Latin America Instrument and Market Guide - HSBC

Disclaimer & Disclosures This report must be read with the disclosures and the analyst

certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Pablo Goldberg

Head of Global EM Research

HSBC Securities (USA) Inc.

[email protected]

+1 212 525 8729

Pablo A. Goldberg is global head of HSBC emerging markets research. He joined the firm in 2008 as head of Latin American fixed income

research. Pablo is responsible for working across asset classes to build opportunities for HSBC’s emerging markets franchise

with research strategy ideas across regions. Prior to joining HSBC, he held similar positions at other international investment banks for

about 15 years. Pablo has a master’s degree in economics from the London School of Economics.

Gordian Kemen

Chief Strategist, Latam FI


[email protected]

+1 212 525 2593

Gordian Kemen is the chief strategist for HSBC’s Latin American fixed income strategy team. He joined the firm in May 2009. Previously,

he had roles in emerging-market research at two major investment banks in London and New York, and he was a lecturer and researcher

in finance at the University of Mannheim, a German business school. He holds a graduate degree in economics from the University of

Konstanz, Germany, and has conducted postgraduate research in finance at the University of Mannheim.

Alejandro Martinez-Cruz

Latam FI Strategist

HSBC Mexico S.A.

[email protected]

+52 55 5721 2380

Alejandro Martinez-Cruz joined HSBC Mexico in 2007 as as member of the fixed income strategy team, and since 2009 has focused on

strategies and trade recommendations in fixed income markets in Mexico, Peru, and Central America. Previously, he was a financial

markets analyst, including a position at the Mexican central bank. He received a master’s degree in economics from the University of

Rochester in the US.

Hernan Yellati

Latam FI Strategist


[email protected]

+1 212 525 3084

Hernan Yellati is a member of the HSBC fixed income strategy team, focusing on the Latin American region. He joined HSBC Argentina

in 2003 as deputy chief economist and moved to the New York office in 2008. Before joining HSBC, Hernan received a master’s

degree in economics from Pompeu Fabra University, and he is a Ph.D. candidate in economics from Birkbeck College, University

of London.

Latin America RatesGuide 2011Exploring Latam instruments, regulations and market conventions

Emerging Markets

Fixed Income Research

March 2011

110309_37261_F1:Layout 1 3/10/2011 2:33 AM

1

Emerging Markets Fixed Income Research March 2011

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Overview 2

Market profiles 9 Argentina 10

Brazil 16

Chile 23

Colombia 29

Mexico 34

Peru 41

Uruguay 46

Disclosure appendix 51

Disclaimer 52

Contents

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The local markets: Risks and opportunities

Investing in the local markets could offer interesting returns, but it also involves a set of risks, conventions, and

regulations not present in hard-currency bonds. These risks can be divided into two groups: economic and

legal/regulatory. As the assets are denominated in local currency, the returns for foreign investors also depend on

fluctuation of the value of the local currency to that of origin. The correlation between rates and FX has not been

stable over time. Also, as these instruments are generally payable in the domicile of the issuer, investors are exposed

to convertibility risk, which is subject to potential restrictions on repatriation of their capital. In the case of a credit

event, because investments are issued under local law, investors might have to face an issuer in foreign courts, which

could delay the speed and amount of any recovery.

Understanding risks and regulations involved when investing in the local markets is crucial. We regard HSBC Rates

Guides as an essential tool for investors venturing into local markets. These guides provide a full description of local

fixed-income instruments, a brief history of the evolution of local markets, the functioning of countries’ monetary

policies, and an explanation of regulatory, settlement, and tax issues. We also recommend complementing these guides

with the information contained in HSBC’s Emerging Markets Currency Guide 2011: A guiding light, 19 January 2011.

The change in Latin American sovereign balance sheets

History shows that reliance on foreign currency debt is a source of vulnerability for a sovereign that does not have

the ability to print the currency it owes. While sources of foreign exchange (exports and portfolio flows) are variable

and subject to shocks, debt obligations to foreigners are fixed in nominal terms, making borrowers subject to any

liquidity crisis. The typical Latin American sovereign balance sheet of the ’80s and ’90s was heavy in foreign

currency-denominated debt and respectively light on international reserves. The presence of foreign debt then

reduced the expansionary effect of currency depreciation, and might even have turned this contractionary in cases of

Overview

Foreign interest in Latin American local markets continues to grow as the

process of rating convergence and capital account opening deepens

Investing in the local markets offers interesting opportunities but involves

a set of risks and regulations that investors need to be aware of

HSBC Rates Guides are an essential information source for investors

venturing into local markets

Table 1: Types of debt and risks involved External debt Local currency global bonds Fixed or floating local debt Inflation-linked debt

Currency Hard currency LC LC Inflation units Payable Same currency USD LC LC Law Foreign Foreign Local Local Convertibility risk No No Yes Yes FX risk No Yes Yes Yes Credit risk Yes Yes Yes Yes Example instrument Brazil ’34 BRL Global ’28 Brazil LTN Brazil NTN-B Source: HSBC

http://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=3UGWxKwFIE&n=286681.PDF

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high foreign debt. This is because both fiscal and monetary policies needed to be tightened pro-cyclically whenever

there was an external shock.

Countries borrowed heavily in hard currency for several reasons. First, savings rates domestically were very low, and

strong investment needs required foreign financing. The lack of a strong pension system did not provide a solid pool

of domestic savings from which investments could be funded, while institutional fragilities led local residents to park

large proportions of their savings abroad. Second, borrowing costs were perceived to be much lower in foreign than

local currency, in particular at times of fixed exchange rates. Third, local currency lending, when available, was

generally for short maturities. This is what economic literature calls “original sin” – the inability of countries to

borrow in their own currency for long terms or in the international markets or both.

Things have changed. Starting at the beginning of the 2000s, Latin American countries started to change the

compositions of their balance sheets, increasing their assets and decreasing their liabilities in foreign currency. How

was the “original sin” overcome? Several things happened at the same time. The adoption of a credible inflation-

targeting framework allowed for issuance of inflation-linked securities. Also, inflation expectations delinked from

the exchange rate, reducing volatility of local interest rates and the proliferation of floating local debt. These two,

inflation linkers and floating paper, were the precursors of the local debt markets in Latin America. Key to the future

development of the market was consolidation of a domestic investor base, which followed from creation of a

defined-contribution pension system and an increase in the amount of local deposits due to improved regulation and

supervision in the financial system.

Foreign investors were attracted to local markets by strong economic growth; a reduction of macroeconomic

volatility that led to achievement of investment-grade by Mexico, Brazil, and Peru (Chile was already investment-

grade); a process of interest rate convergence; currency appreciation expectations; and portfolio diversification

Chart 1. Brazil: Public external foreign balance sheet Chart 2. Argentina: Public external foreign balance sheet

-

50,000

100,000

150,000

200,000

250,000

87 89 91 93 95 97 99 01 03 05 07 09

International reserves x-goldPublic and publicly guaranteed external debt

USD mn

-

20,000

40,000

60,000

80,000

100,000

120,000

87 89 91 93 95 97 99 01 03 05 07 09

International reserves x-goldPublic and publicly guaranteed external debt

USD mn

Source: World Bank, BCB Source: World Bank, BCRA

Chart 3. Brazil local debt composition Chart 4. Mexico debt composition

Inflation Linked

Floating rate

FX-Exchange

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Fixed rate

0%

20%

40%

60%

80%

100%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Fixed-rate

Floating-rate

Inflation-linked

Source: Brazil National Treasury Source: SHCP

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objectives. This not only increased the market cap of local debt, but also increased the level of foreign reserves,

further contributing to the process of balance sheet strengthening.

A growing market

Investors’ appetite for local markets has been growing consistently. Attracted at times by significant carry, prospects

of interest rate convergence, and currency appreciation, emerging markets’ local market funds have been set up

around the world. In addition, EM local markets have attracted increasing interest from crossover funds. Chart 3

shows that local currency funds have been the main driver of increases in assets under management at EM-dedicated

funds. Trading of local-market instruments now accounts for almost 70% of the volume traded in EM fixed income,

up from 31% in 2000.

EM countries now are forming part of the major bond indices, although their weightings are very low. For example,

the EM composition of Citigroup’s World Global Bond Index (WGBI) is less than 2%, and Mexico, the only Latin

American country included, represented only 0.63% by end of February 2011. Yet the share of EM in global indices

continues to grow, on the back of higher ratings, deepening liquidity, and easier access for foreign investors. At the

same time, several benchmarks are looking at EM local markets exclusively. The most commonly used are the

JPMorgan GBI-EM Global and ELMI families, in which Latin America represents about 25 and 20%, respectively.

Barclays runs an EM government inflation-linked index, in which Argentina, Brazil, Chile, Colombia, and Mexico

are represented.

Chart 5 Accumulated flows since 2007 Chart 6. Traded volume per instrument

-20,000

-10,000

0

10,000

20,000

30,000

40,000

2007 2008 2009 2010 2011

Total EM fundsLocal markets

USD mn

0

500

1,000

1,500

2,000

2,500

1997 1999 2001 2003 2005 2007 2009

EXDOther Local

Latam Local

USD mn

Source: EPFR Source: EMTA

Chart 7. Composition of GBI-EM Global Diversified Chart 8. Composition of ELMI+

Brazil, 10.0%Chile, 0.1%

Colombia, 4.2%

Mex ico, 10.0%

Peru, 0.2%

Asia, 24.5%

EMEA, 50.9%

Asia, 33.6%

EM Europe,

38.7%

MENA, 7.9%

Argentina, 2.0%Brazil, 2.0%

Chile, 2.0%Colombia, 2.1%

Mex ico, 10.2%Peru, 1.6%

Source: EPFR Source: HSBC

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Foreign participation varies by market Participation of foreign investors in Latin American local markets has been growing steadily. Chart 10 shows that

this escalated in the case of Mexico over the course of 2010 because of that country’s inclusion in the WGBI index.

This suggests that further rating convergence will allow for the inclusion of other countries into global indices and

“force” higher allocations to EM in general and to the region in particular. An International Monetary Fund study

estimated that each 1% shift in the holdings of US-based, unlevered, institutional investors of domestic securities

could translate into a USD45bn reallocation to EM securities annually, or approximately two-thirds of the flows to

emerging markets in 20091.

Relatively, foreign investors have a strong presence in Latin American markets, slightly less on average than in the

biggest EMEA markets but more than in Asia, where some countries show very little participation. In the case of

Brazil, participation is close to 10%, up from 5% three years ago. In Peru, participation is the highest in the region,

now at 42% and up from zero in 2003. Foreign investor participation in the Colombian local fixed-income market

remains significantly lower than in regional peers.

______________________________________ 1 International Monetary Fund (2010): Resolving the Crisis Legacy and Meeting New Challenges to Financial Stability, Global Financial Stability report, April 2010.

Chart 9. Foreign participation as % of local debt outstanding Chart 10. Mexico foreign participation

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

CO CL BZ MX AR PE TK CZ HU PO CY IN VT PH TH SL TW KO SG ID MY

0%

5%

10%

15%

20%

25%

1999 2001 2003 2005 2007 2009 2011

% of Total amount outstanding

Source: Respective central banks Source: Banxico

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c Table A: Region at a glance: Bond market technicals and liquidity

Argentina Brazil Chile Colombia Mexico Peru Uruguay

Available repo facilities Onshore with central bank Yes Yes Yes Yes Yes Yes Yes Onshore interbank Yes Yes Yes Yes Yes Yes Yes Offshore investors with onshore No No No N/A No Yes, but with special

reserve N/A

Onshore nonbank investor (eg custodian) with onshore

Yes No No N/A Yes N/A N/A

Eligible collateral for repos For CB repos CB bills, CB notes and

bonds Local sovereign bonds Central bank bonds TES, Bonos para la

seguridad, TRDs, TDAs, Títulos de Deuda Externa, TCO, FOGAFIN

Federal government bonds

No T-bills

For interbank repos CB bills, CB notes and bonds

Local sovereign bonds CB, treasury, corp bonds, bank bonds

TES, TCO, corporates, FOGAFIN

Commercial paper, corporate bonds

No T-bills

Mark-to-market requirements

Banks Yes Yes Yes Yes Yes Internal requirements Yes Insurance companies Yes N/A

Yes, except LT hedging Yes Yes Internal requirements Yes

Pension funds N/A N/A Yes

Yes Yes Yes Yes

Mutual funds Yes Yes Yes

Yes Yes Yes Yes

Offshore investor access Direct purchase Yes Only through banks Through banks or

stockbrokers No Yes Yes, with a local

custodian and central bank account

No

Subject to cap No Yes No Yes No Registration requirement No Yes Yes Yes Yes Yes Yes Access to onshore funding Yes No No No No No Access to onshore FX hedging Yes Yes Yes Yes Yes Yes Yes Access to rates hedging (IRS, repo, futures)

Yes Yes IRS Yes Yes (interest rate swap) Yes Yes

Market liquidity statistics

Instrument #1 Treasury bonds LTNs Bonds TES Bonds MBonos Soberanos Bonds Daily turnover ARS1.6bn BRL6.5bn USD300m COP6.0trn MXN15bn PEN140m USD10.0 Buying volume in a single day USD1.0m USD50-100m Depending on tenor, liquid

tenors USD30m COP200bn MXN50M USD50.5m USD1.0

Bid/offer spreads under normal conditions 25-50bp 1-3bp depending on maturity

5bp for liquid tenors 2.5bp 3bp 8bp 50bp

Instrument #2 NTNBs, NTNFs Udibonos VACs Daily turnover BRL1.5bn MXN5bn PEN2.5m Buying volume in a single day USD50-100m MXN30m USD0.9m Bid/offer spreads under normal conditions 1-3bp 3-5bp 20bp

Source: HSBC

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cTable B. Region at a glance: Government bonds

Argentina Brazil Chile Colombia Mexico Peru Uruguay ARS- and CPI-linked (NTN-F and LTN) BTP TES Bonos M Soberanos Notas del Tesoro in UYU

Issuer Economy ministry National treasury National treasury Finance ministry United Mexican States (UMS) Finance ministry Finance ministry Currency Argentine peso (ARS) Brazilian real (BRL) Chilean peso (CLP) Colombian peso (COP) Mexican pesos (MXN) Peruvian Sol (PEN) UYU Form Physical Scripless Scripless Scripless Scripless Scripless Scripless Minimum denomination ARS1 BRL1,000 CLP5.0m COP500,000 MXN100 PEN10 UYU1 Tenors 1 to 30 years 1-10 years (NTN-F) – 1-2 years

(LTN) 5- to 10-years From 6 months to 14 years 3, 5, 10, 20, and 30 years From 1y to 31 years 3-8years

Coupon/discount Fixed Fixed (NTN-F) – Zero (LTN) 6% Fixed Fixed-rate Fixed Coupon Frequency Ad-hoc Semiannual (NTN-F) – zero

(LTN) Semiannual Anual Semiannual Semiannual Semiannual

Amortizing schedule See text Bullet Bullet Bullet Bullet Bullet Bullet Day count 30/360* Business days/252 Actual/360 NL/365 Actual/360 30/360 360 Amount outstanding USD44bn BRL534bn CLP 1.1trn COP98.2trn MXN1.55trn PEN26bn UYU11bn Primary market Auction style No schedule Yankee Dutch Dutch Single rate Dutch No schedule Average issue size N/A Per month: BRL15bn (LTN),

4bn (NTN-F) CLP20.0m COP500bn MXN4.5bn weekly N/A

Issuance cycle N/A Weekly (LTN), 2/month (NTN-F)

Monthly Biweekly Weekly (different tenors each week)

Monthly N/A

Participants N/A Brokers and banks Banks, pension funds, insurance companies, and mutual funds

Pension funds, local Banks, and brokerage houses

Banks, local funds, individuals. Foreign accounts through local Banks.

Banks, market makers N/A

Settlement N/A T+1 Dutch T+0 T+2 T+1 N/A Secondary market Trading mechanism OTC (MAE)/MERVAL OTC/BM&F Exchange or OTC SEN/MEC/OTC OTC Datatec OTC/BVM/BEVSA Trading hours 9am-4pm 9am-6pm 9.30-13.30 8.00-16.00 7am to 2pm 10am to 1pm local time 10.00-17.00 Quoting convention Dirty price to 2 decimal places Yield up to 2 (sometimes 3)

decimal places Yield Semi Act/365 Yield up to 2 decimal places Yield up to 2 decimal places Yield up to 2 decimal places Yield up to two decimal places

Average bid-offer spreads 25-50bp 1-3bp 5bp 2bp 2-4bp 8-10pips 5bp//5pips Average trade size ARS5.0m BRL10m CLP1bn COP5.0bn MXN50m PEN15m UYU20m (USD1.1m) Volume USD40m BRL 3bn for LTN, 1.3bn for

NTN-F CLP 20bn COP5.0trn MXN7-11bn PEN150m UYU5m (USD260k)

Settlement Usually T+3 T+0 T+0, T+1, T+2 T+0 Usually T+2 T+1 T+0, T+1, T+2 Clearing Caja de Valores/Euroclear Selic DCV SEBRA/DECEVAL Local/Euroclear CAVALI BEVSA/BVM/BCU Main participants Local and foreign banks,

foreign investors, insurance companies, individuals, and corporations

Local asset managers, foreigners, local banks

Pension funds, banks, mutual funds, insurance companies, stockbrokers

Pension funds, local banks, brokerage houses, and foreign investors

Local banks and funds, foreign real money funds and hedge funds.

Banks, AFPs, and foreign investors

Pension funds, local banks, insurance companies, brokerage houses, and foreign investors

Regulations for foreign investors Restriction on foreign investment FX restriction: 30% deposit in a

central bank account at 0% interest for one year

CB registration required Need to open local custody with tax ID

Need to open a trading account with an appointed administrator

Not restricted None None

Custodian Local custodian required Local custodian required (Selic) Local custodian required Local or Euroclear Local custodian required Local custodian required, final custody on BCU

Interest income tax No Exempt Capital gains (CG) and withholding (WHT) tax

Yes Exempted when tax treaty exist, if not 0.5%

No No

Capital gains tax No Only if holding is less than 30 days

35%, bonds issued from 2010 0%

Yes No No No

Entry/exit No IOF and CPMF 4% of the interest received No No No No

Source: HSBC

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Emerging Market Central Bank Monitor

Market-implied path of monetary policy rates for key EM countries

An important tool to assess investment

opportunities in local markets is HSBC’s EM

Market Central Bank Monitor. It provides the

market-implied path of monetary policy rates for

key EM countries globally. Initially, we are

covering Brazil, Chile, Czech Republic, Hungary,

India, Israel, Korea, Malaysia, Mexico, Poland,

South Africa, Taiwan, Thailand, and Turkey.

The horizon covers the “monetary policy segment”

of the yield curve, ie the next 24 months.

We compute probabilities of a given move and

provide a history of implied policy moves (see the

table at the bottom of this page).

This report is available as a download from

Bloomberg (HSBCnet on Bloomberg: HSER

<GO>) and the HSBC Global Research Web site

at about 11am London time daily. It uses closing

Asia prices, opening London prices, and last close

New York. We consider the report a useful tool in

generating trade ideas in local markets. We use

consistent bootstrapping and interpolation

methodology to derive all curves, accommodating

specific market conventions and using the most-

liquid instruments for each market.

Market-implied future central bank rates are

computed from implied forward rates, ie we

compute a strip of forward-starting short rates

with start date on effective date following each

future central bank meeting. Forward rates are

derived from local interest rate curves where

available (and cross-currency swaps in a few

cases).

Our approach yields a meeting-by-meeting path of

implied rate moves, rather than cumulative

implied moves over a specific time horizon (eg

“hikes over the next three months”).

The following table provides a glimpse of our

Monitor for Latin America. In addition, it has

implied probabilities for a set of cumulative

implied changes per meeting.

Latin America: Implied rates, implied changes, cumulative implied changes

Brazil Implied Implied Cum. implied Chile Implied Implied Cum. implied Mexico Implied Implied Cum. implied Meeting rate change change Meeting rate change change Meeting rate change change (%) (bp) (bp) (%) (bp) (bp) (%) (bp) (bp)

20-Apr-11 12.40 65 65 17-Mar-11 3.71 21 21 15-Apr-11 4.53 3 38-Jun-11 12.59 19 84 12-Apr-11 3.8 9 30 27-May-11 4.64 11 1420-Jul-11 12.81 22 106 12-May-11 4.11 32 61 8-Jul-11 4.80 17 3031-Aug-11 12.97 16 122 13-Jun-11 4.41 29 91 26-Aug-11 4.89 8 3919-Oct-11 13.09 12 134 13-Jul-11 4.82 41 132 14-Oct-11 5.03 14 5330-Nov-11 13.16 7 141 16-Aug-11 5.02 20 152 2-Dec-11 5.28 25 7819-Jan-12 13.20 5 145 16-Sep-11 5.35 33 185 20-Jan-12 5.49 21 991-Mar-12 13.22 2 147 17-Oct-11 5.48 13 198 2-Mar-12 5.63 14 11312-Apr-12 13.22 0 147 17-Nov-11 5.6 12 210 15-Apr-12 5.76 14 12631-May-12 13.21 -2 146 19-Dec-11 5.69 9 219 4-May-12 5.84 8 13412-Jul-12 13.18 -3 143 19-Jan-12 5.81 12 231 6-Jul-12 6.07 23 15730-Aug-12 13.13 -5 138 20-Feb-12 5.9 9 240 24-Aug-12 6.25 18 17511-Oct-12 13.07 -7 132 20-Mar-12 5.94 4 244 12-Oct-12 6.42 17 19229-Nov-12 12.98 -9 123 20-Apr-12 5.95 1 245 30-Nov-12 6.59 17 20917-Jan-13 12.85 -13 110 21-May-12 5.98 2 248 11-Jan-13 6.74 15 22428-Feb-13 12.85 0 110 21-Jun-12 6.01 3 251 22-Feb-13 6.89 14 239Source: HSBC

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Market profiles

10

Emerging Markets Argentina March 2011

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Market structure

Official data as of September 2010 indicate that total

public debt – excluding bonds that were not presented in

the 2005 and 2010 sovereign restructurings of defaulted

debt – amounted to USD160.9bn. Of this debt, 67.5%

was under Argentine law and 32.5% under foreign law.

Total public debt is mainly composed of bonds, 70%, of

which 27ppt is ARS-denominated and 43ppt hard

currency-denominated. Multilateral and bilateral debt

(excluding Paris Club) accounts for 10% and temporary

advances to the treasury from the central bank

represents 6% of the total debt.

Following the nationalization of the private pension

fund system in October 2008, the public sector ended up

being the main holder of Argentine sovereign debt. We

estimate that bonds held by private sector investors

account for only 18% of GDP.

In this local market guide, we focus on market debt

issued under Argentine legislation, excluding

restructured bonds. By market debt, we mean bonds

either in private or public hands that can be traded in the

secondary market and that are accessible to foreign

investors. Of this group, 47% is denominated in USD

(Bodens and Bonars), 28% inflation-linked (CER

index), 25% floating interest rate Badlar-linked paper,

and only 1% in nominal ARS (see Chart 11).

Argentina

Argentina’s public debt in the hands of private investors accounts for

only 18% of GDP, according to our estimates

Even though activity in CER-linked paper has been picking up, foreign

investors are mostly involved with the USD-denominated segment of the

market

Argentina has not issued for cash in international debt markets since 2001

Chart 11. Argentine local debt composition (excluding restructured debt)

Chart 12. USD-denominated bonds issued under local legislation – USDbn (excluding restructured debt)

25%

1%

28%

22%

24%

ARS Badlar-linked ARS Nominal ARS CER-linked

USD Bodens USD Bonars

4.4

0.7

5.8

1.5

6.4

2.0

Boden 2012 Boden 2013 Boden 2015Bonar V Bonar V Bonar X

Source: Mecon Source: Mecon

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Recent developments

The Argentine bond market has been dominated by

three events: the 2001 debt default (and the

subsequent debt exchanges of 2005 and 2010), the

nationalization of the local pension-fund system in

2008, and questions about the accuracy of inflation

calculation.

The first event constrained the government’s access

to international capital markets, and the others had a

strong impact on the liquidity of local debt and the

process of de-dollarization of liabilities.

Lacking access to foreign debt markets, the

government has resorted to service external debt

owed to multilateral and private creditors with

foreign reserves from the Banco Central de la

República Argentina (BCRA). For this, the

government has issued an IOU to the bank for

USD6.6bn in 2010, and repeated that this year for

USD9.6bn.

While access to voluntary capital markets abroad

remains constrained by potential attachment due to

lawsuits of holders of defaulted debt, we see

increasing prospects that the government may

attempt to issue new debt for cash next year.

Financing costs have dropped from almost 16% in

mid-2010 to a current Boden’15 yield of close to 9%.

Monetary policy

The BCRA does not pursue an explicit inflation target,

although its charter indicates the ultimate goal of the

institution is to preserve the value of the ARS. For this,

the BCRA targets the quantity of money supply based

on quarterly objectives for M2. Central bank bills and

notes – Lebacs and Nobacs – are issued on a weekly

basis to control high-power monetary aggregates.

The central bank also uses repos and reverse repos with

private and public banks to contract or expand the

monetary base.

Key policy rates

Reverse repo rates (pases pasivos) of three and seven

days are set by the central bank as one of the tools to

manage the monetary base and comply with the

monetary program. A reverse repo consists of the

temporary sale of government paper to control the

quantity of money. The difference between the price at

which the central bank sells and buys the bonds is the

rate that financial institutions get for the repo. The

three- and seven-day reverse repo rates are currently set

at 9.0% and 9.5%, respectively.

Table 2:.Argentina: Bond market technicals and liquidity

Available repo facilities Onshore banks with central bank YesOnshore interbank YesOffshore investors with onshore NoOnshore nonbank investor (eg custodian) with onshore YesEligible collateral for repos For CB repos CB bills, CB notes and bondsFor interbank repos CB bills, CB notes and bondsMark-to-market requirements Banks YesInsurance companies YesPension funds N/AMutual funds YesTaxation: Government bonds Onshore investors NoOffshore investors NoOffshore investors’ access Foreign ownership of government bonds As % of outstanding N/ADirect purchase YesSubject to cap NoRegistration requirement NoAccess to onshore funding YesAccess to onshore FX hedging YesAccess to rates hedging (interest rate swaps, repo, futures) YesMarket liquidity statistics Daily turnover (ARSbn) 1.4Buying volume in a single day (USDm) with minimal market impact

1.0

Bid/offer spreads under normal conditions (bp) 25-50Source: HSBC

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Local fixed income instruments

Argentina defaulted on its bonded external and domestic

debt at the end of 2001. Since then, the government has

not issued for cash in the international bond markets due

to risks of attachment by holders of defaulted debt. Until

now, Argentina has exchanged 92% of its defaulted

bonds for new, current bonds through two exchanges in

2005 and 2010. Still, about US4bn of defaulted debt has

not been tendered.

In 2005, the government exchanged defaulted debt in

multiple currencies for USD- and ARS-denominated

Pars (no face value haircuts, but very low coupon) and

Discounts (67% face value haircut, but higher coupon).

Also ARS-denominated Quasi-Pars were issued for

local pension funds only. Investors also received one

unit of USD or ARS GDP warrants (see below) per unit

of tendered debt (see below). A second tranche of the

exchange was reopened in 2010 under similar

conditions, and investors also received Global ’17s as a

compensation for past-due interest.

Considering the restrictions regarding access to

international debt markets, the government accessed

foreign investors via the issuance of Bonars. These

local-law bonds were denominated in both ARS and

USD. Yet since early 2007, by the time market

participants started to question the accuracy of the

consumer price index reading, the government stopped

issuing Bonars.

HSBC provides indicative prices for Argentine domestic

government debt securities via Bloomberg page HSAR.

Bonds

The Argentine local debt market includes a variety of

different types of instruments. The range includes both

ARS- and USD-denominated paper; inflation and

Badlar-linked treasury debt, and central bank paper.

Foreign investors are mostly active in USD-

denominated Boden 2015. The new Global 2017, which

was issued after the reopening of the exchange in June

2010, failed to become the benchmark on the belly of

the curve, given its thin liquidity.

Inflation-linked and Badlar-linked paper is usually

much less liquid than USD-denominated local bonds.

Yet domestic investors, mainly local banks, are active in

this type of instruments. Following the nationalization

of the pension fund system, the social security agency

Anses became a key player in the local market.

In terms of trade quoting, with exception of bonds

issued under the sovereign restructuring – Pars,

Discounts, and Global ’17s – all instruments are quoted

on a dirty, or all-in, price basis.

USD-denominated local debt

Boden 2012

Amount outstanding: USD4.3bn.

Maturity: 3 August 2012.

Amortization: Annual installment of 12.5% of face

value.

Coupon: Six-month Libor rate, paid on a semiannual

basis.

Bonar V, VII, and X

Amounts outstanding: USD1.5bn, USD2.0bn, and

USD6.85bn, respectively.

Maturity: 28 March 2011, 12 September 2013, and 17

April 2017, respectively.

Amortization: Bullet.

Coupon: 7% fixed, paid on semiannual basis.

ARS CER-linked paper

The CER (coeficiente de estabilización de referencia) is

an index produced by the BCRA. The index shows the

daily evolution of consumer prices calculated as a

geometric mean using as input the monthly CPI as

reported by the national statistics agency INDEC.

Chart 13. Debt profile of public bonds

0

2

4

6

8

10

12

14

16

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Amortizations Interest

USDbn

Source: Mecon

13


abc

Bogar 18

Amount outstanding: ARS13.64bn.

Maturity: 4 February 2018.

Amortization: 60 monthly installments of 0.40%, 48

monthly installments of 0.60%, 47 monthly installments

of 0.98%, and a last installment of 1.14% of the CER-

adjusted capital, including capitalized interest up to 4

September 2002, starting on 4 March 2005.

Coupon: 2% annual rate, paid on a monthly basis, based

on CER-adjusted capital (ACT/365). Interest was

capitalized until 4 September 2002. The first payment

took place on 4 October 2002.

Guaranty: Federal taxes under the tax-sharing program

with provinces.

Boden 14


Maturity: 30 September 2014.

Amortization: Eight semiannual installments of 12.5%

of CER-adjusted capital, starting on 31 March 2011.

Coupon: 2% annual rate, paid on a semiannual basis,

based on CER-adjusted capital (ISMA-30/360).

Bocon PR12


Maturity: 3 January 2016.

Amortization: 119 monthly installments of 0.84% and

one final monthly installment of 0.04% of the CER-


January 2006, starting on 3 February 2006.


on CER-adjusted capital (30/360). Interest was

capitalized until 3 January 2006. The first payment took

place on 3 February 2006.

Bocon PRE9

Amount outstanding: ARS293.5m.

Maturity: 15 March 2014.

Amortization: 70 monthly installments of 1.35% and

two final monthly installments of 1.375% of CER-


March 2008, starting on 15 April 2008.


on CER-adjusted capital (30/360). Interest was

capitalized up to 15 March 2008. The first payment took

place on 15 April 2008.

Badlar-linked instruments

The Badlar (private banks) rate is the average rate

among private banks for 30- to 35-day certificates of

deposit of ARS1.0m or higher. The central bank

publishes this on a daily basis.

Bocan 2014

Bocan paper was issued in an exchange of guaranteed

loans (préstamos garantizados nacionales).


Maturity: 30 January 2014.

Amortization: Bullet.

Coupon: Badlar private banks rate +275bp, quarterly

payments starting 30 April 2009. The coupon rate from

issue to 30 January 2010 is 15.4%. The Badlar private

banks rate is calculated as a simple average of the daily

reported rate by the central bank from 10 days before

the beginning of the coupon to 10 days before the

payment of each coupon (same for Bocan 2015).

Bocan 2015


Maturity: 10 September 2015.

Amortization: Six semiannual installments (five of

16.66% and a last one of 16.70%) of the issued amount,

starting on 10 March 2013.

Coupon: Badlar private banks rate +300bp (ACT/365),

quarterly payments starting 10 December 2010.

GDP warrants

Even though formally the GDP warrants are not

considered a pure fixed-income instrument, foreign

investors trade this paper as part of their bond portfolio.

ARS-USD warrants

Issue date: 31 December 2003.

Maturity: 15 December 2035 or earlier.

Coupon: Paid annually, based on the notional amount of

the warrant. The payment will take place on 15

December of the following relevant reference year if the

following three conditions are met: 1) The level of real

GDP has to exceed the base-case GDP. The base case

was established by the government at the time of

issuance and determines a specific real GDP growth-rate

path. 2) Real GDP growth has to exceed the growth rate

corresponding to the base-case GDP. 3) Accumulated

past payments should not exceed 0.48 per notional unit.

The payment amount corresponds to 5% of the

14


abc

difference between actual real GDP measured in ARS

and the base-case GDP.

Derivatives

The onshore interest fixed rate swap (IRS) market is

limited to Badlar versus fixed rate. Maturities are due in

March, June, September, and December with tenors

ranging from six months to two years. Yet most liquid

contracts are 1.5 years and shorter. Most active players

in this market are local banks, with an average ticket of

ARS10m.

Regulatory, settlement, and tax issues

Regulation

Free capital movement is restricted by regulation.

Foreign investors bringing foreign exchange at the spot

exchange rate into the Argentine capital markets are

required to make a 30% deposit at zero interest rate in a

central bank account for a one-year period.

An alternative vehicle used by investors consists of the

following operation. Most fixed income instruments, ie

ARS-Discounts, are quoted in both USD and ARS and

can be traded both domestically and offshore. The

operation in which an investor buys a bond in USD

offshore and sells it in ARS in the domestic market – or

vice versa – results in inflows of ARS (outflows of

USD).The implied exchange rate, the ratio of the USD

to ARS price of the selected instrument, is called the

blue-chip swap (BCS). When engaging in this type of

operation, investors are exposed to the BCS and not the

official spot exchange rate.

Regulation has become tighter to limit this type of

operation. For example, there is a minimum required

period of 72 hours after settlement in the local

custodian, Caja de Valores, for investors to require the

change to Euroclear custodian. As the usual settlement

of Argentine bonds is T+3, a minimum of six working

days is necessary for the bonds to be under a Euroclear

custodian.

Settlement

With the exception of internal central bank bills and

notes, all Argentine paper, either local or external, is

cleared both locally and via Euroclear and Clearstream.

Taxation

Taxes in the form of VAT, capital gains, or income tax

do not apply to transactions in Argentine fixed income

instruments.

Foreign exchange

For details on FX markets, please see HSBC’s Emerging

Markets Currency Guide 2011: A guiding light,

19 January 2011.

Table 4. Normal market conditions

Onshore average daily volume USD600mOnshore spot transaction USD5.0mOnshore bid/ask spread ARS0.001Onshore forward transaction USD300mOnshore forward spread ARS0.0025Offshore average daily volume USD100mOffshore bid/ask spread ARS0.0025Implied option volatility spread 6-month 2 vols (USD 20m)Source: HSBC

Useful links Table 5. Information sources

Central Bank of Argentina www.bcra.gov.arMinistry of Economy (MECON) www.mecon.gov.arNational Bureau of Statistics (INDEC) www.indec.gov.arElectronic open market (MAE) www.mae.com.arOfficial gazette www.boletinoficial.gov.arBuenos Aires stock exchange www.bolsar.comArgentina Securities and Exchange Commission (CNV) www.cnv.gov.arHSBC Argentina Bloomberg page HSAR <GO>Source: HSBC



15


abc

Table 6. Argentina: Bonds

Treasury bonds (USD)

Treasury bonds (ARS- and CPI-linked)

Central bank bills (Lebacs)

Central bank notes (Nobacs)

Issuer Economy ministry Economy ministry Argentine central bank Argentine central bank Currency US dollar (USD) Argentine peso (ARS); US dollar

(USD) Argentine peso (ARS) Argentine peso (ARS)

Form Physical Physical Physical Physical Minimum denomination USD1 ARS1 ARS1 ARS1 Tenors 1 to 30 years 1 to 30 years Up to one year Up to 3 years Coupon/discount Fixed/floating Fixed Zero Badlar + 250bp Coupon frequency Semiannual Ad hoc Zero Quarterly Amortizing schedule See text See text Bullet Bullet Day count 30/360 30/360* Actual/365 Actual/actual Amount outstanding USD69.4bn USD44bn ARS47.3bn ARS25.8bn

Primary market Auction style No schedule No schedule Dutch (one price) Dutch (one price) Average issue size N/A N/A ARS1.0bn ARS1.0bn Auction frequency N/A N/A Usually Tuesdays Usually Tuesdays Participants N/A N/A Local banks, insurance

companies, and mutual funds Local banks, insurance companies, and mutual funds

Settlement N/A N/A T+1 T+1

Secondary market Trading mechanism OTC (MAE)/Merval OTC (MAE)/Merval OTC (MAE)/Merval OTC (MAE)/Merval Trading hours 9am-4pm 9am-4pm 9am-4pm 9am-4pm Quoting convention Clean price to 2 decimal places Dirty price to 2 decimal places Dirty price to 2 decimal places Dirty price to 2 decimal places Average bid-offer spreads 25-50bp 25-50bp 1-5bp 1-5bp Average trade size USD3.0m ARS5.0m ARS10m ARS10m Volume USD40m USD40m USD160m USD160m Settlement Usually T+3 Usually T+3 T+1 T+1 Clearing Caja de Valores/Euroclear Caja de Valores/Euroclear Caja de Valores Caja de Valores Main participants Local and foreign banks, foreign

investors, insurance companies, individuals, and corporations

Local and foreign banks, foreign investors, insurance companies, individuals, and corporations

Local banks, insurance companies, and mutual funds

Local banks, insurance companies, and mutual funds

Regulations for foreign investors Restriction on foreign investment FX restriction: 30% deposit in a

central bank account at 0% interest for one year

FX restriction: 30% deposit in a central bank account at 0% interest for one year

Foreign investors are not allowed to hold central bank paper.

Foreign investors are not allowed to hold central bank paper.

Custodian No Local custodian required Local custodian required Local custodian required Interest income tax No No No No Capital gains tax No No No No Entry/exit No No No No

* 30/360 in most cases Source: HSBC

16

Emerging Markets Brazil March 2011

abc

Market structure

Brazil continues to attract significant interest from

international investors, not least because its local market

provides some of the highest real yields available in

fixed income. At the same time, Brazil’s fixed income

market is comparatively deep and well-developed in

terms of available instruments and liquidity.

The main yield curves used in Brazil are derived from

the futures markets, rather than the government bond

market. DI futures are among the most actively traded

instruments in the local curve, and foreign investors can

access them through offshore CDI swaps.

As of November 2010, the local government bond

market had about USD930bn in notional held by the

public – the central bank is holding an additional

USD420bn in domestic government debt – and this was

more than 20 times larger than the external debt market

of approximately USD42bn. About USD7bn of Global

BRL bonds are outstanding, which provide investors

that have no access to local debt instruments in Brazil

with exposure to Brazilian local yields.

Over the past 10 years, Brazil’s local government debt

profile has changed significantly (see Chart 14). In

November 2010, Brazil had nearly eliminated USD-

linked local debt, from a share of more than 20% of

nominal debt held by the public in 2000. Fixed rate debt

increased from less than 10% to more than 37% over the

same period. Inflation-linked debt also has taken on a

much stronger role in Brazil’s debt management

strategy, with its share rising from less than 6% in 2000

to 28% now. Floating rate debt still plays a large role, at

34%, but its share has declined sharply over the years

from more than 60% 10 years ago. This duration

Brazil

Brazil has the largest local market in Latam by market capitalization; this

is a well-developed and deep market with some idiosyncrasies

Local bonds and CDI swaps are the most relevant instruments for

foreigner investors

Recent developments, mainly the IOF tax, have tempered investors’

appetite for Brazilian local debt, but Brazil still offers some of the highest

real yields in EM

Chart 14. Local debt composition (by notional held by public) Chart 15. Government bonds maturity profile

Inflation Linked

Floating rate

FX-Exchange

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Fixed rate

up to 1yr

1-3yr

3-5yr

5-10yr

+10yr

Source: National Treasury Brazil Source: National Treasury Brazil, HSBC

17


abc

extension of Brazil’s domestic debt stock has helped

reduce local market volatility and made debt service

more predictable. Nonetheless, there is still a long way

to go, as more than 60% of Brazil’s local debt is in

maturity buckets of less than three years (see Chart 15).

Recent developments

The IOF tax, an upfront entry tax on foreigners’

investments in fixed-income securities, was raised

to 6% from 2% in October 2010 (equity investment

still incurs the 2% levy). This measure has

significantly reduced foreign inflows into the

domestic market.

As of January 2011, foreign domestic debt

participation stood at 12%. However, the average

number understates the concentration of foreign

ownership in certain fixed-rate and inflation-linked

bonds. Nonetheless, the share is low overall,

compared to the peer group in Latam (with the

exception of Colombia).

Domestic debt financing strategy continues to target

an increase of the share of fixed-rate and inflation-

linked bonds, with an implicit gradual increase of

the duration of federal debt outstanding.

Pension fund regulation was altered in 2009 by

raising state and municipal pension funds’

minimum allocation in fixed rate funds to 70%.

They need to adjust to the new parameters by June

2011.

Monetary policy

The Banco Central do Brasil (BCB) conducts an

inflation-targeting regime. The inflation target is

currently 4.5%, with a 2% tolerance interval on either

side of the target, and measured relative to the IPCA

inflation index. The BCB regulates liquidity in the

financial system by conducting daily open-market

operations. Copom, the monetary policy committee, is

responsible for monetary policy and for setting the

short-term interest rate. To that effect, Copom meets on

scheduled dates, currently eight times per year, to

determine the target for the interest rate for overnight

interbank loans collateralized by government bonds

registered with and traded on the Sistema Especial de

Liquidação e Custódia (Selic).

The Copom also can establish a monetary policy bias at

its regular meetings; a bias to ease or tighten authorizes

the BCB governor to alter the Selic interest rate target in

the direction of the bias anytime between regular

Copom meetings.

The Copom is composed of the members of the BCB

board of directors: the central bank governor and the

deputy governors of monetary policy, economic policy,

special studies, international affairs, financial system

regulation, financial supervision, bank privatization and

administration. The BCB governor holds the deciding

vote whenever there is a split decision on monetary

policy.

Eight days following each Copom meeting, the BCB

releases the meeting minutes.

The effective Selic rate is an average of all rates traded

during the day. This rate is annualized using 252

business days (exponentially compounded) and can be

tracked through Bloomberg ticker BZSELICA.

Table 7. Brazil: Bond market technicals and liquidity

Available repo facilities Onshore banks with central bank YesOnshore interbank YesOffshore investors with onshore NoOnshore nonbank investor (eg custodian) w/ onshore NoEligible collateral for repos For CB repos Local sovereign bondsFor interbank repos Local sovereign bondsMark-to-market requirements Banks YesInsurance companies N/APension funds N/AMutual funds YesTaxation: Government bonds Onshore investors Capital gain tax bracket from 22.5%

to 15% depending on holding periodOffshore investors Exempt from capital gains unless

from tax haven, 6% IOF upfrontOffshore investors’ access Foreign ownership of government bonds YesAs % of outstanding c12%Direct purchase Only through banksSubject to cap YesRegistration requirement YesAccess to inshore funding No Access to onshore FX hedging YesAccess to rates hedging (interest rate swaps, repo, futures) YesMarket liquidity statistics Daily turnover 6.5bn BRL: LTNs 3.0bn,

NTNBs 1.8bn, NTNFs 1.3bnBuying volume in a single day (USDm) with minimal market impact

50-100

Bid/offer spreads under normal conditions (bp) 1-3 depending on maturitySource: HSBC

18


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Bonds

Federal government debt is issued by the treasury,

which manages both external and domestic debt. The

BCB may intervene in the government debt securities

secondary market for monetary or foreign exchange

policy purposes, by means of auctions or repurchase

agreements.

Domestic government debt securities today are mainly

denominated in BRL and bear fixed- or floating-rate

coupons. Additionally, there is a large portion of

inflation-linked debt.

The National Association of Financial Market

Institutions (Andima) posts secondary market prices for

the main federal domestic securities collected from the

most active market participants. Daily secondary-market

trading volume for specific securities is published

weekly in the Open Market Report published by the

BCB.

HSBC provides executable prices for Brazilian domestic

government debt securities via Bloomberg page HSBS.

BRL fixed rate debt securities

LTN (national treasury bills): This is currently the

security with the greatest secondary-market liquidity.

National treasury is currently holding weekly formal

auctions for LTNs.

Interest: Fixed.

Coupon: Zero coupon.

Amortization: Bullet at maturity.

Tenor: Generally between six months and two years,

subject to market conditions.

Volume outstanding (January 2011): BRL291bn.

NTN-F (national treasury note):

Interest: Fixed.

Coupon: Semiannual.


Tenor: Generally between five and 10 years, subject to

market conditions.


BRL Selic-indexed floating-rate debt securities

The government debt security with the greatest volume

outstanding is the financial treasury bill LFT. LFTs

bear floating-rate interest based on the Selic interest

rate, the benchmark rate in the fixed income market.

National treasury is currently holding weekly formal

auctions for LFTs.

Interest: Floating, indexed to the Selic interest rate.

Coupon: Zero coupon.


Tenor: Variable tenors, generally five years, subject to

market conditions.


BRL inflation-linked floating rate debt securities

National treasury has two types of BRL inflation-linked

debt securities. The C-series national treasury note

(NTN-C) is indexed to the IGP-M inflation index.

Currently NTN-Cs are not issued any longer.

Interest: Floating, indexed to the IGP-M inflation index.

Coupon: Semiannual.


Tenor: Originally long term.


B-series national treasury note (NTN-B) is indexed to

the IPCA inflation index, the yardstick for the inflation-

targeting regime, and is the most actively traded,

inflation-linked government debt security.

Interest: Floating, indexed to the IPCA inflation index.

Coupon: Semiannual.


Tenor: Long term, currently between two and 40 years,

subject to market conditions.


USD-linked fixed-rate debt security

National treasury can also issue USD-linked, fixed-rate

domestic securities, the most relevant of which recently

was the D-series national treasury note (NTN-D).

NTN-Ds are settled in BRL and the USD/BRL fixing

rate is the PTAX of the business day immediately

before the maturity or interest coupon date. Currently,

no NTN-Ds are outstanding, and there are no plans to

resume issuance.

19


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Global BRL bonds

Though global BRL-denominated bonds are legally

external debt, they have become popular with

international investors, because these provide exposure

to local rates without being subject to access constraints

and taxes associated with domestic debt instruments.

Hence, global BRL bonds trade at a significantly lower

yield than their domestic counterparts.

Coupon: Semiannual, currently 10.25% (BRL Global

2028) and 12.5% (2016 and 2022).


Settlement: Settled in USD according to PTAX rate two

business days prior.

Tenor: Long-term, current maturities between 2016 and

2028 outstanding; treasury plans to issue more.

Volume outstanding (January 2011): BRL11.3bn.

Derivatives

The main yield curves used in Brazil are derived from

the futures markets, instead of from the government

bond market or swap curves as usual.

DI futures

The accumulated DI-CETIP overnight interbank interest

rate is the underlying asset for the DI futures traded on

the BM&F Bovespa exchange. Liquidity is significant,

with an open position of more than 10m contracts as of

March 2011. Given that the nature of the DI-CETIP

interest rate is almost identical to that of the Selic rate,

DI futures contracts are an effective indicator of the

market outlook for the results of coming Copom

meetings. The domestic BRL yield curve is

predominantly derived from the DI futures contracts.

CDI futures are monthly futures with contract maturities

covering the next four months and quarterly cycle

months thereafter (January, April, July, and October).

The bulk of the liquidity is in January futures, followed

by the July futures; in terms of tenors, DI futures are

traded out to 10 years, but liquidity is concentrated up to

two years and then falls gradually. Contract size is BRL

100,000. Each contract stops trading on the last business

day of the month proceeding the contract month and

settles on the second business day following the last

trading day.

On the trade date, the trading price P per contract is

calculated as follows (in BRL):

where i = the traded interest rate of the contract, BD =

the number of business days between trade day and the

day before the expiration date of the contract. On any

given day after the trade date, the contract is settled as

daily settlement amount S as follows (in BRL):

where SP is the settlement price of the contract and DI

is the CETIP-DI rate corresponding to the business day

preceding the settlement. The CDI accrual factor

between any two dates is published on the CETIP

website.

Interest rate swaps

The most common interest rate swap in Brazil is the

CDI swap, also known as Pre/DI swap. Both swap legs

are denominated in BRL. The fixed leg is a

predetermined interest rate, typically the yield level on

the trade date of the contract that matches the maturity

of the CDI swap. The floating rate depends on the daily

evolution of the CDI, which is exponentially

compounded on a daily basis according to the business

day/252 convention. There is no upfront or intermediate

cash flow during the life of the swap. In the onshore

market, the P/L is settled at maturity in BRL. For

offshore CDI swaps, settlement occurs in USD using the

PTAX rate. Liquidity in CDI swaps is largest for the

most actively traded DI futures contracts. Note that

there is an onshore/offshore spread for CDI swaps

traded offshore, which currently varies between 3-25bp

depending on tenor but can change depending on market

conditions.

2520

1001

000,100BD

iP

+

=

2521

11 100

1

+×−= −

−t

ttt

DISPSPS

20


abc

Other swaps and derivative instruments

Cupom cambial (DDI-futures) are futures contracts on

the FX-adjusted DI rate. The underlying asset is the

spread between the interest rate obtained from the

difference between the accumulated daily DI rates

realized from the trade date to the last trading day, and

the corresponding variation in the PTAX rate from the

day before the trade date to the last trading day.

Cupom FRA or FRC is a forward rate agreement on

onshore USD rates, traded on the BM&F. The contract

has been designed to blend out CDI and FX risk. It

effectively consists of two DDI contracts, one maturing

in the first DDI month (short leg) and the second one in

the DDI month identical to the FRC traded month (long

leg).

Cupom-CDI swaps are cross-currency swaps with a

fixed-rate, USD-indexed leg and a floating-rate CDI leg

(in BRL).

Other derivatives include inflation-linked swaps, ie the

IGP-M/CDI swaps and the IPCA/CDI swap. However,

none of these has any meaningful liquidity now.

Interest rate options

Interest rate options in Brazil are traded as options on

DI futures and in the form of IDI options. Both are

different conceptually.

Options on DI futures are European options on DI

futures contracts. In the onshore market, these options

trade on the BM&F, and in the offshore market,

investors can enter OTC CDI swaptions. Option expiries

are typically any of the regular DI futures cycle months

(January, April, July, and September), typically up to

one-two years out. Maturities are the same cycle

months, typically three to 12 months after expiry, but

theoretically longer, as well. January and July tend to be

the most liquid maturities, the same as with the

underlying DI futures. Liquidity has already improved

over time, but it is still a nascent market. The last

trading date in a CDI swaption is the last business day

of the month immediately before the contract month.

Premium, daily adjustment and margin requirements are

settled on the next business day.

IDI options are options on the IDI index, a one-day

average DI index tracking the daily return of the DI rate.

Thus, IDI options are effectively options on the average

short-term rate over the transaction period. They are

European-style calls or puts, traded on the BM&F, and

have multiple contract months as maturity dates.


Regulation

The Foreign Capital Law defines foreign capital as any

cash funds that belong to foreign individuals or legal

entities that enter Brazil for use in “economic

activities”: investment in domestic securities and

derivatives, foreign loans to Brazil, and foreign direct

investment. Registration of foreign capital with the

Brazilian Central Bank (BCB) is required and is

essential for capital repatriation and profit remittance or

reinvestment.

Table 8. CDI swap valuation (example)

Trade settlement date 6-Jan-11Maturity date 2-Jan-15Notional (BRL) 50,000,000Fixed rate (pay) 12.05%Business days to maturity 1,005PV (BRL) 31,762,216

Unwinding the swap Unwind date 17-Feb-11Maturity date 2-Jan-15Notional (BRL) 50,000,000Unwind rate 12.54%Remaining business days 975CDI accrual 1.01247359Onshore fixed leg PV (BRL) (31,656,371)Onshore floating leg PV (BRL) 32,158,405

Onshore P&L (BRL) 502,034

Total business days 1,005USD-BRL forward 2.1062USD discount factor 0.9231Offshore fixed leg FV (BRL) (50,000,000)Offshore floating leg FV (BRL) 50,792,944 Offshore FV P&L (BRL) 792,944 Offshore FV P&L (USD) 376,481 Offshore PV P&L (USD) 347,541

Source: HSBC

21


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The most common type of foreign investment in

securities and derivatives is governed by National

Monetary Council (CMN) Resolution 2689. Eligible

securities and derivatives include fixed-income debt

securities and derivatives (exchange and OTC), such as

futures, swaps, and options.

Settlement

All securities and OTC derivatives must be registered in

a custody and settlement system authorised by the BCB

or the Brazilian Securities Commission (CVM) in their

respective areas of authority. Offshore transfers of the

ownership of these securities to other non-resident

investors are not allowed, except in cases of inheritance

or corporate reorganization (eg a merger). The HSBC

Brazilian Financial Markets Handbook has a step-by-

step of account opening procedures and account

structures. Investors also may consult other sources such

as the BM&F Web site.

Taxation

Regarding taxes on financial transactions for foreigners,

it is essential to consult with legal and tax advisers to

navigate individual circumstances.

Broadly speaking, there are three kinds of taxes on

financial operations in Brazil:

Income tax with exemption for nonresident

investors under certain circumstances.

Tax on financial activities (CPMF), which is not in

effect currently.

Tax on financial transactions (IOF). The IOF tax

was reintroduced at a flat rate of 2% in October

2009 for fixed income and equities. This rate was

raised in October 2010 to 6% for new inflows into

fixed income only.

Foreign exchange



19 January 2011.


Onshore average daily volume USD9.1trnOnshore spot transaction USD3-5mOnshore bid/ask spread 5pipsOnshore forward transaction USD3-5mOnshore forward spread 5pipsOffshore average daily volume USD0.3bn outright, USD0.6bn swapsOffshore bid/ask spread USD5mImplied option volatility spread 1-month 1.5 vols

Source: HSBC


Brazil central bank www.bcb.gov.brBrazil’s Futures and Mercantile Exchange (BM&F) www.bmf.com.brBrazil Ministry of Finance www.fazenda.gov.brBrazil’s Securities and Exchange Commission www.cvm.gov.brCETIP (clearing house) www.cetip.com.brNational Association of Fin. Market Institutions www.andima.com.brHSBC Brazilian market page HSBS <GO>Source: HSBC

Table 9. Brazil: Interest-rate swap (IRS) and cross-currency swap (CCS) markets

Onshore IRS Offshore IRS Cupom/Cambial

Nonresident access Yes Yes Yes Tenors BM&F – first business day of each

quarter (Jan, Apr, Jul, Oct) BM&F – first business day of each quarter ( Jan, Apr, Jul, Oct )

BM&F – first business day of each quarter ( Jan, Apr, Jul, Oct )

Liquid tenors Short end, Jan12, Jan13, Jan17 Short end, Jan12, Jan13, Jan17 Short end Average trade size USD10k DV01 USD10k DV01 USD10m Bid/offer spreads under normal conditions (bp) 1-3bps depending on the tenor 1-3bps depending on the tenor 5bps Fixing rate CDI, published by Cetip.

http://www.cetip.com.br CDI, published by Cetip. http://www.cetip.com.br

CDI on the BRL leg, PTAX on the USD leg

Day count Business days/252 basis Business days/252 basis Business days/252 basis on the BRL leg, actual/360 on the USD leg

Effective date Trading date Trading date Trading date Fixing time (local time) O/N rate is published daily by Cetip at

around 6pm O/N rate is published daily by Cetip at around 6pm

O/N rate is published daily by Cetip at around 6pm, PTAX published by the Central Bank at around 6pm daily

Fixing page www.cetip.com.br www.cetip.com.br www.cetip.com.br, www.bcb.gov.br Local market hours 9am-6pm 9am-6pm 9am-6pm Main participants Local banks, mutual funds, hedge funds,

foreigners, insurance companies, pension funds

Local banks, mutual funds, hedge funds, foreigners, insurance companies, pension funds

Domestic market participants

Source: HSBC



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Table 12: Brazil: Bonds

NTN-F and LTN NTN-B and NTN-C LFT

Issuer National treasury National treasury National treasury Currency Brazilian real (BRL) Brazilian real (BRL) Brazilian real (BRL) Form Scripless Scripless Scripless Minimum denomination BRL1,000 BRL1,000 BRL1,000 Tenors 1-10 years (NTN-F) – 1-2 years (LTN) 1-40 years 1-5 years Coupon/discount Fixed (NTN-F) – Zero (LTN) IPCA linked (B), IGP-M linked (C) Zero Coupon frequency Semiannual (NTN-F) – Zero (LTN) Semiannual Zero Amortizing schedule Bullet Bullet Bullet Day count Business days/252 Business days/252 Business days/252 Amount outstanding BRL 527bn BRL446bn BRL530bn

Primary market Auction style Yankee Dutch Dutch Average issue size Per month: BRL15bn (LTN), 4bn (NTN-F) BRL5bn per month BRL7bn per month Auction frequency Weekly (LTN), 2/month (NTN-F) Ad-hoc, currently 2/month Weekly Participants Brokers and banks Brokers and banks Brokers and banks Settlement T+1 T+1 T+1

Secondary market Trading mechanism OTC/BM&F OTC/BM&F OTC/BM&F Trading hours 9am-6pm 9am-6pm 9am-6pm Quoting convention Yield up to 2 (sometimes 3) decimal

places Yield up to 2 (sometimes 3) decimal places

Yield up to 2 (sometimes 3) decimal places

Average bid-offer spreads 1-3bp 1-3bp 1-3bp Average trade size BRL10m BRL20m BRL45m Volume daily BRL 3bn for LTN, 1.3bn for NTN-F BRL1.8bn for NTN-Bs BRL0.5bn Settlement T+0 T+0 T+0 Clearing Selic Selic Selic Main participants Local asset managers, foreigners, local

banks Pension funds, foreigners Local banks, money market funds

Regulations for foreign investors Restriction on foreign investment CB registration required CB registration required CB registration required Custodian Local custodian required (Selic) Local custodian required (Selic) Local custodian required (Selic) Interest income tax Exempt Exempt Exempt Capital gains tax Only if holding is less than 30 days Only if holding is less than 30 days Only if holding is less than 30 days Entry/exit IOF and CPMF IOF and CPMF IOF and CPMF


23

Emerging Markets Chile March 2011

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Market structure

With more than CLP17trn (USD36bn) in local-currency

domestic bonds outstanding, Chile’s local government

bond market is the third-largest in the region, after those

in Brazil and Mexico. In terms of access, Chile ranks

between those two markets, as access is easier in Chile

than in Brazil but it requires more red tape than Mexico

in terms of setting up custodial accounts. Liquidity is

not as high as in Brazil and Mexico, partly because the

local market is dominated by a very large system of

pension funds (AFP), which tend to be buy-and-hold

fixed-income investors. Because of all of these factors,

foreign participation is surprisingly small in the Chilean

domestic government bond market.

One surprising characteristic of the market, given the

country’s long history of inflation-targeting and

relatively low rates of inflation in the past decade, is the

high degree of inflation-linked government debt (see

Chart 16), with BTU, BCU, and PRC the main inflation-

linked instruments constituting more than 60% of all

bonds outstanding (in terms of notional). The maturity

structure of the domestic government bond stock is

well-balanced, with a relatively long average maturity.

Another idiosyncrasy of the Chilean local market is that

there are two issuers for government debt: the central

bank and the finance ministry.

In addition, Chile is one of only three markets with

liquid swap markets, and together with Mexico, is only

one of two Latam markets with a noteworthy inflation-

linked swap market.

Recent developments

In 2010, in the aftermath of the earthquake, Chile

came to the international capital markets for the

first time since 2003. The sovereign issued USD1bn

of a global dollar bond and, for the first time ever, a

CLP-denominated global bond in USD0.5bn issue

size. Both bonds are due in 2020.

The government’s stated strategy, in the

Bicentennial Capital Markets Agenda, is to increase

the depth and liquidity of the financial system and

to provide wider access. In that sense, an increase in

foreign participation through further Global CLP

issuance appears likely. On the domestic bond side,

recent legislation simplifies taxation of foreign

investors in Chile’s sovereign bonds.

Chile

Chile is the third-largest domestic market in Latam

It is one of only three markets in the region with a liquid swap market

A key characteristic is the high degree of inflation indexation

Chart 16. Local debt composition Chart 17. Government bonds maturity profile

BTP6%

PDBC17%

BCU23%

BTU38%

PRC3% BCP

13%

Nominal

Inflation-linked

up to 1yr30%

1-3yr18%3-5yr

13%

5-10yr25%

+10yr14%

Source: HSBC, Bloomberg Source: HSBC, Bloomberg

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There is a continuing trend by the regulator to

encourage local pension funds to invest abroad,

which is part of the government’s strategy to stem

appreciation of the CLP. By September 2011, AFPs

will be able to invest as much as 80% of their assets

abroad.

Monetary policy

The Banco Central de Chile (BCCh) conducts an

inflation-targeting regime. The inflation target is

currently 3%, with a 1% tolerance interval on either side

of the target, and measured relative to the CPI index,

published by the National Institute of Statistics (INE).

Maintaining inflation close to the target level is a

perennial objective in a medium-term horizon of two

years. Consistent with the adaptation of an inflation-

targeting regime, the exchange rate band was abandoned

in 1999 in favor of a free-floating regime. The BCCh

implements its monetary policy by defining a target

level for the nominal interbank interest rate (tasa de

política monetaria, or TPM). To ensure that the

interbank rate falls within the desired range, the central

bank must regulate financial system liquidity (or

reserves) through the use of several instruments: open

market operations, buying and selling short-term

promissory notes, and liquidity deposits and lines of

credits (expanded facilities). These tools also include

the banking reserve over deposits, although in practice

the BCCh does not use this as an active monetary-policy

instrument.

Policy decisions are made at monthly meetings but can

also be made at special meetings. Decisions are made by

simple vote of board members present at each meeting,

with the BCCh governor casting the decisive vote in

case of a tie. The finance minister is allowed to attend

the meetings, with a voice in deliberations and the

ability to suspend for as long as 15 days the

implementation of any resolution. Once this period has

expired, and provided the majority of board members

remain in favor, the board’s decision takes effect with

the simple publication of the resolution in the official

gazette.

The meeting minutes are made public five business days

before the next scheduled meeting, or 15 days following

the meeting, whichever comes first. The document

reports the vote of each board member on the

resolutions passed during the session.

Another important element for the BCCh’s policy

transparency is publication of the Monetary Policy

Report every four months and the Financial Stability

Report semiannually.

The central bank board is composed of five members

appointed by the president, with approval by the senate.

These appointments last for 10 years. Members can be

reappointed for another 10-year term, and positions are

renewed every two years on a rotating basis. The board

itself elects the vice governor from among its members,

and this person remains in this position for the duration

of his or her term. Both the governor and vice governor

can be reelected.

Table 13: Chile: Bond market technicals and liquidity

Available repo facilities Onshore banks with central bank YesOnshore interbank YesOffshore investors with onshore NoOnshore nonbank investor (eg custodian) with onshore NoEligible collateral for repos For CB repos Central bank bondsFor interbank repos CB, treasury, corp bonds, bank bonds Mark-to-market requirements Banks YesInsurance companies Yes, except LT hedgingPension funds YesMutual funds YesTaxation: Government bonds Onshore investors General regime, no specific taxes Offshore investors 4% WHT, 35% capital gains, bond

issued after 2010 with tax benefits without capital gains

Offshore investors’ access Foreign ownership of government bonds YesAs % of outstanding c7%Direct purchase Through banks or stockbrokersSubject to cap NoRegistration requirement YesAccess to inshore funding NoAccess to onshore FX hedging YesAccess to rates hedging (interest rate swaps, repo, futures) IRSMarket liquidity statistics Daily turnover USD 300m, different bonds

and tenorsBuying volume in a single day with minimal market impact

Depending on tenor, liquid tenors USD30m

Bid/offer spreads under normal conditions (bp) 5 for liquid tenorsSource: HSBC

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Bonds

The government issues peso- and UF-denominated

bonds in the domestic market. These issues provide

referential real and nominal interest rates for other

domestic debt. Government debt includes the debt of the

treasury department and the central bank.

HSBC provides indicative prices for Chilean domestic

government debt securities via Bloomberg page HSCH.

CLP fixed-rate debt securities

Less than 40% of Chile’s domestic government debt is

nominal fixed-rate. There are three types of nominal

fixed-rate bonds: BCP, issued by the central bank;

PDBC, zero-coupon bonds issued by the central bank;

and BTP, issued by the treasury.

BCP (Bonos del Banco Central de Chile en pesos) are

fixed-rate peso bonds issued by the BCCh. Currently, 15

bonds are outstanding, and these are tapped or issued in

regular auctions.

Interest: 3%, 6% and 8%.

Coupon: Semiannual.


Tenor: 2-, 5-, and 10-year issues.

Volume outstanding (February 2011): CLP2.3trn.

BTP (Bonos de la Tesorería General de la República

en pesos) are fixed-rate peso bonds issued by the

national treasury.

Interest: 6%.

Coupon: Semiannual.


Tenor: 5- to 10-year issues.


PDBC (Pagarés Descontabes del Banco Central de

Chile) are zero-coupon peso notes issued by the central

bank.

Interest: 0%.


Tenor: 30, 90, 180, and 360 days.


UF inflation-linked floating-rate debt securities

More than 60% of Chile’s domestic government debt is

inflation-linked. There are three types of inflation-

linked bonds: BCU, issued by the central bank; BTU,

issued by the treasury, more liquid by a relatively small

margin, and PRC, also issued by the central bank, with

coupon and redemption linked to the CPI. The

accounting unit used for inflation indexation is called

UF (unidades de fomento), and is published by the

BCCh on a daily basis; see Bloomberg ticker CHUF.

BCU (Bonos del Banco Central de Chile) are

inflation-linked bonds issued by the BCCh and

denominated in UF.

Interest: Current issues 3%, before 2007 issued with

5%.

Coupon: Semiannual, payable in CLP at the current

CLP/UF rate.


Tenor: 5-, 10-, and 20-year issues.

Volume outstanding (February 2011): CLP4trn.

BTU (Bonos de la Tesorería General de la República

en unidades de fomento) are inflation-linked bonds

issued by the national treasury, also denominated in UF.

Interest: Current issues 3%, with odd coupons between

2.1% and 4.5% for older issues.

Coupon: Semiannual, payable in CLP at the current

CLP/UF rate.


Tenor: 5- to 30-year issues.


PRC (Pagarés reajustable Cupón) are sinking-fund,

inflation-linked bonds issued by the central bank.

Amortization: Sinking fund.

Tenor: As long as 20 years.

Volume outstanding (February 2011): CLP520bn.

Global CLP bonds

Only one issue exists at present, the Global CLP 5.5%

of August 2020, with CLP 272bn outstanding. Though

formally counted as external debt, global CLP-

denominated bonds provide access to local market

yields. As in Brazil and Colombia, Global CLP bonds

trade at a significant premium over the domestic bond

curve.

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Derivatives

Chile has an active swap market, with both nominal and

inflation-linked swaps, though liquidity in nominal

swaps trading is somewhat thinner than that in Brazil

and Mexico and rather limited in UF swaps.

Cámara swaps

The most common interest rate swap is the fixed for

floating CLP x Cámara swap. The floating leg is called

Cámara. It is an overnight rate that is compounded on a

daily basis, and paid semiannually on an actual/360

basis against the fixed rate (except swaps with a tenor of

less than one year, which are typically settled at

maturity). The Cámara is calculated by taking the

weighted average of the interbank rate and is published

daily by the central bank. For the most part, the Cámara

fix really represents the banks’ funding cost, so there is

typically no or only a small basis to the monetary policy

rate set by the BCCh. The Cámara rate can be

monitored on Bloomberg using the ticker CHIBNOM.

The compound index is called ICP and can be tracked

on the Bloomberg ticker CLICP (based to September

2002). Liquidity goes from six months out to 10 years,

but tends to be higher in the short end. Typical bid-offer

spreads are 5bp but tend to go wider when volatility

increases.

Another variant is the UF x Cámara swap, where the

fixed leg becomes inflation-linked. UF x Cámara swaps

are traded out to 20 years with bid-offer spreads of 20bp

typically. There are significant hedging needs from

corporate issuers, which are users of the instrument.

UF forwards

In the OTC market, one can buy or sell one UF unit at a

future date. Prices are quoted on the Bloomberg page

HSCH => Option 3. On the maturity date, the contract

is settled by exchanging the difference between the

price agreed at the trade date and the actual value of the

UF (an index that adjusts on a daily basis), converted to

CLP using the CLP/UF exchange rate at the time of

payment (see the Bloomberg ticker CLF). Example: On

9 February 2011, the 9 August 11 UF forward is trading

at 22,000. An investor buys the contract for CLP1m.

Assume that on 9 August 2011, the UF index is at

24,000, which means the investor would stand to

receive CLP2m.

Cross-currency swaps

CLP/Libor swaps provide the ability to receive or pay a

fixed rate in CLP versus floating-rate in six-month

Libor (denominated in USD). Payments occur

semiannually, on an actual/360 basis.

Table 14. Chile: Interest-rate swap (IRS) and cross-currency swap (CCS) markets

Onshore IRS Offshore IRS Onshore CCS

Nonresident access Yes Yes Yes Tenors 1-20Y 1-20Y 1-20Y Liquid tenors 1-5Y 1-5Y 1-5Y Average trade size CLP5bn or UF300k CLP5bn or UF300k CLP5bn or UF300k Bid/offer spreads under normal conditions (bp) 5bp 5bp 5 bp Fixing rate ICP: Published by Abif, www.abif.cl Abif Abif Day count Act/360 Act/360 Act/360 Effective date T+2 T+2 T+2 Fixing time (local time) ICP: Published by Abif Abif Abif Fixing page www.abif.cl www.abif.cl www.abif.cl Local market hours 9.00-13.00 9.00-13.00 9.00-13.00 Main participants Local banks Local banks and offshore banks,

offshore hedge funds Local banks and offshore banks, insurance companies

Source: HSBC

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Regulation

Access to Chile’s domestic bond market has been

simplified but is still relatively more cumbersome than

in comparable countries. Foreign investors need to

obtain a tax identification number and typically sign a

custodial agreement with a bank or broker. At the time

of this writing, the authorities are in the middle of

implementing a new regulation to make it easier for

foreign investors to buy local sovereign debt and

simplify taxation for foreigners. Please seek legal or tax

advice before making an investment decision.

Settlement

Settlement for domestic bonds is conducted through a

central depository (DCV) and settled on T+1, swaps

settle on T+2.

Taxation

Foreign investors are subject to capital gains tax of

35%, which applies to nonresidents but not to

institutional investors. In addition, there is a 4% income

tax, which may be waived if a double taxation

agreement is in place.

Foreign exchange



19 January 2011.


Onshore average daily volume USD4.0bn spotOnshore spot transaction USD2.5bnOnshore bid/ask spread 50pipsOnshore forward transaction USD1.5bnOnshore forward spread 30pipsOffshore average daily volume USD1.0bnOffshore bid/ask spread 50pipsImplied option volatility spread 6-months 0.7 vol (USD30m)

Source: HSBC


Banco Central de Chile (BCCh) http://www.bcentral.clMinistry of Finance http://www.minhda.clNational Statistics Institute (INE) http://www.ine.clElectronic securities exchange http://www.bolchile.clSecurities commission http://www.svs.clPension fund regulator http://www.safp.clHSBC Chile page HSCH <GO>Source: HSBC



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Table 17. Chile: Bonds

BCU BTU BCP BTP PDBC

Issuer Chilean central bank National treasury Chilean central bank National treasury Chilean central bank Currency UF, settles in CLP UF, settles in CLP Chilean peso (CLP) Chilean peso (CLP) Chilean peso (CLP) Form Scripless Scripless Scripless Scripless Scripless Minimum denomination UF500 UF500 CLP5.0m CLP5.0m CLP5.0m Tenors 5, 10, and 20 years 5- to 30-year 2, 5, and 10 years 5- to 10-year Coupon/discount 3% fixed currently 3% fixed currently 3%, 6%, and 8% fixed 6% Zero Coupon frequency Semiannual Semiannual Semiannual Semiannual Zero Amortizing schedule Bullet Bullet Bullet Bullet Bullet Day count Actual/360 Actual/360 Actual/360 Actual/360 Actual/360 Amount outstanding CLP4trn CLP6.3trn CLP2.3trn CLP1.1trn CLP2.9trn

Primary market Auction style Dutch Dutch Dutch Dutch Interactive Average issue size UF3,000,000 UF3,000,000 CLP20.0m CLP20.0m CLP20.0bn Auction frequency Monthly Monthly Monthly Monthly Weekly Participants Banks, pension funds,

insurance companies, and mutual funds

Banks, pension funds, insurance companies, and mutual funds




Settlement

Secondary market Trading mechanism Exchange or OTC Exchange or OTC Exchange or OTC Exchange or OTC Exchange or OTC Trading hours 9.30-13.30 9.30-13.30 9.30-13.30 9.30-13.30 9.30-13.30 Quoting convention Yield semi act/365 Yield semi act/365 Yield semi act/365 Yield semi act/365 Yield act/30 Average bid-offer spreads

3 bp BCU 5y -10y, 5bp for others

3 bp BTU 5y -10y, 5bp for others

5bp 5bp 2bp

Average trade size UF100.000 (about USD4m) UF 100.000 CLP1bn CLP1bn CLP 1bn Volume Daily UF4m (USD160m) Daily UF4m CLP20bn CLP 20bn CLP40bn Settlement T+0, T+1, T+2 T+0, T+1, T+2 T+0, T+1, T+2 T+0, T+1, T+2 T+0, T+1 Clearing Local custodian DCV

(Deposito Central de Valores)

Local custodian DCV (Deposito Central de Valores)




Main participants Pension funds, banks, mutual funds, insurance companies, stockbrokers




Pension funds, banks

Regulations for foreign investors Restriction on foreign investment

Need to open local custody with tax ID





Custodian Interest income tax Capital gains (CG) and

withholding tax (WHT) Capital gains (CG) and withholding tax (WHT)

Capital gains (CG) and withholding tax (WHT)



Capital gains tax For offshore investors: CG 35%, bonds issued from 2010 CG 0%, subject to certain requirements

For offshore investors: CG 35%, bonds issued from 2010 CG 0%, subject to certain requirements




Entry/exit 4% of the interest received 4% of the interest received 4% of the interest received 4% of the interest received 4% of the interest received

Source: HSBC

29

Emerging Markets Colombia March 2011

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Market structure

Local debt has become increasingly relevant in

Colombia over the past 10 years. The proportion of

locally issued paper with respect to total government

debt reached 75% at the end of 2010 from only 25% in

2001.

Within local debt, fixed-rate TES is the largest paper

outstanding, also carrying the highest liquidity.

Inflation-linked UVRs trail by far in size and liquidity,

and the IPC-linked has lost its appeal since the

government discontinued its auctions.

The main market participants in the local market are

pension funds, local Banks, and brokerage houses.

Colombia arguably has the region’s lowest proportion

of foreign investors in its local market, accounting for

only c2% of the total.

Recent developments

Effective this year, foreign investors are allowed to

participate in several local market instruments,

including fixed-income paper, with much looser

requirements. Instead of having to set up a foreign

capital investment fund (FCIF), foreign investors need

only to appoint a local administrator to access the local

market. This regulatory change was made possible by

the issuance of Decree 4800. Even though this reform

represents a step to increase foreign participation in the

local market, the current 33% income tax should

continue to discourage any large flow of foreign

investment into the country.

Colombia

Fixed-rate TES is the most important local instrument, though foreign

investors are active in Global TES, as well

UVR TES (inflation-linked) face increasing demand due to rising inflation

Foreign participation in the local market is materially lower than in regional

peers

Chart 18. Colombian local government debt by currency composition Chart 19. Local debt composition by rate structure (%)

COP

COP UVR

USD

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Jun-01 Dec-02 Jun-04 Dec-05 Jun-07 Dec-08 Jun-10

6%

22%

4%

69%

COP Fixed TES IPC TES UVR Others

Source: Ministry of Finance and Public Credit Source: Ministry of Finance and Public Credit

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Monetary policy

The Banco de la República de Colombia (BanRep)

follows an inflation-targeting rule that aims to keep the

consumer price index between 2% and 4%.

The central bank implements monetary policy by

changing the overnight lending interest rate, which

either provides liquidity to the economy or withdraws

liquidity from it. Through these changes in the

overnight lending rate, BanRep affects the market

interest-rate curve.

BanRep’s board of directors consists of seven members

with one vote each: the finance minister, five full-time

members, and the bank’s general manager, who is

appointed by the other members. Full-time members

and the general manager are appointed to terms of four

years, twice renewable, which means they may remain

on the board as long as 12 years. The Colombian

president replaces two of the full-time members every

four years, halfway through the presidential term.

Under the constitution, BanRep is independent from the

other branches of government and is subject to its own

legal regulation.

Key policy rates

The benchmark monetary policy rate used by the central

bank) is the BanRep overnight lending rate; see the

Bloomberg ticker CORRRMIN.


The Colombian local debt market is composed mainly

of fixed-rate TES bonds (see Chart 19). Foreign

participation in the local fixed income market is still

significantly lower than that in other markets in the

region. The Colombian government in 2010 showed a

preference to issue COP-denominated paper over

external debt, which should result in growing foreign

participation in domestic securities. Yet regulation

continues to stand in the way of a more heterogeneous

market. The benchmark of the local TES curve is the

Coltes 2020, where most of the liquidity is concentrated.

Colombia’s debt profile looks heavily front-loaded,

compared to long-term debt obligations. Local debt

accounts for most of short-term debt payments (see

Chart 20).

Chart 20. Total debt amortization profile (USDbn)

0

2

4

6

8

10

12

14

16

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

Local

External

Source: Ministry of Finance and Public Credit

Table 18. Colombia: Bond market technicals and liquidity

Available repo facilities Onshore banks with central bank COP2.2trnOnshore interbank COP200bnOffshore investors with onshore N/AOnshore nonbank investor (eg custodian) with onshore N/AEligible collateral for repos For CB repos TES, Bonos para la seguridad, TRDs, TDAs,

Títulos de Deuda Externa, TCO, FOGAFINFor interbank repos TES, TCO, corporates, FOGAFINMark-to-market requirements Bank YesInsurance companies YesPension funds YesMutual funds YesTaxation: Government bonds Onshore investors Withholding tax over interest: 7%

less than 5Y and 4% more than 5YOffshore investors Income tax 33%Offshore investors’ access Foreign ownership of government bondsAs % of outstanding 1.527%Direct purchase NoSubject to cap YesRegistration requirement YesAccess to inshore funding NoAccess to onshore FX hedging YesAccess to rates hedging (interest rate swaps, repo, futures) YesMarket liquidity statistics Daily turnover COP6.0trnBuying volume in a single day with minimal market impact

COP200bn

Bid/offer spreads under normal conditions (bp) 2.5Source: HSBC

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Bonds

The Ministry of Finance and Public Credit is

responsible for all government debt issuance. Yet

BanRep announces the conditions of each auction one

day before the scheduled date. Fixed-rate TES and

inflation-linked UVR TES are the only two instruments

with scheduled auctions, the former issued biweekly in

sizes of about COP500bn and the latter auctioned

monthly in amounts close to COP400bn.

COP fixed-rate debt securities

Local TES B are government bonds with maturities

from one to 14 years. These instruments carry a fixed

coupon and amortize their capital at maturity. The local

TES curve is the most actively traded in Colombia.

Auctions for this paper take place twice a month.

COP inflation-linked debt securities

TES UVR (unidades de valor real) are inflation-linked

instruments with maturities ranging from one to 13

years. UVR paper carries an annual fixed coupon and

amortizes capital at maturity. The face value of these

bonds is expressed in UVR units and is adjusted by the

UVR index, which follows the consumer price index

with a one-month lag. On the 15th of every month, the

central bank resets the UVR index for the following 30

days based on the previous month’s CPI reading. The

UVR index is published daily by the central bank.

TES IPC is an inflation-linked instrument with

maturities ranging from one month to three years.

Unlike the TES UVR, the TES IPC has a floating

annual coupon that reflects the 12-month trailing CPI

rate plus a premium in basis points. The nominal

amount is measured in COP.

Global TES bonds

Global TES are COP-denominated bonds with USD

settlement and issued under foreign law. Clearing for

these instruments is available through Euroclear,

allowing foreign investors exposure to local currency

bonds without the need to comply with local

regulations. The USD/COP exchange rate that is used to

calculate coupon and principal payments is a 20-day

average of the average market rate on the third business

day before the payment.

Derivatives

Cross-currency swaps exist for both COP/USD Libor

and UVR/USD Libor.

COP/USD Libor curves extend from one to 15 years

with liquidity concentrated in two- to 10-year tenors.

The average trade size is USD10m, with bid-offer

spreads of 15-20bp.

UVR/USD Libor curves extend from one to 10 years,

with poor liquidity across the curve. Bid-offer spreads

could be as high as 100bp.

Nonresidents may access the FX forward market to

hedge currency risk on underlying investments.


Regulation

Foreign investors may access Colombian local fixed-

income instruments directly through an appointed local

administrator. The administrator can be a local broker

dealer or a fiduciary. Since the issuance of Decree 4800

in December 2010, investors are is no longer required to

have a foreign capital investment fund (FCIF).

Settlement

Government bonds are settled electronically through

Sebra/Deceval administered by BanRep. Foreign

investors must appoint a local custodian. The standard

settlement period for fixed income instruments is T+0 on

a delivery versus payment (DVP) basis.

Taxation

Foreign investors are subject to a withholding tax of 7%

for short-tenor bonds of less than five-year maturities

and 4% for long-tenor bonds of more than five-year

maturities. Withholding tax is deductible from the

income tax of 33%. Regarding gains from currency

appreciation, a 16% value-added tax is applicable to

them if and when funds are repatriated.

32


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Foreign exchange



19 January 2011.


Onshore average daily volume USD1.0bnOnshore spot transaction USD10.0mOnshore bid/ask spread COP2Onshore forward transaction USD10.0mOnshore forward spread COP3Offshore average daily volume USD500mOffshore bid/ask spread COP3Implied option volatility spread 6-month 1 vol

Source: HSBC


Banco de la Republica (BanRep) www.banrep.gov.coMinistry of Finance and Public Credit www.minhacienda.gov.coNational Statistics (DANE) www.dane.gov.coStock exchange www.bvc.gov.coSecurities commission www.superfinanciera.gov.co

Source: HSBC



33


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Table 21. Colombia: Bonds

TES Tasa Fija TES UVR Global TES TES IPC

Issuer Finance ministry Finance ministry Finance ministry Finance ministry Currency Colombian peso (COP) Colombian peso (COP) Colombian peso (COP) Colombian peso (COP) Form Scripless Scripless Scripless Scripless Minimum denomination COP500,000 UVR10,000 COP500,000 Tenors From 6 months to 14 years From 6 months to 13 years 5-10-17 years 10-15 years Coupon/discount Fixed Inflation-linked Fixed Inflation-linked Coupon frequency Annual Annual Annual Annual Amortizing schedule Bullet Bullet Bullet Bullet Day count NL/365 NL/365 NL/365 NL/365 Amount outstanding COP98.2trn COP30.3trn COP5.6trn COP5.3trn

Primary market Auction style Dutch Dutch Dutch N/A Average issue size COP500bn COP400bn N/A N/A Auction frequency Biweekly Monthly No schedule No schedule Participants Local banks and brokerage

houses (market makers program) Local banks and brokerage houses (market makers program)

Foreign banks N/A

Settlement T+0 T+0 T+3 T+0

Secondary market Trading mechanism SEN/MEC/OTC SEN/MEC/OTC OTC SEN/MEC/OTC Trading hours 8am-4pm 8am-4pm 8am-4pm Quoting convention Yield up to 2 decimal places Yield up to 2 decimal places Yield up to 2 decimal places Yield up to 2 decimal places Average bid-offer spreads 2bp 4bp 15-25bp N/A Average trade size COP5.0bn UVR20.0m COP5.0bn N/A Volume COP5.0trn COP5.0bn COP10bn N/A Settlement T+0 T+0 T+0 T+0 Clearing Sebra/Deceval Sebra/Deceval Sebra/Deceval Sebra/Deceval Main participants Pension funds, local banks,

brokerage houses, and foreign investors


Offshore banks, Pension funds, local banks, brokerage houses, and foreign investors


Regulations for foreign investors Restriction on foreign investment Need to open a trading account

with an appointed administrator Need to open a trading account with an appointed administrator

No Need to open a trading account with an appointed administrator

Custodian Local custodian required Local custodian required No Local custodian required Interest income tax Yes Yes Yes Yes Capital gains tax Yes Yes Yes Yes Entry/exit No No No No


34

Emerging Markets Mexico March 2011

abc

Market structure

Over the past 10 years, the Mexican government has

reduced the vulnerability of public debt to FX swings by

increasing the weight of fixed-rate debt in its debt stock.

During that time, the strategy has focused on increasing

the relative importance of domestic debt in the central

government’s debt portfolio. To reach this objective,

price stability and pension system reform have played

important roles to generate confidence among domestic

and foreign investors. Other factors also have

contributed to development of the local rates market,

such as credibility of monetary policy, prudent

management of fiscal accounts, and transparency of FX

policy.

Nowadays, domestic debt represents about 80% of the

central government’s debt, up from 55% in 2000. In

terms of breakdown, nominal fixed-rate debt increased

from 15% in 2000 to 58% at the end of 2010. Since

1999, the government has extended the yield curve from

a maximum maturity of one year to the current 30 years.

The weighted average maturity now stands at almost

seven years.

The Mexican debt market is one of the most liquid in

EM and has strong participation by foreign investors

and local pension funds. Foreign investors hold 22% of

the central government’s total domestic debt. Local

pension funds, Afores, hold 20% and local mutual funds

15%. The rest is distributed among local banks,

insurance companies, and other local investors.

Mexico

Domestic debt represents 80% of central government debt

Government will continue to extend the duration of its total debt portfolio

Foreign investors are exempt from withholding tax on government bonds

Chart 21. Central government debt distribution Chart 22. Domestic debt distribution by rate type

0

20

40

60

80

100

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Domestic Ex ternal

%

0%

20%

40%

60%

80%

100%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Fixed-rate

Floating-rate

Inflation-linked

Source: Ministry of Finance Source: Ministry of Finance

35


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Recent developments

Throughout 2010, public debt policy facilitated the

recovery of the local financial markets and kept a

high degree of flexibility to adapt to financial

markets changes. This contributed to the recovery

of domestic markets following the financial

disruption of 2008 and 2009. Risk indicators of the

debt portfolio have started to improve, following

deterioration during the global financial crisis. In

particular, the government has returned gradually to

the structure of securities issuance that prevailed

before the crisis.

An important factor that contributed to the recovery

of the local debt market was the inclusion of local

fixed-rate bonds, MBonos, in Citi’s World Global

Bond Index (WGBI) on 1 October 2010. Nineteen

MBonos were eligible to be included in the index

with a total market value of MXN116bn, which

represents a market weight of 0.65% of the WGBI.

The inclusion of MBonos in the WGBI fostered

several changes in the issuance policy. As the

minimum size for individual MBonos was

established at MXN10bn, the government started to

sell bonds through debt syndication. This ensures

that new issuances have larger initial amounts

outstanding, leading to better liquidity in the

secondary market and a wide allocation among

local and foreign investors. This program is only

complementary; it has not replaced the issuance

policy of weekly auctions.

In addition, foreign investors’ holdings in nominal-

fixed rate bonds increased sharply in 2010. Total

inflows to the MBonos market were MXN165bn

(cUSD13.2bn) in 2010. About 99% of these flows

were placed among the 19 MBonos eligible for the

WGBI, and more than 50% in short-term bonds

(one- to five-year bonds).

For 2011, the government’s strategy will be focused

on financing most of the fiscal deficit in the

domestic debt market favoring placement of long-

term nominal bonds and inflation-linked bonds.

In the first case, the government will focus on

strengthening the liquidity and efficiency of long-

term government securities through the bond

reopening policy that maintained a reduced number

of benchmark bonds with a considerable amount

outstanding. The syndication program will be used

for 5-, 10-, and 20-year bonds.

Regarding inflation-linked bonds, the government

aims to foster development of the real interest rate

curve due to increasing demand for these securities

originated from public sector workers’ pension

reform (ISSSTE). In that sense, the government

expects to increase gradually the share of inflation-

linked bonds in the total domestic debt portfolio in

the next few years.

Table 22. Mexico: Bond market technicals and liquidity

Available repo facilities Onshore banks with central bank YesOnshore interbank YesOffshore investors with onshore NoOnshore nonbank investor (eg custodian) with onshore YesEligible collateral for repos For CB repos Federal government bondsFor interbank repos Commercial paper, corporate bondsMark-to-market requirements Banks YesInsurance companies YesPension funds YesMutual funds YesTaxation: Government bonds Onshore investors Withholding tax of 0.5%Offshore investors Exempted when there is tax

treaty Offshore investors’ access Foreign ownership of government bonds MXN696bn (of which

MXN492bn is MBonos, MXN170bn Cetes)

As % of outstanding 23%Direct purchase YesSubject to cap NoRegistration requirement YesAccess to inshore funding NoAccess to onshore FX hedging YesAccess to rates hedging (interest rate swaps or IRS, repo, futures) Yes (IRS)Market liquidity statistics MBonos Daily turnover MXN15bnBuying volume in a single day with minimal market impact

MXN50m

Bid/offer spreads under normal conditions 3bpUdibonos Daily turnover MXN5bnBuying volume in a single day with minimal market impact

MXN30m

Bid/offer spreads under normal conditions 3bp to 5bp

Cetes Daily turnover MXN23bnBuying volume in a single day with minimal market impact

MXN200m

Bid/offer spreads under normal conditions 3bp

Source: HSBC

36


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Segregation and reconstitution of fixed-rate bonds

and inflation-linked bonds (STRIPS) has been

possible since 2005. In 2011, it appears likely that

the government will implement measures to

continue development of this market, given the

potential growth of the life annuities market.

Monetary policy

The Banco de México (Banxico) is an autonomous

entity that conducts monetary policy. Its main mandate

is to preserve the currency’s purchasing power. Back in

2001, Banxico established an inflation-targeting regime

with an objective of 3% and a variability band of +/-1%.

The operational tool to conduct monetary policy since

January 2008 has been the policy rate called the Fondeo

rate (overnight rate or tasa de fondeo). Previously,

Banxico used el corto, a money market liquidity

measure, as a monetary policy instrument based on a

target level for banks’ current account balances at the

central bank.

Banxico has a collegiate body consisting of a governor

and four deputy governors who are appointed by the

Mexican president and ratified by the senate. The

president may not remove any governing board

members from their posts. The governor and the deputy

governors serve alternately. The governor serves for six

years, starting in the middle of a six-year presidential

term and ending after the first three years of the

following presidential term. Deputy governors serve for

eight years and are replaced alternately every two years.

The Banxico board meets eight times per year. The

calendar of meetings is released on the central bank’s

Web site. Banxico releases on its Web site the minutes

of the monetary policy meetings two weeks following

each session. In addition, it releases quarterly inflation

reports about five weeks after the end of every quarter.

Banxico uses open market operations such as repos and

deposit/lending facilities. The instruments used for open

market operations are government securities: Bondes D

(floaters) and/or Cetes (bills).

Key policy rates

Fondeo rate: This is the overnight rate charged in the

interbank market. It is a representative interest rate on

one-day repo and one-day outright operations with

certificates of deposit, bank notes, and bankers’

acceptances traded by banks and stock brokerage firms

in the wholesale market. The Bloomberg ticker is

MXONBR.

Key market rates

28-day TIIE rate: The interbank equilibrium interest

rate is the benchmark rate that applies to commercial

bank loans and is published by Banxico at 12.30 pm

local time on a daily basis. To calculate it, every day

Banxico surveys seven banks between 11:45 am and

12:00 pm local time to quote MXN350m. See

Bloomberg ticker MXIBTIIE.


The size of the Mexican domestic bond market as of

November 2010 was about USD343bn, or c35% of

GDP. This amount included central government debt,

IPAB (explained below), corporate sector, public

enterprises, and agencies. Approximately 63% of the

bond market is composed of central government bonds.

The rest is explained by corporate and agency bonds.

There are eight market makers, which have the right to

participate in the “green shoe” one working day

following the weekly auction day. Market makers may

buy the smallest amount between the 20% of the total

amount placed in the primary auction for each bond, and

the total amount of eligible bids sent by the market

maker, for each bond. Eligible bids are those for which

the yield is equal to or lower than the highest yield

allocated in the primary auction, multiplied by some

factor. Also, market makers have access to the securities

lending program with Banxico for as much as 2% of the

total amount outstanding for each bond.

Foreign participation in the Mexican government bond

market jumped to 21% of the total amount outstanding

at the end of 2010, from 12% a year earlier. This was a

consequence of the inclusion of the nominal fixed-rate

bonds to the Citi’s World Government Bond Index

(WGBI), as two-thirds of the increase was concentrated

in the bonds that were eligible to the WGBI (USD13bn)

and the remainder was increased mainly in government

bills (Cetes).

HSBC provides indicative prices for Mexican domestic

government debt securities via Bloomberg page HSMX.

37


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Bonds

Federal treasury certificates (Cetes): These are zero-

coupon bonds issued by the federal government. Cetes

were issued for the first time in 1978 and constitute the

oldest instrument in the local debt market. These bonds

have been the base for development of the local market

and enlargement of the yield curve. Cetes are issued in

auctions on a weekly basis. Maturities range between

one month and one year.

Federal government development bonds (Bondes D):

These floating-rate bonds were issued by the federal

government for the first time in 2006. Bondes D pay

coupon every 28 days at the overnight effective rate,

compounded daily during the interest rate period.

Bondes D are issued in auctions every two weeks in

three- and five-year tenors.

Federal government development bonds with fixed

interest rate (MBonos): These nominal fixed-rate

bonds are issued by the federal government. The first

issuance came in 2000. MBonos pay a semiannual

coupon, which is calculated on an actual/360-day basis.

Currently, the government issues 3-, 5-, 10-, 20-, and

30-year bonds. Previously, a 7-year bond was issued,

but it was discontinued in 2007. The 3- and 5-year

MBonos are auctioned every four weeks and the 10-,

20-, and 30-year bonds every six weeks.

Federal government development bonds

denominated in inflation-indexed investment units

(Udibonos): These inflation-linked bonds issued by the

federal government are denominated in indexed

investment units (UDIs). For the purpose of placement,

interest payments, and amortization, Udibonos are

converted to domestic currency at the value of the UDI

on the corresponding settlement date. Udibonos were

developed in 1996 to protect holders from unexpected

changes in the inflation rate. The government issues 3-,

10-, and 30-year Udibonos every four weeks.

In 1995, Mexico introduced a price level-adjusting unit

of account called Unidad de Inversión (UDI). An UDI is

a unit of account of real constant value. The value of the

UDI changes every day and is calculated based on

information from the previous two weeks, which is

calculated and published by Banxico in the Official

Gazette. UDI values can be found on Banxico’s Web

site.

Savings protection bonds (BPAs): Floating-rate bonds

issued by the Institute for the Protection of Bank

Savings (IPAB), these also are called IPABONOS.

These are not government bonds, but agency bonds.

They refinance the institute’s financial needs and

improve the terms and conditions of its financial

obligations. These bonds were issued for the first time

in 2003. They are issued at a three-year tenor;

previously, they were also issued at a one-year tenor.

BPAs pay interest on a 28-day basis. The reference rate

is one-month Cetes. The interest rate period starts on the

BPAs issuing date. These periods are the same as those

of one-month Cetes issued at primary auction at the

beginning of each period. BPAs are auctioned on a

weekly basis.

Savings protection bonds with quarterly interest

payment (BPATs): These five-year floating-rate bonds

are issued by the Institute for the Protection of Bank

Savings (IPAB). BPATs pay interest on a quarterly

basis. The reference rate is the three-month Cetes, and

the interest rate period must be the same as for those

Cetes issued at primary auction at the beginning of each

period. BPTs are auctioned on a weekly basis.

Savings protection bonds with a biannual interest

payment and protection against inflation (BPA182):

These seven-year, floating-rate bonds are issued by the

Institute for the Protection of Bank Savings (IPAB).

BPA182 pay interest on a semiannual basis. The BPA

182 interest rate has two components: a market rate

(six-month Cetes), and an option that protects the holder

against inflation. That is, this eliminates any possibility

of a negative real interest rate.

Chart 23. MBonos holdings by foreign residents

200,000

250,000

300,000

350,000

400,000

450,000

500,000

Jan-08 May -08 Oct-08 Mar-09 Aug-09 Jan-10 Jun-10 Nov -10

Foreign residents

MXNm

Source: Banxico

38


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The reference rate is the rate of return on Cetes issued in

a primary auction for terms of six months. Coupon

payments are determined at the maximum between the

percentage increase in the value of the UDI over the

interest period and the reference rate and a spread over

six-month Cetes.

Derivatives

Fixed income derivatives consist of onshore and

offshore interest rate swaps and cross-currency swaps.

Interest rate swaps (TIIE swaps): This is an over-the-

counter, fixed-for-floating interest rate swap. The

floating leg is indexed to the 28-day TIIE rate. Swaps

are effective T+1. The first TIIE rate used is the T+0

rate. On the floating leg, the 28-day TIIE rate paid on

each coupon date is fixed on the previous coupon date.

The floating leg “fixes” every 28 days. This is the most

liquid fixed-income derivative traded in the local

market. The TIIE curve extends from three months to 20

years, but 3-, 6-, and 9-months, alongside 1-, 2-, 3-, 4-,

5-, 7-, 10-, 15-, and 20-years are listed, but decent

liquidity is found up to the 10-year tenor. The common

trade size is between MXN100-200m 10-year

equivalent with bid-offer spreads around 3bp.

Swaptions (TIIE swaptions): These are European

options on TIIE swaps. The notional and maturity are

agreed between parties, and for an upfront premium, the

buyer of the swaption can choose the tenor, strike rate,

and length of the option period. The option length

extends from one month to five years, but liquidity can

be found up to two years. Tenors go from one month to

20 years, with the best liquidity in the 1-, 2-, 5-, and 10-

year TIIE.

Inflation linked-interest rate swaps (UDI-TIIE

swaps): This is an interest rate swap traded OTC, where

the fixed-rate leg of the coupon is based on the UDI and

the floating leg is based on the 28-day TIIE. Coupon

payments dates are on an actual/360 day-count basis.

The UDI fixed coupon leg is payable every 182 days

based on an UDI notional amount, but payments on the

floating TIIE leg are every 28 days based on an MXN

notional amount. All payments are made in MXN, and

the UDI fixed-coupon leg is converted to MXN at the

corresponding UDI fixing as of the payment date. At the

end of the contract, principal amounts are exchanged.

The UDI notional is converted to MXN at the

corresponding UDI fixing. Tenors go from six months

to 30 years.

Another variant, which is more liquid, is the UDI-USD

LIBOR swap. This is an offshore swap that consists of

a fixed coupon denominated in UDI that is exchanged

against a floating coupon denominated in six-month

USD Libor. Coupons are paid every six months. Similar

to the TIIE-LIBOR swap, the notional is fixed at the

spot FX rate and is exchanged twice: at the beginning

and at the maturity of the swap. Tenors go from one

year to 30 years.

Cross-currency basis swap (TIIE-USD Libor swap):

This a floating versus floating swap (basis swap)

denominated in two different currencies (MXN and

USD). One leg is MXN-denominated and pays 28-day

TIIE, and the other leg is denominated in USD and pays

one-month Libor rate plus a basis swap spread.

Payments are exchanged every 28 days. Notionals are

fixed at the spot FX rate and are exchanged twice during

the contract, at the beginning and at the maturity of the

swap. Tenors go from three months up to 30 years.


Regulation

Mexico allows for the free flow of capital across its

borders. Thus, there are no barriers to entry or exit.

Foreign investors do not face restrictions to trade

government bonds. Regarding custody, offshore

investors can decide for local custody, through Indeval,

which is recognized by the US Securities and Exchange

Commission (SEC), or Euroclear or Clearstream abroad.

Derivatives trading is regulated by the International Swaps

and Derivatives Association (ISDA). Foreign investors are

required to sign a general contract in accordance with

ISDA regulation when transacting derivatives. Moreover,

depending on the type of derivative (forward, swaps, or

options), a specific contract may need to be closed in

addition to the general one.

39


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Settlement

Mexican government bonds trade both OTC and

thought the Mexican Stock Exchange. Settlement is

usually T+2; however, only for MBonos, the settlement

is allowed for up to T+8. Settlement through local

custody, Indeval, is provided by delivery vis-à-vis

payment. TIIE swaps settlement is T+1, but UDI-TIIE,

UDI-Libor or TIIE-Libor swaps are settled at T+2.

Taxation

There are no entry or exit taxes. Interest payments are

subject to withholding tax, but only in the case of

federal government bonds, foreign residents can be

exempt if there is an agreement to avoid double taxation

between both countries. Local residents are subject to

withholding tax of 0.5%. Derivatives and corporate debt

are subject to withholding tax. Interest payments to

foreign residents in tax treaty countries registered with

the finance ministry are subject to a 4.9% withholding

tax. For those in the absence of a tax treaty, the rate is

10%.

Foreign exchange



19 January 2011.


Onshore average daily volume USD5bn spotOnshore spot transaction USD5mOnshore bid/ask spread 100-130pipsOnshore forward transaction 1-month USD1mOnshore forward spread 1-month 30pips

12-month 100 pipsOffshore average daily volume USD13bn spotOffshore bid/ask spread 50pipsImplied option volatility spread 6-month 0.4 vol (USD50m)Source: HSBC


Banco de Mexico www.banxico.org.mxMinistry of Finance www.hacienda.gob.mxNational Statistics, Geography and Informatics Institute

www.inegi.gob.mx

Mexican Stock Exchange www.bmv.com.mxBanking and Securities Commission www.cnbv.gob.mxSavings for Retirement Commission www.consar.gob.mxReuters Fixing page HSMX01, HSMX02Bloomberg Fixing page HSMX1, HSMX2HSBC Mexico Web page HSMX <GO>Source: HSBC

Table 23. Mexico: Interest-rate swap (IRS) and cross-currency swap (CCS) markets

Onshore IRS Offshore IRS Onshore CCS

Non-resident access Yes Yes Yes Tenors 1-20 years 1-20 years From 3 months to 30 years Liquid tenors 2, 5, and 10 years 2, 5, and 10 years 3m, 6m, 9m, 1y to 5y Average trade size USD15,000 DV01 USD15,000 DV01 USD30m Bid/offer spreads under normal conditions (bp) 3-5bp 3-5bp 10bp Fixing rate 28-day TIIE 28-day TIIE 28-day TIIE and 1-month Libor Day count Act/360-day Act/360-day Act/360-day Effective date T+1 T+1 T+2 Fixing time (local time) 1:00pm 1:00pm 1:00pm Fixing page www.banxico.org.mx www.banxico.org.mx, www.bba.org.uk/ www.banxico.org.mx Local market hours 7am-2pm 7am-2pm 7am-2pm Main participants Interbank Foreign investors Foreign investors, Interbank

Source: HSBC

http://www.banxico.org.mx/



40


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Table 26. Mexico: Bonds

Cetes Bondes D Bonos UdiBonos TIIE swaps

Issuer United Mexican States (UMS)

United Mexican States (UMS)



Interbank agreements

Currency Mexican pesos (MXN) Mexican pesos (MXN) Mexican pesos (MXN) UDIS MXN Form Minimum denomination MXN10 MXN100 MXN100 MXN100 3x1 - 13x1: MXN100, 26x1:

MXN50, 39x1 - 91x1: MXN30, 130x1 - further: MXN20

Tenors 1m, 3m, 6m, and 1 years 3 and 5 years 3, 5, 10, 20, and 30 years 3, 10, and 30 years 3m, 6m, 9m, 1y, 2y, 3y, 4y, 5y, 7y, 10y, 12y, 15y, 20y (1y = 13 payments every 28 days)

Coupon/discount Zero coupon Fondeo rate compounded daily

Fixed rate Inflation-linked UDI Fixed coupon vs. floating 28d TIIE

Coupon frequency Zero 28-day coupon Semiannual Semiannual 28 days Amortizing schedule Bullet Bullet Bullet Bullet Bullet Day count Actual/360 Actual/360 Actual/360 Actual/360 Actual/360 Amount outstanding MXN552bn MXN425bn MXN1552bn MXN525bn N/A

Primary market Auction style Multiple rate allocation Multiple rate allocation Single rate Single rate N/A Average issue size MXN16bn weekly MXN2.0bn weekly MXN4.5bn weekly UDI 500m weekly N/A Auction frequency Weekly (1year tenor every 4

weeks) Weekly (different tenors each week)

Weekly (different tenors each week)

Weekly (different tenors each week)

N/A

Participants Banks, local funds, individuals. foreign accounts through local banks

Banks, local funds, individuals. foreign accounts through local banks

Banks, local funds, individuals, foreign accounts through local banks

Banks, local funds, individuals. foreign accounts through local banks

N/A

Settlement T+2 T+2 T+2 T+2 N/A

Secondary market Trading mechanism OTC OTC OTC OTC OTC Trading hours 7am to 2pm 7am to 2pm 7am to 2pm 7am to 2pm 7am to 2pm Quoting convention Yield up to 2 decimal places Spread over reference Yield up to 2 decimal places Yield up to 2 decimal places Average bid-offer spreads

2-4bp 2-4bp 2-4bp 2-4bp 2-4 up to 50k 4-6 for larger

Average trade size MXN100m MXN100m MXN50m MXN50m In broker market - 2k dv01 Volume MXN7-11bn MXN7-11bn MXN2-4bn 400-600k dv01 Settlement Usually T+2 Usually T+2 Usually T+2 Usually T+2 T+1 (standard TIIE settle) Clearing Local/Euroclear Local Local/Euroclear Local/Euroclear Main participants Local banks and funds,

foreign real money funds and hedge funds.

Local banks and funds, foreign real money funds and hedge funds



Local banks and funds, foreign real money funds and hedge funds .

Regulations for foreign investors Restriction on foreign investment

Not restricted Not restricted Not restricted Not restricted No

Custodian Local or Euroclear Local or Euroclear Local or Euroclear Local or Euroclear No Interest income tax Withholding tax 0.5%, but

foreign investors are exempted when there is a tax treaty

Withholding tax 0.5%, but foreign investors are exempted when there is a tax treaty



4.9% if there is a tax treaty, 10% if not

Capital gains tax Exempted when there is a tax treaty

Exempted when there is a tax treaty




Entry/exit No No No No No

Source: HSBC

41

Emerging Markets Peru March 2011

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Market structure

Peru’s economic growth has averaged 6.7% in the past

seven years. This performance includes 2009, when the

economy only grew 0.9% due to the global financial

crisis. Debt-to-GDP ratios fell from 45% in 2004 to less

than 25% at the end of 2010.

Back in 2002, domestic debt accounted for only 8% of

total debt, but today this is at 45%. In addition, fixed-

rate government debt has increased to 75.8% of total

debt from 40% in 2004. The duration of domestic

market debt is 9.4 years, one of the highest levels in the

region. The government extended the local yield curve

from five years in 2004 to more than 30 years in 2009.

The government has three goals in its debt management

policy:

To increase the share of local-currency, fixed-rate

bonds, Soberanos, in the debt portfolio to contribute

to the de-dollarization of the economy.

To reduce debt amortization payments, particularly

in the next three years.

To deepen local markets by consolidating domestic

debt.

Domestic debt totals about PEN28bn, and more than

85% of it corresponds to nominal fixed-rate bonds,

Soberanos. Participation by foreign investors is high,

and in relative terms, the highest in Latin America.

Foreign investors hold 43% of Soberanos outstanding,

and local pension funds (AFPs) have 38%. The rest is

distributed among local banks, insurance companies,

and local mutual funds.

Peru

Government will continue to focus on domestic debt issuance

Local currency bonds, Soberanos, are the main instruments in the

domestic market

Foreign participation has increased sharply in the past decade

Chart 24. Primary fiscal balance Chart 25. Distribution of central government debt

-2

-1

0

1

2

3

4

5

6

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Primary Fiscal Balance

% GDP

0%

20%

40%

60%

80%

100%

2006 2008 2010

Ex ternal Domestic

Source: BCRP Source: Ministry of Finance

42


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Recent developments

In the past seven years, the Peruvian government has

focused on reducing vulnerability of public finances

through increasing local currency-denominated debt

in the debt portfolio, particularly nominal fixed-rate

debt. Also, the government has extended the yield

curve to more than 30 years.

In 2008, Fitch and Standard & Poor’s upgraded their

sovereign ratings on Peru to investment grade, based

on the improvements in the debt profile, along with

strong macroeconomic fundamentals. In 2009,

Moody’s highlighted the improvements in the debt

profile to upgrade Peru to investment grade, as well.

More recently, S&P said that Peru could be upgraded

in 2011 due to the resilience of macro fundamentals

during the global financial crisis and high economic

growth rates with low inflation. Recently, S&P raised

its outlook on Peru’s foreign currency debt to

positive from stable. S&P may raise its rating if

Peru’s macroeconomic policies remain in place

following the presidential election in April.

Monetary policy

Monetary policy is conducted by the Central Reserve

Bank of Peru (BCRP), an independent entity with

autonomy in its functions. The bank’s purpose is to

preserve monetary stability. Its functions are to regulate

the money supply, administer international reserves,

issue notes and coins, and report on the nation’s

finances.

The BCRP board of directors is the highest institutional

authority. It is composed of seven members. The

executive branch appoints four members, among them

the BCRP president. Congress ratifies the latter and

appoints the other three members. The directors are

appointed for terms of five years. They do not represent

any particular interest or entity. Congress may remove

them from office for serious misconduct.

Since 2002, the BCRP has targeted a range for annual

headline inflation of the city of Lima with a target of

2.5% +/-1%. In 2007, it lowered the target to 2%

+/-1%. The board meets once per month to decide the

reference policy rate. Its decision and a monetary policy

statement are released when markets close. The policy

tool used by the BCRP is the reference rate.

The BCRP intervenes in the FX market to prevent any

excess volatility in the PEN FX rate by buying or selling

USD, or selling short-term central bank certificates of

deposits linked to the FX rate, or both. The main

objective of the intervention is to reduce FX volatility.

The Peruvian economy is highly dollarized; thus, sharp

FX volatility can hurt economic activity through

balance sheet effects. The BCRP does not specifically

target any particular USD/PEN level.

Table 27. Peru: Bond market technicals and liquidity

Available repo facilities Onshore banks with central bank YesOnshore interbank YesOffshore investors with onshore Yes, but with special reserveOnshore nonbank investor (eg custodian) with onshore -Eligible collateral for repos For CB repos NoFor interbank repos NoMark-to-market requirements Banks Internal requirementsInsurance companies Internal requirementsPension funds YesMutual funds YesTaxation: Government bonds Onshore investors Financial transactions tax Offshore investors Exempted from withholding tax

and capital gains tax. Financial transactions tax (0.05%) may

applyOffshore investors’ access Foreign ownership of government bonds PEN12.3bnAs % of outstanding 42.88%Direct purchase Yes, with a local custodian and

central bank’s accountSubject to cap NoRegistration requirement YesAccess to inshore funding NoAccess to onshore FX hedging YesAccess to rates hedging (interest rate swaps, repo, futures) YesMarket liquidity statistics Soberanos (LCbn) PEN140mBuying volume in a single day (USDm) with minimal market impact

USD50.5m

Bid/offer spreads under normal conditions (bp) 8bpVAC (LCbn) PEN2.5mBuying volume in a single day (USDm) with minimal market impact

USD0.9m

Bid/offer spreads under normal conditions (bp) 20bp

Source: HSBC

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Key policy rates

Interbank interest rate: This short-term rate is paid for

borrowing, usually overnight, between local banks. The

BCRP aims to keep the interbank interest rate close to

the policy rate or reference rate through daily open-

market operations


The Peruvian government, through the finance and

economy ministry, issues two types of PEN-

denominated bonds nominal fixed-rate Soberanos and

inflation-linked bonds (VAC). The nominal curve

extends from 1-31 years, and the inflation-linked bonds

curve goes from 1-35 years. Auctions usually take place

once per month in accordance with a schedule provided

by the finance ministry two business days before each

auction.

Liquidity in the local market is still poor and mostly

concentrated in Soberanos, such as the 20’s, 26’s, and

37’s. Traded volumes reach about USD1bn per month.

The total amount outstanding of local-currency bonds is

about PEN28bn, close to USD10bn. Local pension

funds (AFPs) are active in the long end of the curve

(longer than six years) and local banks in shorter tenors.

Foreign investors are more active in the long end of the

curve, too. The government has enforced a market-

makers program to improve liquidity in the local

market. There are six market makers evaluated by the

finance ministry on a monthly basis.

As of November of 2010, nonresidents held 42.8% of

total Soberanos outstanding, followed by local pension

funds with 39.1% and banks with 9.5%.

HSBC provides indicative prices for Peruvian domestic

government debt securities via Bloomberg page HSPE.

Bonds

Nominal fixed-rate bonds (Soberanos): Issued by the

finance ministry, these are the most liquid bonds. The

curve extends up to 31 years. Soberanos account for

92% of total local bonds outstanding. Coupons are paid

on a semiannual basis and are calculated on a 30/360-

day basis.

Inflation-linked bonds (VAC bonds): These are PEN-

denominated instruments issued by the finance ministry.

The principal and coupons are adjusted by the Valor

Adquisitivo Constante (VAC), which is linked to the

Índice de Reajuste Diario, or IRD index. VAC is the

ratio between the IRD at the payment date and the IRD

at the issuance date. The central bank publishes daily

figures of the IRD index. The IRD is adjusted by the

monthly CPI. Coupons are paid on a semiannual basis

and are calculated on a 30/360-day basis.

Derivatives

Cross-currency swap (PEN-LIBOR swap): This is a

fixed local rate in exchange for the six-month USD

Libor rate on a semiannual basis. Tenors go from 1-10

years, but liquidity is very poor.


Regulation

Trading FX has full convertibility and no restrictions.

Offshore investors can hold either PEN- or USD-

denominated accounts onshore. There are no capital

controls, but the BCRP has introduced measures to

contain capital inflows when strong appreciation

pressures appear. The primary objective has been

volatility management, rather to defend a specific FX

rate level.

In April 2008, the BCRP increased the marginal reserve

requirement on PEN deposits by local and foreign

investors to as high as 120% from 40%. At the time of

this writing, this measure had already been removed for

local investors, but the 120% legal reserve requirement

remains in place for foreigners.

Chart 26. Distribution of local pension funds portfolio

0

5

10

15

20

25

30

35

Local Gov ernment

Bonds

Equity Foreign assets

Sep-08

Sep-09

Sep-10

%

Source: Superintendence of Banks

44


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Settlement

Foreign investors may have a local custodian.

Government bonds are settled though the local

custodian Caja de Valores (Cavali). There are two ways

to trade Soberanos, through a local custody account or

through global depository notes (GDNs) of Soberanos.

GDNs are Euroclearable. In both cases, there is an FX

transaction, but if the client has a local custody account,

it is possible to hold PEN; thus, there is no need to do

FX transactions each time the client trades Soberanos.

To hedge FX risk, there is a fully deliverable market for

locals and an NDF market for foreigners. Total traded

volume in the NDF market is about USD400m.

Taxation

Government bonds are exempt from withholding taxes

or capital income tax. However, bond transactions

among domestic investors are subject to the financial

transactions tax (ITF), which applies at a rate of 0.05%

over the amount of the transaction. This also applies

when the foreign client has a local custody account.

Foreign exchange



19 January 2011.


Onshore average daily volume US500mOnshore spot transaction USD3mOnshore bid/ask spread 30pipsOnshore forward transaction USD3mOnshore forward spread 1m 50pipsOffshore average daily volume USD100-150mOffshore bid/ask spread 10pips (0.0010 PEN)Implied option volatility spread 2.5 vols (USD 10m)Source: HSBC


Banco Central de Reserva del Peru (BCRP) www.bcrp.gob.peMinistry of Economy and Finance www.mef.gob.peNational Statistics (INEI) www.inei.gob.peStock exchange www.bvl.com.peSuperintendencia de Banca y Seguros www.sbs.gob.peHSBC Peru page HSPE <GO>Source: HSBC


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Table 30: Peru: Bonds

Soberanos fixed rate VAC

Issuer Finance ministry Finance ministry Currency Peruvian sol (PEN) Peruvian sol (PEN) Form Scripless Scripless Minimum denomination PEN 1,000 PEN 1,000 Tenors From 1y to 31 years Up to 40 years Coupon/discount Fixed Inflation-linked Coupon frequency Semiannual Semiannual Amortizing schedule Bullet Bullet Day count 30/360-day basis 30/360-day basis Amount outstanding PEN26bn PEN2.1bn

Primary market Auction style Dutch Dutch Average issue size PEN250-300m PEN100m Auction frequency Monthly Monthly Participants Banks, market makers Banks, market makers Settlement T+1 T+1

Secondary market Trading mechanism Datatec Datatec Trading hours 10am to 1pm local time 10am to 1pm local time Quoting convention Yield up to 2 decimal places Yield up to 2 decimal places Average bid-offer spreads 10bp 20bp Average trade size PEN15m PEN2m Volume PEN150m PEN30m Settlement T+1 T+1 Clearing Cavali Cavali Main participants Banks, AFPs, foreign investors Banks, AFPs, foreign investors Restriction on foreign investment No No Custodian Local custodian not required Local custodian not required Interest income tax No No Capital gains tax No No Entry/exit No No


46

Emerging Markets Uruguay March 2011

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Market structure

Gross public debt in Uruguay as of 3Q10 totaled

USD22.8bn, or 58.6% of GDP, and central government

debt – excluding central bank and local governments –

amounted to USD15.7bn, or 40.5% of GDP.

Since 2008, the government has been committed to a

policy of accumulating liquid assets equivalent to the

next 12 months of payments, in an effort to reduce

market dependence to service debt.

High debt relative to GDP and its dollarized profile

stand as the main reasons for Uruguay’s not achieving

investment-grade status yet.

Of central government debt, 58% is US dollar-

denominated, but this portion has been reduced sharply

since 2006, when it reached 75%. The government has

committed to continue with debt de-dollarization, with

the objective to reach a 45% share of total government

debt in UYU by 2014.

As a result of several repurchase operations, as well as

exchange offerings, the government has improved the

debt profile. Now about 20.5% of debt matures in the

next five years.

Uruguay

Global UI (inflation-linked) securities are the most popular instrument

among foreign investors

The government has been increasing the proportion of local debt to

reduce the FX exposure of its liabilities

Recent debt swaps improve the debt profile for the coming years

Chart 27. Total public debt by currency Chart 28. Total public debt by coupon type

55% 2%

2% 2%

39%

UYU JPY SDR EUR USD

80%

4%

14%

20%

Fixed rate Libor Multilaterals Other

Source: Central Bank of Uruguay Source: Central Bank of Uruguay

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Recent developments

In 2010, all main rating agencies upgraded

Uruguay’s sovereign debt rating, leaving it in most

cases only one notch away from investment-grade

status.

In 2010, the government expressed objectives of

further reducing the proportion of USD-

denominated debt and enhancing liquidity in the

domestic market. As part of this strategy, in January

2011, the government issued USD1.2bn in both

UYU- and CPI-linked (UI) securities, mainly as

part of an exchange for central bank paper. The

exchange resulted in the extension of maturities and

the issuance of USD136m of fresh financing.

Almost all off the new issuance was subscribed by

local investors: 42% by local banks and 40% by

pension funds.

The Budget Law for the next four years indicates

that, market conditions allowing, the government

seeks to increase the percentage of debt in local

currency from 30% at the end of 2009 to 45% at the

end of 2014.

In addition, to reduce foreign-exchange exposure,

the government has funded itself with issuance of

local currency instruments in the domestic market

in 2010.

The central bank and the Ministry of Economics

and Finance are working together to allow local

instruments to settle via Euroclear, rather than a

local custodian. A project is under way to develop

market makers for local debt instruments.

Monetary policy

The Central Bank of Uruguay follows a monetary policy

rule based on an inflation-targeting regime, which

establishes a target range between 4-6% for 2011 and

uses the overnight interbank rate as its key policy

instrument.

Yet the government’s implicit objective is the real

exchange rate. The aim is to achieve the highest level of

competitiveness compatible with a reasonable inflation

level that at times could be outside the target range for

inflation. In this sense, we consider the current

consensus expectation of inflation at 6.8%% y-o-y for

2011 as tolerable for the central bank.

Considering the relatively small credit market in local

currency and the high level of dollarization of the

economy, we do not see the reference rate as the main

effective instrument to anchor inflation expectations.

Central bank officials recognize that monetary

aggregates are the ultimate target, and that the level of

interest rates should be compatible with those targets.

Chart 29. Debt profile

0

500

1000

1500

2000

2500

IV.10 I.1

1II.1

1III.

11IV

.11 I.12

II.12

III.12

IV.13 20

1320

1420

1520

16

Amortizations

Interests

Source: Uruguayan central bank

Table 31. Uruguay: Bond market technicals and liquidity

Available repo facilities Onshore banks with central bank YesOnshore interbank YesOffshore investors with onshore N/AOnshore nonbank investor (eg custodian) with onshore N/AEligible collateral for repos For CB repos T-billsFor interbank repos T-billsMark-to-market requirements Banks YesInsurance companies YesPension funds YesMutual funds YesTaxation: Government bonds Onshore investors NoOffshore investors NoOffshore investors’ access Foreign ownership of government bonds N/AAs % of outstanding N/ADirect purchase NoSubject to cap NoRegistration requirement YesAccess to inshore funding Access to onshore FX hedging YesAccess to rates hedging (interest-rate swaps, repo, futures) YesMarket liquidity statistics Daily turnover (USDm) 10.0Buying volume in a single day (USDm) with minimal market impact 1.0Bid/offer spreads under normal conditions (bp) 50

Source: HSBC

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Key policy rates

Interbank interest rate: The average market interest

rate (TMM) is derived from overnight interbank

operations, including the central bank. The monetary

policy rate (TPM) works as a target for the TMM so that

the interbank rate does not deviate more than 50bp from

the target on a daily basis.


In Uruguay, both the government and the central bank

issue bonds. They each sell nominal and inflation-linked

bonds. The central government issues bonds locally and

abroad. Locally, the government also sells bonds

denominated in US dollars, and in international markets

it sells global and inflation-linked bonds. The central

bank sells bonds only locally.

HSBC provides indicative prices for Uruguay’s

domestic government debt securities via Bloomberg

page HSUY.

Bonds

Inflation-linked bonds

Unidad Indexada (UI) is a daily index based on the

consumer price index published by the national statistic

bureau (INE) on a monthly basis. The index is based at

1 on June 2002 and varies on a daily basis according to

the following formula, in which d represents the day, M

the month, and DM the number of days of month M:

UId,M= UI5,M-1 ((IPCM-2)/(IPCM-3))^(d+DM-1 -5/DM-1)

for every 1<d<5

UId,M= UI5,M ((IPCM-1)/(IPCM-2))^(d-5/DM) for every

6<d<31

Central bank monetary regulatory notes (letras de regulación monetaria): These are zero-coupon bonds

issued both in UYU and in UI. Tenor may vary; both are

mainly shorter than two years. The total amount

outstanding is about USD1.9bn. Issuance is about

USD5m equivalent on average per auction. Weekly

auctions that are periodically preannounced.

Central bank notes in UI. These notes have fixed-rate

coupons and are issued in tenors that from one to five

years.

Treasury notes and bonds in UI: Fixed-rate bonds are

issued by the central government in UI. Tenors usually

go from five to 10 years. Issuance is about USD60m per

week. Weekly auctions are periodically preannounced.

Global UI bonds: These instruments were issued in the

international market and belong to the external debt

category. Though payments of interest and principal

occur in USD, the Global UI bonds are inflation-linked

securities in local currency.

These instruments benefit from the fact that no local

requirement applies to foreign investors. Being

Euroclearable, they trade at a significant premium with

respect to similar local instruments.

Interest: Semiannual payments are payable at an annual

rate of 5.00% on the principal amount outstanding of the

bonds as adjusted to reflect Uruguayan inflation from the

issue date through the relevant interest payment date.

Amortization: Bullet at maturity. The redemption

amount is equal to the principal amount outstanding of

the bonds as adjusted to reflect Uruguayan inflation from

the issue date through the maturity date.

Tenor: Long-term, current maturities between 2018 and

2036.

USD local debt

Fixed-rate treasury bonds in USD: These are bonds

issued locally by the central government and

denominated in USD. Tenors usually go from one to

two years. These bonds are generally liquid.

Derivatives

Cross-currency swap exists for UYU/USD Libor.

Tenors extend to three years, yet most of the liquidity,

which is usually thin, is found in the one- or two-year

tenor. Settlement takes place over the counter (OTC).

49


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Regulation

Foreign investors need to appoint a local custodian to

settle local debt securities. Custody of local securities,

both in UYU and USD, is concentrated by the central

bank. Yet some private institutions are starting to offer

custody services to investors.

As mentioned above, a project is under way to allow

foreign investors to access the local market via banks

and brokers and settle them via Euroclear.

There are no capital controls regarding foreign portfolio

investments.

Settlement

Settlement can take place over the counter (OTC), via

the Montevideo stock exchange (BVM) or the electronic

exchange (BEVSA). Settlement is typically done on a

T+0 basis, but parties can also agree on T+1 or T+2.

Taxation

There is no taxation related to local debt securities

traded by foreign investors.

Foreign exchange


Markets Currency Guide 2011: A guiding light, 19

January 2011.


Onshore average daily volume USD20mOnshore spot transaction USD0.3mOnshore bid/ask spread 5pipsOnshore forward transaction USD1.0mOnshore forward spread 5pips

Source: HSBC


Banco Central de Uruguay (BCU) www.bcu.gub.uyMinistry of Economy and Finance www.mef.gub.uyNational Statistics (INE) www.ine.gub.uyMontevideo Stock exchange www.bvm.com.uyElectronic Stock Exchange www.bevsa.com.uyHSBC page HSUY <GO>

Source: HSBC


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Table 34: Uruguay: Bonds

Treasury notes in UI Treasury notes in UYU Global CPI linked Local USD

Issuer Finance ministry Finance ministry Finance ministry Finance ministry Currency Inflation-linked UYU CPI-linked (traded in USD) USD Form Scripless Scripless Scripless Scripless/physical Minimum denomination UI1 UYU1 UYU1 USD0.01 Tenors From one month up to 15 years 3-8years 2018, 2027, 2030, 2037 1 month to 9 years Coupon/discount Coupon Coupon Coupon Coupon Coupon frequency Semiannual Semiannual Semiannual Semiannual Amortizing schedule Bullet or amortizing (1/3 per year

in last 3 years) Bullet Bullet or amortizing (1/3 per year

in last 3 years) Bullet or amortizing (1/3 per year in last 3 years)

Day count 360 360 360 360 Amount outstanding USD2.3bn UYU11bn UYU3.8 USD850m

Primary market Auction style Dutch single price No schedule No schedule No schedule Average issue size UI250m N/A N/A N/A Auction frequency 3 times a week N/A N/A N/A Participants Local banks N/A N/A N/A Settlement T+1 N/A N/A N/A

Secondary market Trading mechanism OTC/BVM/BEVSA OTC/BVM/BEVSA OTC/BVM/BEVSA OTC/BVM/BEVSA Trading hours 10.00-17.00 10.00-17.00 Global 10.00-17.00 Quoting convention Yield up to two decimal places Yield up to two decimal

places//Prices Yield up to two decimal Price

Average bid-offer spreads 5-10bp 5bp//5pips 1bp 10pips Average trade size UI5m (USD50k) UYU20m (USD1.1mn) USD1m USD100k Volume UI10m (USD1m) UYU5m (USD260k) USD500k Settlement T+0, T+1, T+2 T+0, T+1, T+2 T+3 T+0, T+1, T+2 Clearing BEVSA/BVM/BCU BEVSA/BVM/BCU Euroclear BEVSA/BVM/BCU Main participants Pension funds, local banks,

insurance companies, and brokerage houses

Pension funds, local banks, insurance companies, brokerage houses, and foreign investors

Local and foreign pension funds, local Banks, insurance companies, brokerage houses, and foreign investors

Pension funds, local banks, insurance companies, and brokerage houses

Regulations for foreign investors Custodian Local custodian required, final

custody on BCU Local custodian required, final custody on BCU

Euroclear Local custodian required, final custody on BCU

Interest income tax No No No No Capital gains tax No No No No Entry/exit No No No No


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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Pablo Goldberg, Gordian Kemen, Hernan Yellati and Alejandro Martinez-Cruz

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Pablo Goldberg Head of Global Emerging Markets Research +1 212 525 8729 [email protected]

EM Fixed Income Research

Americas Gordian Kemen Chief Strategist, Latin America +1 212 525 2593 [email protected]

Alejandro Mártinez-Cruz +52 55 5721 2380 [email protected]

Hernan M Yellati +1 212 525 3084 [email protected]

Asia André de Silva, CFA Head of Rates Research, Asia-Pacific +852 2822 2217 [email protected]

Virgil Esguerra +852 2822 4665 [email protected]

Ki Yong Seong +852 2822 4277 [email protected]

EMEA Di Luo +44 20 7991 6753 [email protected].

EM Currency Strategy

Asia Richard Yetsenga Global Head of EM Currency Strategy +852 2996 6565 [email protected]

Daniel Hui +852 2822 4340 [email protected]

Perry Kojodjojo +852 2996 6568 [email protected]

Americas Clyde Wardle +1 212 525 3345 [email protected]

Marjorie Hernandez +1 212 525 4109 [email protected]

Economics

Latin America Javier Finkman Chief Economist, South America ex-Brazil +54 11 4344 8144 [email protected]

Andre Loes Chief Economist, Brazil +55 11 3371 8184 [email protected]

Sergio Martin Chief Economist, Mexico +52 55 5721 2164 [email protected]

Ramiro D Blazquez +54 11 4348 5759 [email protected]

Lorena Dominguez +52 55 5721 2172 [email protected]

Marcos Fernandes +55 11 3847-9787 [email protected]

Constantin Jancso +55 11 3371-8183 [email protected]

Jorge Morgenstern +54 11 4130 9229 [email protected]

Emerging Europe, Middle East and Africa Murat Ulgen Chief Economist, Central & Eastern Europe, and sub-Saharan Africa +90 212 376 4619 [email protected]

Simon Williams Chief Economist, Gulf Markets +971 4 507 7614 [email protected]

Liz Martins +971 4 423 6928 [email protected]

Alexander Morozov +7 495 783 8855 [email protected]

Asia Pacific Qu Hongbin Managing Director, Co-head Asian Economics Research and Chief Economist Greater China +852 2822 2025 [email protected]

Frederic Neumann Managing Director, Co-head Asian Economics Research +852 2822 4556 [email protected]

Leif Eskesen Chief Economist, India & ASEAN +65 6239 0840 [email protected]

Paul Bloxham Chief Economist, Australia and New Zealand +61 2925 52635 [email protected]

Song Yi Kim +852 2822 4870 [email protected]

Donna Kwok +852 2996 6621 [email protected]

Sherman Chan +852 2996 6975 [email protected]

Wellian Wiranto +65 6230 2879 [email protected]

Global Emerging Markets Research Team

mailto:[email protected]





Disclaimer & Disclosures This report must be read with the disclosures and the analyst

certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Pablo Goldberg

Head of Global EM Research


[email protected]

+1 212 525 8729

Pablo A. Goldberg is global head of HSBC emerging markets research. He joined the firm in 2008 as head of Latin American fixed income

research. Pablo is responsible for working across asset classes to build opportunities for HSBC’s emerging markets franchise

with research strategy ideas across regions. Prior to joining HSBC, he held similar positions at other international investment banks for

about 15 years. Pablo has a master’s degree in economics from the London School of Economics.

Gordian Kemen

Chief Strategist, Latam FI


[email protected]

+1 212 525 2593

Gordian Kemen is the chief strategist for HSBC’s Latin American fixed income strategy team. He joined the firm in May 2009. Previously,

he had roles in emerging-market research at two major investment banks in London and New York, and he was a lecturer and researcher

in finance at the University of Mannheim, a German business school. He holds a graduate degree in economics from the University of

Konstanz, Germany, and has conducted postgraduate research in finance at the University of Mannheim.

Alejandro Martinez-Cruz

Latam FI Strategist

HSBC Mexico S.A.

[email protected]

+52 55 5721 2380

Alejandro Martinez-Cruz joined HSBC Mexico in 2007 as as member of the fixed income strategy team, and since 2009 has focused on

strategies and trade recommendations in fixed income markets in Mexico, Peru, and Central America. Previously, he was a financial

markets analyst, including a position at the Mexican central bank. He received a master’s degree in economics from the University of

Rochester in the US.

Hernan Yellati

Latam FI Strategist


[email protected]

+1 212 525 3084

Hernan Yellati is a member of the HSBC fixed income strategy team, focusing on the Latin American region. He joined HSBC Argentina

in 2003 as deputy chief economist and moved to the New York office in 2008. Before joining HSBC, Hernan received a master’s

degree in economics from Pompeu Fabra University, and he is a Ph.D. candidate in economics from Birkbeck College, University

of London.

Latin America RatesGuide 2011Exploring Latam instruments, regulations and market conventions

Emerging Markets

Fixed Income Research

March 2011

110309_37261_F1:Layout 1 3/10/2011 2:33 AM Page 1

Latin America Instrument and Market Guide - HSBC

Documents

Transcript of Latin America Instrument and Market Guide - HSBC