, the exchange authorizes contracts for the first month of each quarter up to the 5-year maturity;

Expiration date: the first business day of the contract month.

Last trading day: last trading day prior to expiration.

Fixing: daily margin adjustment, with cash-settlement on the following business day.

For the purpose of calculating the margin adjustment value, long and short positions (negotiated in terms of interest

rates – “i”) are converted into unitary price (PU) positions of the inverse nature (eg. a long position in interest rate

becomes a short position in unitary price).

𝑃𝑈 =100,000

(1 + 𝑖)𝑑𝑏/252

where

𝑖 = the quoted yield (base 252)

𝑏𝑑 = number of business days (CDI calendar) between trading date and the last trading day of the contract


The value of the daily adjustment on trading date is calculated on a mark-to-market basis.

For a contract entered at date 𝑡, the calculation occurs according to the following:

𝐴𝐷𝑡 = (𝑃𝐴𝑡 − 𝑃𝑈) × 𝑀

For positions entered at a previous date, the adjustment for each contract is given by:

𝐴𝐷𝑡 = (𝑃𝐴𝑡 − 𝑃𝐴𝑡−1 × 𝐹𝐶𝑡) × 𝑀

where

𝐴𝐷𝑡 = value of the daily adjustment (in BRL)

𝑃𝐴𝑡 = adjustment price announced by BM&F on date 𝑡

𝑃𝐴𝑡−1 = adjustment price announced by BM&F on the business day before valuation date 𝑡 (BM&F calendar)

𝑃𝑈 = unitary price (converted automatically from the quoted yield)

𝑀 = a multiplicative constant set by the exchange – currently, it is equal to 1 (one)

𝐹𝐶𝑡 = the correction factor on date 𝑡, given below:

𝐹𝐶𝑡 = (1 + 𝐷𝐼𝑡−1)1

252

Observation: in infrequent situations (eg. when the exchange closes for a regional holiday) there are more than

one CDI fixing published between BM&F’s trading sessions; whenever this is the case, the correction factor will

be equal to the accumulation of all published CDI fixings.

Options over the IDI index

Market: Futures Exchange (BM&F); OTC offshore

Type: European interest rate options

Underlying: IDI index (Bloomberg ticker: IDIX9 Index)

The IDI index evolves according to the CDI fixing rate published after the closing of the interbank money market. The

index was set at 100,000 on January 02, 2009 and is updated daily through geometric compounding as follows:

IDI t = 100,000 × ∏(1 + 𝐷𝐼𝑢)1

252

𝑡−1

𝑢=1

Call payoff = max(0, IDI T − K)

Put payoff = max(0, K − IDI T)

where

K = the strike price.

IDI T = the value of the IDI index on the expiration date

T = the expiration date


All DI-Over daily fixings must be accrued to the IDI index.

So, whenever there is a holiday in the BM&F calendar which is a working day in the CDI calendar, the index is

updated by two daily factors.

Swaps

Swaps in Brazil are means through which agents can exchange cash flows indexed to different variables. In the

onshore market, they are settled in BRL and usually there is no transfer of the notional amount.

Swaps are registered as OTC trades at the BM&F or at the CETIP.

If one or both counterparties desire, BM&F can act as a Central Counterparty Clearing House (CCP), using

margin posting to mitigate credit risk.

In contrast, Cetip does not guarantee the swaps registered at its system. In order to collateralize the

transaction, the two parties must have between them a local market master agreement developed by the

Brazilian Federation of Banks dubbed Contrato Global de Derivativos.

Contracts registered at the BM&F are usually zero-coupon, while at Cetip they can be registered as multi-cash

flow swaps.

In the domestic market, the swaps with greater liquidity are those with one leg indexed by the CDI overnight rate.

In particular, the fixed-for-floating (PRE x DI) and the US Dollar-DI swap (Dol x DI) are among the most

widely traded contracts.

Since the BRL is not convertible, there are no onshore cross-currency swaps.

The general expression for the payoff of a variable 1 x variable 2 swap at maturity 𝑇 is given by:

𝑃𝑎𝑦𝑜𝑓𝑓𝑇 = (𝑁𝑜𝑡 × 𝐴𝐶𝐹𝑇1) − (𝑁𝑜𝑡 × 𝐴𝐶𝐹𝑇

2)

where

𝐴𝐶𝐹𝑇1 = accumulated correction factor 1 (indexed to variable 1) at maturity date 𝑇

𝐴𝐶𝐹𝑇2 = accumulated correction factor 2 (indexed to variable 2) at maturity date 𝑇

𝑁𝑜𝑡 = notional

Below, we provide a non-exhaustive list of variables commonly used in onshore swaps.

CDI leg

The leg indexed to the variation of the benchmark interbank rate can be negotiated either in terms of a

percentage 𝑃 of the DI fixing value or a spread.

The former applies a negotiated percentage constant 𝑃 over the CDI overnight accrued rate, rather than the

annualized rate fixing directly;

the latter is a multiplicative spread applied to each overnight capitalization factor, even though practitioners

usually refer to it as “CDI+Spread”.

The general formula for the correction leg of the CDI leg in a swap is given by:


𝐹𝑎𝑐𝐷𝐼𝑡 = {[[(1 +𝐷𝐼𝑡−1

100)

1252

− 1] ×𝑃

100] + 1} × (1 +

𝑆𝑝𝑟𝑒𝑎𝑑

100)

1252

𝐴𝐶𝐹𝑇𝐷𝐼 = ∏ 𝐹𝑎𝑐𝐷𝐼𝑗

𝑇

𝑗=𝑏𝑑

where

𝐹𝑎𝑐𝐷𝐼𝑡 = daily correction factor

𝐴𝐶𝐹𝑇𝐷𝐼 = accumulated correction factor at maturity

𝐷𝐼𝑡−1 = DI-Over fixing rate at 𝑡 − 1 calculated and published by Cetip

𝑃 = percentage applied over the daily CDI correction factor

𝑆𝑝𝑟𝑒𝑎𝑑 = effective annualized interest rate (%, base 252) negotiated between the counterparties

Observation: BM&F does not allow contracts whose CDI leg is corrected simultaneously by the percentage

incidence 𝑃 and the 𝑆𝑝𝑟𝑒𝑎𝑑 interest rate.

Fixed-rate leg (PRE)

The fixed-rate leg is corrected by a negotiated constant annualized rate (PRE), using Brazilian 252 business

days day count convention and expressed in percentage (six decimals places).

𝐹𝑎𝑐𝑃𝑅𝐸𝑡 = (1 +𝑃𝑅𝐸

100)

1252

𝐴𝐶𝐹𝑇𝑃𝑅𝐸 = ∏ 𝐹𝑎𝑐𝑃𝑅𝐸𝑗

𝑇

𝑗=𝑏𝑑

where

𝐹𝑎𝑐𝑃𝑅𝐸𝑡 = daily correction factor

𝐴𝐶𝐹𝑇𝑃𝑅𝐸 = accumulated correction factor at maturity

𝑃𝑅𝐸 = fixed rate agreed between the counterparties, expressed in annualized percentage (six decimal places)

Inflation-linked leg (IPCA/IGP-M)

The inflation leg of a swap can be indexed to the official IPCA index or to FGV’s IGP-M9.

Swaps registered at BM&F with an inflation-linked leg cannot mature in less than 30 days.

The market convention is to quote the fixed (real) rate traded, which is called Cupom de IPCA or Cupom de IGP-

M.

𝐹𝑎𝑐𝐼𝑛𝑓𝑙𝑡 = 𝐼𝑛𝑑𝑒𝑥𝑡−1

𝐼𝑛𝑑𝑒𝑥𝑡−2

× (1 +𝑟

100)

1252

9 See section 1.4 for an overview of major Brazilian inflation indexes.


𝐴𝐶𝐹𝑇𝐼𝑛𝑓𝑙

=𝐼𝑛𝑑𝑒𝑥𝑡−1

𝐼𝑛𝑑𝑒𝑥𝑡𝑑−1

× (1 +𝑟

100)

𝑏𝑑252

where

𝐹𝑎𝑐𝐼𝑛𝑓𝑙𝑡 = daily correction factor

𝐴𝐶𝐹𝑇𝐼𝑛𝑓𝑙

= accumulated correction factor at maturity for the inflation-linked leg

𝑏𝑑 = number of business days (CDI calendar) from trading date through the last business day prior to maturity

𝑟 = constant real interest rate negotiated between the parties, annualized using the 252 business days convention

(%, six decimal places)

𝐼𝑛𝑑𝑒𝑥𝑡−1 = last inflation index number (IPCA or IGP-M) available at 𝑡 − 1

𝐼𝑛𝑑𝑒𝑥𝑡𝑑−1 = last inflation index number (IPCA or IGP-M) available at the business day prior to trading date

US Dollar leg

In contrast to the BRL fixed-rate case, the convention is to quote the USD interest rate using linear discounting

and the Act/360 day count.

Upon designing the swap, the parties choose which of the two official exchange rates published daily by BCB will

be used: the PTAX offer rate or the bid one.

In addition, for contracts registered at the BM&F, the parties may input the initial exchange rate used for

correcting the US dollar leg (𝑃𝑇𝐴𝑋𝑡𝑑−1 in the formula).

𝐹𝑎𝑐𝑈𝑆𝐷𝑡 = 𝑃𝑇𝐴𝑋𝑡−1

𝑃𝑇𝐴𝑋𝑡−2

× (1 +𝑅𝑈𝑆𝐷

36000)

𝐴𝐶𝐹𝑇𝑈𝑆𝐷 =

𝑃𝑇𝐴𝑋𝑡−1

𝑃𝑇𝐴𝑋𝑡𝑑−1

× (1 +𝑅𝑈𝑆𝐷

100×

𝑐𝑑

360)

where

𝐹𝑎𝑐𝑈𝑆𝐷𝑡 = daily correction factor

𝐴𝐶𝐹𝑇𝑈𝑆𝐷 = accumulated correction factor at maturity for the US Dollar-linked leg

𝑅𝑈𝑆𝐷 = constant interest rate negotiated between the parties, expressed in annualized (linear base 360) percentage

(six decimal places)

𝑐𝑑 = current days from trading date (inclusive) through maturity date 𝑇 exclusive

𝑃𝑇𝐴𝑋𝑡−1 = spot USDBRL exchange rate (transaction PTAX800, option 5) published by the BCB at 𝑡 − 1; may be the

offer or the bid price, as established in the contract

𝑃𝑇𝐴𝑋𝑡𝑑−1 = spot USDBRL exchange rate (transaction PTAX800, option 5) published by the BCB at the business

day (CDI calendar) prior to trading date; may be the offer or the bid price, as established in the contract


Appendix A – Methodology for calculation of PTAX fixing

BCB Circular 3,537/2011 changed the previous volume-weighted fixing methodology (circular 3,506/2010), to the

arithmetic average of four daily snapshots of the market, as described below:

Depin (BCB department) gathers bid/ask spot (T+2) exchange rate quotes from FX dealers each working day.

The price collection is made in four separate 2-minute periods.

The starting point of these periods is randomly chosen from the following time intervals:

1st collection: from 10:00 to 10:10

2nd

collection: from 11:00 to 11:10

3rd

collection: from 12:00 to 12:10

4th collection: from 13:00 to 13:10

A trimmed average for each of the four collections is computed by excluding the two highest and the two lowest

quotes (bid and ask).

The bid and ask PTAX fixings correspond to the arithmetical average of the four averages described in item 4.

Appendix B – Computation of the Updated Nominal Value

Since Brazilian CPI indexes are published on a monthly basis, it is necessary to accrue into the bond’s updated

nominal value (𝑉𝑁𝐴) the inflation accumulated since the latest IPCA/IGP-M reading. In this appendix, all

business days refer to a CDI calendar.

The market convention is to use Anbima’s forecast to update the VNA in a pro-rata fashion. The association

surveys market participants’ inflation projections for the current month in two occasions: when the IPCA print is

disclosed (around the 10th of the following month) and when the IPCA-15 hit the wires (around the 20

th of the

reference month).

Case I – Calculation date is the 15th day of the reference month

𝑉𝑁𝐴 =𝐼𝑃𝐶𝐴𝑡−1

𝐼𝑃𝐶𝐴0

× 𝑉𝑁𝑏𝑎𝑠𝑒

where

𝑉𝑁𝐴 = the Updated Nominal Value on the settlement day (which is typically T+1)

𝐼𝑃𝐶𝐴𝑡−1 = IPCA index for the month before the reference

𝐼𝑃𝐶𝐴0 = IPCA index for the month prior to the base date

𝑉𝑁𝑏𝑎𝑠𝑒 = nominal value at the base date (1,000)

Observation: whenever the 15th day of the reference month falls on a weekend or a holiday, the adjustment of the

𝑉𝑁𝐴 to IBGE’s official inflation figure will be carried out on the following business day. Therefore, inflation accrual

using Anbima’s IPCA projection will start in the second business day after the 15th.


Case II – Calculation date falls between the disclosure of the previous month IPCA index and

the 15th day of the reference month

𝑉𝑁𝐴 = 𝑉𝑁𝐴𝑡−1 × (𝐼𝑃𝐶𝐴𝑡−1

𝐼𝑃𝐶𝐴𝑡−2

)

𝑑𝑢1𝑑𝑢2

𝑉𝑁𝐴𝑡−1 = previous Updated Nominal Value

𝐼𝑃𝐶𝐴𝑡−1 = index one month before calculation month

𝐼𝑃𝐶𝐴𝑡−2 = index two months before calculation month

𝑑𝑢1 = the number of business days from the 15th of the month before the reference month (inclusive), through the

settlement date (exclusive)

𝑑𝑢2 = the number of business days from the 15th of the month before the reference month (inclusive), through the

15th of the month in which settlement takes place (exclusive)

Case III – Calculation date after the 15th day of the reference month

𝑉𝑁𝐴 = 𝑉𝑁𝐴𝑡−1 × (1 + 𝐼𝑃𝐶𝐴𝑝𝑟𝑜𝑗)𝑑𝑢1𝑑𝑢2

𝑉𝑁𝐴𝑡−1 = previous Updated Nominal Value

𝐼𝑃𝐶𝐴𝑝𝑟𝑜𝑗 = IPCA projection for the reference month gathered from the participants of Anbima’s Macroeconomic

Monitoring Committee (expressed in decimals); the latest projection is available here

𝑑𝑢1 = business days from the 15th of reference month (inclusive), through the settlement day (exclusive)

𝑑𝑢2 = business days from the 15th of the reference month (inclusive), through the 15

th of the following month

(exclusive)

http://www.anbima.com.br/pt_br/informar/estatisticas/precos-e-indices/projecao-de-inflacao-gp-m.htm


Appendix C – Annual Financing Plan (PAF) across the years

The Treasury’s debt profile strategy over the last years aims to increase the total maturity and to decrease its

short term debt (maturing in 12 months).

In line with this strategy, the Treasury is expanding the share of fixed rate and inflation linked debt, as well as

shrinking the share of floating rate and eventually bring down to zero the dollar-linked participation.

Due to market developments during the course of 2016, the Treasury revised the parameters of the PAF. Apart

from 2016, the Treasury only revised in 2008, due to the financial crisis.

In 2016, the reference guidelines of the share of fixed rate debt increased to 33-37% (from: 31-35%) and for

floating rate, they decreased to 27-31% (from: 30-34%).

2.7

2.9

3.1

3.3

3.5

3.7

3.9

4.1

4.3

4.5

4.7

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

PAF - DPF duration


MaximumMinimumActual*

years

* as of May 2017

15%

20%

25%

30%

35%

40%

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

PAF - Short term debt



* as of May 2017

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

PAF - Share of fixed rate debt



* as of May 2017

5%

10%

15%

20%

25%

30%

35%

40%

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

PAF - Share of inflation linked



* as of May 2017


Appendix D - References

Brazilian Security and Exchange Commission CVM (www.cvm.gov.br)

Brazilian Financial and Capital Markets Association (www.anbima.com.br)

http://www.anbima.com.br/pt_br/informar/ima-quantidades-em-mercado.htm

Brazil’s Future and Mercantile Exchange BM&F (www.bmf.com.br)

Brazilian Central Bank (www.bcb.gov.br)

Brazilian Ministry of Finance (www.fazenda.gov.br)

Updated STN bond auctions results since December, 2000 can be found at:

http://sisweb.tesouro.gov.br/apex/COSIS_LEGIS.obtem_arquivo_comunicado?p_id=1125:886732

A recent econometric study on the idiosyncrasies of Brazilian FX Market would be: Santos, Francisco Luna,

Márcio Gomes Pinto Garcia, and Marcelo Cunha Medeiros. “Price Discovery in Brazilian FX Markets”. Brazilian

Review of Econometrics 35, no. 1: 65-94.

10%

15%

20%

25%

30%

35%

40%

45%

50%20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

PAF - Share of floating rate



* as of May 2017

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

PAF - Share of exchange rate



* as of May 2017

http://www.cvm.gov.br/

http://www.anbima.com.br/

http://www.anbima.com.br/pt_br/informar/ima-quantidades-em-mercado.htm

http://www.bmf.com.br/

http://www.bcb.gov.br/

http://www.fazenda.gov.br/

http://sisweb.tesouro.gov.br/apex/COSIS_LEGIS.obtem_arquivo_comunicado?p_id=1125:886732


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