2012 Guide to EM Local Markets

Transcription

GEMs Paper #10
Primer
GEM Fixed Income Strategy & Economics | Global
12 September 2012
2012 Guide to EM Local Markets
Alberto Ades

In-depth investment guide to better understand each market
This guide aims to assist the growing investor base in emerging local markets, an
asset class that combines attractive opportunities with some significant
challenges. While we do not make specific investment recommendations, the
guide leverages BofA Merrill Lynch’s GEM research team to provide a clearer
understanding of the intricacies and pitfalls present in these growing markets.
Jane Brauer
Increasing investor demand
Flavio de Andrade
Foreign investor interest in emerging markets has increased consistently in recent
years. Continued interest in these countries is due in part to uncertainty
surrounding the developed economies, as well as strong fundamentals across
emerging markets in general. The appeal not only lies in the healthier balance
sheets and more fiscally responsible attitudes of these countries, but also in the
attractive growth and interest differentials of their asset markets. Specifically, local
debt markets (LDM) have become an attractive asset class as investors seek
alternative investment opportunities amid converging inflation. LDMs offer
opportunities for debt income through coupons, price and currency appreciation.
Unauthorized redistribution of this report is prohibited. This report is intended for [email protected].

High historical returns
From January 2001 to today, local currency bonds in the emerging markets
generated a cumulative return of 199.9% for an unhedged investor, compared to
88.7% invested in US Treasuries over the same period. Additionally, the Sharpe
ratio for local currency debt for a USD investor was 1.25, but for US Treasuries
only 0.71. The stock of domestic sovereign debt dropped 2% to US$5.5tn in 2011.
Among the three regions, Asia claims the majority of LDM issues, although capital
controls make the region relatively less accessible to foreigners. Emerging
Europe, the Middle East and Africa (EEMEA) is the most accessible region, and
Latin America generally offers the highest yields and total returns. We report
monthly on local bond performance through BofA Merrill Lynch country indices.

GEM FI Strategist, Economist
MLPF&S
Capital controls
While opportunities are abundant, understanding the characteristics of every market in
each region is difficult. An important issue for various governments is the excessive
inflow of capital that strengthens their currencies and interferes with economic policy.
In response to that, some policy makers may intervene and impose measures to
discourage such flows, adding to the challenge of investing in LDMs.
Quantitative FI Strategist
MLPF&S
David Beker
Brazil Economist, FI Strategy
Merrill Lynch (Brazil)
LatAm FI Strategist
MLPF&S
Bin Gao
Rates Strategist
Merrill Lynch (Hong Kong)
Vasileios Gkionakis
MLI (UK)
David Hauner, CFA
EEMEA FI Strategist, Economist
MLI (UK)
Claudio Irigoyen
LatAm FI Strategist
MLPF&S
Albert Leung
Emerging Asia FI Strategist
Claudio Piron
Merrill Lynch (Singapore)
Arko Sen
EEMEA FI Strategist
MLI (UK)
Christy Tan
Emerging Asia FX Strategist
See Team Page for Full List of Contributors
c58da9b710df662c
Trading ideas and investment strategies discussed herein may give rise to significant risk and are not suitable for all investors. Investors should have experience in
FX markets and the financial resources to absorb any losses arising from applying these ideas or strategies.
BofA Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm
may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision.
Refer to important disclosures on page 206 to 207. Link to Definitions on page 204.
11201538
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Contents
Introduction
Overview
Stock of debt
BofAML local market bond indices
EM FX performance contributes
Capital controls
GEM surprise indices
Economic conditions & PMI indices
Asia countries
China
Hong Kong
India
Indonesia
Korea
Malaysia
Pakistan
Philippines
Singapore
Sri Lanka
Taiwan
Thailand
Vietnam
EEMEA countries
Czech Republic
Egypt
Hungary
Israel
Poland
Russia
South Africa
Turkey
LatAm countries
Argentina
Brazil
Chile
Colombia
Mexico
Peru
Appendix
5
6
7
10
12
13
14
14
23
24
34
40
46
52
58
66
70
76
82
88
96
102
107
108
114
118
124
130
136
142
148
155
156
164
172
180
186
194
200
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4
GEMs Pa pe r #1 0
Introduction
Welcome to the 2012 edition of our very comprehensive Guide to EM Local Markets!
This guide aims to assist the rapidly growing investor base in emerging local
markets, an asset class that combines attractive opportunities with some
significant challenges. From January 2001 to today, local currency bonds in the
emerging markets generated a cumulative return of 199.9% for an unhedged
investor, compared to an 88.7% return for those invested in US Treasuries.
Additionally, the Sharpe ratio for local currency debt for a USD investor was 1.25,
but only 0.71 for US Treasuries.
Although we do not provide specific recommendations here, we leverage BofA
Merrill Lynch’s GEM research team and our significant local presence in many
emerging markets to help provide a clear understanding of the intricacies and
pitfalls present in these markets, which we expect will continue to offer interesting
opportunities.
While opportunities are abundant, understanding the characteristics of every
market in each region is difficult. An important issue for various governments is
the excessive inflow of capital that strengthens their currencies and interferes with
economic policy. In response to that, some policy makers may intervene and
impose measures to discourage such flows, adding to the challenge of investing
in LDMs. We cover these and other related issues extensively in our guide.
We have introduced some important changes to this year’s edition, expanding
and homogenizing the discussion on policies and markets for all 27 countries that
we cover in the guide. We now include access issues in local bonds, local
interest rate derivatives, foreign exchange spot and foreign exchange derivatives.
For each market, we address the liquidity, depth, primary instruments, ease for
foreign investor participation and main participants. For a foundation on monetary
policy, we include the main drivers that affect each economy, current policy
framework, base policy rate, open market operations, lending and deposit
facilities, reserve requirements, and a long-term historical perspective. For fiscal
policy, we include government size and participation, evolution, financing needs,
debt profile and debt issuance. We also include the CNH offshore market in
addition to the CNY market.
Special thanks go to Jane Brauer, who coordinated this effort.
We hope you enjoy our guide and look forward to your feedback.
Best regards,
Alberto Ades
Head of GEMs Fixed Income Strategy and Co-head of Global Economics
5
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Overview
Jane Brauer
Local debt markets (LDM) have made great strides in the last 15 years. As of
September 2011 the outstanding stock of local market domestic government debt
amounted to US$5.5tn, compared to just US$0.8tn in December 1997. By far the
largest market in absolute terms is mainland China, with US$1.4tn in outstanding
government debt, followed by Brazil (US$0.8bn) and India (US$0.6bn).
It is clear from this that local currency government debt markets have become an
important source of domestic financing for emerging economies. However, the
size of debt stock should not be taken as a good guide to the underlying liquidity
and functioning of debt markets.
Chart 1: Outstanding debt in USDbn by local
governments and corporates
10000
Corporate
Sov ereign
9000
8000
LDM investment considerations
7000
While the variety of local bonds open to foreign investors may be familiar, there
may be regulations that could lead to capital controls and convertibility risk for
foreign investors. Countries have different regulations, laws and limits for foreign
investment, typically including the need to set up a local account, hire a local
custodian, report activity to the local regulator and pay taxes, if applicable. Also,
each country has its own requirements.
6000
5000
4000
3000
2000
1000
0
1995
1998
2001
2004
2007
2010
Source: BofA Merrill Lynch Global Research, BIS
Table 1: Barriers to cross-border investment
and settlement
(Regulatory barriers)
1 Foreign investor quota
2 Foreign investor registration
3 Currency exchange controls
4 Cash controls-credit balances, overdrafts
5 Tax
6 Omnibus accounts restrictions
7 Regulatory framework
8 Legal framework
9 Local custodian required
(Settlement barriers)
1 Messaging standards
2 Securities numbering
3 Settlement cycle
4 Trade and settlement matching
5 Physical certificates
Source: ADB, BofA Merrill Lynch Global Research
6
Local bond types issued by emerging market countries are no different in nature
than those issued by developed markets. While calculating conventions may
differ, foreign investors normally have access to several debt instruments
denominated in local currency. The most common instruments are fixed-rate
bonds (coupon bonds); fixed-rate notes or bills (zero-coupon bonds sold at
discount); inflation-linked bonds; floating bonds, which are linked to the reference
interest rate or to a market rate close to the reference interest rate; and, in some
cases, foreign exchange-linked bonds, which are linked to a hard currency but
payable in local currency.
For example, some countries limit the amount and/or the type of bonds that
foreign investors can hold, while others impose taxes on capital inflows, have
minimum holding periods or intervene heavily in the foreign exchange market,
and so on (see page 13 for more on capital controls). In some cases, local trading
conventions differ from the international conventions, adding another layer of
caution when trading a local debt instrument.
Even on this basis, investors will need to weigh the relative merits of potential
withholding taxes, clearing and settlement accessibility, and whether they are
included in key global benchmark bond indices. The country sections in the
following pages are intended to guide investors through this maze.
Additionally, policy makers and debt management offices have worked hard to
establish benchmark curves as a means to improve secondary trading. This has
been achieved through coordinated auction schedules, bond buybacks, and
switches to maintain liquidity and benchmarks. Active and liquid interest rate
swap markets are also available for investors hedging in many local markets.
Measures such as average bid-offer spreads and the bond turnover ratio (the
value of bonds traded divided by the average amount of bonds during the
quarterly period) provide a good indication of the accessibility and liquidity of the
underlying markets.
GEMs Pa pe r #1 0
Table 2: Foreign investor holdings of local debt in major GEM local bond markets
Change in LOC (bn)
Holdings USD (bn) Holdings LOC (bn)
1Y
2Y
Asia
India
Indonesia
Malaysia
South Korea
Thailand
EEMEA
Turkey
Poland
Egypt
Israel
Hungary
LatAm
Brazil
Mexico
Peru
Change in LOC (%)
1Y
2Y
Outstanding
As of
4.8
25.1
38.0
49.7
11.6
236.8
235660
115.0
58518
357.6
18
-13210
27.18
1715
166.07
143.64
63440
57.12
19915
252.01
0.9%
29.5%
39.1%
16.4%
12.6%
-0.1%
-6.1%
6.0%
-0.5%
5.2%
0.3%
2.1%
12.3%
3.8%
7.9%
3/1/2012
7/2/2012
5/1/2012
6/1/2012
5/1/2012
44.5
47.2
0.2
5.3
19.8
79.83
167.7
1.47
20.59
4543
13.62
15.66
-23.15
7.68
821.9
38.40
64.70
-44.69
9.83
2331.2
21.1%
31.4%
0.4%
4.9%
40.3%
2.9%
3.0%
-7.0%
1.5%
1.9%
9.1%
10.4%
-15.6%
2.0%
18.9%
7/31/2012
5/31/2012
4/30/2012
6/30/2012
7/31/2012
111.0
64.6
6.7
224.7
834.9
17.58
34.0
221.25
5.56
72.16
457.39
13.58
12.3%
48.6%
51.4%
0.8%
10.6%
12.2%
2.2%
22.4%
35.5%
7/18/2012
5/1/2012
5/1/2012
Source: BofA Merrill Lynch Global Research
Foreign ownership is increasing
Following the 1997 Asian crisis, foreign investment has cycled out and back in
again. Foreign ownership of classes of outstanding government bonds has been
increasing to unprecedented levels, with Peru, Mexico and Hungary up 36%, 22%
and 19%, respectively. The highest concentrations of foreign ownership are in
Peru (51%), Mexico (49%), Hungary (40%), Malaysia (39%), Indonesia (29%),
Poland (31%), Turkey (21%), Korea (16.4%) and Thailand (12.6%) (Table 2). The
net effect of this is that with the increase in the share of outstanding bonds held
by foreigners, domestic yields have declined significantly.
Stock of debt
Jane Brauer
GEM debt stock has been growing 17% per year for 10 years
The total global emerging market (GEM) tradable debt universe increased
another 7% in 2011 to reach a new high of US$11.7tn total debt outstanding
(Table 3). It followed 16% yoy growth in 2010. On average, total GEM debt stock
has grown approximately 17% per year since 2002 and 14% per year since 1994.
Growth in 2011 was due to increased government funding needs, opportunistic
issuance by corporates to fund expansion, and global and GEM-specific demand
for fixed income debt, as fundamental improvements in most emerging countries
provided an attractive alternate to increased risk in developed markets.
Domestic market dominates
Corporate and government debt are mostly in local currency bonds. Domestic
debt (US$9.85tn, up 6%) accounts for approximately 84% of total GEM debt
outstanding, and most of that is government debt (Chart 3). Domestic government
debt accounts for approximately 47% of all GEM debt, followed by domestic
corporate debt at 37% (Chart 3). As a whole, corporate debt has assumed a
much greater stake in GEM debt. Corporate debt grew 17% to US$5.5tn in 2011.
Total government debt outstanding decreased 1% (Table 3).
Table 3: GEM tradable domestic debt (US$bn)
2005
2006
2007
Government
Corporate
Total
2856
1268
4124
3515
1594
5109
4317
1989
6306
2008
4136
2372
6507
2009
4951
3113
8064
2010
5599
3727
9326
2011
5488
4364
9853
Note: Domestic corporate and financial debt from BIS for Brazil, India and Philippines included only debt with maturity <1y, so it was increased by
outstanding debt with maturity >1y but only since 2008; As of September 2011. BIS local market data is reported on a lagged basis of 6-9 months.
Source: BIS, BofA Merrill Lynch Global Research
7
GEMs Pa pe r #1 0
Table 4: Country domestic debt stock (USDbn)
Country
Sovereign
Corporate
Asia
China
Hong Kong
India*
Indonesia
Korea
Malaysia
Philippines
Singapore
Sri Lanka
Taiwan
Thailand
Vietnam
EEMEA
Czech Rep
Egypt
Hungary
Israel
Poland
Russia
S Africa
Turkey
Latin Am
Argentina
Brazil
Chile
Colombia
Mexico
Peru
Fin Inst.
Total
1376
3232
557
92
478
125
64
214
7
189
6
960
104
86
10
73
5
284
79
152
171
65
58
37
3
254
233
59
9
18
86
61
106
192
113
122
196
0
51
75
25
2
10
46
12
39
32
1
71
203
203
226
179
199
48
847
51
78
270
20
6
85
27
2
36
3
7
139
1
85
80
445
24
As of 30 September 2011; BIS local market data is reported on a lagged basis of 6-9 months.
Domestic debt heavily concentrated in a few countries
China, Brazil and South Korea comprise almost 60% of domestic debt. Now at
US$3.2tn, China domestic debt grew 6.6% as of 3Q11, on top of the 18% in 2010
and 16% in 2009. China alone has risen to 33% of domestic debt, which is larger
than all of LatAm’s domestic debt. The BRIC countries (Brazil, Russia, India and
China) comprise 60% of all domestic GEM debt, while the GEM-10 (Brazil,
Mexico, China, India, Indonesia, South Korea, Poland, Russia, Turkey and South
Africa) account for 82% of it.
Chart 2: Domestic tradable debt growth outpaces external debt (US$bn)
10,000
Ex ternal Debt
Domestic Debt
8,000
6,000
4,000
2,000
0
1995
1997
1999
2001
2003
2005
2007
2009
2011
Note: These estimates should be regarded as indicative and may not be strictly comparable across countries. The detailed country data are available
on the BIS website (www.bis.org/statistics/secstats.htm). Domestic debt as of 30 September 2011; BIS local market data is reported on a lagged
basis of 6-9 months.
Source: Source: BIS, BofA Merrill Lynch Global Research
8
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Chart 3: Domestic tradable debt growth (by region, % yoy)
Latam
60%
50%
Asia
Emerging Europe
Chart 4: Dom. tradable debt accounts for 85% of total GEM debt outstanding*
666 , 6%
Africa & ME
1,178 , 10%
40%
30%
20%
4,364 , 37%
10%
0%
-10%
5,488 , 47%
-20%
-30%
'00
'01
'02
'03
'04
'05
'06
'07
'08
'09
'10
Ex ternal Gov ernment
Domestic Gov ernment
'11
Ex ternal Corporate
Domestic Corporate
Note: As of September 2011.
* Shown in US$bn and as % of total, September 2011.
Chart 5: Top countries with domestic tradable debt (US$bn)
Chart 6: Domestic tradable debt regional breakdown
3,500
8%
3,000
4%
2,500
2,000
1,500
23%
65%
1,000
500
0
CN
BR
KR
IN
MX
TW
MY
TR
Latam
Asia
Emerging Europe
Africa & ME
Table 5: GEM tradable debt outstanding by segment 2010-2011 (US$bn)
Sovereign
Corporate
2010
2011
2010
2011
Total
2010
2011
% change 2010-2011
Sovereign
Corporate
Total
External
616
666
1,001
1,178
1,617
1,844
8
18
Domestic
5,599
5,488
3,727
4,364
9,326
9,853
-2
17
14
6
Total
6,215
6,154
4,727
5,543
10,943
11,697
-1
17
7
Note: External as of December 2011; Domestic as of September 2011. BIS local market data is reported on a lagged basis of 6-9 months.
9
GEMs Pa pe r #1 0
BofAML local market bond indices
Jane Brauer
In broad USD and market capitalization-weighted terms, local bond markets have
delivered 65% in total returns since December 2005. We show the performance
of the Merrill Lynch Local Debt Market Plus Index, in which countries are capped
at 10%.
Preston Peacock
BofA Merrill Lynch offers two benchmark types for measuring local debt market
performance:

The LDMP Index offers a broad composite index that tracks countries with
US$10bn in outstanding local currency sovereign debt, excluding foreign
currency ratings of AA3 or higher. Asia accounts for 43% of the LDMP Index,
with EEMEA and LatAm constituting 35% and 22%, respectively.

The Liquid LDM Indices comprise GLEM and GLEE. Asia, EEMEA and
LatAm make up 31%, 43% and 26% of the GLEM index, respectively.
Chart 7: Aggregate total return of BofAML Local
Market Bond Index – LDMP (in USD)
190
LDMP Index
170
GLEM represents a net cap-weighted liquid local debt markets index made up of
liquid fixed-rate bonds with country allocations weighted according to
capitalization weights. GLEE is based on a net equal-weighted methodology,
representing a basket of fixed-rate bonds with equally-weighted country
exposure. Further details can be found on Bloomberg: IND <GO>.
150
130
110
We provide an overview of the country indices, LDMP Plus and Liquid LDM
GLEM in terms of market characteristics and country total returns since inception.
90
Dec05
Dec07
Dec09
Dec11
Please see the Appendix for LDMP index rules and a list of numerous BofA
Merrill Lynch local market indices, including fixed-rate and inflation-linked, by
country and maturity buckets.
Chart 8: Local bond market total return (January 2006 = 100) in USD
LatA m
EM EA
A sia
To tal
190
13
170
11
150
9
130
7
110
5
90
Dec05
LatA m
EM EA
A sia
To tal
3
Dec06
Dec07
10
Chart 9: Local bond market yields (%)
15
210
Dec08
Dec09
Dec10
Dec11
Jan06
Jan07
Jan08
Jan09
Jan10
Jan11
Jan12
GEMs Pa pe r #1 0
Table 6: Local currency country indices – characteristics and total return performance, 30 June 2012
Ticker
No. of
issues
Maturity
/WAL
Mod
duration
YTM
(%)
Face value
(US$mn)
LOC
Rolling 12m total return
USD
EUR
JPY
% mkt val of
LDMP
GLEM
ASIA
LDMA
302
8.3
5.6
5.0
781,186
8.7%
1.0%
15.0%
-0.3%
42.9
India
G0IN
70
9.6
5.7
8.2
447,502
9.2%
-12.3%
-0.1%
-13.4%
10.0
30.6
--
Indonesia
G0ID
31
12.4
7.0
6.3
52,107
18.9%
9.1%
24.3%
7.8%
4.5
7.9
Malaysia
G0MY
58
5.9
4.9
3.3
129,564
5.4%
0.7%
14.6%
-0.6%
9.2
14.8
Philippines
G0PH
56
11.6
7.0
5.0
47,814
16.3%
20.1%
36.7%
18.5%
3.9
--
Singapore
G0SP
17
7.2
6.0
0.9
53,915
5.9%
3.1%
17.4%
1.8%
0.0
8.0
South Korea
G0SK
27
6.4
5.0
3.5
271,963
7.1%
0.7%
14.7%
-0.6%
10.0
--
Thailand
G0TH
43
7.8
5.9
3.5
71,023
5.0%
1.9%
16.0%
0.6%
5.3
--
EMEA
LDME
196
5.8
4.1
6.7
661,843
8.7%
-6.6%
6.4%
-7.8%
35.0
43.2
Czech Rep
G0CZ
14
6.4
5.2
2.1
41,846
8.4%
-8.8%
3.8%
-10.0%
3.0
--
Egypt
G0EG
28
3.0
2.1
16.2
32,197
13.1%
11.4%
26.8%
10.0%
2.2
--
Hungary
G0HU
13
4.5
3.4
7.4
30,817
5.9%
-13.1%
-1.0%
-14.2%
2.2
4.7
Israel
G0IS
12
5.8
4.5
3.2
39,308
10.1%
-3.4%
10.0%
-4.6%
3.1
5.4
Morocco
G0MA
49
5.4
4.4
3.9
23,900
2.9%
-7.1%
5.7%
-8.3%
1.8
--
Nigeria
G0NG
13
6.8
3.5
15.5
12,478
--
--
--
--
0.7
--
Poland
G0PL
15
5.1
4.0
4.7
97,005
7.8%
-10.4%
2.0%
-11.5%
7.1
13.6
Russia
G0RU
28
6.3
4.1
8.0
63,961
5.1%
-9.2%
3.3%
-10.4%
4.2
--
South Africa
G0SA
11
9.4
5.7
7.0
84,018
14.3%
-4.4%
8.8%
-5.6%
6.2
10.2
Turkey
G0TR
13
3.3
2.5
8.6
62,851
11.0%
-0.1%
13.7%
-1.4%
4.6
9.4
LatAm
LDML
42
5.9
3.9
6.8
417,442
16.4%
-0.8%
12.9%
-2.1%
22.0
26.2
11.2
Brazil
G0BR
12
2.9
2.3
8.4
211,082
21.4%
-5.5%
7.6%
-6.7%
10.0
Colombia
G0CO
10
6.2
4.1
6.2
47,833
9.7%
9.5%
24.6%
8.1%
4.0
--
Mexico
G0MX
20
9.2
5.7
5.2
106,625
15.0%
0.8%
14.7%
-0.5%
8.1
15.0
LDM Plus
LDMP
523
6.9
4.7
6.0
1,860,471
10.3%
-1.5%
12.2%
-2.7%
100
--
Liquid LDM
GLEM
10
5.6
4.5
5.5
847
11.7%
-2.3%
11.2%
-3.6%
--
100
Source: Bloomberg, BofA Merrill Lynch Global Research
Table 7: Historical analysis of fixed income asset classes, July 2012
Total return for year 2001
LDM (unhedged
USD investor)
8.5%
LDM (LOC)
17.7%
US Treasury
6.7%
Global Govt.
-0.4%
22.8%
16.2%
11.6%
19.5%
-1.9%
3.3%
13.7%
16.2%
8.8%
2.3%
14.4%
28.1%
11.3%
27.6%
11.8%
US HY
4.5%
Global EM FX
0.2%
EM USD
Sovereign
4.8%
15.7%
5.5%
3.5%
10.1%
10.9%
9.5%
4.2%
6.2%
2.8%
-6.5%
2.7%
1.8%
12.0%
12.7%
6.9%
3.1%
6.2%
11.8%
4.8%
10.6%
13.9%
5.0%
9.1%
10.7%
2.2%
7.0%
6.4%
-4.4%
12.0%
14.0%
10.9%
-26.4%
-8.7%
-10.2%
12.5%
4.9%
-3.7%
2.3%
57.5%
10.7%
27.2%
12.8%
8.7%
5.9%
5.6%
15.2%
6.2%
12.5%
-0.1%
7.7%
9.8%
6.8%
4.4%
-1.8%
8.2%
Ytd, 2012
5.8%
6.9%
2.6%
1.0%
8.0%
2.3%
10.6%
Cumulative return
199.9%
167.1%
88.7%
112.3%
149.0%
53.7%
229.9%
Annualized return
10.0%
8.9%
5.6%
6.7%
8.2%
3.8%
10.9%
Annualized volatility
6.1%
2.3%
4.6%
7.1%
8.4%
5.5%
9.7%
Sharpe ratio
1.25
2.82
0.71
0.61
0.70
0.26
0.88
Note: LDMP index inception was on 2005. The values prior to then are estimates.
Note: The cumulative return, annualized return and annualized volatility pertain to the ‘2001-to-current’ period.
11
GEMs Pa pe r #1 0
EM FX performance contributes
Jane Brauer
A large part of foreign investor interest in emerging market local debt markets has
been driven by the conviction that most local currencies are undervalued and will
continue to appreciate as part of the global rebalancing effort.
Given the significance of FX performance, BofA Merrill Lynch has a series of
benchmark regional FX indices to measure spot and total returns across regions
and on an aggregate global emerging market basis. Since the CNY revaluation in
July 2005, Asia FX spot returns have been outperforming the global GEM spot
benchmark while the total returns, which include local yield differentials, have
been underperforming the global benchmark. Asia now represents 54.5% of the
Global Emerging Markets FX Index, EEMEA 25.5% and LatAm 20.0%.
Table 8: GEM foreign exchange indices
Index
Spot ticker
Total return ticker
Global
Asia
EEMEA
LatAm
Brazil
China
India
Mexico
Russia
Turkey
Mini Global
Mini Asia
Mini EEMEA
Mini LatAm
MLFXGEMS
MLFXAXES
MLFXEMES
MLFXLATS
MLFXBRLS
MLFXCNYS
MLFXINRS
MLFXMXNS
MLFXRUBS
MLFXTRYS
MLFXMGES
MLFXMAXS
MLFXMEMS
MLFXMLAS
MLFXGEMT
MLFXAXET
MLFXEMET
MLFXLATT
MLFXBRLT
MLFXCNYT
MLFXINRT
MLFXMXNT
MLFXRUBT
MLFXTRYT
MLFXMGET
MLFXMAXT
MLFXMEMT
MLFXMLAT
Chart 10: ML FX regional spot indices
Chart 11: ML FX regional total return indices
180
130
170
120
160
Global EM - M LFXGEM T
LatAm - M LFXLATT
EM EA - M LFXEM ET
Asia - M LFXAXET
150
110
140
130
100
120
90
80
70
Jan-05
110
Global EM - M LFXGEM S
Lat Am - M LFXLATS
EM EA - M LFXEM ES
Asia - M LFXAXES
Jan-06
Jan-07
Jan-08
12
100
90
Jan-09
Jan-10
Jan-11
Jan-12
80
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
GEMs Pa pe r #1 0
Capital controls
Jane Brauer
A capital control is a policy device that a government uses to regulate the
investment-oriented foreign currency flows into and out of the country, usually
used to restrict volatile movements of capital due to investor speculation. Controls
on inflows typically respond to the macroeconomic implications of the increasing
size and volatility of capital inflows. Controls on outflows are used to limit the
downward pressure on their currencies, a significant risk to a local bond
investment.
Most emerging market countries have some form of capital controls that can be
increased as needed. Even those with free convertibility of their currency could
institute capital controls if deemed necessary. Capital controls can take the form
of transaction taxes, transfer taxes, withholding taxes, reserve requirements,
unremunerated reserve requirements, multiple exchange rate systems and/or
limitations in terms of the amount of assets to be held, caps on volume permitted,
controls on the international sale or purchase of various financial assets, and
sometimes even limits on the amount of money a private citizen is allowed to take
out of the country.
As the IMF discussed, 1[1] the most common experiences in using capital controls
are capital controls to limit short-term inflows, capital outflow controls during
financial crises and extensive exchange controls during financial crises.
Convertibility risk
Convertibility, or transfer, risk is the risk regarding the conversion from local
currency into foreign currency, and the inability to transfer foreign currency out of
the country. In other words, it is the risk that an investor will not be able to convert
local currency into foreign currency, normally due to exchange restrictions
imposed by a government. Drastic measures may occur during crises. Three
such examples are:

Korea, 1997. Daily currency movement was limited to 5% and the FX market
would shut down after that level was reached.

Russia, 1998. Banks froze dollar withdrawals and the central bank
terminated the fixing of the currency in the Moscow International Currency
Exchange auctions.

Argentina, 2001. Authorities limited domestic resident access to dollars.
Investors can gain exposure to local currency debt in emerging markets by buying
Eurobonds denominated in local currency or transferring money to a specific
country and then buying a local debt instrument. For Eurobonds, although the
debt may be referenced in local currency, it is payable in hard currency,
eliminating the convertibility risk. As a result, Eurobonds’ local currency yields
typically are lower than domestic yields for a particular tenor.
However, the convertibility risk is not the only driver for higher yields in local
bonds. In some countries local debt liquidity is limited, local bonds are governed
by local laws and, in some cases, there are restrictions that prevent or limit the
amount of bonds that can be held by foreign investors.
1
International Monetary Fund, “Capital Controls: Country Experiences with Their Use and Liberalization”.
Occasional paper 190 (2000).
13
GEMs Pa pe r #1 0
GEM surprise indices
Vasileios Gkionakis
+44 20 7995 0143
We introduced a new suite of activity and inflation economic surprise indices
(ESIs) for the emerging markets in May 2012, Surprise! New indices point to
downside risks to GEM assets. We constructed series for the three EM regions
(Asia, EEMEA, LatAm), CEE3 and Turkey, current account surplus and deficit
countries, and the GEM-10 and GEMs.
Table 9: BofAML GEM surprise indices
Description of economic
Bloomberg
surprises
ticker
We built our methodology on the assumption that what matters for markets is not
simply the actual level of surprise but 1) the deviation of surprise from its recent
trend and 2) the volatility of surprises. As a result, surprises that are positive but
also much higher than the recent trends matter, whereas those that are close to
their recent average generally do not. The same holds true for negative surprises.
ML Eco Surprise Asia
ML Eco Surprise CA Def
ML Eco Surprise CA Surplus
ML Eco Surprise CEE
ML Eco Surprise China
ML Eco Surprise EEMEA
ML Eco Surprise GEMs
ML Eco Surprise GEM10
ML Eco Surprise LatAm
ML Eco Surprise GEMs Infl
ML Eco Surprise GEM10 Infl
ML Eco Surprise Asia Infl
ML Eco Surprise LatAm Infl
ML Eco Surprise EMEA Infl
ML Eco Surprise China Infl
ML Eco Surprise CEE Infl
ML Eco Surprise CASurp Infl
ML Eco Surprise CA Def Infl
MESIASIA
MESICAD
MESICAS
MESICEET
MESICNY
MESIEMEA
MESIGEMS
MESIGM10
MESILAT
MESIGEMI
MESIGTI
MESIASII
MESILATI
MESIEEMI
MESICNYI
MESICEEI
MESICASI
MESICADI
Table 10: BofAML activity indices
Description of economic
surprises
Bloomberg
ticker
GLOBALcycle (DMs and GEMs)
DMcycle
GEMcycle (10 largest GEMs)
BRICycle
CHINAcycle
INDOcycle
INDIAcycle
KOREAcycle
POLANDcycle
RUSSIAcycle
TURKEYcycle
SAFcycle
BRAZILcycle
MEXcycle
Composite PMI of 10 largest EMs (miGEM)
Composite PMI of BRICs (miBRIC)
Composite PMI of EM Asia (miASIA)
Composite PMI of EEMEA (miEEMEA)
Composite PMI of LatAm (miLATAM)
MECIGLBC
MECIDMC
MECIGEMC
MECIBRIC
MECICNYC
MECIIDRC
MECIINRC
MECIKRWC
MECIPLNC
MECIRUBC
MECITRYC
MECIZARC
MECIBRLC
MECIMXNC
MECIMGEM
MECIMBRC
MECIMASA
MECIMEME
MECIMLAT
14
How we construct our regional surprise indices
For each activity series that we use for a country, we calculate the surprise
element (actual minus Bloomberg consensus) and then generate a z-score, which
is basically the deviation of the latest surprise from its six-month moving average
(or six-quarter moving average for quarterly data) divided by the standard
deviation of the surprise over the last six months (or six quarters). Our country
activity surprise index is then calculated as a diffusion index between those series
that were greater than 0.5 standard deviations and those that were less than -0.5
standard deviations. In other words, we assume there is a noise zone (-0.5, 0.5)
in which readings do not matter. To calculate the regional index, we aggregate
the country indices in a specific region by GDP-weighting them.
Relationship to GDP growth and market performance
We found that our GEM and regional surprise indices have been highly correlated
with activity and inflation, as well as asset prices. We use the surprise series for
generating trading signals for equities and currencies (see FX and Equity trading
signals from new GEM surprise indices). In our view, results using these indices
and trading rules provide evidence for the usefulness of ESIs as an additional tool
in discretionary and systematic portfolios.
Economic conditions & PMI indices
We developed Economic Conditions Indices (ECIs) in which we apply the
framework used by the Philadelphia Fed to track US real business cycles at a
high frequency. This approach optimally extracts information from data of different
frequencies, which allows us to produce timely estimates of economic activity.
The final reading is expressed as standard deviations away from the long-run
average (z-score); the aggregate indices are GDP-weighted Economic Condition
Indices across the countries included (see GLOBALcycle: a new finger on the
global pulse).
We calculate regional composite PMI indicators as a way of gauging regional
manufacturing performance by filtering out the noise at the individual country
level; these series are also GDP-weighted (see Introducing our GEM
manufacturing indicator: a PMI based approach).
For access to our suite of models please visit MLGD page on Bloomberg (MLGD
<GO>).
GEMs Pa pe r #1 0
15
Table 11: Economic policy regimes
Country
Policy regime
Policy rate
2012 inflation % forecast
Inflation target
Operational independence
Meeting frequency
Multiple Objectives
Lending Rate
3.7%
n/a
Limited but improving
Adhoc
Currency Board Arrangement (CBA)
Base Rate
4.5%
n/a
High, but limited by CBA
Following FOMC
Multiple Objectives
Reverse Repo
7.2%
n/a
High
Quarterly
FX/Inflation
Reference Rate
4.7%
n/a
High
Monthly
Inflation Targeting
Repo Rate
2.8%
2.0% - 4.0%
Very High
Monthly
Informal Taylor Rule
Overnight Rate
2.6%
n/a
Moderate
Monthly
Philippines
Inflation Targeting
Repo Rate
3.3%
n/a
High
Every 6 weeks
Singapore
n/a
3.6%
n/a
Very High
Bi-annual
Taiwan
Rediscount Rate
1.9%
n/a
Very High
Quarterly
Inflation Targeting
Repo Rate
4.1%
0.5% - 3.0%
High
Every 6 weeks
Inflation Targeting
2 Week Repo Rate
3.0%
2.0% ± 1.0%
High
8 per year
FX/Inflation
Overnight Lending/Deposit
8.6%
Not Official
Low
Every 6 weeks
Asia
China
Hong Kong
India
Indonesia
Korea
Malaysia
Thailand
16
BofAML reference sheet: economic policy regimes
EEMEA
Czech Rep
Hungary
Inflation Targeting
2 Week Bill
5.4%
3.0%
High w/ rising political pressure
Monthly
Israel
Inflation Targeting
Discount Rate
1.6%
1-3%
High
Monthly
Poland
Inflation Targeting
7 Day Bill
3.8%
2.5% ± 1.0%
High
Monthly
Russia
FX/Inflation
Refinance Rate
4.9%
Not Official
Low
Monthly
South Africa
Inflation Targeting
Repo Rate
6.1%
3-6%
High
Bi-monthly
Turkey
Inflation Targeting
7 Day Repo Rate
8.9%
5.0%
High
Monthly
Mon. Aggregates
NA
9.8% (CER)
NA
Very Low
NA
Inflation Targeting
Selic Rate
5.1%
4.5% ± 2.0%
High
8 per year
Monthly
Latin Am
Argentina
Brazil
Chile
Inflation Targeting
Overnight Rate (TPM)
2.0%
3.0% ± 1.0%
High
Colombia
Inflation Targeting
Minimum Offered Rate
2.8%
3.0% ± 1.0%
High
Monthly
Mexico
Inflation Targeting
Overnight Rate (Fondeo)
4.1%
3.0% ± 1.0%
High
8 per year
Peru
Inflation Targeting
Reference Rate
3.6%
2.0% ± 1.0%
High
Monthly
GEMs Pa pe r #1 0
Egypt
Table 12: Local debt market characteristics
Dom sovereign
Local accnt
Country
% foreign Withholding and
required? Euroclearable? ownership (May)
Can foreigners
other taxes? repo anywhere?
debt stock
Futures?
(US$bn)
1623
Inflation
BofAML fixed
Index mod
Index mkt cap
linker? (Index) rate index name
duration
(US$mn)
2574000
Asia
China
No
-
Yes
QFII Required
No
No
Yes
-
No
Yes
Yes*
India
Yes
No
1%
Yes
No
Yes*
Indonesia
Yes
No
30%
Yes
Yes
No
82
Korea
Yes
No
17%
Yes
Yes
Yes
475
Malaysia
Yes
Yes
39%
No
No
No
128
Philippines
Yes Only global pesos
-
Yes
No
No
62
Singapore
Yes
-
No
Yes
No
Taiwan
Yes
No
-
Yes
Yes
No
Thailand
Yes
Yes
13%
Yes
No
No
Czech Rep
Yes
Yes
10%
Yes
Yes
Egypt
Yes
No
0.4% (bills)
Yes
No
Hungary
Yes
Yes
40%
Yes
Israel
Yes
No
2%
Poland
Yes
Yes
31%
Yes
No
G0CN
7.2
No
G0HK
4.2
90830
No
G0IN
5.8
448,805
No
G0ID
6.5
111340
Various
G0SK
4.8
530790
No
G0MY
5.0
118590
No
G0PH
5.9
72670
No
G0SP
5.9
128650
157
No
G0TW
7.7
158500
166
THCPI
G0TH
6.2
199530
No
73
No
G0CZ
5.8
42,509
No
110
No
G0EG
2.1
31,130
Yes
No
45
No
G0HU
3.6
29,475
Yes
No
No
134
ISCPINM
G0IS
4.7
42,917
Yes
Yes
No
154
POCPILB
G0PL
(G0P I-LINKED)
4.1
98,420
(6,716)
608
EEMEA
Russia
Yes
Only 2018s
4% (OFZ)
Yes
No
Yes
115
No
G0RU
4.3
61,279
No
Yes
29% (2011)
No
Yes
No
129
SACPI
G0SA
6.1
90,928
Yes
No
19%
Yes
Yes
No
221
TUCPI
G0TR
2.5
66,668
Argentina
Yes
Some Bonds
-
Yes
Yes
No
71
CER
-
-
-
Brazil
Yes
No
12%
Yes
No
Yes
936
IPCA and IGPM
G0BR
2.6
181,000
Chile
Yes
Yes
-
Yes
Yes
No
54
UF
G0CL
4.3
10,278
Colombia
Yes
No
-
Yes
No
No
86
UVRI
G0CO
4.4
55,711
No
Yes
31%
Yes
Yes
Yes
304
UDI
G0MX
6.1
Yes
No
-
Yes
No
No
12
VAC/IDR
G0PE -
8.7-
122,734
12,026-
South Africa
Turkey
Latin Am
Mexico
Peru
Source: Various local authorities, BIS, Bloomberg, BofA Merrill Lynch Global Research
GEMs Pa pe r #1 0
Yes (offshore no)
Hong Kong
BofAML reference sheet: local debt market characteristics
17
Table 13: Major local debt instruments
Country
Asia
China
Hong Kong
India
Indonesia
Philippines
Avg daily vol
(US$mn)
BBG ticker
Act/365
Act/365
1-3
1-3
-
5000-6000
11-12
PBOC 0 Govt
CGB Govt
10 yrs
365d / 10 yrs
zero
annual (< 7yrs)
/ semi-annual (>10
yrs)
CNH
semi-annual
HKD zero / semi-annual
Act/365
Act/365
2/3
128 / 25
Treasury Bill /
Treasury Bond
SBI / T-bills
365d / 30 yrs
INR zero / semi-annual
Act/365 / 30/360
2-3 / 3-5
6/1
9 mos / 1 yr
IDR
zero
Act/360
-
-
-
Sovereign Bond
/ Fixed Rate Bond
KTB / MSB
30 yrs
IDR
semi-annual
Act/Act
2-7 / 2-3
1-2 / -
200-500 / -
20 yrs / 2 yrs
KRW
Act/365
2-3 / -
10
4800 / 2900
365d
20 yrs
1 yr / 3 yrs
MYR
MYR
MYR
semi-annual
/ quarterly (>1 yr)
zero
semi-annual
zero
Act/Act
-
4
1.5
5
7
7
7 / 34
11
740
3 / 425
10 yrs
3 yrs
364d
25 yrs / 5 yrs
MYR
MYR
PHP
PHP
semi-annual
zero
semi-annual /
quarterly
Act/Act
Act/360
30/360
1.5
3
-
7
34
1
<1
375
815
-
SGD zero / semi-annual
Act/365 / Act/Act
10 / 1.5-3
4
1.2 / -
zero
semi-annual /
annual
LKR Depends on index
TWD zero / semi-annual
Act/364
Act/Act
10
20
1
0.5
10
30
Act/Act
Act/365
- / 0.20
- / 1.5
30/360
30/360
30/360
2-4
2-4
2-4
1.5-3
1.5-3
1
35-115
65-165
65-165
SRILIB Govt
TGTB Govt / TGB
Govt
THAITB Govt
TBMA
THAISB Govt
30/360
6
1.5-3
1.5-2.5
BOTB Govt
Zero
Fixed
PBOC Bills
Bonds
3 yrs
50 yrs
CNY
CNY
Offshore
Fixed
"Dim Sum Bonds"
Bills / Notes
Fixed
Zero
Fixed
Zero
Fixed
Islamic Zero
Inflation
Fixed
T-Bills
Govt Securities
Islamic T-Bills /
Sukuk BNM
Govt Investment
Monetary Notes
T-Bills
Fixed Rate Treas
Notes
/ Retail Treas
Bonds
SGS Bills / SGS
Bonds
T-Bills
Bonds / Rupee
Loans
Bonds (CCPI)
Bills / Bonds
3 yrs
12 mos / 30 yrs
Zero
Fixed
Fixed
T-Bills
Loan Bonds
Savings Bonds
182d
50 yrs
10 yrs
THB
THB
THB
Fixed
BOT Bonds
7 yrs
THB
Islamic Fixed
Disc or Cpn
Zero
Fixed
Fixed
Sri Lanka
Zero
Fixed
Thailand
Avg ticket size
(US$mn)
Currency
Singapore
Taiwan
Bid/ask (bp)
Max tenor
Source: Various local authorities, Bloomberg, BofA Merrill Lynch Global Research
1 yr / 30 yrs
364d
20 yrs / 30 yrs
LKR
LKR
zero
semi-annual
quarterly & semiannual
semi-annual
71,000 / 40,000 HKTB Govt / HKGB
Govt
45-70 / 450-9,100 ITB Govt / IGB Govt
-/
INDOTB Govt
/ INDOBL Govt
INDOGB Govt
NDFB Govt
/ KORMSB Govt
MGTB Govt
MGS Govt
MITB Govt / SBNMI
Govt
MGII Govt
BNMN Govt
RPTB Govt
RPGB Govt
SITB Govt / SIGB
Govt
SRILTB Govt
SRILGB Govt
GEMs Pa pe r #1 0
Malaysia
Day count
Bond (linker)
Fixed
Korea
Coupon freq
Type
18
BofAML reference sheet: major local debt instruments
Table 14: Major local debt instruments
Type
Bond (linker)
Max tenor
Currency
Coupon freq
Day count
Bid/ask (bp)
Avg ticket size
(US$mn)
Fixed
T-bills / Bonds
12 mos / 35 yrs
CZK
zero / annual
ISMA-30/360
4-6
2-4
Egypt
Fixed
T-bills / Bonds
364d / 10 yrs
EGP zero / semi-annual
Act/365 / Act/Act
10-20 (bills)
10
Hungary
Fixed
T-bills / Bonds
12 mos / 15 yrs
HUF
zero / annual
Act/360 / Act/Act
10-15
1
Israel
Fixed
Makam / Shara /
ILGOV
18 mos / 20 yrs
/ 30 yrs
ILS
zero / annual /
annual
Act/365
2-4
2.5
Inflation ILCPI (ISCPINM) /
GALIL (ISCPINM)
Fixed
T-bills, OK
/ PS, DS, WS
Floating DZ, WZ (WIBOR)
Inflation
IZ (POCPILB)
Fixed
OFZ
Fixed
Bonds
30 yrs / 20 yrs
ILS
annual
Act/365
2-4
2-3
52wk, 2yrs
/ 25yrs
9 yrs
11 yrs
30 yrs
35 yrs
PLN
zero / annual
3-4
6-8
PLN
PLN
RUB
ZAR
semi-annual
annual
annual
semi-annual
Act/360, Act/Act /
Act/Act
Act/Act
Act/Act
Act/365
Act/365
10-15
2-3
2-4
3-6
Act/365 / Act/Act
3-5
2-3
Act/Act
5
Poland
Russia
South
Africa
Turkey
Fixed
T-bills / Bonds
24 mos / 10 yrs
TRY
Floating
Floating (various
linkers)
Inflation (TUCPI)
10 yr
TRY
zero / quarterly
& semi-annual
91 or 182 days
10 yr
TRY
semi-annual
Act/Act
3
BRL zero / semi-annual
Bus/252
2-5
Inflation
Latin Am
Argentina
Brazil
Chile
Colombia
Mexico
Peru
(Please see separate table for Argentina Bonds)
Fixed
LTN / NTN-F
3.5 yrs / 10yrs
Floating
Inflation
Fixed
LFT (SELIC)
NTN-B (IPCA)
BCP / BTP
6 yrs
38 yrs
10 yrs / 20yrs
BRL
BRL (VNA index)
CLP
semi-annual
semi-annual
Bus/252
Bus/252
Act/365
1-3
2-5
4-6
Inflation
29 yrs / 30 yrs
UF, settled in CLP
semi-annual
Act/365
4-6
Fixed
Inflation
Fixed
BCU (UF) / BTU
(UF)
TES
TES UVR (CPI)
Cetes / Bonos
14 yrs
COP
11 yrs UVR, settled in COP
364d / 30 yrs
MXN
annual
annual
zero / 182 days
1-5
3-10
2-5
Inflation
Udibonos (CPI)
28 yrs UDI, settled in MXN
Fixed
Inflation
Soberanos
Soberanos (VAC)
30 yrs
PEN
34 yrs VAC, settled in PEN
NL/365
NL/365
Act/360 linear /
Act/182 semiannualized 182/360
rate
182 days Actual/182, semiannualized 182/360
semi-annual
Act/360
semi-annual
Act/Act
Source: Various local authorities, Bloomberg, BofA Merrill Lynch Global Research
Avg daily vol
(US$mn)
BBG ticker
150-200 CZTB Govt / CZGB
Govt
20-50 (bonds)
EGYTB Govt /
EGYGB Govt
150-200
HTB Govt / HGB
Govt
MAKAM Govt
35
/ 130-200 / SHAHAR Govt /
ILGOV Govt
/ 40-65
40-67 ILCPI Govt / GALIL
Govt
600-750 PTB Govt / POLGB
Govt
POLGB Govt
POLGB Govt
100-150
RFLB Govt
2000
SAGB Govt
2-3
200
/ 450
40-50
TURKTB Govt /
TURKGB Govt
TURKGB Govt
4
100
TURKGB Govt
25 1825 for both (about BLTN Govt / BNTNF
75% LTN/ 25%
Govt
NTN-F)
1
100
BLFT Govt
10
1570
BNTNB Govt
5
80
BCPCL Govt /
BTPCL Govt
4.4
150
BCUCL Govt /
CHILBT Govt
2.8
3350
COLTES Govt
2.8
165
COLTES Govt
4
800
MCET Govt /
MBONO Govt
2-5
4
160
MUDI Govt
5
15
1
0.3
58
12
PERUGB Govt
PERUGB Govt
GEMs Pa pe r #1 0
Country
EEMEA
Czech Rep
BofAML reference sheet: major local debt instruments
19
Table 15: Major local swap characteristics
Characteristics of most actively traded swap
IRS or CCS
more active?
Liquid
tenors
Yes
Yes
Yes
IRS
IRS
IRS
Yes*
Yes
Korea
Yes
Malaysia
Country
Asia
China
Hong Kong
India
IRS? Cross-currency?
Yes
Yes
Yes
Indonesia
good
very liquid
very liquid
2-5
2
2-7
7 Day Repo
HIBOR 3m
NSE MIBOR
Act/365
Act/365
Act/365
Act/365
Act/365
Act/365
CCS
1-5y
1-10y
Entire
Curve
n/a
poor
n/a
US LIBOR 6m
Act/365
Yes
IRS
1-10y
very liquid
2
KWCDC 3m
Yes
Yes
IRS
1-10y
good
2-4
Yes*
Yes
Yes
Yes
Yes
Yes
Yes
Yes
CCS
IRS
IRS
IRS
n/a
1-10y
1-5y
1-5y
poor
very liquid
good
good
Yes
No
IRS
2-10y
Egypt
Hungary
Israel
Poland
No
Yes
Yes
Yes
No
Yes
No
No
IRS
IRS
IRS
Russia
Yes
Yes
South Africa
Turkey
Yes
Yes
Yes
Yes
Latin Am
Argentina
Brazil
Float cpn freq
BBG ticker
quarterly
quarterly
annual
(s/a for >1yr)
semi-annual
IRSB CH
IRSB HK
IRSB IN
Act/360
quarterly
quarterly
annual
(s/a for >1yr)
semi-annual
Act/365
Act/365
quarterly
KLIB 3m
Act/365
Act/365
quarterly
n/a
2
2-3
3-4
US LIBOR 6m
SORF 6m
TDCC 90day
THBFIX
Act/365
Act/365
Act/365
Act/365
Act/360
Act/365
Act/365
Act/365
semi-annual
semi-annual
quarterly
semi-annual
good
3-5
PRIBOR 6m
(1y IRS is 3m)
Act/360
Act/360
annual
semi-annual (1y
IRS is quarterly)
IRSB CZ
n/a
1-10y
1-10y
1-12y
good
good
good
4-6
4
3-4
Act/365
Act/365
Act/Act
Act/360
Act/365
Act/365
annual
annual
annual
CCS
1-5y
good
5-10
BUBOR 6m
TELBOR 3m
WIBOR 6m
(1y IRS is 3m)
US LIBOR 3m
Act/Act
Act/360
annual
semi-annual
quarterly
semi-annual (1y
IRS is quarterly)
quarterly
IRS
CCS
1-10y
1-5y
very liquid
good
3-5
5
JIBAR 3m
US LIBOR 3m
Act/365
Act/360
Act/365
Act/360
quarterly
annual
quarterly
quarterly
good 1 liquid tenors,
2-5 for les
liquid
moderate
4-5
CDI
DU/252
DU/252
at maturity
Camara and UF
linked swap
Act/360
IBR (IRS) & 6m
LIBOR (CCS)
TIIE 28d
& US LIBOR 1M
US LIBOR 6m
Act/360
(Please see separate table in Argentina section)
Yes
Yes IRS (Futures)
Chile
Yes
Yes
Colombia
Yes
Yes
Mexico
Yes
Peru
Fixed cpn freq
No
IRS
1-5y
(January
contracts)
1-10y
CCS (IRS
gaining liquidity)
Yes
IRS
1-10y
poor
1-10y
Good
10 (IRS)/6
(CCS)
3-4
Yes
1-10y
very poor
20
CCS
* Poor liquidity, but some banks with strong onshore presence may quote on a bilateral basis to clients.
28/360
Act/360
1/360 of rate
semi-annual
compounded on
(bullet < 18m)
ACT days
Act/360 quarterly & semiannual
28/360
Monthly (28d)
Act/360
semi-annual
IHUSWO3
<crncy>
quarterly IHUSWO1 CMPN
<crncy>
quarterly
MRSWQO1
<crncy>
semi-annual
semi-annual
IRSB SI
quarterly
IRSB TW
semi-annual
IRSB TH
n/a
IRSB HU
IRSB IS
IRSB PD
RRUSSW
<Curncy>
IRSB SA
TYUSSW
<Curncy>
Futures settled ODA <cmdty> CT
daily
semi-annual
IRSB CL
quarterly& semiannual
monthly
IRSB CO
semi-annual
FWCM PEN
IRSB MX
GEMs Pa pe r #1 0
Bid/ask (bp)
Philippines
Singapore
Taiwan
Thailand
EEMEA
Czech Rep
Floating leg Fixed day count
Floating day
count
Liquidity
20
BofAML reference sheet: major local swap characteristics
Table 16: FX characteristics
Country
FX regime
Deliverable?
Code
FX spot avg daily trading
vol (US$bn)
Forward liquid tenors
Options liquid tenors
Asia
China
Managed Float
No (offshore Yes)
CNY (offshore CNH)
20 (CNH 0.8-1.3)
2y
2y
Hong Kong
Currency Board
Yes
HKD
6
1y
2y
India
Managed Float
No
INR
5
1y
2y
Indonesia
Managed Float
No
IDR
1
1y
1y
Korea
Free Float
No
KRW
6
1y
2y
Malaysia
Managed Float
No
MYR
1.5-2.0
1y
2y
Philippines
Free Float
No
PHP
0.8-1.2
1y
1y
Singapore
Managed Float
Yes
SGD
6.0-7.0
1y
2y
Taiwan
Managed Float
No
TWD
1.0-1.5
1y
2y
Thailand
Managed Float
Yes
THB
1.0-1.2
1y
n/a
Czech Rep
Floating
Yes
CZK
3.0
up to 1y
up to 2y
Egypt
Managed Float
Yes
EGP
0.3-0.4
up to 6m
n/a
Hungary
Floating
Yes
HUF
5.0
1y
up to 1y
Israel
Floating w/ Intervention
Yes
ILS
2
up to 1y
up to 1y
Poland
Yes
PLN
6.0
up to 1y
up to 2y
Russia
Managed Float
Yes
RUB
5.0-10.0
up to 1y
up to 2y
South Africa
Yes
ZAR
7.0-8.0
up to 1y
up to 1y
Turkey
Floating w/ Auctions
Yes
TRY
10.0-12.0
up to 1y
up to 1y
BofAML reference sheet: FX characteristics
EEMEA
Argentina
Highly Managed
No
ARS
0.2
2y
1y
Brazil
No
BRL
1.8
2y
2y
Chile
No (convertible, most offshore
CLP
1.6
2y
1y
1y
trades are non-deliverable)
Colombia
No
COP
1.0
1y
Mexico
Yes
MXN
10
2y
2y
Peru
No
PEN
0.5
1y
n/a
GEMs Pa pe r #1 0
Latin Am
21
GEMs Pa pe r #1 0
22
GEMs Pa pe r #1 0
Asia countries
23
GEMs Pa pe r #1 0
China
Overview
Bin Gao
+
China’s bond market has undergone a dramatic change in the past 10 years.
Government debt accounted for just 16.8% of GDP in June 2001, compared with
34.7% of GDP today (US$2.6tn absolute size) 2. This represents by far the largest
local government bond market in Asia ex-Japan terms, and ranks third in terms of
government bonds outstanding, behind the US and Japan. Regulated onshore
access to foreigners has limited its international role, but the government is
making big efforts to open up its bond market for foreign access through revised
qualified foreign institutional investor (QFII), RMB qualified foreign institutional
investor (RQFII) and other programs.
3969
Ethan Mou
+
3741
Monetary policy
Table 17: China ratings profile (long-term local
currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Aa3
Aa3
Aa3
A1
A1
A1
-
AAAAAAA+
A+
A
A
ABBB+
BBB
BBB
BBB
BBB
AAAAAAAAAAAAA+
A+
A
A
A
A
-
Chart 12: Estimated CPI components for China
in 2011
19.2
Housing
13.7
Recreation & education
10.2
Transport and comm.
Health, medical and
9.5
personal products
5.5
Household items
Background. Originally founded in 1948, the People’s Bank of China (PBoC)
was given the authority by the state department to start performing the duties of
the country’s central bank in 1984. The authority was legalized by the National
Peoples Congress in 1995, along with the legal confirmation. The bank was
further modernized and given greater macroeconomic responsibility in the same
year, and again in 2003. A nine-member management team including five deputy
governors supports current Governor Zhou Xiaochuan. There is also a Monetary
Policy Committee (MPC) consisting of at least 12 members with outside
representatives from the State Council and financial regulatory bodies that meet
quarterly. In practice, the MPC plays an advisory role.
Policy framework. The 2003 legislation outlines 13 major policy responsibilities.
Key among them are regulating financial markets, maintaining CNY equilibrium,
managing FX reserves and managing the state treasury as fiscal agent. The
reality is that the executive State Council holds considerable sway over the PBoC
in appointing the governor and signing off on policy rate decisions and CNY
appreciation. The PBoC does not have an explicit inflation target mandate, but
targets a combination of inflation, M2 money supply and loan growth. The key
policy rates are the 1y deposit and lending rates. Unlike many other central banks
that tend to favor price tools only, the PBoC actively conducts its policy using both
measures.
Base rate. The PBoC officially regulates the whole curve of deposit and lending
rates. It sets the benchmark rates for deposits from demand to 5y time deposits,
and for lending from 3 months to more than 5 years. Of them, the 1-year deposit
and lending rates are the benchmarks that the market focuses on. Previously,
banks’ deposit rates were capped at benchmark rates, while lending rates could
float from 0.9x to 4x the benchmark rates. The household mortgage rate is
allowed to go as low as 0.7x the benchmark lending rate. In June and July, the
PBoC took an important step toward interest deregulation by increasing the cap
on the deposit rate to 1.1x the benchmark rate and lowering the floor on the
lending rate to 0.7x the benchmark rate.
8.4
Clothing
3.3
Tobacco & alcohol
30.2
Food
0
10
20
30
40 %
Open market operations. Given State Council influence over policy making,
open market operations (OMO) are an important discretionary tool of the PBoC in
managing liquidity and monetary targets. It schedules auctions every Tuesday
and Thursday at 10am. Tuesday is typically for 1y PBoC bills and 28-day repo,
while Thursday is for 3m and 3y bills and the 91d repo. Primary dealers must
Source: NBS, BofA Merrill Lynch Global Research
2
24
Including both sovereign and policy bank bonds
GEMs Pa pe r #1 0
Conventions
Bonds
indicate their bidding interest (level and size) a day in advance, with the PBoC
announcing the auction size at 4.30pm on Monday and Wednesday.
Quote: Yield to maturity
Settlement: T+3
Basis: Act/365
Coupon frequency: semi-annual above 10-year, annual
below 7-year
IRS
Above and beyond sterilization needs, the 3m and 1y bills are used to manage
liquidity from redemptions and IPO demand. There are some constraints on the
ability for the PBoC to issue 1y bills above the official 1y lending rate without the
approval of the State Council. As such, the 1y bill auction yield is watched closely
for impending signs of a policy rate hike if it rises meaningfully above the 1y
lending rate.
Fixing: Various products: 7d repo fix, 3M Shibor, 1y
benchmark deposit, 1y benchmark lending
Coupon frequency: Quarterly, floating/fixed Act/365
CCS
Fixing: 6m USD LIBOR
So far this year the PBoC has stopped issuing bills in the OMO and mainly
resorts to repo and reverse repo operations, with the latter rarely used in the past.
More active use of reverse repo suggests the PBoC is moving toward its western
peers and starting to manage the short-term money market rate, more
specifically, the 7d repo rate.
Coupon frequency: Semi-annual USD day count Act/360,
local Act/365
Lending and deposit facilities. Commercial banks and other depositary
institutions can borrow from the PBoC for short-term liquidity support. The rate is
usually set higher than the benchmark deposit rate but lower than the benchmark
lending rate. The July 2012 rate was at 3.85% for 1y loans, compared to the 1y
benchmark deposit and lending rates at 3% and 6%, respectively. Financial
institutions can also borrow at the PBoC’s discount window by using commercial
bills as collateral. The July 2012 rediscount rate is 2.25%.
These facilities are not used by banks very often, as seeking help from the central
bank might send a bad signal to the PBoC and the banking regulator – the
Chinese Banking Regulatory Commission (CBRC).
Reserve requirements. The reserve requirement ratio (RRR) is an important
discretionary policy tool. Unlike many other countries that use bills to sterilize the
FX inflow explicitly, the PBoC primarily relies on the RRR to do the work. By
doing this, it transfers the sterilization costs to the banking sector. The PBoC
started a new round of RRR cuts in November 2011, and has cut the RRR three
times by 50bp as of July 2012. In July 2012, the RRR was 20% for major banks,
and 16.5% for small and medium sized banks. RRR changes have a tendency to
be announced in the second half of the month. The PBoC pays 1.62% on
required reserve and 0.72% on any excess reserves deposited at the PBoC.
Fiscal policy
The key market drivers are monthly CPI, industrial production, money supply,
fixed asset investment and PMI. The National Bureau of Statistics has not
officially disclosed the CPI component weightings; however, there is partial
information available: food is at 30.2% and housing 19.2%.
Key multi-year macro policy and leadership changes are decided by the party
first, with the National Congress typically meeting every five years. The measure
is then sanctioned by the National People’s Congress and the People’s Political
Consultative Conference. The 18th National Congress of the Communist Party of
China will take place in 2012. Usually held between September and November, it
marks a symbolic change in leadership and policy direction for the next five years.
The short end of the bond curve moves with monetary policy, which in turn is
driven by a combination of growth and inflation. The longer end has strong
correlation with the stock market.
25
GEMs Pa pe r #1 0
Bond market
China’s onshore bond market represents the largest in Asia ex-Japan with an
estimated US$3.5tn in outstanding bonds. However, relative to its own GDP it is a
more modest 47%. There are seven broad categories of bonds: government
bonds, PBoC bills, policy bank financial bonds, corporate bonds, enterprise
bonds, commercial papers and medium-term notes. Bond trading occurs through
two key platforms: the more liquid interbank OTC market, and the Shanghai and
Shenzhen exchanges.
Foreign investor access is limited to qualified Foreign Institutional Investor status
and specially approved central banks, sovereign wealth funds and certified Hong
Kong/Macau/foreign banks. For a more comprehensive guide on the onshore
bond market, please see our primer, China: large bond market growing and
opening, 11 April 2012.
Money market. The money market is made up of three curves: repo, Shibor and
depo. The overnight and 7d repo rates are the established benchmarks and
account for more than 70% of market volume. This is a collateralized lending rate,
and its fixing is published every day at 11am local time, based on the median of
all transacted prices from 9-11am on the China Foreign Exchange Trading
System (CFETS). Daily average turnover is CNY300bn for o/n repo and
CNY50bn for 7d repo. The Shibor curve is an uncollateralized interbank
borrowing offer rate set by 16 onshore banks with tenors from o/n to 1y. Beyond
credit premium, the Shibor rate can be biased higher, as banks are incentivized to
set higher fixings to improve the margins on loans linked to the Shibor rates.
PBoC bills. PBoC bill tenors range from 3, 6 and 12 months up to 3 years. The
primary objective is sterilization and liquidity management. They are auctioned via
the China Government Securities Depository Trust and Clearing Company (CDC).
Treasury bonds. Also known as Central Government Bonds (CGB), Treasury
bonds are issued by the Ministry of Finance to fund the government’s budget
deficit. Total outstanding CGB is estimated at CNY6.5tn, or 30% of total
outstanding government and corporate bonds. Maturities range from bills (3, 6,
and 9 months) to bonds (1, 3, 5, 7, 10, 15, 20, 30 and 50 years). Coupons are
paid semi-annually above 10y tenors and annually for 7 years and below.
Chart 13: Maturity profile of Treasury bonds in CNYbn
Chart 14: Outstanding bonds by type in CNYbn
9,000
1,200
8,000
1,000
Treasury bonds
7,000
PBoC bills
6,000
800
5,000
600
Financial bonds
4,000
Enterprise bonds
3,000
400
2,000
Short-term financing
1,000
200
0
Source: BofA Merrill Lynch Global Research, Bloomberg
26
May-12
Nov-11
May-11
Nov-10
May-10
Nov-09
May-09
Nov-08
MTN
May-08
2061
2042
2039
2033
2030
2027
2024
2021
2018
2015
2012
0
* Financial bonds include both the policy bank bonds and commercial ban bonds.
Source: BofA Merrill Lynch Global Research, chinabond.com.cn
GEMs Pa pe r #1 0
Policy bank bonds. Issued by the three policy banks (China Development Bank,
Agricultural Development Bank of China and China EXIM Bank) for infrastructural
development. Strictly speaking CDB is no longer a policy bank, but a commercial
bank. However, its bonds still enjoy the zero-risk weights on bank assets and
dominate under the category of policy bank bonds with an outstanding amount at
CNY4.8tn, or 67% of outstanding policy bonds. From January to May 2012, the
CDB issued 38 times for a total of CNY506bn, while the other two issued a
combined 17 times for CNY371bn.
Corporate debt. A collection of bonds predominantly issued by state-owned
enterprises and foreign joint venture companies. However, this category has been
opened to private sector corporations without the need for bank guarantees. The
main bond category includes commercial bank bonds, enterprise bonds, shortterm financing papers (ST financing) and medium-term notes (MTN). ST financing
and MTN are the most actively traded in the interbank market. Total outstanding
corporate bonds are at CNY5.3tn, or 25% of total bond market.
Auction and placement mechanism. Government Treasury bonds are issued
under a hybrid auction by the Ministry of Finance with maturities up to 50 years.
Beyond the MoF, the three policy banks also issue bonds by auction, but usually
in Dutch style. There is no complete calendar of regular auction, though daily
updates can be found on chinabond.com. The MoF typically publishes its
issuance plan of key maturities (1, 3, 5, 7, 10 years) at the end of the year, and
complete issuance plan for the next quarter at the end of the quarter. However,
the issuance amounts are not disclosed. In 2012, the CDB announced its
issuance plan for the year, with detailed tenors, dates and amounts.
Derivatives market
Interest rate swaps. The swap market continues to grow fast and robustly,
despite continued concern over the reliability and consistency of the fixing for the
floating reference leg of the swap. Essentially, there are five IRS curves based on
the 7d repo (compounded quarterly), the overnight Shibor, the 3m Shibor, the 1y
benchmark deposit rate and the 1y benchmark lending rate. Although the 7d repo
offers the best in underlying liquidity, it suffers from abrupt and volatile squeezes
in market liquidity. As a result, it may not always be reflective of underlying
macroeconomic trends. While the 1y deposit provides a better macro proxy, it
lacks the same liquidity as the 7d repo and Shibor-based IRS instruments.
Table 18: China interest rate swaps (IRS) - market notional values (May 2012)
Total notional amount
% of total
Benchmark
(CNYbn)
notional amount
7-Day Repo Rate
SHIBOR Overnight
SHIBOR 3-Month
1-Year Term Deposit Interest Rate
1-Year Lending Interest Rate
149
59
40
15
1
56.5
22.4
15.1
5.5
0.3
Source: BofA Merrill Lynch Global Research, chinamoney.com.cn
27
GEMs Pa pe r #1 0
Table 19: Summary statistics of China derivative products and their markets
Avg daily
Avg
Bid-Ask
Fixings and
Product
trading volume transaction size
spread
other notes
Interest rate swaps
1-year
CNY 3.2bn
CNY 100mn
2bp
CNY 1bn
CNY 50mn
2bp
CNY 1.5bn
CNY 200mn
3bp
CNY 800mn
CNY 100mn
5bp
CNY 10mn
10-15bp
USD 50mn
USD 10mn
USD 5mn
15bp
20bp
30bp
5-year
ND Interest rate swaps
1-year
5-year
Cross-currency swaps
ND Cross Currency Swaps
1-year
USD 300mn
5-year
USD 50mn
10-year
USD 10mn
CIRS <GO>
Bloomberg
11am 7-day repo,
11.30 Shibor
CNREPOFIX=CFX,
Reuters
11am local time fixing
illiquid
PNDS, Reuters
FX market
The CNY is characterized as a managed float, with PBoC officials claiming that
the currency is managed against a basket of top 10 trading partners. So far, the
weights have not been disclosed. Our economists estimate that four major
currencies (USD, EUR, JPY and KRW) account for roughly 77% of the basket
(Cracking yuan’s basket, 28 June 2010).
Table 20: Weights of RMB basket
weights
USD
EUR
JPY
KRW
SGD
RUB
AUD
GBP
MYR
INR
CAD
BRL
IDR
THB
PHP
TWD
BoAML
BIS
12.3
16.8
8.3
8.2
2.9
3
2.7
1.3
2.5
1.2
2.5
3.1
2.4
2
2.2
1.3
1.8
2.7
1.7
0.9
1.6
0.8
1.4
1.8
1.4
0.8
6.6
40.3
21
16
18.4
Source: BIS, BofA Merrill Lynch Global research calculations. Note BIS'basket for China has 43 currencies.
The key shift in regime came on 21 July 2005 when the PBoC announced a one-off
2.1% revaluation against USD. Thereafter, CNY has been characterized by three
types of appreciation: aggressive 12% annualized appreciation, modest 5-6%
annualized appreciation, and marginal 0-2% annualized appreciation against the
USD.
Table 21: Vital statistics and characteristics of China's FX markets
FX
Tradable
products product
CNY Onshore
Spot
Spot
Forwards
Forwards
CNY Offshore
Forwards
NDF
Options
NDO
CNH Offshore
Spot
Spot
Forwards
Forwards
Avg daily
trading
volume
Bid-Ask
spread
Reuters
reference Key facts
USD 20bn USD 5-20mn CNY 0.0005- CNY=CFXS ▪ Proper documentation required.
0.002
▪ Trading hours: 9:00-16.30 Beijing
USD 5-10bn USD 10- CNY 0.0010- CNYF=
50mn
0.0150
USD 4-5bn
USD 1050mn
CNY 0.00200.0100
PNDF
PNDG
USD 500800mn
USD 50mn
0.3-1.0 vol
TTDE
USD 1.5-2bn USD 10mn CNH 0.00200.0030
USD 2-3bn
28
Avg
trading
size
USD 1020mn
▪ CNY is non-deliverable currency, offshore
entities can access the market through NDF.
▪ Dollar settled NDF on CNY are available till
tenors of 10y and are liquid for tenors shorter
than 2y.
▪ Dollar settled NDO on CNY are available till
tenors of 7y and are liquid for tenor shorter
than 2y.
CNH=D2 ▪ CNH is CNY traded and deliverable
offshore, primarily in HK.
▪ There is no fixing rate set by the authorities.
CNH 0.0020- BGCHKCNY ▪ CNH forward curve is liquid up to one year.
0.030
GEMs Pa pe r #1 0
Bloomberg pages
FX rates
CNY Curncy ALLQ<GO>
Cross section of China markets
OTC CNY <GO>
Reuters pages
PBoC pages, Reserve Requirements
<PBOC>
PBoC SAFE fixings
<SAEC>
7-day repo fixing
<CNREPOFIX=CFXS>
Useful official websites
The People’s Bank of China (PBOC)
www.pbc.gov.cn
State Administration of Foreign Exchange (SAFE)
www.safe.gov.cn
National Development and Reform Commission
www.ndrc.gov.ch
China Banking Regulatory Commission
www.cbrc.gov.cn
China Securities Regulatory Commission
www.csrc.gov.cn
Ministry of Commerce
www.mofcom.gov.cn
Useful market websites
China Depository & Clearing
www.chinabond.com.cn
China FX Trade System
www.chinamoney.com.cn
China Government Securities Depository Trust & Clearing
Company Ltd
http://www.chinaclear.cn
Shanghai Interbank Offered Rate
http://www.shibor.org
CNY transactions are managed by the electronic brokerage system CFETS,
established in 1994. Its functions also include CNY lending, bond trading,
derivatives and surveillance. Operating hours are 9am to 4.30pm, and every
morning at 9:15am (local) a fixing is announced based on weighted average of
market makers with discretion and published on Reuters page SAEC. USD/CNY
is then allowed to trade within a +/-0.5% band around this fixing. The PBoC
widened the USD/CNY trading band to +/-1.0% on 16 April 2012.
Currently, USD/CNY, HKD/CNY, JPY/CNY, EUR/CNY, GBP/CNY, CNY/MYR and
CNY/RUB are directly traded on the system.
SAFE is the State Administration of Foreign Exchange, a sub-division of the
PBoC, and responsible for FX regulations, reserve management and intervention.
Table 22: Local institutional base (by May 2012)
Holdings
(CNYbn)
Total bonds
PBoC, MoF, Policy banks
Commercial Banks
- National Commercial Bank
- Foreign Bank
- City Commercial Bank
- Rural Commercial Bank
- Rural Cooperative Bank
- Others
Credit cooperative banks
Non Bank Fin Inst
Securities Companies
Insurance Companies
Fund Houses
Non Financial Inst
Individual Investors
Exchanges
Others
21,728
1,650
14,737
12,401
245
1,441
574
62
14
490
78
164
2,075
1,774
30
265
372
92
%
of total
7.6
67.8
57.1
1.1
6.6
2.6
0.3
0.1
2.3
0.54
0.8
9.6
8.2
0.1
1.2
1.7
0.4
Source: BofA Merrill Lynch Global Research , chinabond.com.cn
Investor base
Major local investors include state-owned banks, shareholding commercial banks,
securities companies, credit cooperatives, insurance companies and investment
funds. Among the pension funds, the Social Security Fund has an estimated size
of US$130bn, of which 50% is designated to be invested in deposits and
government bonds.
The government has also made efforts to provide foreign investors with better
access to the onshore bond markets. There are three main avenues to invest in
onshore bond markets: QFII, RQFII and interbank bond market investment quota.
All three are subject to approvals and quotas.
The QFII scheme was launched jointly by the CSRC and PBoC in November
2002 and came into force on 1 December 2002. Bonds-wise, a QFII was only
allowed to invest in bonds traded on exchanges, which barely accounts for 2% of
total bonds outstanding. However, on 27 July 2012, the CSRC officially revised
the QFII rules to allow QFIIs to invest in the dominant interbank bond market. The
entry requirements of QFII are also lowered significantly. Awarded QFII quota is
US$28.5bn out of a total of US$80bn, as of July 2012.
29
GEMs Pa pe r #1 0
RQFII refers to offshore institutional investors with RMB raised offshore. The
program was launched in December 2011 and allowed for investment in the
interbank bond market. However, currently the pilot program is restricted to only
Hong Kong subsidiaries of the onshore fund and securities firms.
In August 2010 the PBoC launched a scheme to allow three kinds of institutions
to invest in the onshore interbank bond market. The eligible investors are:

Foreign central banks that facilitate cross-border trade/investment with China
and are involved with currency cooperation.

CNY clearing banks in Hong Kong/Macau.

Offshore CNY trade settlement banks.
As of June 2012, these investors held CNY96bn bonds in the interbank market.
There are also 18 countries/regions that signed currency swap agreements with
China, and the total size is CNY1.84tn.
Rules, regulations capital controls and taxation
Foreign investor access in local bonds is principally through QFII status. This sets
several criteria laid out by the CSRC that require fund management, insurance,
securities and bank entities to have relative AUM size, years of experience and
capital. QFII also requires a local custodian and broker.
Additionally, QFII access is designated through the exchange traded market (see
Clearing & Settlement), which is not as liquid as the interbank market. CNY tradesettlement banks and central banks are allowed to access the interbank market.
More recently, the CSRC announced revisions to the QFII rules to allow access to
the interbank bond market for the QFII and lower the entry criteria.
Tax on QFII investment for coupon and dividend follows corporate income tax
rules, currently at 10%. The capital gains are also exempted from business tax.
But the issue of whether corporate income tax applies remains unclear and waits
to be clarified. The degree to which that the tax can be reimbursed depends on
the tax treaties and other regulatory considerations defined by the China State
Administration on Taxation.
Clearing and settlement
There are two clearing and settlement platforms. The China Government
Securities Depository Trust and Clearing Company (CDC) clears transactions in
the interbank market in real time. The China Securities Depository and Clearing
Company (CSDCC) is the sole depository, clearing and registration company for
securities traded on the Shanghai and Shenzhen exchanges. CSDCC provides
settlement T+1. Note that CDC is under the regulatory supervision of the PBoC
and CBRC, while the CSDCC is under the supervision of the CSRC.
CNH market
The simple definition of CNH is the offshore deliverable FX market for CNY
created in Hong Kong. However, its scope and implications are far-reaching and
could conclude with the internationalization of the renminbi. While Hong Kong is
the justifiable focus of the CNH market, efforts are also under way in Macau,
ASEAN and around the world to facilitate the deliverability of CNY. For a more
comprehensive guide on the CNH markets, see Credit primer: Off-shore RMB
market, 07 February 2011. For the latest CNH trends, see Off-shore RMB bond
market: Retrospectives & perspectives, 29 Jan 2012.
30
GEMs Pa pe r #1 0
The genesis of the CNH market began on 18 November 2003 when Hong Kong
announced that banks could conduct personal renminbi business on a trial basis,
following approval by the PBoC and China’s State Council. The next key
milestone occurred in July 2007, when the China Development Bank completed
its first issuance of renminbi bonds in Hong Kong. Essentially, this marked the
start of the “dim sum bond” market and the establishment of financial
intermediation between Hong Kong and the mainland.
Table 23: Comparing offshore CNH spot with onshore and offshore NDFs
CNY spot FX
Onshore CNY
Offshore CNH
Offshore NDF
Average daily turnover
Average transaction size
Bid-Ask spread
Settlement
Fixing
USD10-15bn
USD100mn
10pips
CNY
9.15am Beijing, Reuters
CNY=CFXS
USD1.5-2bn
USD10mn
20pips
CNY
CNYFIX=
USD3-4bn
USD10-20mn
30-40pips 1Y
USD net settlement
9.15am Beijing, Reuters
CNY=CFXS
Source: BoA Merrill Lynch Global Research, Bloomberg - these are indications under normal market conditions
The CNH spot market. Established in August 2010, the CNH spot market is
open to all corporates or institutions so long as they comply with the banking
regulations of Hong Kong. Market liquidity has improved as corporate trade
settlements have supplied CNY liquidity to the markets. More recently, the Hong
Kong Monetary Authority (HKMA) dropped limits to the net open position ruling,
and started to conduct 7d repo to provide liquidity if requested by banks. As such,
the differential between the CNH and onshore CNY spot markets has narrowed
as improved supply has been able to satiate global demand.
Forwards and swaps. Beyond the onshore CNY and offshore CNH spot markets,
there has been a rapid development in the CNH FX forwards markets. Thus far,
liquidity has improved significantly, and the curve extends out to one year. This
compares to the onshore CNY forwards and NDF forwards, which trade out to five
years and beyond. Unlike the NDF forwards market, both the onshore and offshore
deliverable forwards are a function of their respective money-market interest rate
differentials. CNH deposit rates are significantly lower than the onshore CNY
market due to the “liquidity duopoly” of the clearance bank, Bank of China, and the
PBoC Shenzhen branch that sets the benchmark for the market.
Table 24: Comparing offshore CNH forwards with onshore and offshore NDFs
CNY FX forwards
Onshore CNY
Offshore CNH
Offshore NDF
Average daily turnover
Average transaction size
Bid-Ask spread
Settlement
Fixing
Volatile, average USD1bn
USD10mn
1W 5pips
1M 5pips
3M 20pips
6M 45pips
1Y 25pips
CNY
No fixing
USD2-3bn
USD10-20mn
1W 5pips
1M 10pips
3M 15pips
6M 30pips
1Y 30pips
CNY
No fixing
USD3-4bn
USD10-20mn
1W 35pips
1M 20pips
3M 30pips
6M 30pips
1Y 30pips
USD net settlement
SEAC Reuters page, 2 day
before maturing
Source: BoA Merrill Lynch Global Research, Bloomberg - these are indications under normal market conditions
CNH forwards. In the case of CNH forwards, the curve is based on the USD and
RMB deposit differentials in the offshore market. Typically, the CNH forward curve
trades above the onshore CNY curve at the front end, as the CNY interest rate is
higher than the USD. The higher offshore renminbi deposits rates are a function of
the typically thinner liquidity and CNH demand imbalance than the onshore market.
The estimated average daily turnover in this market is around USD200-500mn.
31
GEMs Pa pe r #1 0
Chart 15: CNH deposits in Hong Kong (CNHbn)
700
600
500
CNH IRS market. This market is benchmarked off the onshore 3m Shibor rate,
though other benchmarks may be used. The tenor is quoted up to 10y, but demand
for the product is limited as, offshore corporates typically source and hedge cheaper
funding in USD and HKD markets. Moreover, existing hedging needs are also being
handled by the current CNY NDIRS market.
Prospects for the development of this market will depend on the development of the
offshore CNY bond market in Hong Kong and liberalization of the offshore bank
access to the onshore bond market. Ultimately, the key purpose of the CNH IRS
market will be for bond issuers and investors to hedge their interest rate risks.
400
300
200
100
Jan-12
Jul-11
Jul-10
Source: BoA Merrill Lynch Global Research, HKMA
Jan-11
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
0
CNH dim sum bonds. Dim sum is the Cantonese term given to dumplings and a
reference to “the heart’s little treasures”. Dim sum bonds are the adopted name
for CNH-denominated bonds settled in CNH that are issued offshore in the Hong
Kong market.
A CNH sovereign bond curve has emerged following the CNY5bn issuance by the
mainland’s Ministry of Finance of 3y, 5y and 10y Chinese government bonds on 1
December 2010 (details of which can be found in Tender Information
Memorandum). On 28 June 2012, the Ministry of Finance made another issuance
of the 3y, 5y, 10y and 15y government bonds. Note the first CNH sovereign issue
took place in October 2009 for RMB6bn. These issues traded at significantly
lower yields than their mainland counterparts, illustrating the higher demand for
offshore CNH bonds. However, the spread has narrowed significantly due to a
declining expectation of CNY appreciation and improved access to the onshore
bond market by offshore investors.
Trend of CNH dim sum bonds. As the expectation of CNH appreciation cools down,
investors are focusing more on the yields and credit quality of the dim sum bonds.
From the perspective of supply and demand, the previous low yields of CNH bonds
were largely due to the imbalance of supply and demand. The fast growing CNH
deposits were chasing a very limited amount of CNH bond supply. However, after
hitting a peak of CNH627bn in November 2011, the CNH deposits are experiencing a
continuous declining trend and dropped CNH75bn by the end of April 2012.
There are also more investment channels for the CNH funds. Banks in Hong Kong
are making more CNH loans and thus offering higher deposit rates, and the onshore
fixed income market is becoming more open to offshore investors. Therefore, the
yields of CNH bonds are converging to their onshore counterparts; and so far this
convergence has been more apparent in the longer tenor.
Table 25: BofA Merrill Lynch Dim Sum Bond Index Reference List
Ticker Name
All maturities:
CNHJ
The BofA Merrill Lynch Dim Sum Index
CJHG
The BofA Merrill Lynch Dim Sum Government Index
CJHC
The BofA Merrill Lynch Dim Sum Corporate Index
CJHQ
The BofA Merrill Lynch Dim Sum Agency Index
CJHP
The BofA Merrill Lynch Dim Sum Policy Bank Index
CNIJ
The BofA Merrill Lynch Dim Sum Investment Grade Index
One year and longer indices:
CNOH
The BofA Merrill Lynch 1+ Year Dim Sum Index
CNHG
The BofA Merrill Lynch 1+ Year Dim Sum Government Index
CNHC
The BofA Merrill Lynch 1+ Year Dim Sum Corporate Index
CNHQ
The BofA Merrill Lynch 1+ Year Dim Sum Agency Index
CNHP
The BofA Merrill Lynch 1+ Year Dim Sum Policy Bank Index
CNIH
The BofA Merrill Lynch 1+ Year Dim Sum Investment Grade Index
32
GEMs Pa pe r #1 0
On 28 June 2012 the Ministry of Finance issued CNH15.5bn CGB bonds to
institutional investors with maturities of 3y, 5y, 7y, 10y and 15y. The issuance
drew orders of CNH58.6bn, with a bid-cover ratio of 3.8, which is lower than the
4.6 last year. The auctioned yields were lower than the secondary market for the
3-7 tenor, but higher for the 10-15y tenor. The results show that the demand for
CNH bonds is still quite robust, although not as strong as last year. Furthermore,
the narrower spread with the onshore bond suggests that the expectation for
continued CNY appreciation has diminished. There are also higher hopes of
continued capital account opening.
For this auction, the MoF also separately allocated CNH2bn to global central
banks. This is the first time the MoF has done so to a dedicated class of
investors. It drew bids from five central banks.
Table 26: Summary of China bond markets and products
Instrument
Government bonds
Issuer
Currency
Minimum Denomination
Tenor
Interest rate/coupon
Coupon Payments
Day Count Calculation
Amortization Schedule
Form
Amount outstanding (as of Feb 2012)
Secondary market
Trading
Quotation Convention
Settlement Period
Average Daily Turnover
Bid/offer spread (0-5Y)
Bid/offer spread (5Y+)
Average trade size
Clearing Mechanism
Major players
Trading hours
Regulations
Restrictions on Foreign Investment
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit
Primary Auctions
Auction Style
Average Issue Size
PBoC bills
Policy bank bonds
CNY
CNY100,000
1, 3, and 6 months; 1 and 3 years
Annual coupon paid on 1y and above
Zero-coupon below 1y
Act/365
Bullet
Scripless
CNY2.1tn
CNY
CNY1,000
Up to 30 years
Fixed/Floating
Semi-annual above 10y, annual below 7y
Act/365
Bullet
Scripless
CNY6.7tn
Interbank and stock exchanges
Yield (2 to 4 decimals)
T+0/1
CNY37bn
2-8bp, 1-3bp for current issue
2-8bp
Interbank
Yield (1-3 decimals)
T+0/1
CNY50bn
1-3bp
Interbank
Yield (2 to 4 decimals)
T+0/1
CNY78bn
2-8bp, 1-3bp for current issue
2-8bp
Interbank: China Government Securities
Depository Trust & Clearing (CDC)
Stock Exchanges: China Securities
Depository Clearing Corporation (CDSCC)
Interbank participants and domestic
institutional investors trade OTC in bearer
form. Smaller domestic investors and QFIIs
trade listed securities on the Shanghai or
Shenzhen stock exchanges
9:00-12:00 and 13:30-16:30 (Beijing)
Only primary dealers
Interbank participants
9:00-12:00 and 13:30-16:30 (Beijing)
9:00-12:00 and 13:30-16:30 (Beijing)
Government of the People's Republic of
China, local governments
CNY
CNY1,000
Up to 50 years
Fixed
Semi-annual above 10y; annual below 7y
Act/365
Bullet
Scripless
CNY7.4tn
QFIIs permitted or approvals under PBoC
pilot scheme for CB, CNH clearing and
settlement banks
Local custodian required
Exempted
Residents are exempted; tax treatment on
capital gains by foreign investors is as yet
unclear, may be subjected to 25% corporate tax
Approval needed from PboC and CFETS
People's Bank of China
CDB, CADB, EXIM Bank
Approvals under PBoC pilot scheme for CB, approvals under PBoC pilot scheme for CB,
CNH clearing and settlement banks
CNH clearing and settlement banks.
NA
NA
NA
NA
Exempted
Residents are exempted; tax treatment on
capital gains by foreign investors is as yet
unclear, may be subjected to 25% corporate tax.
Approval needed from PboC
American auction - sale is done either
Dutch auction - sale is done either through Dutch auction
through mandatory allocation to state banks mandatory allocation to state banks for
for distribution to individuals or via
distribution to individuals or via underwriting
underwriting syndicates. The PBoC will act as syndicates. The PBoC will act as chief
chief coordinator in both cases.
coordinator in both cases.
RMB22-32bn
RMB3-50bn
CNH10-30bn
Minimum Amount of Tender. Source: BofA Merrill Lynch Global Research , CEIC, China Government Securities Depository Trust and Clearing Company LTD
33
GEMs Pa pe r #1 0
Hong Kong
Overview
Albert Leung
+
7137
Hong Kong is one of three Currency Board regimes in Asia, along with Macau
and Brunei. It is viewed as having one of the deepest and most liquid capital
markets free from any capital restrictions. As such, the HKD Currency Board
remains a very credible and robust regime.
Monetary policy
Background. The Hong Kong Monetary Authority (HKMA) was created in 1993
and oversees the smooth running of the Currency Board under the Linked
Exchange Rate System created in 1983 as part of its four key functions. Other
functions include financial system stability, maintaining Hong Kong’s status as an
international financial center and managing the Exchange Fund. The HKMA’s
chief executive is Norman Chan, who reports to John Tsang, the country’s
financial secretary.
Table 27: Hong Kong ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Aa1
Aa1
Aa1
Aa2
Aa2
Aa2
Aa3
Aa3
Aa3
-
AAA
AAA
AAA
AA+
AA+
AA
AA
AAAAAAAAAAA+
AA+
AA+
AA+
AA+
AA+
AA+
AA+
AA+
AA+
AA+
AA+
AA+
AA+
Base rate. The base interest rate forms the foundation upon which the discount
rates for repurchase agreement transactions are computed. Currently, the base
rate is set at 50bp above the US Fed Fund Rate, or the average of the five-day
moving averages of the overnight and 1m HIBORs (Hong Kong Interbank Offered
Rate), whichever is higher. The HKMA announces the base rate every day. Note
that HIBOR liquidity came under stress during the 2008-09 global financial crisis,
leading the HKMA to institute temporary refinements to ease HIBOR liquidity
conditions. These have since expired, with the exception that the HKMA will use FX
swaps and term repos to provide HKD liquidity on a case-by-case basis.
Chart 16: Key CPI components for Hong Kong
%
Housing
Food
Misc serv ices
Transport
Open market operations. By virtue of the Currency Board system, the HKMA is
not required to sterilize intervention, but rather enforce two-way convertibility
conditions; meaning, to sell HKD at 7.75 and buy it at 7.85 against the USD. In
doing so, the interest rates automatically adjust to incentivize capital flows to bring
the HKD back in line with its 7.8 central parity against USD. For example, intense
pressure and capital inflows to buy HKD at 7.75 against USD would prompt the
HKMA to sell HKD, expanding the monetary base and causing HKD interest rates
to fall below USD interest rates. Assuming 100% Currency Board credibility would
mean capital would flow out of HKD and back into USD.
The HKMA also operates a discount window facility to smooth interest rate volatility
and allow banks to access overnight funding based on the base rate used to repo
eligible securities such as Exchange Fund paper as collateral. Currently, the base rate
is set at 50bp above the prevailing US Fed Funds Rate or the 5d moving average of
the overnight and 1m HIBOR rate, whichever is higher. HIBOR is fixed daily at 11am
and published at 11.30am on Reuters (HIBOR=R), using a panel of 17 banks. An
average is taken after eliminating the highest and lowest two values.
Durable goods
Misc goods
Clothing
Utilities
Alcohol & Tobacco
0
10
34
Policy framework. The Hong Kong dollar is officially linked to the US dollar at a
rate of 7.8 through a linked exchange rate system, the Currency Board. This means
that every HKD7.8 in the monetary base are backed by USD1. The monetary base
comprises Certificates of Indebtedness (CoIs), notes and coins, the Aggregate
Balance, and Exchange Fund Bills and Notes. Banks are required by law to buy
CoIs in exchange for issuing HKD notes and depositing the necessary USD backing
with the HKMA’s Exchange Fund. The Aggregate Balance represents the balance
of clearing accounts held by banks with the HKMA.
20
30
40
The HKMA can also buy and sell Exchange Fund Bills to execute OMO. Note that
the May 2005 refinements to the Currency Board allow the HMKA discretion to
conduct OMOs when HKD is within the Convertibility Zone of 7.75-7.85 against
the USD to ensure “smooth functioning”.
GEMs Pa pe r #1 0
Conventions
Bonds
Settlement: T+1
Basis: Act/365
Coupon frequency: Semi-annual
IRS
Fixing: 3m HIBOR
CCS
Lending and deposit facilities. In Hong Kong banks are allowed to obtain
temporary liquidity through the discount window using repurchase agreements
with Exchange Fund Bills and Notes as collateral. Discount window refers to the
facility through which banks can borrow HKD funds overnight from the HKMA.
The discount rate is calculated as follows: the base rate will apply for the first 50%
of the borrowing and the rate applied for the other half will be the base rate + 5%
or overnight HIBOR for the day, whichever is higher.
Reserve requirements. The HKMA does not have any reserve requirements for
local banks, though there is a requirement for all authorized institutions in Hong
Kong to meet a minimum monthly average liquidity ratio of 25%. This is calculated
as the ratio of liquefiable assets to qualifying liabilities (liabilities due in one month).
Economic drivers
Coupon frequency: Quarterly USD day count Act/360,
Given the nature of the Currency Board system, the Hong Kong monetary policy
is effectively tied to that of the US. More recently, a decoupling has occurred by
virtue of the Fed’s zero interest rate policy. As a result, the front end of the curve
can be driven by liquidity shifts related to IPO funding activity, HKD revaluation
speculation and Hong Kong bank funding needs.
local Act/365
Overall we expect Hong Kong’s economy to be very tied to the fortunes of both
China and the US. Inflation remains an issue, although it has moderated from the
8% peak in 2011. As in the CPI component, housing and food are the two most
important components (Chart 17). While food price have moderated, we expect
rent to stay high, keeping inflation pressure intact.
Bond market
HK Exchange Fund Bills. The Exchange Fund issues these bills, which are
guaranteed by the government. Maturities range from 91 to 182 and 364 days.
Respectively, the bills are issued at discounts weekly, biweekly and monthly.
They are principally used for OMO and owned mainly by banks for their own
liquidity needs. As of June 2012, there was HKD587.5bn in outstanding bills.
Average daily turnover stood at HKD20bn as of June, with bid-off spreads of 3bp
and issuance sizes of HKD4-40bn.
Negotiable Certificates of Deposit. Issued by banks and financial institutions
either as fixed or floating rates, NCDs have bounced back strongly following a sharp
decline in issuance during the global financial crisis. Issuance is done through
private placement or public syndication. As of May 2012 there was HKD175bn in
outstanding NCDs, which are actively traded in the secondary market
Hong Kong Exchange Notes. Issued by the Exchange Fund, these notes range
in maturity from 2-15 years and underpin the benchmark yield curve for Hong
Kong. They are semi-annual fixed coupon bullet bonds with the longer tenors (10
and 15 years) issued semi-annually and the 2, 3, 5 and 7 years issued quarterly.
Again, these are mainly held by banks and used as collateral against the discount
window. Moreover, market makers can run short positions in bills and notes under
a condition known as “fungibility”, which circumvents the need for a cash repo
market. In principle, it is possible to go short above and beyond the outstanding
amount of a specific security.
As of June 2012, there was HK$69bn in outstanding Exchange Notes, with the 13y tenors accounting for 42%. Average daily turnover stood at HKD11.6bn as of
June and bid-offer spreads at 5-10bp, depending on tenor. Issuance sizes range
from HKD700mn to HKD1.3bn per auction.
35
GEMs Pa pe r #1 0
Hong Kong Special Administrative Region (SAR) Government Bonds.
Initiated in 2004 as part of an effort to develop the benchmark bond market
further, in 2011 2 and 5y paper has been issued with 10y issuance scheduled in
August 2011 (HKD8.5bn total). An estimated HK$30bn was outstanding in
remaining tenor of institutional bonds as of June. Retail bond issuances are also
offered. Importantly, unlike Exchange Fund paper, government bonds are not
backed by FX reserves and do not form part of the monetary base. The bonds
represent an unsecured liability of the Hong Kong government and cannot be
used as collateral against the discount window.
The Hong Kong Mortgage Corporation. Issuance began in 1998 as a means to
funding mortgage purchases from the secondary market. Owned by the
government through the Exchange Fund, the 1998 HKD20bn Debt Issuance
Program (DIP) was established to raise funds in the institutional market for
general financing requirements (developing the mortgage market and home
ownership). The program doubled to HKD40bn in 2003. In 2004, the program was
extended to the retail market for HKD20bn.
Auction and placement mechanism. The Exchange Fund Bills Program was
introduced in 1990 and issued by competitive tender on a bid-yield basis
(minimum bid HKD500,000). Bills are issued at discounts in denominations of
HKD500,000 in computerized book entry form. Announcements of tender results
are made on Reuters (HKMAOOD) and (HKMAOOE). Settlement is completed on
the first business day immediately following the relevant tender day.
Exchange Fund Notes are issued by competitive tender on a bid-price basis or by
non-competitive tender, subject to a minimum bid of HK$50,000. The form of the
notes is a computerized book entry form in the Securities Accounts maintained by
the HKMA. Competitive tenders must be submitted through Recognized Dealers,
which are also appointed as Eligible Market Makers by 10:30am on the relevant
tender day. Tender results will be announced no later than 3:00pm on the
relevant tender day. Settlement will be effected on the first business day
immediately following the relevant tender day.
Derivatives market
Interest rate swaps. These swaps are very actively traded and very liquid with
tenors ranging up to 15 years, though beyond 10 years liquidity is less abundant.
There are no restrictions on foreign investors to the IRS market. The 3m HIBOR
fixing provides the reference rate for the floating leg with settlement being T+0
before 11am and T+1 afterward.
Chart 17: Maturity profile of Hong Kong government bonds (HKDbn)
18
Hong Kong GB maturing (HKDbn)
16
Chart 18: Outstanding government debt (HKDbn, as of Dec’ 2011)
Gov ernment Bonds
50
12
Statutory Bodies
50
10
Local Corporates
14
8
96
Non MDB Ov erseas Borrow ers
6
4
Authorized Institutions
2
Ex change Fund
HKD
15
Multilateral Dev elopment Banks
167
229
655
0
2012
2014
2016
2018
Source: BofA Merrill Lynch Global Research, CEIC, ADB
36
2020
2022
2024
2026
0
100 200 300 400 500 600 700 800
GEMs Pa pe r #1 0
Bloomberg pages
HKD CURNCY <GO> ALLQ<GO>
OTC HKD<GO> - HK market monitor
HKMA <GO> - HKMA page
GBHK <GO> HK government bonds
HKMC <GO> - HK Mortgage Corporation
HIBO <GO> - HIBOR fixing
Reuters pages
HIBOR= HIBOR fix
HKMAOOB – HKMA Aggregate Balance
HKMAOOD – Bills and Notes tenders
HKDISC1 – Chronology of discount rate
HKEFB – EF Bills issuance schedule
Basis swaps. These swaps represent cash flow exchanges between 3m floating
USD LIBOR against 3m floating HKD HIBOR. They are typically used for
corporate liability hedging and investor asset swapping and are liquid out to five
years in normal conditions. In turn, basis swap pricing can also affect issuer
participation in Hong Kong’s bond market.
For instance, debt fundraising by overseas issuers (excluding multilateral
development banks) as the pronounced negative basis in 2010 increased the
hedging costs of overseas issuers raising funds in HKD and then swapping into
USD proceeds. In the end, it was cheaper to issue directly into the USD debt
market. In 2012 the opposite occurred with basis turning positive, meaning it is
cheaper to raise funds in USD. In this respect, the HIBOR-LIBOR basis is very
sensitive to local and global liquidity and funding conditions.
HKEFN – EF Notes issuance
Swaptions. Actively quoted and traded in Hong Kong with a market in caps,
floors and generic swaptions.
Table 28: Summary statistics of Hong Kong derivative products and their markets
Hong Kong Monetary Authority (HKMA)
www.info.gov.hk
Financial Services and Treasury Bureau
http://www.fstb.gov.hk/
Invest Hong Kong
www.investhk.gov.hk
Hong Kong Government Bond Program
www.hkgb.gov.hk
Mandatory Provident Fund
http://www.mpfa.org.hk/eindex.asp
Avg daily
trading volume
Avg
transaction size
Bid-Ask spread
Interest rate swaps
1-year
5-year
HKD3-4bn
HKD500mn
HKD 150K DV01
HKD 100K DV01
2bp
2bp
10-year
HKD200mn
HKD 50K DV01
2bp
HKDSW1/ HKABHIBOR
HKDSW5/ HKABHIBOR
HKDSW10/
HKABHIBOR
HKD1-2bn
HKD 100K DV01
2bp
HDBS/ LIBOR01 /
HKABHIBOR
Trades individually as
IRS & Basis
HKD 50k DVO1
4bp
LIBOR01 PYHKD
NA
NA
HKD500mn
HKD60mn
2 vol
2 vol
HDSP015 Curncy
HDSP055 Curncy
Product
Basis swaps
Cross currency swap
HK Securities and Futures Commission
http://www.sfc.hk/sfc/html/EN
HK Exchanges and Clearing Limited
http://www.hkex.com.hk/eng/index.htm
Hong Kong Association of Banks
www.hkab.org.hk
Central Money markets Unit
https://www.cmu.org.hk/cmupbb_ws/eng/page/wmp0100/wm
p010001.aspx
Hong Kong Mortgage Corporation Limited
www.hkmc.com.hk/eng/
HK Interbank Clearing Limited
http://www.hkicl.com.hk/clientbrowse.do?docID=119&lang=e
n
HK Institute for Monetary Research
http://www.hkimr.org/index.asp
Bloomberg /
Reuters Reference
Swaptions
1x5
5x5
FX market
Hong Kong is one of the largest centers for FX activities globally. Transactions
across all instruments have increased, particularly in forwards and FX swaps.
Domestically, HKD trading averages US$15bn daily for spot, forwards and options.
The HKD has been linked to the USD since 1983 with the objective of maintaining
a stable external value of the HKD against other major currencies. To achieve
stability, HKMA has been accumulating substantial reserves to keep the
exchange rate within a narrow band, HKD7.75-7.85 per USD.
HKMA only intervenes when either the strong (7.75) or weak side (7.85) is
triggered. This convertibility undertaking reinforces the automatic stabilization of
the system by expanding or contracting the monetary base and affecting interest
rate differentials to encourage capital flows consistent with the Currency Board.
37
GEMs Pa pe r #1 0
Table 29: Hong Kong FX market vital statistics and characteristics
Avg daily
Avg
FX
Tradable trading
trading Bid-Ask Reuters
Products product volume
size
spread reference Key facts
HKD Onshore
Spot
HKD Spot
USD8.0bn USD5-20mn
Forwards
USD6.0bn
Options
Forwards
FX Options USD1.0bn
USD1050mn
USD50mn
HKD
0.00020.0010
HKD
0.00020.0010
0.1-0.5 vol
HKD=D2 ▪ No restrictions, accessible to
both onshore and offshore
entities.
HKDF= ▪ Forwards are available till
tenors of 10y and are liquid for
tenors shorter than 1y.
TTDE ▪ Options are available till
tenors of 10y and are liquid for
Investor base
The key holders of Exchange Fund Bills and Notes are banks due to their wide
use as collateral with the HKMA discount window. Moreover, banks are required
to maintain a minimum liquidity ratio of not less than 25% on average during each
calendar month in accordance with the Ordinance. Moreover, the investments are
required to be in high-quality liquid assets.
Exchange Fund Bills and Notes are held by banks to meet the liquidity ratio
requirement. Banks hold Hong Kong Special Administrative Region Government
Bonds, but some are held by fund managers and insurance companies.
However, overall the supply of Hong Kong bonds has been insufficient to satisfy
investor demand. In particular, pension funds and insurance companies continue
to receive rising contributions from scheme members and policy holders. The key
pension funds include the Mandatory Provident Fund and Occupational
Retirement Schemes Ordinance (ORSO). In 2008, total contributions and
premiums were estimated at HKD212bn against HKD debt issuance of
HKD138bn (excluding Exchange Fund debt). The difficulty is that Exchange Fund
issuance is contingent on USD inflows given its overriding purpose as part of the
Monetary Base and Currency Board system.
Table 30: Hong Kong – asset allocation of Mandatory Provident Fund
Equities
Deposits & Cash Debt securities
Hong Kong
Japan
Asia
North America
Europe
Overall
15%
1%
16%
Memo item:
Assets under management, HK$bn (Dec 2011)
11%
2%
1%
5%
3%
22%
34%
4%
8%
8%
8%
62%
Overall
60%
6%
9%
14%
11%
100%
264
Source: BofA Merrill Lynch Global Markets
Article 112 of the Basic Law embodies Hong Kong’s laissez faire approach to free
capital flows and commitment to the Currency Board system. At a market level,
the Securities and Futures Commission (SFC) represents an independent nongovernmental body charged with regulating the securities and futures market. The
main body of legislation that underpins the SFC is the Securities and Futures
Ordinance established in 2003. In addition to regulating a broad range of markets,
the SFC also regulates investment products offered to the public, listed
companies and the Hong Kong Exchanges and Clearing Limited.
38
GEMs Pa pe r #1 0
Government issued and denominated HKD debt is not subject to taxation in the
form of capital gains, stamp duty or withholding tax on interest income. This is
also the case for eligible multilateral organizations that issue HKD debt. In the
case of corporate bonds, there is a profit tax of 16.5% applicable to corporations.
Section 4 of the Clearing and Settlements Systems Ordinance (CSSO) gives
designation and oversight to the HKMA. As such, the HKMA oversees a variety of
settlement systems: Central Moneymarkets Unit (CMU), HKD Clearing House
Automated Transfer System (CHATS), Continuous Linked Settlement (CLS),
Euro Clearing House, USD Clearing House and the Renminbi Clearing House
automated transfer systems.
The CMU was created in 1990 and provides clearing and settlement for
Exchange Fund Bills, Notes and other HKD debt securities. It is also linked to the
HKD Real Time Gross Settlement System (RTGS) that provides end-of-day
delivery versus payment (DvP) to members and this has been extended to USD,
EUR and RMB RTGS systems, facilitating delivery versus payment (DvP)
capability for debt securities in these currencies as well as overnight repo facilities
for USD and EUR payment systems in Hong Kong. As such, overseas investors
can opt to settle through Euroclear, Clearstream or CMU if they have an account.
A task force known as the Pan-Asian CSD Alliance has been set up among a
group of Asian central banks and central security depositories and Euroclear to
improve the cross-border post-trade infrastructure in Asia.
Table 31: Summary of Hong Kong bond markets and products
Instrument
Exchange Fund Bills
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Amount outstanding (as of Jun 2012)
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Minimum Amount of Tender
Exchange Fund Notes
Hong Kong Monetary Authority
HKD
HKD500,000
91, 182 and 364 days
Issued at discount
Zero
Act/365
Bullet
Registered
HKD587,447mn
Hong Kong Monetary Authority
HKD
HKD50,000
2, 3, 5, 7 and 10 years
Semi-annual
Fixed
Act/365
Bullet
Registered
HKD69,000mn
OTC
Yield
T+0/ T+1 (after 11:00 Hong Kong)
HKD16.251mn
2bp
3bp
HKD1bn
Central Money Markets Unit (CMU)
Only eligible market makers
9:00-11:30 and 14:00-17:00 (Hong Kong)
Open to individual and institutional investors but only through
recognized dealers only
OTC
Price
T+0/ T+1 (after 11:00 Hong Kong)
HKD658mn
3bp
5bp
HKD200mn (for 2y-5y); HKD100mn (for 5y+)
Only eligible market makers
9:00-11:30 and 14:00-17:00 (Hong Kong)
Open to individual and institutional investors but only through
recognized dealers, stock exchange participants, or through
Central Clearing and Settlement System
No restrictions
None
None
None
No restrictions
None
None
None
Competitive tender on a bid-price basis or non-competitive
tender
HKD5-40bn
HKD500,000
Competitive tender on a bid-price basis or non-competitive
tender
HKD0.6-1.2bn
HKD50,000
39
GEMs Pa pe r #1 0
India
Overview
Albert Leung
+
7137
Local investors are the dominant players in the Indian bond market, with foreign
investors largely closed off to the market and subject to limits. In recent years the
government has increased the limits significantly, especially in infrastructure
bonds and incrementally broadening the investor base in government bond
market. The restrictions mean foreign investors are involved mainly in the
offshore non-deliverable swap market where they can take views about the future
path of monetary policy, inflation and growth. Liquidity in the non-deliverable OIS
market has improved significantly in recent years.
Monetary policy
Background. The Reserve Bank of India (RBI) sets policy rate eight times a
year, with repo and reverse repo being the key benchmark policy rates. Currently,
the repo rate at 8% is 100bp above the reverse repo rate at 7%. The overnight
rate (floating leg of the IRS fixing) is slightly above the repo rate since banks are
short liquidity on aggregate. This manner by which RBI conducts liquidity
management is known as the Liquidity Adjustment Facility.
Table 32: India ratings profile (long-term local
currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Baa3
Ba1
Ba1
Ba2
Ba2
Ba2
Ba2
Ba2
Ba2
Ba2
Ba2
Ba2
Ba2
BBB-u
BBB-u
BBBBBBBBBBBBBB+
BB+
BB+
BB+
BB+
BBBBBB
BBBBBBBBBBBBBBBBBBBBBBB+
BB+
BB+
BB+
BB+
BBB-
Source: Bloomberg, BofA Merrill Lynch Global Research; Note: * indicates
negative outlook change; ** indicates positive outlook change
Chart 19: Key WPI components for India
Manufactured
65.0%
products
Fuel
14.9%
Primary
20.1%
articles
0.0%
50.0%
Weights in WPI
Source: Ministry of Industry, India
40
100.0%
Policy framework. The central bank has a multiple indicator approach, which
means it monitors a number of indicators, including interest rates, inflation, money
supply, credit, exchange rate, trade, capital flows and fiscal position. The repo
rate signals the monetary policy stance. In a tightening cycle the overnight is
likely to be anchored slightly above the repo rate. But in a rate cut cycle, the
overnight rate can go to as low as the reverse repo rate. The RBI’s main
objectives include maintaining price stability and ensuring an adequate flow of
credit to the productive sectors.
Base rate and other key rates. Repo is the rate for banks that apply overnight
loans from the RBI. Reverse repo is the rate banks get by placing surplus liquidity
to the RBI overnight. Eligible securities to be used as collateral to obtain overnight
funding from RBI include gold, cash and other securities, such as government
bonds. If a bank runs out of eligible collateral, it can resort to the Marginal
Standing Facility (MSF) at the RBI, up to 2% of book, where the borrowing rate
would be 1% above the repo rate.
Open market operations. The RBI can announce OMO anytime when it deems
bond yields are too high, or use it as a means to provide liquidity to the banking
system when it is short of liquidity.
Lending and deposit facility. Repo and reserve repo rates are introduced as
part of the Liquidity Adjustment Facility (LAF) to act as a signal for the money
markets and are tools for liquidity management. When the RBI needs to absorb
excess liquidity, it can choose to raise the cash reserve ratio by curtailing the
lending capacity of the banks. Other alternatives include using the statutory
liquidity ratio (SLR) to adjust the proportion of net demand and time liabilities to
hold stipulated government securities for banks, or by selling and issuing more
government securities through OMO.
Reserve requirements. The RBI has a cash reserve ratio (CRR) requirement for
banks. This refers to the proportion of customer deposits and notes that each
commercial bank must hold as minimum reserves.
GEMs Pa pe r #1 0
Conventions
Fiscal policy
Bonds
India has one of the highest fiscal deficits (% GDP) among Asia countries with the
central government targeting a deficit of 5.1% GDP, but our economist thinks it is
very likely to be higher. For now RBI is helping to support the bond market and
inject liquidity via OMO and the recent measure to increase the foreign
institutional investor (FII) government debt quota by $5bn to $20bn. However,
structural reform remains the key, which we think is most likely needed to bring
inflation lower and attract foreign investment of government securities (GSec).
Settlement: T+1
Basis: 30/360
IRS
Fixing: OIS – O/N MIBOR; NDOIS – O/N MIFOR
Bond market
Coupon frequency: quarterly, floating/fixed Act/365
India’s government bond issuance totaled INR5.09Tln INR for the April
2011/March 2012 fiscal year. Foreign investors are subject to limits. Foreign
investors can now buy up to US$20bn in government securities and US$40bn in
corporate bonds. Bonds trade through two platforms: 1) the NDS OM order
matching system managed by the Clearance Corporation of India Limited (CCIL),
where 80-85% of the market volumes go through; and 2) an interbank broker
market. Foreign institutional investors cannot trade through the NDS OM system;
they must trade through an onshore licensed broker.
CCS
Fixing: 6m USD LIBOR or 6M MIFOR
local Act/365
Money market. The main instrument in the money market is call money.
Treasury bills are issued by the RBI on behalf of the government. Other
instruments increasing rapidly in volume of issuance include certificates of
deposit (CD) issued by banks, with tenors of less than a year, and development
finance institutions, with tenors of 1-3 years. There is also a growing commercial
paper (CP) market, which is a discount instrument issued by corporates to raise
short-term funds.
Treasury bills. The RBI issues Treasury bills on behalf of the government with
tenors of 91, 181 and 364 days. The 91d bills are issued every Wednesday, with
the other two tenors auctioned on alternate Wednesdays. They are zero-coupon
instruments issued at a discount to face value and are the main money market
instrument in India.
Chart 21: Bid-to-cover moving average of past five auctions for India
government bonds
Chart 20: Maturity Profile of India government bonds (INRbn)
4.00
3.0
BTC Mov ing Av erage
Maturing India Gov ernment bonds (INRbn)
2.5
3.50
2.0
3.00
1.5
2.50
1.0
2.00
0.5
20-Jul-12
29-Jun-12
1-Jun-12
18-May-12
3-Apr-12
27-Apr-12
2041
17-Feb-12
2036
20-Jan-12
2032
30-Dec-11
2027
25-Nov-11
2024
28-Oct-11
2021
9-Sep-11
2018
18-Aug-11
2015
22-Jul-11
2012
1-Jul-11
1.50
0.0
Source: BofA Merrill Lynch Global Research, RBI.
Source: BofA Merrill Lynch Global Research, RBI.
41
GEMs Pa pe r #1 0
Bloomberg pages
INR Curncy ALLQ<GO> FX rates
OTC INR <GO> - Market monitor
RBIN <GO> - Reserve Bank of India
RBIM <GO> - India government bonds
INMO <GO> - Government borrowing program
Reuters pages
IN/RBI – Reserve Bank of India page
IN/BENCH – Benchmark bonds, bills, fixes
IN/FINMDA – Money market association
Reserve Bank of India (RBI)
www.rbi.org.in
Ministry of Finance
www.finmin.nic.in
http://commerce.nic.in/
Government bonds (Gsec). The RBI issues bonds on behalf of the government,
which are used primarily to finance the government budget deficit. Maturities
range between 2 and 30 years. The bonds are issued as securities bearing a
fixed coupon paid semi-annually. Primary dealers underwrite these issues with a
minimum underwriting commitment (MUC), which provides a buffer to the market
since the RBI cannot participate in the primary market. At the end of August 2012,
the market totaled INR28.42tn.
The RBI also conducts liquidity injecting OMO via the secondary market for
government bonds, or by changing the schedule for primary auctions when
needed. Through these actions the RBI can often have an important impact on
the bond market. For example, when liquidity is tight and the RBI steps in to buy
bonds, the bond market is likely to find some support from these operations.
Public sector undertaking (PSU) bonds. Public sector corporations issue
these bonds in which the federal or state governments have a majority stake.
Maturities are typically 2-10 years and some of the issues have an explicit
government guarantee from the state or federal government.
Directorate General of Foreign Trade
http://www.dgft.gov.in/
Auction and placement mechanism. Treasury bills are issued via auctions,
although government securities can also be issued on tap or through OMO. The
auctions are normally French or Dutch, with the main difference between the two
being the fact that all winning bidders are filled at the cut price/yield in the Dutch
auction rather than their individual bids. Most PSU bonds are issued via private
placements.
Securities and Exchange Board of India
http://www.sebi.gov.in
Derivatives market
Ministry of Statistics and Program Implementation
http://mospi.nic.in/Mospi_New/site/home.aspx
National Stock Exchange of India
http://www.nseindia.com/
The Clearing Corporation of India
www.ccilindia.com
Association of Mutual Funds in India
www.amfiindia.com
Fixed Income Money Markets and Derivatives Association
www.fimmda.org
42
Interest rate swaps (IRS). The main yield curve is the onshore overnight indexed
swap (OIS) curve. These trade at tenors up to five years, benchmarked against
the Mumbai Interbank Offer Rate (MIBOR), which is published by the National
Stock Exchange. Tenors beyond five years tend to be illiquid and traded
irregularly.
For offshore investors, the non-deliverable OIS is reasonably liquid, also out to 5y
tenors. At times, there is a spread between onshore OIS and offshore NDOIS
rates because of differences in flows, which cannot automatically be arbitraged
because of the degree of market segmentation. Daily volumes in the onshore OIS
market average about INR100bn.
GEMs Pa pe r #1 0
Table 33: Summary statistics of India derivative products and their markets
Avg daily
trading volume
Product
Interest rate swaps OIS
1-year
INR50bio
5-year
INR30bio
10-year
INR500mio
Interest rate swaps MIFOR
2-year
INR2bio
5-year
INR1bio
10-year
Very rarely
1-year
INR20bio
5-year
INR25bio
10-year
INR500mio
Market prices out of
mifor curve
Avg
transaction size
Bid-Ask spread
Reuters reference
notes
USD5k
USD10k
USD5k
2-3bp
2-3bp
5-7bp
NSERO Index
NSERO Index
NSERO Index
USD2k
USD5k
USD5k
20-25bp
20-30bp
30-40bp
MIFOR=
MIFOR=
MIFOR=
USD5k
USD10k
USD5k
2-3bp
2-3bp
5-7bp
IRSWN1 Curncy
IRSWN5 Curncy
IRSWN10 Curncy
NA
NA
NA
FX market
Since 1993 India has been following a managed float exchange rate regime that
reflects market demand and supply conditions. While the RBI does not institute a
fixed target or preannounced band, the value of the rupee is tracked using the
real effective exchange rate (REER), based on the currencies of India’s major
trading partners (USD, EUR, GBP, JPY, CNY and HKD). As such, RBI’s stated
policy is to intervene only to contain too much volatility.
The RBI announces a daily reference rate for the INR against the USD, EUR,
GBP and JPY. It also monitors exchange rate movements carefully, and at times
of excessive market fluctuation, intervenes to maintain external competitiveness.
The rupee is fully convertible on the current account. INR purchase can be
executed with necessary document proofs. However, INR is only partially
convertible on the capital account. It is not convertible on the capital account
unless approval issued by central bank for capital account transactions.
Table 34: India FX Market Vital Statistics and Characteristics
Avg daily
Avg
FX
Tradable trading
products product volume
spread Reference Key facts
size
INR Onshore
Spot
INR Spot
Forwards
Options
USD5bn
INR
USD4-5bn
Forwards
FX Options USD50100mn
INR 0.005USD
3-10mn
0.03
INR 0.02USD
5-20mn
0.05
USD15mn 0.4-1.0 vol
INR = D2 ▪ Trading hours: 9:00 -17:00
(Mumbai)
INRF= ▪ Forwards on INR are
available and liquid up to 1 yr
INRVOL ▪ FX Options on INR are
available till tenor of 5 years
and are liquid for tenor shorter
than 2 years.
INR Offshore
Forwards
NDF
USD1.52.0bn
USD
5-20mn
INR0.020.10
PNDF
PNDG
Options
NDO
USD350400mn
USD
10-30mn
0.4-1.0 vol
TTDE
▪ INR is non-deliverable.
▪ Offshore entities can access
the market through NDF.
▪ Dollar settled NDO on INR
are available till tenor of 5
years and are liquid for tenor
shorter than 2 years.
43
GEMs Pa pe r #1 0
Investor base
Foreign holdings of government bonds have stagnated over the past 12 months;
total holdings are at around INR230bn, close to 1% of the total outstanding. The
weak INR is probably part of the reason why ownership has not increased this
year. Among local investors, fund managers, insurance companies and banks are
the major investors in government bonds.
Rules, regulations capital controls taxation
Foreign investors -- institutional and qualified non-institutional -- can invest in debt
instruments. Currently, the limits are US$20bn for government bonds and
US$40bn for corporate bonds. Of the US$20bn in GSec, US$5bn must be
invested in bonds with a remaining maturity of more than five years.
FII are currently liable for withholding tax of 15-20% depending on the residency
of the institution. If fixed-income assets are held for less than a year, a short-term
capital gains tax of 10% is also levied. However, if the resident country of the FII
has completed a tax treaty with India, it may be exempt from many of these taxes.
In addition to fixed-income assets, P-notes are also exempt from these taxes, but
only SEBI registered FII are allowed to invest via P-notes.
The Clearance Corporation of India Limited is the central counterparty for all
transactions in GSec. Trades are settled on a delivery versus payment (DVP)
basis, and the CCIL guarantees all trades using the Settlement Guarantee Fund,
which is financed out of margins paid by all market participants.
Chart 22: Foreign holdings of India government bonds
270
240
Foreign Holdings of India Gov Bonds (INR bn)
% of foreign holding of India Gov Bonds
1.0%
210
0.8%
180
150
0.6%
120
0.4%
90
60
0.2%
30
0.0%
0
Mar07
Mar08
Mar09
44
1.2%
Mar10
Mar11
Mar12
Table 35: Local institutional base as of March 2012
Holders
Holdings in INRbn
Commercial Banks
Bank-Primary Dealers
Non-Bank PDs
Insurance Companies
Mutual Funds
Co-operative Banks
Financial Institutions
Corporates
FIIs
Provident Funds
RBI
Others
Total
8301
2249
23
4823
39
682
85
316
201
1705
3297
1160
22880
% of total
36.28
9.83
0.10
21.08
0.17
2.98
0.37
1.38
0.88
7.45
14.41
5.07
100
GEMs Pa pe r #1 0
Table 36: Summary of India bond markets and products
Instrument
Treasury bills (ITB)
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Amount outstanding
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Treasury bonds (IGB)
Government of India
INR
INR25,000
91, 182, 364 days
Issued at discount
Zero
Actual/365
Bullet
Registered
INR2.04tn (as of Jun 2012)
Government of India
INR
INR10,000
2-30 years
Fixed
Semi-annual
30/360
Bullet
Registered
INR22.88tn (as of July 2012)
OTC and NSE trading
OTC (yield to 2 decimals);
NSE (yield to 4 decimals)
T+1
INR2-3bn
2-3bp
OTC
Clean price to 4 decimals
INR250mn
Clearing Corporation of India Ltd (CCIL)
Primary Dealers, banks
9:00-17:00 (Mumbai)
T+1
INR20-400bn
3-5bp, 1bp for liquid benchmark bonds
3-5bp, 1bp for liquid benchmark bonds
INR50mn
Clearing Corporation of India Ltd (CCIL)
9:00-17:00 (Mumbai)
Primary Dealers, banks, non residents
Only SEBI registered FII can invest. Investment limit is
INR10bn.
Local custodian required for foreign investors
Foreigners subject to max 20% withholding tax and 30% on
interest income, unless reduced by preferential tax treaty
FIIs are subject to 30% (short-term) and 10% (long-term)
capital gains tax
Only SEBI registered FII can invest. Investment limit is
INR10bn.
Local custodian required for foreign investors
Foreigners subject to max 20% withholding tax and 30% on
interest income, unless reduced by preferential tax treaty
FIIs are subject to 30% (short-term) and 10% (long-term)
capital gains tax
Primary Auctions
Auction Style
Multiple price auction method
Average Issue Size
INR80-150bn
INR25,000
Multiple price auction method for existing issues and yield
based auction method for new issuances
INR10-50bn
INR10,000
Custodian
Withholding Tax
Capital gains Tax
45
GEMs Pa pe r #1 0
Indonesia
Overview
Albert Leung
+
7137
Indonesia represents one of Asia’s key local bond markets due to its larger market
size, higher relative yield and recent investment grade status. Total outstanding
local government bonds are estimated at IDR799tn, of which 29.5% (IDR236tn)
was held by foreign investors as of August 2012. Despite this, hedging opportunities
are restricted because the IRS market is illiquid, leaving short-dated nondeliverable
forward FX as a proxy hedge against sudden capital reversal and bond market
dislocation. Tight USD liquidity onshore dragged the IDR earlier in 2012, although
the situation stabilized after Bank Indonesia (BI) USD Time Deposit auctions. FX
reserves were at US$106bn as of June.
Monetary policy
Background. De Javasche Bank (DJB) was established in 1828 by the
Government of Nederlands-Indische as a bank to issue and circulate currencies.
In 1953, the Act of Bank Indonesia declared the establishment of Bank Indonesia
(BI) to replace DJB as the central bank, with three main tasks: monetary policy,
banking and the payment system.
Table 37: Indonesia ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Baa3
Ba1
Ba2**
Ba2
Ba3
Ba3
B1
B2
B2
-
BB+
BB+
BB+
BB+
BB+
BB+
BB+
BB
BB
B+
BBB
BBBBB+
BB+
BB
BB
BBBBBBB+
B+
B
BB-
The board’s decision-making process emphasizes deliberations. When
deliberations fail to produce an agreement, the governor will exercise his authority
to decide for the board.
Policy framework. Bank Indonesia has an inflation-targeting framework (ITF)
that was adopted formally in July 2005. This replaced the previous monetary
policy using base money as the monetary policy target. Under the ITF, BI
announces future inflation targets for specific periods and responds to potential
inflation overshoot or undershoot with the instruments at its disposal. Essentially,
BI sets a policy rate known as the BI rate, which serves as the primary instrument
for influencing economic activity with the overriding objective of achieving the
desired inflation level. The current inflation target for 2012 is 4.5% +/- 1% for
headline inflation.
Note: * indicates negative outlook change; ** indicates positive outlook
change.
Chart 23: Key CPI components of Indo
Housing, Electricity , Gas & Fuel
25%
Food
20%
Transp, Comm & Finance
19%
Processed Food, Bevg, Tobacco
Open market operations. To enhance OMO effectiveness, BI launched twicedaily announcements of liquidity conditions in the banking system. This involves
total liquidity and excess reserves projections. The main tool includes monthly
auctions of Bank Indonesia Certificates (SBIs), which have 3m and 6m tenors.
Other monetary operations tools include FASBI, overnight repo, fine tune
operations (contraction and expansion), and sharia SBIs.
8%
Clothing
7%
Others
4%
0%
5%
10%
46
Base rate. The overnight rate is BI’s policy rate. The lower limit of the benchmark
rate (deposit facility) is also key because this rate (FASBI) represents the prevailing
rate when commercial banks place money market funds overnight with BI. Lowering
the rate would encourage banks to transact with one another, and vice versa.
17%
Edu, Recreation & Sports
15%
20%
BI’s roles were further fine-tuned in subsequent years, with the additional single
objective to achieve and maintain the stability of the rupiah value set in 1999. The
Board of Governors consists of current Governor Darmin Nasution and six deputy
governors. Members of the board are appointed for five-year terms and may be
reappointed to the same position for no more than one subsequent term. The
Board of Governors meets at least once a month to deliberate and decide on
general policy on monetary affairs, and at least once a week to evaluate policy
implementation or to decide on other strategic and principle policies.
25%
30%
Lending and deposit facilities. The FASBI rate applies to deposits with BI. For
borrowing from BI, the ceiling rate (BI rate +50bp) applies for individual banks that
experience liquidity shortages.
GEMs Pa pe r #1 0
Conventions
Bonds
Settlement: Variable, usually T+2 or T+3
Basis: Act/365
Coupon frequency: Semi-annual or quarterly
CCS
Coupon frequency: Semi-annual, USD day count
Act/360, local Act/360
Reserve requirement. The statutory reserve requirement for commercial banks is
8% of third-party deposits, while the secondary reserve requirement (government
bonds, BI certificates) is 2.5%. The reserve requirement was raised in 2010 to
control credit growth and excess liquidity, but has remained unchanged since 2011.
Economic drivers
The key market drivers are monthly CPI, trade balance, money supply and credit
growth. The Central Bureau of Statistics divides the CPI basket into seven main
components: 1) food (19.57%); 2) processed food, beverages and tobacco
16.55%); 3) housing, electricity, gas and fuel (25.41%); 4) clothing (7.09%); 5)
health (4.44%); 6) education, recreation and sports (7.81%); and 7)
transportation, communication and finance (19.12%). As for external trade,
Indonesia’s main exports fall into the non-oil and gas category (82.2%), and
consist primarily of commodities-related products like palm oil, mining and coal.
Domestic demand supports economic growth, with private consumption and
investment expected to remain strong. Growth from the external side is expected
to decline, with export growth still affected by weak world demand and lower
international commodity prices. Strong domestic demand is expected to be high
and lead to import growth.
Bond market
Indonesia’s local government bond market represents the sixth largest in Asia exJapan with an estimated USD103.93bn in outstanding bonds. There are four
broad categories of bonds: Treasury bonds, recap bonds (variable and fixed),
Treasury bills (SBIs), and retail bonds.
Bond trading occurs through two key platforms: 1) the more liquid Indonesian
Government Securities Trading System (IGSTS) provided by the Indonesia Stock
Exchange; and 2) the Fixed Income Trading System (FITS) via the Surabaya
Stock Exchange.
Apart from retail bonds, which are limited to Indonesian retail investors in the
primary market, foreigners are allowed to participate in the primary and
secondary markets of the other debt papers.
The money market. OMO tools like SBIs, term deposits, repo and reverse repo,
as well as standing facilities like the deposit facility, lending facility and repo SBI
make up the money market. The shortest money market instrument in terms of
tenor is interbank call money, which is announced twice a day for liquidity
measures. There are similar instruments in the sharia version.
The SBI bills and term deposits are the most actively traded and transacted
among the OMO tools, the latter a rising influence since mid 2010. BI stopped
issuing 1m SBIs in July 2010 and 3m SBIs in January 2011, so investors have
been extending duration to the 6m and 9m parts of the curve.
Term deposits were previously known as a fine-tune contraction. The other tools
were not actively transacted, especially the repo, which was previously known as
fine-tune expansion.
SBI bills. Sertifikat Bank Indonesia is the central bank’s policy instrument for
absorbing excess liquidity in the financial markets. In a rising interest rate
environment and recovering confidence in the rupiah, SBIs became a very
popular carry instrument for foreign investors also wanting to benefit from a
strengthening rupiah. However, BI took issue with this distortion to its policy
instrument, extended the holding period and stopped issuing 3m SBIs.
47
GEMs Pa pe r #1 0
Bloomberg pages
Currently, foreign investors have a six-month holding period for SBI purchases.
This is problematic for the under-developed IRS market, as the 3m SBIs had
represented the reference fix for the floating leg of the IRS.
IDR Curncy ALLQ<GO> FX rates
OTC IDR<GO> – Market monitor
EXNI<GO> – Local bond broker page
Treasury bills. SPNs were introduced in 2007 and initially planned to be an
alternative investment instrument to SBIs. The main difference is the issuer. SBIs
are central bank papers while SPNs are fiscal tools used for government funding.
SPNs are issued in 1y tenors only, so they have not been able to gain much
market attention compared to SBIs.
BIJA<GO> - Bank Indonesia FX and MM page
BIPU<GO> - Bank Indonesia rates and bonds page
JIBO<GO> – Jakarta Interbank Borrowing page
Reuters pages
BIJA – Bank Indonesia page
Treasury bonds. Also known as Surat Utang Negara (SUNs), Treasury bonds are
issued by the Ministry of Finance to fund the government’s budget deficit. However,
these bonds originated from recapitalization bonds, which were issued during the
Asian financial crisis to 35 troubled banks. There are two types of Treasury bonds:
fixed-rate and variable. Maturities range from bills (3, 6 and 9 months) to bonds
(1, 3, 5, 7, 10, 15, 20 and 30 years). Coupons are paid semi-annually above 10y
tenors and annually for 7y and below.
BIFA – Bank Indonesia FX reserves
BILINK – Bank Indonesia web links
Bank Indonesia (BI)
www.bi.go.id
Ministry of Finance
www.depkeu.go.id
Ministry of Industry and Trade
www.kemenperin.go.id
Debt Management Office
http://www.dmo.or.id/en/index.php?section=1
Capital Market and Financial Institution Supervisory Board
www.bapepam.go.id/
Indonesia State Pension Fund
www.jamsostek.co.id/
Taspen Employee Pension Fund
http://www.taspen.com/
Indonesia Deposit Insurance Corporation
http://www.lps.go.id/
Indonesia Stock Exchange
www.jsx.co.id
Indonesia Exchange
www.idx.co.id
Corporate debt. The corporate debt market is small but growing. Bond issuance is
limited primarily to domestic entities. It consists of two types of instruments: state
agency bonds and private corporate bonds issued by state-owned companies and
domestic private companies, respectively. The maturity range for both is typically 58 years. Most bonds issued by private corporations are listed in the Indonesia Stock
Exchange (IDX). The majority of secondary market trading is done via the Fixed
Income Trading System bond trading platform. Foreign investors are allowed to
participate in the corporate debt market with no investment limit.
Auction and placement mechanism. Government bond auctions can be
competitive, noncompetitive or a combination of both. Amounts to be allotted by
competitive and noncompetitive bids are announced prior to auction. If
competitive or noncompetitive bids exceed or fall below target amounts, then the
split may be adjusted to accommodate demand.
The Ministry of Finance makes prior announcements on pricing method, multiple
or uniform. Under the multiple pricing method, allotments are at the price
submitted by the individual bidder. Under the uniform pricing method, allotments
are at the weighted average bidding price.
Chart 24: Maturity profile of Indonesia government bonds (IDRtn)
60
Indonesia GB maturing (IDRtn)
Chart 25: Outstanding government debt (IDRtn, as of 31 July 2012)
IDR tn
900
IDR tn
50
750
50
40
600
40
30
450
20
300
30
10
150
20
0
10
0
2012 2014 2016 2018 2020 2022 2024 2026 2028 2031 2037 2041
Source: BofA Merrill Lynch Global Research, ADB
48
0
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Govt Debt Securities
Govt Debt Securities- Government bond
SBI
Govt Debt Securities-Treasury Bill (RHS)
Source: BofA Merrill Lynch Global Research, CEIC, Indonesia DMO
Jul-12
GEMs Pa pe r #1 0
Auction dates are announced by BI’s money market Information Center (PIPU).
Usually, indicative auction dates for bonds are announced about a month ahead of
time, but details are announced a week prior to the auction date. Held twice a month,
28d SBI auctions take place during the first and third weeks. For 3m SBI, BI holds an
auction in the first week of each month. It announces schedule changes via PIPU.
Derivatives market
Interest rate swaps. The market is illiquid, underdeveloped and does not
represent a viable hedging alternative for investors.
FX market
The Indonesian rupiah is not fully convertible and can only be tradable on a
nondeliverable basis in the offshore market. Indonesia has been following a
managed float exchange rate regime since 1999. BI seeks to maintain a stable
rupiah to achieve its goal of export-driven growth. The currency has been under
depreciating pressure, and from time to time has displayed high beta
characteristics relative to other Asian currencies. However, since bottoming out in
April 2009, the IDR has been recovering, and the strong macro fundamentals and
improvement in sovereign ratings suggest that the recovery is structural.
BI intervenes occasionally in the FX market to check uneven variations in the
exchange rate. To do that, it has been accumulating substantial exchange
reserves to achieve stability. Regulations are also in place to curb speculative
capital flows that may cause excessive currency volatility.
Table 38: Vital statistics and characteristics of Indonesia's FX market
Avg
Avg daily
FX
Tradable trading
size
IDR Onshore
Spot
IDR Spot
USD3-10mn
IDR5-20
IDR=
IDR
Forwards
USD600mn USD5-20mn
IDR5-50
IDRF=
IDR Offshore
Forwards
NDF
USD600- USD5-10mn
800mn
IDR5-30
PNDF
PNDG
Options
NDO
USD100150mn
0.6-1.5 vol
TTDE
Forwards
USD1bn
USD1030mn
▪ Proper documentation
required.
▪ Trading hours: 0800-1600
(Jakarta)
-NA
▪ IDR is non-deliverable
currency.
the market through NDF.
▪ USD settled NDF on IDR are
available to 10y and are liquid
up to 2y.
▪ Dollar settled NDO on IDR
are available to 5y and are
liquid up to 1y
Investor base
Foreign investors surpassed banks to become the largest holders of outstanding
Indonesian government debt in 2011, although in 2012 the percentage of foreign
holding has dropped back because of concern over USD liquidity and the ability
exit. But recently the situation has improved and foreigners net bought recap
bonds again in July 2012. Foreign investors have been dominated by real money
accounts, which allocate more than 60% of the holdings in tenors beyond 5y.
The banks’ holding share has declined steadily from over 80% 10 years ago. The
original use of recapitalization bonds has faded and banks have turned to lending
with bond yields becoming less attractive.
49
GEMs Pa pe r #1 0
Banks can be divided broadly into two categories: state and private banks.
Private banks tend to have a more even split between their investment and
trading bond accounts, which makes them more active in the secondary market.
State banks have a much higher allocation (above 70%) of bond holdings in their
investment accounts, which makes them more passive as buy and hold investors
and more active in the primary market.
Insurance companies are dominated by Jamsostek and Taspen, the two state
bodies, and account for 13.6% of the holding share. Their focus is largely in the
back end, beyond 10y tenors. Jamsostek and Taspen play an active role in the
primary market, adopting a buy to hold investment policy.
Table 39: Local and foreign institutional base (as of 31 August 2012)
Holdings (IDRbn)
Total Govt Bond Outstanding
Banks
Bank Syariah
Bank Indonesia
Mutual Fund
Insurance Company
Foreign Holder
Pension Fund
Securities Company
Others
% of total
803.1
290.6
4.6
31.6
47.2
109.0
233.2
34.6
0.6
56.3
100%
36%
1%
4%
6%
14%
29%
4%
0%
7%
The rules and regulations for the bond market are governed mainly by BI and
BAPEPAM, the Capital Market and the Financial Institution Supervisory Board
under the Ministry of Finance. BAPEPAM is responsible for granting licenses,
setting rules and regulations, supervising market participants, and establishing
capital market accounting standards. It has the authority to issue government
debt securities with prior approval from the People's Legislative Assembly. BI
stipulates and administers regulations regarding the issuance, sale and purchase
of these debt instruments. Generally, there are no restrictions on foreign investors
owning government or corporate bonds.
However, in 2002, BI introduced measures restricting Indonesian banks from
conducting the following IDR transactions with nonresidents:

Transferring IDR to offshore banks for any reason other than payments
related to economic activities.

Providing credit, overdrafts or fund placements in IDR.

Purchases of securities in IDR issued by nonresidents.

Inter-office transactions in rupiah.

Equity participation in IDR.
Interest and capital gains on bonds coursed through the Indonesia Stock
Exchange (IDX) are subject to a single final withholding tax of 20%. Interest and
capital gains from bond transactions not reported to the IDX are subject to
general income taxes (30% maximum) after a preliminary withholding tax of 15%
is deducted. Both the interest income and capital gain tax liabilities can be
mitigated contingent on tax treaties with Indonesia. Interest income tax of 20% or
tax treaty rates is applicable in the case of SBI T-bills.
50
GEMs Pa pe r #1 0
Settlement is governed by the Capital Market Law and the BAPEPAM’s
regulations. Settlement of all government bonds is scripless and conducted
through the Scripless Securities Settlement System (BI-SSSS). Transactions are
settled via delivery of securities. PT Kustodian Sentral Efek Indonesia (KSEI)
conducts the clearing and settlement of corporate bonds through the Fixed
Income Trading System. Settlement in the derivatives market is on a cash basis.
The Indonesian Clearing and Guarantee Corporation (KPEI) acts as the
counterparty for settling and liquidating an open position upon contract maturity.
Table 40: Summary of Indonesia bond markets and products
Instrument
Sovereign bonds
Fixed rate bonds (FR)
Issuer
Currency
Principal
Tenor
Republic of Indonesia
IDR
Republic of Indonesia
IDR
2-30 years
2-30 years
Coupon Payments
Form
Amount outstanding
Secondary Market
Trading
Fixed
Semi-annual
Actual/Actual
Bullet
Scripless
IDR799tn (as of July 2012)
Fixed
Semi-annual
Actual/Actual
Bullet
Scripless
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Sertifikat Bank Indonesia
(SBI; T-bills)
Bank Indonesia
IDR
IDR100,000 (par)
SBI (6m, 9m);
T-bills (3m, 1y)
Issued at discount
Zero coupon
Actual/360
Bullet
Scripless
OTC or Indonesian Government Securities OTC or Indonesian Government Securities OTC
Trading System (IGSTS) provided by the IDX. Trading System (IGSTS) provided by the IDX.
Price
Yield
Yield
Typically T+2 or T+3
Typically T+3 (or negotiated)
Typically T+3 (or negotiated)
USD200-500mn
2-7bp
2-3bp
2-5bp
3bp
USD1-2mn
Bank Indonesia Scripless Securities
Settlement System (BI-SSS); DVP Settlement Settlement System (BI-SSS); DVP Settlement Settlement System (BI-SSS); DVP Settlement
Banks, securities companies, money market Banks, securities companies, money market Banks, securities companies, money market
brokers
brokers
brokers
Mon-Thu: 9:30-noon and 13:30-17:00
Mon-Thu: 9:30-noon and 13:30-17:00
Mon-Thu: 9:30-noon and 13:30-17:00
Fri: 9:30-11:00 and 2:00-5:00
Fri: 9:30-11:00 and 2:00-5:00
Fri: 9:30-11:00 and 2:00-5:00
(Jakarta time)
(Jakarta time)
(Jakarta time)
Auction Participants. Retail investors should Participating banks
Auction Participants designated by the
submit applications through Auction
Ministry of Finance
Participants designated by the Ministry of
Finance
Not restricted
Local custodian required for individual
investors
Interest and capital gains on bonds coursed
through the Indonesia Stock Exchange (IDX)
are subject to a single, final withholding tax of
20%.
Interest and capital gains from bond
transactions not reported to the IDX are
subject to general income taxes (30%
maximum) after a preliminary withholding tax
of 15% is deducted.
None
Not restricted
investors
20%.
Interest and capital gains from bond
transactions not reported to the IDX are
subject to general income taxes (30%
maximum) after a preliminary withholding tax
of 15% is deducted.
None
Competitive tender using multiple price
method or noncompetitive bid at weighted
average competitive price.
IDR7tn
IDR10bn
Private placement by Government to banks
participating in recapitalization.
IDR7tn
IDR10bn
Not restricted
investors
20%.
Interest income tax of 20%, or tax treaty
rates.
None
Dutch-style yield auction, in which successful
bidders are allotted securities at a uniform
yield.
IDR50bn
51
GEMs Pa pe r #1 0
Korea
Overview
Albert Leung
+
7137
Korea’s swap and bond market is one of the most liquid and well developed in the
region. 3y KTB futures have excellent liquidity and are exempt from WHT, which
is appealing to foreign investors who are large players in this product. Bond
issuance is benign in 2012. Demand is outstripping supply, and KTB has been
one of the major beneficiaries of real money and sovereign wealth fund asset
reallocation. Foreign ownership of government bonds is at about 18%. Part of the
inflow comes from regional central banks as they diversify their FX reserves.
Jaewoo Lee
+82 2 3707 0465
Monetary policy
Background. The Bank of Korea (BoK), established on 12 June 1950, performs
the typical functions of a central bank, such as bank note issuance and monetary
policy formulation. In addition, the BoK undertakes the operation and oversight of
the payment and settlement systems, and manages the nation's foreign exchange
reserves. It also monitors the financial system and evaluates its stability,
publishing its findings for the parliament and general public.
Table 41: South Korea ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Aa3
A1
A1
A2
A2
A2
A3
A3
A3
A3
A3
Baa1
Baa1
A+
A+
A+
A+
A+
A+
A+
A+
A+
A+
A+
A
A
AA
AA
AA
AA
AA
AA
AA
AA
AAAAAAA
A
Policy framework. The BoK has had inflation-targeting as its monetary policy
framework since 1998. It considers price stability as the most important monetary
policy objective, while also taking into account economic growth and financial
stability in implementing the monetary policy. The bank determines the inflation
target in consultation with the government. The current inflation target is set at
3.0±1% yoy of annual average CPI inflation rate for the 2010 to 2012 period.
Base rate. The base rate is the BoK’s operational target through which the bank
influences the short and long-term market interest rates, and thus the real
economic activities and inflation. The base rate is the reference rate used by the
BoK in 7d repo transactions. The MPC sets the base rate each month at its policy
meeting, and the BoK steers the overnight call rate toward the base rate level,
which subsequently affects market interest rates.
Chart 26: Key CPI components of Korea
Housing, Water, Electricity & Fuels
17%
Transport & Communication
17%
12%
Restaurants & Hotels
11%
Education
7%
Health
6%
Clothing & Footw ear
15%
Others
0%
52
Open market operations. The BoK conducts its monetary policy mainly through
OMOs, by which it affects the level of reserves in the banking system and steers the
overnight call rate toward the base rate. OMOs are conducted through outright or repo
transactions of government securities and monetary stabilization bonds (MSB), and
through commercial banks’ deposits in the monetary stabilization account (MSA).
Outright transactions are conducted only limitedly, to adjust liquidity permanently and
affect long-term market rates directly. Securities transactions thus focus on repo
transactions, mostly with 7d maturities. MSA, introduced in 2010, is a term deposit
facility used mainly to fine-tune the reserve levels and cope with unexpected changes
in reserve supply and demand.
15%
Food & Beverages
10%
The BoK’s Monetary Policy Committee (MPC) is the policy-making body responsible
for formulating the monetary and credit policies of the economy. The MPC consists of
seven members, with the BoK governor serving as the chairman of the committee
concurrently. The MPC holds a monthly policy-setting meeting, usually on the second
Thursday or Friday. Resolutions at an MPC meeting are adopted by a simple majority
when there are at least five members present. The committee’s decisions are
announced immediately following the meeting on the BoK website, and the minutes of
the monetary policy meetings are published two weeks after the meetings since
September 2012 (used to be published six weeks after the meetings).
20%
Lending and deposit facilities. The BoK operates lending and deposit facilities
to control the availability of banking institutions’ funds. Its lending and deposit
facilities consist of aggregate credit ceiling loans, liquidity adjustment loans and
deposits, intraday overdrafts, and special loans.
GEMs Pa pe r #1 0
Conventions
Bonds
Settlement: T+1
Basis: Act/365
IRS
Fixing: 91-day CD
Coupon frequency: Quarterly fixed/floating Act/365
CCS
local Act/365
For the aggregate credit ceiling loan, which was introduced in 1994, the BoK fixes
a cap on its loans to domestic banks and fixes individual shares allocated to
banks on the basis of performance-related parameters. For liquidity adjustment
loans and deposits the BoK offers an unrestricted standing facility to control the
volatility of the call rate. The loan and deposit interest rates are set at 100bp
above and below the BoK base rate. Intraday overdrafts help tide over intraday
shortages of settlement funds. Special loans are extended to augment the bank’s
capital and financial market stability.
Reserve requirement. The BoK imposes reserve requirements on the deposits
and other liabilities of banking institutions. This system was introduced originally
for the protection of depositors, but can also be used, if considered necessary, to
control the funds available to banks through a reserve requirement ratio
adjustment. Should an institution’s reserves fall short of its legal reserve
requirements, which are computed monthly, it must pay the bank a penalty of 2%
of the amount of the average deficiency during the applicable period.
Fiscal policy
The key market drivers are monthly export numbers, monthly CPI inflation and
industrial production. The inflation target set at an annual average target gives the
BoK considerable flexibility, and BoK puts considerable weight on the growth
outlook and the inflation target. As a very open economy, global developments
feature prominently in BoK discussions of monetary policy, and the exchange rate
is a key variable in that regard. The BoK tends to intervene actively in the FX
market to smooth short-term volatility when capital inflows are strong.
Bond market
Korea’s local government bond market (Korea Treasury Bonds, KTB) is the
second largest in Asia with US$524bn in outstanding bonds, or 48.2% of GDP. In
January 2011 the government re-imposed a 14% tax on interest income and a
20% capital gain on KTB holdings and monetary stabilization bonds in a bid to
deter speculative inflows into the local fixed-income market. As of July 2012
foreign investors held 17.5% of the market in KTBs and MSBs.
Korea treasury bonds. KTBs are issued monthly with benchmark issues at 3, 5,
10 and 20y points on the yield curve, of which 3y KTBs tend to be the most liquid
part of the curve. KTB futures are traded actively at 3y and 10y tenors. With
demand for duration from local investors such as insurance companies
increasing, the Ministry of Strategy and Finance (MoSF) started issuing 30y KTBs
in September 2012.
Inflation-linked bonds. KTBi were first issued in 2007, with yield linked to the
headline CPI. These bonds tend to be illiquid. Two issues (2017 and 2020) trade
occasionally in the secondary market. The MoSF announced that it intends to
step up KTBi issuance in a bid to improve market liquidity, and expects interest in
inflation-linked bonds to improve given the backdrop of rising inflation.
Special public bonds. Municipal governments, state corporations and financial
institutions issue special public bonds, which typically have government
guarantees with maturities of 2-9 years.
Corporate bonds. With typical maturities of up to 5y, corporate bonds are issued
by non-financial private companies through public offerings underwritten by
financial institutions.
Money market. Monetary stabilization bonds issued by the BoK form benchmark
yields for short-term interest rates and are used by the BoK to mop up structural
excess liquidity. The size of the outstanding MSB issues was 212tn KRW as of May
2012. MSB was initially issued as BoK sterilized its FX purchases from the market to
53
GEMs Pa pe r #1 0
lean against appreciation pressures caused by capital inflows. Over the past year
MSB size growth has slowed as FX inflows moderate. Banks have tended to access
the money market for short-term funding by issuing certificates of deposit (CDs).
However, issuance has trailed off since the Financial Supervisory Service (regulator)
announced that from 2014 banks loan-to-deposit ratio would be limited to 100%. The
91-day CD rate is an important reference rate for the swap market, as it is the floating
leg for interest rate swap contracts, including forward rate agreements (FRAs).
Auction and placement mechanism. Korean treasury bonds are issued for
financing government projects and social welfare schemes. KTB is a fixed-coupon
bond with semi-annual interest payments and maturities of 3, 5, 10 and 20 years.
KTBs are issued monthly according to the auction calendar announced at the
beginning of the month. With respect to issuance of new benchmark KTBs, 3y KTBs
are issued in June and December; 5y KTBs are issued in March and September; 10y
KTBs are issued in June; and 20y KTBs are issued in December every year.
KTBi, or inflation-linked treasury bonds, were introduced in March 2007 to secure
a stable long-term funding base and reduce interest expenses. The KTBi
removes inflation risk by adjusting the principal. The principal of KTBi securities
has been guaranteed by the government since June 2010.
Since June 2009 KTB auctions have followed the Dutch method, adopting a
differential pricing auction method. Auctions are announced on the Wednesday
immediately preceding. Only primary dealers are allowed to participate in the auction
process. Individual and institutional investors, and domestic or foreign investors can
participate in KTB auctions via the designated 20 primary dealers in the market.
Noncompetitive Bids Option II was implemented in September 2006.
Foreign investors are required to open a foreign currency investment account and a
non-resident Korean currency investment account. They may appoint an
onshore/local custodian to operate their account. The minimum investment amount is
W1mn and the maximum is W1bn. KTBs are allotted at the highest stop out yield
determined at the competitive auction. Delivery of allotted KTBs occurs the next day.
Derivatives market
Interest rate swaps. The onshore IRS curve has good liquidity out to 10 years with
the 91-day CD floating rate as the reference floating leg for IRS contracts, and has
thin liquidity beyond 10 years up to 20 years. The main players in the market are
local banks, local issuers of debt and foreign investors.
Chart 27: Maturity profile of Korea Treasury Bonds (KRWbn)
70
KTB maturing (KRWbn)
60
Chart 28: Outstanding government debt (KRWtn, as of 31 July 2012)
400
350
KRW tn
300
50
250
40
200
150
30
100
20
50
0
10
Jul-00
Jul-02
Jul-04
Jul-06
Jul-08
0
2012
2014
2016
2018
54
2021
2026
2028
KTB
2030
NHB
MSB
Jul-10
Jul-12
GEMs Pa pe r #1 0
Bloomberg pages
KRW Curncy ALLQ<GO> – FX rates
OTC KRW<GO> – Market monitor
BOK<GO> – Bank of Korea
KORMSB<CORP> – Monetary stabilization bonds
NDFB<CORP> – Korea Treasury Bonds
KSDA<GO> – Benchmark bond yields
KBPM<GO> – Korea Bond Pricing and CD rates
Reuters pages
BOK01 – BOK market interest rates
KBP01 – Korea Bond Pricing & KMCC
KFTC/MENU – SMBS FX fixing & volumes
KRCD91=BOKK 91CD fixing
MTMAV – Closing benchmark yields
Bank of Korea (BOK)
www.bok.or.kr
Ministry of Strategy and Finance
www.mosf.go.kr
Korea Treasury Bonds
http://ktb.mosf.go.kr/eng/
Ministry of Foreign Affairs and Trade
www.mofat.go.kr
Ministry of Commerce, Industry and Energy
www.mke.go.kr
Financial Supervisory Service
English.fss.or.kr/fss/en/main.jsp
Korea National Statistics Office
www.kostat.go.kr
National Pension Service
www.nps.or.kr
National Tax Service
www.nts.go.kr
Korea Bond Web
www.bondweb.co.kr
Korea Futures Exchange
www.krx.co.kr
Forward rate agreements are used by corporates and investors to hedge against
movements in the base rate set by the BoK, while longer tenors are used to
hedge long-term assets or liabilities. Structured note issuers are particularly
active in hedging duration risk and receive IRS beyond 5y tenors. This steady
reception can keep the IRS curve below the KTB curve.
Cross-currency swaps. Quoted out to 10 years at least. with liquidity being good
out to five years, the cross currency swaps market is dominated by offshore debt
issuers who receive the CCS to hedge against interest-rate risk, and by local
exporters (including shipbuilding companies) that have future export receipts and
receive the CCS curve. USD liquidity can come under stress during periods of
global risk aversion and drive the basis between the CCS and IRS wide. The
authorities have instituted a number of measures, including limits on domestic
banks’ net foreign open positions, to contain foreign borrowing in an attempt to
ease the potential for USD liquidity squeezes in the onshore market during
periods of global turmoil.
Forward rate agreements. Tenors up to 9x12 are available, but are rarely traded in
the interbank market. FRAs are usually traded between clients and market makers.
KTB futures. The three-year bond futures contract is one of the most liquid bond
futures contracts in the world. Contracts expire March, June, September and
December, with one contract size of W100mn. Each contract is made up of a basket
of bonds (usually three KTBs), typically two 3y and one 5y KTB. Foreign investors
continue to be major players in the 3y KTB futures market, as are local securities
companies that tend to hold significant intra-day positions. The KTB futures market
allows investors to express short duration views given the illiquid KTB repo market.
Table 42: Summary statistics of Korea products and their markets
Avg daily
Avg
Bid-Ask
trading
transaction
Product
Bloomberg reference
volume
size
spread
Interest rate swaps
1-year
KRW1-2tn
5-year
KRW1-2tn
10-year
KRW1-2tn
1-year
KRW800bn
5-year
KRW150bn
10-year
KRW50bn
1-year
KRW100-150mn
5-year
KRW100-150mn
10-year
KRW100-150mn
Swaptions
1x5
n/a
5x5
n/a
10-15k DV01
10-15k DV01
10-15k DV01
2bp
2bp
2bp
PYKRW
PYKRW
PYKRW
KRW 50bn
KRW 20bn
KRW 10bn
2bp
2bp
2bp
KSDA4
NA
NA
10k DV01
10k DV01
10k DV01
10bp
10bp
10bp
PYKRW
PYKRW
PYKRW
KRW100bn
KRW20bn
1.5 vol
1.5 vol
KWSP015 Curncy
KWSP015 Curncy
Korea Securities Dealer Association
www.ksda.or.kr
Korea Financial Investment Association
http://www.kofia.or.kr
Korea Capital Market Institute
http://www.kcmi.re.kr
FX market
The BoK maintains the principle that the exchange rate should be determined by
the interaction of the demand for and supply of foreign exchange. However, the
bank has been known to accumulate large amounts of international reserves, and
on occasion under MoSF directive use reserves to moderate any large currency
fluctuations not caused by underlying economic fundamentals.
On the nominal effective exchange rate (NEER), the won has fallen significantly
from its peak since late 2007, with the slide exacerbated by the Lehman crisis in
2008/2009. While some of the losses have been recovered, the appetite for a
strong won appears to be lacking compared to previous years.
55
GEMs Pa pe r #1 0
Even though the KRW follows a free-float regime, the BoK has been intervening
in the FX markets to keep the currency from excessive short-term movements.
Other than announcing a base rate every month, the central bank can also opt to
partake in OMO to adjust market liquidity, tightening or loosening lending and
deposit facilities, as well as the reserve requirements ratio for domestic and
foreign currencies.
Table 43: Vital statistics and characteristics of Korea's FX market
Avg daily
Avg
FX
Tradable trading trading Bid-Ask Reuters
size
KRW Onshore
Spot
KRW Spot
USD6.0bn
USD3-10mn KRW 0.1-0.5
KFTC01
Forwards
KRW
Forwards
USD10bn
USD10-30mn KRW 0.5-2.0
KFTC23
KRW Offshore
Forwards
NDF
USD2.0bn
USD5-20mn KRW 0.3-2.0
PNDF
PNDG
Options
NDO
USD1.0bn
USD30100mn
0.2-0.8 vol
TTDE
▪ Proper documentation required.
▪ Trading hours: 9:00-15:00 (Seoul)
-
▪ KRW is non-deliverable currency.
▪ Offshore entities can access the
market through NDF.
▪ Dollar settled NDF on KRW are
available till tenors of 10y and liquid
for tenors shorter than 1y.
▪ Dollar settled NDO on KRW are
available till tenors of 5y and liquid for
Investor base
Banks remain the largest local investors in KTBs, followed by pension funds and
insurance companies. However, in recent years insurance companies have been
increasing their share of the KTB market as they extend the duration of their assets,
especially after the Financial Supervisory Service (FSS) reduced the recommended
yield level for insurance products from 4.0% to 3.75%. Further reduction is possible
with the recent strong rally in KTB after BoK started cutting rates.
Table 44: Holders of KTB (KRWbn)
Banks
Pension Funds
Insurance
Securities Firms
Investment Trust
Others
Total
Local institutional base
Holding (KRWbn)
% of total
148,381
82,909
72,458
23,509
17,668
3,987
348,912
43%
24%
21%
7%
5%
1%
100%
Source: BofA Merrill Lynch Global Research, Korea MoSF
Currently, foreigners own 17% of outstanding KTB and MSB. In recent months
there has been very strong interest by foreign investors in the Korea bond market,
from both traditional fund managers and sovereign wealth funds. First, this market
is one of the most liquid bond markets in Asia. Second, anecdotally, sovereign
wealth fund investors from countries such as Norway, Switzerland and
Kazakhstan suggest this could be a secular trend to diversify into EM bonds from
developed markets.
In January 2011 the authorities reintroduced a withholding tax of 14% on interest
income plus 1.4% local tax on nonresident investments in KTBs and MSBs, and a
27.5% net capital gains tax or 11% tax on gross sale proceeds, whichever is
lower. Starting in 2015, the principal of inflation-linked bonds is to be taxed at a
rate yet to be determined.
56
GEMs Pa pe r #1 0
The Korea Securities Depository (KSD), the country's sole central securities
depository, conducts the clearing and settlement of securities. KSD is under the
supervision of the Ministry of Strategy and Finance, the Financial Supervisory
Commission and the Financial Supervisory Service. Securities purchases or sales by
a nonresident investors are settled physically at the KSD or at a custodian bank. The
original order is placed with a local broker or standing proxy. Transactions settle T+1
in most cases, but up to T+3 when a foreign investment is involved.
The BoK administers the payments system. It uses a real-time gross settlement
system known as the BoK Financial Wire Network (BOK-WIRE).
Table 45: Summary of Korea bond markets and products
Instrument
Korean Treasury Bonds (KTB)
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Amount outstanding
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Monetary stabilization bonds (MSB)
Inflation-linked KTB (KTBi)
Ministry of Strategy and Finance (MoSF)
KRW
KRW10,000 (par)
3, 5, 10, 20 years
Fixed
Semi annually
Act/365
Bullet
Bearer
KRW355tn (as of June 2012)
Bank of Korea
KRW
KRW10,000 (par)
14, 28, 63, 91, 140, 182, 362, 392, 546 days, 2
years
Discount and coupon
Quarterly (for those longer than 1 year)
Act/365
Bullet
Bearer
KRW164tn (as of June 2012)
10 years
Fixed
Semi-annually
Act/365
Bullet
Bearer
KRW6.4tn (as of June 2012)
Korea Stock Exchange (KSE) and OTC via
securities firms.
Yield (to 3 decimals)
T+1
KRW5tn
1bp up to KRW30bn, 2-3bp off the run
1bp up to KRW30bn, 2-3bp off the run
KRW10bn
Korea Securities Depository (KSD)
Banks, Pension Funds, Insurance, Securities
Firms, Investment Trust
9:00-15:00 (Seoul)
Resident and nonresident individual and
institutional investors through custodian banks
and foreign exchange banks.
Korea Stock Exchange (KSE) and OTC via
securities firms.
T+1
KRW3tn
NA
NA
KRW10bn
9:00-15:00 (Seoul)
OTC
T+1
KRW10-20bn
NA
NA
KRW10bn
9:00-15:00 (Seoul)
No restrictions but foreign investors are required
to register and obtain an Investment Registration
Certificate (IRC) with the Financial Supervisory
Board (FSB)
Require appointment of a standing proxy for
trading and designation of a local custodian
15.4%
Foreign investors are subject to 27.5% tax of net
capital gains or 11% of gross sale proceeds,
whichever is lower. Tax may be further reduced
by preferential tax treaty
No restrictions but foreign investors are required
Board (FSB)
15.4%
Dutch style auction
KRW10-50tn
10,000KRW
Mix of Dutch and conventional auctions
KRW300bn/month
10,000KRW
Ministry of Strategy and Finance (MoSF)
KRW
KRW10,000 (par)
Regulations
Restrictions on Foreign Investment No restrictions but foreign investors are required
Board (FSB)
Custodian
Withholding Tax
15.4%
Capital gains Tax
Primary Auctions
Auction Style
Dutch style yield auction
Average Issue Size
KRW5-8tn
10,000KRW
57
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Malaysia
Overview
Albert Leung
+
7137
Malaysia’s bond market is the fourth largest in the region and one of the most
accessible to foreigners with no withholding taxes or capital gains tax. It also
offers thriving Islamic bond and money markets. As of July 2012, foreign holdings
were estimated at 42% of an outstanding MYR291bn in Malaysia Government
Securities. (MGS) These developments are a radical change from the capital
controls imposed at the height of the Asian crisis and the USD/MYR peg that held
until 21 July 2005.
Monetary policy
Background. Bank Negara Malaysia (BNM) was established in 1959 and brought
under legal revision in 2009. It is wholly owned by the government and reports to
the finance minister. The bank has multiple roles, first and foremost conducting
prudent monetary policy and low inflation, followed by financial stability. It is also
charged with the development of the financial system and to act as a banker and
adviser to the government. The current 10-member board of directors has been
headed by Dr Zeti Aziz since May 2000.
Table 46: Malaysia ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
A3
A3
A3
A3
A3
A3
A3
A3
A3
A3
A3
A3
A3
A
A
A+
A+
A+
A+
A+
A+
A+
A+
A+
A
A
Policy framework. The Monetary Policy Committee meets every two months to
decide on the policy interest rate; currently the overnight policy rate (OPR). In
addition to the OPR, floor and ceiling rates are set to provide a policy corridor
(±25bp). Thereafter, a policy statement is released at 6pm local time on the same
day of the MPC meeting. The BNM does not have an explicit inflation target
mandate, but evaluates the growth and inflation outlooks together. The central
bank also exerts influence through statutory reserve requirements, the exchange
rate, and some moral suasion on lending and credit conditions.
A
A
A
A
A+
A+
A+
A+
A+
A
A
AA-
Open market operations. BNM uses OMO twice a day via conventional and
Islamic approaches to manage aggregate balances. Instruments include reserve
requirements, repos, standing facilities, bill issuance, government operations and
other BNM activities. Sterilization operations are conducted through a
combination of BNM note issuance, money market tenders, repos and FX forward
book intervention.
Lending and deposit facilities. Malaysia plans to impose new rules on the local
interbank lending market. The goal is to ensure that the 12 lenders whose
estimates are used to compile the Kuala Lumpur Interbank Offered Rate
(KLIBOR) are required to lend funds to other banks at that day’s rate during a
five-minute period beginning at 11am every day.
Chart 29: Key Malaysia CPI components
32%
Food & Beverages
23%
Housing, Water, Electricity & Fuels
21%
Recreation & Culture
5%
Furnishings, Household Equip & Maintenance
4%
Others
9%
0%
5% 10% 15% 20% 25% 30% 35%
58
Fiscal policy
6%
Miscellaneous Goods & Services
Reserve requirements. BNM requires banking institutions to maintain reserves
in their SRA at the bank, for the balances that are at least equal to the prescribed
ratio. Currently, the statutory reserve requirement is 4%.
The key market drivers are monthly CPI, export data and industrial production. A
long-term consideration is the Economic Transformation Plan (revised every five
years), which has implications for debt issuance. Housing and fuel accounts for
23% of the CPI basket, though fuel subsidies and administered prices can delay
energy inflation pass-through.
GEMs Pa pe r #1 0
Conventions
Market participants also watch the capital account closely for signs of outflows. In
addition, BNM supplies data on foreign purchases of local bonds with a twomonth lag, which is tracked as a lagging indicator of foreign demand for
Malaysian local debt. More recently, the market has looked to potential increases
in fiscal expenditures ahead of a possible general election later in the year.
Bonds
Settlement: Variable; typically T+1 or T+2
Basis: Act/Act
Bond market
We expect Malaysia to issue RM91bn of Malaysia Government Securities and
Malaysia Government Investment Issues (MGII) this year, representing a 7%
increase in gross issuance versus 2011. Malaysia balances its financing needs
between local and external debt issuance and the use of private placements.
External Islamic issues, sukuks, are very popular.
IRS
Fixing: 3m KLIBOR
CCS
Fixing: 3m KLIBOR
Money market. The conventional money market consists of an interbank market
and another market intermediated through discount houses. The key instruments
are overnight and call money, T-bills, short-dated government securities, bankers’
acceptances, and negotiable certificates of deposit (NCDs) to a lesser extent.
Interbank transactions are limited to overnight, 7d and 1m funding needs among
commercial and merchant banks. The key benchmark money market rate is the
3m KLIBOR that is the polled average of 12 banks’ quotes announced each day
at 11am local time. Tenors include 1, 2, 6, 9 and 12 months, but the 3m serves as
the reference fix for the floating leg of the interest rate swap market.
Coupon frequency: Quarterly USD day count Act/360,
local Act/365
The Islamic Interbank Money Market (IIMM) created in 1994 serves the Islamic
banking system and has a full range of instruments: Mudarabah Interbank
Investments, Wadiah Acceptance, Government Investment Issues, BNM-I notes,
Sell and Buyback agreements, as well as Islamic versions of accepted bills,
negotiable instruments, debt securities and BNM sukuks (SBNMI). For further
details see http://iimm.bnm.gov.my/index.php?ch=4&pg=4&ac=22
Negotiable instruments of deposit (NIDs) and certificates of deposit. These
money market instruments are issued by banks and authorized depository
institutions, typically used for short-term repos, traded in a liquid secondary
market, and not subject to withholding tax. Maturities range from 3 months to 10
years, though the short-dated paper is most actively traded.
Chart 30: Maturity profile of Malaysian government bonds (MYRbn)
45
350
MGS maturing (MYRbn)
40
Chart 31: Outstanding government debt (MYRbn, as of August 2012)
35
30
25
20
15
10
MYR bn
140
300
120
250
100
200
80
150
60
100
40
50
20
0
5
Aug-00
0
2012
2014
2016
2018
2021
2025
2027
2030
2032
0
Aug-02
Aug-04
MGS
Aug-06
T-Bills (RHS)
Aug-08
Aug-10
Aug-12
GII (RHS)
Source: BofA Merrill Lynch Global Research, CEIC
59
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Malaysian Government Securities. MGS are fixed-rate, semi-annual coupon
bonds with bullet repayment. The issuance is outlined in an annual calendar with
issuance size announced a week prior.
The tenors go out to 20 years with the 3, 5 and 10-year MGS the benchmark
issues. Switch auctions are also conducted to maintain liquidity along the curve.
BNM also introduced Callable MGS in 2006 (MGSC), giving the government the
option to redeem issues at par with a five-day notice period to bondholders.
Malaysian Government Investment Issues. MGIIs are long-term dividend
paying sukuks intended for development financing. Maturities for these issues are
3, 5, 7 and 10 years. They are priced on the principle of Bai’ Al-Inah, where the
government sells a specified portion of its assets and will later repurchase these
assets at the original value plus profit at a later date. This profit is defined as a
weighted average yield achieved in a competitive tender.
BNM Treasury bills. BNM issues these government bills weekly at a discount
through competitive auction with 3, 6 and 12-month maturities. Auctions are
typically Thursday and issues Friday. T-bills are actively traded in the secondary
market.
BNM monetary notes. Created in 2006, these notes are designed to manage
liquidity in the conventional and Islamic markets and replace previous BNM bills
and negotiable notes. Maturities range from 3 weeks to 3 years and can be either
coupon or discount based. The notes are issued twice a week and the calendar is
released every two weeks.
Corporate bonds and private debt. Two broad categories: Khazanah Bonds
and Cagamas Papers. Khazanah represents the government’s investment arm,
which usually issues zero-coupon paper under the Islamic principle of Murabahah
with tenors ranging of 3, 5, 7 and 10 years.
Cagamas bonds are unsecured bearer bonds issued by the national mortgage
corporation created in 1986. In general, there are five types of issues, ranging
from fixed-rate bonds (up to 10y maturity) to floating rate bonds (up to 10y
maturity), with rates pegged to 3m and 6m KLIBOR and Cagamas Notes that are
short-term, less than 12m maturity, issued at discount or with coupon.
The other two types of Cagamas bonds are based on Islamic principles used to
finance a variety of forms of housing debt, hire purchase debts and housing
loans. Sanadat Mudharabah Cagamas bonds are issued under the Islamic
principle of Mudharabah and are usually redeemable at par at maturity with
tenors up to 10 years. Sanadat Cagamas bonds are issued under the Islamic
principle of bai bithaman ajil and redeemable at par together with the dividend
due at maturity date.
Auction and placement mechanism. The BNM issues MGS and GII via
competitive auction on behalf of the government to finance its development
expenditure. MGS are long-term, fixed-rate, coupon-bearing bonds with bullet
repayment of principal upon maturity. Coupon payments are made semi-annually.
GII are long-term dividend-bearing sukuks issued by the government. The tender
announcement detailing the size and exact date of the issue is at least five
business days prior to the issue date through BNM’s Fully Automated System for
Issuing/Tendering (FAST). “When issued” trading begins on the official release of
the MGS auction results and ends when tender results are given.
60
GEMs Pa pe r #1 0
Bloomberg pages
Derivatives market
MYR Curncy ALLQ<GO> – FX rates
Interest rate swaps. 3m KLIBOR provides the reference fixing for the floating leg
of interest rate swaps. Tenors and liquidity range up to 10 years and are actively
traded. Relative to futures, IRS provide a better interest rate hedging instrument.
Foreign investor access is typically done through nondeliverable NDIRS as
access to the onshore market is restricted to hedging underlying bond exposures
OTC MYR<GO> – Market monitor
BNM<GO> – Bank Negara Malaysia page
BNM<GO>B – Bank Negara bond page
BNMF<GO> – Bank Negara money markets
Reuters pages
NEGARA – Bank Negara Malaysia page
BNM002 – Malaysia auction calendar
KLIBOR= – KL Interbank Offered Rates
Bank Negara Malaysia (BNM)
www.bnm.gov.my
Treasury Malaysia
www.treasury.gov.my
National Economic Advisory Council
www.neac.gov.my
Employment Provident Fund
www.kwsp.gov.my
Bond Info Hub
http://bondinfo.bnm.gov.my
Kuala Lumpur Stock Exchange
www.klse.com.my
Bursa Malaysia
www.bursamalaysia.com
Rating Agency Malaysia
www.ram.com.my
Securities Commission
www.sc.com.my
Cross currency swaps. CCS are less liquid than the IRS, but tenor does extend
to 10y. Onshore access for foreign investors is limited to bond hedging purposes.
KILBOR futures. Liquidity remains wanting and turnover is low. KLIBOR futures
are based on 3m KLIBOR and on the typical quarterly cycle: March, June,
September and December. Contract size is RM1mn with the maximum number of
net long or net short positions limited to 5,000 contracts for all months combined.
MGS bond futures. There are 3y and 5y tenors, but poor liquidity makes them an
unattractive hedging proposition.
http://www.bursamalaysia.com/website/bm/derivatives/products/Financial_Derivat
ives/fmg32.html
Table 47: Summary statistics of Malaysia derivative products and their markets
Average daily
Average
Bloomberg
Product
trading volume transaction size Bid-ask spread
reference
Interest rate swaps
1-year
5-year
10-year
1-year
5-year
10-year
Cross-currency swaps onshore
NA
offshore
NA
NA
450mm
500mm
50mm
100mm
50mm
30mm
2bp
4bp
4bp
MYSW1Y Index
MYSW5Y Index
MYSW10Y Index
450mm
500mm
50mm
100mm
50mm
30mm
2bp
4bp
4bp
MRSWQO1
MRSWQO5
MRSWQO10
USD20mn
USD20mn
USD20mn
20bp 5y tenor
10bp 1-3y tenor
25bp 3y plus
NA
NA
NA
FX market
Malaysia has been operating as a managed float since July 2005, with the MYR
being determined by market fundamentals. Promoting exchange rate stability
remains a primary objective for BNM. The central bank monitors the nominal
effective exchange rate against an undisclosed basket of currencies to ensure
that the MYR remains close to its par value. The system allows for free flow of
payments and transfers on the current account, but controls and restrictions are
in place for the capital account.
Trading in the MYR averages USD1.5–2.0bn daily in the spot market and
USD1.0-1.5bn in the forwards market. Liquidity in the offshore markets for
nondeliverable markets and options generally has been lower. However, greater
liberalization in late 2010 has helped to bridge the spreads between onshore and
offshore FX markets.
61
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Table 48: Vital statistics and characteristics of Malaysia's FX market
Average
daily
Average
FX
Tradable trading
trading
Bid-ask Reuters
size
MYR Onshore
Spot
MYR Spot
Forwards
MYR
Forwards
MYR Offshore
Forwards
NDF
Options
NDO
USD1.52.0bn
USD3-20mn MYR 0.0010.004
USD1.01.5bn
USD1050mn
USD1.5bn USD5-20mn
USD400500mn
USD1050mn
MYR=
MYR
0.00050.004
MYRF=
MYR
0.00100.0050
PNDF
PNDG
0.4-1.0 vol
TTDE
required.
▪ Trading hours: 0800-1700
(Malaysia)
-NA
▪ MYR is a nondeliverable
currency.
the market through NDF
▪ Dollar settled NDF on MYR
are available up to 10y tenors
and are liquid for tenor shorter
than 1y
▪ Dollar settled NDO on MYR
and are liquid for tenors
shorter than 2y
Chart 32: The key local and foreign investors in the Malaysian
government securities markets (MGS)
70%
Chart 33: Foreign ownership of MGS and MTB as % of total
outstanding
% of total
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
60%
50%
40%
30%
20%
10%
0%
Mar-05
Mar-06
EPF
Mar-07
Mar-09
Mar-10
Banks and Insurance companies
62
Mar-08
Mar-11
Mar-12
Foreigners
% of total
Jan-05
Jan-07
Jan-09
Foreign holdings of MGS
Jan-11
Foreign holdings of MTB
GEMs Pa pe r #1 0
Investor base
As of March 2012 the largest investors in outstanding Malaysian Government
Bonds were financial institutions, the Employment Provident Fund (EPF) and
foreigners. Higher frequency BNM data show foreign investors increasing their
share of outstanding MGS to close to 40% as of March. The BNM data also show
that financial institutions (banks) increased their absolute share, but relative to the
size of issuance this share declined.
The EPF is the biggest single buyer of bonds, though it has been charged with
the mandate to lower its MGS holdings and allocate more overseas. The 2011
annual report showed that EPF held around RM125bn of MGS.
We expect foreign holdings in MGS to continue to increase in percentage terms.
The key reason is diversification of sovereign wealth fund/central bank reserves
into Asia assets, a trend that should be structural. Malaysia benefits because its
yield level is still reasonable (10y around 3.4% currently). Also it is one of the
largest bond markets in Asia, along with China and Korea.
Relative to those two markets Malaysia has the advantage, in that China’s bond
market is not close to being fully open to foreign investors. In Korea, foreign bond
investors still need to pay withholding tax depending on jurisdictions, while bond
transactions are not yet Euroclearable and local custodians are required. For
Malaysia, bond trades are Euroclearable and there is no withholding tax applied
to either T-bill or MGS/GII transactions, with Malaysia being part of the Citigroup
WGBI index.
Table 49: Investor profile of Malaysian government debt
Mar-12
% share
1.46
31.80
8.66
0.18
11.81
39.16
6.93
Public Sector
Employees Provident Fund
Insurance companies
Central Bank of Malaysia
Banking institutions
Foreign holders
Other
MYRbn
4.12
89.44
24.35
0.51
33.20
110.12
19.48
Mar-10
% share
1.86
39.40
7.85
1.04
19.48
21.75
8.61
MYRbn
4.73
100.38
20.01
2.66
49.64
55.42
21.95
Mar-07
% share
0.06
0.59
0.10
0.01
0.12
9.78
2.63
MYRbn
10.72
105.25
17.64
1.29
22.31
17.56
4.72
Table 50: EPF holdings, growth and composition share as of December 2011
2011
2010
MGS
Loans and bonds
Equity
Money market
Property
Total
% of total
26.5
34.2
35.6
3.2
0.4
100%
RMbn
124.57
160.69
167.21
14.94
1.82
469.23
growth
5%
12%
9%
-38%
-4%
100%
RMbn
119
143
154
24
1.9
441.9
growth
4%
8%
54%
4%
27%
100%
2009
RMbn
114
132
100
23
1.5
370.5
growth
3%
7%
14%
22%
-4%
100%
63
GEMs Pa pe r #1 0
Foreign investors can access the onshore local fixed income market, and are
required to have a local custodian. FX and interest hedging is allowed, but must
match the underlying notional and maturity date of the asset. There is no
withholding tax on interest income or capital gains.
Successful bids are allocated via the Real Time Electronic Transfer of Funds and
Securities System (RENTAS) by lodging the securities with their appointed
Authorized Depository Institution (ADIs). Settlement then takes place
automatically through RENTAS on a delivery versus payment basis (DVP)
All short-term and long-term government securities are auctioned through a
variable rate multiple price auction format known as an English auction.
Occasionally, a private placement is conducted for specific MGS issues to
identified institutions per the approval of the Ministry of Finance. There are no
restrictions on nonresidents investing in MGS or GII. MGS are available to retail
investors in a minimum denomination of RM1,000, and in multiples of RM1,000.
See the Malaysia Bond Info Hub for more details.
64
GEMs Pa pe r #1 0
Table 51: Summary of Malaysia bond markets and products
Instrument
Malaysian Treasury Bills (MTB)
Issuer
Government of Malaysia, facilitated by BNM Government of Malaysia, facilitated by BNM. Government of Malaysia, facilitated by BNM
Malaysian Islamic Treasury Bills (MITB)
Malaysian Government Securities (MGS)
Islamic bonds based on Islamic principles
(Bai’ Al-Inah)
Currency
MYR
MYR
Principal
Conventional
Islamic
MYR
Conventional
Tenor
91, 182, and 365 days
1 year
3 to 20 years
Issued at discount
Issued at discount
Fixed rate. Coupon rate is based on the
Coupon Payments
Zero coupon
Zero coupon
Semi-annual
weighted average yields of successful bids
---
---
Actual/Actual
Bullet
Bullet
Bullet
Form
Scripless
Scripless
Scripless
Amount outstanding
MYR2.32bn
MYR2bn
MYR291bn
(as of July2012)
Secondary Market
Trading
OTC or money brokers
Discounted yields to two decimal places;
Discounted yields to two decimal places;
Price basis to two decimal places
trading based on bands of remaining tenure. trading based on bands of remaining tenure.
10 bands in total
10 bands in total
Settlement Period
T+1
T+1
T+2
MYR32.8mn
MYR8.63mn
MYR2.17bn
4bp
5bp
1.5bp
NA
NA
1.5bp
MYR20mn
Average trade size
MYR20mn
MYR20mn
Clearing Mechanism
DVP via RENTAS
DVP via RENTAS
DVP via RENTAS
Major players
Pension fund, insurance companies, asset
management companies, securities
companies and primary dealers
Trading hours
9:00-12:00 and 14:00-17:00
9:00-12:00 and 14:00-17:00
9:00-12:00 and 14:00-17:00
(Kuala Lumpur)
(Kuala Lumpur)
(Kuala Lumpur)
Bidders
Principal dealers appointed by BNM
Principal dealers appointed by BNM
Principal dealers appointed by BNM.
Not restricted
Not restricted
Not restricted
Custodian
Authorized Depository Institutions recognized Authorized Depository Institutions recognized Authorized Depository Institutions recognized
Regulations
by BNM
by BNM
Withholding Tax
Exempted
Exempted
by BNM
Exempted
Capital gains Tax
Exempted
Exempted
Exempted
Entry/Exit Tax
None
None
None
Competitive tender on the basis of highest
Competitive auction on a yield basis
Primary Auctions
Auction Style
Competitive auction on yield-bid basis
price tendered (or lowest yield)
Average Issue Size
MYR100mn
MYR80mn
MYR3.5bn
8.5% of the issue (primary dealer)
65
GEMs Pa pe r #1 0
Pakistan
Overview
Claudio Piron
+65 6678 0401
The fixed income market in Pakistan did not start functioning on a free market
basis until after 1990. Before that, the government borrowed at administratively
determined rates by issuing on-tap instruments and captive funding by raising
cash reserve requirements and statutory liquidity requirements. Long-term
government paper called Federal Investment Bonds (FIBs) were introduced in
1992 and replaced with Pakistan Investment Bonds (PIBs) in 2000. The
government debt consists of floating, permanent and unfunded debt. Market
Treasury Bills (MTBs) and PIBs form the floating and permanent segment of debt
while National Savings Schemes (NSS) forms the unfunded (on tap) segment of
government debt.
The first corporate bond instrument called Term Finance Certificates (TFCs) were
issued in 1995. The corporate debt market has gained activity since 2000 when
the SBP restricted institutional investment in NSS.
Monetary policy
Table 52: Pakistan ratings profile
Moody's
S&P
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
BBBBCCC+
BB
BB
BB
BB
BBBBB+
B+
B3
B3
B3
B3
B2
B1
B1
B2
B2
B2
B3
Caa1
Caa1
Background. Pakistan’s monetary and currency functions were managed by the
Reserve Bank of India (RBI) for the first 11 months following its partition from
India. The State Bank of Pakistan (SBP) commenced operations in July 1948 and
was nationalized in 1974. The SBP Act of 1956 forms the basis of its operations
today. Financial sector reforms in 1994 gave the SBP greater autonomy.
Policy framework. SBP seeks to maintain stable prices and stability of the
financial system. It follows a monetary targeting framework with intermediate
targets for M2. It also uses indirect tools like the cash reserve ratio and statutory
liquidity requirement to influence the level of liquidity in the system. The monetary
policy committee meets once every two months to review monetary policy.
Open market operations. The SBP conducts OMOs to smooth liquidity in the
system. MTBs are used often for OMOs.
Base rate. The discount rate serves as the State Bank of Pakistan’s chief policy
signal and is the rate at which the central bank lends short-term credit to
commercial banks.
Lending and deposit facilities. The SBP now favors using repo and reverse
repo facilities more than reserve requirements in managing money market
liquidity. Repos are typically conducted for overnight to 4-week tenors. The SBP
O/N reverse repo facility and overnight repo facility set the respective floor and
ceiling interest rate corridor, which has been fixed at a width of 300bp since
August 2009.
Chart 34: Key Pakistan CPI components
35%
Food & Non-alcoholic Beverages
10%
8%
Clothing & Footwear
Furnishing & Household Equipment Maintenance
4%
Education
4%
10%
Others
0%
66
Reserve requirements. SBP has used a cash reserve requirement since its
creation, and banks have to meet two CRR settings: one that requires a minimum
4% of their time and demand liabilities (TDL) subject to CRR, and another that
requires a weekly average of 5% of their TDL, subject to CRR. Banks are also
required to keep a fraction of their assets (SLR) in the form of Treasury bills or
other approved securities. This is set at 19% of total time and demand liabilities.
Time deposits with 1y tenors and above do not require any CRR or SLR.
29%
Housing, Water, Electricity, Gas & Other Fuels
10%
20%
30%
40%
GEMs Pa pe r #1 0
Conventions
Fiscal policy
Bonds
Pakistan’s markets are driven more by political event risk than macro trends.
Headline inflation, which has run at double-digit rates since 2008, is a primary
economic focus. Some of this is due to national and local floods in 2010 and
2011, respectively, which led to higher food prices (the food group has the
greatest weight in the CPI basket at 38.5%).
Settlement: T+2
Basis: Act/365
Recently the current account has started to feel the pinch of global economic
slowdown, with the deficit expanding to US$4.5bn in FY2012 compared to the
US$0.2bn surplus recorded in FY2011. A deteriorating external account and the
beginning of repayments to the IMF in 2012 led to the increased exchange rate
volatility, with the PKR depreciating 9.9% in FY2012. However, recent news flow on
potential realization of foreign flows from US is lending some stability to the PKR.
IRS
Fixing: KIBOR
Basis: Act/365
CCS
Fixing: KIBOR
Bond market
Basis: Act/365
Pakistan’s fiscal deficit for FY2011 (June-July) was 5.9% of GDP. The figure is
higher at 6.6% if including the PKR120bn in debt of the oil and gas companies.
Similarly, the numbers for FY2012 suggest the fiscal deficit could be above 6% of
GDP. The major fiscal drags on the economy since 2008 have been the debt
servicing cost (20% of expenditures), the US$10bn losses from the floods in July
2010 and growing costs of combating terrorism. The government has announced
its intention to cap the fiscal deficit at 4.7% of GDP in FY2013.
In the first nine months of FY2012, the government borrowed PKR847bn from
domestic sources, which was 21% higher than the comparable period last year.
Total outstanding government debt from domestic sources has risen sharply and
was PKR7.2tn in March 2012, which is up 1.8x the FY2009 level.
Money market. Since Pakistan is a monetary-targeting regime, money supply
determines the interest rate level. Interest rate signaling is done by changing the
auction cutoff yields for the 6m MTBs.
Market Treasury Bills. Introduced in 1991, MTBs are short-term, zero-coupon
bonds issued at a discount and available for maturities of 3, 6 and 12 months.
Non-competitive bids have been allowed since 2009. MTBs for replenishment are
instruments with 6m maturity for government borrowing directly from the SBP.
Outstanding MTBs as of 2010 totaled PKR2,399bn.
Chart 35: Maturity profile of Pakistan government bonds (PKRbn)
Chart 36: Outstanding Pakistan government bonds (PKRbn, as of end
2010)
PKR bn
300
Pakistan Inv estment Bonds maturing (PKRbn)
3000
250
2500
200
2000
150
1500
MTBs
PIBs
1000
100
500
50
0
0
2012
2014
2016
2018
Source: SBP, BofA Merrill Lynch Global Research
2020
2022
2024
2028
2036
1999 20002001 2002 20032004 2005 20062007 2008 20092010
Source: SBP, BofA Merrill Lynch Global Research
67
GEMs Pa pe r #1 0
Bloomberg pages
OTC PKR<GO> – Market monitor
SBPK<GO> – State Bank of Pakistan
MOSB PKR<GO> – Most traded bonds
Pakistan Investment Bonds. PIBs were introduced in 2000 to assist the
development of a benchmark yield curve and serve as a guide to the corporate
bond market. PIBs are long-term bonds available for maturities of 3, 5, 10, 15, 20
and 30 years. Outstanding PIBs as of 2010 totaled PKR505bn.
PKSTAN Govt<GO> – USD sovereign bonds
FMPK – Financial Market Association
Reuters pages
SBPK01SBP – State Bank of Pakistan
SBPK09 – SBP market operations
KONIA – Karachi Overnight Index
Unfunded debt. This consists of the National Savings Schemes administered by
the Central Directorate of National Savings (CDNS) division of the Ministry of
Finance. These include Prize Bonds, Special Savings Certificate Registered
Bonds, Defense Saving Certificate, Behbood Saving Certificate, Regular Income
Certificate, etc. The bonds are available on a tap basis.
State Bank of Pakistan
http://www.sbp.org.pk/
Corporate debt. The corporate bond market in Pakistan is beginning to develop.
It largely consists of Term Finance Certificates (TFC) and Commercial Paper
(CP). TFCs are available for fixed and floating rates. The Securities and
Exchange Commission of Pakistan (SECP) regulates the issuance of TFCs.
Ministry of Finance
http://www.finance.gov.pk/
Derivatives market
Financial Markets Association of Pakistan
http://www.fma.com.pk/
FX forwards. Liquid for maturity periods of less than a year.
Interest rate and cross currency swaps. Pakistan has onshore IRS and CCS
markets. But liquidity is very poor and the markets are less developed. Major
participants include banks and corporates. Liquidity is mostly in the 1m to 3y
maturities segment.
FX market
The SBP periodically intervenes in the spot and forwards market to maintain the
value of SBP according to what it deems appropriate. After being pegged to
sterling until 1971, the PKR was pegged to the USD at PKR9.90 before switching
to a managed floating rate system in 1982. SBP followed a two-tier exchange rate
system in 1998-99 to reduce pressure on official reserves and prevent the
economy from the adverse implications of sanctions imposed on Pakistan.
Table 53: Vital statistics and characteristics of Pakistan's FX market
Tradable FX
products
PKR Onshore
Spot
PKR Spot
Forwards
PKR Offshore
Forwards
Avg daily
trading
volume
Bid-Ask
spread
Reuters
reference
USD435mn
0.05-0.10bp
PKR=
PKR Forwards USD200–250mn 1 day: 0.005bp,
1-3 months:
0.03bp,
6 months:
0.05bp
NDFs
Illiquid
68
SBPK02
SBPK04
DBNDG
Key facts
▪Documentary proof required
▪Trading Hours: weekdays 9:00-16:30
(Pakistan Time); Saturday 9:00-13:30
▪Supporting documents required
▪Hedging trade payables and receivables
up to 12 months
▪ Forward booking against all types of
imports has been temporarily suspended
since July 2008
▪ PKR is not a fully convertible and nondeliverable currency
▪ ISDA documentation is required
GEMs Pa pe r #1 0
Investor base
Banks, development financial corporations (DFIs), provident funds, pension
funds, mutual funds and corporates constitute the major local investors.
Table 54: Holders of Pakistan government debt (Jun-10)
Holder type
PKRmn
State Bank of Pakistan
Deposit money banks
Other financial institutions
International institutions
Foreign government and banks
Others
Federal govt debt: intra govt debt
Total government debt
1164
1042
253
2183
1574
2040
138
8,395
% share
14%
12%
3%
26%
19%
24%
2%
100%
Source: CEIC, BofA Merrill Lynch Global Research
Rules, regulations, capital control and taxation
Foreigners and residents are taxed on the interest income of their bond
investments at 10%; this can be reduced subject to appropriate double-taxation
treaties. Capital gains tax is imposed on 75% of the net gains from holding
securities for more than one year at a rate of 35% for corporates and 20% for
individuals and 25% for others.
A Subsidiary General Ledger Account (SGLA) is required by all bank and nonbank financial institutions to be held with the SBP for government and bank
customer owned securities. Custody is managed through the SGLA. Government
bonds are settled on a delivery versus payment basis.
Table 55: Summary of Pakistan bond markets and products
Instrument
Pakistan Investment Bonds (PIBs)
Issuer
Currency
Tenor
Coupon Payments
Form
Amount outstanding (as of 2010)
Secondary Market
Trading
Major players
Trading hours
Regulations
Withholding Tax
Capital gains Tax
Primary Auctions
Auction Style
Average Issue Size
Market Treasury Bills (MTBs)
Government of Pakistan
PKR
3, 5, 10, 15, 20 and 30 years
Semi-annual
Semi-annual
book entry
PKR505bn
Government of Pakistan
PKR
3, 6 and 12 months
Zero-coupon
Zero-coupon
book entry
PKR2399bn
Thin
Banks
9:00-16:30 (Pakistan Time)
Relatively more active
Banks
9:00-16:30 (Pakistan Time)
10% for residents and non-residents or lower subject to a tax
treaty
35% for corporates and 20% for individuals and 25% for
others on 75% of the LT gain
10% for residents and non-residents or lower subject to a tax
treaty
35% for corporates and 20% for individuals and 25% for
others on 75% of the LT gain
SBP and MoF decide cut off and target amounts
PKR50bn
SBP and MoF decide cut off and target amounts
PKR350bn
Source: BofA Merrill Lynch Global Research , CEIC, China Government Securities Depository Trust and Clearing Company LTD
69
GEMs Pa pe r #1 0
Philippines
Overview
Christy Tan
+65 6591 0427
The size of the Philippines local currency bond market rose 5.8% yoy at the end
of 2011. Currently, more than two-thirds of the outstanding value is in government
bonds, with corporate bonds growing rapidly in recent years. While a 20%
withholding tax may have dissuaded investors in the past, interest in local
currency bonds has been growing since the S&P credit rating upgrade to doubleBB with a stable outlook in 2011.
Monetary policy
Background. Bangko Sentral Ng Pilipinas (BSP) oversees monetary policy, with
the primary objective of promoting and maintaining a low and stable inflation
environment for balanced and sustainable economic growth. The central bank
adopted this inflation-targeting framework in 2002.
Table 56: Philippines ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Ba2
Ba2
Ba3
Ba3
B1
B1
B1
B1
Ba2*
Baa3*
Baa3
Baa3
Baa3
BB+
BB+
BB+
BB+
BB+
BB+
BB+
BB+
BBB
BBB
BBB+
BBB+
BBB+
BBBBBBBB+
BB+
BB+
BB+
BB+
BB+
BB+
BB+
BBBBBBBBB
To keep prices stable, the BSP uses a number of monetary policy instruments to
adjust the liquidity level in the system. Some of the tools at its disposal include
the use of open market operations, fixed-term deposits, standing facilities and the
reserve requirements for banks to manage money supply within the system.
The seven-member Monetary Policy Board meets every six weeks to discuss,
review and decide on monetary policy directions. The policy interest rates are the
overnight reverse repo rate and the repo rate.
Base rates. The official interest rate in Philippines is the reverse repo rate (RRP),
which is the overnight borrowing rate. There is also the overnight repurchase
(RP) or lending rate. The Monetary Policy Board sets and adjusts key policy
interest rates to achieve the country’s inflation target. Adjustments to these rates
influence and affect short-term market interest rates.
* indicates negative outlook change; ** indicates positive outlook change..
The policy rate was 3.75% as of July 2012, after the BSP implemented three rate
cuts this year alone to cushion the economy against slower global growth in light
of the deepening Eurozone crisis and slowdown in US and China. The move was
also to protect the downside of the inflation target.
Chart 37: Key Philippines CPI components
39%
Food and Non Alcoholic Beverages
Restaurants & Misc Goods & Services
12%
Transport
8%
Education
3%
Furnishings, Household, Equip & Maintenance
3%
Others
12%
0%
10%
70
Open market operations. OMO is a key component of monetary policy
implementation. The BSP controls the liquidity by publicly buying or selling
government securities from banks and financial institutions through repurchase,
reverse repurchase transactions, outright transactions, and foreign exchange
swaps. By controlling money supply, the central bank is able to exert some
influence on the prices of goods and services to achieve its inflation objectives.
23%
Housing, Water, Electricity, Gas & Fuels
20%
Policy framework. The BSP uses the headline consumer price index (CPI) as
the key monetary policy target. Consistent with the inflation-targeting framework,
in July 2010 the Monetary Policy Board announced the BSP’s shift to a fixed
inflation target of 4 ± 1% for 2012-2014. The Development Budget Coordination
Committee (DBCC) approved the shift to a fixed medium-term inflation target from
a variable annual inflation.
30%
40%
50%
Under repurchase/reverse repurchase agreements, the central bank purchases
government securities from a bank with a commitment to sell them back at a
specified future date at a predetermined rate. However, repos can only serve as
temporary adjustments to the money supply given the short-term nature of repo
agreements (max of 14 or 30 days).
GEMs Pa pe r #1 0
Conventions
Bonds
Settlement: T+1
Outright purchases are used to affect the money supply if a permanent
adjustment is required. Outright transactions refer to the direct purchase or sale
by the BSP of its holdings of government securities from or to financial
institutions. Foreign exchange swaps are also used by the BSP under OMO.
Basis: Act/360 or 30/360
CCS
Coupon frequency: Semi-annual; USD day count
The Special Deposit Account (SDA) facility, which consists of fixed-term deposits by
banks and trust entities of banks and nonbank financial institutions, can also be used
as a liquidity management tool. SDAs have increased in popularity after the facility
was expanded to include trust entities in April 2007. Funds in the SDAs also jumped
10% yoy in April 2012, as investors continued to search for high-yielding instruments
due to the lack of major infrastructure and development projects in the country.
In July 2012 the BSP tightened rules around the SDAs by requiring banks to
indicate the nationality of depositors, and prohibiting foreign funds from investing
in SDAs. This move was to ensure SDAs are not used as a haven for “hot money”
and to curb currency speculation. The BSP subsequently reduced rates on SDAs,
a move toward monetary easing. Rates were cut by 3.125bp across the board.
Lending and deposit facilities. One monetary policy instrument is the BSP’s
rediscounting facility, which allows banks to refinance loans that they extend to
their clients, in order to help the banks meet temporary liquidity needs. Through
this, the BSP is able to influence credit volume in the financial system. There are
two types of rediscounting facilities available – the peso rediscounting facility and
the exporters’ dollar and yen rediscount facility (EDYRF). Banks or financial
institutions can obtain credit from the BSP using promissory notes or other loan
papers of its borrowers as collateral.
Reserve requirements. Managing reserves is key to liquidity management.
Previously, the BSP had reserves in two forms: regular (or statutory) reserves
and liquidity reserves. Up to 40% of statutory reserves that banks deposit with the
BSP were paid interest of 4% per annum, while interest paid on liquidity reserves
was based on the rate of comparable government securities, less half a
percentage point.
This policy was changed in February 2012 when the Monetary Policy Board
decided to merge the statutory and liquidity reserves into a single set of reserves,
and interest payments on bank reserves were terminated. At the same time, the
BSP cut banks’ required reserves by 3 percentage points to the current 18%.
Reserve requirements apply to peso demand, savings, time deposit and deposit
substitutes (including long-term non-negotiable tax-exempt certificates of time
deposit, or LTNCTDs) of universal banks (UBs) and commercial banks (KBs).
Economic drivers
The key market drivers are monthly CPI, export/import figures, overseas
remittances and budget deficit/surplus. CPI weights are as follows: food and nonalcoholic beverages (39.0%), housing and utilities (22.5%), and restaurants and
miscellaneous goods and services (12.0%).
The macroeconomic outlook for the Philippines is generally stable. The economy
remains in a sweet spot that features strong growth, low interest rates and a
stable currency buoyed by a positive current account. Fiscal conditions are
improving with better tax collections and fiscal prudence, and public debt (56.7%
of GDP in 2011) and external debt (27.5% of GDP in 2011) remain at healthy
levels. Foreign reserves also grew to a stronger USD76.1bn at end-June 2012.
71
GEMs Pa pe r #1 0
Bond market
The Philippines government issues two kinds of government securities: Treasury
bills and bonds.
Treasury bills. T-bills are government securities issued by the Bureau of the
Treasury (BTr) that mature in less than a year. These bills are typically offered in
91, 182 and 364-day tenors, have zero coupons and are sold at a discount from
the face value. They can be traded in the secondary market before maturity.
Fixed Rate Treasury Notes (FXTNs). Issued by the Bureau of the Treasury,
these are interest-bearing notes with maturities longer than a year, for 2, 5, 7, 10,
15 and 25 years. Coupons are fixed and paid semi-annually.
Retail Treasury Bonds (RTBs). These government bonds are issued primarily
by the Bureau of the Treasury and cater to retail investors. Interest-bearing, the
bonds are offered in 3 and 5-year tenors. Coupons are fixed and paid quarterly.
Corporate debt. The corporate debt market is relatively small compared to the
government bonds and limited to a handful of large local private corporations,
such as San Miguel Brewery and Ayala Corporation. Typically, the bonds are
issued in 2-7 year tenors. Coupons are usually floating with payments made
quarterly. Corporate bonds are usually underwritten by financial institutions
licensed by the Securities and Exchange Commission (SEC).
Auction and placement mechanism. In the secondary market, investors can
purchase government securities through any of the Government Securities
Eligible Dealers (GSEDs) or financial institutions licensed by the Securities and
Exchange Commission. However, they have no obligation to make markets, and
many do not make two-way quotes.
Purchase of FXTNs can be done through auctions in the primary market or OTC
in the secondary market. Auctions are usually held biweekly on Tuesdays, with
settlements on Thursdays.
Chart 38: Maturity profile of Philippine government bonds (PHPbn)
Chart 39: Maturity profile of issuance of Philippine government
securities over time in PHPbn
2500
1,200
1,000
2000
800
1500
600
PHP bn
1000
400
500
200
[1-3]
Source: BofA Merrill Lynch Global Research, Bureau of the Treasury
72
[3-5]
[5-10]
[>10]
Mar-12
Sep-11
Mar-11
Sep-10
Mar-10
Sep-09
Mar-09
Sep-08
Mar-08
Sep-07
Mar-07
Sep-06
2036
2034
2032
2030
2028
2026
2024
2022
2020
2018
2016
2014
2012
Mar-06
0
-
GEMs Pa pe r #1 0
Bloomberg pages
Derivatives market
PHP Curncy ALLQ<GO> – FX rates
Interest rate swaps. The market remains underdeveloped with poor liquidity. As
such, it does not provide investors with a viable hedging instrument.
OTC PHP<GO> – Market monitor
CBPH<GO> – Bangko Sentral ng Pililpinas page
BTRP<GO> – Bureau of Treasury auction results
FMPH<GO> – Fund Manager Association
PDEX<GO> – Philippine Dealing & Exchange Corp.
Reuters pages
BANGKO – Central bank page
PDSPESO – FX market volumes and fixing
FX market
The FX market in the Philippines is relatively small compared to others in the
region, but has grown considerably in the last decade. Average daily turnover is
about US$1.4-1.9bn. Most transactions are concentrated in FX spot transactions,
with the FX forwards and swap markets expanding at a more gradual pace.
Table 57: Vital statistics and characteristics of the Philippines' FX market
PHIBOR – Philippine Interbank Offered Rate
Average
daily trading Average
volume trading size
ASIANNDF= – Asia NDF markets and fixing
FX products
Tradable
product
PDSMENU – Philippine Dealing System
PHP Onshore
Spot
PHP Spot
USD8001200mn
USD3-10mn PHP 0.01-0.05
PDSPESO
Forwards
Forwards
USD600700mn
USD5-10mn PHP 0.02-0.40
PHPF=
PHP Offshore
Forwards
NDF
USD600700mn
USD3-10mn PHP 0.02-0.10
PNDF
PNDG
Options
NDO
USD50100mn
USD10-30mn
TTDE
PDSTSY – Treasury Reference rates
Central Bank of the Philippines (BSP)
www.bsp.gov.ph
Department of Finance
www.dof.gov.ph
Bid-ask
spread
Reuters
reference Key facts
Bureau of the Treasury
www.treasury.gov.ph
Securities and Exchange Commission
www.sec.gov.ph
Department of Trade and Industry
www.dti.gov.ph
0.5-1.0 vol
required
▪ Trading hours: 9:00-12:00
and 14:30-16:00 (Manila)
▪ Forwards on PHP are
available and liquid for tenors
shorter than 3m
▪ PHP is a non-deliverable
currency
the market through NDF
▪ Dollar settled NDF on PHP
and liquid for tenors shorter
than 2y.
▪ Dollar settled NDO on PHP
and liquid for tenors less than
2y
National Statistics Office
www.census.gov.ph
Investor base
Philippines Social Security System
The government, financial institutions and retail investors are more active in bond
issues of short to medium-term maturities. Pension funds, insurance companies
and other asset management companies tend to invest in bonds of longer
maturities.
www.sss.gov.ph
Philippines Dealing and Exchange Corporation
www.pdex.com.ph
Money Market Association of the Philippines
www.mart.com.ph
The Government Service Insurance System (GSIS) and Social Security System
(SSS) are the largest state pension funds, and mandated by the Securities and
Exchange Commission to adopt a conservative investment strategy focused on
government debt and shares of leading local companies. The local mutual fund
industry is one of the least developed in Asia and has a narrow investor base with
only a few institutional investors in the local bond market. Licensed insurance
firms such as Ayala Life Assurance; Philam Insurance and Sun Life Financial are
also major investors in government bonds of longer tenors.
73
GEMs Pa pe r #1 0
Foreign investors are free to invest in government securities. Capital inflows have
been increasing, but the BSP announced that they are still at manageable levels.
The central bank has not imposed any capital controls yet.
Resident and nonresident investors are subject to a 20% withholding tax on
interest income. However, there is no capital gains tax levied on government
securities for all investors. The withholding tax on interest income can be reduced
contingent on double taxation treaties.
Transactions are cleared through the Registry of Scripless Securities (RoSS),
administered by the Bureau of the Treasury. Standard settlement for government
securities is T+1. Deviation from the standard is possible if negotiated and agreed
upon by both parties. Trading hours (Monday-Friday) are from 9:30am to noon,
and from 2:30pm to 4:00pm.
Global peso notes
The government has started to develop an offshore peso curve, which has seen
very strong offshore demand even though the trading dynamics and liquidity of
these issues have been somewhat limited.
The global peso notes (GPN) trade pari passu to USD sovereign bonds and are
governed by New York Law, but only sovereign USD bonds are deliverable into
CDS. The GPN offers low cost funding for the sovereign and is linked to the USD
bonds in terms of a credit event.
The first global peso note was launched in September 2010 for USD1bn with an
initial maturity of 10 years. A second 25-year bond was issued in January 2011
for USD1bn. A third is expected subject to market conditions. Though the face
value currency is the Philippine peso, settlement is made in the US dollar in the
offshore market. Investors bear interest rate and foreign exchange risks.
The attraction of the bonds is that foreign investors are not subject to the onshore
withholding taxes and the issuer benefits from not having to take on FX risk.
74
GEMs Pa pe r #1 0
Table 58: Summary of the Philippines bond markets and products
Instrument
Treasury bills (T-bills)
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Amount outstanding
(as of April 2012)
Secondary Market
Trading
Settlement Period
Bid/offer spread (0-5y)
Bid/offer spread (5y+)
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Fixed Rate Treasury Notes (FXTNs)
Retail Treasury Bonds (RTBs)
PHP
PHP10,000
91, 182 and 364 days
Issued at discount
Zero coupon
Actual/360
Bullet
Scripless
PHP257,790mn
PHP
PHP10,000
2,3,4,5,7,10,20 and 25 years
Fixed
Semi-annual
30/360
Bullet
Scripless
PHP1,140,146mn
PHP
PHP5,000
3-10 years
Fixed
Quarterly
30/360
Bullet
Scripless
PHP615,640mn
OTC
Yield (to 4 decimal places)
T+1 (or negotiated)
PHP2bn
15bp
PHP50mn
RoSS (Registry of Scripless Securities)
Banks, government agencies, financial
institutions and retail investors
9:00am-12:00pm and 2:00-4:00pm
(Manila time)
Bank and non-bank financial institutions
licensed to deal in the primary market via
Government Securities Eligible Dealers
(GSEDs)
OTC
T+1 (or negotiated)
PHP8bn
15bp
20bp
PHP30mn
Banks, Pension funds, insurance companies,
asset management funds
9:00am-12:00pm and 2:00-4:00pm
(Manila time)
Bank and non-bank financial institutions
licensed to deal in the primary market via
(GSEDs)
OTC
T+1 (or negotiated)
PHP1bn
15bp
20bp
PHP30mn
Banks, Pension funds, insurance companies,
asset management funds
9:00am-12:00pm and 2:00-4:00pm
(Manila time)
Individual investors through appointed
underwriters. No restrictions on foreign
investors.
No restrictions; however, purchases have to
be financed through inward foreign exchange
remittances or from withdrawals against
foreign currency accounts.
Registry of Scripless Securities (RoSS)
Subject to 20% final withholding tax, applies
to residents and nonresidents
No capital gains tax on all government
securities, for residents and nonresidents
None
None
None
English auction (multiple price auction) via
(GSEDs) and through negotiated sale
PHP3bn
PHP10mn
Dutch auction via Government Securities
Eligible Dealers (GSEDs) and through
negotiated sale
PHP2-4bn
PHP10mn
Book building and public offering through
appointed underwriters
PHP20-40bn
Variable up to PHP100,000
75
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Singapore
Overview
Albert Leung
+
7137
Singapore’s bond market is one of the fastest growing and most developed in
Southeast Asia. Domestically, local currency government securities have grown
significantly since the first Singapore Government Securities (SGS) were
introduced in 1998. Daily average turnover of SGS (excluding T-bills) is around
SGD1.29bn thus far in 2012.
Monetary policy
Background. The Monetary Authority of Singapore (MAS) has been in charge of
promoting sustained non-inflationary economic growth and developing Singapore
into a sound and progressive financial hub since its inception in 1971. Other than
conducting monetary policy for the country, the central bank also acts as the
financial agent of the government and has the power to supervise and regulate
the financial sector, as well as manage foreign reserves.
Policy framework. Since 1981 Singapore’s monetary policy has been centered
on managing the exchange rate through the basket band crawl (BBC). The
nominal effective exchange rate (NEER) index is calculated by weighting the
exchange rate with a basket of currencies of its major trade partners and
competitors. The NEER can float within a band that is allowed to crawl to adjust
with the policy requirements and fundamentals. This is done to mitigate shortterm volatility and prevent misalignment in the SGD.
Table 59: Singapore ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
AAAu
AAAu
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
Monetary policy is reviewed semi-annually, in April and October, to ensure
alignment with economic fundamentals and market economics, so as to maintain
a low inflationary environment that is favorable for sustained economic growth in
the short to medium term.
Base rate. Singapore does not have a base rate.
Open market operations. To ensure that the SGD stays within the prescribed
policy band, the MAS tends to intervene in the FX market using spot or forward
FX transactions. Intervention may be in the form of a purchase of SGD against
the USD to stem any depreciation or to moderate the pace of appreciation by
injecting more SGD into the market. While the frequency of FX intervention is not
always disclosed, the Monetary Management Division typically reports the size of
FX intervention and money market operations internally on a biweekly basis.
Lending and deposit facilities. MAS operates a standing facility and intra-day
liquidity facility. The former allows banks to obtain SGD liquidity using eligible
foreign currencies or borrow SGD direct from the MAS. The intra-day liquidity
facility is more for banks that need larger amount of funds.
Chart 40: Key Singapore CPI components
25%
Housing
16%
Recreation and Others
Fiscal policy
16%
Transport
Education and Stationery
7%
6%
Health Care
Others
8%
0%
5%
10%
76
Reserve requirements. Banks are required to maintain a reserve requirement or
minimum cash balance with the MAS as a proportion of their liabilities base.
22%
Food
15%
20%
25%
30%
The key market drivers are monthly CPI, industrial production and non-oil
domestic exports. CPI weights are as follows: food (22.1%), housing (20%),
utilities (3.6%) and fuel (2.4%). The macroeconomic outlook for Singapore is
generally stable with a healthy fiscal balance, no foreign debt and high foreign
exchange reserves. As an open economy, Singapore’s GDP is driven largely by
manufacturing, financial services, gaming and tourism.
GEMs Pa pe r #1 0
Conventions
Bond market
Bonds
With a prudent fiscal policy, Singapore has been enjoying extended periods of
healthy budgetary surpluses. As such, the government does not need to finance
any shortfalls in expenditures through the issuance of government bonds.
Settlement: T+1
Basis: Act/365 (SGS bills) or Act/Act (SGS Notes)
The primary objective of developing the bond market is thus to deepen the
domestic capital markets by providing a robust government yield curve as a
pricing benchmark for private debt securities, and to foster the growth of an active
secondary market to enhance risk management.
IRS
Fixing: 6m SOR
Coupon frequency: Semi-annual; fixed/floating Act/365
There are three broad categories of bonds in Singapore, mainly SGS T-bills, SGS
bonds and corporate bonds. Total outstanding local currency bonds breached
SGD211bn in March 2012, with 60% in government securities.
CCS
Fixing: 6m SOR
Money market. Singapore has a sizable repo market to support market-making
activities of the primary dealers. This enables primary dealers to make long/short
positions such as buying one bond and selling another to take advantage of yield
curve arbitrage opportunities. Typical transactions are about S$25mn, traded
9:00-15:30 (Singapore) with a settlement of T+1.
local Act/365
SGS T-bills. SGS T-bills are sold at a discount and offered at 3m and 1y, with a
minimum denomination of S$1,000 (par value). 3m T-bills are issued weekly while
1y T-bills are issued based on an annual calendar (see the SGS website),
announced each September for the following year. Typical issue size is around
SGD2.3-3.7bn.
SGS Bonds. SGS Bonds are usually of longer duration, with tenors ranging 2-20
years. Bonds are denominated in nominal amounts of S$1,000 (par value) with
fixed-rate coupons issued semi-annually. Average issuance sizes are usually
within SGD2-3bn and bond auctions are based on an annual calendar, typically
announced each September for the following year (see the SGS website).
Chart 41: Maturity profile of Singapore government bonds (SGDbn)
14
Chart 42: Outstanding local currency bonds by type (SGDbn)
90
SGS maturing (SGDbn)
SGD bn
80
12
70
60
10
50
40
8
30
6
20
10
4
0
Jun-05
2
Jun-06
Jun-07
Jun-08
SGS T-bills
0
2012
2014
2016
2018
2020
2022
2027
2042
Jun-09
Jun-10
Jun-11
Jun-12
SGS bonds
77
GEMs Pa pe r #1 0
Bloomberg pages
SGD Curncy ALLQ<GO> – FX rates
OTC SGD<GO>
SIGB<GO> – Monetary Authority of Singapore page
MOSBSGD<GO> – Most traded bonds
ABSI <GO> – Association of Banks in Singapore
Reuters pages
MAS01 to MAS06 – Issuance, auctions, results
SGDDFIX=ABSG – SOR fixing
SIBOR= SIBOR fixing
ABSIRFIX1 – ABS Fixings Index
Monetary Authority of Singapore (MAS)
www.mas.gov.sg
Ministry of Finance
www.mof.gov.sg
Ministry of Trade and Industry
www.mti.gov.sg
Singapore Government Securities
www.sgs.gov.sg
Central Provident Fund
www.cpf.gov.sg
Singapore Stock Exchange
Corporate debt. Most corporate bonds in Singapore are issued by governmentlinked companies and statutory boards, such as Temasek Holdings, Keppel Corp,
etc. The three biggest issuers are the Housing Development Board (HDB), Public
Utilities Board (PUB) and Land Transport Authority. The corporate bond market
has been experiencing robust growth, increasing 30.9% yoy in 2010, with total
bonds outstanding reaching S$97bn.
Auction and placement mechanism. All SGS securities are auctioned using a
uniform price auction. Successful bids, whether competitive or noncompetitive,
will be allotted at the same uniform yield, which is the highest accepted yield (cutoff yield) of successful competitive bids submitted at the auction. All entities and
individuals, including nonresidents, are free to bid on the auction. However,
applications have to be submitted through MAS-certified primary dealers.
In all SGS auctions, 40% of the total issuance amount is reserved for
noncompetitive bids, one in which the bidder does not specify a price in
percentage yield. For competitive bids, successful placement will depend on the
price quoted. A lower yield represents a more competitive bid, as it is an
indication of a lower interest rate accepted.
Derivatives
Interest rate swaps. Singapore is the second largest interest rate derivatives
market in Asia, according to the latest BIS survey. Last year, average daily
turnover in OTC interest rate swaps reached SGD78bn, a 37% yoy increase
(Bloomberg swap tickers are SDSWx with x standing for tenors of the IRS).
Average ticket sizes are about SGD20mn, with tenors varying 1-15 years and
actively traded from 8:30-17:00 (Singapore). Fixing is based on 6m SOR with T+1
settlement. The 6m SOR fixing means there is no zero bound on interest rates,
which recently caused IRS yields to turn negative based on the FX implied
interest rate fixing.
Table 60: Summary statistics of Singapore derivative products and their markets
www.sgx.com
Singapore Foreign Exchange Market Committee
www.sfemc.org
Investment Management Association of Singapore
http://www.imas.org.sg
Product
Average daily
Average
trading volume
transaction size
Bid-ask spread
Bloomberg
reference
ABSIRFIX
Interest rate swaps
1-year
SGD500mn
5K DVO1
2bp
5-year
SGD200mn
10K DVO1
2bp
NA
10-year
SGD100mn
10K DVO1
2bp
NA
SGD200-300mn
SGD50mn
3-5bp
NA
5y tenor
5y tenor
Swaptions
1x5
NA
SGD50mn
2 vol
SDSP015 Curncy
5x5
NA
SGD5mn
2 vol
SDSP055 Curncy
78
GEMs Pa pe r #1 0
FX market
Singapore is the world’s fourth largest foreign currency exchange center, and the
second largest in Asia behind Tokyo, making up more than 5% of total global
turnover. Trading in the SGD averages about USD6-7bn daily in the spot market,
and USD3-4bn in the forwards market. Like India, Singapore has two deliverable
forwards markets: onshore and offshore. They share similar characteristics but
the trading in the offshore forwards market pales in comparison to that in the
onshore market.
This favorable growth is likely to be sustained in this key regional financial hub, as
greater economic activity is focused in emerging Asia. We maintain this view
even though foreign exchange transaction trading volume slowed globally in 1Q
2012 after peaking at $4.7tn in October 2011, according to the latest BIS report.
Table 61: Vital statistics and characteristics of Singapore’s FX market
FX
products
Tradable
product
Avg daily
trading
volume
Avg
trading
size
Bid-ask Reuters
SGD Onshore
Spot
SGD Spot
USD6-7bn USD3-10mn
SGD
SGD=D2 ▪ BofAML can trade SGD in the
0.0002-
spot market
0.0006
Forwards
Forwards
USD3-4bn
USD10-
SGD
50mn
0.00002-
PYSGD
▪ Forwards are available up to
10y tenors and are liquid for
0.0005
tenors shorter than 1y
SGD Offshore
Forwards
Forwards
USD1bn
USD10-
SGD
50mn
0.00002-
PYOS
10y tenors and are liquid for
0.0005
Options
FX options USD500mn
USD3050mn
0.2-0.8vol
▪ Forwards are available up to
TTDE
▪ Options are available up to 10y
tenors and are liquid for tenors
shorter than 2y
Investor base
The Central Provident Fund is a major holder of Singapore bonds. Foreigners can
access the Singapore bond market without needing pre-approval and there is no
capital gain or income taxes on the bond investments. Generally, primary dealers,
insurance companies, fund managers and finance companies are the key bond
holders.
Operationally, primary dealers provide liquidity into the SGS market by quoting
two-way prices under all market conditions, and underwrite issuances of debt
securities during SGS auctions. Currently, there are 13 banks certified as primary
dealers with the MAS. Primary dealers also play a critical role by providing
accurate and timely feedback to the central bank, and in turn assisting in the
development of the SGS market in Singapore.
79
GEMs Pa pe r #1 0
The secondary market is dominated by banks, merchant banks and stock-broking
firms that also participate actively in the SGS market by buying and selling
securities, either as a principal or agent. Beginning June 2011, retail investors are
also allowed to trade SGS on the Singapore Exchange (SGX). This provides an
additional avenue for retail investors to diversify into safe but higher-yielding
alternatives to bank deposits. Though there is no official estimate, we estimate
that foreign ownership is approximately 20-25% of outstanding bonds.
Rules, regulations, capital controls and taxation
Singapore is an open market economy with no capital controls. All entities and
individuals, including nonresidents, are free to purchase government debt
securities in Singapore, without any restrictions. Funds can also be freely remitted
in and out of Singapore.
Resident and nonresident investors are exempted from interest income tax and
there is no capital gains tax. Bonds issued under the Qualifying Debt Securities
(QDS) scheme are granted concessionary tax treatment, and there is no stamp
duty imposed on any securities. Financial institutions and corporations enjoy a
10% concessionary tax on interest income.
Transactions are cleared on a delivery versus payment basis over the MAS
Electronic Payment System (MEPS+) and MAS’ SGS book-entry clearing system.
Trading of SGS securities is from 9:00-11:30 and 2:00-16:30 (Singapore) with a
T+1 settlement date convention.
80
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Table 62: Summary of Singapore bond markets and products
Instrument
Singapore Government Securities Bills (SGS Bills)
Singapore Government Securities Bonds (SGS Bonds)
Issuer
Monetary Authority of Singapore
Monetary Authority of Singapore
Currency
SGD
SGD
Principal
SGD1,000 (par)
SGD1,000 (par)
Tenor
3 months to 1 year
2, 5, 10,15 and 20 years
Issued at discount
Fixed
Semi-annual
Coupon Payments
Zero coupon
Actual/365
Actual/Actual
Bullet
Bullet
Form
Registered
Registered
Amount outstanding
SGD59.6bn (as of June 2012)
SGD83.1bn (as of June 2012)
Trading
OTC (SGS Bills not listed on Singapore Exchange)
OTC (SGS Bills not listed on Singapore Exchange)
Yield
Yield
Settlement Period
T+1
T+1
Secondary Market
SGD1.568mn
SGD1,071mn
5bp
3bp
NA
3bp
Average trade size
SGD5mn for on the runs (benchmarks) and off the runs
SGD5mn for on the runs (benchmarks) and off the runs
Clearing Mechanism
MAS Electronic Payment System (MEPS+)
MAS Electronic Payment System (MEPS+)
Major players
Banks, merchant banks, stock-broking firms
Banks, merchant banks, stock-broking firms
Trading hours
Bidders
9:00-11:30 and 14:00-16:30
9:00-11:30 and 14:00-16:30
(Singapore time)
(Singapore time)
All entities or individuals, including nonresidents, may
participate. Applications have to be submitted through an
participate. Applications have to be submitted through an
approved SGS primary dealer
approved SGS primary dealer
(As of Jun2012)
No restrictions; foreign investors can freely remit funds in and No restrictions; foreign investors can freely remit funds in and
out of Singapore
out of Singapore
Custodian
SGX central depository (CDP)
SGX' central depository (CDP)
Interest Income Tax
Individuals are exempted from interest income tax, but
Individuals are exempted from interest income tax, but
institutions and corporations are taxed at a 10%
institutions and corporations are taxed at a 10%
concessionary rate, for residents and nonresidents.
concessionary rate, for residents and nonresidents.
Capital gains Tax
No capital gains tax on government securities, for residents No capital gains tax on government securities, for residents
and non-residents.
and nonresidents.
Entry/Exit Tax
None
None
Primary Auctions
Auction Style
Uniform pricing; successful competitive and noncompetitive Uniform pricing; successful competitive and noncompetitive
bidders will be allotted securities at a uniform yield, which is bidders will be allotted securities at a uniform yield, which is
the cut-off yield of successful competitive bids submitted at
the cut-off yield of successful competitive bids submitted at
the auction.
the auction.
Average Issue Size
SGD2.3-3.7bn
SGD2-3bn (benchmark issues)
SGD1,000
SGD1,000
81
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Sri Lanka
Overview
Claudio Piron
+65 6678 0401
Sri Lanka’s government and corporate bond markets started operating actively in
the early 1990s. The earliest instruments issued were non-marketable rupee
loans and short-term Treasury bills. Since the financial sector reforms and
restructuring in the late 1990s, the market has widened and deepened
considerably.
The Treasury bond was introduced in 1997 to meet the government’s medium
and long-term financing needs. Foreign currency-denominated bonds were
issued in 2001. Inflation-linked bonds were introduced in 2005, and the market
was opened to foreign investors in 2006. The increase in Treasury bond
maturities has aided the establishment of a medium-term yield curve and
provided a benchmark for the corporate bond market.
Monetary policy
Background. Following the political independence of Sri Lanka in 1948, the
Central Bank of Ceylon was established in 1949 by the Monetary Law Act (MLA)
and commenced operations on 28 August 1950. It was renamed the Central Bank
of Sri Lanka (CBSL) in 1985. The objectives outlined in the MLA consisted of
stabilizing prices and the exchange rate, and economic development objectives
such as increasing production and employment.
Table 63: Sri Lanka ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
-
B+
BBBBB+
B+
BBBBBB-
Policy framework. The MLA was amended in 2002 and redefined the central
bank’s objectives into 1) maintaining economic and price stability, and
2) maintaining financial system stability with a view to encourage and promote the
development of the productive resources of the country.
BBBBB+
B+
B+
BBBBBB-
The Central Bank of Sri Lanka (CBSL) uses monetary policy to maintain low
inflation for sustainable long-term economic growth. It seeks to maintain a stable
macroeconomic environment, a strong regulatory framework and a sound
financial system. This is done by checking threats to the financial system through
market surveillance and financial institution oversight of the payments system.
The MLA confers corporate status to the monetary board. An eight-member
Monetary Policy Committee (MPC) was established in 2001 to assist the
monetary board in formulating monetary policy. The MPC meets once a month to
review monetary policy in light of the latest economic developments.
Open market operations. The CBSL uses OMOs actively to manage liquidity.
The interest rate corridor is bound by the repo rate on the lower end and the
reverse repo rate on the upper end. This functions as a guide for overnight
interest rates in the money market.
Chart 43: Key Sri Lanka CPI components
41%
Food & Non-alcoholic Beverages
17%
Education
4%
Furnishing & Household Equipment
4%
Health
3%
11%
Others
0%
10%
82
Daily auctions by way of repo transactions are conducted to absorb excess
liquidity, and reverse repurchase transactions are conducted to inject liquidity.
The standing facility is available to participating institutions faced with temporary
shortage of or excess liquidity at rates defined by the bounds of the interest rate
corridor. The CSBL conducts outright transactions by Treasury bill sales to
absorb excess liquidity and outright purchases to inject liquidity.
24%
Housing, Water, Electricity
20%
30%
40%
50%
Base rate. The key benchmark policy rates are represented by the repo and
reverse repo rates, which provide the respective floor and ceiling for the policy
interest rate corridor.
GEMs Pa pe r #1 0
Conventions
Lending and deposit facilities. The repo and reverse repo rates represent the
key overnight deposit and lending rates for the money market. SLIBOR is Sri
Lanka’s interbank lending rate, calculated daily by the CBSL according to rates
supplied by local commercial banks.
Bonds
Settlement: T+2
Basis: Act/365
Reserve requirements. The statutory reserve requirement (SRR), or the
proportion of the deposit liabilities that commercial banks are required to keep as
cash with the central bank, is used occasionally to influence money supply.
IRS
Fixing: 6m SLIBOR
Economic drivers
Sri Lanka came out of a long and protracted civil war in 2009, and the priority was
to stabilize the economy, consolidate the budget deficit and bring inflation down.
Sri Lanka has a US$2.5bn Stand-By Arrangement with the IMF that is aimed at
consolidating macroeconomic stability while providing financial assistance to help
the economy adjust to the post-conflict phase.
Recent trends reveal that inflation is falling on a sustainable basis, while budget
performance is also improving sharply. The external current account is being
supported not only by the loan from the IMF, but by increasing inflows of foreign
investment, including from the wider Sri Lanka Diaspora.
Food accounts for the overwhelming macro driver of inflation at 41% of the
basket. Above and beyond this, the current account deficit also has an important
bearing on the currency.
Bond market
The Public Debt Department (PDD) of the CBSL handles the government’s debt
management and financing needs. The Domestic Debt Management Committee
of the PDD meets every month to prepare the short-term and long-term borrowing
plans after considering the government’s cash flow needs, the market conditions
and monetary developments. The government’s rising fiscal deficit has led to a
significant increase in outstanding Treasury bonds, from LKR0.2tn in 2000 to
LKR1.8tn in 2011.
The broad categories of bonds in Sri Lanka are T-bills, T-bonds, rupee loans and
Sri Lanka Development Bonds (SLDB).
Money market. Sri Lanka has an active interbank call money and Treasury bill
market. The secondary market for Treasury bills is very active and includes
outright sales and purchases, and repo and reverse repo transactions.
Chart 44: Maturity profile of Sri Lanka government bonds (LKRbn)
400
Chart 45: Outstanding government debt (LKRbn)
2,000
LKR bn
Sri Lanka GB maturing (LKRbn)
350
1,500
300
1,000
250
200
500
150
0
100
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
50
0
2012
2014
2016
2018
2020
2023
2032
Rupee Loans
Sri Lanka dev elopment bonds
Treasury bills
Treasury bonds
83
GEMs Pa pe r #1 0
Bloomberg pages
Other short-term money market instruments like certificates of deposit and
commercial paper are not fully developed. Access to foreign investors is
restricted.
OTC LKR<GO> – Market monitor
CBSL<GO> - Central Bank page
SLBF <GO> - Sri Lanka Primary Dealers’ Association
T-bills. Bills are issued on a discount basis with payment of interest upfront, and
redeemable at par. The T-bills are available for 91, 182 and 364-day tenors. The
minimum bid amount is LKR5mn and in multiples of LKR1mn.
Reuters pages
CENSL1 – Central bank page
LKPLDFIX – Sri Lanka implied forward fixings
T-bonds. Redeemable at par, T-bonds are conventional and inflation-linked
bonds. Tenors for conventional bonds run 2-20 years. Coupon payments for
conventional bonds are fixed and paid semi-annually. Inflation-linked bonds have
3y tenors and the coupon payment is linked with the Consumer Price Index. The
minimum bid amount is LKR5mn and in multiples of LKR1mn. Average ticket size
is US$1mn and bid-ask spread is 25bp. The average daily volume is US$10mn.
SLIBOR – Sri Lanka Interbank Offered Rates
Central Bank of Sri Lanka
www.cbsl.gov.lk
Ministry of Finance and Planning
Rupee loans. These are LKR-denominated bonds issued on a tap basis at par
with the interest rate being determined administratively. Tenors for these bonds
run 2-30 years. Coupon payments are fixed and paid semi-annually. The
minimum bid amount is LKR100. Only Sri Lankan citizens are eligible to hold
these bonds.
www.treasury.gov.lk
Ministry of Industry and Commerce
www.industry.gov.lk
Department of Census and Statistics
www.statistics.gov.lk
Sri Lanka development bonds. These are USD-denominated bonds issued for
2 and 3-year tenors. The interest rate is paid semi-annually and computed on a
variable rate based on 6m LIBOR plus a fixed margin. They are redeemable at
par. The income tax paid in Sri Lanka is reimbursed by the government.
Colombo Stock Exchange
www.cse.lk
International sovereign bonds. Launched in 2007, the CBSL has auctioned five
issues of these USD-denominated bonds. Tenors are 5 and 10 years and
average issue size is around USD1bn.
Employees’ Provident Fund
www.epf.lk
Auction and placement mechanism. The government conducts 3-4 Treasury
bond auctions in a month depending on its financing requirement. Auction dates
are announced two days prior to the auction. The PDD informs all participants in
the Central Depository System (CDS) about the bonds available for auction to
foreign investors.
Chart 47: Ownership of foreign debt of Sri Lanka (LKRbn)
Chart 46: Sri Lanka has allowed the LKR to be more market
determined since February 2012
140
1,000
135
130
800
125
600
120
400
115
110
200
105
0
100
Jan-11
Jul-11
Jan-12
USD-LKR
84
Jul-12
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Multilateral
Bilateral
Financial Markets
GEMs Pa pe r #1 0
Treasury bills are auctioned every Wednesday, with auction dates announced on
the Monday before the auction. All investors are required to submit their bids
before 11am on the auction date through primary dealers who bid competitively
on a multiple price basis. Successful bidders are informed within two hours of the
deadline for the submission of bids.
Derivatives market
Forward market. Onshore deliverable forwards are available for hedging FX
exposure subject to documentary proof of trade or Treasury bond investment.
The overall liquidity of the market is poor, with the most liquid segment being less
than six months. The bid-ask spread is LKR 0.08 and average ticket size is
US$1mn. The average daily volume is US$50mn. Foreign currency spot and
forward transactions have to be channeled through licensed commercial banks
having an authorized dealer license from the CBSL. The NDF and IRS markets
exist but are highly illiquid. Also there is no local CCS market.
FX market
Sri Lanka follows a managed float exchange rate regime. After experimenting
with a dual exchange rate regime in 1967-94, FX controls were loosened
gradually and a uniform exchange rate was introduced that was managed against
a basket of currencies. The LKR is fully convertible on the current account, but
only partly convertible on the capital account. The CBSL intervenes in the FX
market daily to curb excessive volatility in the LKR.
The FX market can be classified as a client or retail market, and an interbank or
wholesale market. The main participants in the interbank market are commercial
banks that act as authorized dealers in the foreign exchange. The commercial
banks that act as authorized dealers buy and sell foreign exchange from their
customers in the retail market. FX transactions take place through the spot
market and the forward market.
Foreign trade/service-related transactions are freely permitted. However, capital
account transactions require approval from the Exchange Control Department.
Table 64: Vital statistics and characteristics of Sri Lanka's FX market
LKR Onshore
Spot
Forwards
LKR Offshore
Forwards
Tradable FX
products
Avg daily
trading
volume
Bid-ask
spread
Reuters
reference
LKR Spot
USD 50m
LKR 0.08
LKR=
LKR Forwards
USD 50m
LKR 0.20-0.35
LKRF=
NDFs
Highly Irregular
DBNDG
Key facts
▪ No restrictions on local trade/service
related and stock market transactions.
▪ Capital account transactions require prior
approval from Exchange Control
▪ Trading Hours: 9:00-17:00 (Sri Lanka)
▪ Documentary evidence required
▪ Forwards are allowed for hedging
against stock market-related transactions
up to four days from the date of purchase.
Settlements must be routed through
SIERAs
▪ LKR is non-deliverable
▪ ISDA documentation is required.
85
GEMs Pa pe r #1 0
Investor base
The primary market for Treasury bills and Treasury bonds is dominated by
authorized dealers, primary dealers, insurance companies and mutual funds.
There are 11 primary dealers appointed by the CBSL that bid competitively in the
auctions and are responsible for providing liquidity to the secondary market by
quoting bid and offer yields for the government securities. The Employees
Provident Fund is the largest holder of Treasury bonds.
Foreign holdings of T-bills and bonds are both estimated under 10% of
outstanding amounts. Foreign investors can purchase up to 12.5% of total
outstanding government bonds and T-bills.
Table 65: Ownership breakdown of local Treasury bonds and bills (as of December 2011)
Ownership of
Ownership of
bills (LKRbn) % of total
bonds (LKRbn) % of total
Central bank
Commercial banks
Departmental and other
official
Employees Provident
Fund
Insurance & Finance
Other Provident Funds
Private & Other
Savings institutions
Total
170
186
29%
31%
6
1%
0
11
1
158
59
591
0%
2%
0%
27%
10%
Central bank
Commercial banks
Departmental and other
official
Employees Provident
Fund
Insurance & Finance
Other Provident Funds
Private & Other
Savings institutions
Total
0
207
0%
11%
37
2%
927
34
8
360
246
1,819
51%
2%
0%
20%
14%
Foreign investors and nonresidents can hold up to 10% of the total conventional
Treasury bonds and Treasury bills outstanding. Foreign investors are required to
register with licensed commercial banks or primary dealers at the Central
Depository System maintained by the PDD. They are allowed to enter repo and
reverse repo transactions, with eligible investors only using T-bills as collateral.
To invest in T-bonds, foreign investors are required to open a rupee account
called a Treasury Bond Investment External Rupee Account with a licensed
commercial bank (LCB). The LCB opens a security account with CDS on behalf
of the investor and is allowed to trade Treasury bills and Treasury bonds freely in
the secondary market. 3
For Treasury bills and Treasury bonds, a 10% withholding tax on interest income is
collected at the primary issue. No stamp duty is payable. For rupee loans, a 10%
withholding tax on interest income will be deducted from coupon payments. For Sri
Lanka Development Bonds, income tax paid in Sri Lanka will be reimbursed.
Securities are scripless and settled electronically. Transactions are cleared on a
delivery versus payment (DVP) basis over the Real Time Gross Settlement
System (RTGS). Settlement of successful bids takes place on T+2 days from the
auction date. Investors are required to maintain accounts with commercial banks
or primary dealers for the cash settlement of their transactions. In the secondary
market, primary dealers and commercial banks quote their bid daily and offer
prices for government securities. Investors can select from the best deals.
3
86
CBSL PDD T-bill Investor Guide, CBSL PDD T-bond Investor Guide.
GEMs Pa pe r #1 0
Table 66: Summary of Sri Lanka bond markets and products
Treasury bills
Treasury bonds
Rupee loans
Sri Lanka Development Bonds
Tenor
Democratic Socialist Republic of Sri
Lanka
91, 182 and 364 days
Lanka
2-30 years
Lanka. Bank of Ceylon is paying Agent
2 and 3 years
Currency
Issuance Method
Sri Lanka rupees (LKR)
Auction basis
Lanka
Conventional bonds: 2,3,4,5,6,10,15 and
20 years; inflation-linked bonds 3 years
Auction basis
Auction system
Bidding at Auctions
Through competitive bidding price
By primary dealers
Eligible Investors
Sri Lankan citizens (no restriction on
purchase of bonds). Foreign country
funds, mutual funds or regional funds,
Corporate bodies incorporated outside
Sri Lankan and citizens of foreign
states (10% of the total conventional
Treasury bills outstanding is available
for foreign investors)
Bills are issued on a discount basis
with payment of interest upfront.
Issuer
Interest Payment
Minimum Amount of a Bid at
Primary Auction
Minimum unit of an investment
Method of Sale in the Primary
Market
Interest Rate
Redemption
Taxation
Secondary Market Trading
US dollars (USD)
Tap basis and open until fully subscribed Auction basis
or decision to close by the issuer
Through competitive bidding price
Through competitive bidding margin
By primary dealers
Directly by individuals/institutions or Designated agents appointed by the
through primary dealers
Central Bank of Sri Lanka
Foreign citizens and entities, Nonresident
Sri Lankan citizens (no restriction on Sri Lankan citizens
Sri Lankans, Sri Lankan dual citizens,
purchase of bonds). Foreign country
authorized dealers, primary dealers, and
funds, mutual funds or regional funds,
specified companies that have entered
Corporate bodies incorporated outside
Sri Lankan and citizens of foreign
into agreements with the Board of
states (10% of the total conventional
Investment of Sri Lanka and insurance
companies registered under the
Treasury Bonds outstanding is
available for foreign investors)
Regulation of Insurance Industry Act
Conventional bonds: fixed and semi- Fixed and semi-annual coupon
Interest paid semi-annually and
annual coupon payments. Inflationpayments
computed on variable rate based on 6linked bonds: coupon payments based
month LIBOR plus a fixed margin
on Consumer Price Index
Rupees 5mn (Rs. 5,000,000/=) and in Rupees 100 (Rs. 100/=)
Minimum investment at the auction is
multiples of Rupees 1mn (Rs.
USD100,000/=. In the secondary market
1,000,000)
minimum investment is USD 10,000/=.
Rupees 5mn (Rs. 5,000,000/=) and in
multiples of Rupees 1mn (Rs.
1,000,000/=) [Is this the best way to
list currency?]
1 Rupee (Re. 1/=)
1 Rupee (Re. 1/=)
Offered weekly via competitive auctions Offered via competitive auctions to
to primary dealers on multiple price bases primary dealers
Market determined
Market determined
Face value of the bill will be paid at
Face value will be paid at maturity.
maturity
10% withholding tax on interest to
resident and 15% to nonresident
collected at the primary issue. No
stamp duty.
stamp duty.
Through primary dealers or Licensed Through primary dealers or Licensed
Commercial Banks.
Commercial Banks.
Issued on tap basis at par
Administratively determined
Securities are redeemed at par upon
maturity.
stamp duty.
By registration at the PDD
Offered via competitive auctions to
designated agents
Securities are redeemed at par upon
maturity.
Income tax paid in Sri Lanka will be
reimbursed by the issuer.
Through designated agents by
registration at the PDD
Source: CBSL, BofA Merrill Lynch Global Research
87
GEMs Pa pe r #1 0
Taiwan
Overview
Albert Leung
+
7137
Taiwan offers a liquid investment grade bond market, but access to foreign
investors is cumbersome and foreign participation is small compared to other Asia
markets. In November 2010 and January 2011 the government reduced onshore
access to foreign investors to 30% of their total investment portfolio in
government bonds. Additionally, the reserve requirement on nonresident local
currency accounts was raised to 90% of balances on 30 December 2010,
implying no interest paid. Locally, banks account for some 40% of ownership,
followed by the insurance sector at around 25%.
Monetary policy
Table 67: Taiwan Ratings Profile (Long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Aa3
Aa3
Aa3
Aa3
Aa3
Aa3
Aa3
Aa3
Aa3
Aa3
Aa3
Aa3
Aa3
AA-u
AA-u
AAAAAAAAAAAAAAAAAAAA
AA+
AAAAAA
AA
AA
AA
AA
AA
AA
AA
AA
AA
-
Background. Originally inaugurated in Canton, the Central Bank of China (CBC),
transferred to Taipei in 1949, resumed operations in 1961 and modernized to its
present form in 1979 via the Central Bank of China Act. The CBC’s
responsibilities include ensuring financial stability, sound banking, stable
domestic prices and external currency valuation, and fostering economic
development. At an operational level, the bank is involved with monetary
management, treasury agents, clearance and settlement, and FX management.
Legally, the CBC comes under the Executive Yuan (the Executive body of the
government), which together with the president also appoints the board of
directors. There are 15 directors, including representatives from the Ministry of
Finance and Ministry of Economic Affairs that are not subject to the five-year term
limit. The board of directors meets at the end of each quarter to decide on policy.
Current Governor Fai-Nan Perng has been at his post since 1998.
Policy framework. The CBC’s primary policy tool is its discount window, which
operates on two levels. The first is the discount rate that is used as a policy signal
and an avenue for banks to access discounted loans by using eligible banker’s
acceptances, trade acceptances and promissory notes. The traditional tightening
and easing cycle is represented by quarterly increments of 12.5bp.
The second discount window tool is short-term accommodations, where a bank
can compensate for a reserve deficiency by drawing on promissory notes made
payable to the CBC. The promissory notes can be secured on a collateral and
non-collateralized basis. Short-term accommodations are made for a maximum
10 days and cannot be for more than 10% of the bank’s required reserves.
Chart 48: Key Taiwan CPI components
Reserve requirement hikes are another tool open to the CBC; however, this is
seldom used, with the CBC using OMO more. The bank does not have an
inflation target or single policy target, but it does announce an M2 target range for
each year; 2.5-6.5% has been set for 2012.
Edu & Ent
17%
Food
26%
Housing
28%
Others
29%
0%
10%
20%
88
30%
Base rate. The benchmark policy rate is the rediscount rate, the discount rate on
10-day loans to banks. The overnight rate refers to the rate at which banks
borrow and lend to each other.
40%
Open market operations. OMOs represent the most important tool for the CBC
and are actively used to manage reserve levels and interbank call-loan interest
rates. The instruments used in the OMOs include government bills and bonds,
and negotiable certificates of deposit (NCDs) issued by the CBC. These NCDs
can be issued outright or transacted on a repo basis to manage excess liquidity.
GEMs Pa pe r #1 0
Conventions
Typically, the CBC issues NCDs of 1, 3 and 6-month tenors daily and adjusts the
rates paid on NCDs by around 7bp for every 12.5bp hike in the discount rate.
Outstanding NCDs were estimated at TWD6.7tn as of July 2012. Occasionally the
CBC will auction NCDs of 1 or 2-year tenors as a means to absorb excess
liquidity more aggressively.
Bonds
Settlement: Variable; typically T+1 or T+2
Basis: Act/365
IRS
Fixing: 90-day CP rate
CCS
Reserve requirements. The blended required reserve ratio (weighted average of
different type of deposits) is around 5.5% currently.
local Act/365
Lending and deposit facilities. As above, banks can cover reserve shortfall by
borrowing from the CBC at the discount rate. Banks can also borrow without
collateral, but a higher lending rate will apply. For deposits, CBC issues NCDs
regularly.
Fiscal policy
Taiwan is often viewed as a regional leading indicator for the export and techoriented export cycle. This reflects Taiwan’s high-tech export profile and the fact
that it is one of the first to release export orders, trade and industrial production
data for the region. Despite the leading nature of Taiwan’s economic data, the
swap curve is very much driven by US rates and the US economic cycle.
Bond market
Taiwan’s local fixed income market ranges in maturity from 2-30 years. Typically
the issuance is evenly distributed along the 5-20 year part of the curve. We
expect gross issuance to be TWD730bn in 2012, with the pace of issuance
evenly distributed through the year.
Money market. Treasury bills, commercial paper, bankers’ acceptances and
NCDs are the four key instruments of the money market. In terms of outstanding
size and issuance, commercial paper dominates the market, followed by NCDs,
Treasury bills and bankers’ acceptances.
Chart 49: Maturity profile of Taiwan government bonds (TWDbn)
Chart 50: Outstanding government bonds and bills (TWDbn)
TWD bn
5000
10
4500
9
4000
8
400
3500
7
350
3000
6
2500
5
2000
4
250
1500
3
200
1000
2
500
1
500
Taiw an GB maturing (TWDbn)
450
300
150
0
100
Jun-05
0
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
Jun-12
50
0
2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2040 2042
Source: CEIC, Taiwan CBC, BofA Merrill Lynch Global Research
Treasury bills
Negotiable certificates of deposits
Gov ernement bonds
Bankers acceptances (RHS)
89
GEMs Pa pe r #1 0
Bloomberg pages
TWD Curncy ALLQ<GO> FX rates
TWD OTC<GO> – Market monitor
CBRC<GO> – Central bank page
NTMM<GO> – Taiwan money market rates
TDON<GO> – Interbank and overnight rates
MOSB TWD<GO> – Most traded bonds
TWDI<GO> – Taiwan Interbank Money Center
TFEX<GO> – Taipei Forex Inc.
Reuters pages
CBCINDEX – Central bank page
TAIFX1 – Taipei Forex Inc.
TWCP= – Primary market CP fixing
TWCPE – Secondary market CP fixing
TWFRA – Taiwan FRAs
Central Bank of Taiwan (CBC)
www.cbc.gov.tw
Ministry of Finance
www.mof.gov.tw
National Treasury Agency
www.nta.gov.tw
Ministry of Economic Affairs
www.moea.gov.tw
Council for Economic Planning & Development
www.cepd.gov.tw
Financial Supervisory Commission
www.fscey.gov.tw
GreTai Securities Market
www.otc.org.tw
Taiwan Depository and Clearing Corporation
www.tdcc.com.tw
Commercial paper (CP). Corporates issue commercial paper for underlying
business (trade) or non-business (finance) activities, and may require a bank
guarantee, though this restriction is exempt from Ministry of Finance preapproval. CP rates are fixed in the secondary market at 11am among 22
contributors (see Reuters page TWCPBA), from 10 days to 180 days. The threemonth fixing rate is the reference rate fix for the floating leg of the IRS market; it is
calculated by taking the average of the mid-rates after excluding the bottom and
upper quartiles. The CP tenors range from 1 week to 1 year and are issued at
discounts.
Negotiable certificates of deposits. NCDs issued by commercial banks are
estimated at TWD231bn outstanding, net of the TWD6.7tn central bank NCD
issuance noted above. Typically commercial banks issue up to 12-month tenors.
The most important NCD issuance is the TWD100bn, 364-day issued by the CBC
in the first week of each month. Any changes in the total size or issuance yield
could be interpreted as a signal for a change in monetary policy.
Table 68: Composition of Government debt
Central government
Local government
Total bonds outstanding
Debt (TWDmn)
% of total
4,689,616
134,745
4,824,361
97%
3%
100%
Local government bonds. Benchmark tenors are provided by the 5, 10 and 20year issues, all of which were issued four times in 2010. The outstanding maturity
structure is focused between 2012 and 2016, accounting for 44% of the
outstanding TWD4.3tn in government bonds. These bonds are auctioned monthly
with a fixed coupon and bullet payment based on a scheduled quarterly issuance
by the CBC. Trading volumes are very active and estimated at TWD116tn in
2012, according to Gretai Securities.
Auctions and placement mechanism. An issuance calendar is released at the
beginning of each year specifying the tenors of bonds scheduled to be issued.
The actual issue size for each quarter is then specified on the 23rd of the month
preceding the quarter. The CBC commissions central government bond dealers
to participate in the government bond auctions and placements.
To encourage active bidding and reduce the funding cost of the Treasury, the
CBC switched to a single yield auction method for auctioning CGBs in July 2004.
Competitive bids must be expressed as a yield. The minimum bid size is
TWD100mn, and thereafter in multiples of TWD10mn. The bids are accepted in
ascending order of bidding yield. To be accepted, the bidding yield must be lower
than the maximum acceptable yield set by the Ministry of Finance.
All successful bidders are required to settle awarded securities at the highest
accepted yield at the auction. An electronic bidding system has been in place
since March 2001. Auction results are published on the CBC and Ministry of
Finance websites.
90
GEMs Pa pe r #1 0
Generally, Taiwan bonds trade in a very narrow range, as the absence of fresh
foreign investors together with the CBC likely to stay on hold for now means
major opportunities do not exist. With the spread between 10y Taiwan
Government Bond (TGB) and 10y UST now merely 30-40bp compared to well
over 200bp pre-Lehman, investing overseas to search for higher yields may
become a less attractive option.
However, the overall size of TGB market, especially for the long tenor ones, is still
not big enough for the pension funds. As a result, we do not expect the narrower
TGB vs UST spread to necessarily lead to stronger TGB.
Derivatives market
Interest rates swaps. IRS provide a very liquid hedging market out to 15 years,
with the greatest liquidity up to 5 years. The 90-day CP rate provides the
reference for the floating leg of the swap. Offshore investors are unable to access
the onshore IRS market, but can hedge effectively through the liquid
nondeliverable IRS. The divergence between the bond-swap spread can be
considerable at the back end due to corporate liability and asset manager
portfolio hedging demand.
Cross currency swaps. CCS are another very liquid hedging market that
extends to 10 years and offers the most liquidity up to 5 years. Again, offshore
investors are unable to access the onshore CCS market and are limited in
hedging ability in the nondeliverable CCS market due to its illiquidity.
Bond futures. A 10-year bond futures contract is offered by the Taiwan Futures
Exchange based on a TWD5mn face value and 3% coupon. Deliverable bonds
are those cheapest to deliver and include book-entry government bonds that are
maturing in not less than 8 years and 6 months. Delivery months are the standard
futures quarters, but unfortunately the contracts are not liquid and actively traded.
There also exists a 30-day CP interest rate futures market with a face value of
TWD100mn, and cash settled with settlement price based on the volume
weighted average price.
Table 69: Summary statistics of Taiwan derivative products and their markets
Avg daily
Avg
Bloomberg
Prod.
trading volume transaction size Bid-Ask spread
reference
Interest rate swaps
1-year
TWD8bn
TWD1bn
1bp
5-year
TWD5bn
TWD300mn
2bp
NTSW01 Curncy
NTSW05 Curncy
10-year
TWD1bn
TWD300mn
5bp
NTSW010 Curncy
1-year
TWD5bn
TWD2bn
2bp
TRSWNI1 Curncy
5-year
TWD2bn
TWD500bn
3bp
TRSWNI5 Curncy
10-year
TWD500mn
TWD250bn
5bp
TRSWNI10 Curncy
USD50-100mn <1y
USD10mn
5-10bp
NA
USD30mn <2y
Swaptions
1x5
NA
TWD1bn
2 vol
TRSP015 Curncy
5x5
NA
TWD100mn
2 vol
TRSP055 Curncy
91
GEMs Pa pe r #1 0
FX market
The CBC has overseen and managed a flexible floating regime since 1979. The
market determines the TWD exchange rate. However, the central bank stands
ready to intervene in the event of any seasonal or irregular volatility. Currently,
the TWD is not fully convertible and traded as nondeliverable forwards in the
offshore markets. Any onshore spot transactions by investors have to be
registered with CBC.
The CBC can use many monetary tools to pursue price stability in the FX market,
such as the buying and selling of government securities through OMO, using the
discount window or reserve requirement ratio. The CBC targets M2 money supply
growth through its control of the monetary base with OMO. A variety of OMO
tools are available to the CBC, but the principle measure is net issuance of
negotiable certificates of deposit. Additionally, 1, 3 and 6-month NCD rates are
typically adjusted 5-7bp with every 12.5bp hike in the policy discount rate.
Table 70: Vital statistics and characteristics of Taiwan's FX market
Avg
Avg daily
FX
Tradable trading trading Bid-Ask Reuters
size
TWD Onshore
Spot
TWD Spot
USD1.0- USD5-20mn TWD 0.0051.3bn
TAIFX1
0.020
▪ TWD purchase can be executed
with necessary document proofs
▪ Trading hours: 09:00-12:00 and
14:00-16:00 (Taipei)
Forwards
Forwards
USD1.5bn USD5-20mn TWD 0.005-
TWDF=
▪ Forwards on TWD are available
till tenors of 10y and liquid for
0.040
TWD Offshore
Forwards
NDF
USD1.3- USD5-20mn TWD 0.0201.8bn
0.100
PNDF
▪ TWD is non-deliverable
PNDG
▪ Offshore entities can access the
market through NDF
▪ Dollar settled NDF on TWD are
available till tenors of 10y and
liquid for tenors shorter than 1y
Options
NDO
USD200300mn
USD30mn 0.2-0.8 vol
TTDE
▪ Dollar settled NDO on TWD are
available till tenors of 5y and
liquid for tenors shorter than
2y
Investor base
Foreign participation in the Taiwan bond market is small compared to other Asia
markets. First, Taiwan yield is one of the lowest in Asia. Second, and perhaps
more importantly, foreign institutional investment in government bonds and
Treasury bills is capped at 30% of cash inflow. The rest has to be invested in
other instruments such as equities and corporate bonds, which make bond
investment less attractive.
92
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Table 71: Composition of money market participants (as of June 2012)
TWDbn
Treasury Bills
Commercial Paper
Bankers' Acceptances
Negotiable Certificates of Deposit
Government Bond: Central Govt
Government Bond: Local Govt
Corporate Bond
Financial Debenture
Total
% share
130.0
926.0
5.5
265.5
4689.6
134.7
1490.7
943.6
8585.7
2%
11%
0%
3%
55%
2%
17%
11%
100%
Foreign investors face a withholding tax of 20% on interest income, though there is
no tax on capital gains for offshore bond investors. The withholding tax can be
reduced to 10% depending on the existence of relevant double tax treaties. A tax
guarantor, usually the local sub-custodian, must be in place to vet that appropriate
taxes have been paid before foreign investors can remit their proceeds.
The central bank has introduced extensive reforms since a large-scale relaxation
of foreign exchange regulations began in 1987. Currently, there are no
restrictions on foreign exchange positions, or the movement of capital. Foreign
portfolio investments have also been liberalized with the abolishment of the
qualified domestic institutional investors (QDII) system in October 2003. Foreign
investors are now classified as foreign institutional investors (FINI) or foreign
individual investors (FIDI), with no limits on total investment amount.
Once registered with the Taiwan Stock Exchange, investors are also free to
choose any authorized foreign exchange bank to conduct foreign exchange
transactions. There is no limit on the total investment amount of any FIDI and
FINI. Transactions are conducted via a domestic custodian bank. A one-time FDI
investment exceeding 10% requires documentation and registration with the
Investment Commission of the Ministry of Economic Affairs.
There are no restrictions on inward and outward remittances related to foreign trade
in goods and services. Total annual remittance up to US$5mn by an individual and
up to US$50mn by a legal entity can be conducted directly through authorized
banks (CBC approval required for remittances of higher amounts). A single
remittance of up to US$100,000 by a nonresident is allowed directly through
authorized banks (CBC approval required for higher amounts). Outward remittance
of capital gains and stock dividends are allowed from realized earnings.
Table 72: Life insurance company AUM distribution among asset classes (as of June 2012)
TWDbn
% share
Foreign Assets
Loans
Portfolio Investments(PI)
Real Estates Investments
Claims on Financial Institutions
Cash in Vaults
Other Assets
Total Assets or Liabilities
4577
1219
4946
493
966
0
1654
13857
33%
9%
36%
4%
7%
0%
12%
100%
93
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Government bonds are traded through the Electronic Bond Trading System
(EBTS) and settled T+2 on a delivery against payment basis. Repo and reverse
repo trades are settled on the trading day. Most of the government bonds are
paperless and require investors to have a book-entry account (bond passbook) to
record bond ownership. This also allows the authorities to keep a close eye on
foreign flows and ownership.
The Taiwan Depository and Clearing Corporation (TDCC is the clearing and
depository body. Major operations include 1) providing book-entry of securities
transactions; 2) clearing and settlement of securities traded on the TSEC and
GTSM exchanges; 3) clearing and settling both cash and securities among
emerging stocks; 4) computer process handling for the clearing of futures market;
5) registering securities issued in dematerialized form; and 6) providing computer
process of book-entry for participants.
Entrusted by the Securities and Futures Bureau, Financial Supervisory
Commission (FSC) and Executive Yuan, the TSCD also does the auditing of
shareholders affairs for issuing companies.
94
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Table 73: Summary of Taiwan bond markets and products
Instrument
Treasury bills
Central government bonds
Issuer
Ministry of Finance
Ministry of Finance
Currency
TWD
TWD
Principal
TWD100,000
TWD 100,000
Tenor
3, 6, 9 and 12 months
2, 5, 10, 20 and 30 years
Issued at discount
Fixed
Coupon Payments
Zero
Semi-annual
Act/365
Act/365
Bullet
Bullet
Form
Registered (Book entry)
Registered (Book entry)
Amount outstanding
TWD130bn (as of June 2012)
TWD4.69tn (as of June 2012)
Secondary Market
Trading
Direct call
OTC
Yield (to three decimal places)
Yield (to three decimal places)
Settlement Period
T+1 (negotiable)
T+2
n/a
n/a
Bid/offer spread
trades only primary
0.2bp for liquid 10yr benchmark
trades only primary
5-10bp for illiquid bonds
Average trade size
n/a
TWD50mn
Clearing Mechanism
Delivery versus payment (DVP) basis
Delivery versus payment (DVP) basis
Major players
CBC-designated banks and financial institutions
Banks, financial institutions and licensed securities firms
Trading hours
9:00-15:00 (Taipei)
9:00-15:00 (Taipei)
Only FINI permitted
Only FINI permitted
Custodian
Withholding Tax
Foreign investors are subject to 15% withholding tax, unless Foreign investors are subject to 15% withholding tax, unless
tax reduced by preferential tax treaty
tax reduced by preferential tax treaty
Capital gains Tax
NA
NA
Entry/Exit Tax
NA
NA
Regulations
Primary Auctions
Auction Style
Single price auction
Single price auction or multiple price auction
Average Issue Size
TWD30-40bn, 9m, 1y tenors
TWD30-50bn
NA
TWD50mn
95
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Thailand
Overview
Albert Leung
+
7137
Post flood reconstruction and strong domestic demand supported Thailand’s
economy in the first half of 2012, but the weak external backdrop has started to
impact growth. With inflation still within the Bank of Thailand’s (BoT) target of
0.5-3%, there is a chance the central bank could reduce the policy rate from the
current 3% level if external environment deteriorates further.
Monetary policy
Background. Thailand implemented an inflation-targeting regime in 2000 with
price stability as its central objective. The central bank targets core inflation,
which is reviewed annually in cooperation with the Monetary Policy Committee
(MPC), and is 0.5-3.0% currently. Whenever there is a breach of the target “the
MPC shall explain why inflation has moved from the target, the policy action that
the MPC is taking to deal with it as well as the period within which the MPC
expects inflation to return to target”, according to monetary policy target
subsection of the BoT site.
Policy framework. A seven-member monetary policy committee, chaired by the BoT
governor, is responsible for the policy interest rate level. There are four external
members on the committee, two deputy governors and the governor. The external
members have three-year terms and cannot serve more than two consecutive terms.
Table 74: Thailand ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
AAAAA
A
A
A
A
A
AAA-
Base rate. The monetary policy stance is signaled through the 1-day repo rate. At
that rate, the BoT conducts fixed-rate repo/reverse repo transactions with
financial institutions. This anchors short-term interest rates and signals the BoT’s
monetary policy stance. Longer-term liquidity operations are conducted at
variable rate tenders, whereby financial institutions submit bids by specifying both
price and quantity. The other key rate to note is the 6m THB Fix, which is the
fixing rate for IRS markets. It is determined by onshore USD/THB FX forwards
rates, and can diverge quite significantly from the 1-day repo policy rate.
AAAAA
A
A
A
AABBB+
BBB+
BBB+
Open market operations. The BoT conducts OMO to adjust liquidity in the
interbank money market. The objective is to ensure that short-term money market
rates move with the policy rate. Among the various tenors, the 1, 7 and 14-day
repo/reverse repo transactions are the most common to absorb liquidity from the
system, but terms can go up to six months. These transactions are conducted
through primary dealers.
Chart 51: Key Thailand CPI components
Food & Beverage
33%
Transport & Communications
27%
Housing & Furnishing
23%
Health & Personal Care
7%
Recreation, Reading, Education & Religion
5%
Clothing & Footw ears
3%
Others
2%
0%
5% 10% 15% 20% 25% 30% 35%
96
The BoT also periodically conducts outright purchases of government securities
from primary dealers to permanently drain/inject liquidity into the system. In 2003,
the BoT began to issue its own bills to give its OMO added flexibility in managing
liquidity. These are issued as discount instruments with maturities of up to a year.
The BoT has also issued its own bonds periodically. The investor base for the
bills and bonds are similar to those that would invest in government bonds,
namely commercial banks, specialized financial institutions, finance companies,
securities companies, pension funds, mutual funds and insurance companies.
Lending and deposit facilities. The BoT provides collateralized overnight
borrowing and lending to the market through the End-of-Day Liquidity Adjustment
Window. The interest charged on overnight borrowing is 50bp above the policy
rate and 50bp below for banks that deposit excess funds with the BoT.
This corridor ensures that overnight rates and 1d repo rates remain anchored with
a 100bp range. The tradeoff in setting the corridor for overnight rates is a balance
between keeping the corridor sufficiently wide to ensure that banks clear the
money market among themselves on most occasions, and narrow enough so that
short-term interest rates fluctuate within an acceptable range.
GEMs Pa pe r #1 0
Conventions
Reserve requirement. The BoT imposes a reserve requirement (6% currently) for
its deposit liabilities over a fortnight. They can be held in a mix of non-remunerated
deposits at the BoT, vault cash (maximum of 2.5%) and eligible public securities.
Bonds
Settlement: T+2
Fiscal policy
Basis: 30/360
The key market drivers are monthly CPI, core CPI, monthly export numbers and
industrial production. Being a very open economy, global developments feature
prominently in BoT monetary policy discussions, and the exchange rate is a key
variable. The BoT tends to intervene actively in the FX market to smooth shortterm volatility, and subsequently sterilize FX intervention by conducting FX swaps
and issuing bills.
Coupon frequency: Mostly semi-annual
IRS
Fixing: 6m THBFIX
Coupon frequency: Semi-annual fixed/floating Act/365
Bond market
CCS
The government bond market has increased in size rapidly over the last several
years, to THB1351bn, or about 49% of GDP. Effective October 2010, the
authorities re-imposed a 15% withholding tax on foreign investors’ interest income
and capital gains on their investments in Thailand government bonds, BoT bonds,
and state enterprise bonds.
Coupon frequency: Semi-annual USD day count
Thailand government bonds. Issued weekly, government bonds have maturities
from 3-50 years. In 2011, the government issued its first inflation-linked
government debt at THB40bn.
Inflation-linked bonds. The government issued its first inflation-linked bond in
2011 with a tenor of 10 years (July-21 maturity with 1.2% coupon) and a coupon
paid semi-annually. Since then reopenings occur once every quarter to improve
liquidity. Currently total outstanding size is around 90bn THB. There was some
discussion about whether the Public Debt Management Office (PDMO) would
consider issuing shorter tenor linkers, as they offer a better hedge against nearterm inflation, but it appears PDMO believes longer tenor linker would be more
popular given the higher coupon.
Bank of Thailand bond. The BoT issues bills and bonds regularly, ranging from
14d bills up to 3y BoT bonds. Generally, BoT bond yields (2-3y) are slightly higher
(5-15bp) than government bonds of the same tenors. The primary objective of
BoT bonds is to maintain currency stability and facilitate the development of
money and debt securities markets.
State enterprise bonds. Issued by state-owned enterprises, maturities can be up
to 10 years. The auctions are managed by the PDMO and are normally done
through a Dutch auction.
Chart 53: Outstanding government bonds and bills (THBbn, as of
Chart 52: Maturity profile of Thai government bonds in (THBbn)
December 2011
350
3,000
THBbn
THBbn
3,000
Thai GB maturing (THBbn)
300
2,500
2,500
250
2,000
2,000
200
1,500
1,500
150
1,000
1,000
100
500
50
0
500
0
2005
0
2012
2014
2016
2018
2021
2023
2025
2027
2029
2032
2039
2041
2006
2007
Gov bonds
2008
2009
T-bills (RHS)
2010
2011
BoT (RHS)
97
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Corporate bonds. Typical maturities are 3, 5 and 7 years. Most issuance by
corporates is done through private placements, but on occasion they are
auctioned to the public market.
Auction and placement mechanism. Government bond and Treasury bill
auctions are held weekly under the BoT’s supervision. Auctions are conducted as
competitive bids (ie, an American auction). Noncompetitive bids are made
available for individual investors in small sizes of THB4-40mn. The PDMO
conducts the auctions of state-owned enterprise bonds using a Dutch auction
system. Corporate bond issues need Securities Exchange Commission approval
and a credit rating. If the issue size is smaller than THB100mn, or less than 10
investors are providing the offer, the condition for a credit rating can be waived.
Derivatives market
Interest rate swaps. Both the onshore and offshore IRS curves generally have
good liquidity out to 10 years. The floating leg of the IRS contract is the 6m FX
forward-implied interest rate. Local banks and life insurance companies are active
in hedging their asset and liabilities in the IRS market, and lumpy flows going
through the market can have an effect when liquidity is poor.
Cross-currency swaps. Onshore liquidity is good out to 10 years and there is
little to no liquidity offshore. Thailand investment companies are active in
investing savings abroad and tend to swap THB for foreign currencies.
Table 75: Summary statistics of Thailand derivative products and their markets
Average daily
Product
trading volume
Interest rate swaps
1-year
THB3,000
5-year
THB3,000
10-year
THB1,000
1-year
THB3,000
5-year
THB3,000
10-year
THB1,000
1-year
USD20-30
5-year
Not liquid
10-year
Not liquid
Average
transaction size
Bid-ask
spread
Bloomberg/Reuters
reference
THB1,000
THB500
THB500
3bp
3bp
4bp
TBSW01 Curncy
TBSW05 Curncy
TBSW010 Curncy
THB1,000
THB500
THB500
3bp
3bp
4bp
TBSWNI1 Curncy
TBSWNI5 Curncy
TBSWNI10 Curncy
USD10mio
USD10mio
USD10mio
5bp
10bp
20bp
TBUSSW1 Curncy
TBUSSW5 Curncy
TBUSSW10 Curncy
FX market
In a global context Thailand’s FX market remains small. Daily transaction volume
averages about US$1-1.2bn in the spot market and is smaller in the onshore
forward market, with liquidity in the offshore forward market significantly lower,
especially for tenors longer than 1y.
The BoT manages the THB under a managed float regime and intervenes to correct
short-term volatility. The THB is deliverable. Currency convertibility was reinitiated in
March 2008 with the removal of the unremunerated reserve requirement on shortterm capital flows. For example, the new regime places a THB10mn limit on
residents borrowing THB from nonresidents when there is no underlying
transaction. Conversely, the limit on residents lending THB to nonresidents was
increased to THB300mn per group when there is no underlying transaction.
Transfers in foreign currency for direct and portfolio investment are freely
permitted. Capital transfers by Thai residents are subject to certain regulations.
98
GEMs Pa pe r #1 0
Bloomberg pages
THGO<GO> – Thai government links
FX swaps. The BoT also uses FX swaps to influence liquidity in the money market.
Liquidity is withdrawn by conducting sell-buy FX swap operations with onshore and
offshore banks; reverse buy-sell FX swap operations are used to inject liquidity into
the money market. Tenors for these operations are normally up to a year, but most
transactions are conducted within a three-month maturity.
TBMA<GO> – Thai Bond Market Association
Table 76: Vital statistics and characteristics of Thailand’s FX market
THB Curncy ALLQ<GO> – FX rates
OTC THB<GO> – Market monitor
BTHA – Central bank page
MOSBTH<GO> – Most traded bonds
Reuters pages
BOT1 – Bank of Thailand FX page
BOT13 – Bond issuance schedule
MOF01 – Ministry of Finance
FX
Tradable
products
product
THB Onshore
Spot
THB Spot
Forwards
Forwards
THBFIX= Thai baht implied fixings page
Bank of Thailand (BOT)
THB Offshore
Forwards
Forwards
www.bot.or.th
Avg daily
trading
volume
Avg
trading
size
USD1.0- USD3-10mn THB0.010.03
1.2bn
USD0.7USD10- THB0.011.0bn
30mn
0.10
USD400- USD5-30mn THB0.010.10
700mn
Ministry of Finance
www.mof.gov.th
www.moc.go.th
Ministry of Trade
www.thaitrade.com
Securities and Exchange Commission
www.sec.or.th
Budget Bureau
www.bb.go.th/bbhomeeng
Public Debt Management Office
www.pdmo.mof.go.th
Government Pension Fund
www.gpf.or.th
The Stock Exchange of Thailand
www.set.or.th
Bond Electronic Exchange
www.bex.or.th
Thai Bond Market Association
www.thaibma.or.th
Thailand Securities Depository Co. Ltd
www.tsd.co.th
TRIS Rating Company Ltd
www.trisrating.com
Bid-ask
spread
Reuters
reference Key facts
THB=D2 ▪ Proper documentation required.
THBF=
▪ Forwards on THB are very
liquid for tenors shorter than 6m
and moderately liquid for
9-12 months.
PREE
▪ THB is non-deliverable.
the market through offshore
forwards
▪ Offshore forwards on THB are
available up to 5y tenors and are
liquid for tenors shorter than 1y.
Investor base
Banks are major investors in Thai government bonds. According to its own policy,
the Government Pension Fund (GPF) must invest greater than 60% in local fixed
income, the majority (40%) of which are Thai government bonds. But this portion
also includes HG Thai Corporate debentures. Note that the GPF is not a
government entity, nor is it a Sovereign Wealth Fund.
Mutual funds and insurance companies are also big investors in Thailand
government bonds, as well as households. Collectively, these segments hold
about 40% of outstanding stock. They are regulated by the SEC. Many of these
asset management companies have been diversifying by investing abroad with
approval from the SEC. These companies can invest in overseas government
bonds, international organization bonds and other instruments, but only if they
meet certain ratings criteria.
Foreigners own 14% of Thailand government bonds. This has been a general
trend since the 2008 financial crisis. With bond curves now quite flat, further
inflow into Thai bonds are likely to be contingent on the BoT cutting policy rates.
Table 77: Ownership breakdown of Thai government bonds (as of July 2012)
THBbn
% share of total
Central Bank
Other Depository Corporations
Financial Corporations not elsewhere classified
Central Government
Local Government
Other Nonfinancial Corporations
Public Nonfinancial Corporations
Households & Nonprofit Institution Serving Household
Nonresidents
Total
218
475
916
497
1
14
1
405
417
2943
8%
16%
32%
17%
0%
0%
0%
14%
14%
99
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Table 78: Breakdown of insurance sector holdings
Life insurance fund
investment assets
Q1 2012 investments
Deposit with the Insurance Commissioner
Bonds
Treasury Bills
Notes
Tax Credit Card Issued by MoF
Stocks
Convertible Debentures
Investment Units
Warrant of Common Stocks
Other
Loans
Investment
Fixed Deposit: Bank
Cash & Current Deposit with Financial Instit
Certificates of Deposit
Immovable Assets: Building
Immovable Assets: Real Estate
Amount Deposit on Reinsurance Treaties
Due from Reinsures
Uncollected Premiums
Accrued Income
Operating Asset
Other Assets
Head Office Account
Total Assets
THBbn
0.52
877.48
0.20
135.97
0.00
129.15
180.47
14.57
0.05
0.00
76.00
12.36
22.48
11.23
4.92
17.66
2.42
0.00
1.51
15.82
20.75
2.06
4.79
0.00
1530
% Share
0.0%
57.3%
0.0%
8.9%
0.0%
8.4%
11.8%
1.0%
0.0%
0.0%
5.0%
0.8%
1.5%
0.7%
0.3%
1.2%
0.2%
0.0%
0.1%
1.0%
1.4%
0.1%
0.3%
0.0%
100%
Non life insurance fund
investment assets
0.91
43.18
0.37
15.58
0.00
43.86
14.35
8.37
0.17
0.00
4.00
0.15
46.61
60.28
1.21
9.88
0.37
0.37
79.99
17.28
1.50
1.72
409.08
0.00
759
% Share
0.1%
5.7%
0.0%
2.1%
0.0%
5.8%
1.9%
1.1%
0.0%
0.0%
0.5%
0.0%
6.1%
7.9%
0.2%
1.3%
0.0%
0.0%
10.5%
2.3%
0.2%
0.2%
53.9%
0.0%
100%
There is a withholding tax of 15% on interest income, which can be reduced to
about 10% for foreign investors from jurisdictions with a tax treaty with Thailand.
Capital gains are generally exempt from tax for nonresidents.
In August 2009, a relaxation of regulations made it easier for Thai residents to
take capital abroad. For example, institutional investors can now carry out
derivative transactions linked to their foreign investments, including borrowing
and lending securities. Most derivative transactions of this nature are restricted to
plain vanilla.
Foreign investors are subject to a 15% tax on capital gains that may be reduced
to 10%, subject to being eligible for tax treaties. There is no withholding tax on
interest income earned on government loan bonds. Thai regulations and taxation
are subject to change, and investors are recommended to contact the relevant
government bodies and seek tax advice.
Foreign investors can settle onshore using a local custodian or offshore through
Euroclear. Clearing onshore through the stock exchange is settled at T+2 using a
book-entry system. The delivery versus payment (DVP) system reduces
settlement risks. Over the counter transactions will eventually be done on a DVP
basis but are currently settled by physical delivery.
100
GEMs Pa pe r #1 0
Table 79: Summary of Thailand bond markets and products
Instrument
Issuer
Currency
Principal
Tenor
Treasury bills
Ministry of Finance, facilitated by
Bank of Thailand
THB
THB1000 (par)
Less than one year, typically having
28, 91 and 182-day maturity periods
Sold at discount from face value
Coupon Payments
Form
Amount outstanding
Zero coupon
30/360
Bullet
Scripless
nil (as of December 2011)
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
OTC or BEX
Yield
T+2 but can vary by bilateral
agreement
THB1-3.5bn
2-4bp
NA
THB50-100mn
BAHTNET (Euroclear available)
Mutual funds, pension funds,
insurance companies, banks, asset
management and private funds
9:00am-12:00pm and
1:30-4:00 pm (Bangkok time)
Primary dealers and other
institutions authorized by the
Ministry of Finance.
Regulations
Restrictions on Foreign Investment No restrictions; foreign investors
free to invest in Thai bonds
Custodian
Withholding Tax
Effective from 13 October 2010,
foreigners are required to pay a
15% tax on interest income on
government, central bank or state
enterprise bonds, unless rate is
reduced by a preferential tax treaty
Capital gains Tax
Effective 13 October 2010, a 15%
tax on capital gains imposed on
foreign investors, unless the rate is
reduced by preferential tax treaty.
Entry/Exit Tax
None
Primary Auctions
Auction Style
Offered weekly via competitive
auction to primary dealers and other
eligible participants
Average Issue Size
THB50-100bn
THB10mn for competitive bids
Government loan bonds
Bank of Thailand
THB
THB1000 (par)
1 to 20 years
Government savings bonds
Bank of Thailand
THB
THB1000 (par)
3 to 10 years
Bank of Thailand (BoT) bonds
OTC or BEX
Yield
agreement
THB2-5bn
2-4bp
2-4bp
THB50-100mn
9:00am-12:00pm and
institutions authorized by the
Ministry of Finance can submit
competitive or non-competitive bids.
Others to submit non-competitive
bids only through primary dealers.
OTC or BEX
Yield
agreement
THB2-5bn
2-4bp
2-4bp
THB20-40mn
9:00am-12:00pm and
Thai nationals, residents,
cooperatives, foundations,
monasteries, educational
institutions, hospitals and others not
specifically stated as ineligible.
OTC or BEX
Yield
agreement
THB50-80mn
6bp
NA
THB50-100mn
9:00am-12:00pm and
institutions authorized by the Bank
of Thailand.
Bank of Thailand
THB
THB1000 (par)
Of varying maturity; zero-coupon
bonds (less than a year); fixed rate
and floating bonds (more than 1
year) and savings bonds (4-7 years)
Fixed
Fixed
Fixed except for floating rate bonds
which are based on BIBOR
(Bangkok Interbank Offered Rate)
Semi-annual
Quarterly/ Semi-annual
Semi-annual
30/360
30/360
30/360
Bullet
Bullet
Bullet
Scripless
Scripless
Scripless
THB2.6tn (includes all government THB2.6tn (includes all government THB2.6tn (as of December 2011)
bonds, as of December 2011)
bonds, As of Dec2011)
No restrictions; foreign investors
Effective from October 2010,
foreigners are required to pay a
foreigners required to pay 15%
15% withholding tax on government, withholding tax on government,
central bank or state enterprise
bonds, unless the rate is reduced by bonds, unless rate is reduced by a
a preferential tax treaty
preferential tax treaty
Effective 13 October 2010, 15% tax Effective 13 October 2010, a 15%
on capital gains imposed on foreign tax on capital gains imposed on
investors, unless rate reduced by foreign investors, unless the rate is
preferential tax treaty.
None
None
eligible participants. Non
competitive bids are available for
other investors
THB50-100bn
THB10mn for competitive bids; noncompetitive are between THB440mn
foreigners required to pay 15%
withholding tax on government,
bonds, unless the rate is reduced by
a preferential tax treaty
Effective 13 October 2010, a 15%
tax on capital gains imposed on
foreign investors, unless the rate is
None
From selling agents like the BoT,
Government Savings Bank and
authorized commercial bank
eligible participants
branches during subscription time.
THB50-100bn
Vary between THB10,000-50,000
depending on the issue
THB30-50bn
THB10mn for competitive bids
101
GEMs Pa pe r #1 0
Vietnam
Overview
Claudio Piron
+65 6678 0401
The development of Vietnam’s bond market has been hampered in the recent
past due to the sharp reversal of economic growth, the declining VND outlook and
rising inflation, which have driven foreign investors away. In the domestic market
appetite for bonds has been lackluster the past two years, as several corporates
have resorted to loan financing instead of bond financing.
Monetary policy
Background. The State Bank of Vietnam (SBV) was established in 1960 with the
renaming of the Vietnam National Bank in accordance with the 1946 Constitution
of the Democratic Republic of Vietnam. Monetary policy is largely the
responsibility of the National Assembly and the government, with the SBV
integrated with the Vietnamese government.
Table 80: Vietnam ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
B1
B1
B1
Ba3
Ba3
Ba3
-
BBBB
BB
BB+
BB+
BB+
BB+
BB
BB
BB
BB
B+
B+
B+
BBBB
BB
BB
BB
BB
BB
BB
Policy framework. The SBV’s stated objectives are stabilizing the value of the
currency, controlling the inflation rate, facilitating socio-economic development,
ensuring national defense and security, and improving the living standards of the
people. The SBV base reference rate is used to signal interest rates in the
economy and serves as a ceiling on the commercial lending rate. Other
instruments used by the SBV include the reserve requirements for deposits, as
well as the collateralized refinancing and discount facilities. Monetary Policy
Committee meetings are not pre-announced, but are held every month.
Open market operations. OMO started in July 2000, and are used by the SBV to
control the liquidity in the market. Through OMO, the SBV regulates the flow of
money by conducting outright sales and purchases of securities or repurchase
agreements. Since 2003, securities with a maturity of more than one year
maturity have been used.
Base rate. This was used up until 2010 as the key interest rate for setting the
ceiling on commercial lending capped at 1.5 times the base rate. As a
consequence of interest rate liberalization, this no longer applies and the gap
between base and lending rates has widened. However, markets still watch the
base rate as an indicator for future rises in commercial lending rates.
Lending and deposit facilities. The discount rate is the interest rate charged on
SBV loans to commercial banks, while the refinance rate is the rate charged on
lending facilities to credit institutions.
Reserve requirements. These requirements are tiered according to the
institutional status. Specifically, state-owned commercial banks are charged from
1% to 8% depending on the tenor and whether the demand deposits are in VND
or FX. Reserve requirements are required to be held entirely in cash.
Chart 54: Key Vietnam CPI components
Foods & Foodstuffs
40%
Housing & Construction Materials
10%
Transportation
9%
Household Equipments & Appliances
9%
Garment, Hats & Footwear
7%
Education
6%
Others
20%
0%
5%
10% 15% 20% 25% 30% 35% 40% 45%
102
Fiscal policy
Like other Asian countries, Vietnam also expanded fiscally to boost economic
growth after the 2008 financial crisis. This led to a widening of its budget deficit to
6.99% of GDP in 2009. However, the government has taken steps to stabilize the
deficit, targeting a budget deficit of 4.8% in 2012. Standard & Poor’s raised
Vietnam’s rating outlook from negative to stable in June 2012 on credible
measures taken by authorities to tighten finances.
GEMs Pa pe r #1 0
Conventions
Coupon frequency: Annual
Macroeconomic volatility has been high in Vietnam in recent years, with the
authorities battling a high current account deficit, low FX reserves and high
inflation. This has limited impact on the credit, as there are concerns that in the
short term Vietnam continues to suffer from bouts of stop-go macroeconomic
policies implemented by the authorities. The food component of CPI accounts for
the highest component at 39.9%, which is common for many of Vietnam’s peers.
IRS
Bond market
Bonds
Settlement: T+1
Basis: Act/Act
Vietnam was plagued by hyperinflation in the 1980s and 1990s, and restrictive
fiscal and monetary policies were used to bring it under control. Since 2000 the
fiscal deficit has been largely controlled at around 3% of GDP. Vietnam’s
economic growth was hit by the financial crisis in 4Q 2008, leading to a drop in
exports and inward foreign direct investment. In 2009 the government announced
a US$8bn stimulus package to boost growth. However, rising inflation the past
two years has again shifted the focus toward a tighter fiscal policy; inflation
touched 22.2% yoy in July 2011.
Fixing: VNIBOR
Coupon frequency: Semi/semi; Act/365
Government bonds are used to finance large-scale infrastructure investment.
Bond auctions usually take place three times a week. The bond market broadly
consists of government bonds, government guaranteed bonds, municipal bonds
and corporate bonds.
Money market. The VNIBOR represents the money market curve, and is a clean
borrowing/lending rate derived by compiling the interest rate of 17 commercial
banks. The most common tenors for borrowing/lending are overnight 1 week, 2
weeks, 1 month, 2 months and 3 months. The repo market offers another avenue
for borrowing. For interbank repos, the most common tenors are up to 1 month.
SBV conducts repos through the open market with the most common tenors
being 7-14 days.
State Treasury bills. The bills are issued at a discount and offered on a one-year
basis by the State Treasury to finance the state budget. The bills are issued
weekly with typical issue size around VND1tn.
SBV bills. The bills are issued by the SGV for liquidity management. Tenors are
1 week, 2 weeks, 1-2 months and up to 1 year, with the 1-2 month the most
common. SGV bills can be issued up to three times a week. Banks are the most
common bidders because they are eligible collateral for repos.
Chart 56: Outstanding government debt (VNDtn)
Chart 55: Maturity profile of government debt (VNDtn)
1200
60
Vietnam GB Maturing (VNDtn)
Vietnam gov ernment debt (VNDbn)
50
1000
40
800
30
600
20
400
10
200
0
0
2012
2013
2014
2015
2016
2017
2020
2021
2022
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
103
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Bloomberg pages
OTC VND<GO> – Market monitor
SBVN <GO> – State Bank of Vietnam
VBMA<GO> – Bond Market Association
T-bonds. The State Treasury issues T-bonds to finance its budget. With tenors
ranging from 2-15 years, T-bonds are issued weekly at auction sizes around
VND200bn-1tn. Up to five auctions can be conducted in a month. The auction
calendar is announced quarterly.
SBVM – State Bank of Vietnam auctions
Reuters pages
SBVGUIDE – State Bank of Vietnam
VMOF – Ministry of Finance
VND=SBVN – Vietnam FX spot
VNDFIX= – Interbank fixing rates
State Bank of Vietnam
www.sbv.gov.vn
State Securities Commission of Vietnam (SSC)
www.ssc.gov.vn
Ministry of Finance
Municipal bonds. Agencies authorized by the Provincial People’s Committees
issue municipal bonds at a spread over the ceiling set by the Ministry of Finance,
above that of a similar T-bond tenor. The largest municipal issuer is Ho Chi Minh
City. Tenors are usually 3, 5, 10 and 15 years.
Corporate bonds. The corporate bond market consists of bonds issued by stateowned companies and banks. Tenor usually ranges 2-10 years and are issued at
a floating rate. The market is not well developed.
Auction and placement mechanism. Government bonds in Vietnam are
auctioned by way of direct auctions, underwriting and retailing. T-bills and Tbonds are usually issued via direct auctions by the Hanoi Securities Trading
Centre (HASTC), which fixes the yield. This yield may be specified by the Ministry
of Finance. Retailing is used to issue central project bonds and education fund
bonds. Auction announcements by the Ministry of Finance are done four days
prior to the auctions.
www.mof.gov.vn
Ho Chi Minh Stock Exchange (HOSE)
www.hsx.vn
Derivatives market
Interest rate swaps. Vietnam’s derivatives market has yet to develop. Liquidity in
the FX options, IRS and CCS market is very low, but has improved recently.
FX market
The SBV fixes the reference rate for the VND with respect to the USD, and
specifies a trading band within which the currency can vary. The SBV frequently
intervenes in the FX spot and swaps market to maintain the value of the VND
against the USD. The VND has been facing weakening pressure since 2008.
The SBV devalued the VND in November 2009, February 2010, August 2010 and
February 2011. The last policy move devalued the VND by 7% and narrowed the
trading band to 1% around the interbank average from the earlier 3% of the daily
weighted average transaction rate in the interbank FX market.
Rising trade deficits over the past four years have led to the development of a
parallel currency market to fulfill the excess demand for USD. The devaluations
have been used for converging the official rate with the black market rate.
Investor base
The investor base mostly consists of banks, insurance firms, fund management
and securities companies. Data on the their respective market shares are not
available, though local state-owned banks are seen as dominant players in the
secondary market, together with domestic life insurance companies.
Major state-owned banks include the Vietcombank Securities Company, Vietnam
Bank for Rural and Agriculture Development, Industrial and Commercial Bank of
Vietnam, and Bank for Investment and Development of Vietnam. Domestic life
insurance companies have 49% of their total investments in government bonds.
Unfortunately, publicly available data on foreign ownership are unavailable, but
seen as small given the lack of market depth and lack of access to onshore
funding, FX and interest rate hedging to foreign investors.
104
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Only investors having a certificate of bond bidding issued by the Ho Chi Minh City
Securities Trading Centre (HSTC) can participate in bond auctions. All bids have
to be channeled through these members. Trading on the Ho Chi Minh Stock
Exchange (HOSE) and Hanoi Securities Trading Center (HASTC) requires a
securities transaction code, which allows the participant to open a securities
transaction account with a member securities company. Repatriation of capital
gains or profits requires the maintenance of a foreign currency account and VND
account with a foreign custodian bank.
Individual investors are exempt from personal income tax for interest income
earned from investing bonds. Institutions are subject to 28% corporate income tax
for any income derived from bonds.
Clearing and settlement is centralized through the Vietnam Securities Depository
(VSD). Cash clearing is settled through Vietnam’s only designated clearing
banks, the Bank for Investment and Development of Vietnam. Securities are
settled through VSD. The settlement date convention is T+1.
Table 81: Summary of Vietnam bond markets and products
Treasury bonds and Central Project
Instrument
bonds
Investment bonds
Government guaranteed bonds
Issuer
State Treasury of Viet Nam
Currency
Tenor
Coupon Payments
Amount outstanding (as of June 2012)
Secondary Market
Trading
Vietnamese dong
State-owned Financial Institutions; Credit and Enterprises appointed by the Prime Minister
Financial Institutions appointed by the PM
to be project owners of government projects
Vietnamese dong
Vietnamese dong
5, 10 and 15 years
Determined by the Ministry of Finance
Annual
2, 3, 5, 7, 10 and 15 years
Annual
Greater than 1 year
Annual
Traded in the monetary market or discounted
or pledged at the State Bank of Viet Nam;
Listed and traded on the HSTC.
Banks, insurance firms, fund management
and securities companies
or pledged at the State Bank of Viet Nam;
Listed and traded on the HSTC.
or pledged at the State Bank of Viet Nam
Major players
Trading hours
Withholding Tax
Capital gains Tax
Primary Auctions
Auction Style
No
No
No
10%
10%
10%
No separate capital gains tax; gains are taxed No separate capital gains tax; gains are taxed No separate capital gains tax; gains are taxed
at the standard corporate tax rate of 25%.
Retail through the State Treasury system,
underwriting, via issuance agencies, auction
through the Ho Chi Minh City Securities
Trading Centre (HSTC)
VND100mn
Retail through the State Treasury system,
Underwriting, Via Issuance Agencies
underwriting, via issuance agencies, auction
through the Ho Chi Minh City Securities
Trading Centre (HSTC)
VND100mn
VND100mn
Source: BofA Merrill Lynch Global Research , ADB
105
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106
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EEMEA countries
107
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Czech Republic
Overview
Arko Sen
+44 20 7995 1576
The Czech Republic is one of the more developed and open CEE states, and its
convergence toward the Eurozone is advanced. Exports total about 70% of GDP,
concentrated in machinery and transport equipment to the EU. A strong banking
sector, solid competitive position and prudent macro management underpin the
Czech Republic’s “safe haven” reputation. We expect modestly weaker growth in
the coming years relative to the last decade due to the spillover effects of the
Eurozone crisis and ongoing fiscal tightening efforts.
Mai Doan
+44 20 7995 9173
Raffaella Tenconi
+44 20 7995 9173
Monetary policy
Background. The Czech National Bank (CNB), the supervisor of the Czech
financial market, is an independent entity. The supreme governing body of the
CNB is the Bank Board, consisting of the governor, two vice-governors and four
members, all appointed to six-year terms by the president of the Czech Republic.
Table 82: Czech Republic ratings profile (longterm local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
A1
A1
A1
A1
A1
A1
A1
A1
A1
A1
A1
Baa1
Baa1
AAAAA
A
A
A
AAAAAAA-
A+
A+
A+
A+
A+
A
A
A
AABBB+
BBB+
BBB+
The CNB’s major communication instruments include press releases and press
conferences held after the rate-setting meetings, rate-setting meeting minutes
with detailed voting outcomes, and a quarterly inflation report. The decision
making process is the most transparent in EEMEA. The CNB publishes monthly,
quarterly and annual forecasts of main macro indicators, including the short-term
rates in its inflation report, and regularly comments on CPI and GDP data.
Policy framework. The CNB’s primary objective is to maintain price stability. An
inflation-targeting framework was adopted in 1998. The CNB is responsible for
setting the inflation target, with the current 2%±1% target based on the headline
CPI inflation in place since January 2010.
Base rate. The main monetary policy instrument is the two-week repo rate. The
CNB accepts surplus liquidity from banks and in return transfers eligible securities
to them as collateral. The two parties agree to reverse the transaction at a future
date, when the CNB as the borrower repays the principal of the loan plus interest
and the creditor bank returns the collateral to the CNB.
The board meets eight times a year to discuss monetary policy issues. Decisions
are adopted by a simple majority of votes. The governor has the deciding vote in
case of a tie.
Chart 57: Key CPI components for Czech Rep
6.9
Misc
15.0
Food
Housing
33.8
Others
44.3
0
10
20
108
Open market operations. Open market operations are mostly executed in the
form of repo operations, with the main one being repo tenders with basic duration
14 days; as a result, the two-week repo rate is considered key for monetary
policy. Repos with shorter maturities are executed from time to time. Two-week
repo tenders are currently used exclusively for absorbing liquidity due to the
systemic liquidity surplus in the Czech banking sector. The CNB conducts
variable rate tenders, which means that the declared repo rate serves as the
maximum limit rate at which banks’ bids can be satisfied in the tender. Repo
tenders are usually announced three times a week.
30
40
50
The supplementary instrument is the 3-month repo tender. In these operations
the CNB does not intend to send signals to the market, so the 3-month repo rate
used for this tender is the money market rate in effect when the tender is called.
The last 3-month tender was called in January 2001.
GEMs Pa pe r #1 0
Conventions
Fine-tuning instruments (foreign exchange operations and securities operations)
are used ad hoc, mainly to smooth the effects on interest rates caused by
unexpected liquidity fluctuations in the market. These instruments are rarely used.
Bonds
Settlement: T+3
Lending and deposit facilities. The interest rates applied to these facilities form
the corridor for short-term money market rates and for the 2-week repo rate.
Basis: ISMA-30/360
Coupon frequency: Annually
The deposit facility is a non-collateralized standing facility that banks can use to
make overnight deposits of surplus liquidity with the CNB. The minimum volume
is CZK10mn. The deposits are remunerated at the discount rate, which generally
provides a floor for short-term interest rates on the money market.
IRS
Fixing: 6m PRIBOR 11am CET (1y IRS fixes against 3m
PRIBOR
Coupon frequency: Annual fixed Act/360, semi-annual
floating Act/360
The marginal lending facility is a standing facility that banks with a general repo
agreement with the CNB can use to obtain overnight liquidity from the CNB in the
form of repos. The minimum volume is CZK10mn. The interest rate applied to this
facility is the Lombard rate. Banks make minimal use of this facility due to a
persistent liquidity surplus. The Lombard rate provides a ceiling for short-term
interest rates in the money market. The CNB can temporarily limit or completely
suspend the provision of Lombard loans at any time due to extraordinary
monetary policy reasons.
Reserve requirements. The reserve requirement is 2% of the reserve base
(bank's primary liabilities with maturity up to two years). The funds on this account
have been remunerated at the 2-week repo rate up to the pre-specified volume of
minimum reserves. The reserve requirement is currently of little significance as a
monetary policy instrument.
To keep the interbank payment system functioning smoothly following the
lowering of the reserve requirement to its present level, a collateralized intraday
credit facility was introduced. Within this facility, the CNB provides short-term
intraday credit to banks to enable them to make payments even if they do not
have sufficient funds on their payment system accounts with the CNB. No interest
is charged on intraday credit and there is automatic spillover into the marginal
lending facility in the event of non-repayment.
Chart 58: Maturity profile of outstanding Czech government securities
in CZKbn
250
CZGB
Chart 59: Outstanding CZK debt types by category (latest)
Gov ernment T-
CZTB
CZK 223.2bn
bills
200
150
Gov ernment
CZK
bonds
1,107.6bn
100
50
CZK 161.1bn
o/w floating
2056
2052
2048
2044
2040
2036
2032
2028
2024
2020
2016
2012
0
0
200
400
600
800
1,000 1,200 1,400
109
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Bloomberg pages
Fiscal policy
CZK Curncy ALLQ<GO> – FX rates
As a small open economy, the Czech Republic depends heavily on exports to the
EU, particularly Germany. The near to medium-term growth outlook is
undermined by a double whammy of slowing external demand and ongoing fiscal
consolidation at home. The banking sector is mostly foreign owned, primarily by
Austria and Belgium; however, prudent management (low NPL, L/D well below
100%) means that the Czech Republic is the least exposed among CEE to the
deleveraging process in the Eurozone.
OTC CZK<GO> – Market monitor
CNB<GO> – Central bank and bond auctions
Reuters pages
FX page <ECB37>
Bonds page 0#CZTSY=
Useful websites
Czech National Bank
www.cnb.cz
Ministry for National Economy
www.mfcr.cz
Central Statistics Office
www.czso.cz
Prague Stock Exchange
www.pse.cz
Prague Securities Centre
www.centraldepository.cz
Bond market
The Czech local debt market. The market remains small. The government bond
market is similar in size to Hungary’s with a total outstanding amount of around
USD60bn.
Short-term or floating rate debt. Around 15% of the debt is in T-bills, while
another 12% is in FRNs.
Fixed coupon debt. The remaining 83% of debt has a fixed coupon. The yield
curve is quite extended, reaching out to a maturity of 2057. Typically the curve
has imitated the behavior of the core European markets, as the Czech economy
and the central bank’s activity are highly synchronized with the Eurozone,
especially Germany and the European Central Bank.
Bonds are traded on the Prague stock exchange or OTC. Average daily trading
volumes are around USD150-200mn with typical ticket sizes of USD2-4mn.
Liquidity is concentrated in the on-the-run 3y and 5y benchmarks.
The Ministry of Finance shifted the composition of debt significantly over the past
decade. While Treasury bills were the majority issue type 10 years ago, this pattern
changed over time and fixed-rate bonds became dominant. The increasing supply
of bonds should help the local debt market gain more depth in the coming years.
Currently, issuance is distributed relatively evenly across the curve and more than
half of the outstanding debt has a maturity of five years. The average maturity of
government debt is the highest in CEE due to changes in the past decade, and
since around 2005 the average has been over five years.
Auction and placement mechanism. Bond auctions are held by the CNB on a
competitive basis, usually twice a month. Results are posted on the Ministry of
Finance website. Issuance calendars for T-bills and bonds are published quarterly
on the first working day of the preceding month. There is also a detailed auction
announcement 3-4 working days prior to the auction. Bonds are issued in bookentered form on bearer, and only those on the list of direct participants can bid.
Auctions usually occur on Wednesdays for bonds and Thursdays for T-bills. The
former has standard maturities of 3, 5, 10 and 15 years, though there is no
specified pattern of issuance. Standard T-bill maturities are 13, 26, 39 and 52
weeks. Usually only one bond is offered at any auction.
Derivatives market
Czech FRAs and IRS are relatively active with daily volumes averaging around
USD200-300mn with a typical ticket size of USD 10K DV01 and bid-offer 3-5bp.
Interest rate swaps. Most interest rate swaps are 2-10 years and have been
traded more than cash bonds. The floating leg is 6m PRIBOR, with the exception
of the 1y IRS, which fixes against 3m PRIBOR. FRAs are most popular for trading
the front end of the curve with liquidity up to one year.
Basis swaps. Cash flow exchanges between 3m floating EURIBOR against 3m
floating PRIBOR. They are liquid out to two years in normal conditions.
110
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Table 83: Summary statistics of Czech derivative products and their markets
Product
Interest rate swaps
1-year
5-year
10-year
Avg daily
trading volume
Avg
transaction size
Bid-Ask spread
Bloomberg /
Reuters reference
EUR 150mn
EUR 150mn
EUR 150mn
5-10K DV01
5-10K DV01
5-10K DV01
3-5bp
3-5bp
3-5bp
CKSW1 /CZKVIEW
CKSW5 /CZKVIEW
CKSW10 /CZKVIEW
EUR 5mn
EUR 25mn
5bp
CKEUBS1/ICAPCZK
Basis swaps
FX market
The Czech koruna (CZK) is fully convertible and has been freely floating since
1997. The government and the central bank have a joint responsibility for the
exchange rate. The CNB has not intervened in the FX market since 2002 but
frequently refers to the CZK rate in comments on monetary policy. Convergence to
the Eurozone is advanced. However, the public and authorities have always been
skeptical about the euro. We expect Eurozone membership in the next decade.
EUR/CZK dominates trading but USD/CZK is liquid too. Daily volumes average
around USD3bn, with typical ticket sizes of USD25mn and bid-offer around CZK
0.02. The forwards and swap markets are liquid out to one year. Options are also
available but liquid up to two years.
Table 84: Vital statistics and characteristics of the Czech Republic’s FX market
Avg daily
Avg
Bloomber
FX
Tradable trading
trading Bid-Ask g/Reuters
size
HKD Onshore
Spot
CZK Spot
USD3bn
USD25mn
Forwards
Forwards &
Swaps
USD4bn
USD1030mn
Options
FX Options USD0.2bn
USD20mn
CZK 0.02
CZK/ECB
Fix
<ECB37>
CZK 0.01- CKFS/ECB
0.05
Fix
<ECB37>
0.5 vol
EURCZKV/
ECB Fix
<ECB37>
▪ EUR/CZK dominates trading
but USD/CZK is liquid too.
▪ Forwards are liquid up to 1y.
▪ Options are available till
tenors of 5y but are liquid up to
2y.
Investor base
Given the lack of pension reform, the voluntary third pillar plays a modest role in
the government bond market. As of 3Q11, pension funds and insurance
companies held around 20% of outstanding debt. Other financial institutions held
around 40%, with the remainder mostly held by the rest of the world.
Currently, existing pension funds and mutual funds are invested heavily in fixed
income instruments, with 82% of assets under management devoted to this asset
class. Potential pension reforms in the coming years (with some signs of
accelerated momentum in 2011/2012) could cause this sector to increase in
importance.
Foreign interest in government paper has been stable over the past two years,
4
and foreigners currently hold around 10% of the outstanding local debt. In terms
of absolute levels, nonresidents hold around USD7.5bn, which compares to
around USD17bn in Hungary and USD44bn in Poland.
4 Foreigner holdings of government debt have been stable in recent years and the Ministry of Finance started
reporting figures for non-resident holdings explicitly since January 2011.
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Chart 60: Distribution of government securities holdings
Financial institutions
Rest of w orld
45%
40%
Chart 61: Foreign holdings of Czech local currency government debt
securities
Institutional inv estors
200
Domestic gov t. debt securities held by non-residents (CZK bn)
Domestic gov t. debt securities held by non-residents (% of total, rhs)
14
35%
12
30%
150
10
25%
20%
8
100
6
15%
10%
4
50
2
5%
0
0
0%
Jan-11
Apr-11
Jul-11
Source: BofA Merrill Lynch Global Research, Haver
Oct-11
Jan-12
Apr-12
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
The last amendment to the Foreign Exchange Act in 1995 lifted exchange
controls, aligning Czech rules with the EU’s. There are no restrictions on foreign
currency transactions or on ownership of fixed income securities.
Ten percent of the gross income paid to nonresidents is withheld by resident
payers as a “tax securing”. A securing rate of 1% applies to nonresident income
derived from the sale of financial instruments to residents. The securing tax
liability may be eliminated under double taxation treaties and for EEA tax
residents. A withholding tax of 15% is generally imposed on dividends and
interest payments to nonresidents; royalties are taxed at 25%.
Clearing settlement and taxation
Settlements occur via the Central Depository of Securities (CDCP), and can take
place through Euroclear and Clearstream.
112
GEMs Pa pe r #1 0
Table 85: Summary of Czech Republic bond markets and products
Instrument
Treasury bills
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Amount outstanding (as of July 2012)
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Government bonds
Ministry of Finance
CZK
CZK1,000,000
13, 26, 39, and 52 weeks
Issued at discount
Zero
ISMA-30/360
Bullet
Registered
CZK 223bn
Ministry of Finance
CZK
CZK10,000
3, 5, 10, and 15 years
Fixed
Annual
ISMA-30/360
Bullet
Registered
CZK 1,108bn
OTC and Prague Stock Exchange
Price
T+3
Central Depositary of Securities, Euroclear, Clearstream
Primary dealers
9:00-16:30 (Czech Rep)
All entities or individuals, including non-residents, may
participate.
OTC and Prague Stock Exchange
Price
T+3
CZK5bn
4-6bp
2-4bp
CZK50-100mn
Central Depositary of Securities, Euroclear, Clearstream
Primary dealers
9:00-16:30 (Czech Rep)
participate.
No restrictions
Yes
15% on dividends and interest payments to non-residents
1% applies to nonresidents income derived from the sale of
financial instruments to residents; 25% on royalties
None
No restrictions
Yes
15% on dividends and interest payments to non-residents
1% applies to nonresidents’ income derived from the sale of
financial instruments to residents; 25% on royalties
None
Dutch
CZK6bn
None
Competitive multiple price
CZK7bn
None
4-6bp
NA
113
GEMs Pa pe r #1 0
Egypt
Overview
Arko Sen
+44 20 7995 1576
Egypt represents the strongest medium-term real convergence story in the MENA
region, but the January 25 Revolution and the lengthened political transition have
grounded the economy. Growth has been weak and the external fiscal positions
have seen few convincing signs of underlying improvement. The election of
Mohamed Morsi as president has been perceived as bringing legitimacy back to
the transition process, but the delicate political balance could put policies to
address economic imbalances at risk, in our view.
Jean-Michel Saliba
+44 20 7995 8568
Monetary policy
Background. The Central Bank of Egypt (CBE) operates as an independent legal
and public entity. Its board, which also serves as the Monetary Policy Committee
(MPC), consists of nine members: the chairman (governor), vice-chairmen (two
deputy governors) and seven other members, including the chairman of the
Egyptian Financial Supervisory Authority, a representative from the Ministry of
Finance, as well as three outside economic advisors and one legal advisor.
Table 86: Egypt ratings profile (long-term local
currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
B2
B2
Ba1
Ba1
Ba1
Ba1
Ba1
Ba1
Ba1
Ba1
Ba1
Ba1
n/a
B
B+
BB+
BB+
BB+
BB+
BB+
BB+
BB+
BB+
BB+
BBBBBB-
B+
BBBB+
BB+
BB+
BB+
BB+
BB+
BB+
BB+
BB+
BBBBBB-
Policy framework. A new monetary policy framework was launched in June
2005 with a medium-term goal of moving to inflation-targeting. A corridor for
overnight facilities was introduced as the main policy instrument in June 2005,
completing the move from a quantitative operational target (excess reserves) to a
price target (overnight interbank rate). Steering the overnight interbank rate within
the corridor is the operational target of the CBE, while market liquidity continues
to be managed through its open market operations.
The CBE operates a managed floating currency regime and maintains a tight grip
on USD/EGP. The exchange rate channel is the most effective disinflation tool at
the CBE’s disposal. The CBE has estimated that 26% of a nominal exchange rate
shock is transmitted to the CPI after a year. Most other monetary transmission
channels are weak.
Base rate. The MPC meets on Thursdays every six weeks to set the overnight
deposit and overnight lending rates. Transparency of decision-making has
improved with the release of a core inflation measure in October 2009, followed
by monthly inflation notes. The CBE has an informal comfort zone of 6-8% for
core CPI. The CBE intends to meet its inflation objectives by steering short-term
interest rates, keeping in its view developments in credit and money supply, as
well as other factors that could influence the underlying rate of inflation.
Chart 62: Key CPI components for Egypt
Transport
5.7
Health
6.3
18.4
Housing
39.9
Food
0
10
114
20
The CBE is responsible for formulating monetary policy and supervising its
implementation, and realizing price stability and banking system soundness.
Implementation of CBE policies takes place within the context of the
government’s economic policy through the Coordinating Council. The council is
chaired by the prime minister, and includes three government ministers, the CBE
governor and two deputy governors, and six economic outside advisors.
30
40
Open market operations. CBE instruments were issued for the first time in
August 2005 as the primary instruments for liquidity management. T-bills and
newly launched repos of various tenors are the most prominent tools, as CBE
notes, CDs and deposit auctions have not been issued since 2006, 2007 and
2011, respectively. To decrease the volatility of the overnight interbank rate since
the revolution and facilitate liquidity management in the banking sector, the CBE
launched a weekly 7-day repo auction facility in March 2011. Similarly, the CBE
GEMs Pa pe r #1 0
Typical conventions
launched a new monthly 28-day repo facility, auctioned at a variable rate with a
floor set at the minimum of the 7-day repo rate.
Bonds
Lending and deposit facilities. The overnight deposit and lending rates, which
form the policy interest rate corridor, are the main lending and deposit facilities.
Overnight lending is rarely tapped, while the overnight deposit rate facility is
tapped more frequently (daily average of EGP 2.5bn in June 2012).
Settlement: T+1
Basis: Act/Act
IRS
Reserve requirements. The CBE cut the RRR on domestic currency deposits by
200bp to 12% in March 2012, and again by 200bp to 10% in May to ease EGP
liquidity conditions in the banking sector. Reserve deposits at the CBE are not
remunerated. Reserve requirements are levied on demand and timed deposits
with maturity of less than three months. Foreign currency deposits attract an RRR
rate of 10% and domestic currency deposits now attract the same rate.
n/a
Fiscal policy
Until the political transition fully plays out, political developments including the
orientation of a new administration and the fate of the exchange rate policy will be
the main macro drivers, in our view. With the lack of foreign private sector
financing flows, whether through FDI or portfolio, the banking sector excess EGP
liquidity has deteriorated. Combined with the large borrowing requirements of the
sovereign, this has contributed to increasing yields on T-bills.
Bond markets
The Egyptian local debt market. This market is relatively large, with around
USD150bn in outstanding debt. However, trading remains small. Trading volumes
are typically greater in the T-bill market and can reach USD150-200mn. Bond
volumes are more likely to range around USD20-50mn per day. Trading in the
secondary market is mostly OTC. The primary dealer system introduced in 2004
gives them the exclusive right to bid at auctions for bills/bonds and act as market
makers. There are 15 primary dealers including the CBE.
Short-term or floating rate debt. T-bills account for about USD60bn of
outstanding debt. They are issued at 91, 182, 273, and 364-day tenors.
Fixed coupon debt. Bonds constitute around USD45bn of debt. There are also
sizable portions of securities issued to the CBE and bank restructuring bonds.
Chart 63: Maturity profile of outstanding Egypt government securities
in EGPbn
Chart 64: Outstanding Egyptian debt types by category
250
EGYGB
EGYHB
EGYTB
200
150
EGP 8.2bn
Housing bonds
Gov ernment
EGP 280.6bn
bonds
100
50
Gov ernment T-
EGP 388.8bn
bills
2024
2022
2020
2018
2016
2014
2012
0
0
100
200
300
400
500
115
GEMs Pa pe r #1 0
Bloomberg pages
EGP Curncy ALLQ<GO> – FX rates
OTC EGP<GO> – Market monitor
Auction and placement mechanism. The average maturity of domestic debt is
small at just around one year, given that most debt is in T-bills and most bonds
have less than three years to maturity.
CBEG<GO> – Central bank and bond auctions
Reuters pages
FX page <FEMF>
Bonds page 0#EGTSYS=
Useful websites
Central Bank of Egypt
www.cbe.org.eg
The government has been trying to develop the primary dealer market and
increase liquidity for government securities. To this end, it follows a benchmark
strategy where it issues debt at selected maturities (3, 5, 7 and 10 years).
The CBE conducts auctions on behalf of the Ministry of Finance. There are
weekly competitive auctions for the bills where only authorized primary dealers
are allowed to bid. The Ministry of Finance publishes a quarterly issuance
schedule and auction details are announced by the CBE one week before.
www.mof.gov.eg
Auction results are announced at the end of day. Bond auctions are less frequent,
though the Ministry of Finance is starting to issue more bonds, primarily in the 3y
and 5y sectors, with auctions usually held every three weeks.
Egypt FSA
Derivatives market
www.efsa.gov.eg
There is no liquid swap/FRA market in Egypt.
Central Agency for Public Mobilization and Statistics
FX market
Ministry of Finance
http://www.capmas.gov.eg
Egypt stock exchange
www.case.eg
Ministry of Investment
www.investment.gov.eg
Misr for central clearing, depository and registry
www.MCDR.com.eg
The Egyptian pound is fully convertible but only authorized banks can deal in FX.
Daily FX trading occurs from Sunday to Thursday for spot and forwards. Average
daily spot trading volume amounts to USD300-400mn. Nondeliverable forwards
are mostly liquid out to 6m, with average ticket size of USD5mn.
Table 87: Vital statistics and characteristics of Egypt’s FX market
Avg daily
Avg
Bloomberg/
FX
Tradable trading trading Bid-Ask
Reuters
size
spread
reference Key facts
EGP
Spot
Forwards
EGP spot
Forwards &
Swaps
USD0.30.4bn
USD3050mn
USD10mn
EGP0.002
USD5mn
EGP0.020.15
OTC EGP /
0#EGP=
OTC EGP /
EGPNDF=
▪ Mainly trades against
USD.
▪ Liquid up to 6 months.
Investor base
The domestic banking sector dominates the debt market. Banks hold around 60%
of the outstanding T-bills, almost evenly split between the public and private
sectors. Foreign presence increased pre-revolution and at the end 2010 was near
23% of outstanding T-bill stock. Since then it has declined to 1% amid a massive
capital exodus. Foreign holdings of bonds are also minimal.
The CBE established an interbank system in 2004, and only authorized banks
can deal in FX. The supervisory authority and central bank oversee a special
mechanism for repatriation services. Sales proceeds from T-bills are not eligible
for this mechanism.
Foreign investors are only allowed to maintain local and FX cash accounts to
facilitate securities settlement. Current accounts are generally noninterest
bearing. There is a 20% withholding tax applicable on interest income on T-bills
issued since May 2008 and bonds issued since July 2008. Double taxation
treaties apply as usual in deciding the effective rate.
116
GEMs Pa pe r #1 0
Chart 66: Foreign holdings of Egypt local currency government bills
Chart 65: Distribution of government bills holdings
100%
Rest of World
Domestic gov t. bills held by non-residents (EGP bn)
Domestic gov t. bills held by non-residents (% of total, rhs)
80%
70
30
60
25
50
60%
20
40
40%
10
20
20%
0%
Jan-05
15
30
Jan-07
Jan-09
10
5
0
0
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
Jan-11
Misr for Central Clearing, Depository and Registry (MCDR) is the central clearing
house and depository. It is regulated by the EFSA and the CBE.
Table 88: Summary of Egypt bond markets and products
Instrument
Treasury bills
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Government bonds
Ministry of Finance
EGP
EGP25,000 (par)
91, 182, 273 and 364 days
Issued at discount
Zero
Act/365
Discount
Registered
EGP376bn
Ministry of Finance
EGP
EGP1,000 (par)
3, 5, 7 and 10 years
Fixed
Semi-annual
Act/Act
Bullet
Registered
EGP281bn
OTC
Yield
T+2
USD150-200mn
10-20bp
NA
USD10mn
Misr for Central Clearing, Depository and Registry (MCSD)
Primary dealers
10:00-13:00 (Egypt)
Mostly banks
OTC and stock exchange
Yield
T+1
USD20-50mn
30-50bp
30-50bp
USD10mn
Misr for Central Clearing, Depository and Registry (MCSD)
Primary dealers
10:00-13:00 (Egypt)
Mostly banks
No restrictions
Yes
Withholding tax at 20% on T-bills issued since May 2008,
unless reduced by double tax treaties
None
None
No restrictions
Yes
Withholding tax at 20% on bonds issued since July 2008,
unless reduced by double tax treaties
None
None
Competitive tender in a Dutch auction format via primary
dealers
EGP2-3bn
None
dealers
EGP1-2bn
None
117
GEMs Pa pe r #1 0
Hungary
Overview
Arko Sen
+44 20 7995 1576
Hungary is one of the more developed and open CEE states. Economic growth in
the latter half of the past decade has been highly leveraged on external trade,
facilitated by large capital inflows, as Hungary has been undergoing multi-year
fiscal consolidation. The EU, and Germany in particular, is Hungary’s main export
destination, with large exposure to the auto sector. The Fidesz government has
shown a more pro-growth bias to its policies, but is still constrained by the high
leverage in the economy and the fragile external backdrop.
Mai Doan
+44 20 7995 9173
Raffaella Tenconi
+44 20 7995 9173
Monetary policy
Background. The National Bank of Hungary (NBH) is an independent entity. The
supreme decision-making body of the NBH is the Monetary Policy Council (MPC),
which consists of at least five and at most nine members, including the governor,
at least two and no more than three deputy governors, and up to six outside
members, all with six-year mandates. The prime minister recommends
candidates for governor and deputy governor to Hungary’s president. Other
members are appointed by Parliament.
Table 89: Hungary ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Ba1
Ba1
Baa3
Baa1
A3
A2
A2
A1
A1
A1
A1
A3
A3
BB+
BB+
BBBBBBBBB
BBB+
BBB+
AAAAAA-
The MPC’s major communication instruments include press releases and press
conferences held after rate-setting meetings, minutes of the rate-setting meetings
with detailed voting outcome, and a quarterly inflation report.
BB+
BBBBBBBBB
BBB
BBB+
BBB+
BBB+
AAAAA-
Policy framework. The primary objective of the NBH is to maintain price stability.
An inflation-targeting framework was adopted in 2001. The NBH sets the inflation
target in agreement with the government. A CPI inflation target of 3% was agreed
to in 2005, effective beginning 2007. A ±1ppt ex-post deviation from the 3% target
is acceptable. The target will be reviewed at the time of Hungary’s entry into
Exchange Rate Mechanism (ERM) II, but within three years after the target has
been set, at the latest.
Base rate. The rate on the 2-week NBH bill serves as the policy rate from 2007.
By changing the base rate the central bank affects its operating target, the 3month money market rates and indirectly the general economic developments.
The MNB bill is available once a week through a fixed rate auction for the
counterparties, and all bids are accepted by the central bank. The MPC ratesetting meeting is usually scheduled toward the end of each month. Decisions are
adopted by a simple majority of votes. In case of a tie, the governor has the
casting vote.
Money market instruments. The instruments include central bank deposits,
collateralized loans, outright securities transactions, repo, issue of debt securities
and FX swap. Of these instruments, only deposits, loan transactions and debt
securities issuance are used regularly by the MNB during normal market
conditions. Outright securities transactions and FX swaps are seldom applied by
the NBH, while the repo transactions were replaced by other instruments in 2001.
Chart 67: Key CPI components for Hungary
6.5
Misc
Food
19.7
Housing
21.0

Others
52.8
0
20
118
40
60
Central bank deposits. A counterparty of the central bank places funds with
the central bank under pre-specified conditions or those evolving at tenders.
A central bank deposit remains non-callable during its term. The overnight
deposit constitutes the bottom of the interest rate corridor where the central
bank is continuously available to accept deposits.
GEMs Pa pe r #1 0
Conventions

Bonds
Settlement: T+2
Basis: Act/Act
Collateralized loans. Since 2002 collateralized loans have had a dual
function in the MNB’s set of instruments: the overnight collateralized loan has
become a monetary policy instrument due to the upper limit of the interest
rate corridor, while the intra-day loan facilitates settlements within the same
business day. At the top of the interest rate corridor (policy rate +/-1%), the
central bank meets, without quantity limits, the temporary liquidity needs of
the commercial banks using its overnight collateralized loan.
IRS
Open market operations. Under outright purchases or sales of government
securities, which qualify as classical open market operations, a central bank
trades with securities, primarily government papers, in the secondary market in
order to control liquidity supply. The MNB uses this instrument only in extreme
market and liquidity situations, which was the case in 2003 and autumn 2008.
Fixing: 6m BUBOR 11am CET (1y IRS fixes against 3M
BUBOR)
Coupon frequency: Annual fixed Act/365, semi-annual
floating Act/360
Lending and deposit facilities. The repo transaction occupied a central position
among the MNB’s instruments until December 2001. As a lending facility, the
overnight repo rate functioned as the upper limit of the interest rate corridor.
Since then this role has been played by collateralized loans.
The MNB operated the overnight swap as a standing facility until April 2001 under
conditions identical to those of the overnight repo. Thereafter, the MNB
reintroduced FX swap tenders in Autumn 2008 to reduce FX liquidity strains and
to limit the volatility of forint yields.
Reserve requirements. From October 2010, the reserve requirement has been
2%, 3%, 4% or 5% of the reserve base (defined in the NBH decree), as chosen
by the credit institutions, or, in the absence of such choices, 2%. Credit
institutions have to meet the reserve requirement only as an average of one
month, which allows them to reallocate their liquid assets within the month. Since
Hungary’s accession to the EU the interest rate on minimum reserves has been
identical to the prevailing central bank base rate, which means that minimum
reserve requirements no longer impose an implicit tax on the banking system.
Fiscal policy
Hungary depends heavily on exports to the EU, particularly Germany. The
banking sector is mostly foreign owned, primarily Austria, Germany and Italy.
Chart 68: Maturity profile of outstanding Hungary government
securities in HUFbn
Chart 69: Outstanding HUF debt types by category (latest)
2000
Interest Bearing Bills
HSB Gov t
HUF 60.5bn
HTB Gov t
MNV Zrt
1500
HUF 239.9bn
HUF
Gov ernment T-bills
1000
1,679.4bn
HUF
Gov ernment bonds
500
8,399.5bn
o/w floating
HUF 548.2bn
2028
2026
2024
2022
2020
2018
2016
2014
2012
0
0
2,000
4,000
6,000
8,000
10,000
119
GEMs Pa pe r #1 0
Bloomberg pages
HUF Curncy ALLQ<GO> – FX rates
OTC HUF<GO> – Market monitor
GDMA <GO> – Bond auctions
NBH<GO> – Central bank
Reuters pages
FX page <ECB37>
Bonds page 0#HUTSY=
Useful websites
National Bank of Hungary
http://mnb.hu
Ministry for National Economy
http://www.ngm.gov.hu
http://www.ksh.hu
Debt Management Agency
http://www.akk.hu
Hungary FSA
www.pszaf.hu
Budapest stock exchange
http://www.bse.hu
Central Clearing House and Depository
http://www.keler.hu
The private sector is very leveraged, with FX loans at around 60-70% of the total.
Deleveraging the banking sector and the expansion of the transport sector will be
the key structural forces in the coming decade, in our view. We expect the
dramatic scale-back of foreign banks in Hungary to push up private sector
savings, which eventually should allow the economy to finance more of its
consumption independent of credit. The expansion of the transport sector will
boost exports and support investment in the near term.
Over the past decade Hungary grew 2.2% on average – 4.2% in the first five
years and 0.5% in the second. There could be a similar pattern this decade, but in
reverse.
Bond market
The Hungarian local debt market is relatively small and is about US$45bn in size.
Securities are traded both OTC and on the stock exchange.
Short-term or floating rate debt. Around 18% of debt is in T-bills, while FRNs
take up a modest 5% share in outstanding debt.
Fixed coupon debt. The remaining 77% is mostly in fixed rate bonds. The curve
extends out to 15 years, but the supply in the long end is limited. 15/A, 17/A and
19/A are among the most liquid instruments. Liquidity has decreased since the
crisis and trading volumes now average about US$ 150-200mn with typical ticket
sizes of US$1mn.
Auction and placement mechanism. The Government Debt Management
Agency (AKK) carries out government bond issuance. The AKK’s main objective
is to finance the central government at the lowest costs in the long run, taking
account of risks. This objective is quantified by setting benchmarks, which in part
are based on an optimal portfolio model using Value-at-Risk (VaR) and Cost-atRisk (CaR) analysis.
For 2012, the AKK set a benchmark of 61-83% for the share of fixed rate bonds
within total HUF-denominated issuance, while the share of floating rate debt,
which includes all short-term debt, is set to be between 17% and 39%. The AKK
also targets the Macaulay duration of the HUF debt portfolio at 2.5 years (+/- 0.5
year) in order to keep an acceptable level of refinancing risk.
About half of gross domestic bond issuance takes place with sales of the 3-year
fixed-rate bond, and around 30% with sales of the 5-year bond. Of the total
issuance at the 3-year tenor, around 10% is the 3-year floater (2015/B), which is
offered once a month with the 1-year discount T-bill.
The AKK handles all auctions. An annual and monthly calendar is published with
detailed information provided five days before the auction. Auctions are
competitive discriminatory price. Primary dealers are obliged to quote two-way
prices, especially for benchmark securities. Noncompetitive bids are also
accepted. T-bills are auctioned weekly, with 3m bills every Tuesday and 6m and
12m bills on Wednesdays and Thursdays of odd-numbered weeks, respectively.
Bond auctions occur on Thursdays of every even numbered week, with two series
offered simultaneously: 3y and 5y together, and 3y and 10y or 15y together.
While the AKK typically conducts simultaneous sales of the 3, 5, and 10y bonds,
at times it offers the 15y bond, replacing the 10y, depending on market
conditions. Only primary dealers can participate in auctions. Offers are submitted
by 11am with results published by 1pm on the AKK website and HUISSUE page
on Reuters.
120
GEMs Pa pe r #1 0
Derivatives market
The IRS and FRA market is quite active and fixes vs BUBOR. The cross-currency
basis swap market (vs Euribor) is also quite active, with local banks the key
players as a result of the large FX mortgage market. The ASW market is much
less active/liquid than it was pre-crisis and is now mostly done using maturity
matched bonds and swaps.
Interest rate swaps. Very actively traded, interest rate swaps exist for tenors up
to 30 years, though beyond 10 years liquidity is less abundant. 1y IRS fixes
against the 3m BUBOR, while the rest fix against 6m BUBOR. There are no
restrictions on foreign investors to the IRS market.
Basis swaps. These swaps represent cash flow exchanges between 3m floating
EURIBOR against 3m floating BUBOR. They are liquid out to 2 years in normal
conditions.
Cross currency swaps. Available but rarely tapped.
Table 90: Summary statistics of Hungary derivative products and their markets
Product
Interest rate swaps
1-year
5-year
10-year
Avg daily
trading volume
Avg transaction
size
Bid-Ask spread
Bloomberg/Reuters
reference
25K DV01
50K DV01
25K DV01
5K DV01
5K DV01
5K DV01
8-10bp
4-6bp
4-6bp
HFSW1/HUFVIEW
HFSW5/HUFVIEW
HFSW10/HUFVIEW
EUR 50mn
EUR 15mn
2bp
HFBS/ICAPHUF
Basis swaps
FX market
The Hungarian forint (HUF) is fully convertible and deliverable; it has been freely
floating since February 2008 when the authorities abandoned the flexible peg of
the forint to the euro, which has been in place since May 2001. The government
chooses the FX regime in agreement with the NBH. The NBH has staged
emergency rate hikes to deter HUF weakness in times of increased volatility.
There have also been unofficial interventions and periodic auctions for local
banks to meet FX demand from early redemptions of CHF mortgages. We expect
Eurozone membership in the next decade.
The forint is relatively liquid with average daily volumes of US$5bn, average ticket
size of US$20mn and bid-offer around HUF 0.2. EUR/HUF largely dominates
trading volumes. Forwards and swaps are liquid out to 1y.
Table 91: Vital statistics and characteristics of Hungary’s FX market
FX
Tradable
products
product
HUF Onshore
Spot
HUF Spot
Avg daily
trading Avg trading
volume
size
Bid-Ask
spread
USD5bn
USD2mn
HUF 0.2
Forwards
Forwards & USD1-3bn
Swaps
USD20mn
HUF 0.1
Options
FX Options USD0.2bn
USD30mn
0.75 vol
Bloomberg/
Reuters
reference Key facts
HUF/CEB
Fix
<ECB37>
HFFS/ECB
Fix
<ECB37>
▪ EUR/HUF dominates trading
volumes.
▪ Forwards liquid up to 1 year,
swaps liquid out to 10 years.
▪ 2y most liquid, others often
trade as spread to 2y.
EURHUFV/ ▪ Liquid up to 1 year.
ECB Fix
<ECB37>
121
GEMs Pa pe r #1 0
40%
35%
Rest of World
Chart 71: Foreign holdings of Hungary local currency govt bonds
5000
30%
Domestic gov t. bonds held by non-residents (HUF bn)
Domestic gov t. bonds held by non-residents (% of total, rhs)
50
4000
40
20%
3000
30
15%
2000
20
1000
10
25%
10%
5%
0
0%
Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12
Jan-04
0
Jan-06
Jan-08
Jan-10
Jan-12
Investor base
Hungary has a relatively diversified investor base. Typically, foreign investors
have held the largest share of government securities, although this trend was
disrupted by the crisis in 2008. However, since late 2011 foreign interest in local
debt has been rising with Hungary in talks to start bailout negotiations with the
IMF. Nonresident holdings fell to around 20% of outstanding debt in 2010 but
have since recovered to exceed long-term levels around 30%, making them the
largest owner of Hungarian debt once again.
Domestic financials hold about 40%, with pension funds and insurance
companies holding the rest. Recently implemented government legislation has
virtually shut down the private pension fund industry. As a result, the drop in the
share of government securities holdings by institutional investors has been
compensated by a much higher share by nonresidents.
The authorities have lifted all restrictions on foreign currency transactions since
2001. There are also no restrictions on ownership of fixed income securities.
There is no withholding tax on interest for non-individual entities, but 20% is
applied to individual entities. The latter can be reduced through double tax
treaties.
Settlements for all government paper occur via KELER, the central depository
and clearing house. Clients with an account can also settle transactions via
Euroclear and Clearstream.
122
GEMs Pa pe r #1 0
Table 92: Summary of Hungary bond markets and products
Instrument
Treasury bills
Government bonds
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Amount outstanding
(as of July 2012)
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Government Debt Management Agency (AKK)
HUF
HUF10,000
91, 182 and 364 days
Issued at discount
Zero
Act/360
Discount
Registered
HUF 1,725bn
Government Debt Management Agency (AKK)
HUF
HUF10,000
3, 5, 10 and 15 years
Fixed
Annual
Act/Act
Bullet
Registered
HUF 7,975bn
OTC and Budapest Stock Exchange
Yield
T+2
HUF 25bn
15bp
NA
HUF200mn
KELER (central depository and clearing house), Euroclear
Major players
Trading hours
Bidders
Primary dealers and brokers
8:45-17:00 (Hungary)
participate.
OTC and Budapest Stock Exchange
Yield
T+2
HUF 35-45bn
10bp
10-15bp
HUF200mn
KELER (central depository and clearing house), Euroclear,
Clearstream
Primary dealers and brokers
8:45-17:00 (Hungary)
participate.
No restrictions
Yes
None for non-individual entities, 20% for individual entities
None
None
No restrictions
Yes
None for non-individual entities, 20% for individual entities
None
None
Competitive discriminatory price
HUF45bn
None
Competitive discriminatory price
HUF45-60bn
None
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
123
GEMs Pa pe r #1 0
Israel
Overview
Arko Sen
+44 20 7995 1576
Israel is a developed market due to its strong fundamentals, high per capita
income, skilled human capital, and technology-intensive and innovative industry.
At the same time, it enjoys emerging market growth, which has averaged 3.6%
over the last 10 years. The flexibility in the economy together with a proactive
central bank allowed the country to escape the global recession in 2009, and
grow 0.9%. Still, Israel suffers from some developing country problems such as
an inefficient labor market, while the recent escalation in geopolitical risks
represents a big burden to the relatively poor public finances.
Mai Doan
+44 20 7995 9597
Monetary policy
Table 93: Israel ratings profile (long-term local
currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
A1
A1
A1
A1
A1
A2
A2
A2
A2
A2
A2
A2
A2
A+
A+
A
A
A
A
AAAAAAA-
A
A
A
A
A
AAAAAAAA-
The BoI meets monthly to discuss interest rate policy. Its major communication
instruments include press releases after the rate-setting meetings, minutes of the
rate-setting meetings, and reports on price stability and economic developments,
at least twice annually.
Policy framework. The primary objectives of the BoI are to maintain price
stability, to support the government's growth and employment targets, and to
support financial system stability. An inflation-targeting framework was adopted in
1998. The government, in consultation with the governor, determines the pricestability range, which is currently 1-3%.
Base rate. The BoI sets the level of short-term interest rates, which are then
implemented by the Markets Department via a range of monetary instruments,
including monetary auctions, makam auctions, repo auctions and, when
necessary, by intervening in makam and bond trading on the securities exchange.
Open market operations. Monetary auctions for deposits from and/or loans to
the banks are a major instrument due to the precision and speed of their effect.
Through these auctions, the BoI can affect the money supply and the short-term
rate of interest in the money market, thereby preventing undesirable fluctuations
in the monetary base resulting from a temporary increase in government
monetary activities. Monetary auctions to the banks are for various fixed periods
of one day and one week. When the banks take monetary loans, they provide
collateral in the form of government bonds and makam.
Chart 72: Key CPI components for Israel
4.4
Misc
16.9
Food
Housing
37.4
Others
41.3
0
10
20
124
30
Background. The Bank of Israel (BoI) is an independent entity. A new Bank of
Israel law, effective 1 June 2010, established a Monetary Policy Committee
(MPC), chaired by the governor, to make interest rate and monetary policy
decisions. The MPC consists of six members, three from the bank and three
public representatives. The governor is appointed by the president of the state
per recommendation of the government; the deputy governor is appointed by the
government per the recommendation of the governor; and an additional bank
employee is appointed by the governor. The outside members are appointed by
the government, per recommendation of the Candidate Search Committee.
40
50
The makam is a short-term security (up to one year) that the BoI issues to affect
the monetary base and the rate of interest in the money market. Makam resemble
deposit auctions in how they affect the monetary base. But because makam are
issued to the public and their yield is determined by trading on the stock
exchange, they reflect the public's expectations regarding inflation and changes in
monetary policy, information that helps the BoI to plan its monetary steps.
GEMs Pa pe r #1 0
Conventions
The BoI has been performing repo transactions in the capital market since
October 2007. In this activity, which it performs by way of auctions, the bank
purchases bonds and makam from institutional entities and banks and sells them
back a week later at a predetermined price. This is different than the repo
transactions that the bank performed in 2004-2006 when it sold makam and
bought them back a week later.
Bonds
Settlement: T+1
Basis: Act/365
IRS
Lending and deposit facilities. Since September 2005, the BoI has made a
window available to the banks for monetary loans, without a quota, at an interest
rate currently 0.25ppt above the BoI published rate. The loans are provided for
one day, against collateral, and repaid automatically the next business day.
Fixing: 3m TELBOR 12 noon
Coupon frequency: Annual fixed Act/365, quarterly
floating Act/365
The BoI has also made a window available to the banks for local currency
deposits, without a quota, at an interest rate currently 0.25ppt below the BoI
published rate. The deposits are for one day and repaid automatically on the next
business day.
Reserve requirements. Banks are required to deposit a certain proportion of the
money that the public deposits with them into the central bank. Until the early
1990s, the BoI used changes in the reserve requirement as an instrument of
monetary policy, but no longer does so.
Fiscal policy
Israel is already developed, implying very limited additional benefits from the
initial cycle of real convergence. As a result, medium-term potential growth is
likely to come down. However, the country has a top competitiveness ranking,
and the reform-driven attempts to lower the public deficit and increase national
savings should support growth in the medium term. Demographics are still
favorable as well, with old-age dependency half the European level.
The key exports are in the high-tech sector, with the US and Eurozone as the top
trading partners. The trade channel should slow Israel’s growth prospects, as
foreign trade is likely to grow less than in the past decade.
The primary goal of fiscal policy is to continue the gradual reduction of public debt
over the medium term. Fiscal consolidation efforts are supported by a fiscal rule
setting real expenditure growth with a 1.7% annual cap on real spending growth,
which could be adjusted as public debt approaches 60% of GDP, and with
declining annual deficit targets reaching 1% of GDP in 2014. Israel adopted a
two-year budget framework in July 2009. The fiscal year ends in December.
Chart 73: Maturity profile of outstanding Israel government securities
in ILSbn
120
Gov ernment T-bills
IL TBIL & MAKAM Gov t
100
IL CPI & GALIL Gov t
80
Chart 74: Outstanding Israeli debt types by category
ILS 126.6bn
Gov ernment bonds
ILS 346.6bn
ILGov & SHAHAR & ILFRN Gov t
60
o/w ILB
40
20
ILS 139.8bn
ILS 32.0bn
o/w floating
2042
2039
2036
2033
2030
2027
2024
2021
2018
2015
2012
0
0
100
200
300
400
500
125
GEMs Pa pe r #1 0
Bloomberg pages
Bond market
ILS Curncy ALLQ<GO> – FX rates
The Israeli bond market is one of the larger debt markets in EEMEA, with total
outstanding debt sitting around US$145bn, of which about 70% is tradable debt.
OTC ILS<GO> – Market monitor
BOI<GO> – Central bank and bond auctions
Reuters pages
FX page <BOIT12>
Bonds page 0#ILSAHR=TA
Useful websites
Bank of Israel
http://www.bankisrael.gov.il
Ministry of Finance
http://www.mof.gov.il
Central Bureau of Statistics
Short-term floating rate debt. T-bills are called makams and used by the BoI.
Makams constitute about 26% of tradable debt. FRNs constitute another 7%.
CPI-linked bonds called ILCPI have been issued since 2005. CPI-linked debt has
the largest share in total debt in the region, with around 30% of tradable debt.
Fixed coupon debt. The remaining 37% of tradable debt has a fixed coupon.
Fixed coupon bonds, the ILGOVs, are the most liquid instruments, with the 10year bond trading especially actively. Average daily trading volumes of bonds are
about US$ 0.1-0.2bn, with typical trading sizes of US$2-3mn.
The share of CPI debt has been reduced gradually by the Ministry of Finance in
recent years. The proportion of non-tradable debt, issued to pension funds and
insurance companies, has also been reduced. The curve extends out to 30 years,
but liquidity is scarce beyond 15 years.
http://www.cbs.gov.il
Tel Aviv stock exchange
http://www.tase.co.il
Israel securities authority
http://www.isa.gov.il
Previously, linkers were called Galil bonds – one of the oldest linker markets in
the world. There are two key differences between the two. For Galils, interest is
calculated by the compounding formula while simple interest is computed for the
new series. Second, Galils have a floor at par, whereas the linkage for the new
series does not provide that protection. In the nominal market, the government
also started issuing ILGOV bonds in 2005; previously they were named Shahar.
The difference in interest computation is similar to the linkers, otherwise they are
essentially the same.
Auction and placement mechanism. Average maturity of outstanding debt has
increased steadily in recent years, and is currently around 6.5 years. More than
half of domestic debt is in medium to long-term debt, with 58% of the debt having
a maturity greater than four years. Only 14% of domestic debt is held in makams,
which by definition have maturity up to 12 months. The Ministry of Finance
typically issues new bonds at 3y, 5y and 10y maturity, which are referred to as
the benchmarks, and at 20y and 30y maturity from time to time.
Table 94: Summary statistics of Israel derivative products and their markets
Product
Interest rate swaps
1-year
5-year
10-year
Avg daily
trading volume
Avg
transaction size
Bid-Ask spread
Bloomberg/Reuters
reference
USD 25-50K DV01
USD 50-100K DV01
USD 50-70K DV02
USD 5-10K DV01
USD 5-10K DV01
USD 5-10K DV01
4bp
4bp
4bp
ISSW1/ILSVIEW
ISSW5/ILSVIEW
ISSW10/ILSVIEW
USD 25mn
USD 5-10mn
10-20bp
ISBS/ICAPILS
Basis swaps
Bond issuance is conducted by Ministry of Finance’s government debt
management unit. Bonds are issued to primary dealers, Tel Aviv Stock Exchange
(TASE) members and other authorized participants. Auctions are conducted by
the Bloomberg auction system and biddings are competitive multi-price and noncompetitive. Annual issuance plans, monthly calendars and more detailed
notifications three days ahead of auctions are provided.
126
GEMs Pa pe r #1 0
Derivatives market
IRS are liquid, though not as much as the government bonds. FRAs and IRS
trade out to 20y, but most trading is out to 10y. There is also a market for inflation
swaps (real and breakeven). Typical transaction size for IRS is US$5-10K DV01
with 4bp bid-offer spreads. In options, there is an active interest rates vol market
that goes up to 3y, while the FX vol market is available with vanilla and exotics
against both EUR and USD.
FX market
The Israeli shekel is fully convertible and has floated freely since June 2005 when
the BoI formally ended the previous FX regime (a trade-weighted basket with
wide fluctuation bands).The BoI intervenes on an ad hoc basis in an attempt to
slow ILS appreciation, and when it judges conditions in the FX market are
disorderly or do not reflect underlying economic conditions.
ILS has an active market with average daily volumes for spot FX around US$2bn
and typical ticket sizes of US$20mn. USD/ILS dominates trading volumes, though
EUR/ILS trades a lot as well. The relatively diversified destination of trade is one
reason for this. The option market is liquid to 1y but quoted to 5y. Daily volumes
average around US$200mn and transaction sizes are typically around US$10mn.
The forward/swap market is liquid out to 1y, with a daily volume of US$1-2bn and
transaction sizes around US$20mn.
Table 95: Vital statistics and characteristics of Israel’s FX market
Avg daily
Avg
Bloomber
FX
Tradable trading
size
spread Reference Key facts
ILS
Spot
Forwards
Options
ILS Spot
USD2bn
USD20mn ILS 0.003 –
ILS/
▪ Mainly trades against USD
0.006
<BOIT12>
Forwards & USD0.7bn USD20mn ILS 0.005
ISFS/ ▪ Liquid up to 1 year.
Swaps
for up to 1y for forwards,
<BOIT12>
USD50mn
for swaps
0.4 vol
USDILSV/ ▪ Options available till tenors of
FX Options USD0.2bn USD10mn
<BOIT 12> 5y but are liquid up to 1y
Investor base
The investor base is almost entirely domestic, with foreign ownership of debt very
low. Nonresidents hold only about 3.2% of tradable government bonds. In
contrast, nonresidents have sharply increased their holdings of makams since
2008; their share of the bills has increased from 1% to around 30%. The
remaining makams are held equally by the public, mutual funds and commercial
banks, each having a share around 20%.
The ownership of government bonds, which constitute the bulk of local debt, is
quite diversified among various sectors of the economy. The public holds the
largest share, currently at 23%, due to high household savings. Institutional
investors take up the rest of the holdings, with provident funds, pension funds,
banks and mutual funds the remaining major players. Currently, their share of
government bonds is 19.9%, 14.6%, 12.6% and 11.7%, respectively. Insurance
companies hold another 10% of the debt.
127
GEMs Pa pe r #1 0
Chart 76: Foreign holdings of Israel local currency government bonds
Chart 75: Distribution of government debt holdings
70
Domestic gov t. debt securities held by non-residents (ILS bn)
14
60%
60
12
50%
50
10
40%
40
8
30%
30
6
20%
20
4
10%
10
2
0%
0
0
80%
70%
Jan-00
Rest of World
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Pension funds are the major holders of government debt domestically, even
though regulations that required them to hold at least 30% of their AUM in
government bonds have been abolished. They are permitted to invest in nontradable bonds only if the share of bonds in their AUM drops below the 30%
mark. This change is part of an effort by the government to increase the liquidity
of tradable government debt.
Foreign investors are exempt from tax on government bonds issued after May
2000, as of January 2004 (previously 25% withholding tax). With new regulation,
gains upon redemption of makams issued with a maturity date of no more than 13
months from the date of issuance are taxed at 25%.
In January 2011 the BoI also imposed a reporting obligation on Israeli residents
and nonresidents who transact in FX swaps and forwards of more than US$10mn
in a day. Nonresidents transacting in makams and short-dated bonds of more
than ILS10mn in one day also have to report to the BoI. The reports have to
specify transaction details and holdings of such assets. Resident banks also have
to put up a 10% RRR against derivative transactions with non-residents.
Bonds are cleared in the Tel Aviv clearing house with trading on the Tel Aviv
stock exchange, as well as MTS and other authorized platforms. The market is
open from Sunday to Thursday.
128
GEMs Pa pe r #1 0
Table 96: Summary of Israel bond markets and products
Instrument
Treasury bills (makams)
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Amount outstanding
(as of July 2012)
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Government bonds (ILGOV)
Inflation-linked bonds (ILCPI)
Ministry of Finance
ILS
ILS 100 (par)
Up to 1 year
Issued at discount
Zero
Act/365
Bullet
Scripless
ILS 127bn
Ministry of Finance
ILS
ILS 1,000 (par)
Up to 20 years
Fixed / Floating
Annual (quarterly for floating)
Act/365
Bullet
Scripless
ILS 347bn
Ministry of Finance
ILS
ILS 1,000 (par)
Up to 30 years
CPI-linked
Annual
Act/365
Bullet
Scripless
ILS 140bn
OTC and Stock Exchange
Price
T+1
USD35mn
5bp
NA
USD2mn
Tel Aviv Clearing House (TACH)
Primary dealers
10:00-17:00 (Israel)
All entities or individuals, including nonresidents,
may participate. Mostly local banks.
Price
T+1
USD130-200mn
2-4bp
2-4bp
USD2-3mn
Primary dealers
10:00-17:00 (Israel)
may participate. Mostly local banks, pension,
provident and insurance funds.
Price
T+1
USD40-65mn
2-4bp
2-4bp
USD2-3mn
Primary dealers
10:00-17:00 (Israel)
All entities or individuals, including
nonresidents, may participate. Mostly local
banks, pension, provident and insurance
funds.
No restrictions
No restrictions
No restrictions
Yes
Yes
Yes
None on interest from bonds issued after 08 May None on interest from bonds issued after 08 May None on interest from bonds issued after 08
2000 (25% WHT on interest for bonds issued
2000 (25% WHT on interest for bonds issued
May 2000 (25% WHT on interest for bonds
earlier).
earlier).
issued earlier).
Gains upon redemption of Makams issued with a None
None
maturity date of no more than 13 months from
the date of issuance at 25%.
None
None
None
Competitive tender in a multiple price format via
primary dealers
ILS10mn
None
Competitive tender in a multiple price format via
primary dealers
ILS10mn
None
Competitive tender in a multiple price format
via primary dealers
ILS10mn
None
129
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Poland
Overview
Arko Sen
+44 20 7995 1576
Poland is the biggest and most diversified economy in the CEE. The large
domestic demand base helps cushion the country greatly during external
downturns. Poland is also the largest recipient of EU structural and cohesion
funds. We expect Poland to remain the fastest growing country among its peers,
with GDP growth of 3.4% in the coming decade.
Mai Doan
+44 20 7995 9173
Monetary policy
Raffaella Tenconi
+44 20 7995 9173
Background. The National Bank of Poland (NBP) is an independent entity. The
Monetary Policy Council (MPC) constitutes one of the directing bodies of the
NBP, responsible for setting interest rates, among other things. The 10-member
MPC consists of the chairperson, appointed by the president, and nine members
who are appointed in equal numbers by the president, the Sejm and the Senate.
Table 97: Poland ratings profile (long-term local
currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
A2
A2
A2
A2
A2
A2
A2
A2
A2
A2
A2
Baa1
Baa1
AAAAAABBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
AAAAAABBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
The MPC meets once a month to decide on a level of interest rates consistent
with the adopted inflation target. Decisions are adopted by a simple majority of
votes. In case of a tie, the chairperson has the casting vote. The MPC’s major
communication instruments include press releases and press conferences held
after the rate-setting meetings, minutes from the rate-setting meetings, a quarterly
inflation report with detailed voting outcomes, and a report on monetary policy
implementation.
Policy framework. The fundamental objective of the NBP’s activity is to maintain
price stability. An inflation-targeting framework has been in place since 1998. The
NBP is responsible for setting the inflation target. Since 2004, the bank has
adopted a continuous target of 2.5%±1% based on headline CPI inflation.
Base rate. The principal instrument of monetary policy is the short-term interest
rate, the NBP's reference rate. This rate determines the minimum yield obtainable
on the main open market operations (7-day NBP money market bills), while at the
same time affecting the level of short-term interest rates in the market. NBP can
also intervene in the FX market if it deems this necessary in order to achieve the
inflation target. It has been very active in using verbal interventions in this regard.
Open market operations. The central bank conducts open market operations to
enable the POLONIA rate to settle close to the NBP’s reference rate.
Main operations are carried out on a regular, weekly basis and typically with 7day maturities. A fixed rate at the level of the NBP’s reference rate is binding
during tenders. These operations are carried out via issuance of NBP bills due to
the expected persistence of liquidity surplus in the banking sector in 2012.
Chart 77: Key CPI components for Poland
Fine-tuning operations may be conducted with the aim of limiting the volatility of
short-term market interest rates. They may involve liquidity-absorbing operations
(issuance of NBP bills, reverse repo transactions) or liquidity-providing operations
(redemption of NBP bills before maturity, repo transactions).
5.1
Misc
24.2
Food
Housing
25.9
Others
44.8
0
10
20
130
30
40
50
Structural operations may be conducted in order to affect long-term liquidity
structure in the banking sector. If required, the central bank will issue bonds and
purchase or sell securities on the secondary market.
GEMs Pa pe r #1 0
Conventions
Lending and deposit facilities. The standing deposit facility enables banks to
deposit their liquidity surpluses with the central banks on an overnight basis. The
deposits carry a variable interest rate (deposit rate) set by the MPC. The interest
on the facility constitutes the lower limit for the market rate.
Bonds
Settlement: T+2
Basis: Act/Act
The standing lending facility (Lombard credit) enables banks to obtain credit from
the central bank on an overnight basis. Lombard credit is collateralized with
securities accepted by the central bank. The interest on this loan constitutes the
upper limit for the overnight rate.
IRS
Fixing: 6m WIBOR 11am CET (1y IRS fixes against 3m
WIBOR)
Coupon frequency: Annual fixed Act/Act, semi-annual
The intraday credit facility, involving both zloty and euro-denominated noninterest
bearing loans offered by the NBP, is an important element of the central bank’s
settlement system as the source of funds to be obtained during the trading day.
These loans are collateralized with securities accepted by the NBP.
floating ACT/365
Reserve requirements. Beginning 31 December 2010, the required reserve rate
is 3.5% for all the types of deposits, except for funds obtained from repurchase
agreements, whose required reserve rate is 0%. Beginning 1 May 2004, required
reserve funds carry interest, currently set at 90% of the rediscount rate. This is
applied when the central bank lends money, buying back notes held by
commercial banks.
Fiscal policy
Poland is a well diversified and competitive economy. Though the fundamentals
are strong, the next two years could be challenging. We anticipate that western
European banks, which dominate the local market, will expand only modestly in
the near term. The corporate sector is a pillar of strength in the economy: profits
are high, indebtedness is moderate and currency mismatch has diminished.
Meanwhile, household debt in FX is 40% of total debt and is dominated by CHF
housing loans. The Swiss franc appreciation and tighter liquidity pose serious
challenges to indebted consumers. Poland should continue to receive abundant
EU funds, which should allow the multi-year program of road-building to continue
and help improve the country’s infrastructure.
Chart 79: Outstanding Polish debt types by category (as of 2011 eop)
Chart 78: Maturity profile of outstanding Poland government
securities in PLNbn
100
Gov ernment T-bills
POLGB Gov t
PLN 12.0bn
PTB Gov t
80
BGK
60
Gov ernment bonds
PLN 29.8bn
PLN 495.2bn
o/w 2y zero-cpn
40
PLN 108.8bn
o/w floating
20
PLN 63.6bn
o/w ILB
PLN 20.7bn
2036
2033
2030
2027
2024
2021
2018
2015
2012
0
0
100
200
300
400
500
600
700
131
GEMs Pa pe r #1 0
Bloomberg pages
Bond market
PLN Curncy ALLQ<GO> – FX rates
The Polish bond market is one of the largest in EEMEA and one of the more
liquid ones. Total outstanding debt is about USD170bn, more than 90% of which
are bonds.
OTC PLN<GO> – Market monitor
PLMF<GO> – Bond auctions page
NBP<GO> – Central Bank monitor
Reuters pages
FX page <ECB37>
Bonds page 0#PLTSY=
Useful websites
National Bank of Poland
http://www.nbp.pl
Ministry of Finance
http://www.mf.gov.pl
http://www.stat.gov.pl
Financial Supervision Authority
http://www.knf.gov.pl
Warsaw stock exchange
http://www.gpw.pl
The National Depository for Securities
http://www.kdpw.pl
Short-term or floating rate debt. Treasury bills account for about 3% of total
marketable securities, while FRNs (WZ series) constitute about 12%. Poland
began to issue inflation-linked debt in August 2004, but it constitutes only around
4% of debt.
Fixed coupon debt. The remaining 81% of debt has a fixed coupon. 2y zerocoupon bonds (OK series) are among the most liquid instruments and comprise
about 22% of bonds. The state-owned bank BGK also issues bonds at auctions,
but infrequently.
The curve extends out to 30y, with the most liquid being the Apr 14s, Oct 17s and
Oct 21s; liquidity dries up past the Apr 29s. There are two CPI-linked bonds that
are very illiquid and only rarely tapped. Most of secondary market trading is OTC.
The repo market is not well developed and buy-sellback transactions dominate.
Auction and placement mechanism. The average maturity of domestic debt
has risen gradually in recent years and stands at 4.35 years. One-third of
outstanding debt has maturity between 5 and 10 years, while only 9% of
outstanding debt has greater maturity than 10 years. The Ministry of Finance
monitors average maturity to manage interest rate risk and refinancing risk.
The NBP organizes the auctions for the Finance Ministry. Auctions are held on
Wednesdays in multi-price format (Dutch auction) via primary dealers. Following
the regular sale, non-competitive auctions may be organized for bidders
successful at the regular one. T-bill auctions are usually held on Mondays. The
Ministry of Finance announces an annual schedule laying out the timing of
different series’ auctions (including switch auctions), a quarterly schedule
detailing the range of amounts to be offered and a monthly schedule with further
detail. The final offer/supply is announced two days before the auction, and
offered amounts may change depending on market sentiment. In 2011, the
average bond sale was PLN 3.4bn at the auctions, with average bid-cover of 2.3.
Table 98: Summary statistics of Poland derivative products and their markets
Product
Avg daily
trading volume
Avg
transaction size
Bid-Ask spread
Bloomberg/Reuters
reference
50K
125K
50K
5-10K DV01
5-10K DV01
5-10K DV01
3-4bp
3-4bp
3-4bp
PZSW1/PLNVIEW
PZSW5/PLNVIEW
PZSW10/PLNVIEW
EUR 100mn
EUR 25mn
5-10bp
PZBS/ICAPPLN
Interest rate swaps
1-year
5-year
10-year
Basis swaps
Derivatives market
The derivatives market is well developed, with FRAs and IRS relatively liquid.
Forward swaps are fairly liquid with 1y1y and 5y5y the most popular. Longer
maturities are less liquid. FRAs fix against either 3m or 6m WIBOR. While an
overnight rate, POLONIA, is published daily by the NBP (based on overnight
interbank deposits), the OIS market is not very liquid.
132
GEMs Pa pe r #1 0
The most liquid interest rate derivative is the single currency interest rate swap
(fixed for floating) with liquidity going up to 12y. The active interest rates vol
market goes up to 3y. Note that for the 1y1y forward the fixing rate is the 3m
WIBOR. Basis swaps (1v3-month/3v6-month) are also actively traded.
FX market
The Polish zloty is fully convertible and has been freely floating since April 2000.
It is a relatively liquid EM currency with average daily volumes ranging about
USD5-6bn, ticket sizes typically around USD25mn and bid-offer spreads at PLN
0.002. EUR/PLN comprises the overwhelming bulk of trading volumes. Forwards
and swaps are liquid up to 1y. A foreign exchange swap involves the purchase or
sale of zloty by the NBP for foreign currency in the spot market, with a
simultaneous sale (repurchase) under a specified date forward transaction.
The NBP conducts infrequent direct interventions in the FX market, but has
regularly carried out conversion of EU funds in the market to dampen market
volatility or lean against extreme valuations.
We expect Eurozone membership by the end of this decade at the earliest, as
appetite fell sharply during the Eurozone sovereign debt crisis.
Table 99: Vital statistics and characteristics of Poland’s FX market
Bloomber
Avg daily
Avg
FX
Tradable trading
size
PLN Onshore
Spot
PLN Spot
Forwards
Options
USD6bn
USD25mn
PLN 0.002
PLN/ECB ▪ Mainly trades against EUR.
Fix
<ECB37>
Forwards & USD3-4bn USD50mn PLN 0.002- PZFS/ECB ▪ Liquid up to 1y.
Swaps
up to 3m;
0.008
Fix
30mn up to
<ECB37>
1y
0.6 vol
EURPLNV/ ▪ Options available till tenors of
ECB Fix 5y but are liquid up to 2y.
<ECB37>
Investor base
Poland’s local debt market has one of the most diversified investor bases.
Domestic institutional investors are important players, with pension and insurance
funds holding about 30% of debt. Local investment funds hold another 6% and
the rest is split between domestic banks and foreign investors, with the former
holding a greater share.
Foreign investors hold just over 30% of outstanding debt, which makes them the
largest type of investor by market share. Foreign interest has been strong in
recent years and foreign positioning is especially high in the 3-5 year sector.
Poland’s domestic institutional investors (private pensions, mutual funds and
insurance) had PLN475bn in AUM as of 2010, or 34% of GDP – a steady
increase from 2002’s PLN103bn, or less than 10% of GDP. Contributions to
private pensions are mandatory, so pension funds dominate the institutional
investor base (47% of total AUM in 2009, followed by insurance at 28% and
mutual funds at 25%).
133
GEMs Pa pe r #1 0
The growth in AUM has been driven primarily by pension and mutual funds,
averaging more than 40% yoy in the years prior to the 2008 financial crisis, which
led to a 13% decrease in total institutional investor asset valuation.
Traditionally pension funds have favored fixed income, with around 60% of total
AUM versus 40% for equities, but the trend has been moving in favor of equities.
Mutual fund asset allocation was roughly equally split between fixed income and
equities securities in 2010 (51% vs 46%, respectively), with equity investments
having a steady proportional increase at the expense of fixed income since 2002,
when the proportion was less than 8% of total AUM.
The 1999 pension fund reforms led to a significant modernization of the system,
introducing mandatory private pensions (OFE) and voluntary occupational
pensions (PFE) on top of the pay-as-you go system. However, the mandatory
funded schemes face governance issues, while supplementary pensions are
constrained by their inflexibility (AUM at less than 1% of all private pensions’
investment portfolio).
In 2004, the government adopted new voluntary personal pension plans (IKE).
Although more popular than PFE, so far they have remained below expectations,
partly due to their limited fiscal attractiveness.
In 2011, the government reformed the second pillar. The first part of the reform
changed the cash flow received by the private pension funds. OFE inflows will be
cut by a third in 2011/12, returning to the current rate by 2017 with the help of
new fiscal incentives that should boost a voluntary top up of the second pillar. The
reduced contributions will be redirected to a segregated fund held with ZUS, the
social security state office.
The reason for this change is primarily fiscal accounting. Under the ESA95
methodology, defining the calculation of the Maastricht indebtedness parameters,
the transfers to OFEs count as spending, lifting the deficit by approximately 1.4%
of GDP each year. By redirecting part of the OFE inflows to a sub-account with
ZUS, the deficit will be reduced by approximately 1% of GDP in 2011 and 2012.
This change reduces Poland’s expected fiscal shortfall, but does not change the
fundamental structural deficit left following the aggressive reduction in the social
security cuts the PiS government delivered a few years ago.
Rest of World
60%
180
Domestic gov t. debt securities held by non-residents (PLN bn)
35
50%
150
30
40%
120
30%
90
20%
60
10%
30
5
0%
0
0
70%
Jan-00
Jan-02
Jan-04
134
Chart 81: Foreign holdings of Polish local currency government bonds
Jan-06
Jan-08
Jan-10
Jan-12
Jan-00
25
20
15
10
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
GEMs Pa pe r #1 0
The second part of the reform is a cap on management fees pension funds can
charge. The government discussed introducing more flexibility in the investment
strategy of OFEs: greater limits for foreign assets and great scope of derivatives
product use. It also considered supporting the creation of different funds with
gradation of risk profiles. Unfortunately no timeline is available on when these
changes will be implemented. Meanwhile, tight budget constraints could lead to
another reduction in the compulsory contributions to the private pension funds,
eliminating an important domestic support to the stock market.
The Foreign Exchange Law of 2002 harmonized Polish regulations with EU
standards. It removed all limitations on capital flows between Poland, the
European Economic Area (EEA), and the Organization for Economic Cooperation and Development (OECD). Capital flows involving countries outside the
EEA or OECD are subject to NBP authorization. A withholding tax is deducted at
19% on dividends, 20% on royalties and interest payments to nonresidents,
unless reduced by double tax treaties.
Clearing settlement and taxation
The national depository for securities (KPDW) conducts the settlement of T-bond
transactions in the secondary market. As of 16 April 2012, Polish securities are
also Euroclearable.
Table 100: Summary of Poland bond markets and products
Instrument
Treasury bills
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Ministry of Finance
PLN
PLN1,000 (par)
30, 49 and 52 weeks
Issued at discount
Zero
Act/360
Discount
Registered
PLN11.7bn
Government bonds
Ministry of Finance
PLN
PLN1,000 (par)
2-30 years
Fixed / Floating
Annual (semi-annual for floating)
Act/Act
Bullet
Registered
PLN515.3bn
Price
Price
T+2
T+2
PLN0.3bn
PLN2-2.5bn
5bp
3-4bp
NA
1-2bp
USD15-20mn
PLN25mn
National Depository for Securities (KPDW)
National Depository for Securities (KPDW)
Primary dealers
Primary dealers
9:00-16:30 (Poland)
9:00-16:30 (Poland)
participate. Mostly local banks, investment funds, corporates. participate. Mostly local banks, investment funds, corporates.
No restrictions
Yes, through KPDW
Withholding tax at 19% on dividends, 20% on royalties and
interest payments to nonresidents, unless reduced by double
tax treaties.
None
None
No restrictions
Yes, through KPDW
Withholding tax at 19% on dividends, 20% on royalties and
interest payments to nonresidents, unless reduced by double
tax treaties.
None
None
dealers or non-competitive tender
PLN1-2bn
None
dealers or non-competitive tender
PLN2-4bn
None
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Russia
Overview
Arko Sen
+44 20 7995 1576
The Russian economy remains on a steady trend of recovery, posting robust
growth in 2011-early 2012 driven almost entirely by healthy expansion of
domestic demand. High oil prices clearly helped the recovery by supporting
robust investment and rebuilding corporate profits. However, positive consumer
demand appears to be driven increasingly by domestic factors and labor market
trends. The internal labor market remained rather tight even during the crisis,
supporting consumer income and confidence. Generous social transfers and
wage indexations by the government have further contributed to an existing
positive trend.
Vladimir Osakovskiy
After having finally completed an important political transition, market attention is
on Russia’s economic reform agenda. Despite early disappointment, Russia has
delivered meaningful liberalization of oil industry taxation, intensified its efforts to
reform the pension system and reaffirmed its long-term commitment to
privatization.
Table 101: Russia ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Baa1
Baa1
Baa1
Baa1
Baa1
Baa2
Baa2
Baa2
Baa3
Baa3
Ba2
Ba3
B3
BBB
BBB
BBB
BBB
BBB
BBB+
BBB+
BBB
BB+
BB
BB
B+
B-
BBB
BBB
BBB
BBB
BBB
BBB
BBB+
BBB
BBBBB+
BBB+
B
9%
Serv ices
17%
Non-food
37%
Food
37%
0%
10%
136
20%
30%
Monetary policy
Background. The Central Bank of Russia (CBR) is legally and constitutionally
independent. Policy is set by the board of directors, which has 11 members and
appointed terms of four years. The official policy mandate is aimed at general
price and currency stability. The currency stability mandate is interpreted as
prevention of sharp FX volatility.
Policy framework. The CBR is moving away from the historical peg of the RUB
to USD and to the EUR/USD basket. Also, the central bank has reiterated an
eventual shift to a full float, even though there is no specific timeline for that.
Currently, the RUB is allowed to freely fluctuate within a rather wide trading band,
which by itself is adjusted by 5 kopeks upward or downward after cumulative
interventions of US$500mn.
Base rate. The refinancing rate is the main reference indicator for CBR rates, and
is set at 8%. This is the upper level of a wide set of other policy rates, where the
bottom is set by a depo rate (ON to 1m), which is also the key liquidity absorption
policy rate. Between these limits, important liquidity provisioning rates are direct
auction repo rate (ON to 1y), fixed rate repo (ON to 1m), as well as FX swap rate.
Chart 82: Key CPI components for Russia
Housing/utils
The government is set to establish the Central Depository and allow for full
access to Euroclear and Clearstream exchanges to open up the local OFZ
market. The liberalization is scheduled to be completed later this year, even
though actual implementation might surprise on the downside by delaying the
process to early 2013.
40%
Open market operations. The CBR aims to smooth out sharp FX movements
and manage the RUB trading band, leveraging on its abundant FX reserves.
However, the focus of open market operations is gradually shifting toward the
money market, where the CBR is providing/absorbing liquidity through auction
repo, fixed rate repo, FX swap, Lombard loans, deposits and other policy tools.
An additional liquidity provisioning option also exists in the form of deposit auctions
by the Ministry of Finance. Any existing liquidity excesses in the treasury are offered
as short-term deposits to an approved list of banks on an ad hoc basis.
GEMs Pa pe r #1 0
Typical conventions
Lending and deposit facilities. The main lending facility of the CBR is the direct
auction repo operations, which are offered against approved collateral within daily
limits in ON, 1-week, 3-month and 1-year durations. Apart from that, the CBR also
offers standby fixed repo facility, FX swaps, Lombard loans and has an option of
unsecured lending, which it used during the peak of the 2008-2009 crisis. On the
liquidity absorption side, CBR accepts ON and 1m deposits.
Bonds
Quote: Price
Settlement: T+0
Basis: Act/365
IRS
Reserve requirements. Requirements are differentiated across resident and
nonresidents, and across liabilities in RUB and FX. The reserves are set at 5.5%
on all liabilities against nonresidents, and 4% of all other liabilities.
Fixing: 3m Mosprime
Coupon frequency: Annual fixed Act/Act, quarterly
floating Act/Act
CCS
Fiscal policy
Starting next year Russia will have new budget rules, which should help anchor
budget spending commitments to more conservative oil price assumptions. The
new budgets will be developed based on five-year oil prices, which will be
increased to the 10-year average by 2018. The size of the projected budget
deficit will be capped at 1% of GDP under this rule. Possible revenue shortfalls or
excesses in case of short-term oil price deviations from this benchmark will be
financed/saved from the reserve fund (USD60.5bn as of 1 July 2012).
Coupon frequency: Annual fixed Act/Act, quarterly
floating; initial/final principal exchange
New budget rules and an already stretched budget provide a meaningful
constraint for potential anti-crisis fiscal responses, so measures will likely be
limited to refinancing options for the FX debt and a commitment to existing
spending projections, in our view. In case of a sustained drop in oil prices the new
budget rules also provide for a change of sticky five-year oil price benchmark to a
more flexible three-year moving average, which could trigger meaningful
downward adjustment of spending commitments.
As a result of the implementation of these new budget rules, the general outlook
of Russian fiscal framework remains rather robust despite major spending
commitments made during the recent presidential election campaign. The budget
deficit is expected to remain well below 1% of GDP, suggesting moderate and
sustainable net increase in supply. Any additional spending obligations will likely
be financed by further tax increases.
Chart 84: Outstanding Russian debt types by category
Chart 83: Maturity profile of outstanding Russian government
securities in RUBbn
500
RFLB
Fed. sav ings
GSO
RUB 593.1bn
bonds
400
300
RUB
OFZ bonds
3,129.6bn
200
o/w floating &
100
RUB 641.6bn
step coupon
2036
2033
2030
2027
2024
2021
2018
2015
2012
0
0
1,000
2,000
3,000
4,000
137
GEMs Pa pe r #1 0
Bloomberg pages
Bond markets
RUB Curncy ALLQ<GO> – FX rates
The Russian bond market is about USD125bn, and expected to continue to
expand rapidly. The government bond market was only about USD40bn in 2009,
well below any other emerging market economy. According to our estimates, by
2013 the government bond market will be just below USD200bn, putting it much
closer to the rest of the BRIC economies.
OTC RUB<GO> – Market monitor
CBR<GO> – Central bank monitor
Reuters pages
FX: RUBMCMEEMTA=
Bonds: 0#RUTSY=MM
Useful websites
Bank of Russia
www.cbr.ru/eng/
Ministry of Finance
www.minfin.ru/
Statistics office (Rosstat)
www.gks.ru/wps/portal/english
OFZ bonds are regarded as benchmarks and provide guidance for the rest of the
domestic debt market. Average trading volumes in OFZs are around USD100150mn per day compared to USD70-100mn in cross currency swaps. Bid offer
spreads range from 5-15bp for the OFZs and ticket sizes in swaps are usually
greater than bonds at around USD5K DV01 for cross currency.
Short-term or floating rate debt. Floating rate and step coupon bonds (OFZAD) constitute around 20% of the bond market. There are no bills outstanding.
Fixed coupon debt. The remaining 80% of the bond market has a fixed coupon
(OFZ-PD). This share is set to rise, as the government has issued only fixed
coupon bonds recently. The most liquid part of the curve is the belly, with the 2, 3,
5 and 7-year OFZs most actively traded. The curve extends out to 30 years.
Moscow stock exchange
www.micex.com
around 3.2 years for the OFZ-PD (around 6.5 including OFZ-AD), which is likely
to rise quickly given plans to increase local debt issuance significantly. The
Ministry of Finance aims to maintain the average duration of the stock of
outstanding OFZs at five years.
The borrowing program aims to increase liquidity in the domestic debt market with
a diversified investor base. The Ministry of Finance has established benchmark
bonds at standard maturities (3, 5, 10, 15 and 30 years) and in volumes sufficient
to enhance liquidity. Most new issuance is concentrated in the medium to longend part of the curve at 5, 7, 9, 10 and 15 years.
The Ministry of Finance issues bonds in competitive auctions through the CBR. A
quarterly schedule is provided on their website at the start of the quarter and
details are provided on the day before the auction, including expected yields of
the securities to be auctioned. Only dealers can participate in the auctions.
Table 102: Summary statistics of Russia derivative products and their markets
Product
Avg daily
trading volume
Avg
transaction size
Bid-Ask spread
Bloomberg /
Reuters reference
35K
20K
15K
USD5K DV01
USD5K DV01
USD5K DV01
5-10bp
7-10bp
7-10bp
OTC RUB / RUBVIEW
OTC RUB / RUBVIEW
OTC RUB / RUBVIEW
USD100mn
USD 5K DV01
10bp
OTC RUB / ICAPRUB
Cross currency swaps
1-year
2-year
5-year
Basis swaps
Derivatives market
Recently some new products have been introduced, including overnight swaps
and swaps that fix versus a FX swap implied fixing. The former is fixed versus the
newly introduced RUONIA rate and the latter versus FX swap implied RUB rates.
The fix process for RUONIA is relatively more rigorous and should spur the usage
of the product.
138
GEMs Pa pe r #1 0
The NFEA swaps could eventually overtake IRS trading. The fix is based on
market implied rates, and currently the implied par rates are similar to the CCS
levels. Unlike CCS contracts, no principal exchanges are required in this new
product, which diminishes the counterparty risks involved. OIS swaps fix against
RUONIA. There is moderate liquidity up to five years in basis swaps.
Investors are also able to trade futures contracts on OFZs on the Russian Trading
System (RTS) and the Moscow Interbank Currency Exchange (MICEX) since
early 2011. However, volume of trading remains small; it was just over USD60mn
in July 2011.
FX market
The Russian ruble has been fully convertible and market access much easier
since July 2006. Still, some residual hurdles do exist. It is possible to trade
RUB/USD futures on CME, where it is also possible to do block trades,
minimizing counterparty risk. Trading volumes average around USD5-10bn per
day, with ticket sizes around USD10-20mn on average. Bid-offers are about 1-2
kopecks. Though the RUB is now deliverable, offshore trading among many
investors is mostly via NDFs. The best liquidity is available from 07:00-15:00
when MICEX is open. In FX forwards/NDFs, both deliverable and nondeliverable
forwards trade with good liquidity.
Interventions are based on levels of RUB basket versus the band, currently
around 32.15-38.15, and shift by 5 kopecks every time the CBR buys or sells
USD500mn. CBR periodically announces the amount of its recent interventions
and the current band.
Table 103: Vital statistics and characteristics of Russia’s FX market
Avg daily
Avg
Bloomberg
FX
Tradable trading
trading Bid-Ask / Reuters
size
RUB
Spot
RUB Spot USD5-10bn
Forwards
Forwards & USD3-4bn
Swaps
Options
FX Options
USD0.20.3bn
USD10- RUB0.002 OTC RUB /
20mn
RUBVIEW
USD10- RUB0.002- OTC RUB /
20mn for
0.008
RUBVIEW
outrights;
USD3050mn for
swaps
USD25mn
0.75 vol OTC RUB /
RUBVIEW
▪ Mainly trades against USD.
▪ Liquid up to 1y.
▪ Options available till tenors
of 5y but are liquid up to 2y..
Investor base
Domestic banks dominate the Russian bond market, holding about 35% of
outstanding OFZs, 40% of outstanding corporate bonds and 60% of municipal
bonds. In fact, domestic banks reduced their allocation to OFZs recently in a bid
to make way for loans but still account for a sizable part of the holdings. The other
major player in the OFZ bond market is the second pillar of the state pension
fund, whose assets are managed by Vnesheconombank (VEB). Private pension
funds, which have more than RUB1,000bn in AUM, do not invest in OFZs
currently. The CBR retains its holdings of OFZs that it accumulated prior to 2008.
Nonresident holdings of OFZs are rather low. While we estimate that
nonresidents directly hold less than 5% of outstanding OFZ stock (approximately
RUB64bn in September 2011), there may be as much as another 5% of stock
139
GEMs Pa pe r #1 0
they are indirectly exposed to via derivatives like total return swap. Historically the
difficulty of entry/exit from the market has kept foreign investors at bay. However,
with issuance picking up and rules being eased, interest is likely to rise. The full
spectrum of liberalization with Euroclear access would be ideal, but even the
advent of OTC trading, settlement through Clearstream, and the ability to open
foreign nominal accounts should encourage further inflows and reduce the
“access discount”, in our view.
Russia’s institutional investor base is small in absolute size and relative to GDP.
In our view the key culprits are the boom-bust cycles of the past 20 years and
limited trust of the public in the rule of law. These limitations undermined attempts
to encourage more personal pension saving in recent years. As a result, we think
macroeconomic stabilization and an improvement in the judicial system are likely
to be the most important factors determining growth of domestic AUM.
Russian mutual funds date back to 1996, but it was only in the 2000s and the
recovery of the Russian stock market from the 1998 crisis, that these funds
received a major boost. Average annual growth rate was as high as around 90%
between 2001 and 2009, but as of end-2009, AUM still came in at less than 1% of
GDP. The peak was in 2007 when AUM registered RUB770bn, or 2.3% of GDP.
Historical data and details on asset allocation are limited. Pension funds, where
some detail is available, primarily invest in fixed income (more than 80% of AUM
since 2005). Mutual funds reportedly invest a large part of their portfolio in real
estate and other illiquid assets; available data show real estate/rental funds
account for about 45% of all mutual funds’ AUM as of 2009.
The mandatory pension system in Russia consists of two pillars, the pay-as-yougo and savings components. As of end-3Q11, total size of the mandatory pension
savings reached RUB1,563bn, of which VEB manages RUB1,196bn with at least
RUB900bn invested in OFZ and other state debt. The VEB’s investment
declaration suggests minimal share of government debt in RUB and foreign
currencies of at least 50% of total portfolio, with no restrictions on the maximum,
which clearly puts the domestic pension funds industry among the most important
and reliable buyers of the OFZ market.
There are several hindrances to owning domestic assets, although efforts have
been made to improve the ease of access. Purchase and sale of foreign currency
must be done via Russian authorized banks, so nonresidents need to maintain
accounts locally. Opening/using these accounts can be a cumbersome process.
Since February 2012, government bonds trade in the main market section of
MICEX, which allows for a larger market and simpler trading procedures. The
trading rules for OFZs and corporate bonds are now synchronized so that OFZs
can be traded OTC as well. In addition, bonds may soon be allowed to settle on
Euroclear/Clearstream, and MICEX is considering ways to cut down the number
of trading accounts needed, merge settlement systems and extend the period of
settling trades to T+3.
There is a 15% withholding tax on OFZ interest payments, which can be reduced
subject to double tax treaties. Residents are taxed at 20% for capital gains.
140
GEMs Pa pe r #1 0
Chart 86: Financial institutions' holdings of government securities
100%
24%
80%
37%
60%
4%
40%
20%
26%
Banks
CBR
9%
VEB
Non-residents
Source: BofA Merrill Lynch Global Research, Haver, www.nlu.ru, CBR
0%
Jan-03
Others
Jul-04
Jan-06
Jul-07
Jan-09
Jul-10
Jan-12
Trading occurs on MICEX. The National Settlement Depository (NSD) serves as
the settlement depository institution for GKO/OFZ and other MICEX traded
securities. Full market access to Euroclear and Clearstream might be delayed
until early 2013.
Table 104: Summary of Russia bond markets and products
Instrument
Government bonds (OFZs)
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Amount outstanding
(as of July 2012)
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Ministry of Finance
RUB
RUB1,000 (par)
3-30 years
Fixed
Annual
Act/365
Bullet
Registered
RUB3,160bn
OTC and Stock Exchange (MICEX)
Price
T+0
USD100-150mn
10-15bp
5-10bp
USD2-4mn
MICEX (Euroclear/Clearstream pending)
Primary dealers
10:30-17:30 (Moscow)
Mostly local banks and investment funds
Nonresidents can transact via local brokers
National Settlement Depository (NSD)
15% on interest payments, unless reduced by double tax treaties
20% for residents
None
Competitive tender in a multiple price format via primary dealers
RUB100-150bn
None
141
GEMs Pa pe r #1 0
South Africa
Overview
Arko Sen
+44 20 7995 1576
South Africa is a small, open and commodity-based economy. Over the past two
decades it has become increasingly services based, with manufacturing and
mining in relative decline. Together with prudent and countercyclical macro policy,
this has helped dampen growth fluctuation post-1995. That said, since the 1994
political settlement, South Africa has become more exposed to the global trade
cycle, reintegrating back into the world economy.
Matthew Sharratt
+27 21
We think GDP growth in 2012 is likely to remain well below trend (currently
estimated around 3.50-3.75%) at 2.8%, with risks increasingly tilted to the
downside as the Eurozone debt crisis continues. We are more positive on a
medium-term basis given supportive domestic drivers. From a likely 3.5% GDP
growth rate in 2013, we see potential for growth to accelerate 4-5% during 20142018, assuming the government is able to implement its spending plans and
global commodity prices remain supportive.
Monetary policy
Background. The South African Reserve Bank’s (SARB) operational
independence is constitutionally guaranteed. Since 2000 SARB has targeted an
inflation range of 3-6% on a “medium-term” horizon. The range is set by the
National Treasury. The Treasury reclarified the SARB’s flexible inflation-targeting
mandate in February 2010. This allows the central bank to look through
temporary deviations in inflation from the target range that may have resulted
from a supply shock. The stated aim is to allow for interest rate smoothing over
the cycle, which may mitigate any output variability from the monetary policy
response to the shock.
Table 105: S Africa ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
A3
A3
A3
A3
Baa1
Baa1
Baa1
Baa1
Baa2
Baa2
Baa2
Baa2
Baa3
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB
BBB
BBBBBBBBB-
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB
BBB
BBBBBBBBB-
Policy framework. The Monetary Policy Committee (MPC) consists of six
members, led by Governor Gill Marcus. The MPC meets every two months. MPC
meetings run for three days to allow for sufficient deliberation. The repo rate
decision is usually announced up to 10 minutes into the delivery of the statement
by the governor at the press conference. No minutes or voting records are
published, although the governor does give an indication at the press conference
of whether the decision was unanimous or not, usually when prompted by
journalists. The SARB issues quarterly bulletins, monetary policy review every six
months and monetary policy statements.
Chart 87: Key CPI components for South Africa
Food
15.7
18.8
Transport
Housing
22.6
Other
43.0
0
10
20
142
30
40
50
The SARB’s inflation forecasts are premised on an unchanged interest rate path,
so the SARB makes no assumptions of the future path for interest rates, whether
its own or by incorporating market pricing.
Base rate. The main mechanism used to implement monetary policy is the
refinancing system by which SARB provides liquidity to the banks. The main
refinancing operation is the weekly 7-day repurchase auction, which is conducted
with the commercial banks, at the repo (policy) rate as determined by the MPC.
The SARB lends funds to the banks against eligible collateral, which comprises
assets that also qualify as liquid in terms of the prudential liquid asset
requirement. Commercial banks structure their private sector lending around the
prime lending rate, which is set at 350bp over the repo rate.
GEMs Pa pe r #1 0
Typical conventions
Open market operations. The SARB uses three types of open market
instruments to drain excess liquidity, namely debentures, longer-term reverse
repos and foreign exchange swaps. The SARB reinstituted its forward book in
August 2010, which it had closed in 2004, as a means of countering rand
strength. The SARB buys USD spot and sells it forward in order to sterilize the
liquidity impact of the spot purchases on the domestic money market.
Bonds
Settlement: T+3
Basis: Act/365
IRS
Lending and deposit facilities. In addition to the main repo facility, the central
bank offers a range of end-of-day facilities for the commercial banks to square off
the daily positions on their settlement accounts; for example, access to their cash
reserve balances held with the bank, supplementary repos/reverse repos
conducted at the repo rate, and an automated standing facility whereby the endof-day balances on the banks' settlement accounts are automatically settled at a
rate of 100bp below or above the repo rate.
Fixing: 3m JIBAR 11am
Coupon frequency: Quarterly fixed Act/365, quarterly
floating Act/365
Reserve requirements. In terms of the Banks Act, banks are required to hold a
prescribed percentage of their total liabilities in cash on their cash-reserve
accounts at the bank. The cash reserve requirement is currently set at 2.5%.
Fiscal policy
South Africa follows a fiscal year that starts on 1 April and extends until 31 March
of the following year. The borrowing schedule and targets are thus set on this
fiscal calendar. The Budget Statement is delivered in February and sets out the
government's detailed spending and tax policies for the coming fiscal year. The
Medium-Term Budget Policy Statement (MTBP) is released every October,
setting out the medium-term spending envelope and often trailing key policy
changes that will be implemented in the following financial year.
Bond market
The South African bond market is one of the most liquid markets in EM with
tenors going out to 36 years and a deep local investor base. The outstanding
amount is around US$125bn in total.
Short-term or floating rate debt. T-bills constitute around 16% of outstanding
debt, while CPI-linked bonds constitute around 15% of debt. Liquidity in the CPI
linkers is much poorer compared to bonds, and there is only one FRN.
Chart 88: Maturity profile of outstanding South Africa government
securities in ZAR
140
SAGB Gov t
120
SACPI Gov t
SATB Gov t
100
Chart 89: Outstanding South African debt types by category
Debentures
ZAR 17.7bn
Gov ernment T-bills
ZAR 157.9bn
80
60
Gov ernment bonds
ZAR 848.9bn
40
20
ZAR 146.0bn
o/w ILB
2048
2045
2042
2039
2036
2033
2030
2027
2024
2021
2018
2015
2012
0
0
200
400
600
800
1,000
1,200
143
GEMs Pa pe r #1 0
Bloomberg pages
ZAR Curncy ALLQ<GO> – FX rates
OTC ZAR<GO> – Market monitor
SABA<GO> – Bond auctions page
SARB<GO> – Central bank monitor
Reuters pages
FX page ZAR=>
Bonds page 0#ZATSY=
Useful websites
South Africa Reserve Bank
http://www.reservebank.co.za
National Treasury
http://www.treasury.gov.za
http://www.statssa.gov.za
Financial Services Board (FSB)
http://www.fsb.co.za
Johannesburg Securities Exchange (JSE) / Bond
Exchange of South Africa (BESA)
http://www.jse.co.za
Strate (central securities depository)
http://www.strate.co.za
Fixed coupon debt. The remaining 69% of debt has a fixed coupon. Government
bonds are normally referenced by their serial numbers. For example, the most
liquid bond on the curve is the 13.5 of 2015 is R157. The R186 (10.5 of 2026) is
the next most liquid issue. However, liquidity is high across the curve with bidoffer around 2-3bp for up to USD15-30K DV01.
around 10 years for fixed bonds and slightly higher at 12 years for inflation-linked
bonds. The Treasury plans to issue US$18bn on average in long-term debt over
the next two years. The Treasury does not issue new bonds frequently, but it
introduced two new long-end bonds and plans three new inflation-linked bonds in
the current fiscal year. An unusual feature of the bond market is that certain
bonds, such as the R157, R186 and R2048, have their maturities split over three
years as the Treasury attempts to improve liquidity and manage refinancing risk
by reintroducing these bonds.
The government’s risk management framework sets benchmarks for the
composition of debt in order to reduce risks due to fluctuations in interest rates
and inflation. Specifically, foreign debt is capped at 20% of total debt and the
composition of domestic debt is aimed to consist of 70% fixed and 30% non-fixed
bonds. However, the share of non-fixed rate debt increased from 26.3% in
2007/08 to 36.3% in 2011/12, as the government increased T-bill and inflationlinked bond issuance to finance the borrowing requirement due to the onset of the
global crisis. Issuance in non-fixed rate debt should decline to meet the
benchmark.
Bond auctions are held by the SARB through primary dealers every Tuesday and
announced on the preceding Wednesday. Auctions are uniform yield Dutch, and
the results are displayed on the SARB website. CPI linkers are auctioned twice
per month on Fridays. T-bill auctions take place weekly and are offered in 91,
182, 273 and 364-day tenors. In addition, noncompetitive auctions are conducted
in fixed rate bonds, which provide primary dealers a 48-hour option of taking up
an additional 30% of their allocation at the auction clearing yield. Switch auctions
are also conducted regularly, in which short-term bonds are exchanged for
longer-term bonds.
Table 106: Summary statistics of South Africa derivative products and their markets
Product
Interest rate swaps
1-year
5-year
10-year
Avg daily
trading volume
Avg
transaction Size
Bid-Ask spread
Bloomberg/Reuters
reference
USD50-100K DV01
USD100K DV01
USD100-200K DV01
USD10-20K DV01
USD10-20K DV01
USD10-20K DV01
3-4bp
3-4bp
4-5bp
SASW1/ZARVIEW
SASW5/ZARVIEW
SASW10/ZARVIEW
USD100mn
USD25mn
5-6bp
SABS/ICAPZAR
Basis swaps
Derivatives market
South Africa is probably the most liquid and sophisticated EM local currency
derivatives market in the European time zone. The market for IRS, FRAs and
forward swaps is very liquid, particularly up to 10y. IRS and FRAs trade in tickets
from USD5-50K DV01 with average Street ticket between USD10-20K. There is a
reasonably active FRA market all the way to the 21x24 tenor and the IRS market
goes all the way to 30 years with an unusually big list of local players active in the
very long end of the curve.
144
GEMs Pa pe r #1 0
There is also an active interest rates vol market up to 3y. The FX vol market is
available with vanilla and exotic instruments against EUR and USD.
The JSE (BESA merged into JSE in 2009), the central exchange authority for
bonds, also deals with financial and commodities futures and options. It also
provides three widely used bond indices: ALBI, an all-bond index containing the
top 20 vanilla bonds by liquidity and market capitalization; GOVI, the top 10
government bonds within ALBI; and OTHI, the remaining bonds from ALBI. CPI
bond indices also now exist, and CILI is the composite across issuers.
FX market
The South African rand (ZAR) was introduced in 1961 and is today a fully
convertible and deliverable currency. The stated policy of both the SARB and
Treasury is to opportunistically increase the level of foreign exchange reserves
during periods of Rand strength. This policy is to help mitigate rand strength, lower
volatility and raise the level of reserves, which at USD42bn are only 11% of GDP.
The SARB uses foreign-exchange swap transactions to drain rand liquidity from the
market on a temporary basis. These swaps can be conducted for maturities of up to
12 months and can be conducted for normal liquidity management or to sterilize
foreign exchange purchases. When the swaps mature, the US dollars are returned
to the SARB which, in turn, delivers the rand to the counterparties. The bank might
opt to roll these swaps for future maturities when they mature. However, shorterdated swaps are also conducted in the opposite direction; that is, to inject liquidity.
In the past, SARB was seen buying foreign currency against ZAR to
counterweight investment inflow. However, outright interventions are rare and
SARB follows a less active approach compared to other countries in EEMEA to
intervene in the market.
The average daily spot turnover ranges around USD7-8bn, much of which is
against USD. A typical ticket size is around USD30mn with a bid-ask of ZAR 0.05.
It is one of the top three liquid EM currencies (ex-Asia) with options, FX forwards
and swaps all liquid out to 1y. In forwards and swaps, the average ticket size is
between USD50-100mn with a bid-ask spread of ZAR 0.03-0.05 and daily volume
of USD1bn for forwards and USD9bn for swaps. In options, daily volume
averages around USD0.3bn and the typical ticket size is USD20mn. Options are
available up to five years but liquid only up to one year. Trading hours are 07:0017:00 GMT, and liquidity drops considerably outside of London hours.
Table 107: Vital statistics and characteristics of South Africa’s FX market
Avg daily
Avg
Bloomber
FX
Tradable trading
size
ZAR
Spot
Forwards
Options
ZAR Spot USD7-8bn USD30mn ZAR 0.05 ZAR/ZAR=> ▪ Mainly trades against USD.
Forwards & USD1bn for USD50mn ZAR 0.03SAFS/ ▪ Liquid up to 1 year.
Swaps
forwards, for forwards;
0.05
ZAR=>
USD9bn for USD100mn
swaps
up to 1y
0.75 vol USDZARV / ▪ Options available till tenors of
ZAR=> 5y but are liquid up to 1y.
145
GEMs Pa pe r #1 0
Investor base
South Africa’s domestic institutional investor base (public and private pension
funds, unit trusts, and insurance) is the largest in EEMEA in absolute terms, as
well as in percentage of GDP. Total AUM amounted to USD578bn by the end of
1Q12, or 150% of GDP, equally dominated by pension funds and insurers, with
each accounting for about 40% of total assets. The growth in the overall sector
has been led by unit trusts, with growth averaging 28% yoy from 2003 to 2007,
followed by pension funds (16%) and insurance companies (13%).
South African institutional investors favor equity over fixed income in their asset
allocation. In 1Q 2012, equity instruments registered 50% of AUM by pension
funds, unit trusts and insurance. Pension funds’ allocation to equity has been on a
gradual upward trend since 2003 at the expense of fixed income securities.
Institutional investor holdings of fixed income securities have remained at 23% of
total assets since 2Q 2011.
The pension system continues to be dominated by non-contributory means-tested
government grants financed by general revenues. Occupational retirement plans
are limited to those employed in the formal sector. South Africa’s economic
structure is such that unemployment levels are elevated and many people lack
access to an affordable retirement funding plan.
To alleviate this concern, the government is hoping to introduce a mandatory
earnings-related contributory system to complement redistributive social
assistance. This opens up the scope for expansion of the institutional investor
base in South Africa, though admittedly the pension reforms and efforts to boost
comparably very low labor participation rates will likely be a long process.
The government has also continued its gradual relaxation of exchange controls
on domestic investors. As part of a package of measures to respond to surging
portfolio inflows and to concretize the announcements made by the minister in the
2010 MTBP, the National Treasury announced a 5 percentage point increase in
the limit to the percentage amount that institutional investors can invest offshore
(now 25% for retirement funds).
Rest of World
70%
Domestic gov t. bonds held by non-residents (ZAR bn)
Domestic gov t. bonds held by non-residents (% of total, rhs)
Institutional Inv estors
60%
300
35
50%
250
30
40%
200
30%
150
20%
100
10%
50
5
0%
0
0
2007
2008
Source: BofA Merrill Lynch Global Research, SARB
146
Chart 91: Foreign holdings of S. African local currency government
bonds
2009
2010
2011
2007
25
20
15
10
2008
2009
Source: BofA Merrill Lynch Global Research, Haver, SARB
2010
2011
GEMs Pa pe r #1 0
Short-term debt in the form of T-bills is primarily held by local commercial banks,
which held 76% of the total amount of bill issuance in 2011/12. Only 1% of T-bills
was held by international investors. In contrast, long-term debt holdings are
dominated by institutional investors, primarily pension funds among them.
However, the share of pension funds in ownership of domestic bonds has
decreased from 47.2% in 2007 to 33% in 2011, while that of foreign investors
rose from 10.6% to 29.1% over the same period. Domestic financial institutions
hold around 24% of outstanding debt in bonds.
Foreign investors are not specifically subject to any exchange control restrictions
on the convertibility and repatriation of their local sale proceeds. Income and
capital are freely repatriated to foreign investors. There is no withholding tax on
interest payments.
JSE is the central exchange authority for bonds and clearing/settlement occurs
via Strate. All government bonds and most others are listed on it.
Table 108: Summary of South Africa bond markets and products
Instrument
Treasury bills
Issuer
Currency
Principal
Tenor
Coupon Payments
Form
Amount outstanding
(as of July 2012)
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Government bonds
Inflation-linked bonds
South African Treasury
ZAR
ZAR10,000 (par)
91, 182, 273 and 364 days
Issued at discount
Zero
Act/365
Bullet
Scripless
ZAR158bn
ZAR
ZAR1,000,000 (par)
Up to 35 years
Fixed
Semi-annual
Act/365
Bullet
Scripless
ZAR849bn
ZAR
ZAR1,000,000 (par)
Up to 22 years
CPI-linked
Semi-annual
Act/365
Bullet
Scripless
ZAR146bn
Yield
T+3
USD0.5bn
1-3bp
NA
USD3-6mn
Strate
Primary dealers
9:00-17:00 (South Africa)
banks, investment funds, corporates.
Yield
T+3
USD2bn
2-3bp
2-3bp
USD3-6mn
Strate, Euroclear
Primary dealers
Yield
T+3
USD0.1-0.2bn
2-3bp
2-3bp
USD25-50mn
Strate, Euroclear
Primary dealers
No restrictions
Yes
None
None
None
No restrictions
Yes
None
None
None
No restrictions
Yes
None
None
None
Competitive tender in a Dutch auction format via Competitive tender in a Dutch auction format via Competitive tender in a Dutch auction format via
primary dealers and non-competitive tender
ZAR0.5-1bn
ZAR2-3bn
ZAR0.5bn
None
None
None
147
GEMs Pa pe r #1 0
Turkey
Overview
Arko Sen
+44 20 7995 1576
Despite growing headwinds for global growth, Turkish economic activity has held
up relatively well and has bounced back from its 1Q 2012 trough. MENA partially
offsets the weakening Eurozone demand for Turkish exports, stable TRY and
interest rates keep business and consumer sentiment positive, and the labor
market remains in good shape. We see room for a policy response if Europe
deteriorates, particularly on the fiscal side. Though it remains large, the current
account continues to adjust given lower oil prices and economic rebalancing, but
we expect the latter to hit rock bottom by 4Q 2012. Moody’s upgrade put an
investment grade rating back on the horizon as soon as 2013.
Turker Hamzaoglu
+44 20 7996 2417
Jean-Michel Saliba
+44 20 7995 8568
Monetary policy
Background. Following the 2001 crisis, Central Bank of Turkey (CBT) law was
amended significantly that April to ensure the CBT’s independence, prevent fiscal
financing and make price stability the primary objective. The CBT will support the
government’s growth and employment policies, provided it is not in conflict with its
price stability objective. The Monetary Policy Committee (MPC) was established,
chaired by the governor and composed of vice governors, a board member and a
member to be appointed on the governor’s recommendation.
Table 109: Turkey ratings profile (long-term
local currency)
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
Ba1
Ba2
Ba2
Ba3
Ba3
Ba3
Ba3
Ba3
B1
B1
B1
B1
B1
BB
BB
BB
BBBBBBBBBBBBB+
BBB+
Policy framework. The CBT adopted an inflation-targeting regime in 2006 after
implicit inflation-targeting during 2002-05. The inflation target is set jointly by the
government and the CBT and is currently 5% for 2012, 2013 and 2014.
BB+
BB+
BB+
BB+
BBBBBBBBB+
B
B
B
B
The CBT has judged since late 2010 that it was appropriate to preserve an
unorthodox flexible monetary policy, with flexibility provided by the interest rate
corridor coupled with effective liquidity management. The 2012 monetary policy
framework introduced a regime-switching model that the CBT uses to tighten or
ease liquidity conditions and its blended cost of funding on a discretionary, daily
basis.
On “exceptional” days, FX daily selling auctions may amount to more than
US$50mn, direct FX intervention will be in the cards and there will be no daily
TRY 1-week repo auctions at the fixed policy rate, but any 1-month repo auctions
are unaffected.
On “normal” days, any FX daily selling auctions will be limited to US$50mn; there
will be no direct FX intervention; daily TRY 1-week repo auctions will take place at
the fixed policy rate, with size at the CBT’s discretion, though the minimummaximum size is pre-announced monthly following MPC meetings; and
competitive weekly 1-month Dutch repo auctions will take place on Fridays, the
upper limit of which is pre-announced monthly following MPC meetings.
Chart 92: Key CPI components for Turkey
Furnishings
7.4
Housing
16.4
Transport
16.7
Food
26.2
0
10
148
Base rate. Monthly, the CBT sets the benchmark policy rate, which was shifted
from the overnight borrowing rate to the one-week repo rate in May 2010. Banks
bid for the amount they want to borrow at the fixed rate during normal days while
1-week repo funding is withheld during exceptional days.
20
30
Minutes are published within five working days of the meeting, while inflation and
financial stability reports are issued quarterly and bi-annually, respectively. In
addition to the policy rate and the monthly funding parameters announced during
the MPC meeting, other tools such as the overnight interest rate corridor and
reserve requirement rates (RRRs) have been used by the CBT.
GEMs Pa pe r #1 0
Typical conventions
Open market operations. The CBT may, with an aim to effectively manage the
liquidity in the system, conduct open market operations such as issuance of
central bank bills, outright purchase and sale of securities, repo and reverse repo,
lending and borrowing securities and lending and borrowing of TRY deposits, and
act as an intermediary in these operations.
Bonds
Settlement: T+0 or T+1
Basis: Act/Act (Act/365 for zero coupon)
Coupon frequency: Semi-annual for 5y and 10y,
Lending and deposit facilities. The overnight deposit rate and overnight lending
rate, which form the overnight interest rate corridor, are the main lending and
deposit facilities. The CBT also maintains an overnight borrowing facility for
primary dealers via repo transactions at a rate 50bp lower than the ceiling of the
overnight corridor. Additionally, there is the late liquidity window where the CBT
provides unlimited liquidity lending/borrowing facility to the banks between 16:0016:30 against collateral.
quarterly for 3y
IRS
Fixing: 3m TRLIB3M
floating Act/360
The CBT announces repo auction amounts at 10am local time, and in case of an
unforeseen excessive liquidity shortage, intra-day traditional 1-week repo
auctions may be also announced. The CBT also operates FX deposit/lending
facilities, with the lending rate cut last effective August 2011 and the maturity of
borrowing raised from 1 week to 1 month effective January 2012. The CBT
resumed its intermediary role in the FX deposit markets in November 2011 to
enhance liquidity in the interbank FX market.
CCS
Fixing: 3m US LIBOR
floating Act/360
Reserve requirements. Reserve requirement rates have been used actively
since 4Q 2010, first as part of the CBT’s exit strategy. In that context of ample
global liquidity, a low policy rate, a wider interest rate corridor to the downside
and high required reserve ratios were assessed as an appropriate policy mix.
Furthermore, RRRs became differentiated according to maturity to encourage the
extension of the maturities of TRY deposits.
However, a deteriorating global risk appetite subsequently led the CBT to cut FX
RRRs in June 2011, cut TRY RRRs in October and November 2011, as the
overnight rate corridor was hiked higher, and allow banks to hold a portion of TRY
reserve requirements in FX (moved gradually from 0% to 60% maximum) and
gold (moved gradually from 0% to 30%). TRY and FX required reserves have not
been remunerated since October 2010 and December 2008, respectively.
Fiscal policy
The budget is on an accrual basis, and submitted to the parliament by the end of
October and approved by year-end. The annual budgets are in line with the threeyear framework announced in the medium-term program. The realizations are
announced monthly, in detail. The Treasury announces the financing of the
budget by an annual borrowing program prior to the start of the year.
Chart 93: Maturity profile of outstanding Turkey government securities
in TRYbn
100
Chart 94: Outstanding Turkish debt types by category
Gov ernment bonds
T U R KGB Gov t
TRY 388.8bn
80
o/w floating
60
TRY 111.7bn
o/w zero-cpn
40
TRY 75.0bn
(<2y maturity )
20
o/w ILB
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
0
TRY 68.2bn
0
100
200
300
400
500
149
GEMs Pa pe r #1 0
Bloomberg pages
Bond market
TRY Curncy ALLQ<GO> – FX rates
Turkey is the largest government bond market in EEMEA and one of the most
liquid bond markets in the region, with about USD216bn in outstanding debt.
OTC TRY<GO> – Market monitor
CBT<GO> – CBT and bond auctions page
TUPM<GO> – ISE bond monitor
Reuters pages
FX page CBTA=>
Bonds page 0#TRTSYA=IS
Useful websites
Central Bank of Turkey
http://www.tcmb.gov.tr/
Turkey Treasury
http://www.treasury.gov.tr
Turkey Statistics Office
http://www.turkstat.gov.tr
Banking Supervision Authority
http://www.bddk.org.tr
Istanbul Stock Exchange
http://www.ise.org
Short-term or floating rate debt. Zero-coupon bonds with less than 2y
maturities constitute around 20% of debt and are very liquid. FRNs take up 28%.
After ramping up issuance of CPI bonds in 2009, the proportion has fallen since.
Inflation-linked bonds constitute around 18% of outstanding debt.
Fixed coupon debt. The remaining 34% of debt has a fixed coupon with maturity
greater than 2y. Overall fixed coupon (including zero-coupon) issuance
accounted for 77% of total in 1H 2012. Normal ticket size is around USD2-3K
DV01. The benchmark 2y bond, currently Mar-14s, is typically the most liquid
instrument. The benchmark bonds are typically issued in January, April, July and
October, and can be reissued in two consecutive months following the first
issuance. The other liquid instruments include the previously issued 2y
benchmarks, the 5y benchmark and the 10y note, currently Jan-22s.
just below the 3y mark, currently sitting at 35 months. The duration of TRYdenominated securities (excluding non-cash and CPI-linked) was 14.8 months as of
May 2012. The Treasury follows the benchmark borrowing strategy introduced in
2006, whereby it aims to borrow at the same maturities on a regular basis. While
the 2y fixed rate coupon bonds are issued every month, 5y and 10y bonds are
issued in the months with relatively high debt redemption. The Treasury aims to
increase the average maturity of domestic borrowing and boost the market liquidity
of all debt securities along the yield curve by sticking to this strategy.
A three-month rolling borrowing program and auctions, detailing financing targets
and securities, are announced on the last working day of each month. Related
auction details are provided prior to the auction at least one day in advance. In line
with the benchmark strategy, fixed coupon bonds can have 2, 5 or 10y maturities
with quarterly or semi-annual coupons. FRNs have maturity of 5 or 7y and coupons
based on weighted average compound rate in the TRY-denominated zero-coupon
bond auctions over the previous three months before each coupon period. CPI
bonds extend out to 10y and have a semi-annual coupon. The structure is based on
the Canadian format.
Auctions are conducted by the CBT and details are posted on the Treasury
website. Retail and corporate investors can participate in auctions through
branches of the CBT, banks or brokers. Banks can bid through the Electronic
Fund Transfer system (EFT) while brokers bid through the Takasbank Electronic
Transfer System (TETS). Auctions are Dutch style average price. Only public
institutions and primary dealers can take part in the noncompetitive auction; only
the latter can take part in switch and buyback auctions.
Table 110: Summary statistics of Turkey derivative products and their markets
Product
Cross currency swaps
1-year
2-year
5-year
Avg daily trading
volume
Avg
transaction size
Bid-Ask spread
Bloomberg/Reuters
reference
USD200mn
USD150mn
USD50mn
USD2K DV01
USD4K DV01
USD5K DV01
5bp
5bp
5bp
TYUSSW1/ICAPTRY
TYUSSW2/ICAPTRY
TYUSSW5/ICAPTRY
Illiquid
Illiquid
40bp
TYBS/ICAPTRY
Basis swaps
150
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Derivatives market
With the exception of the 2y zero-coupon paper, the most liquid instruments in Turkey
are cross currency swaps (vs 3m USD), with bid-offer of 5bp in size of 2-5K DV01.
CCS are particularly liquid out to 5y but less so up to 10y. Average daily turnover is
around USD400mn. FRAs and single currency IRS are not very liquid, but improving,
with bid-offer typically around 40bp. The IRS fixes against the 3m TRLIBOR.
There is also an interest rates vol market with the active market up to 1y expiries,
but trading activity is fairly light. In the FX vol market investors have access to
vanilla and exotic instruments against both EU
R and USD.
FX market
The lira (TRY) is one of the most liquid currencies in EEMEA, with average daily
volume of USD10-12bn and average ticket size of USD10-20mn. USD/TRY
dominates trading but EUR/TRY is traded actively as well. Forwards, options and
FX swaps are all liquid. Forwards and swaps can be quoted out to 5y but are
most liquid out to 1y. Daily volumes average around USD3-4bn with average
ticket size of USD50mn up to 6mn and 20mn up to 1y. In options, daily volumes
average around USD0.5bn with a typical ticket size around USD25mn and good
liquidity up to 1y. TRY is at its most liquid between 07:00-15:00 GMT, Monday to
Friday. Trading out of hours usually involves wider spreads.
TRY is fully convertible and deliverable, and has floated freely since the crawling
peg was abandoned in February 2001. The currency was redenominated in
January 2005 by dropping six zeros after a period of price stability. The CBT
conducts regular FX interventions, at times in the form of daily auctions to sell
irregular amounts of USDTRY. Recently, the CBT has opted to tame the volatility
in the currency by limiting TRY liquidity to banks on a daily basis and forcing them
to convert their FX to TRY to meet required reserves. CBT also retains the option
to adjust the share of required reserves to be kept in FX and the reserves option
coefficients at its policy meetings to boost its FX reserves.
Table 111: Vital statistics and characteristics of Turkey’s FX market
Bloomber
Avg daily
Avg
FX
Tradable trading
size
TRY
Spot
Forwards
Options
TRY Spot
USD1012bn
USD1020mn
TRY 0.005 TRY/CBTA ▪ Mainly trades against USD.
▪ EUR/TRY also actively
traded, as well as crosses vs
ZAR or ILS.
Forwards & USD1.5-2bn USD50mn 3bp up to TYFS/CBTA ▪ Liquid up to 1y.
up to 6m; 6m; 5bp up
Swaps
20mn up to
to 1y
1y
0.5 vol USDTRYV / ▪ Options available till tenors of
CBTA 5y but are liquid up to 1y.
Investor base
The fixed income market is dominated by the banking sector, which has held 55-60%
of the debt since 2008. After the banks, corporate investors and nonresidents matter
most. The domestic non-banking sector holds around 25% of debt while nonresidents
hold another 18%. Turkish domestic institutional investors (private pension funds,
mutual funds and life) had TRY48bn of AUM as of 2011, or 3.9% of GDP.
151
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Chart 96: Foreign holdings of Turkish local currency government
bonds
70%
Rest of World
Institutional Inv estors
80
60%
Domestic gov t. debt securities held by non-residents (TRY bn)
20
70
50%
40%
60
50
15
30%
40
10
20%
30
10%
20
10
5
0%
0
0
Jan-06
Jan-07
Jan-08
Jan-09
Source: BofA Merrill Lynch Global Research, Ministry of Finance
Jan-10
Jan-11
Jan-12
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
While this represents around a 45% increase since 2005 in absolute terms, in
percent of GDP there has been only a minimal expansion (AUM was at 4.9% in
2005). Mutual funds and pensions dominate the domestic institutional investor
base, accounting for around 69% and 26% of total AUM as of 2009. The former
has experienced very volatile growth rates in recent years, but the latter has
displayed average growth of around 60% since 2006.
Turkey is clearly taking baby steps for now, but the low base suggests potential
for rapid growth in the sector. In our view, the growth will likely be led by the
private pension funds, while the mutual funds could face some headwinds in the
low interest rate environment.
Both pension and mutual funds predominantly invest in fixed income securities.
The share of fixed income instruments in the AUM of pension funds has dwarfed
that of equities (72% vs 12% as of end-2011, respectively). Similarly, mutual
funds had only 3.1% of AUM in equities, or TRY945mn (USD510mn) as of end2011. The peak was in 1993 when the share of equity investments in mutual
funds’ AUM reached 18%. Before the 2001 crisis, the share of equity allocations
in total averaged around 12% between 1997 and 2000.
The private pension system was introduced in 2003, serving as a complementary
scheme to the mandatory social security PAYG system. As it is voluntary for both
employers and employees, investment in pension funds remains fairly low relative
to investments in mutual funds.
There are two different types of mutual funds in the Turkish market. Type A funds
must invest at least 25% of their assets in equities issued by Turkish companies,
while there are no investment restrictions on Type B funds. Type B dominate the
mutual funds sector in terms of net asset value (95% of total), with most of the
portfolio in fixed income (24% of AUM as of end 2010) or reverse repo (47% of
AUM as of end 2011).
Turkey’s financial market is highly liberalized, with regulatory bodies improving
steadily since 2001. There are no restrictions on capital flows. There is a
withholding tax (WHT) on interest income and capital gains on domestic notes
issued after January 2006, which stands at 10% for real persons and 0% for
institutions.
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Bonds trade OTC and on the Istanbul Stock Exchange. Best prices at any time
are posted on TRTSY=IS page on Reuters. Settlement can be T+0 or T+1 if
executed after 14:00. Outright sales and repo/reverse repo transactions take
place from 9.30-12:00 and 13:00-17:00 every day.
Table 112: Summary of Turkey bond markets and products
Instrument
Treasury bills (zero-coupon up to 2y)
Government bonds
Inflation-linked bonds
Turkish Treasury
TRY
TRY100 (par)
5 to 10 years
Indexed to CPI
Semi-annual
Act/365
Discount
Scripless
TRY75bn
Turkish Treasury
TRY
TRY100 (par)
2, 5, 7 and10 years
Fixed / Floating
Quarterly for 3y fixed bonds and floating bonds
issued since 2007; semi-annual otherwise
Act/Act
Bullet
Scripless
TRY242bn
Yield
T+0 (T+1 if executed after 14:00)
USD200mn
5bp
NA
USD2K DV01
Istanbul Stock Exchange (ISE)
Primary dealers
9:30 – 12:00 and 13:00-17:00 (Turkey)
may participate. Mostly local banks, investment
funds, corporates.
Yield / clean or dirty price
USD450mn
5bp
5bp
USD2-3K DV01
Primary dealers
9:30 – 12:00 and 13:00-17:00 (Turkey)
may participate. Mostly local banks, investment
funds, corporates.
Clean or dirty price
USD100mn
3bp
3bp
USD4K DV01
Primary dealers
9:30 – 12:00 and 13:00-17:00 (Turkey)
Issuer
Currency
Principal
Tenor
Coupon Payments
Turkish Treasury
TRY
TRY100 (par)
Up to 2 years
Issued at discount
Zero
Form
Amount outstanding
(as of July 2012)
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Bidders
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit Tax
Primary Auctions
Auction Style
Average Issue Size
Act/Act
Bullet
Scripless
TRY68bn
No restrictions
No restrictions
No restrictions
Yes
Yes
Yes
Withholding tax on interest income and capital Withholding tax on interest income and capital Withholding tax on interest income and
gains on domestic notes issued after Jan 2006 is gains on domestic notes issued after Jan 2006 is capital gains on domestic notes issued after
10% for real persons and 0% for institutions.
Jan 2006 is 10% for real persons and 0% for
institutions.
Withholding tax on interest income and capital Withholding tax on interest income and capital Withholding tax on interest income and
gains on domestic notes issued after Jan 2006 is gains on domestic notes issued after Jan 2006 is capital gains on domestic notes issued after
Jan 2006 is 10% for real persons and 0% for
institutions.
None
None
None
Competitive tender in a Dutch style average
price or non-competitive tender
TRY2-3bn
None
TRY2-4bn
None
TRY2-3bn
None
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154
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Latin America countries
155
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Argentina
Overview
Jane Brauer
Argentina’s bond market has undergone several drastic changes over the last 10
years. After the sovereign default in 2002 and the restructuring that followed in
2005 (67% haircut of face value), the country again became a player in the
international emerging debt markets, with foreign investors active in the Argentine
bond market. Nevertheless, liquidity declined substantially compared to the end of
the 1990s as the government negotiated with holdouts from the restructuring and
started de-leveraging debt by focusing on the internal market.
Pension funds, nationalized in 2008, play a significant role. They have been
rolling over the debt services received into new government debt, but mainly
keeping the percentage of the total portfolio in government debt unchanged in
recent years. The Fondo de Garantía de Sustentabilidad (FGS) is a closed fund,
as it has only received about US$2bn in net inflows since inception in October
2008. The FGS discloses its portfolio with several months of delay.
Table 113: Argentina local debt ratings profile
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
B3
B3
B3
B3
B3
B3
B3
B3
B3
B3
Ca
Ca
-
Bu
Bu
B
BBB+
B+
BSD
SD
SD
SD
BB
BBBBBBBBBBBBBBBBBB-
B
B
B
BBB
B
BBCC
C
C*
BB+
BB+
BB+
BB+
-
Chart 97: Key CPI Component of Argentina
37.9%
Food
Transport
16.6%
Monetary policy
Background. In the past monetary misconduct and inflation have resulted in
substantial, periodic currency devaluations in Argentina. From 1970 to 1990
policy makers failed to implement sufficient monetary policies to reduce inflation
from the hyperinflation peak of 1989. To bring inflation down to single digits, in
1991 the Central Bank of the Argentine Republic (BCRA) created a currency peg,
where the peso was pegged 1 for 1 to the dollar, with every peso backed by hard
currency reserves.
The model brought stability and growth during the 1990s, but an overvalued peso
relative to Brazil and other trading partners led to a loss of competitiveness and a
deterioration of fiscal and trade accounts. In 2002 the country defaulted on its
sovereign debt and the dollar peg was abandoned. Since devaluating its
currency, the BCRA has been managing the exchange rate while controlling
monetary capital flows and inflation, with the aim of promoting economic growth.
Policy framework. Unlike most central banks in the region, the BCRA does not
target inflation. In the bank’s own assessment, low levels of financial
intermediation and a highly dollarized economy limit its ability to target inflation
via a key interest rate. Instead, the BCRA targets M2, a measure of money supply
that includes currency in circulation and checking and savings accounts.
12.1%
Housing
Clothes
Although the BCRA does not target a specific exchange rate level, it intervenes
regularly in the FX market, maintaining a slow and steady speed of ARS
depreciation, in order to promote export competitiveness. ARS is a nondeliverable
currency and the central bank intervenes in the onshore and offshore forward
markets, as well as in the spot market.
7.3%
5.6%
Health
Other
20.5%
0%
10%
20%
156
The government has been increasing debt with government agencies to finance
its gap in recent years. It has been resorting to central bank financing and
transfers for more than 3% of GDP per year since 2010. Total debt, excluding
defaulted debt not exchanged in the 2005 and 2010 restructurings, amounted to
USD178bn as of December 2011. Total public debt is 40% denominated in pesos
and 60% in USD, 70% under local law and 30% under foreign law. Debt
excluding government agencies holdings amounts to only 24% of GDP.
30%
40%
Base rate. The Badlar rate is the average rate among private banks for 30-35
day certificates of deposit of ARS1mn or higher. This is usually the market rate for
borrowing and lending between private entities, and normally tracks the target
repo rate. The central bank publishes Badlar daily.
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Conventions
Bonds
Quote: Dirty price
Settlement: T+3
Basis: 30/360, act/365
Coupon frequency: Monthly, quarterly, semi annual
IRS
Fixing: n/a
Coupon frequency: n/a
CCS
Fixing: n/a
Coupon frequency: n/a
Open market operations. Given its monetary policy, the BCRA targets money
supply based on M2. As a result, the central bank issues bills and notes – Lebacs
(Letras del Banco Central) and Nobacs (Notas del Banco Central) – to control highpower monetary aggregates. The BCRA auctions securities on Tuesdays and settles
T+1. Average size is ARS1bn and main participants are local banks, insurance
companies and mutual funds. The size of the auction depends on the amount of
sterilization required to meet monetary targets at any point in time. Foreigners are no
longer permitted to own these notes because they are not Euroclearable.
Lending and deposit facilities. The BCRA also uses repos and reverse repos
with private and public banks to contract or expand the monetary base. The
market for repo securities is based on sterilization paper issued by the BCRA –
Lebac and Nobac – and performing Treasury bonds. 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.
Reserve requirements. The central bank uses the reserve requirements as a
discretionary tool to control liquidity and credit in the banking system. As of
August 2012, the ratio was 19% of total short-term deposits. The BCRA has
changed reserve requirements several times in the past, but they have remained
stable in recent years.
Fiscal policy
The fiscal position of Argentina has deteriorated significantly in recent years. We
anticipate the federal government will likely post a primary deficit of 0.5% of GDP
this year, which compares to a surplus of 3.1% of GDP in 2008. Given that
Argentina has lost access to voluntary debt financing, this deficit and debt
services are financed by ANSeS – the government pension fund – and
increasingly by the BCRA. The government has used US$33.9bn of BCRA
reserves in the 2006-2012 period, and it is increasingly relying on the BCRA peso
issuance to finance the deficit, which will likely keep inflationary pressures strong.
Macro drivers
INDEC has faced criticism since 2007, when official measures of growth and
inflation began to diverge from private sector estimates with growth overestimated
and inflation significantly underestimated. However, INDEC figures are still the
official reference for inflation and GDP-linked securities and, as a result, are still
followed closely by the market.
The release that captures most of the attention is the monthly activity indicator
EMAE, as it tracks the quarterly GDP data that feeds into the calculation of the
GDP warrant payment. The CER inflation data have lost attention since the
government has started to release very stable numbers (close, but below 10%
yoy) several years ago, but it will likely recover its luster if/when this or the next
administration starts to more closely reflect the true inflation pressures, as there is
a sizable stock of CER-adjusted debt.
In the meantime, to compensate for the very low official inflation reports, the
market adjusts the prices of inflation-linked bonds via low prices, which produce
high “real” yields, so that “real” yields plus reported CER inflation produce a fair
bond yield.
The quarterly Balance Cambiario, a cash-basis balance of payments released by
the BCRA, also draws some attention, as it provides a measure of capital
outflows, among other interesting data.
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Bond market
This section provides an overview of the main Argentine local debt instruments,
some of which have unique conventions. Below, we provide a summary table
covering the key characteristics of each instrument traded. Local currency bonds
are either linked to the officially reported inflation index, CER, or they have a floating
coupon based on Badlar. In addition, there are USD-denominated local law
Bodens, Bonars and Par and Discount bonds (Table 115). The most liquid USDdenominated local law bonds are the Boden 15 and Bonar X (2017).
Bodens. A federal bond issued after the 2002 default to compensate banks for
the asymmetric pesification of their balance sheets and the pesification of
domestic bank accounts, as well as the FX impact on pensioners. The last Boden
was issued in 2005, with reopenings through 2008.
Bonars. The main source of current issuance, with auctions and reopenings
since 2006 through local dealers. The last reopening was in 2009.
Bocones. Primarily issued for pensioners and suppliers to the government, in
part to compensate for reduced social security payments to pensioners. The
longest Bocones capitalizes to 2013.
Bogars. The product of a provincial debt exchange, issued through an SPV that
captures tax co-participation payments from the provinces, but are not a direct
obligation of any one province. These are inflation-linked.
Bocan bonds (‘13s, ‘14s, ‘15s and ‘16s). These pay a coupon of Badlar plus a
spread ranging from 275bp to 375bp.
Pars and Discounts. ARS-denominated issues created from the 2005 exchange
of defaulted debt. The Pars have low coupons and amortize, while the Discounts
capitalize and amortize. Both are inflation-linked.
Peso-denominated government bonds
Face quote. The market convention is to quote the original face of a bond,
regardless of the growth due to capitalization or inflation.
Price quote. The market convention on all local bonds is to quote them on a
“dirty price” basis. The dirty price is an all-in price. Dirty prices tend to grow
because of the growth in the coupon, as well as the increase in the factor and
inflation index. These prices will drop with coupon or amortization payments, by
an amount that is close to that of the payment.
Chart 99: Outstanding bonds by type
Chart 98: Maturity profile of Argentine Treasury bonds in ARSbn
12
Local Debt
Other
Ex ternal Debt
12%
10
ARS Inflation
linkers
28%
8
6
4
ARS
158
2045
2042
2039
2036
2033
2030
2027
2024
2021
50%
2018
0
2015
USD
2012
2
10%
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Bloomberg pages
BMLT <GO>
OTC ARS <GO>
OTC ARS FX <GO>
OTC ARS FI <GO>
Reuters pages
IAMCO1
ROFEX
Central bank
http://www.bcra.gov.ar/
Finance ministry
http://www.mecon.gov.ar/finanzas/
Statistics agency
http://www.indec.gov.ar/
Pension regulator
http://www.anses.gob.ar/
Currency of Settlement. All bonds with an ISIN can settle in any currency that
Euroclear or Clearstream accepts. Peso bonds typically trade in pesos or USD.
The most common transactions are in USD, clearing through Euroclear. The
implied FX rate is the ratio ARS price/USD price.
Clearing. Trading of ARS and USD bonds with offshore clients, is through
Euroclear and settles mostly in USD. Some trades settle in ARS when an investor
receives an ARS coupon or principal payment. ARS trading with onshore clients
via MAE usually settle through Argenclear.
Convertibility Restrictions of Payments. ARS coupon and principal payments
are paid to Euroclear’s bank in a local ARS account. Foreigners can still freely
convert coupon payments into USD at the official rate as of July 2012 but not
amortization payments. Financial institutions, corporates and individuals are
restricted on how much FX they can hold via capital ratios and monthly transfers.
The government always verifies the origin of the money to prevent money
laundering. The operation of the blue chip swap is required on amortizations on
ARS-denominated bonds to bring the full ARS cash flows to a foreign currency.
Repatriating ARS payments via a blue chip swap. For ARS amortization
payments on ARS-denominated bonds, funds can be repatriated through a blue
chip swap. In a blue chip swap transaction, a foreign investor buys a locally-listed
security with the ARS cash flow and sells the same security offshore for foreign
currency. The ratio of the two prices implies an exchange rate, which can be above
or below the actual FX rate. This repatriation does entail risks, in the decoupling of
the official exchange rate market and the executable foreign exchange level. The
blue chip FX rate was over 50% higher than the official FX rate in 2012.
Ex-dividend date. The ex-dividend date is typically four business days prior to
the coupon payment date. With normal T+3 settlement, bonds that trade prior to
the ex-dividend date have a right to receive the next coupon payment. Bonds that
trade on or after that do not receive the next coupon. The bond must settle one
day before a typical USD bond.
Inflation-linked. The CER that applies to a coupon or principal payment is
typically that of 10 days prior to the coupon payment date.
Inflation index. The CER Index can be found on Bloomberg ARCECOES Index.
The index is updated with daily future values for the month following the CPI
announcement. The CER may also be found on the central bank website at
http://www.bcra.gov.ar. The path is > Statistics > Monetary and Financial
Variables > Main Variables.
Base CER. The CER as of bond issuance date (10 days prior for Pre08, Pro12,
Boden07, Boden 14, Par Peso, Quasi Par, Disc Peso and five days prior for
Bogar 18).
USD and EUR-denominated bonds
Face quote. The market convention is to quote the original face of a bond,
regardless of the growth due to capitalization.
Price quote. The market convention on all external debt is to quote them on a
clean price basis. However, local law bonds, even if denominated in USD, are
quoted on a dirty price basis.
Currency of Settlement. All bonds with an ISIN can settle in any currency that
Euroclear or Clearstream accepts. The most common transactions are in USD,
clearing through Euroclear. The implied FX rate is the ratio ARS price/USD price.
159
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Coupon and principal payments on local law USD bonds. All USD or EUR
cash flows may be paid out in USD, provided those flows occur through Euroclear
or a similar offshore entity. The local law Par and Discount bonds have identical
coupons and principal payments as the New York Law bonds. The government
has more capacity to change the payment terms of a local law bond than a New
York law bond. For that reason, the local law bonds have much lower prices and
are far less liquid than New York law bonds.
GDP warrants
The 2005 and 2010 exchange included GDP warrants as part of the exchange
package. They were embedded into the bonds at the time of issue and were
detached in November 2005. The GDP warrants, which expire in 2035, make
annual payments on 15 December if annual GDP growth and cumulative real GDP
growth in the prior year both exceed certain scheduled levels.
The future payments of the foreign currency warrants are calculated in ARS and
then converted from ARS to the respective currency at a future FX rate, but one
year before the payment date. As the EUR declines relative to the USD, the
future EUR payments will be larger. The equilibrium level in the prospectus is
1.25865, which is where the EUR/USD was when the government fixed the
formulas for determining relative payments.
From December 2006-2011, the ARS GDP warrant paid out ARS0.65, ARS1.38,
ARS2.46, ARS3.72, 0.00, ARS5.98; the USD GDP-linked warrants paid out
US$7.39 ($0.62, $1.32, $2.28, $3.17, $0.00 and $4.38); and the EUR warrants
€6.75 (€0.66, €1.26, €1.99, €2.84, €0.00 and €4.19).
There were no payments in 2010 because growth was under the 3.2% threshold.
The warrants have a cap on total payments of 0.48 per currency unit. These
securities produced the highest return of all EM debt assets from 2005-2011.
Valued at $2 at the time of the 2005 exchange, in addition to the above dividend
payouts, the price has risen over six-fold.
Auction and placement mechanism
The central bank issues bills and notes – Lebacs (Letras del Banco Central) and
Nobacs (Notas del Banco Central) – to control high-power monetary aggregates.
The BCRA auctions securities on Tuesdays and settles T+1. Average size is
ARS1bn and main participants are local banks, insurance companies and mutual
funds. The size of the auction depends on the amount of sterilization required to
meet monetary targets at any point in time. Foreigners are no longer permitted to
own these notes because they are not Euroclearable.
The government places bonds directly with the nationalized Anses pension fund.
The pension fund may trade or sell some of its holdings from time to time. The
government does not borrow in the public local markets through actions, or offer
banks and other financial institutions.
Derivative market
The derivatives market in Argentina is very illiquid given the fluctuation of the FX
and the lack of long term financing. The IRS market is restricted to the Badlar
versus the fixed rate, but as of today the products have no pricing because
inflation figures have been understated by the government.
FX market
The peso is a heavily managed, nondeliverable floating currency. Companies in
Argentina are required to convert foreign exchange inflows from exports into pesos
within a short time frame. Devaluation and inflation spikes have caused rapid
selloffs during certain periods when the BCRA sells USD positions to support its
160
GEMs Pa pe r #1 0
currency and prevent portfolio dollarization. The FX is artificially pegged to the
country‘s competitiveness and inflation levels, which erodes local costs and exports
in USD terms. FX devaluation is a result of inflation growth driven by governmental
fiscal and monetary expansion to bolster demand and consumption.
The peso is a nonconvertible currency. Average trading volume is about
USD200mn per day. There is an onshore forward market with liquidity up to 12
months. Foreign investors gain exposure to ARS through the offshore market in
non-deliverable forwards. There is a liquid curve for NDFs extending out to 12
months. The fixings for NDFs are determined by the Emerging Markets Trade
Association (EMTA). The central bank releases a fixing for ARS as well.
The EMTA rate is determined by a daily 1pm survey of ARS dealers, with results
published at 5pm. The dealers quote the rate at which a bank or financial
institution can convert ARS into USD5. The official ARS rate is relatively stable,
but the blue chip rate is unofficial and varies widely. As of July 2012, the banks
surveyed for ARS rates are providing the levels at which they can get USD at
close to the official rate.
A two-tiered exchange rate is possible, with the second USD/ARS rate being
much higher. If ARS dealers in the EMTA survey of the ARS fixing were to quote
the higher rate, the ARS rate would jump. For this reason, nondeliverable
forwards, especially long-dated ones, are at a much higher level than the likely
future official ARS. The implied yields from those forward ARS reflect
convertibility risk and are greater than that found in the market.
Chart 100: Badlar rate
Chart 101: Blue chip rate and official ARS
7
25
6.5
20
Blue chip rate
Official ARS
Apr-10
Apr-11
6
15
5.5
5
10
4.5
5
4
3.5
Dec-11
Dec-10
Dec-09
Dec-08
Dec-07
Dec-06
Dec-05
Dec-04
0
3
Oct-09
Oct-10
Oct-11
Apr-12
5 Survey question: Each survey participant will be asked to provide a reasonable judgment of what is (or, in the
case of an Unscheduled Holiday, would be) the current prevailing free market Argentine peso spot rate for a
standard size Argentine peso/US dollar wholesale financial transaction for same-day settlement in the Buenos
Aires marketplace on the Valuation Date. In arriving at this indicative quotation, survey participants will be
directed to take such factors into consideration as they deem appropriate, and which factors may (but need not)
include any or all of the following: the spot rate(s) implied in the offshore non-deliverable foreign exchange
market for Argentine peso/US dollar transactions; the spot rate implied by any other financial market
transactions, to the extent that such other financial markets are open for business; the spot rate used in
connection with any commercial transactions for goods or services from offshore suppliers or providers; any
existing rate for trade finance transactions; and any other existing unofficial rate for Argentine peso/US dollar
transactions (commercial or otherwise).
161
GEMs Pa pe r #1 0
Table 114: Argentina’s FX market vital statistics and characteristics
FX product
Onshore
spot
forward
Offshore
NDF
Tradable
product
Avg daily
trading
volume
Avg trading
size
Bid-Ask
spread
ARS spot
USD200mn
USD1mn
ARS 0.001
ARS forward
USD400mn
USD1mn
ARS 0.005
ARS NDF
USD100mn
USD3mn
ARS 0.01
Reuters
reference
Trading hours
USTARTD1=M 10.00-15.00
E
n/a
10.00-15.00
n/a
8.30-16.00
Note: Proper documentation is required.
Investor base
The pension funds were nationalized in 2008 when the pension system had about
US$40bn in assets. The Anses portfolio has about 60% government debt. The
Anses is an important source of demand and supply, and has a market impact as
it rotates out of one bond into another. The local capital markets supply has been
absorbed by insurance companies, which have been concentrating over 50% of
their portfolios in government bonds.
Central bank LEBACS and NOBACS are not Euroclearable anymore and holding
is restricted to onshore investors. In addition, financial institutions, corporates and
individuals are restricted on how much FX can hold via capital ratios and monthly
transfers. There are many currency restrictions for local investors buying USD.
Foreigners with ARS assets can receive dividends and repatriate their capital
through the blue chip. As of July 2012, locals cannot save in USD, but they can
hold USD obtained before July 2012 in a local bank and transfer those USD to an
offshore bank.
With the exception of LEBACS and NOBACS, Treasury debt is done OTC and
through the stock exchange. Treasury is cleared domestically and offshore
through MAE, Argenclear and Euroclear.
Chart 102: Anses pension fund portfolio breakdown
Chart 103: Anses pension fund public debt holding in USDmn
Others, 7,369,
Others
Infrastructure
9%
Stocks
Cuasi Par
26%
ARS, 9,935,
8%
36%
financing
14%
Bonar 14,
Time deposits
2,070, 7%
10%
Government
bonds and
corporate bonds
59%
162
Bonar 16,
2,526, 9% Bonar 18,
2,964, 10%
Disco ARS
33, 3,515,
12%
Currency
Market
Quote
Coupon Reset
Capitalizing
Amortizing
Ticker
Cpn
Maturity
Issue Date
Frequency
Coupon Payment Dates
Amt Outstanding (bn)
Governing Law
ISIN
USD
Domestic
Dirty
6Mo Libor Flat. Max =3%.
-Y
ARGBOD
3
4/30/2013
10/30/2002
2
April 30, Oct 30
0.24
local
ARARGE035709
USD
Domestic
Dirty
Fixed
--ARGBOD
7
10/3/2015
10/3/2005
2
April 3, Oct 3
5.82
local
ARARGE03F144
Bonar VII
Bonar X
DISC USD
PAR USD
USD
Domestic
Dirty
Fixed
--ARGBON
7
9/12/2013
9/12/2006
2
Mar 12, Sep 12
2
local
ARARGE03F342
USD
Domestic
Dirty
Fixed
--ARGBON
7
4/17/2017
4/17/2007
2
April 17, June 17
6.86
local
ARARGE03F441
USD
Domestic
Clean
Int Partly Cap to 2013
Y
Y
ARGENT
8.28
12/31/2033
11/29/2005
2
June 30, Dec 31
1.11
local
ARARGE03E113
USD
Domestic
Clean
Step Up Coupon
-Y
ARGENT
2.5
12/31/2038
11/29/2005
2
Mar 31, Sep 30
1.23
local
ARARGE03E097
Table 115: USD/EUR-denominated outstanding bonds, governed by local law
BODEN 13
BODEN 15
Currency
Market
Quote
Coupon Reset
CER-linked inflation
Badlar floater
Base CER
Capitalizing
Amortizing
Ticker
Cpn
Maturity
Issue Date
Frequency
Coupon Payment
Dates
Amt Outstanding(bn)
Governing Law
ISIN
Pro 13
BOGAR 18
ARS
Domestic
Dirty
Int Cap to 3/15/08
Y
ARS
Domestic
Dirty
Int Cap To 1/3/06
Y
ARS
Domestic
Dirty
Int Cap to 3/15/14
Y
ARS
Domestic
Dirty
Int Cap To 10/02
Y
1.4671
Y
Y
ARGBOC
2
3/15/2014
3/15/2004
12
15th
1
Y
Y
ARGBOC
2
1/3/2016
2/3/2002
12
3rd
1.4657
Y
Y
ARGBOC
2
3/15/2024
3/15/2004
12
15th
1
Y
Y
ARGBOG
2
2/4/2018
2/4/2002
12
4th
1.5176
-Y
ARGBON
2
9/30/2014
9/30/2004
2
Sep 30, Mar 31
1.4551
Y
Y
ARGENT
5.83
12/31/2033
6/30/2005
2
June 30, Dec 31
0.29
local
ARARGE03B309
1.58
local
ARARGE035162
1.93
local
ARARGE03B219
11.82
local
ARBNAC030255
4.65
local
ARARGE03E931
10.47
local
ARARGE03E121
BODEN 14
DISC ARS
PAR ARS
BOCAN 14
BOCAN 15
ARS
ARS
Domestic
Domestic
Dirty
Dirty
Fixed Int Partly Cap to 2013
Y
Y
ARS
Domestic
Dirty
Step Up Coupon
Y
ARS
Domestic
Dirty
--
ARS
Domestic
Dirty
--
1.4551
-Y
ARGENT
1.18
12/31/2038
6/30/2005
2
Mar 31, Sep 30
Y
-N
N
ARGBON
BADLAR+275
1/30/2014
1/30/2009
4
30th
Y
-N
Y
ARGBON
BADLAR+300
9/10/2015
9/10/2009
4
10th
2.86
local
ARARGE03E105
6.36
local
ARARGE03G316
10.84
local
ARARGE03G506
GEMs Pa pe r #1 0
Table 116: Argentine peso-denominated outstanding bonds
PRE 9
PRO 12
163
GEMs Pa pe r #1 0
Brazil
Overview
David Beker
+5511 2188 4371
The Brazilian fixed income market is the largest in Latin America. Liquidity varies
across asset class, but the fact that the BRL is not a convertible currency and
foreign portfolio inflows are subject to the IOF tax (financial operations) limits
foreign participation in local fixed income.
Flavio de Andrade
Brazil is rich in natural resources including iron ore, soybeans and crude oil but
exports are only about 11.9% of GDP. The key driver of the economy is private
consumption, which represents 60.3% of Brazilian GDP.
Monetary policy
Background. In 1999, after more than four years of adopting a fixed-exchange
rate with a defined depreciation path, the government decided to let the BRL float.
To help anchor the new regime, the central bank implemented an inflationtargeting model.
Table 117: Brazil local debt ratings profile
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
Baa2
Baa2
Baa3
Baa3
Ba1
Ba1
Ba2
Ba3
Ba3
B2
B2
B1
B1
B3
Caa1
-
ABBB+
BBB+
BBB+
BBB+
BBB
BB+
BB
BB
BB
BB
BB+
BB
BBBB+
BB+
BB
BBB
BBB
BBBBBBBBBBB+
BB
BBBBB+
B
B+
B+
B
BBBB-
Chart 104: Key Brazil CPI components
Food
23.2%
Transport
20.1%
Housing
14.8%
Healthcare
11.2%
Personal ex pend
10.2%
Other
20.5%
0%
10% 20% 30% 40%
Policy framework. The inflation target has declined over time, but has been at
4.5% with a 2% band since 2005. In 10 years of inflation-targeting, inflation fell
within the target band in all years except 2001 and 2002. The bank targets
consumer inflation using the IPCA index, which is calculated and released by the
IBGE 6 biweekly (IPCA and IPCA-15).
Base rate. The monetary policy committee (COPOM) holds eight meetings a year
to decide the Selic target interest rate (BZSTSETA Index on Bloomberg). A short
policy decision statement is released after each meeting, indicating whether the
decision was unanimous or not; if it was not, the statement reveals the options
being discussed. Starting in 2012, the statement reveals the votes for each board
member. The bank also releases monetary policy meeting minutes on the
Thursday of the week following each meeting, bringing a deeper discussion on
the economic backdrop and the rates decision.
The Brazilian Central Bank (BCB) publishes quarterly inflation reports, presenting
its own forecast for the inflation and GDP paths within a two-year horizon. A
feature of the COPOM outcome is that the BCB may also introduce a bias for the
monetary policy, which would allow the bank to change interest rates between
meetings. The last time the bank used a bias (up or down) was in March 2003.
Open market operations. The BCB manages liquidity by doing repo operations
(operações compromissadas) backed by local government bonds. These repo
operations help the BCB to steer the effective Selic rate toward the target rate.
Lending and deposit facilities. The BCB adopts a segregated system for
remunerating required reserves. Reserves on cash deposits do not earn interest,
while reserves on term and savings deposits earn the Selic and the savings rate,
respectively. Banks that do not meet the reserve requirement can borrow from the
BCB at the redesconto (discount) rate, currently set at Selic + 4%.
Reserve requirements. Reserve requirements are an important monetary policy
instrument. There are different reserve requirement brackets for cash and term
deposits and for savings accounts. Reserve requirements were about 31% of
total deposits in July 2012, one of the highest in the world.
6
164
Statistics Agency (Instituto Brasileiro de Geografia e Estatistica).
GEMs Pa pe r #1 0
Conventions
FX policy. Brazil has a managed floating FX regime in which the BCB intervenes
to smooth FX volatility, cushion FX movements, build up FX reserves and correct
level distortions. The BCB is very transparent on the intervention mechanism,
using spot, short-term forwards and swap auctions. When it decides on spot
intervention, it conducts an auction through dealers with discretion on the
amounts. In terms of the swaps, the bank auctions FX swaps 7 (sells dollars on a
future date) or reverse FX swaps (buys dollars on a future date).
Bonds
Settlement: T+1:
Basis: Bus/252
Coupon frequency: Semi-annual (compounded rate)
IRS (Interest rate future)
Fiscal policy
Fixing: DI
Brazil has pursued primary surplus fiscal targets since 1998 in order to create
conditions for the debt to GDP ratio to decline over time. The primary surplus
fiscal target for 2012 is 3.1% of GDP. As interest rates reach historically low
levels, reducing debt interest expenses, focus on the overall budget result should
increase. After ending 2002 at 60.4% of GDP, the net public debt declined to
36.4% by the end of 2011. Gross general government public debt moved from
76.7% of GDP to 54.2% of GDP in the same period.
Coupon frequency: bullet, daily settled
CCS
Fixing: Cupom cambial x DI
Coupon frequency: Act/360 on dollar leg, Bus/252 on
BRL leg
The stock of federal public debt reached BRL1.97tn in June 2012, of which 41%
was local nominal (plus BRL globals), 32% inflation-linked, 23% Selic 8-linked and
only 4% EXD (minus BRL globals). This compares to 16% fixed rate debt, 47%
Selic-linked debt and 24% FX-linked debt back in 2004. The government remains
focused on bolstering its debt profile by replacing floating debt (Selic-linked) by
fixed rate and inflation-linked bonds, extending maturities, creating benchmark
bonds and improving liquidity in the secondary market.
Macro drivers
Several releases tend to be market moving events. Besides the monetary policy
decisions, market participants focus on the COPOM minutes and the analyst
survey the BCB releases every Monday morning. The key inflation releases are
the IPCA and IPCA-15 from the IBGE, though market participants also focus on
the broad inflation numbers released by FGV (IGP-10, IGP-M and IGP-DI). On
growth, market participants focus on retail sales, industrial production, monthly
and quarterly GDP and job creation.
Chart 106: Brazilian debt composition; total BRL 1971n (USD981bn)
Chart 105: Brazil – maturity profile (in USDbn) of local BRLdenominated debt (including BRL Global EXD)
LTN
NTN_F
LFT
NTN_B
NTN-C
BRL Globals
200
Floating 23%
Inflation linker
33%
150
100
USD (EXD)
4%
50
BRL 40%
0
2012 2016 2020 2024 2028 2032 2036 2040 2044 2048
Source: National Treasury, BofA Merrill Lynch Global Research
Source: National Treasury, BofA Merrill Lynch Global Research
7 One leg is onshore dollar rates (cupom cambial) plus FX change and the other leg is CDI (interbank deposit
rate).
8
Selic rate is the rate set by the Brazilian Central Bank in its monetary policy meetings (COPOM).
165
GEMs Pa pe r #1 0
Bond market
In June 2012 total federal government domestic debt was BRL1882bn and 14bn
of Global BRL, for a total of USD943bn. The main local currency debt instruments
are LTN (zero discount bonds), NTN-F (fixed coupon bonds), NTN-B (IPCA
inflation-linked bonds) and LFT (floating rate bonds). The NTN-Cs (IGPM
inflation-linked bonds) are off the run and being replaced by NTN-Bs. The
Treasury has also focused on replacing the floating rate LFTs for fixed-rate and
inflation linkers.
The day count convention of local bonds is [business days/252], and semi-annual
coupons are compounded based on the annual coupon rate. For example, the
NTN-Fs 10% coupon translates into a 4.88% payment each semester. In addition,
the price to yield relation in Brazil is always expressed in terms of dirty price.
LTN. The LTNs (Letras do Tesouro Nacional) are short-term (up to 5 years),
zero-coupon bonds that make up 29% of local issued federal government debt.
LTNs are issued in 6, 12, 24, 36 and 48-month maturities, with the January 2016
the longest available. The LTNs are traded mainly by locals; foreigners hold 15%
of the outstanding BRL 542bn.
NTN-F. The NTN-Fs (Notas do Tesouro Nacional serie F) are fixed rate bonds
with 10% coupons and semi-annual payments. The longest NTN-F bond is the
January 2023. The most liquid tenors are the 2017 and 2021, but we expect there
may be a shift to the on the run 2018 and 2023. The NTN-F series represent 12%
of all local issued federal government debt. The NTN-Fs are popular among
foreign investors who hold 44% of the outstanding BRL 222bn.
NTN-B. The NTN-Bs (Notas do tesouro nacional serie B) are IPCA inflation-linked
bonds that pay a 6% semi-annual coupon and account for 30% of total
outstanding local debt. The IPCA is the consumer price index calculated by the
IBGE in which BCB inflation target is set. The NTN-Bs are denominated in VNA
(valor nominal) and settled in BRL. The NTN-B VNA is an inflation indexed unit
based on monthly IPCA variation, published by the Treasury the 15th day of each
month. The longest NTN-B matures in August 2050. The liquid tenors are 2016,
2022, 2030 and 2050.
LFT. The LTNs (Letras do Tesouro Nacional) are short-term (up to 6 years),
floating rate, zero-coupon bonds, which make up 24% of local issued federal
government debt. The total return is a function of the Selic rate and the discount
of the bond, as the face amount of these bonds is capitalized daily at the effective
Selic rate. The LTNs are traded mainly by locals; foreign investors hold a little
over 1% of the outstanding amount.
NTN-C. The NTN-Cs (Notas do tesouro nacional serie C) are IGPM inflationlinked bonds that pay a semi-annual coupon. They are not very liquid, accounting
for only 3% of total outstanding local debt. The IGPM is the CPI calculated by
Fundacao Getulio Vargas. The NTN-Cs are denominated in VNA (valor nominal)
and settled in BRL. The NTN-C VNA is an inflation-indexed unit based on monthly
IGPM variation, published by the Treasury the first day of each month. Even
though the NTN-B and NTN-C VNAs carry they same name, they represent
different units of measurement because they track different inflation indices.
Auction and placement mechanism
The Brazilian National Treasury is responsible for bond issuance. Besides
announcing an annual borrowing plan between January and February each year,
166
GEMs Pa pe r #1 0
the Treasury announces a monthly schedule for bond auctions on the last Friday
of the prior month. The schedule contains the date for each bond auction with
specific bonds (including maturities) to be issued each day. The size of each offer
is announced on the day of the auction. In addition to the traditional auctions, the
Treasury also conducts exchange auctions and buyback auctions. Most domestic
issuance is done on a competitive basis through auctions with multiple prices.
The LFT and NTN-B issuance are exceptions, and placed via Dutch auctions.
Derivatives market
PRExCDI futures
The DI futures market in Brazil is the most liquid interest rate derivative market in
LatAm. They are traded on the BM&FBovespa exchange in Brazil and reference
the overnight interbank interest rate, the CDI (Certificado de Deposito
Interbancario). The DI future rate tracks the effective interest rate between the
trade date and the maturity of the contract on a 252-business-day basis. Contract
maturities are available for the coming four months and for every quarter
thereafter. The contract is quoted on a yield basis, but cash value of the position
is given by the present value per contract (BRL100,000 notional), discounted by
the most current traded interest rate.
At the end of initial trade date the future is marked-to-market based on the
settlement (closing) interest rate. After that, the cash value of the open position is
indexed daily to reflect the actual overnight rate and at the end of each day the
position is adjusted. The PnL is based on the updated value of the position
against the settlement interest rate at the end of the trading session. This ensures
that from the trade date until expiration, the DI futures reflect the exact difference
between the traded fixed yield and the reported floating DI rate for the period
between the trade date and maturity. The contract performs like a fixed for
floating swaps.
Table 118: Summary statistics of Brazil derivative products and their markets
Product
Interest rate (Onshore)
PRExDI Future
Average daily
trading volume
USD40bn
Option on DI futures
60k contracts
IDI options
600k contracts
Interest rate (Offshore)
PRExDI offshore
swap
USD1mn DV01
Average
transaction size
Bid-ask
spread
Fixings and
other notes
2k contracts Jan 14, 1bp liquid tenors, 2- Monthly contracts,
5k contracts Jan 15
5bp less liquid
January expirations
are most liquid
5k contracts
0.5% vol
Monthly contracts,
January and July
expirations most
liquid
10k contracts
10pts per contract Monthly contracts,
January and July
expirations most
liquid
25k DV01
1bp liquid tenors, 2- Matches subset of DI
5bp less liquid
futures contracts,
January and July
expirations
Source: BofA Merrill Lynch Global Research, BM&F
167
GEMs Pa pe r #1 0
Bloomberg pages
OTC BRL <GO> – Market monitor
ODA <cmdty> – CT DI futures
CDIE <GO> – Market implied rates
BNLTN Govt <GO> – LTN bonds
BNTNF Govt <GO> – NTN-F bonds
BNTNB Govt <GO> – NTN-B bonds
BMLT <GO> – LatAm local markets
Reuters pages
<BRL=>
Central bank
http://www.bcb.gov.br/
Finance Ministry
http://www.fazenda.gov.br/
Statistics agency
http://www.ibge.gov.br/home/
Pension association
http://www.abrapp.org.br
Bond auctions
http://www.stn.fazenda.gov.br/divida_publica/leiloes.asp
BM&F – Futures, Commodities, Stock Exchange
http://www.bmfbovespa.com.br/
Association of Capital Markets Operators (ANBIMA)
http://portal.anbima.com.br/
All DI futures contracts mature in the first business day of the contract month.
9
Liquidity tends to be concentrated in the January contracts , as they match the
maturities of the NTN-Fs. Bondholders tend to use the DI futures to switch from
fixed to floating interest rate exposure. Bid-ask spreads are as narrow as 1bp up
to Jan-14, and 2-5bp in the longer tenors (in up to 10k DV01). The day count
convention for DI futures (and other Brazilian fixed income) is 252 business days.
Offshore players that are not set up to trade locally use offshore PRExDI swaps
to take positions in the onshore DI futures market. With the elevated IOF tax, the
spread between onshore and offshore prices increased with offshore yields
trading below onshore yields due to foreign net demand for receivers and the cost
for dealers to replicate and hedge these instruments in the local market.
Onshore-offshore spread 10
The onshore-offshore spread reflects the BRL convertibility risk (in and out), as
the BRL is not a deliverable currency. The spread also reflects IOF taxes. In
2010, the government increased the IOF tax from 2% to 4% and then to 6%. As a
result, the on-off spread increased as the cost for investing in Brazilian assets
became higher vís-a-vís investing in Brazilian assets abroad. One example of this
is the increase in spread between Global BRL bonds and the local NTN-F bonds,
as well as the compression in NDF implied yields.
Previously, when foreign investors traded offshore NDF and offshore yields, the
banks providing liquidity used to hedge themselves onshore at the BM&FBovespa
futures market. However, with the IOF tax on onshore FX derivatives positions,
the onshore and offshore markets have become more disconnected.
Cupom cambial and FX swaps
The cupom cambial is an onshore dollar interest rate. There are two major
instruments to trade the cupom cambial: cupom cambial futures (DDI) and the
11
cupom cambial forward rate agreement (FRC ). The DDI has exposure to moves
in the local dollar rate and moves in the FX. The FRC, also known as the clean
cupom cambial, has exposure to the dollar rate but not to FX moves. The FRC is
made up of two DDI contracts, a receiving leg and a paying leg. One of the DDI
contracts in the FRC is the front future to remove the FX exposure. The amount in
the two DDI contracts are such that it has the same present value.
Offered occasionally by the central, bank, the currency swaps consist of two legs:
one is the FX change + the onshore dollar rate (cupom cambial), and the other
leg is the CDI. When the central bank receives the FX change and the cupom
cambial and pays the CDI, the swap is called reverse-FX swap. When the central
bank receives the CDI and pays the FX change, the cupom cambial the swap is
called FX swap.
Interest rate options 12
The two key interest rate options traded in Brazil are the swaptions (option on DI
future) and IDI options (1 day Bank Deposit Index). Brazil swaptions are more
common among foreign investors, while locals concentrate their positions on IDI
options (options on the cumulative value of the CDI between the trade date and
the maturity of the option).
9
Contracts can be found at ODA Cmtdy CT <go> on Bloomberg.
For more details see: Brazil: onshore-offshore spread 101
(http://research1.ml.com/C/?q=PJLqDX1ocgXltljEpgrEYA__&r=)
10
11
Contracts can be found at GDA Curncy CT <GO> on Bloomberg.
For more details see: What’s unique in LatAm swaptions?
(http://research1.ml.com/C?q=Hgfm0ECzASUTVpttwucbzQ__&s=)
12
168
GEMs Pa pe r #1 0
FX market
The BRL is not deliverable, but its daily volume including spot, futures and NDFs
exceeds US$15bn, competing with the MXN as one of the most liquid currencies
in the region. The BRL is traded during BM&FBovespa trading hours, and the
dollar futures (particularly the front future) are one of the most liquid products on
the exchange. BRL liquidity declines significantly in the off-hours market (over the
counter), with the bid-offer widening.
PTAX. The daily reference FX fixing rate. Under new methodology implemented
in 2011, the BCB surveys all 14 FX dealers 13 four times a day to get BRL price
quotes. The BCB conducts one survey, in any two minutes, from 10:00am to
10:10am, 11:00am to 11:10am, 12:00am to 12:10am, and 1:00pm to 1:10pm.
Each foreign exchange dealer must give a quote with bid-offer for a BRL
transaction in the interbank market. The BCB then excludes the outliers – the two
highest and two lowest quotes – and calculates the average of the quotes. The
calculated average is released after each quote. The daily PTAX is the average of
all surveys. Under the old methodology, the PTAX was a volume weighted
average of all BRL spot transactions during the day.
Table 119: Brazil’s FX market vital statistics and characteristics
FX
product
Onshore
Spot
Future
Forwards
Options
Tradable
product
BRL spot
USD/BRL
future-BM&F
Forward
Options
BM&F/OTC
Avg daily
trading
volume
Avg
trading
size
Bid-ask
spread
Reuters
reference
Key facts
USD1.8bn
USD15bn
USD5mn
USD5mn
7pips
5pips
<BRL=BR>
< 0#DOL:>
Settlement: T+2
Fixing PTAX
USD45mn
USD1.25bn
USD5mn
USD15mn
5pips (short)
0.3 – 0.5 vols
<BRLNDFOR=BR>
< BR/OPT5>
Fixing PTAX
Fixing PTAX
3m 10 pips,
12m 50 pips
0.3 – 0.5 vols
< BRLNDFOR=>
Fixing PTAX
< BR/OPT5>
Fixing PTAX
Offshore
NDF
Forward
USD4.5bn
USD10mn
NDO
Options
USD750mn
USD30mn
1 pip = 0.0001 BRL Source: BofA Merrill Lynch Global Research, BM&F
Chart 107: Monetary policy rate (Selic) declines to record lows
Chart 108: Brazil foreign reserves rise, $376bn in July 2012
400
17.5%
SELIC policy target rate
350
Foreign reserv es (USD bn)
300
15.0%
250
200
12.5%
150
100
10.0%
50
0
7.5%
Jan-06
Jan-08
Jan-10
Jan-12
Source: Banco Central do Brasil, BofA Merrill Lynch Global Research
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Banco do Brasil, Bradesco, Itau Unibanco, HSBC, Credit Suisse, Citibank, Santander, JP Morgan, Bank of
America Merrill Lynch, BTG Pactual, BNP Paribas, Banco Votorantim, Goldman Sachs, and Morgan Stanley.
13
169
GEMs Pa pe r #1 0
Investor base
Foreign investors have increased their participation in the domestic debt market
significantly in the last five years. In 2006 foreign investor participation in the
domestic federal public debt was close to 2%, and increased to 7% in 2008 and
12.2% in June 2012. Following the recent growth, foreign participation in the
NTN-Fs reached 12.2% of the outstanding amount in May 2012.
The local mutual fund holdings in Brazil continue to grow at a fast pace,
exceeding BRL2.1tn ($1tn) in May 2012, over 10% growth in the last 12 months.
As of July 2012 local mutual funds held BRL864bn in government bonds. In GDP
terms, assets under management from pension funds and mutual funds
increased from 53% of GDP in 2005 to 64.7% of GDP in 2011 (49.8% of GDP for
mutual funds and 14.9% of GDP for pension funds). On a regional basis, Brazil
accounts for 66.5% of the total assets under management in LatAm.
As the public and private pension system is small, its overall government
securities holding is very small at 15.3% of total assets, or BRL91bn as of March
2012. The public pension system (closed) is by far the largest share of the
nation’s overall retiree pool. The public system runs large deficits due to legacy
benefit and early retirement age. As a result, the private system (open) is growing
very rapidly, but is very small compared to other LatAm countries. Both open and
closed pension funds offering defined-contribution or defined-benefit plans are
overseen by Associação Brasileira das Entidades Fechadas de Previdência
Complementar (ABRAPP).
Taxation depends on the instruments, holding periods and origin of funds. The
fiscal treatment regarding the income tax varies according to the origin of funds
(from tax havens or not) and the type of investment. The IOF is a tax levied on
14
credit and fixed income transactions of locals and foreigners. The IOF treatment
depends on the type and investment tenor. All investors incur an IOF charged on
very short-term gains up to a 30-day holding period, based on a declining rate.
Foreign investors are open to invest in Brazil but under resolution 2689 must
register with the BCB. Foreign investor inflows to buy local fixed income are taxed
with a 6% IOF when the transaction involves an inflow of foreign currency or
switching from another asset class that does not incur the IOF. When buying
longer-maturity bonds, investors dilute the tax burden over the duration of the
bond. The outflows of foreign currency do not incur the IOF.
Table 120: History of IOF on FX
12-Mar-08 22-Oct-08 19-Sep-09 4-Oct-10 18-Oct-10 28-Mar-11 6-Apr-11 26-Jul-11 1-Dec-11 29-Feb-12 12-Mar-12 14-Jun-12
Portfolio
Fixed income
Equities
Deposit margin on derivatives
External loans
90 days
270 days
1 year
2 years
3 years
5 years
Long BRL positions on FX derivatives*
1.5%
0%
0.38%
0%
0%
0.38%
2%
2%
0.38%
4%
2%
0.38%
6%
2%
6%
6%
2%
6%
6%
2%
6%
6%
2%
6%
6%
0%
6%
6%
0%
6%
6%
0%
6%
6%
0%
6%
5.38%
0.38%
0.38%
0.38%
0.38%
0.38%
0%
5.38%
0.38%
0.38%
0.38%
0.38%
0.38%
0%
5.38%
0%
0%
0%
0%
0%
0%
5.38%
0%
0%
0%
0%
0%
0%
5.38%
0%
0%
0%
0%
0%
0%
6%
6%
6%
0%
0%
0%
0%
6%
6%
6%
6%
0%
0%
0%
6%
6%
6%
6%
0%
0%
1%
6%
6%
6%
6%
0%
0%
1%
6%
6%
6%
6%
6%
0%
1%
6%
6%
6%
6%
6%
6%
1%
6%
6%
6%
6%
0%
0%
1%
Note: *On 16 March 2012, the government reduced the bracket from 1% to zero for export hedges.
Source: Brazilian Central Bank, Finance Ministry, BofA Merrill Lynch Global Research
14
170
Imposto sobre Operacoes Financeiras (Tax on Financial Operations).
GEMs Pa pe r #1 0
In July 2011 the government introduced a 1% IOF on the daily increase in the
short USD long BRL positions in derivatives. Investors should check with their tax
consultants for specific details and particular issues.
Government securities acquired in primary placement auctions are settled on T+1
through the Selic, which is administered by the BCB. Securities traded in the
secondary market and on repo with the BCB are settled on a delivery versus
payment (DVP) basis and typically settle on T+1, but could settle on T+0 or T+2.
Table 121: Summary of Brazil bond markets and products
Instrument
LTN
Issuer
Currency
Tenor
Coupon Payments
Amount outstanding
(as of June 2012)
Secondary Market
Trading
Settlement Period
Average trade size
Clearing Mechanism
Major players
Trading hours
Regulations
Custodian
Withholding Tax
Capital gains Tax
Entry/Exit
Primary Auctions
Auction Style
Average Issue Size
NTN-F
NTN-B
Federal government (Tesouro Nacional)
BRL
1000
1-4 years
0
Zero coupon
Bus/252
Bullet
BRL541.6bn
BRL
1000
1-10 years
10% semi-annual compounded
Semi-annual
Bus/252
Bullet
BRL222bn
IPCA-linked VNA (settled in BRL)
NTN-B VNA
1-38 years
6% semi-annual compounded
Semi-annual
Bus/252
Bullet
BRL570bn
OTC or Exchange (BM&F SISBEX)
Yield
T+1 (foreign clients tend to use T+2 or T+3)
BRL3650bn (LTN + NTN-F)
2-5bp (can vary between 1-10bp)
50,000 bonds
Selic book entry
Local banks and local funds
9am-6pm (Sao Paulo, more liquidity 10-4)
Yield
BRL3650bn (LTN + NTN-F)
50,000 bonds
Selic book entry
9am-6pm (Sao Paulo, more liquidity 10-4)
Yield
BRL3140bn
10,000 bonds
Selic book entry
9am_6pm (Sao Paulo, more liquidity 10-4)
No restriction, required registration with the
BCB and IOF tax
Banks
Locals 15-22.5%, nonresidents 15%
IOF tax on foreign inflows/no exit tax
BCB and IOF tax
Banks
BCB and IOF tax
Banks
Competitive auction
Varies (minimum tender 1,000 bonds)
Competitive auction
Dutch auction
Source: BofA Merrill Lynch Global Research , ANBIMA, Tesouro Nacional, Banco Central do Brasil
171
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Chile
Overview
Marcos Buscaglia
The Chilean local government debt market is the fourth largest in Latin America
after Brazil, Mexico and Colombia. Corporate borrowers represent the bulk of the
local debt market, followed by the central bank and the Treasury. The FX and the
fixed income derivatives markets are liquid and the third largest in the region.
Flavio de Andrade
Chile is the most open economy in LatAm and has the biggest exposure to China.
Mining represents more than 60% of exports. A structural surplus fiscal rule has
been set to isolate public finances from copper price swings, and the government
has substantial savings abroad to face copper price declines.
Monetary policy
Table 122: Chile local debt ratings profile
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
Aa3
Aa3
Aa3
A1
A1
A1
A1
A1
A1
A1
A1
A1
A1
A1
-
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AA
AAAAA+
A+
A+
A+
A+
A+
A+
A+
AAAAAAAAAAAAAA
-
Chart 109: Key Chile CPI components
25.3%
Fo o d
19.3%
Transpo rt
Ho using go o ds
7.5%
Leisure
7.5%
Educatio n
6.0%
Health
5.4%
0%
10%
172
20%
Base rate. The BCCh achieves its objective by controlling the overnight interest
rate known as Tasa de Politica Monetaria (CHOVCHOV Index on Bloomberg), or
TPM. The board meets the second or third Thursday of every month and issues a
monetary policy statement along with their decision after market close. Minutes of
the meeting are published three weeks after. A chart packet is published the day
before the meeting, highlighting the key macro and financial variables that factor
into the policy decision.
The board also produces a monetary policy report, known in Spanish as IPOM, at
the end of each quarter that delineates the bank’s baseline macroeconomic
projections. Often, a change in these projections results in an adjustment in
monetary policy stance.
Open market operation. The central bank conducts its open market operations
through purchases and sales of securities issued by the BCCh (Cupos de
Pagarés y Bonos), repurchases, liquidity deposits and currency swaps.
Reserve requirements. Reserve requirements are not used as a monetary
instrument to modify liquidity conditions. Moreover, the reserve requirement rates
have remained relatively unchanged since 1980 16.
15.7%
Other
Policy framework. The BCCh targets an explicit inflation level, currently at 3%
(+/- 1% margin of error) with a two-year horizon. Symmetrically, the central bank
is concerned with missing target bands, namely inflation exceeding or falling short
of the respective inflation bands. The BCCh targets the consumer price index
(CPI), calculated and released by INE. 15
Lending and deposit facilities. The BCCh offers standing overnight liquidity
(SLF) and deposit facilities (SDF) to authorized financial institutions. It
compensates the SDF at TPM – 25bp and charge the SLF at TPM + 25bp.
Additionally, the BCCh offers an intraday liquidity facility (ILF), which corresponds
to a loan that must be repaid on the same day without cost of interest to the bank.
13.3%
Ho using
Background. Central Bank of Chile (BCCh) basic constitutional law establishes
three fundamental objectives: to preserve the currency stability, to ensure the
normal functioning of domestic payments, and to ensure the normal functioning of
external payments. In 1999 the exchange rate band mechanism was abandoned,
and a free-floating regime adopted. Since 2000, the BCCh has implemented an
inflation target mechanism.
30%
15
Statistics Agency (Instituto Nacional de Estadística).
16
The only exception was in 1994 when the BCCh decided to constitute reserves requirement using a calendar-
GEMs Pa pe r #1 0
Conventions
FX policy. Chile allows for a free floating exchange rate, but in the past the
central bank has intervened to curb CLP strength. As an inflation-targeter, the
BCCh’s interest in the FX level is related to impact on the inflation rate. In the
words of former Governor Jose De Gregorio (our translation): “Even though the
pass-through is low, it does not eliminate the impact of exchange rates on
inflation”. 17 The BCCh justified its last two interventions in terms of building
reserves and FX misalignment (April 2008), and building reserves and smoothing
out the effects of the FX adjustment (January 2011).
Bonds
Settlement: T+2 (also T+0 and T+1):
Basis: ACT/365
IRS
Fixing: CAM (Camara rate)
Fiscal policy
Coupon frequency: bullet for tenors under 18m, semi-
Fiscal policy. Since 2001 Chile has based its fiscal policy on the concept of
structural balance 18 of the consolidated central government. In simple terms, this
means that budgeted spending will be in line with cyclically adjusted fiscal policy,
adjusting by economic activity, and copper and molybdenum prices. The
government plans to restore structural fiscal balance by the end of President
Piñera's administration. The government has the capacity to expand fiscal policy
if there is a shock, as it has about US$15bn in the sovereign wealth fund.
annual 2y and longer
CCS
Fixing: CLP x LIBOR
Coupon frequency: 6m or 3m
Debt issuance. Up until March 2012 the government had been a net creditor,
with gross debt and net credit with respect to GDP at 10.5% and 8.1%,
respectively. During 1Q the Treasury did not issue external debt but published its
local debt issuance schedule in February. However, the government has
increased issuance somewhat following the 2010 earthquake with the dual goals
of financing the reconstruction effort and building benchmark maturities in the
sovereign yield curve. Low debt levels coupled with solid fiscal management and
strong institutions have led Chile to be ranked as one of the safest credits in EM
by all three rating agencies.
Chart 110: Chile – maturity profile (USDbn) of local CLP-denominated
debt
5
BCP
BCU
BTP
BTU
Chart 111: Chile debt composition; total USD58bn
CL (Treasury )
Treasury (UF)
8%
33%
4
CLP (BCCh)
3
21%
CLP (EXD)
2
2%
1
USD (EXD)
UF (BCCh)
0
2012 2015 2018 2021 2024 2027 2030 2033 2036 2039 2042
Source: Direccion de Presupuestos (Budget office), Chile Central Bank, BofA Merrill Lynch Global Research
5%
32%
Source: Direccion de Presupuestos (Budget office), Chile Central Bank, BofA Merrill Lynch Global Research
day basis from a working-day basis, and to compensate lowered the different reserve requirement for cash
deposits and for savings accounts from 10% and 9% to 9% and 3.6%, respectively.
17 De Gregorio, J.. “ Tipo de Cambio, Ajuste Real y Politica Monetaria”, Documentos de Política Económica No.
34, August 2009.
18
From a conceptual standpoint, cyclically adjusted balance is more appropriate.
173
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Macro drivers
In terms of market impact, the most important macro data releases are monthly
CPI and the IMACEC economic activity proxy, both released during the first full
week of the month. Toward month-end, an economic activity report is released
with details on industrial production, copper sales, construction activity and other
variables. Additionally, the BCCh publishes a monthly economists’ expectations
survey and a biweekly market maker expectations survey, which include GDP,
monetary policy rate, inflation and USD/CLP local debt market forecasts.
Bond market
The BCCh and the Treasury represent a significant portion of the Chilean fixed
income market. Currently, the central bank is issuing inflation-linked bonds up to 30
years and peso-denominated bonds out to 10 years. The Treasury issues inflationlinked bonds up to 30 years. Primary dealers authorized to participate in the auction
process include banks, pension funds, insurance companies and local stock brokers.
A large share of the local government debt is inflation-linked. The demand for
inflation assets comes from insurance companies and pension funds. Local
corporates also issue Unidades de Fomento (UF) bonds in order to raise cheaper
funds. These bonds are issued in UF, which is a local currency indexed to inflation.
BCP. Fixed-rate bonds issued by the BCCh, denominated in CLP. There are over
20 maturities distributed out to 10 years. All newly issued BCPs have a 6%
coupon while a few older issues have an 8% coupon. The BCP represents the
largest series of fixed-rate government bonds outstanding, with CLP2.3tn (USD
7bn) outstanding, roughly 14% of the local government debt.
BCU. Inflation-linked bonds issued by the BCCh, denominated in Unidades de
Fomento and settled in CLP. The UF is an inflation-linked unit published by the
central bank. There are over 25 maturities distributed out to 29 years. All newly
issued BCUs have a 3% coupon while a few older issues have 5% coupon. With
UF372mn (CLP8.4tn/USD17bn) outstanding, it represents 33% of the local
government debt.
BTP. Fixed-rate bonds issued by the Chilean Treasury, denominated in CLP. There
are seven bonds out to 20 years. All BTPs carry a 6% coupon. With CLP2.2tn (USD
4.5bn) outstanding, it represents only 9% of the local government debt.
Chart 113: Chile – a net creditor
Chart 112: Chile – policy rate and inflation
50%
12%
10%
40%
8%
30%
6%
20%
4%
10%
2%
0%
0%
-2%
-4%
-10%
O/N Policy Rate
CPI (y oy )
Gross Debt (% of GDP)
-6%
Mar-00
-30%
Mar-02
Mar-04
174
Net Debt (% of GDP)
-20%
Mar-06
Mar-08
Mar-10
Mar-12
1991
1994
1997
2000
2003
2006
2009
2012
GEMs Pa pe r #1 0
Bloomberg pages
OTC CLP <GO> – Market monitor
BCPCL Govt <GO> – BCP bonds
BCUCL Govt <GO> – BCU bonds
BTPCL Govt <GO> – BTP bonds
CHILBT Govt <GO> – BTU bonds
BTU. Inflation-linked bonds issued by the Chilean Treasury, denominated in UF
and settled in CLP. There are over 20 maturities distributed out to 30 years. All
newly issued BTUs have a 3% coupon while a few older issues have coupons
that vary from 2.1-4.5%. The BTU represents the largest series of UF-linked
government bonds outstanding with UF410mn (CLP9.3tn/USD 19bn), or about
36% of the local government debt.
Reuters pages
<CLP=>
PDBC (Pagares Descontables del Banco Central). A zero-coupon, short-term
discount note issued with the following maturities: 30, 60, 90, 180 and 360 days.
There is a total of CLP2.3tn (USD 4.7bn) outstanding and the bulk of the trading
activity is carried by banks that use it to fine-tune reserves.
Central bank
http://www.bcentral.cl/
Finance Ministry
http://hacienda.cl/
Statistics agency
http://www.ine.cl/home.php
Pension regulator
http://www.safp.cl/
Budget office
http://www.dipres.gob.cl/
Chile Internal Tax Revenue Agency
http://www.sii.cl/
Bond auctions
http://www.bcentral.cl/operaciones-financieras/mercadoabierto/resultado-licitaciones/index.htm
Exchange: Bolsa de Comercio
http://www.bolsadesantiago.com/
Global CLP. Issued in 2010, a single external bond denominated in CLP and
settled in USD. The bond carries a 5.5% coupon and matures in August 2020. In
September 2011 the Global CLP was reopened, increasing the total outstanding
to CLP434bn (USD 900mn). The government has stated its plans to continue
issuing more Global CLPs to contribute to the “internationalization of the CLP”.
UF (Unidad de Fomento). An inflation-linked unit of account, published daily by
the BCCh and used to index inflation-linked bonds and other inflation-linked
instruments. The UF is calculated daily such that the shift in the UF from the 10th
of the current month until the 9th of the following month is equal to the previous
month’s inflation. In any given day between those two dates the UF’s growth rate
is proportional to the inflation rate, compounded daily.
Auction mechanism. The annual issuance schedule for the placement of
Treasury bonds each month is published before the beginning of the year by the
Office of Public Debt at the Finance Ministry. In its role of Fiscal Agent of the
Treasury, the BCCh announces and conducts the placement auctions monthly.
The central bank also coordinates with the Treasury to issue central bank bonds
monthly. Placements of Treasury and central bank bonds are done via Dutch
auctions. Banks, mutual funds, pension funds and insurance companies are
eligible to participate in primary auctions.
Derivatives market
There is an active market for interest rate swaps (IRS), with the most common
instruments the CLPxCAM (fixed/floating local rates swaps) and UFxCAM (fixed
inflation-linked/floating local rate). Investors can also enter into cross currency
swaps (CLP/USD and UF-USD) and basis swaps (CAMxLIBOR). In addition,
CLP-UF forwards are widely traded given the preponderance of UF-linked debt.
CLPxCAM swaps
The CLPxCAM swap is a fixed for floating swap: one leg pays a fixed annualized
rate and one leg receives a floating rate based on the Tasa Camara (CLICP
Index <GO> on Bloomberg), an overnight rate reported by the central bank and
representing the average prevailing interbank lending rate.
For tenors under 18 months, the swaps are bullet, with a single exchange of fixed
for floating at expiration. For tenors over 18 months, cash flows are exchanged
semi-annually on an actual/360-day count. The floating leg is determined by
compounding the daily CAM rates over the reset period. Liquidity is relatively
good for 2-5 year tenors, with bid-ask spreads around 4-5bp for 5-10K DV01 on
the most liquid tenors: 2, 5 and 10 years.
175
GEMs Pa pe r #1 0
UFxCAM swaps and inflation breakevens
An investor entering into an UFxCAM swap agrees to pay a fixed rate on a UF
notional, and in exchange receives a floating rate indexed to the Tasa Camara,
paid on a CLP notional. On the trade date, the UF and CLP notionals are equated
using the spot UF rate at settlement. Cash flows are exchanged semi-annually
with the UF payment converted to CLP at the prevailing UF rate. Since the UF
rate follows inflation, a UF payer in an inflationary environment will owe
increasing amounts at each settlement date. At maturity, investors exchange
notional based on the prevailing UF rate.
Conceptually, a UFxCAM receiver can be thought of as long an inflation-linked
bond, or simply long inflation. A UFxCAM payer is therefore short an inflationlinked bond, or simply short inflation. Corporations often issue inflation-linked debt
(thereby being short inflation) and receive UFxCAM swaps to hedge their inflation
exposure. At times, large corporate hedging demand can push UFxCAM swaps to
negative rates in the short tenors, 6 months to 1 year.
Market implied breakeven inflation rates can be calculated using the nominal and
inflation-linked swaps. The breakeven is the rate at which investors are indifferent
from entering into a UFxCAM or CLPxCAM swap, and can be derived as follows:
(1 + x ) / (1 +y) -1 where x = CLP x CAM rate and y = UF x CAM rate
Breakeven inflation does not account for liquidity, term premium or convexity. An
investor that expects inflation to be higher than the breakeven rate can benefit
from receiving UFxCAM and paying CLPxCAM. Investors may execute the trade
in two legs, or can trade the breakeven as a standalone product. Liquidity is
concentrated from 2-10 year tenors.
Cross currency and basis swaps
Cross currency swaps usually trade on CLPxUSD and UFxUSD based on the
LIBOR. Most common are semi-annual basis and actual/360-day count. An investor
agrees to pay the fixed rate (CLP or UF), and in exchange receives a floating rate
equal to 6m USD LIBOR. Notional is exchanged at trade inception and then at
maturity, so the fixed rate payer is long the foreign currency, such as USD or EUR,
for the duration of the trade, and therefore is exposed to the currency risk.
Investors may also trade basis swaps, which are floating-floating swaps where
one investor pays the floating Camara rate and receives LIBOR + spread. Cross
currency and basis swaps are often used by the local banking system in order to
access an attractive source of USD funding.
Table 123: Summary statistics of Chile derivative products and their markets
Average daily
Average
Bid-ask
Fixings and
Product
spread
other notes
Interest rate swap
CLP x CAM
(Camara) swap
Real rate swap
UF x CAM swap
75K DV01
5-10K DV01
75K DV01
5K DV01
4-5bp up to 5y, 5-7bp Out to 15 years, not
longer tenors
liquid out to 18
months
Inflation forwards
CLPUF forwards
UF 10mn
UF 500,000
CLP10-20 (1m to 1y) 80% volume on first
two inflation months
CLP x LIBOR
20K DV01
USD 20mn
176
4-5bp
10bp
Most liquid 1y, 2y,
and 5y
Convention 6m
LIBOR plus spread,
most liquid 2-5y
GEMs Pa pe r #1 0
FX market
USD/CLP is the third most traded currency pair in LatAm behind the USD/MXN
and USD/BRL, with average daily turnover of over USD2bn. The CLP is nondeliverable offshore.
The onshore spot is the most liquid FX instrument. Forward outright and FX
swaps are also liquid. USD/CLP forwards are settled against the daily fix called
the Dolar Observado published by the BCCh. The USD/CLP trade at forward
premium given current rate differentials. Local pension funds are active in the FX
market as hedgers of the currency exposure on their sizeable foreign investment
position.
Investors may also enter into CLP-UF and USD-UF forwards (Table 123). In
either case, the buyer of the forward is entering into agreement to buy/sell CLP
(or USD) at a future date and sell/buy UF. Contracts are settled against the UF
index. The buyer of the forward contract profits if inflation, as reflected in the
CLP-UF rate, is higher than what is priced in by the market over the life of the
contract.
Table 124: Chile’s FX market Vital statistics and characteristics
Tradable
product
Avg daily
trading
volume
Avg
trading
size
Bid-ask
spread
Reuters
reference
CLP spot
USD2.0bn
USD1mn
20pips
<CLP=>
NDF on
CLP
USD1.5bn
USD10mn
10-15pips
<CLPNDF=>
Offshore
NDF
Fx outright
USD750mn
USD 10mn
30pips
<CLPNDF=>
Fixing
observado
NDF
NDO
Fx swaps
ND Options
USD1bn
USD50mn
USD 20mn
USD10mn
20 pips
10bp
<CLPVOL>
Fixing
observado
FX product
Onshore
Spot
Forwards
Key facts
Settlemen
t: T+1
Spot vs
longer
dates
1 pip = CLP0.01
Investor base
Chile’s local investor base is quite large given the size of its local pension fund
and insurance industries. Local insurance firms make up the largest demand for
inflation-linked debt and related instruments.
The pension system was privatized in 1981, requiring individuals to make
contributions to individual savings accounts managed by one or more private
management companies, or administrators known as AFPs. Pension fund assets
under management totaled over US$144bn (58% of GDP) as of June 2012.
Mutual fund AUM accounts for 15% of GDP.
The pension fund system is broken down into five types of funds (A to E) that
differ by investment risk.

Fund A is the riskiest with 76% of the portfolio invested in equities and 24%
invested in fixed income.

Fund E is the least risky with 1.3% invested in equities and 98.7% in fixed
income, as of June 2012.
177
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The total AFP investment portfolio has close to 60% invested in fixed income
securities (domestic and offshore) and 40% invested in equities (domestic and
offshore). There are legal limits to pensions’ asset allocations, which sometimes
affect their investment decisions. In particular, limits on unhedged foreign
investments affect pensions’ participation in the FX forwards market.
Table 125: Pension fund limits (% of AUM)
Sovereigns
Equities
Foreign Investment
Unhedged foreign investment
A
30-40
80
45-100
30-50
B
30-40
60
40-90
25-40
C
35-50
40
30-75
20-35
D
40-70
20
20-45
15-25
E
50-80
5
15-35
10-15
Source: Superintendencia de Pensiones
Foreign investors and institutions can invest and trade in the local market but are
required to obtain a Taxpayer Identification Number (RUT: rol unico tributario).
Non-domiciled and nonresident individuals and entities are subject to an
additional tax (AT), a withholding tax that applies to Chilean earned income and
to certain specific payments defined by law. Generally, capital gains are
considered normal income. Also, any premium payable on redemption of the
securities will be treated as interest and subject to the Chilean interest
withholding tax, as described above. The AT rate is currently 35%, but drops to
4% for interest income paid on loans or bonds to foreign financial institutions. In
addition, the rate may vary (or even be exempt) for residents of countries with a
dual tax treaty with Chile.
As a reflection of Chile’s intention to promote its capital markets, legislation enacted
in April 2009 grants resident and nonresident investors a tax benefit for capital
gains obtained from the transfer or sale of debt securities under certain conditions.
Most local government bond transactions settle on T+1, but T+0 and T+2 are
available under certain conditions when both counterparties agree during time of
trade. Settlement and clearing are carried out by Deposito Central de Valores
(DCV), a local depository and clearing institution. Transactions on swaps and
most derivatives settle on T+2.
178
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Table 126: Summary of Chile bond markets and products
Instrument
BCU
BCP
BTU
BTP
Issuer
Central Bank of Chile
Treasury
Treasury
PDBC
Currency
UF (settled in CLP)
CLP
UF (settled in CLP)
CLP
CLP
UF500
CLP5mn
UF500
CLP5mn
CLP5mn
Tenor
0 to 29 years
0 to 10 years
0 to 30 years
0 to 20 years
Up to 360 days
3% for on the run (5% a few
6% for on the run (8% two off 3% for on the run (2.1-4.5% a 6%
off the run)
the run bonds)
few off the run)
zero
Coupon Payments
Semi-annual, 180/360
ACT/365
ACT/365
ACT/365
ACT/365
zero
ACT/365
Bullet
Bullet
Bullet
Bullet
Bullet
Amount outstanding
UF372mn (CLP8.4tn)
CLP3.5tn
UF410mn (CLP9.3tn)
CLP2.2tn
CLP2.3tn
(as of June 2012)
Secondary Market
Trading
OTC and Bolsa de Comercio OTC and Bolsa de Comercio OTC and Bolsa de Comercio OTC and Bolsa de Comercio OTC and Bolsa de Comercio
(auction and Telerenta)
Yield
Yield
Yield
Yield
Yield
Settlement Period
Common T+1, also T+0 and Common T+1, also T+0 and
Common T+1, also T+0 and
T+2
T+2
T+2
T+2
T+2
USD100mn
USD50mn
USD50mn
USD30mn
USD30mn
6bp
6bp
6bp
6bp
3bp
N/A
4bp up to 10y, 6bp longer
tenors
tenors
tenors
tenors
Average trade size
UF100K
CLP3bn
UF100K
CLP3bn
Clearing Mechanism
Local DCV
Local DCV
Local DCV
Local DCV
Local DCV
Major players
Insurance companies (long
banks
end), pension funds (belly),
mutual fund (short end),
banks
banks
banks
banks
10:00am to 1.00pm
10:00am to 1.00pm
10:00am to 1.00pm
10:00am to 1.00pm
10:00am to 1.00pm
(Santiago)
(Santiago)
(Santiago)
(Santiago)
(Santiago)
No restriction
No restriction
No restriction
No restriction
No restriction
Trading hours
varies
Regulations
Restrictions on Foreign
Investment
Custodian
DCV
DCV
DCV
DCV
DCV
Withholding Tax
Foreigners pay 35%
Foreigners pay 35%
Foreigners pay 35%
Foreigners pay 35%
Foreigners pay 35%
withholding or qualify for 4% withholding or qualify for 4% withholding or qualify for 4% withholding or qualify for 4% withholding or qualify for 4%
withholding if they execute
withholding if they execute
withholding if they execute per withholding if they execute per withholding if they execute per
Capital gains Tax
per Government guidelines.
per Government guidelines.
Government guidelines.
Foreigners from dual tax
treaty countries pay 4%
Foreign investors in non-dual Foreign investors in non-dual Foreign investors in non-dual Foreign investors in non-dual Foreign investors in non-dual
tax treaty countries pay 35%. tax treaty countries pay 35%. tax treaty countries pay 35%. tax treaty countries pay 35%. tax treaty countries pay 35%.
These same investors can
avoid capital gains taxes if
No
No
No
No
No
they execute per Government they execute per Government they execute per Government they execute per Government they execute per Government
guidelines
guidelines
guidelines
guidelines
guidelines
Entry/Exit
Primary Auctions
Auction Style
Dutch auction
Dutch auction
Dutch auction
Dutch auction
Dutch auction
Average Issue Size
USD230mn monthly
USD200mn monthly
USD400mn monthly
USD140mn monthly
USD400mn monthly
179
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Colombia
Overview
Francisco Rodríguez
Colombia is the third largest Latin American local sovereign bond market, roughly
one-tenth the size of Brazil’s and one-third the size of Mexico’s, but larger than
those of Chile, Argentina or Peru. The government has concentrated on
promoting liquid local debt benchmarks with 1, 3, 5, 10, and 15-year maturities.
The longest local bond is the Jul-24 TES, which accounts for almost one-fifth of
all TES outstanding. A high rate of withholding tax on foreign investors continues
to limit the growth of this market.
Flavio de Andrade
The Colombian economy is highly dependent on exports of hydrocarbons and
minerals. Total exports of non-renewable natural resources account for 71% of
total exports, up from 39% 10 years ago and 12% 40 years ago. Oil output has
nearly doubled over the past eight years and, according to government plans, will
expand by 50% more by 2020. Colombia has a stable political environment,
although an armed insurgency has recovered in recent years.
Monetary policy
Table 127: Colombia local debt ratings profile
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
Baa3
Baa3
Baa3
Baa3
Baa3
Baa3
Baa3
Baa2
Baa2
Baa2
Baa2
Baa2
Baa2
Baa2
Baa2
-
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB
BBB
BBB
BBB
BBB
BBB
BBB
BBB+
A
A+
A+
A+
BBB
BBB
BBBBBBBBBBBBBBBBBBBBBBBBBBBBBB
BBB
-
Source: BofA Merrill Lynch Global Research. Bloomberg
30.1%
Food
28.2%
Base rate. Banrep meets monthly to decide the key policy rate and publishes a
brief policy statement with its decision after market close. The reference rate
(CORRRMIN Index on Bloomberg) is the minimum repo rate to be offered at
Banrep’s daily auction. The meeting is followed by a press conference with the
Banrep governor, at which he is occasionally accompanied by board members.
Open market operations. Transitory operations are carried out through short-run
repurchase agreements (if expansionary) or reverse repurchase agreements (if
contractionary). Permanent operations are carried out through sales of the public
debt portfolio. Banrep can also receive deposits from authorized entities.
15.2%
Transport
Education
5.7%
Clothing
5.2%
Other
Lending and deposit facilities. Required reserves are remunerated at 37.5% of
the target inflation rate.
15.6%
0%
10%
20%
180
Policy framework. The Constitution establishes Banrep as independent of all
other branches of government. Its board has seven members, including the
finance minister. During the disinflationary process Colombia had interim biennial
inflation target ranges that were reduced progressively. The current target range
now coincides with the long-run target, 3 ±1%.
The minutes are released two weeks after the meeting. These typically indicate
whether the decision was unanimous or a majority. Additionally, Banrep presents
a bi-annual report to Congress that assesses the country’s economic
perspectives and its monetary and FX policy guidelines.
Chart 114: Key Colombia CPI components
Housing
Background. The Bank of the Republic of Colombia (Banrep) started following
inflation-targeting policy in 1991. In 2000 the board fixed 3% as the long-run
inflation target, and embarked on a disinflationary process, gradually lowering its
target rate. This allowed Colombian inflation to reach single-digit rates for the first
time since the 1960s, and to fall below the long-run target range by 2009.
30%
40%
Reserve requirements. Short-term deposits are subject to an 11.5% reserve
requirement. CDs and other deposit instruments with duration less then 18
months are subject to a 6% requirement. CDs and other deposits instruments
with durations greater then 18 months are exempt from reserve requirements.
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Conventions
FX policy. Banrep intervenes in the FX market with the objective of maintaining
an adequate level of reserves, reducing short-term FX fluctuations, and
moderating excessive longer-term fluctuations that endanger price or financial
stability. The bank can use a combination of direct purchase auctions, put/call
options or discretional intervention; only direct purchase auctions have been used
since 2009.
Bonds
Settlement: T+0
Basis: NL/365
In February Banrep announced a program to purchase at least $20mn per day, a
program that has been extended until 2 November. The bank can auction options
(put or calls) when the market moves to ± 5% of the 20-day moving average.
IRS
Fixing: IBR
Coupon frequency: Quarterly
Fiscal policy and debt issuance
CCS
Fiscal policy. Total expenditures of the nonfinancial public sector are 28.4% of
GDP, with 18.1% coming from the central government and the rest from local and
regional governments and decentralized entities of the public sector. Over the
past 10 years Colombia has reduced its deficit from 5.1% to 2.8% of GDP, and its
stock of pubic debt from 59.1% to 43.4% of GDP. Sustained economic growth
and increasing oil fiscal revenues have helped fiscal consolidation.
Fixing: 6m LIBOR
In 2010 and 2011 the Santos administration pushed through a set of aggressive
reforms for fiscal institutions, including constitutional reforms to change the
royalties distribution system and protect fiscal responsibility principles. The
administration also adopted a fiscal rule to target a structural fiscal deficit of 1.0%
of GDP by 2020, as well as the creation of national and regional stabilization
funds. However, the implementation of the rule designed by the Ministry of
Finance does not foresee investment in the national stabilization fund until 2023,
as it intends to use any surpluses to bring the central government debt to GDP
ratio to below 20%. Colombia’s increasing oil dependence has also brought about
fiscal reliance on oil revenues, with the fiscal contribution of oil at 4-6% of GDP.
Debt issuance. As of March 2012 Colombia had outstanding debt of COP248tn
(US$134bn), of which 172tn (69%) was internal and 31tn (28%) was external. Of
internal debt, the central government owed 89.3%, almost all of it in the form of
bonds. Of the bonds owed by the central government, 75.6% are denominated in
COP and 24.4% are linked to inflation through the Unidad de Valor Real (UVR)
index, which is set by the central bank based on the previous month’s CPI print.
Chart 115: Colombia – maturity profile (in USDbn) of local COP and
UVR denominated debt (including COP denominated TES Global)
16
COP
UVR
Chart 116: Colombia – total outstanding debt (local and external)
TES Global COP
USD, 23.2%
14
12
10
8
Other, 0.9%
6
4
COP, 58.6%
UVR (COP),
17.3%
2
0
2012
2014
2016
2018
2020
2022
2024
* As of 6/30/2012. Total 153tn COP ($86bn).
Source: BofA Merrill Lynch Global Research, Ministerio de Hacienda y Credito Publico.
2026
181
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Bloomberg pages
Bond market
OTC COP <GO> – Market monitor
There are two types of bonds issued regularly in the local debt market. The
government issues fixed-rate, COP-denominated TES and inflation-linked UVR
bonds. Liquidity in the secondary market is increasing, with average daily
trading volume of approximately USD4bn. Maturities of 2-5 years account for
more than half of trading volume, in line with the sovereign’s maturity profile.
The bid-ask spread for the liquid bonds can be as tight as 2bp.
COLTES Govt <GO> – Tesoro Bonds
SENC <GO> – SEN TES market prices
BVCO <GO> – BVC TES market prices
ICCO <GO> – ICAP live prices
TDCO <GO> – Tradition live prices
GFCO <GO> – GFI live prices
Reuters pages
<CO=>
Useful Official websites
Central bank
http://www.banrep.gov.co
Finance Ministry
http://www.minhacienda.gov.co
Investor Relations Colombia
http://www.irc.gov.co
Statistics agency
http://www.dane.gov.co
Financial institution regulator
http://www.superfinanciera.gov.co
TES Tasa Fija. These are annual fixed-rate bonds issued in COP that pay full
principal at maturity. Maturities currently range from 1-15 years, but the
government could issue longer maturity bonds. Most of the liquidity in the market
is concentrated in these bonds.
TES UVR. These are inflation-linked securities that have an annual fixed coupon
and pay the principal at maturity. The face value of these bonds is expressed in
terms of UVR. The UVR Index is a unit published daily by the central bank and
tied to the CPI of the previous month. Liquidity in UVR bonds is low, and it
accounts for less than 10% of the daily trading volume. The liquidity of these
bonds is cyclical since the inflation in Colombia is mostly concentrated in the first
months of the year, particularly January through March. During these months
bond returns are usually more attractive, so liquidity increases.
TES Global (COP-denominated). There are three TES Globals maturing in
2015, 2021 and 2027, denominated in COP. Since 2005, US$7bn of these bonds
have been issued. They are designed for offshore investors, governed under New
York Law and pay all coupons and principal payments in USD.
Bond auctions
http://www.banrep.gov.co/informeseconomicos/ine_sub_tesb.htm
Stock exchange
http://www.bvc.com.co
Auction and placement mechanism. TES auctions are administered by Banrep.
The auctions usually occur the Wednesday (or following business day) of
monetary weeks (weeks with four or more banking days). COP TES are usually
auctioned during the second and fourth monetary weeks of the month, and TES
UVR during the third monetary week.
Derivatives market
Cross currency swaps. CCS exists for both COP/LIBOR and UVR/LIBOR. Most
Colombian CCS have a fixed local rate leg and a floating 6-month USD Libor leg.
This curve goes from 1 to 25 years and liquidity is typically concentrated between
the 1 and 10-year tenors. Bid-ask spreads are typically 5bp and the average
ticket size is USD10mn. The UVR/LIBOR goes from one to 15 years but is rarely
traded. Bid-ask spreads are 25bp.
Interest rate swaps. The main interest rate swap traded in Colombia is the IBR
swap, which is an OIS tied to the overnight interbank lending rate (IBR). For
maturities 18 months and shorter the swap makes a single net payment for the
fixed and floating legs at maturity. For 2-year and above the netted payments are
exchanged every quarter. At each reset the floating leg amount is based on the
effective compounded rate from the daily IBR rates during the reset period. The
fixed leg is based on the usual Actual/360 convention.
IBR swaps are slowly gaining liquidity. Daily volume of IBR 19 swaps is around
COP200bn, most transactions are 3 month to 3 year tenors but sometimes trades
to 10 years and the average bid-ask is about 10bp.
19
182
IBR = Indicador Bancario de Referencia.
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Local futures. TES futures have been traded on the Colombian Stock Exchange
since 2008. Liquidity is still thin in this market; however, locals expect it to grow
over the coming years. In June 2012, stock exchange launched a future on the
overnight interbank lending rate (IBR).
Table 128: Summary statistics of Colombia derivative products and their markets
Avg daily
Avg
Bid-Ask
trading
transaction
Product
Other notes
volume
size
spread
Cross Currency Swap
COP/LIBOR
USD50mn
UVR/LIBOR
USD5mn
USD10mn
USD5mn
5bp
25-50bp
6mLIBOR, liquid in 1-10 year tenors
6mLIBOR, same tenors as COP/LIBOR
but poor liquidity. Inflation Index:
Bloomberg UVR Index
Interest Rate Swap
COP/IBR
USD100mn
USD10mn
10bp
O/N IBR daily compounded, most trading
in 3m-3y year tenors, trades to 10 years.
Local Futures
TES
COP100,000mn COP1,000mn
0.05pct
IBR
0.40pct
Quarterly maturities (Mar, Jun, Sep, Dec)
and next two monthly maturities. Three
different underlying: Short-term, Mediumterm and Long-term COP TES.
Four maturities: Mar, Jun, Sep, Dec
COP20,000mn
COP1,000mn
FX market
The COP is a free-floating, nondeliverable currency with an average daily trading
spot volume of USD1bn. There is an onshore forward market with maturities up to
18 months, but liquidity is concentrated in 1-3 months. These forwards can be
cash settled or delivered if a foreign exchange liability/asset exists.
The fixing rate for NDF contracts is the TRM, which is a volume weighted average
of the spot market transactions on the fixing date. The TRM is calculated by the
Superintendencia Financiera de Colombia (financial institutions regulator). In
recent years, futures on TRM started trading on the stock exchange and are
slowly gaining liquidity (daily average volume USD60mn). There is also an NDF
and NDO offshore market. The NDF offshore market is liquid up to 1 year, and
the NDO trades a few times a week.
Table 129: Colombia’s FX market vital statistics and characteristics
FX
product
Onshore
Spot
Tradable
product
Avg daily
trading
volume
Avg
trading
size
Bid-Ask
spread
Reuters
reference
COP Spot
USD1bn
USD10mn
COP1-3
<CO=>
Forwards
Forwards
USD
400mn
USD10mn
COP2-3
<CO=>
Settlement:
T+2
Fixing TRM
Offshore
NDF
NDF
NDO
Fx outright
Fx swaps
Options
USD600mn
USD600mn
USD10mn
USD10mn
USD10mn
USD10mn
COP2-3
COP2-3
1 vol
CO/COL03
CO/COL03
CO/COL03
Fixing TRM
Fixing TRM
Fixing TRM
Key facts
Note: Fixing NDF is TRM with day count convention Act/360
Investor base
The main holders of local TES are the pension funds (defined contribution), which
hold almost 28% of the total local TES outstanding. Local commercial banks also
play a mayor role in the local government bond market, with their holdings
183
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accounting for 20.6% of the total outstanding. Other major holders are the public
entities and public trust funds, which account for 14.4% and 11.9%, respectively.
Foreign investors can invest in local debt instruments through a local investment
administrator (broker dealer or trust fund administrator). Foreign investment in
debt securities has grown significantly in recent years, but still accounts for less
than 3% of the total TES outstanding.
Rules, regulations, capital control taxation
There have been capital controls in Colombia in the past, but as of August 2012
there were none. The income tax for fixed income investments is 33%. There is a
withholding tax (deductable of income tax) on interest payments of 7% for bond
maturities of less than 5 years and 4% for longer maturities.
Investors are also subject to a 16% value added tax on currency repatriation
gains. Although investors pay the VAT, it is based on the dealer’s foreign
currency gain on the transaction relative to the tax base exchange rate. The tax
base exchange rate is the dealer’s average exchange rate from the previous day.
In addition, there is a 0.4% financial transactions tax on after-tax funds repatriated
from Colombia. This tax can be avoided if using the same intermediary to close
an open currency position.
There are two main depository institutions in Colombia: DCV, administered by
Banrep; and Deceval, administered by the Colombian Stock Exchange. DCV can
only be used for government bonds, while Deceval can be used for any kind of
fixed income security. Colombia’s payment system is SEBRA, also administered
by BanRep. The majority of the trades in TES are settled delivery versus payment
(DVP) through SEBRA and DCV. The standard settlement for government
securities is T+0.
Chart 117: TES trading volume
Chart 118: FDI on debt instruments in trillion COP
2021-2026
2012-2013
13%
11%
6
5
4
2017-2020
3
16%
2
1
2014-2016
60%
Source: BofA Merrill Lynch Global Research, BanRep
184
0
Feb-01
Feb-03
Feb-05
Feb-07
Source: BofA Merrill Lynch Global Research, Superfinanciera
Feb-09
Feb-11
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Table 130: Summary of Colombia bond markets and products
Instrument
TES Tas Fija
TES UVR
Issuer
Tesoreria General de La Nacion
Tesoreria Nacional de La Nacion
Currency
COP
UVR (settled in COP)
COP500,000/increment COP100,000
UVR10,000/increment UVR1,000
Tenor
1 to 16 years
1 to 16 years
Annual
Annual
Fixed (in UVR)
Coupon Payments
Fixed
NL/365
NL/365
Bullet
Bullet
Form
Scripless
Scripless
Amount outstanding
COP114,572bn
COP 33,682bn
Trading
Exchange (BVC, SEN) and OTC
Exchange (BVC, SEN) and OTC
Yield
Yield
Settlement Period
T+0
T+0
COP6000bn
COP 300bn
1bp
3bp
1bp for benchmarks and 3-5bp for others
3 – 10bp
Average trade size
COP5bn
COP 5bn
Clearing Mechanism
DVP via SEBRA/DCV or Deceval
DVP via SEBRA/DCV or Deceval
Major players
Locals (pension funds, banks and broker/dealers)
Locals (pension funds, banks and broker/dealers)
Trading hours
8:00-15:40 (Bogota)
8:00-15:40 (Bogota)
There are no restrictions for foreign investment. However,
There are no restrictions for foreign investment. However,
investments must be made through a local broker/dealer or
investments must be made through a local broker/dealer or
fiduciary.
fiduciary.
(as of June 2012)
Secondary Market
Regulations
Custodian
Withholding Tax
7% for maturities of less than 5 years and 4% for longer
7% for maturities of less than 5 years and 4% for longer
maturities.
maturities.
Capital gains Tax
33%
33%
Entry/Exit
16% value added on currency appreciation
16% value added on currency appreciation
Primary Auctions
Auction Style
Dutch
Dutch
Average Issue Size
COP10tn
COP10tn
COP500,000,000
UVR1,000,000 (≈ COP200,000,000)
185
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Mexico
Overview
Carlos Capistran
+52 555 2013350
The Mexican fixed income market is the second largest in LatAm in terms of
volume. Remarkable public debt management has led to a relatively high
proportion of local debt being long-term securities. The government issues fixed
rates (Cetes, MBono, inflation-linked bonds) and floating rates (Bondes). The
main local players include banks and private funds, although these are outpaced
by foreigners due to the ease of entry and exit, high spreads against advanced
economies, and inclusion in global bond indices. International reserves are at
historical highs amid strong macroeconomic fundamentals. Market intervention
has taken place only in scenarios of very poor liquidity.
Flavio de Andrade
Market drivers
Table 131: Mexico local debt ratings profile
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa1
Baa3
Baa3
Baa3
Baa3
Baa3
Baa1
Baa1
-
AA
A
A
A+
A+
A
A
AAABBB+
BBB+
BBB+
BBB+
BBB+
BBB+
BBB+
A+
AAAA-
BBB+
BBB+
BBB+
BBB+
AABBB+
BBB+
BBB
BBB
BBB
BBB
BBB
BBBBBBBBB-
Chart 119: Mexico CPI components
28.2%
Housing
23.3%
Food
14.6%
Transport
Edu &
ent ert ainment
7.8%
0%
10%
Background. At the end of the 1990s, monetary policy gradually converged to an
inflation-targeting regime. High central bank credibility has led to low and stable
inflation. Inflation and inflation expectations are low by historical standards, and
well anchored in the sense that cost-push shocks such as MXN depreciations or
tax increases do not have second round effects, providing stability to the nominal
system of the economy. Short-term interest rates have been stable since 2009.
The long end of the curve usually follows long rates in the US.
Policy framework. Banxico’s primary objective is to ensure the stability of the
national currency’s purchasing power. In 2002 Banxico set a permanent inflation
target of 3% (with a +/- 1% variability range). The central bank became
autonomous in 1994 and is ruled by a staggered five-member board, chaired by
Governor Agustín Carstens.
Base rate. Since 2008 the central bank has implemented monetary policy by
20
targeting the overnight interest rate, known as Tasa de Fondeo (MXONBR Index) .
The board meets eight times a year, issuing a monetary policy statement at 10am
NYT. Two weeks after the release, the board publishes meeting minutes to improve
transparency. Banxico produces a quarterly inflation report in which it presents
growth and inflation forecasts for the following 7-8 quarters.
Reserve requirements. There are none.
16.9%
Other
Monetary policy
Open market operations. Short-run liquidity is managed through credit or debit
auctions with banks and through securities purchases or sales.
9.2%
Healt hcare
As a small and open economy with strong trade and financial links with the US,
economic data north of the border often have a greater impact on Mexico’s fixed
income market. A free floating FX serves as a buffer to external shocks given the
fully convertible, deliverable and liquid currency. Among domestic data, bi-weekly
CPI prints head the list and are published by INEGI at 9am NYT around Day 9
(previous month inflation) and Day 24 (1H inflation of the current month) of each
month. Monthly volatility and long publication lags of other indicators typically
cause markets to shrug off domestic data surprises.
20%
30%
40%
FX policy. The currency is free floating and Mexico does not target USD/MXN
levels. However, the Foreign Exchange Commission (FEC), formed by members
of Banxico and the Ministry of Finance, has intervened in the FX market during
Source: BofA Merrill Lynch Global Research, INEGI
20
186
The Bloomberg ticker for the effective Tasa de Fondeo is MXBRBA Index
GEMs Pa pe r #1 0
Conventions
Bonds
Settlement: T+2:
Basis: Actual/182, semi-annualized 182/360 for Mbono
and Udibono, Act/360 simple interest for CETES
high illiquidity scenarios. A USD sales auction mechanism activates when the
exchange rate is 2% above the previous day’s level. However, the US$400mn
auctioned, in a market with a daily turnover of around US$18bn, represents just
2.2% of total. This could be considered as a signal that the FEC stands ready to
act if dollars become scarce.
Fiscal policy and debt issuance
Coupon frequency: Semi-annual (182/360)
Fiscal policy. Disciplined public finances allowed for small counter-cyclical fiscal
policy in 2010, leading to a slight deviation from the usual budget-balanced rule
followed in the last years. The public deficit was set at 0.4% for 2012 GDP, down
from 0.6% in 2011, excluding investment in Pemex, which accounts for almost
another 2% of GDP. However, public finances remain highly dependent on oil
revenues and low oil prices could limit further fiscal stimulus.
IRS
Fixing: TIIE
Coupon frequency: 28d
CCS
Debt issuance. The government’s net debt at 26.5% of GDP is low relative to
economies with better credit rating profiles. Strategy has focused on 1) reducing
external exposure by increasing domestic debt (79% of total in 2011, up from 59% in
2001 and 20% in 1995); 2) broadening the investor base through a syndicated auction
mechanism; 3) taking advantage of extremely low international interest rates through
issuance in foreign markets, such as the samurai bond issuance; and 4) extending
debt average maturity (7.6 years in 2011, up from 1.5 years in 2000).
Fixing: LIBOR x TIIE
Coupon frequency: 6m
Bond market
Table 132: Foreign holdings of local bonds
Foreign
Outstanding
holding
(MXNbn)
Mbono
Udibono
BondesD
Cetes
Total (MXNbn)
Total (USDbn)
47.8%
11.0%
0.5%
42.2%
30.9%
30.9%
1,723
705
815
861
4,104
308
In July 2012 total net government domestic debt was MXN3526bn, or US$265bn.
The main debt instruments issued in local currency are MBonos (fixed-rate
bonds), Cetes (short-term zero-coupon bills), Udibonos (inflation-linked bonds),
and Bondes D (floating rate bonds). Authorities also issue Bonos de Proteccion al
Ahorro (BPA). All bonds and coupon payments are made on Thursdays, which
imply semi-annual coupon payments made every 182 days (Mbonos and
Udibonos). Monthly payments are made every 28 days (Bondes D).
Mbonos. Fixed-coupon bonds that make up the largest share of local issued
federal government debt, accounting for 42% of total outstanding local debt.
Mbonos pay semi-annual coupons ranging from 5% to 10% and the full face
amount at maturity. These bonds are very popular among foreigners, who hold
48% of the outstanding MXN 1723bn. As of July 2012, foreigners held more than
70% of the outstanding amount of the Jun 2020, Jun 2021, and Dec 2024.
Source: BofA Merrill Lynch Global Research, Banxico
Chart 120: Mexico – maturity profile (in USDbn) of local MXNdenominated debt
Chart 121: Mexico debt composition; total USD345bn
50
Mbono
UdiBono
BondesD
Floating
CETES
18%
40
Udi 15%
30
20
10
MXN 55%
0
USD (EXD)
9%
other(EXD)
2012 2015 2018 2021 2024 2027 2030 2033 2036 2039 2042
3%
Source: BofA Merrill Lynch Global Research, SHCP, Banxico
Source: BofA Merrill Lynch Global Research, SHCP, Banxico
187
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Udibonos. Inflation-linked, fixed-coupon bonds that account for 17% of total
outstanding local debt. Udibonos are denominated in Unidades de Inversión
(UDI) and settled in MXN. UDI is an inflation-indexed unit based on the bi-weekly
CPI index. The bonds pay semi-annual coupons ranging from 2.5% to 5.5%,
which are also UDI-denominated at each payment date and converted to MXN at
the UDI rate.
Cetes. Short-term, liquid zero-coupon bills that account for 21% of all outstanding
local debt. The longest Cetes are issued with 364 days to maturity. Cetes are also
popular among foreigners, who hold 42% of the total outstanding.
Bondes D. Floating-rate bonds that pay a floating coupon every 28 days based
on the 28-day compounded daily Fondeo rate (MXBRBA Index in Bloomberg).
The Bondes D represent 20% of the outstanding federal local debt; however,
there has been little demand among foreigners, who hold less than 0.5% of the
outstanding amount.
Auction and placement mechanism. Mexico has a very transparent placement
mechanism. The Hacienda (SHCP – Secretariat of Finance and Public Credit)
puts out the annual borrowing plan 21 that states the annual strategy for issuance
of local and external debt. At the beginning of each quarter the SHCP sends to
Banxico a list of all local bonds to be placed during the quarter, specifying the
specific bond, tenor, amount to be placed and date of each auction. Regular
auctions are held on Tuesdays, with results published on Banxico’s website 30
minutes after the closing bids. The settlement takes place T+2 through INDEVAL.
The shorter tenors of the Mbono (3-7 years) are auctioned three times a quarter,
while longer maturities (10-30 years) are auctioned twice a quarter. Currently,
Udibonos in all tenors are auctioned three times a quarter. Shorter tenors of
Cetes (182 days and below) are auctioned every week, while the 364-day Cetes
are auctioned three times a quarter. Currently, 5y Bondes D are auctioned every
2 weeks.
In addition to regular auctions, there a few syndicated auctions designed to place
new issues within a broad universe of investors and insure that a new issuance
reaches a large outstanding amount from the first placement. In 2012 Mexico
used a syndicated issue to place MXN15bn of the new benchmark 30-year bond,
the Nov-2042. In the last 12 months there were also syndicated placements for a
5-year (Jun-2017), 10-year (Jun 2022) and 20-year (May 2031) bond.
UDI inflation-linked account. The Unidades de Inversión is calculated daily
such that the shift in the UDI rate from the 10th to the 25th of every month is equal
to the bi-weekly CPI rate in the second half of the previous month. The shift from
the 25th to the 10th will be equal to the CPI variation in the first half of the month.
This mechanism ensures that a portion of the future accrual of the UDI is known
in advance. For example, when the bi-weekly inflation for the first half of the
month is released, market participants learn the daily UDI that will apply for each
day until the 10th day of the following month. Analogously, the daily UDI that will
be applied for each day until the 25th of the current month is known when the biweekly inflation corresponding to the second half of the previous month is
released.
21http://www.hacienda.gob.mx/English/public_credit_new/public_debt_policy/Paginas/ANNUALBORROWINGPLAN.aspx
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Bloomberg pages
Derivatives market
OTC MXN <GO> – Market monitor
TIIE swaps
Mexico’s interest rate derivative market is one of the most liquid in LatAm. The
most popular interest rate swap is the fixed-floating TIIE swap, a name derived
from the floating leg reference. The Tasa de Interés Interbancaria de Equilibrio
(TIIE) is the average 28-day interbank lending rate. The TIIE is determined daily
by a Banxico survey of local banks. In the last 12 months the 28-day TIIE rate has
been approximately 30bp higher than the Fondeo rate. Despite the wide but
stable basis between the TIIE and the effective Fondeo rate, the short end of the
TIIE swap is a direct way to trade on Banxico’s monetary policy path.
MBONO Govt <GO> – Mbonos
MUDI Govt <GO> – Udibonos
MCET Govt <GO> – CETES
Reuters pages
<MXN=>
Central bank
http://www.banxico.org.mx/
Finance Ministry
http://www.shcp.gob.mx/
Statistics agency
http://www.inegi.org.mx/
Netted payments in a TIIE swap for the floating and fixed legs are exchanged
every 28 days. By market convention, swap maturities are quoted based on the
number of payment dates. For example, there will be 13 payment dates over the
course of a year, so a 1y TIIE swap is quoted as a 13x1. TIIE swaps are very
liquid with a typical average bid-ask spread of 2bp. Liquidity is generally good out
to 10 years.
Netted payments are exchanged at the end of every 28-day period based on the
following two cash flow amounts:
Pension regulator
Fixed leg amount = Notional * (swap rate) * (28/360)
Floating TIIE leg amount = Notional * (TIIE28days) * (28/360)
http://www.consar.gob.mx/
Bond auctions
http://www.banxico.org.mx/portales/especializados/tasasIn
TIIE28days is the 28-day TIIE rate observed at the beginning of the reset period.
teres/ResuSubaPrimaNew-1.html
Table 133: Summary statistics of Mexico derivative products and their markets
Product
Stock exchange
http://www.bmv.com.mx/
Avg daily
trading volume
Avg
transaction Size
Bid-Ask
Spread
Interest rate swap
TIIE swaps
750k DV01
10-20k DV01
2bp
TIIE volatility
100k Vega
10-20k Vega
1%
Cross currency
TIIE x LIBOR
50k DV01
10k DV01
3-5bp
20k DV01 weekly
(combined with UDI x
TIIE)
20k DV01 weekly
(combined with UDI x
TIIE)
5k-10k DV01
15-20bp
5k-10k DV01
15-20bp
UDI x LIBOR
UDI x TIIE
Fixings and
other notes
3m – 30y, liquid up to
10y
1m1y – 10y10y,
caps-floors 6m – 10y
3m – 30y, 10y the
most liquid tenor
Traded but thin
market
Traded but thin
market
Other derivatives
Liquidity in other interest rate derivatives is limited, but market participants can
trade in TIIE/LIBOR, UDI/TIIE, UDI/LIBOR and UDI/MXN-fixed swaps. These are
all cross-currency swaps with two floating legs. Liquidity is best in TIIE-LIBOR
swaps where the bid-ask spread is roughly 3-4bp; in the others it can range from
15-20bp. Liquidity in the TIIE-LIBOR is concentrated in tenors up to 10y.
UDI Libor and UDI TIIE usually trade two or three times a week. Average ticket
size is 5k DV01 up to 5y tenors and 10k 7y and beyond. Liquidity is focused in the
5-7y range, but trades 1-3y too. Bid offer is around 15-20bp but when liquidity is
better bid-ask can be as low as 10bp. The swaps all work similarly in that
principal is exchanged at inception and maturity, but payment dates vary by
instrument.
189
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Interest rate options 22
Mexico has a relatively liquid market for interest rate options, with the underlying
being TIIE swaps. Expiries range from one month to 10 years on underlying TIIE
swaps ranging from one year to 10 years. The most common structures are payer
and receiver swaptions. Investors may also trade caps/floors which pays the
buyer a spread whenever 28d TIIE fixes above/below the agreed upon strike.
FX market
According to the BIS, the MXN is the most liquid currency in EM, accounting for
1.3% of global daily FX turnover. It is also the only deliverable currency in LatAm.
Average daily volume in the spot and major FX instruments exceed USD40bn.
With concerns regarding the growth prospects in the US and the sovereign debt
crisis in Europe, trading volume in MXN has dropped significantly in the last year
but remains the most liquid currency in EM.
The MXN’s liquidity and deliverability make it a preferred currency for speculative
investors that often use it to express a view on global risk appetite or hedge other
EM FX exposures. As a result, USD/MXN spot consistently exhibits a high degree
of correlation to US equities and risk appetite indices such as the VIX.
In addition to spot, USD/MXN forwards (traded as swaps) are deliverable and
quoted out to two years. The 1m through 12m tenors are very liquid. While the
daily volume in the spot currently runs at nearly USD10bn, in the forward (swap)
volume is about three times larger at $30bn. Further out, investors engage in
cross-currency swaps. Liquidity in USD/MXN currency options is good out to two
years. The aggregate daily volume in FX options is about USD750mn and in
normal periods the bid-ask is approximately 0.3-05 vol points depending on the
tenor and on the size of the trade.
Table 134: Mexico’s FX market vital statistics and characteristics
FX
product
Spot
Forwards/
Swaps
Options
Tradable
product
MXN spot
Deliverable
forwards
Option on
MXN
Avg daily
trading
volume
Avg
trading
size
Bid-Ask
spread
Reuters
Reference
Key facts
USD10bn
USD30bn
USD10mn
USD10mn
30 pips
30 pips
<MXN=>
<MXNFWD=>
WMR fixing
deliverable
USD750mn
USD30mn
0.3 vols
<0#DA*.XD>
12:30 NYT cut for
exercise
Investor base
Both foreigners and local pension funds make up the largest share of Mexico’s
investor base. As of July 2012 foreign investors accounted for the largest share of
Mbonos holdings with 47.8% of the outstanding amount. Nonresidents held more
than 70% of Mbonos in the belly of the curve such as the Jun ’20, Jun ’21 and
Dec 2024. Local pensions are the largest holders of the longer tenors.
For more details see: What’s unique in LatAm swaptions?
(http://research1.ml.com/C?q=Hgfm0ECzASUTVpttwucbzQ__&s=)
22
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Local pension funds have grown so quickly that they now dominate the local
investor base. (Mexico: pension funds the strongest local players). As of 2011,
pension fund assets under management (AUM) increased to 10.2% of GDP from
5% of GDP in 2002. Mutual funds account for 9% of GDP. Overall, institutional
AUM accounts for about 22% of GDP. The sophistication and success of the
Afores system has made the pension fund segment increasingly relevant in
Mexico’s financial markets.
The pension fund system was transformed in 1997 from pay-as-you-go to a
private scheme of defined-benefit and defined-contribution plans. The national
commission for the pension system (Consar) is the regulator and supervisor. Its
main objective is to regulate the retirement funds administrators of Afores –
private institutions authorized to manage individual retirement accounts. There
are 13 Afores pension funds that have enjoyed deregulation recently. Each
worker in the formal labor force has an individual retirement account, in which
contributions are obligatory for the employee, employer and the government.
The pension fund system is broken down into five types of funds that differ in the
amount of investment risk (SB1 to SB5). The SB5 manages money for those
younger than 26 years old and is the riskiest; SB1 manages money for people
over 56 and is the most conservative. The majority of the system is invested in
fixed income, with a heavy bias for Mexico sovereign debt. As of July 2011, 8.6%
of pension fund assets were invested in equities, 17.4% in local corporate debt
and 59.2% in sovereign bonds. International exposure remains small with only
12% of assets invested abroad (equities and fixed income).
In addition to having a deliverable currency Mexico is open to foreign flows of
capital in and out of the country. There is no form of entry or exit taxation, or
barrier for foreign capital. Although foreign investors are not allowed to collect
deposits locally there are no restrictions on local lending for foreign institutions, as
long as the source of funding is abroad. The strong participation of nonresidents
in the Mbonos reflects Mexico’s openness to foreign capital.
Chart 122: Higher foreign participation, especially in Mbonos and
Cetes
50
40
Udibono
Cetes
Bondes D
Mbono
Total gov ernment securities
Chart 123: USD/MXN exhibits high correlation to global risk and VIX
16
MXN
80
VIX
70
15
60
14
30
50
13
20
40
12
30
10
11
20
0
10
10
Jan-08
Oct-08
Jul-09
Apr-10
Source: BofA Merrill Lynch Global Research, Banxico
Jan-11
Oct-11
Jul-12
Jan-07 Oct-07
Jul-08
Apr-09 Jan-10 Oct-10 Jul-11
Apr-12
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Foreign investors are exempt from withholding taxes in government securities,
including IPAB and state-owned banks. The treatment for withholding and capital
gains taxes for foreign investors depend on the instrument and on whether the
nonresident is domiciled in a country with dual tax treaty with Mexico.
For countries with a dual tax treaty there are no withholding taxes for FX-linked
derivatives, TIIE swaps and derivatives involving sovereign debt instruments. In
addition, foreign investors from countries with a dual tax treaty with Mexico are
subject to a 4.9% withholding tax over interest income on corporate debt. For
investors from a country without a tax treaty the withholding rate may be higher
than 4.9% and could reach 15%.
Local investors are subject to a 0.5% withholding tax on foreign government
securities. Investors should check with their tax consultants for specific details
and particular issues.
Purchases of government bonds in primary market auctions are settled through
INDEVAL at T+2. INDEVAL is a private central clearing house that serves both as
a securities depository and as provider of securities settlements services.
Although most transactions with government securities in the secondary market
are settled at T+2, Indeval provides the option of delivery versus payment (DVP),
which is determined during the time of trade and can involve settlement as early
as same day (T+0). Registration of all securities is made on the settlement date
by INDEVAL.
The typical settlement for TIIE swaps is T+1, and T+2 for TIIE-LIBOR, UDI-TIIE
and UDI-LIBOR. Several OTC derivatives, such as the TIIE swap market rely on
the International Swaps and Derivatives Association (ISDA) agreements, which
require nonresident investors conform to proper documentation and master
agreement in Mexico.
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Table 135: Summary of Mexico bond markets and products
Instrument
Mbonos
Udibonos
Cetes
Issuer
Federal government (Hacienda)
Currency
MXN
UDI (settled in MXN)
MXN
100
100
10
Tenor
3 to 30 years
3 to 30 years
28 to 364 days
Fixed rate
Fixed rate on Udi
Zero coupon
Coupon Payments
Semi-annual (182 days)
Semi-annual (182 days)
Zero
Actual/182, semi-annualized 182/360
Actual/182, semi-annualized 182/360
Actual/360 simple interest
Bullet
Bullet
Bullet
Amount outstanding
MXN1,723bn
MXN705bn
MXN861bn
OTC
(as of June 2012)
Secondary Market
Trading
OTC
OTC
Yield
Yield
Yield
Settlement Period
T+2
T+2
T+2
MXN10bn
MXN2bn
MXN10bn
2bp (3-5bp for less liquid tenors)
2bp
2bp
Average trade size
MXN50mn
MXN50mn
MXN100mn
local clearing, Euroclearable
Clearing Mechanism
Major players
Non-resident investors, local pensions, banks local pensions, banks
Non-resident investors, banks
Trading hours
7:00-14:00 (Mexico)
7:00-14:00 (Mexico)
7:00-14:00 (Mexico)
No restrictions
No restrictions
No restrictions
Custodian
Indeval
Indeval
Indeval
Withholding Tax
0.5% for locals, none for foreign investors
Capital gains Tax
None when there is a dual tax treaty
Entry/Exit Tax
None
None
None
Auction Style
Dutch auction
Dutch auction
Competitive auction
Average Issue Size
Varies by tenor MXN 4.5bn – MXN 8.5 each Varies by tenor UDI 650mn – UDI 800mn
Regulations
Primary Auctions
placement
MXN 31.5bn biweekly
each placement
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Peru
Overview
Francisco Rodríguez
Peru has a small local sovereign bond market that is roughly 10% the size of
Colombia’s and 1% of Brazil’s. Over the last decade the government has
improved its debt profile with great success. It has issued local debt out to 2046
and external debt out to 2050. In December 2011, duration of internal debt was
9.2 years and external debt 7.6 years. Refinancing risk has also been lowered,
with less than 30% of debt maturing in less than five years.
Flavio de Andrade
The share of local currency debt has risen to 43.1% of the total government debt
as of March 2012, but remains low in comparison to countries in the region,
exposing Peru to some exchange rate vulnerability. As of December 2011 the
fixed rate debt has increased significantly to 76.9% of the total debt from 32.9% at
year-end 2000. An extension in debt maturities, a reduction of the relative debt
burden, and an increase in central bank reserves have led rating agencies to
upgrade Peru multiple times, from BB status in 2005 to investment grade in local
debt in 2006 and in foreign currency debt in 2008.
Table 136: Peru local debt ratings profile
Moody's
S&P
Fitch
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
Baa3
Baa3
Baa3
Baa3
Baa3
Baa3
Baa3
-
BBB+
BBB+
BBB+
BBB+
BBB+
BBBBBBBB+
BB+
BB+
BB+
BB+
BB+
BBBBBBBBB-
BBB+
BBB
BBB
BBB
BBB
BBBBBBBB+
-
Chart 124: Peru CPI components
37.8%
Food
16.5%
Transport
14.9%
Education
Housing & Utilities
Housing goods
9.3%
5.8%
Peru has a democratic multi-party system with orderly transfers of power;
however, governance problems, particularly in the mining sector, have been a
cause of concern in recent times.
Monetary policy
Background. In 2002 the Central Reserve Bank of Peru (BCRP) adopted an
explicit inflation-targeting regime with a target of 2.5% +/- 1%, which was lowered
to 2% in 2007. The board meets once a month to decide the reference policy rate,
publishing its decision along with a brief statement after market close. Average
inflation from 2002 to 2006 was 2.01% and 3.53% from 2007 to 2011.
Policy framework. According to the Peruvian constitution, the BCRP is a legally
autonomous entity with operational and policy-setting autonomy. Its board has
seven members, four of which – including the BCRP governor – are appointed by
the president and ratified by Congress. The remaining three members are
appointed by Congress. Central bank law mandates the reappointment of all
members within the first 30 days after 28 July in the year of general elections.
However, the three congressional appointees have not yet been renewed for the
current presidential term, currently a delay of 11 months.
Base rate. The BCRP board meets on Thursday of the second week every month
to decide on the reference policy rate, publishing its decision along with a brief
statement after market close. The reference rate (PRRRONUS Index on
Bloomberg) is the BCRP overnight borrowing rate. Minutes of the meeting are not
published.
15.8%
Other
0% 10% 20% 30% 40%
194
The Peruvian economy is highly dependent on commodities exports, particularly
gold and copper. Commodities exports account for 77% of total exports, with gold
and copper at 45% of total exports, up from 31% 10 years ago and 21% 20 years
ago. Gold output has grown nearly tenfold over the past 10 years.
Open market operation. The BCRP regulates liquidity through auctions of BRCP
certificates of deposit, repos of BRCP CDs or Peruvian treasury Bonds, foreign
currency repos, and auctions of Banco de la Nacion deposits in the BCRP.
GEMs Pa pe r #1 0
Conventions
Lending and deposit facilities. Required reserves in local currency are
remunerated at the overnight rate less 100bp. Required reserves in foreign
currency are remunerated at 60% of Libor.
Bonds
Settlement: T+3 (T+1 for primary auctions)
Basis: ACT/360 on fixed rate, ACT/ACT on VAC linkers
CCS
Reserve requirements. General regime deposits are subject to a minimum legal
requirement of 9%. The marginal legal requirement for local currency deposits is
30% and 55% for foreign currency deposits.
FX policy. The PEN has been a free-floating currency since 1990, but a high
level of dollarization has constrained monetary policy flexibility. In May 2012, 51%
of the total credit to the private sector was extended in USD and 41% of total
deposits were held in USD. Although the PEN remains undervalued by several
fundamental measures (6.5% according to our COMPASS model), the central
bank is hesitant to allow a fast pace of appreciation due to the detrimental impact
this would have on domestic USD savers. To temper appreciation pressures, the
central bank has been accumulating reserves aggressively.
Fixing: LIBOR
Coupon frequency: Act/360
The BCRP buys/sells dollars in the currency market with the aim of preventing
high exchange rate volatility and providing the treasury with the necessary funds
to cover external debt service. In practice, the BCRP has been purchasing dollars
in order to prevent local currency appreciation and expand its international
reserves. Reserves totaled US$57.2bn as of June 2012 and were the largest in
the region as a percentage of GDP (32%), having grown by 72% in the last three
years. The BCRP does not purchase dollars every market day. After each
purchase the central bank carries out sterilization operations to prevent
inflationary pressures.
Fiscal policy
Fiscal policy. Total expenditures of the non-financial public sector are 24.0% of
GDP, with 12.6% coming from the central government and the rest from local and
regional governments, as well as decentralized entities of the public sector. Over
the past 10 years Peru has progressively eliminated its deficit, which went from
2.1% of GDP to a surplus of 0.9% of GDP between 2002 and 2011. Its stock of
public debt fell from 46.7% to 20.8% of GDP in the same period. Sustained
economic growth and increasing mining fiscal revenues have helped fiscal
consolidation.
Chart 125: Peru maturity profile (USDbn) of local PEN-denominated
debt
4.0
Fix ed Rate
Inflation linker
3.5
Chart 126: Peru tradable debt composition; total USD22bn
Nominal 50%
Inflation linker
(VAC) 4%
3.0
2.5
2.0
1.5
1.0
0.5
USD(EXD)
0.0
46%
2012 2015 2018 2021 2024 2027 2030 2033 2036 2039 2042 2045
Source: Peru Finance Ministry, BofA Merrill Lynch Global Research
* In the tradable debt we only include local Soberanos and external Global Bonds
Source: Peru Finance Ministry, BofA Merrill Lynch Global Research
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Debt issuance. As of March 2012 Peru had outstanding debt of PEN97bn
(US$36.2bn), of which PEN55bn (56.9%) was internal and PEN42bn (43.1%)
external. Central government debt, most in the form of bonds, comprised 83.1%
of total internal debt. Of the local bonds issued by the central government, 98.9%
are denominated in PEN. But the mainstream local bonds (Soberanos) are all
denominated in PEN.
Bond market
Local bond issuance is concentrated in two types of bonds: PEN-denominated
fixed-rate Soberanos and PEN-denominated inflation-linked VAC. Peru is
concentrating on benchmark maturities (defined as face greater than PEN4bn),
prioritizing the 2042, 2031 and 2020 Soberanos, in that order. As memories of
double-digit inflation in the 1990s fades and the degree of dollarization in the
economy declines, the nominal local rates market is likely to continue to grow.
Liquidity in the local bond market remains poor with only PEN3-4bn (USD1-1.5bn)
of local bonds traded every month.
Fixed-rate Soberanos. The Soberanos are fixed-rate bonds with maturities out
to 2042. These bonds pay a semi-annual fixed rate coupon. The largest issue is
the August 2020 with PEN9bn outstanding ($3.4bn). The most liquid Soberanos
are the ones with larger outstanding face such as the Aug20s, Aug26s, Aug 31s
and Aug37s, and the Aug ‘17s.
Inflation-linked VAC. The VACs are inflation-linked bonds with maturities out to
2046. The linkers pay a semi-annual fixed coupon and final principal, all of which
are adjusted by the VAC at payment date. The VAC is linked to monthly inflation
and published daily by the BCRP. The largest issue of the VAC linker is the
January 2035 with PEN1.1bn outstanding ($423mn). Linkers have poor liquidity
with monthly trading volume of less than USD50mn.
Foreign investors and local pensions are the largest holders. Recently, however,
nonresidents have accounted for a greater portion of local bond holdings, now
exceeding the holdings of private pension funds (AFPs).
Auction and placement mechanism. Soberanos are issued to officially
appointed market makers via Dutch auctions. In 2012 the Ministry of Finance
appointed six market makers: five primary and one secondary (aspirante) 23. The
primary auctions are conducted through the Datatec system and settled at T+1.
Auctions can occur monthly although in the last 12 months there were only nine.
For 2012 the primary market makers are Banco de Crédito del Perú, BBVA Banco Continental, Citibank,
Deutsche Bank, Scotiabank, and the aspirante is Banco Internacional del Perú.
23
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Bloomberg pages
Derivatives market
OTC PEN <GO> – Market monitor
Investors can also trade cross currency swaps to express a view on local rates,
yet we caution liquidity in these is poor. In a PEN/LIBOR swap an investor agrees
to pay a fixed local rate in exchange for USD6mn USD LIBOR semi-annually.
PERUGB Govt <GO> – Soberanos
Reuters pages
<PEN=>
Table 137: Summary statistics of Peru derivative products and their markets
Central bank
http://www.bcrp.gob.pe/
Product
Finance Ministry
http://www.mef.gob.pe/
Rates
Statistics agency
http://www.inei.gob.pe/
Pension regulator
http://www.sbs.gob.pe/0/home.aspx
Bond auctions
http://www.mef.gob.pe/ESPEC/mercado/mercado_secund
ario.php
Lima Stock Exchange
http://www.bvl.com.pe/
Avg daily
Avg
Bid-Ask
spread
Fixings and
other notes
20bp
Poor liquidity
Cross currency swap
PEN x LIBOR
USD10mn
LIMABOR
USD 3mn
Started trading
Not enough history,
recently
and poor liquidity
FX market
USD/PEN is non-deliverable and daily trading volume ranges from USD350500mn, with the central bank regularly accounting for anywhere from 50-100% of
the day’s trading volume depending on PEN performance. The BCRP allowed
PEN to strengthen in 2010, but in 2011 volatility increased due to the presidential
elections. The overall trend after the elections has been gradual appreciation with
low volatility. The NDF curve is highly illiquid, but is quoted out to one year. It
tends to invert from time to time in anticipation of the BCRP allowing greater
flexibility.
Table 138: Peru’s FX market vital statistics and characteristics
Tradable
product
Avg daily
trading
volume
Avg
trading
size
Bid-Ask
spread
Reuters
reference
PEN Spot
USD550mn
USD1mn
10 pips
<PEN=>
DATATEC
fixing
Offshore
NDF
Forward
USD250mn
USD3mn
30 pips on
1m
<PENNDF
OR=>
DATATEC
fixing
NDO
Options
Very
infrequent
FX
product
Onshore
Spot
Key facts
1 pip = PEN 0.0001
Investor base
Foreign investors are the major holders of Soberanos (aggregate fixed rate and
VAC). By March 2012 nonresidents accounted for just under 50% of the amount
outstanding.
As of 2011, pension fund and mutual fund AUM accounted for 17.6% and 3.1% of
GDP, respectively. Total institutional AUM (USD34.1bn) accounts for roughly
21% of GDP, compared to 2002 when total institutional AUM accounted for only
10% of GDP. As one of the more flexible systems in LatAm in terms of exposure,
Peruvian pension funds held 59% of their portfolio in fixed income securities and
41% in equities as of 1Q 2011. Mutual funds, on the other hand, invest heavily in
fixed income securities. As of 1Q 2011, 96% of Peruvian mutual funds AUM were
invested in fixed income securities, compared with 4% in equities.
197
GEMs Pa pe r #1 0
It is worth noting that recent changes in regulations allow insurance companies to
move life insurance policy benchmarks away from VAC and USD rates increasing
share of new issues in nominal PEN which should drive future demand for longer
dated bonds.
Local and foreign investors are exempt from capital gains tax on government
securities. Currently there is the tax on financial transactions (ITF) at a rate of
0.05% of the amount of all financial transactions, either in domestic and foreign
currency.
CAVALI is the major depository and clearing institution in Peru. It has been
operating as an independent institution responsible for settlement services and
securities custody since its spin-off from the BVL (Lima Stock Exchange) in 1997.
Government securities settle through CAVALI, including the ones issued to
primary dealers. Foreign investors must appoint a local custodian.
Table 139: Still highly dollarized economy (%)
Bank credit
Deposits
2000
82.3
82.4
2001
81.6
80.2
2002
80.7
79.5
2003
78.6
77.6
2004
76.6
72.3
2005
72.4
69.4
2006
65.3
67.4
2007
61.9
62.0
2008
56.7
60.5
2009
52.0
57.2
2010
49.5
46.1
2011
50.2
47.3
Jun 2012
50.4
44.0
Note: % of total bank credit and deposits in USD
Chart 128: Peru foreign reserves continue to rise, at $58bn in July
2012
Chart 127: Foreign participation of Soberanos reaches 50% in 2012
50%
Foreign participation
Outstanding debt (PEN bn)
40%
60
30
50
25
40
30%
20
30
20%
15
10%
0%
Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11
Source: BCRP, BofA Merrill Lynch Global Research
198
35
10
Peru Foreign Reserv es (USD bn)
20
5
10
0
0
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
GEMs Pa pe r #1 0
Table 140: Summary of Peru bond markets and products
Instrument
Soberanos fixed-rate
Issuer
Republic of Peru
Soberano VAC-linker
Republic of Peru
Currency
PEN
IRD/VAC (settled in PEN)
1,000
1,000
Tenor
1 to 30 years
1 to 34 years
Semi-annual
Semi-annual
Coupon Payments
Fixed rate
Fixed rate
ACT/360
ACT/3ACT
Bullet
Bullet
Amount outstanding
PEN28.7bn
PEN2.6bn
Trading
Datatec
Datatec
Yield
Yield
Settlement Period
T+3
T+3
PEN175mn
PEN 500k
5bp
15bp
5bp
15bp
(as of June 2012)
Secondary Market
Average trade size
PEN3mn
PEN1mn
Clearing Mechanism
Local CAVALI, or offshore
Local CAVALI, or offshore
Major players
Nonresidents, local funds, banks
Local banks and funds
Trading hours
9:30am – 2:30pm NY
9:30am – 2:30pm NY
Regulations
No restrictions
No restrictions
Custodian
CAVALI
CAVALI
Withholding Tax
ITF tax (0.05% of transacted amount)
ITF tax (0.05% of transacted amount)
Capital gains Tax
Foreigners exempt, locals 30%
Foreigners exempt, locals 30%
Entry/Exit
None
None
Auction Style
Dutch auction
Dutch auction
Average Issue Size
PEN 250mn
Last issuance May 2010
Primary Auctions
199
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Appendix
BofAML Local Debt Markets Plus Index (LDMP) rules
The BofA Merrill Lynch Local Debt Markets Plus Index is designed to track the
performance of sovereign debt publicly issued and denominated in the issuer's
own domestic market and currencies other than the more established top-tier
sovereign markets.
To be included in the Index, a country must have:

At least $10bn (USD equivalent) outstanding face value of Index qualifying
debt (ie, after imposing constituent level filters on amount outstanding,
remaining term to maturity, etc).

At least one readily available, transparent price source for its securities.
In addition, the following countries are specifically excluded from the index: G10
countries, Euro members and all countries with a foreign currency long-term
sovereign debt rating of AA3 or higher (based on an average of Moody’s, S&P
and Fitch). Qualification with respect to country size criteria is determined
annually based on information as of 30 September, but does not take effect until
31 December.
Conversion of local currency outstanding face value into USD terms is based on
the average of the previous 12 month-end exchange rates up to and including the
30 September evaluation date. To be excluded on the basis of Euro membership,
entry into the European Monetary Union must be announced on or before the
country qualification date (30 September) and must take effect on or before
1 January of the upcoming year.
Currently qualifying countries and their respective minimum local currency
requirements are as follows: Brazil (BRL1bn), China (CNY20bn), Colombia
(COP500bn), Czech Republic (CZK20bn), Egypt (EGP2bn), Hungary (HUF50bn),
India (INR30bn), Indonesia (IDR1tn), Israel (ILS1bn), Malaysia (MYR1bn), Mexico
(MXN5bn), Morocco (MAD2.5bn), Philippines (PHP5bn), Poland (PLN2bn),
Russia (RUB10bn), South Africa (ZAR5bn), South Korea (KRW1tn), Thailand
(THB10bn) and Turkey (TRY2bn).
In addition, qualifying securities must have at least one year remaining term to
final maturity and a fixed coupon schedule. Callable perpetual securities qualify
provided they are at least one year from the first call date. Fixed-to-floating rate
securities also qualify, provided they are callable within the fixed-rate period and
are at least one year from the last call prior to the date the bond transitions from a
fixed to a floating rate security. Bills, inflation-linked debt and strips are excluded
from the Index; however, original issue zero-coupon bonds are included in the
index and the amounts outstanding of qualifying coupon securities are not
reduced by any portions that have been stripped.
Index constituents are capitalization-weighted based on their current amount
outstanding, provided the total allocation to an individual country does not exceed
10%. Countries that exceed the limit are reduced to 10% and the face value of
each of their bonds is adjusted pro rata. Similarly, the face values of bonds of all
other issuers that fall below the 10% cap are increased pro rata. In the event
there are fewer than 10 countries in the Index, each is equally-weighted and the
face values of their respective bonds are increased or decreased on a pro rata.
200
GEMs Pa pe r #1 0
Accrued interest is calculated assuming next-day settlement. Cash flows from
bond payments that are received during the month are retained in the index until
the end of the month, and then removed as part of the rebalancing. Cash does
not earn any reinvestment income while it is held in the index. The index is
rebalanced on the last calendar day of the month, based on information available
up to and including the third business day before the last business day of the
month. Issues that meet the qualifying criteria are included in the index for the
following month. Issues that no longer meet the criteria during the course of the
month remain in the index until the next month-end rebalancing at which point
they are removed from the index. Inception date: 31 December 2005
Note: The above rules take into account all revisions up to and including 31
December 2010.
BofA Merrill Lynch EM Sovereign Bond Index (WSBV) rules
The BofA Merrill Lynch Emerging Markets Sovereign Bond Index (WSBV) is a
subset of The BofA Merrill Lynch World Sovereign Bond Index (WSOV) excluding
all FX G10 and western European countries. The WSOV Index is designed to
track the performance of sovereign debt publicly issued and denominated in the
issuer's own domestic market and currency. In order to be included in the Index, a
country:

Must have at least $10bn (USD equivalent) outstanding face value of index
qualifying debt (ie, after imposing constituent level filters on amount
outstanding, remaining term to maturity, etc).

Must have at least one readily available, transparent price source for its
securities.
Qualification with respect to country size criteria is determined annually based on
information as of 30 September, but does not take effect until 31 December.
Conversion of local currency outstanding face value into USD terms is based on
the average of the previous 12 month-end exchange rates up to and including the
30 September evaluation date.
BofAML Global EM Inflation-Linked Government Index rules
The BofA Merrill Lynch Global Emerging Markets Inflation-Linked Government
Index tracks the performance of inflation-linked sovereign debt publicly issued by
emerging market countries in their own domestic market and local currency.
Countries are selected for inclusion in the index by an index committee based on
a combination of quantitative and qualitative criteria.
Changes in constituent countries, if any, are announced annually at the end of
January and take effect at the 31 March rebalancing (ie, the Annual Rebalancing
Date). Index constituents are market value-weighted, subject to a 20% maximum
country weight and a 2% minimum country weight. The index excludes FX G10
members, all western European countries, territories of the US and western
European countries, and South Korea.
201
GEMs Pa pe r #1 0
Table 141: The BofA Merrill Lynch indices as of August 2012
Ticker The BofA Merrill Lynch indices
# bonds Duration
LDMP
LDMA
LDML
LDME
WSBV
GLEE
GLEM
GEMI
WBDI
GEMT
G0BR
G0CL
G0CN
CNHG
G0CZ
G0EG
G0HK
G0ID
G0IN
G0IS
G0MA
G0MX
G0MY
G0NG
G0PH
G0PL
G0RU
G0SA
G0SK
G0SP
G0TH
G0TR
G0TW
GBRI
GISI
GCLI
GMXI
G0PI
GSAI
GSKI
GTRI
G1CN
GVCN
G2CN
G5CN
G3CN
G6CN
G4CN
G7CN
GMCN
G9CN
G8CN
GFCZ
GBHK
GVHK
GEM fixed rate indices
Local debt markets plus index
Asia local debt markets plus index
Latin America local debt markets plus index
EMEA local debt markets plus index
GEM sovereign bond index (ex-G10 FX & ex-w. Europe)
Net equal-weighted liquid local debt markets index
Net-cap weighted liquid local debt markets index
GEM inflation-linked indices
Global emerging markets inflation-linked govt index
Global diversified emerging mkts inflation-linked govt index
Global emerging markets inflation-linked govt tracker
GEM country fixed rate indices (maturity > 1 year)
Brazil govt index
Chile govt index
China govt index
Dim Sum govt index
Czech republic govt index
Egypt govt index
Hong Kong govt index
Indonesia govt index
India govt index
Israel govt index
Morocco govt index
Mexico govt index
Malaysia govt index
Nigeria govt index
Philippines govt index
Poland govt index
Russia govt index
South Africa govt index
South Korea govt index
Singapore govt index
Thailand govt index
Turkey govt index
Taiwan govt index
Inflation indices by country (maturity > 1 year)
Brazil inflation-linked govt index
Israel inflation-linked govt index
Chile inflation-linked govt index
Mexico inflation-linked govt index
Poland inflation-linked govt index
South Africa inflation-linked govt index
South Korean inflation-linked govt index
Turkey inflation-linked govt index
GEM fixed rate country indices by maturity buckets
1-3 year China govt index
5+ year China govt index
1-4 year Czech Republic govt index
0-3 year Hong Kong govt index
1-5 year Hong Kong govt index
202
524
289
41
194
752
10
10
4.8
5.7
4.1
4.2
5.7
4.5
4.4
76
88
13
7.8
7.4
7.4
11
17
136
13
13
26
60
30
73
13
48
20
59
13
57
15
29
12
28
16
42
12
76
2.5
4.2
7.2
3.9
5.5
2.3
4.2
7.2
5.6
4.4
4.4
6.1
4.9
3.3
7.0
4.0
4.2
5.8
5.2
6.5
6.1
2.5
8.2
13
10
26
9
2
6
3
10
8.3
7.6
8.7
9.6
5.1
10.7
6.8
3.8
30
55
25
97
22
42
20
9
81
39
30
5
38
38
1.9
2.7
3.6
4.4
5.2
6.3
7.3
8.9
9.6
13.1
14.1
2.2
1.3
2.4
Ticker The BofA Merrill Lynch indices
GBIN
G1IN
GVIN
G2IN
G5IN
G3IN
G6IN
G4IN
G9IN
G1MY
G1MX
G1PL
GFPL
GBSP
G1SP
GVSP
G2SP
G3SP
G1SA
GFSA
GWSA
GBSK
GSKV
G1TH
G1TR
CJHG
GJEG
GJNG
GJBI
GJEI
GJSI
GJMY
GJXI
GJPI
GJAI
GJKI
GJRI
L0HD
LHD0
L4HD
L1HD
LHD1
L5HD
L3HD
LHD3
L0MR
LMR0
L1MR
LMR1
L3MR
LMR3
L1SG
L3SG
L6SG
LSG6
# bonds Duration
GEM fixed rate country indices by mat. buckets (cont'd)
1-2 year India govt index
10+ year India govt index
1-3 year Malaysian govt index
1-3 year Mexico govt index
1-3 year Poland govt index
1-4 year Poland govt index
0-3 year Singapore govt index
1-3 year South Africa govt index
0-3 year South Korean govt index
1-5 year South Korean govt index
1-3 year Thailand govt index
1-3 year Turkey govt index
Fixed rate indices by country (maturity > 1 mo)
Dim Sum govt index (>1mo)
Egypt government index (>1mo)
Nigeria government index (>1mo)
Inflation indices by country (maturity > 1mo)
Brazil inflation-linked government index (>1mo)
Chile inflation-linked government index (>1mo)
Israel inflation-linked government index (>1mo)
Malaysia government index (>1mo)
Mexico inflation-linked government index (>1mo)
Polish inflation-linked government index (>1mo)
South Africa inflation-linked government index (>1mo)
South Korean inflation-linked government index (>1mo)
Turkey inflation-linked government index (>1mo)
Short duration country indices (maturity < 6 mos)
Hong Kong dollar overnight LIBID index
Hong Kong dollar overnight LIBOR index
Hong Kong dollar 1-month LIBID average index
Hong Kong dollar 1-month LIBID constant maturity index
Hong Kong dollar 1-month LIBOR constant maturity index
Hong Kong dollar 3-month LIBID average index
Hong Kong dollar 3-month LIBID constant maturity index
Hong Kong dollar 3-month LIBOR constant maturity index
Malaysian ringgit overnight LIBID index
Malaysian ringgit overnight LIBOR index
Malaysian ringgit 1-month LIBID constant maturity index
Malaysian ringgit 1-month LIBOR constant maturity index
Malaysian ringgit 3-month LIBID constant maturity index
Malaysian ringgit 3-month LIBOR constant maturity index
Singapore dollar 1-month LIBID constant maturity index
Singapore dollar 6-month LIBOR constant maturity index
6
13
25
12
49
11
24
13
24
14
4
5
7
7
4
7
3
2
2
3
5
17
17
9
8
1.3
1.8
2.6
3.3
4.1
4.5
5.4
5.9
8.5
1.7
1.9
1.7
2.1
1.3
2
2.8
3.9
5.8
1.7
2.1
3.4
1.3
2.4
2.0
1.4
13
31
16
3.9
2.0
2.6
14
30
12
68
10
2
7
3
10
7.6
7.9
6.7
4.6
9.1
5.1
9.3
6.8
3.8
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
0
0
0
0.1
0.1
0.1
0.2
0.2
0
0
0.1
0.1
0.2
0.2
0.1
0.2
0.5
0.5
GEMs Pa pe r #1 0
Options Risk Statement
Options and other related derivatives instruments are considered unsuitable for
many investors. Options strategy is by definition governed by a finite
duration. The most severe risks associated with general options trading are
total loss of capital invested and delivery/assignment risk, all which can
occur in a short period.
203
GEMs Pa pe r #1 0
Link to Definitions
GEM Macro
Click here for definitions of commonly used terms.
Macro
Click here for definitions of commonly used terms.
204
GEMs Pa pe r #1 0
Special Disclosures
Some of the securities discussed herein should only be considered for inclusion in
accounts qualified for high risk investment.
205
GEMs Pa pe r #1 0
Important Disclosures
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This research report provides general information only. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer,
to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for
differences). This report is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation
and the particular needs of any specific person. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and
implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.
206
GEMs Pa pe r #1 0
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207
GEMs Pa pe r #1 0
Team Page
Global Emerging Markets Fixed Income Strategy and Economics
Alberto Ades
MLPF&S
Jane Brauer
Quantitative FI Strategist
MLPF&S
Vasileios Gkionakis
MLI (UK)
Isidore Smart
Arko Sen
EEMEA FI Strategist
MLI (UK)
Matthew Sharratt
S. Africa, Nigeria Economist
Merrill Lynch (South Africa)
Raffaella Tenconi
Italy, CEE, Ukraine Economist
MLI (UK)
Mai Doan
GEM Economist
MLPF&S
CEE, Israel Economist
MLI (UK)
Emerging Asia Economics
Hak Bin Chua
MENA Economist
MLI (UK)
ASEAN Economist
Jaewoo Lee
Korea Economist
Merrill Lynch (Seoul)
Ting Lu
China Economist
Indranil Sen Gupta
India Economist
DSP Merrill Lynch (India)
Marcella Chow
Emerging Asia Economist
Larry Hu 9
China Economist
Xiaojia Zhi
China Economist
Emerging Asia FX and Fixed Income Strategy
Claudio Piron
Bin Gao
Rates Strategist
Albert Leung
Christy Tan
Emerging Asia FX Strategist
EEMEA Fixed Income Strategy and Economics
David Hauner, CFA
EEMEA FI Strategist, Economist
MLI (UK)
Turker Hamzaoglu
Turkey, MENA Economist
MLI (UK)
Vladimir Osakovskiy
Russia, CIS Economist
Merrill Lynch (Russia)
208
Jean-Michel Saliba
Latin America Economics
Marcos Buscaglia
LatAm Economist
MLPF&S
David Beker
Brazil Economist, FI Strategy
Merrill Lynch (Brazil)
Carlos Capistran
Mexico Economist
Merrill Lynch (Mexico)
Francisco Rodriguez
Andean Economist
MLPF&S
Javier Rouillet
Merrill Lynch (Argentina)
LatAm FX and Fixed Income Strategy
Claudio Irigoyen
LatAm FI Strategist
MLPF&S
Ezequiel Aguirre
LatAm FI Strategist
MLPF&S
Flavio de Andrade
LatAm FI Strategist
MLPF&S
Sebastian Rondeau
LatAm FI Strategist
MLPF&S