local markets handbook

Latin American Fixed Income Research December 2013

LOCAL MARKETS HANDBOOK 2014 A Guide to Latin American Rates

ARGENTINA

BRAZIL

CHILE

COLOMBIA

MEXICO

PERU

URUGUAY

Alejandro Estevez-Breton David Duong Alejandro Rivera (212) 350-3917 (212) 407-0979 (212) 350-0734

[email protected] [email protected] [email protected]

Juan Pablo Cabrera* Marcela Bension* (3491) 257-2172 +598 (2) 1747-5537

[email protected] [email protected]

U.S. investors inquiries should be directed to Santander Investment at (212) 350-0707. *Employed by a non-US affiliate of Santander Investment Securities Inc. and is not registered/qualified as a research analyst under FINRA rules.

LATAM Latin America Local Markets Summary ............. 3 ARGENTINA ...................................................... 4 ARS Bonar ......................................................... 9 ARS Boden....................................................... 11 Bocon ............................................................... 12 Bogar ................................................................ 14 Discounts and Pars (ARS-Denominated) ........ 16 Domestic USD Bonds ...................................... 17 Global USD Bonds ........................................... 18 GDP-linked Securities ...................................... 20 ARS vs. USD LIBOR Swaps ............................ 22 BRAZIL ............................................................ 23 LTN ................................................................... 35 NTN-F ............................................................... 37 LFT ................................................................... 39 NTN-B .............................................................. 41 NTN-C .............................................................. 45 Global Bonds Denominated in BRL ................. 46 DI Futures......................................................... 47 Pr-DI Swaps ................................................... 51 Pr-CDI Swaptions ........................................... 53 DI Options ........................................................ 54 IDI Options ....................................................... 55 IGP-M x CDI Swaps ......................................... 56 IPCA x CDI SWAPS ......................................... 57 FRC Futures ..................................................... 58 USD Futures .................................................... 60 SCC (Cross-Currency Swaps) ......................... 61 CHILE ............................................................... 63 BCU .................................................................. 68 BTU .................................................................. 70 BCP .................................................................. 71 BTP .................................................................. 72 PDBC ............................................................... 73 CLP-Denominated International Bonds Due

2020 ............................................................ 74 Cmara swaps ................................................. 75 CLP vs. USD LIBOR Swaps ............................ 77 UF vs. USD LIBOR Swaps ............................... 77 Inflation forwards (UF/CLP).............................. 78

COLOMBIA ..................................................... 79 TES .................................................................. 85 Fixed-Rate TES in COP ................................... 87 TES UVR ......................................................... 89 Floating-rate TES IPC ...................................... 89 Short-term TES in COP ................................... 91 Global TES ....................................................... 92 COP vs. USD LIBOR Swaps ........................... 96 IBR Swap ......................................................... 96 MEXICO ........................................................... 97 Bonos ............................................................. 106 Bondes ........................................................... 108 Cetes .............................................................. 109 Udibonos ........................................................ 110 Strips .............................................................. 112 BPA, BPAT, and BPA182 .............................. 113 TIIE Swaps ..................................................... 114 TIIE Swaptions ............................................... 115 UDI vs. USD LIBOR Swaps ........................... 116 UDI vs. TIIE Swaps ........................................ 116 MexDer .......................................................... 117 PERU ............................................................. 120 Fixed-Rate Bonos Soberanos ........................ 124 Inflation-Linked Bonos Soberanos ................. 125 URUGUAY ..................................................... 127 Foreign Exchange Market .............................. 132 Central Bank Bills (Letras de Regulacin

Monetaria) ................................................. 133 UYU Treasury Bills......................................... 136 UYU Treasury Notes ...................................... 137 UI Treasury Notes .......................................... 139 UI Treasury Bonds ......................................... 141 Dollar Treasury Bonds (Domestic Law) ......... 143 UYU vs. USD LIBOR Swaps ......................... 144

LATIN AMERICA LOCAL MARKETS SUMMARY Argentina Brazil Chile Colombia Mexico Peru Uruguay

ARS BRL CLP COP MXN PEN UYU FX policy framework Convertibility Non-convertible Non-convertible Partially convertible Non-convertible Fully convertible Partially convertible Partially convertible Regime Managed float Dirty float Free float Free float Float Managed float Free float

Central Bank intervention Daily discretionary,

spot & onshore forward

Discretionary, spot, fwd, FX swaps and

other regulatory mechanisms.

Discretionary. Daily Central Bank

purchases and USD swaps used in the

past

Discretionary USD buying. Options

have been used in the past.

Sporadic rules-based volatility USD spot sales

Discretionary spot & USD CDs as well as

USD reserve requirements

Discretionary, spot & occasionally

forward

Average ticket in US$ million & bid/ask (pips) 5mn & 10 cents 50 mm & 10pips 5mn & 50pips 5mn & 100-200pips 5 mm & 5-10 pips 1.5mn & 10pips 400k & 50-100pips

Spot daily average trading in US$ billion 0.2 (onshore) 2.2 1.8-2 1-1.5

21 (swaps)+16 (fwds & fut) 0.5 0.0

Market daily fixing EMTA Industry Survey PTAX (Central

Bank) Observed BCCh rate TRM

(Superfinanciera) Banxico official

MXN fixing Official rate (BCRP) Official Closing rate

(C. Bank)

Forward daily trading in US$ 40mn at 1m-3m (on & offshore) 16.9 (BM&F) 1.0 1.0 9 150mn 2mn

Monetary policy regime Money supply target Inflation target Inflation target Inflation target Inflation target Inflation target Indicative inflation target Inflation target 2011 Not applicable 4.5% (200 bps) 3.0% (1pp) 3.0% (1pp) 3.0% (100 bps) 2.0% (100bps) 5% (200bps)

Policy rate Reverse repo Selic BCCh monetary policy BanRep O/N repo Banxico O/N "fondeo" BCRP reference No reference rate

since July 1st 2013 Bond market Local govt. debt outstanding LCY billion 858.0 1,916.7 25,516.0 164,649.0 4,907.5 51.1 355.0

Local govt. debt outstanding US$ billion 143.0 820.5 49.2 87.4 374.3 18.4 16.8

Fixed 8.7% 39.9% 28.1% 77.4% 42.8% 80.1% 36.4% USD 59.1% 0.6% 0.0% 0.0% 0.0% 0.0% 3.6% Inflation linkers 23.2% 35.6% 71.9% 22.6% 19.1% 19.9% 60.0% Floaters 9.0% 23.3% 0.0% 0.0% 21.2% 0.0% 0.0% Other* 0.0% 0.6% 0.0% 0.0% 16.8% 0.0% 0.0%

Average duration & maturity (years) ** 3.1 & 10.4 4.2 & 6.7 6.25 & 8.1 4.30 & 6.20 n.a. & 7.8 7.2 & 13 n.a. & 4.6

Daily turnover LCY billion 2.9 18.9 220.0 2.4 24.0 0.1 0.6 Daily turnover USD billion 0.6 8.1 0.4 1.2 1.8 0.0 0.0 Daily turnover as % of outstanding 1.7% 1.0% 0.9% 1.4% 0.5% 0.3% 0.2%

Daily turnover as % GDP 0.1% 0.4% 0.2% 0.3% 0.1% 0.0% 0.1% Local debt (securities) as % GDP 23.0% 39.6% 17.0% 21.0% 26.8% 6.2% 30.0%

AFP participation in local debt (% ) n.a. 17.3% 65.0% 28.3% 25.2% 26.1% 29.0%

Foreign participation in local debt (%)** 10.0% 16.9% 1 to 3% 6.6% 40.0% 57.5% 25.0%

Derivatives FX options Not available Available Available Available Available Not available Available

1-month ATM implied vol spread 0.70%-1.00% 1.00-1.50% 1.50-2.00% 0.5%-0.75%

Inflation forwards Not available Not available UF/CLP Not available Not available Not available UI/USD OTC Average ticket in local units & bid/ask UF300k (10 pesos)

Swaps nominal ARS x Badlar Pre-DI CLP x Camara IBR Swaps TIIE Not available Exclusively available OTC Average ticket in US$ million & bid/ask (bps) 1mn (75bps) 25 k DV01 (1-2 bps) 10k DV01 (5-10 bps)

5k DV01 (10-15bps)

10k DV01 (4-5 bps)

Swaps inflation-linkers Not available IPCA x CDI UF x Camara Not available UDI x TIIE Not available Not available Average ticket in US$ million & bid/ask (bps) 20k DV01 (15 bps) 10k DV01 (5-10 bps) No longer liquid

Cross currency ARS x USD Libor CDI x Cupom Cambial CLP & UF x USD

Libor COP & UVR x USD

Libor TIIE x USD Libor PEN & VAC x USD

Libor UYU x USD ,

exclusively OTC

Bid-ask spread 600bps 20k DV01 (15 bps) 10mn (10bps) 20mn (15bps) 10k DV01 (15-20 bps) 5 mm (20 bps) 50-75 bps

Sources: Corresponding Central Banks, government ministries, and other regulatory bodies, and Santander. *Others include GDP warrants in Argentina (duration estimate excludes warrants). **In Argentina excluding Par and discounts from the exchange which are subject to foreign law; in Peru duration is calculated with most-liquid fixed bonds.

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ARGENTINA MACRO BACKGROUND

In 2013, the government of Argentina remained absent from international and local debt markets and continued meeting its external obligations through the use of the Central Banks foreign reserves. As such, Central Bank reserves declined to just US$33 billion at the end of October 2013 from US$43.3 billion at end 2012, covering less than four months of imports. Meanwhile, the official exchange rate depreciated on average 2% monthly during the same period.

Argentine asset prices continue to be driven by the legal battle with holdout creditors, a battle that now also includes participants of the exchange and the trustee for the restructured bonds. On 23 August 2013, the U.S. Court of Appeals of the Second District ruled against Argentina in favor of payment on the order of US$1.3 billion to the holdout creditors. However, the ruling was stayed until the U.S. Supreme Court decided to hear the case and eventually make a judgment. The Supreme Court could make a decision on whether to hear the case in 2014, but there is no firm timeline. In the interim, Argentina may continue to service its debt without fear of attachment.

The fiscal deficit continued widening all during 2013. In the last 12 months to August, the primary deficit reached 0.2% of GDP (including nontax revenue such as BCRA and ANSES transfers) and 2.2% of GDP after interest payments. The government continues focusing all its financing strategy on domestic sources such as Central Bank loans, ANSES transfers, and/or intragovernment debt issuances. According to our calculations, the BCRA and ANSES transfers represented 3.8 times the size of the accumulated primary result of the first eight months of the year. In 2012 and 2011, such numbers were lower at 2.1 and 0.8 times, respectively. We do not see significant changes to the current expansionary fiscal stance, considering the traditional bias of the present administration regarding public spending.

Since late 2011, mounting balance-of-payment tensions led authorities to launch a set of new measures and controls aimed at fostering USD supply and curbing demand, especially from the corporate and household sectors. These controls were significantly tightened during 2012 and have led to increasing pressures on the so-called blue-chip exchange rate, which reflects the implicit USD/ARS rate resulting from the onshore ARS and the offshore USD price of the same financial asset (such as sovereign bonds or highly traded stocks). These FX developments have added uncertainty in terms of convertibility risk and are leading to less participation by foreign investors in the domestic market.

PUBLIC DEBT COMPOSITION Public sector borrowing requirements for 2014 are estimated at US$35 billion, but this could rise to US$38 billion if the economy expands more than 3.5% and payments on GDP warrants are due. We estimate that the funding of this US$11 billion will be secured through different forms of Central Bank assistance (profits, loans, USD reserve transfers to the Treasury) and intra-public-sector debt issuance. We believe the chances of Argentina coming back to international debt markets for sizable amounts of financing during the next year are negligible, especially after the recent negative ruling from U.S. courts on the resolution of the defaulted debt of 2001.

The latest official report indicates that Argentinas net public debt (including holdouts) stands at around US$92 billion, which represents a low 20% of GDP. (It was around 40% of GDP before the nationalization of the private pension system back in 2008, and almost 70% just before the default in 2001.) The gross public debt reaches US$208 billion (or 46.2% of GDP), but US$116 billion corresponds to intra-public-sector debt and bondholdings by state-owned institutions (such as the Central Bank or ANSES, the social security entity). Sovereign bonds in the hands of private investors are estimated at US$52 billion, with almost three quarters of that amount in dollar-denominated issues.

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Gross & net public debt stock (US$ billions) US$bn

Bonds 127.2 - Local currency 33.7 - Foreign currency 93.5 Loans 63.1 - Multilateral agencies 18.5 - Commercial banks 6.9 - Central bank & other agencies 23.9 - Other 13.8 Paris Club 5.9 Total Public debt (official) 196.2 Holdouts 11.5 Total public debt adjusted 207.7 - In hands of BCRA, ANSES & BNA 115.8 Net public debt (adjusted) 91.9 Gross public debt, % of GDP 46% Net public debt, % of GDP 20%

As of June 30, 2013. Public sector holdings include ANSES, BCRA, and BNA. Sources: MECON and Santander estimates.

Public sector borrowing requirements, 2014 Amortization profile of bond debt (% of total)

2014 federal government funding needs USD bn* USD bn**

Uses 34.9 38.4 Interest payments 6.9 10.4 Amortizations 28.0 28.0

Sources 22.6 25.4 Primary result -4.8 -4.8 IFI 1.7 1.7 FX reserves 3.3 6.1 Public agencies roll over (includes only BCRA loans) 22.3 22.3

Public agencies new debt (includes only BCRA loans) 12.3 13.0

0%

2%

4%

6%

8%

10%

12%

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

*No GDP warrant payment. ** GDP warrant payment assuming 3.5% GDP growth. Sources: Economy Ministry and Santander.

As of June 30, 2013. Includes holdings of state-owned entities (BCRA, ANSES). Excludes intra-public-sector Treasury bills. Total debt maturities amount to US$124.3 billion (local and foreign currency bonds). Sources: Economy Ministry and Santander.

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Local Markets Handbook 2014

FIXED INCOME MARKET ARS and CER-linked bondsSecondary market liquidity and outstanding amounts

Maturity Traded volumes Monthly avg

Outstanding amount (US$ millions)

In hands of ANSES/BCRA*

Bonar 14 279.7 3,602 55% Bonar 15 98.2 1,407 32% Bonar 16 n.a. 2,326 87% Pro 12 4.9 269 n.a. Pre 9 2.4 74 n.a. Pro 13 56.1 983 11% Boden 2014 7.3 140 n.a. Par bonds 10.3 1,222 2% Quasi Par bonds 0.2 13,631 68% Discounts 61.0 5,681 53% Bogar 18 83.6 6,398 15% Total 603.7 36,205

Monthly traded volumes at MAE (Mercado Abierto Electrnico), cash basis, in millions of U.S. dollars (average of July, August and September 2013). Outstanding stock as of June 30, 2013. n.a.: Not available.. Sources: MAE, IAMC, Superintendencia de AFJP, Economy Ministry, and Santander.

Dollar-denominated bondsSecondary market liquidity and outstanding amounts


Outstanding amount (US$ million)


Boden 15 1,009.2 5,818 6% Global 17 20.7 966 0% Bonar 18 n.a. 3,374 83% Bonar X 493.8 6,398 37% Bonar 19 n.a. 961 85% Discount 39.3 10,746 53% Par 71.6 6,695 2% Total 1,635 34,957 Monthly traded volumes at MAE (Mercado Abierto Electrnico), cash basis, in millions of U.S. dollars (average of July, August and September 2013). Outstanding stock as of June 30, 2013. n.a.: Not available. Sources: MAE, IAMC, Superintendencia de AFJP, Economy Ministry, and Santander.

GDP-linked securitiesSecondary market liquidity and outstanding amounts


Outstanding amount (notional, US$ mn)


ARS 42.3 7,152 0% USD 44.1 20,324 11% EUR n.a. 24,651 0% JPY n.a. 467 0% ARS 42.3 7,152 0% Total 86 52,594 Monthly traded volumes at MAE (Mercado Abierto Electrnico), cash basis, in millions of U.S. dollars (average of July, August and September 2013). Outstanding stock as of June 30, 2013. *n.a.: Not available. Sources: MAE, Superintendencia de AFJP, Economy Ministry, and Santander.

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REGULATORY AND TAX ISSUES

Investors participating in the local foreign exchange market (MULC) face several restrictions, among which we highlight the following:

1. Minimum stay period. Debt of nonresidents in foreign currency must have a tenor no shorter than 365 days. All forms of prepayment are prohibited. Bond issuance in primary markets, with public offer and effectively traded in self-regulated markets, is exempted from this obligation.

2. Nonremunerated foreign currency deposit. Investors are required to make a nonremunerated deposit at the Central Bank equivalent to 30% of the foreign currency amount entering the local foreign exchange market. Some exemptions include (1) debt issuance to invest in local nonfinancial assets and (2) funds applicable to the purchase of public sector bonds in primary auctions.

3. Foreign exchange controls for institutional investors. The Central Bank resolution 5314 established that local banks are not entitled to buy U.S. dollars in the official MULC market for the purchase of dollar- denominated bonds, although some exceptions exist. As a result, local banks participation in the local bond market has declined significantly, with a consequent impact on overall market volumes.

4. Existence of gap between onshore and offshore bond prices. Given the imposition of new foreign exchange and capital controls in 2011 and 2012, the gap between onshore and offshore bond prices has widened sharply over the last few years.

Investors are strongly encouraged to consult their legal advisors regarding tax, foreign exchange, and capital regulations under Argentine law, which are subject to frequent changes, according to events observed in the last few months.

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A NOTE ABOUT MODELING INFLATION-LINKED (CER) BONDS

The CER is an index that was officially created on February 4, 2002, and was intended to maintain the real value of pesofied obligations (Bloomberg ticker is CER ). The value of the CER index was set at 1.00 for February 4, 2002, and reached 3.4635 as of November 6, 2013, meaning that consumer prices as measured by INDEC increased by 246% in the last 10 years. The underlying reference used to compile the index is CPI inflation published by INDEC (Institute of Statistics and Census), which can be found on the Central Banks website (http://www.bcra.gov.ar). The CER is published by the Central Bank of Argentina on the seventh day of every month, and it provides a daily quote for each day of the following month (including weekends) using the following formulas (included in resolution 47/02 published by the Economy Ministry):

Between the first day of the month and the sixth day of that same month:

k

i

itt CPI

CPICERCER

1

3

21

=

Where t is the day, i is the month, and k is days in month i-1. The value of the CER index for May 1 equals the value of the index on April 30 times the daily geometric average of the inflation observed during March.

Between the seventh day of the month and the last day of that same month:

k

i

itt CPI

CPICERCER

1

2

11

=

Where t is the day, i is the month, and k is days in month i. The value of the CER index for May 7 equals the value of the index on May 6 times the daily geometric average of the inflation observed during April.

The objective of adjusting ARS-denominated bonds by CER was to maintain the real value of amortization installments and coupon payments of the debt issued after the pesofication, i.e., Bodens, Bocones, and Bogars. Consequently, the way to model all those bonds is to apply the CER index to the initial value of the principal amount and to calculate amortization and interest payments on the gross-indexed principal (i.e., the nominal amount). Therefore, each amortization or coupon payment is calculated on the total indexed principal (the current nominal value of the principal).

Example:

Period CER Indexed principal (in ARS)

Percentage amortized

Amount amortized (in ARS)

Residual real amortization Coupon

Interest amount (in ARS)

T0 1.00 100.00 100% real 2% + CER T1 1.20 120.00 25% 30 75% real 2% + CER 2.40 T2 1.40 140.00 25% 35 50% real 2% + CER 2.10 T3 1.60 160.00 25% 40 25% real 2% + CER 1.60 T4 1.80 180.00 25% 45 0% real 2% + CER 0.90 Total 100% 150

Source: Santander.

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ARS BONAR

This category comprises peso-denominated Bonars issued under local law. There is only one outstanding series of fixed-rate ARS Bonars (issued in 2007) and two series of floating-rate, BADLAR-linked ARS Bonars, also known by local players as Bocans (issued in 2009 as part of a debt exchange for Prstamos Garantizados). BADLAR-linked Bonars trade on a dirty-price basis. Trading hours are generally 9:00 to 15:00 local time.

Bloomberg ticker ARGBON

BONAR ARS 2014 Issuer Government of Argentina. Authorized by Resolution 52/2009 from the

Secretary of Finance and Resolution 197/2007 from the Secretary of Treasury; subject to Argentine law, also known as Bocan 2014. Date of issuance: January 30, 2009.

Maturity January 30, 2014.

Coupon Quarterly, fixed at 15.40% annually for the first four coupons. Since April 30, 2010, the annual coupon is equivalent to the private banks BADLAR rate (provided by the Central Bank, BADLARPP Index at Bloomberg), plus a 275-bp spread. The BADLAR rate will be the average observed between the 10th business day prior to the beginning of the coupon period and the 10th business day prior to the end of the coupon period. It is paid on the 30th of January, April, July, and October, or the following business day.

Day count Calculated on an actual/actual basis.

Amortization Bullet.

Convention For yield calculation purposes, floating-rate coupons are generally calculated by adding the fixed spread (275 bps) to the average BADLAR rate of the last ten observations.

9


BONAR ARS 2015 Issuer Government of Argentina. Authorized by Resolution 57/2009 from the

Secretary of Finance and Resolution 216/2007 from the Secretary of Treasury; subject to Argentine law, also known as Bocan 2015. Date of issuance: September 10, 2009.

Maturity September 10, 2015.

Coupon Quarterly. The first eight coupons will be capitalized on a quarterly basis. Starting December 10, 2011, interest payments will be in cash. The coupon rate will be equivalent to the private banks BADLAR rate (provided by the Central Bank, BADLARPP Index at Bloomberg), plus a 300-bp spread. The BADLAR rate will be the average observed between the 10th business day prior to the beginning of the coupon period and the 10th business day prior to the end of the coupon period. It is paid on the 10th of March, June, September, and December, or the following business day.

Day count Calculated on an actual/actual basis.

Amortization Six semiannual installments; each of the first five installments of 16.66% and the last one of 16.70%. It is paid on the 10th of March and September.

Convention For yield calculation purposes, floating-rate coupons are generally calculated by adding the fixed spread (300 bps) to the average BADLAR rate of the last ten observations.

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ARS BODEN ARS-denominated Bodens (Bonos del Estado Nacional) are government securities issued by the National Treasury after the declaration of default in December 2001, mainly as compensation for the effects of asymmetric pesofication in the banking system. Bodens trade in the market on a dirty-price basis. Trading hours are generally 9:00 to 15:00 local time.


BODEN 2014 Issuer Ministry of the Economy. Boden 2014s were initially issued as part of the

defaulted debt exchange program carried out by Argentina in 2005. The purpose of the issuance was to exchange the Treasury Notes subscribed by the Pension Fund Administrators (AFJPs) in December 2001. The 2014 series was authorized by Resolution 170/05 from the Ministry of Economy and Production. Date of issuance September 30, 2004..

Face value ARS100 adjusted by CER.

Maturity September 30, 2014.

Coupon Semiannual; 2% on principal adjusted by CER. It is paid on March 30 and September 30. The first coupon is paid on March 30, 2005.

Day count Calculated on a 30/360 basis.

Amortization Eight semiannual installments of 12.5% of principal adjusted by CER. First payment was on March 31, 2011.

11


BOCON

Bocones (Bonos de Consolidacin) are government securities issued by the National Treasury to cancel debts with pension beneficiaries or public sector suppliers. Bocones trade in the market on a dirty-price basis. Trading hours are generally 9:00 to 15:00 local time.

Bloomberg ticker ARGBOC

BOCON PRO 12 (BOCON PROVEEDORES 4TA SERIE EN PESOS) Issuer Government of Argentina. Bocon Pro 12 (Pr12) was issued to cancel

government debts with suppliers and contractors. The series was authorized by Decree 1873/02, Resolution 638/02. Date of issuance: February 3, 2002.


Maturity January 3, 2016.

Coupon Monthly; 2% on principal adjusted by CER. It is paid on the third of each month or following working day. First coupon paid on February 3, 2006. During the four-year grace period, interest was capitalized on a monthly basis.


Amortization 120 monthly installments; Each of the first 119 installments of 0.84%, and the last of 0.04%, of principal adjusted by CER. First amortization paid on February 3, 2006.

BOCON PRE 9 (BOCON PREVISIONAL 4TA SERIE EN PESOS) Issuer Government of Argentina. Bocon Pre 9 was issued to cancel government

debts with pension beneficiaries of the pay-as-you-go system. The series was authorized by Law 25827, Art. 66 and Resolution 378/04. Date of issuance: March 15, 2004.


Maturity March 15, 2014.

Coupon Monthly; 2% on principal adjusted by CER. Paid on the 15th day of each month or following business day. First coupon was paid on April 15, 2008. During the four-year grace period, interest will be capitalized on a monthly basis.


Amortization 72 monthly installments; each of the first 70 installments of 1.35%, and the last two of 2.75%, of principal adjusted by CER. First amortization payment was on April 15, 2008.

12

BOCON PRO 13 (BOCON PROVEEDORES 6TA SERIE EN PESOS) Issuer Government of Argentina. Bocon Pro 13 was issued to cancel government

debts with suppliers of the public sector. The series was authorized by Law 25827, Art. 66 and Resolution 378/04. Date of issuance: March 15, 2004.


Maturity March 15, 2024.

Coupon Monthly; 2% on principal adjusted by CER. Paid on the 15th day of each month or the following business day. First coupon will be paid on April 15, 2014. During the four-year grace period, interest will be capitalized on a monthly basis.


Amortization 120 monthly installments. Each of the first 119 installments of 0.83%, and the last one of 1.23%, of principal adjusted by CER. First amortization payment will be on April 15, 2014.

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BOGAR

Bogars (Bonos Garantizados) were issued as part of a restructuring of provincial liabilities. Bogar 18s trade in the market on a dirty-price basis. Unlike most other CER-indexed bonds, the bonds currently have a credit rating from Fitch only. Trading hours are generally 9:00 to 15:00 local time.


BOGAR 2018 Issuer Banco de la Nacin Argentina, in its role as trustee of the Fondo Fiduciario

de Desarrollo Provincial. Bogars were issued in exchange for provincial liabilities, including bonds, bills, and loans, under Decree 1387/2001 and Economy Ministry Resolutions 539/02 and 624/02. Cash flows are currently guaranteed by the government of Argentina. Date of issuance February 4, 2002.


Maturity February 4, 2018.

Coupon Monthly; 2% adjusted by CER. Paid on the fourth of each month or the following business day. First coupon paid on October 4, 2002. During the seven-month grace period, interest was capitalized on a monthly basis.

Day count Calculated on an actual/365 basis.

Amortization Bogars amortize in 156 monthly installments. The first 60 payments correspond to 0.40% of principal, the subsequent 48 payments correspond to 0.60% of principal, the following 47 payments correspond to 0.98% of principal, and a last installment equivalent to 1.14% of principal, adjusted by CER. The first amortization date was March 4, 2005.

Additional features Adjusted principal including capitalized interest and CER was set at 134.9631292 as of September 4, 2002, according to the Economy Ministrys tutorial. Interest and amortization coupons are adjusted by the CER coefficient corresponding to the fifth business day prior to the payment date.

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BOGAR 2020

Issuer Banco de la Nacin Argentina, in its role as trustee of the Fondo Fiduciario de Desarrollo Provincial. Bogars were issued in exchange for provincial liabilities, including bonds, bills, and loans, under Decrees 1387/2001, 1579/2002, and 977/2005. Cash flows are currently guaranteed by the government of Argentina. Date of issuance February 4, 2002.


Maturity October 4, 2020.

Coupon Monthly; 2% adjusted by CER; paid on the fourth of each month or the following business day. First coupon paid on September 4, 2005. During the 43-month grace period, interest was capitalized at 2% annually.

Day count Calculated on an actual/365 basis.

Amortization Bogars amortize in 156 monthly installments. The first 60 payments correspond to 0.40% of principal, the subsequent 48 payments correspond to 0.60% of principal, the following 47 payments correspond to 0.98% of principal, and a last installment equivalent to 1.14% of principal, adjusted by CER. The first amortization date was November 4, 2007.

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DISCOUNTS AND PARS (ARS-DENOMINATED) ARS-denominated Discounts and Pars were issued by the National Treasury in exchange for defaulted bonds in 2001. They all trade in the market on a dirty-price basis. Trading hours are generally 9:00 to 15:00 local time.

Bloomberg ticker ARGENT

ARS DISCOUNT Issuer Government of Argentina. Authorized by Decree 1735/04, Resolution

20/05, and issued under Argentinas 2005 debt exchange.

Maturity December 31, 2033.

Face value ARS1, adjusted by CER. Adjustment factor is calculated using the CER value 10 days prior to the payment date over the CER value 10 business days prior to the issue date (December 31, 2003).

Coupon Semiannual, 5.83%, with partial capitalization until December 31, 2013. Capitalization rules: December 31, 2003-December 31, 2008: 2.79% paid in cash, 3.04% capitalized; December 31, 2008-December 31, 2013: 4.06% paid in cash, 1.77% capitalized; December 31, 2013-December 31, 2033: 5.83% paid in cash, 0.00% capitalized.


Amortization 20 semiannual installments of 5% of principal adjusted by CER, on June 30 and December 31 of each year, or the following business day. First installment will be paid on June 30, 2024.

ARS PAR Issuer Government of Argentina. Authorized by Decree 1735/04, Resolution



Face value ARS1, adjusted by CER. Adjustment factor is calculated using the CER value 10 days prior to the payment date over the CER value 10 working days prior to the issue date (December 31, 2003).

Coupon Semiannual step-up coupon. First coupon paid on March 31, 2006. Coupon schedule: December 31, 2003-March 31, 2009: 0.63%; March 31, 2009-March 31, 2019: 1.18%; March 31, 2019-March 31, 2029: 1.77%; March 31, 2029-December 31, 2038: 2.48%. Short first coupon and short last coupon.


Amortization 20 semiannual installments of 5% of principal adjusted by CER. The first 19 installments will be paid on March 31 and September 30 of each year or following business day, with the final installment paid on December 31, 2038. The first installment will be paid on September 30, 2029.

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DOMESTIC USD BONDS

This category comprises USD-denominated Bodens (Bonos del Estado Nacional) and Bonars (Bonos Argentinos) issued under local law. Bodens were issued by the National Treasury as compensation for the effects of asymmetric pesofication in the banking system in 2002, while Bonars were first issued by the National Treasury in early 2006 through auctions in the local primary market. Bodens and Bonars trade in the market at dirty prices. Trading hours are generally 9:00 to 15:00 local time.


BODEN 2015 Issuer Government of Argentina. Authorized by Resolutions 240/2005 (Secretary

of Treasury) and 85/2005 (Secretary of Financing). Subject to Argentine law. Date of issuance October 3, 2005.

Face value US$100.

Maturity October 3, 2015.

Coupon Semiannual 7% fixed coupon. Paid on the third of April and October, or the following business day. First coupon paid on April 3, 2006.



BONAR X (BONAR 17) Issuer Government of Argentina. Authorized by Resolution 24/2007 from the

Secretary of Finance and Resolution 100/2007 from the Secretary of Treasury; subject to Argentine law. Bonar X was voluntarily placed in the market in order to meet the National Treasurys financial needs. Date of first issuance: April 12, 2007.

Face value US$1.

Maturity April 17, 2017.

Coupon Semiannual 7% fixed coupon. Paid on the 17th of April and October, or the following business day. The first coupon was paid on October 17, 2007.



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GLOBAL USD BONDS

This category comprises the USD-denominated bonds issued under international law after the restructuring of the sovereign debt in 2005. Pars and Discounts were issued in 2005 during the first phase of the debt swap, while Global 2017s were issued in 2010 during the reopening (or phase II) of the transaction. Trading hours are generally 9:00 to 15:00 local time.


USD DISCOUNT Issuer Government of Argentina. Authorized by Decrees 1735/04 and 563/10, and

issued under Argentinas 2005 and 2010 debt exchanges; subject to New York law.


Face value US$1.

Coupon Semiannual; 8.28%, with partial capitalization to December 31, 2013. Capitalization rules: December 31, 2003-December 31, 2008: 3.97% paid in cash, 4.31% capitalized; December 31, 2008-December 31, 2013: 5.77% paid in cash, 2.51% capitalized; December 31, 2013-December 31, 2033: 8.28% paid in cash, 0.00% capitalized.


Amortization 20 semiannual installments of 5% of principal paid on June 30 and December 31 of each year, or the following business day. The first installment will be paid on June 30, 2024.

USD PAR Issuer Government of Argentina. Authorized by Decrees 1735/04 and 563/10, and

issued under Argentinas 2005 and 2010 debt exchanges; subject to New York law.


Face value US$1.

Coupon Semiannual step-up coupon. December 31, 2003-March 31, 2009: 1.33%; March 31, 2009-March 31, 2019: 2.50%; March 31, 2019-March 31, 2029: 3.75%; March 31, 2029-December 31, 2038: 5.25%. Short first coupon and short last coupon.


Amortization 20 installments of 5% of principal. The first 19 installments will be paid on March 31 and September 30 of each year or following business day, with the final installment paid on December 31, 2038. The first installment will be paid on September 30, 2029.

GLOBAL 2017 Issuer Government of Argentina. Authorized by presidential Decree 563/2010.

Subject to New York law; date of issuance: June 2, 2010.

Face value US$1.

18

Maturity June 2, 2017.

Coupon 8.75%, on a semiannual basis.



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GDP-LINKED SECURITIES GDP-linked securities (also known as GDP kickers or GDP warrants) were issued as part of the debt exchange of 2005 and phase II in 2010. They initially were attached to Discounts, Pars, and Quasi-Discounts, but started trading independently as of November 29, 2005. Trading hours are generally 9:00 to 15:00 local time.


GDP-LINKED SECURITY ARS & USD Issuer Government of Argentina. Authorized by Decree 1735/04, Resolution


Expiration date Earlier of December 15, 2035, or when payment cap is reached.

Payments Payments contingent on performance of Argentinas GDP. If conditions are met, payments are made on December 15 of each year following the relevant reference year. The first payment was made on December 15, 2006.

Calculation date Prospectus indicates November 1 of each year following the relevant reference year. However, in the last few years the government made the official announcement some days later (for instance, November 27, 2009).

Payment conditions Payment made if three conditions met: (1) Actual Real GDP for reference year exceeds Base Case GDP for that year; (2) annual growth of Actual Real GDP for reference year exceeds Base Case GDP growth rate for that year; and (3) accumulated total payments do not exceed payment cap.

Payment calculation Aggregate notional amount of securities held multiplied by Available Excess GDP. All calculations of payments (if any) will be carried out by the Economy Ministry. For the reference year 2012, the payment was null, as actual GDP growth in that year has been lower than the critical threshold value (1.90% vs. 3.26%, respectively).

ARS Warrant (expressed in ARS) = 5% of Excess GDP per unit of notional amount = 5% x Excess GDP x (1/238651.5 = 0.000419%).

USD Warrant (expressed in USD) = 5% of Excess GDP per unit of notional amount = 5% x Excess GDP x (1/81800 = 0.001222%) / USD/ARS Exchange Rate.

Excess GDP: amount, if any, by which Actual Real GDP, converted to nominal ARS, exceeds the Base Case GDP, converted to nominal ARS.

Actual Real GDP: GDP of Argentina in constant ARS for each calendar year as published by INDEC. Currently, INDEC uses 1993 as the year to calculate base prices.

USD/ARS Exchange Rate: Average free market rate during the 15 calendar days prior to December 31 of the reference year.

Payment cap Payments will cease if accumulated total amount paid exceeds 48% of the notional amount expressed in each currency. Including the estimated payment for the 2012 reference year, the accumulated total amount paid is 23.4% for ARS warrants and 18.0% for USD warrants.

Amortization None.

20

Base case GDP

Reference Year

Base Case GDP (1993 ARS mn)

Base Case GDP Growth

Reference Year

Base Case GDP (1993 ARS mn)

Base Case GDP Growth

2005 287,012.52 4.26% 2020 458,555.87 3.00% 2006 297,211.54 3.55% 2021 472,312.54 3.00% 2007 307,369.47 3.42% 2022 486,481.92 3.00% 2008 317,520.47 3.30% 2023 501,076.38 3.00% 2009 327,968.83 3.29% 2024 516,108.67 3.00% 2010 338,675.94 3.26% 2025 531,591.93 3.00% 2011 349,720.39 3.26% 2026 547,539.69 3.00% 2012 361,124.97 3.26% 2027 563,965.88 3.00% 2013 372,753.73 3.22% 2028 580,884.85 3.00% 2014 384,033.32 3.03% 2029 598,311.40 3.00% 2015 395,554.32 3.00% 2030 616,260.74 3.00% 2016 407,420.95 3.00% 2031 634,748.56 3.00% 2017 419,643.58 3.00% 2032 653,791.02 3.00% 2018 432,232.88 3.00% 2033 673,404.75 3.00% 2019 445,199.87 3.00% 2034 693,606.89 3.00%

Base case GDP subject to adjustment if INDEC elects to change the year for base prices from 1993 to another year. Source: Economy Ministry.

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ARS vs. USD LIBOR CROSS-CURRENCY SWAPS The ARS vs. USD LIBOR swap is a cross-currency swap that trades over the counter, where the investor pays or receives a fixed ARS rate and in exchange receives or pays a floating rate indexed to 6-month USD LIBOR.

SUMMARY OF TERMS

Reference This is a cross-currency swap in which the fixed leg is denominated in ARS and the floating leg is denominated in USD. The USD reference rate is 6-month LIBOR. The swap is quoted in terms of the ARS fixed rate.

Conventions In the offshore market, semiannual cash flows are typically calculated on a 30/360 or actual/360 basis for the ARS leg, and actual/360 basis for the USD leg. ARS payments are converted to USD based on the EMTA ARS Industry Survey Rate. In the onshore market, the ARS leg is generally calculated on an actual/365 basis.

Maturity Levels are quoted up to the 7-year tenor (generally for 2, 3, 4, 5, and 7 years).

Settlement Generally T+2.

Liquidity Liquidity has been thin since mid-2007.

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BRAZIL MACRO BACKGROUND

Brazils debt markets have undergone a remarkable transformation over the past few years, coinciding with dramatic changes in the countrys economic and financial situation, and ultimately leading to Brazils upgrade to investment-grade status by the major rating agencies. Two agencies decided to upgrade even before the collapse of Lehman Brothers, with S&P moving first in April 2008 and Fitch following in May 2008. Finally, Moodys decided to match its peers in September 2009, once the Brazilian economy proved resilient after a massive external shock. Over the course of 2011, Fitch, Moodys, and S&P each announced (the first in April, the second in June, and the third in November) a one-notch upgrade that moved Brazils long-term foreign currency sovereign rating to the second to last investment-grade rating (the first is now at BBB, the second at Baa2, and the third at BBB).

Both Fitch and Moodys currently have stable outlooks (the former since April 2011 and the latter starting in October 2013), while S&P recently downgraded its outlook to negative (since June 2013). The rating agencies based their upgrades largely on the fact that Brazils potential growth rate had increased, which helped support the medium-term fiscal outlook and external liquidity position. However, as the potential growth rate appears to have decelerated, inflation has remained stubbornly high, and fiscal accounts have deteriorated over the last two years, there has been increased concern among investors and analysts that there is a chance of a downgrade, especially from S&P, as it currently has a negative outlook on Brazils foreign currency long-term sovereign debt rating.

Brazils policy framework since 1999, the main driver of the countrys recent economic success, had been based on three main principles, or the so-called triad: a floating FX regime, inflation targeting, and tight fiscal policy. This stable and predictable macro framework reduced the economys vulnerability to external shocks and paved the way for faster growth. Starting in the mid-2000s, policymakers have managed to stabilize overall macroeconomic policy and effectively (1) transform Brazil into a net external creditor beginning in 2008 (that is, international reserves exceed the gross external debt), (2) reduce inflation significantly to more predictable single-digit figures since 2004, (3) cut the Selic rate by an impressive 1,975 bps since its recent peak in May 2003 to an all-time low of 7.25% starting in October 2012, and (4) change the internal debt profile radically by virtually eliminating the exposure of local bonds to currency fluctuations and substantially reducing sensitivity to interest rate fluctuations (the share of FX-linked bonds is converging to zero, while the share of Selic floaters fell about 32 p.p. from 52.4% in December 2004 to around 20.4% in September 2012, the lowest on record).

Brazil received considerable attention in the three years after the collapse of Lehman Brothers, as it was among the least affected economies during the international financial crisis and ensuing global recession of 2008-09. However, a bumpy recovery path in 2012, accompanied by an increasingly assertive and discretionary policy, has made investors much less interested in Brazilian local assets. Over the course of 2012 and 2013, Brazilian economic policy has become increasingly unpredictable and more discretionary. Oftentimes, substantial market moves in the FX and rates markets have been based on expectations of either Central Bank (Bacen) intervention or government policy action. Indeed, any articles, news, and blogs published on any of those subjects (with opinions and quotes from unidentified government sources) have, for example, pushed the BRL to move substantially, especially when it was mostly range bound. Many market players have gotten the impression that Brazil policymakers interpretation of each of the principles of the so-called triad has become increasingly fuzzy in the past two years.

Part of the reason behind for the flexibilization of the policy principles may be that the recent external environment of low growth and low-interest-rate monetary policy for a prolonged period in developed market (DM) economies is making the implementation of policy much more challenging, especially in a country with such unique conditions as Brazil (high interest rates, a large public sector role in the economy, and structural supply-side restrictions due to low productivity and abundant red tape). Although many other emerging market (EM) economies have also become more assertive and innovative in terms of policies to face this new and unusual external environment, Brazil seems to be leading the way due to its much more aggressive role in the

23


use of discretionary policy. Brazils Central Bank has become more tolerant of higher inflation for the sake of faster growth and structurally lower rates and is much more active in preventing BRL appreciation (despite the IPCA being mostly in the upper half of the 2.5-6.5% inflation target range since 2010), while the government has become less focused on fiscal austerity (in part complicating the Central Banks job of fighting inflation).

One of the consequences of the more discretionary and flexible policy approach to the triad was a strong negative price action in all Brazilian assets since Fed officials first hinted that there could be a tapering of QE3, back in May 2013. Although the Central Bank has been tightening policy since April 2013 (with a hawkish tone) and also unveiled an FX intervention program in August to contain the BRL, the fiscal accounts have been deteriorating quite rapidly, which has triggered concern among investors. The Central Bank announced in mid August 2013 one of the biggest FX intervention programs in EM history, with daily auctions of US$500 million in FX swaps from Mondays through Thursdays, and US$1 billion in FX credit lines on Fridays, lasting until at least December 31, 2013. Our calculations (which include local holidays) suggest that the total program would reach around US$53 billion (US$35 billion in FX swaps and US$18 billion in credit lines) if ended by the earliest date announced (December 31, 2013). The BRL managed to post a strong reversal (of as much as 12% at the peak) right after the FX intervention program was announced , but has started to weaken once again since mid-October on the back of a broad-based recovery in the USD (as measured by the DXY index) and investors ongoing concern about Brazils fiscal dynamics. In fact, local rates have performed much worse that the FX, in part because the FX intervention program has been largely offset by increasing concern about fiscal numbers.

Fiscal data and any comments from government officials regarding fiscal targets (for this and next year) are likely to remain the main drivers for rates and also to an extent for the BRL. Additionally, the sovereign debt ratings agencies, especially S&P (which currently has the only negative outlook on Brazils long-term foreign-currency sovereign debt rating) will also be waiting for the final 2013 fiscal results as well as any fiscal commitments for 2014 before taking action on the rating.

Many investors have started to question Brazils growth outlook, not only from a structural growth standpoint, but also based on the lack of stability in the policy framework. Investors may be increasingly concerned about the potential exhaustion of the demand-side growth model, which was successful during most of the last decade, because of increasingly evident restrictions in the supply side (including loss investment ratios and poor productivity). The economic recovery has underperformed expectations even after massive monetary policy easing of 525 bps in the 14 months after the August 2011 surprise Selic rate cut, along with a sizable fiscal stimulus and amid record low unemployment and relatively high consumer confidence. In fact, a sharp deceleration in economic activity since 1Q11 has become an important market driver, especially as the Central Bank embarked on an aggressive easing cycle and more assertive FX policy, leading to a sizable rally in rates and contributing to BRL weakness over the course of 2012. A tightening cycle in 2013 (since April) along with widening 10Y UST rates (due to anticipation to tapering) and deteriorating fiscal numbers has triggered poor price action in both rates and the BRL over the course of 2H13.

The combination of an increase in the IOF tax in Brazil and the inclusion of local government-issued MBonos in Mexico in the WGBI index in October 2010 helped shift offshore flows from local instruments in Brazil to equivalent assets in Mexico. In fact, one of the key developments since 2010 was the generalized use of the IOF tax (either by increasing/decreasing it in markets that had already been taxed or by imposing it on new markets) as a tool to regulate foreign inflows and/or manage the dynamics of some markets (effectively acting as a macroprudential measure). The first effort was announced by the government in October 2010 when the IOF tax on fixed income investments applied to nonresidents increased from 2% to 6% (increasing first to 4% on October 5 and then to 6% on October 18, with the latter change also applying to foreign investors margin deposits in the futures markets), which effectively reduced liquidity in several market segments (such as fixed- rate NFN-Fs) in a significant manner (see Regulatory and Tax Issues section. The government decided to lower the IOF tax on fixed income and FX derivatives in June to contain the losses seen in the local bond and FX markets, which in part seems to have only reduced the losses driven by investors ongoing concerns about the deterioration in Brazils fiscal accounts, which may end up in a sovereign rating downgrade.

24

GOVERNMENT POLICY AND THE CRISIS

The 2008-09 global financial crisis had a fairly limited impact on borrowing by the National Treasury. The spike in risk aversion forced the Treasury to temporarily reduce the average maturity of the debt offered in its weekly auctions. Over the course of this year, the National Treasury has been increasing the supply at the longer end of the curve (last year it had to cut back), without affecting placement ratios as much (final sales compared with initial offering) for these longer-dated securities. For instance, the placement ratio (including second round auction) for the Jan. 21 NTNF bonds (see more details below in the NTNF section), the only longer-dated bond offered in both 2011 and 2012, fell from an average of 61.0% in 2011 to 54.5% in 2012 (through February, as the new Jan. 23 NTNF bonds became the benchmark starting in March). As of November 7, the placement ratio for the Jan. 23 NTNF bond (Jan. 21 NTNF was no longer issued) in 2013 reached 56.6%, right at the lower end of the 55-65% historical average. Generally, the fact that the Treasury can count on a virtually captive domestic market (offshore investors hold only around 15.5% of all outstanding government bonds as of July 2013) for its securities means that its funding operations in the local market go relatively smoothly despite external shocks. In other words, local public financing is more a matter of pricing (more attractive rates) than of actual final investor demand. In any case, the government has a cushion of liquidity of approximately five months worth of Federal Public Debt (FPD) payments.

Treasury external debt buybacks (face value) and outstanding debt (US$ millions)

Bond Buybacks in 2009

Buybacks in 2010

Buybacks in 2011

Buybacks in 2012

Buybacks in 2013 (Jan-Aug)

Outstanding (Aug 2013)

PRE-BRADY - - - - - - EURO BONDS 139 406 412 12 - 1,149 Euro 09 - - - - - - Euro 10 - - - - - - Euro 11 65 152 - - - - Euro 12 72 157 - - - - Euro 15 3 60 353 6 - 713 Italian Lira 2017 - 38 59 7 - 436 USD GLOBALS 916 2,803 1,865 675 449 29,845 A Bond 238 621 602 189 140 563 BR09 - - - - - - BR09F - - - - - - BR10 - - - - - - BR10N - - - - - - BR11 35 192 - - - - BR12 7 147 - - - - BR13 30 192 69 57 12 - BR14 28 81 144 76 32 381 BR15 - 71 380 135 10 1,090 BR17 - - - - 2,552 BR19 129 30 10 - 5 1,123 BR19N - - - - - 2,360 BR20 36 247 10 - - 377 BR21 - - - - 3,143 BR23 - - 6 - - 2,161 BR24 1,436 BR24N 21 5 - - - 553 BR25 10 74 11 - - 1,671 BR27 7 1 20 - - 2,508 BR30 88 85 5 - - 599 BR34 15 - 18 - - 2,122 BR37 - - - - - 3,112 BR40 272 1,057 591 219 249 953 BR41 - - - - - 3,141 BRL GLOBALS - - - 706 - 6,097 BR16 - BRL - - - 291 - 1,317 BR22 - BRL - - - 415 - 1,030 BR24 - BRL 1,439 BR28 - BRL - - - - - 2,310 TOTAL 1,056 3,209 2,278 555 449 37,091

Source: Brazil National Treasury.

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The market for international debt suffered in 2011 together with the rest of the capital market, but it bounced back as sentiment improved in 2012. However, the anticipation of potential tapering in the Feds QE3 policy also affected primary issuance starting in May 2013 and lasted a few weeks. The important thing to keep in mind is that Brazil does not depend on the international market to cover its public sector borrowing requirements. The Treasury pays attention to the market for USD-denominated debt, but the key policy objective is to maintain a liquid benchmark curve to help the private sector obtain funding. After debt buyback operations rebounded in 2010 compared to 2009 (increasing from US$1.1 billion to US$3.2 billion), the government again reduced the pace in 2011 (with new supply falling to US$2.3 billion in 2011).

The 2008-09 international crisis had a more direct impact on private sector credit, both domestically and in terms of the access of Brazilian firms to the international capital market. The governments response was to implement a series of measures to ease the credit crunch and support economic activity, such as lowering reserve requirements, implementing incentives for larger commercial banks to acquire the portfolios of smaller lenders, and providing tax relief to some sectors. Probably the most innovative measures implemented were to provide foreign currency liquidity to the local market after the international capital markets shut down in 2008 following the collapse of Lehman Brothers, in the form of sales in the spot and derivatives markets, foreign currency loans to the private sector, and currency swap arrangements with foreign central banks. Some of these measures, such as FX swaps and FX credit lines, have been reintroduced in response to the pressure seen on the BRL given increased investor anticipation of the Feds tapering of its QE3 policy.

The impact of the international financial crisis was probably the most apparent in the FX market, causing the BRL to plunge from a precrisis high of around USD/BRL1.54 to a low of USD/BRL2.62 at the beginning of December 2008, a 69% move in about four months. The Central Bank injected US$10.2 billion in foreign currency through its FX repo facility (between September and November 2008), provided another US$7 billion in funding for trade finance lines (October 2008-March 2009), and sold US$14.5 billion in the FX spot market. In total, almost US$32 billion in foreign currency liquidity was provided to the market. In addition, the Central Bank sold about US$37.4 billion in FX swaps in 4Q08.

About a year after Lehman collapsed, the Central Bank closed out its position in FX swaps, US$5.4 billion in trade finance line funding was returned to the Central Bank, and in May 2009 the Central Bank resumed its precrisis policy of buying foreign currency in the spot market, adding an astounding US$116.85 billion to reserves between May 2009 and September 2011, for an average monthly purchase of US$4 billion during that period. International reserves stood at around US$206 billion when Lehman Brothers collapsed in September 2008, touching a low of US$187 billion in February 2009 and recovering since then. By the end of 2011, they had risen to about US$379 billion, making Brazil the worlds sixth largest foreign reserve holder. Although the Central Bank stopped its USD purchases in the spot market between October 2011 and February 2012 due to the escalation of the European crisis, it resumed its purchases from February to May 2012, buying a cumulative US$11.2 billion during the period. Foreign reserves as a percentage of GDP have increased rapidly over the last decade amid elevated terms of trade and strong foreign inflows (mainly due to consistently high FDI and bouts of strong portfolio flows), accompanied by long-term currency appreciation over the last few years (from a peak of around USD/BRL4 in 2002 to closer to USD/BRL2 more recently). Foreign reserves virtually trebled from 6.6% in January 2002 to a high of 18% in November 2012, falling back only slightly to 16.2% in October 2013.

In 2011, the governments response to the escalating European debt crisis was much more modest, with measures such as a payroll tax reduction in September 2011 in a few export-led sectors such as apparel and cars and the announcement in November 2011 of a slower implementation of new accounting rules on the sale of portfolio loans in order to help small and mid-sized banks increase their funding, as the European debt crisis threatened liquidity. In December 2011, the Finance Ministry announced another set of measures in the form of subsidies (with announced costs of around BRL7.6 billion or 0.15% of GDP between 2011 and 2012), implemented via lowering the tax rates on different sectors, including the IOF tax on some types of consumer loans (reversing the increase from 1.5% to 3.0% back in April 2011), income tax on some individuals, taxes on home appliances, taxes on low-income housing, taxes on some food items, and lowering the IOF tax to zero on foreign investment in stocks and infrastructure debentures.

The escalation of the European debt crisis over the course of 2011, along with incremental FX intervention efforts, caused the BRL to weaken sharply from a 13-year high of USD/BRL1.53 in July 2011 to a 2-year low

26

of USD/BRL1.96 in September, a 28% move in about two months. This severe shift in the market triggered a reversal in the Central Banks FX policy from a massive purchase of USD in the spot and currency swaps markets in the first three quarters of the year to a complete halt in spot purchases and the initiation of USD supply via currency swaps in September. Bacen managed to buy US$48 billion in the spot market through September 15 (with almost continuous daily buying), but abstained from further purchases in the remainder of 2011. The spot purchases resumed in February 2012 briefly until May, for a cumulative US$11.2 billion, as the BRL rallied in 1H12 (testing the 1.7 to the downside), but Bacens demand for the greenback has since ended.

In the FX swap market, the Central Banks net position started in neutral territory in December 2010 and peaked at a long US$11.5 billion position by April 2011 due to an aggressive supply of reverse FX swaps (equivalent to USD purchases) to counter a stronger BRL. Bacen then shifted gears once again by the summer of that year (in the Southern Cone), moving its FX swaps exposure to negative territory (offering USD to the market) given the rapid move from 1.7 in early 2Q12 to about 2.1 later in the quarter, reaching a record low of more than US$10.8 billion in short positions in July 2012. In the three months to November, the Central Bank maintained a moderately long position that hovered around US$3-5 billion as the BRL reversed closer to the 2 handle. However, by the beginning of December, the Central Bank switched its net FX swaps from a long to a modest short position of about US$215 million, a more appropriate level given that the BRL flirted with 2.14, its weakest level against the greenback since May 2009.

Over the course of 2012, the Central Bank continued to deliberately move interest rates closer to international standards by aggressively easing monetary policy, while the government took a much more proactive role compared to 2011. Some of the targeted measures taken by the government included: (1) reduction of either import or IPI tax for infrastructure and cars in 2Q12 through August (later extended until the end of 2013) and standardization of the tax structure on ports; (2) extension of tax cuts on appliances and construction materials (first announced in December 2011); (3) reduced BNDES loan rates for trucks and capital goods (rates fell from 5.5% to 2.5%); (4) reduction in utility rates by an average of 20% for industrial and retail sectors, to start in 2013; (5) extension of the payroll tax cut to additional sectors; and (6) announcement by BNDES of a reduction in its so-called TJLP rate for long-term infrastructure investment to 5% starting in January 2013 , from 5.5%, while it will extend for another year by BRL100 billion ($48 billion) an emergency credit line established during the 2009 credit freeze to fund the purchase of capital goods.

Aggressive expansion in Bacens FX swaps position

-70

-60

-50

-40

-30

-20

-10

0

10

Nov-10 Mar-12 Aug-12 Feb-13 Aug-13

1.501.60

1.701.801.90

2.002.102.202.30

2.402.50

Bacen USD FX swaps position (US$ bn)USD/BRL (inverted scale, RHS)

Data as of November 14, 2013. Sources: Bacen, Bloomberg, and Santander.

As international markets started in 2Q13 to anticipate a potential tapering of the Feds QE3 policy, many EM assets suffered important losses. The Central Bank initially responded in June with a relatively discretionary supply of FX credit lines and FX swaps. Technocrats from the Finance Ministry and Bacen had been aware since early 2013 that the BRL had to depreciate further in order to redress some macroeconomic imbalances and adjust to new external conditions (less sanguine terms of trade and slower Chinese demand). However, as the BRL weakened as much as 26% from a recent low of 1.94 in March 2013 to 2.45 in August 2013 (weakest level since December 2008), we believe Bacen officials probably started to worry about the speed and

27


magnitude of the move, fearing an increasing loss of confidence among investors (both local and offshore) that could lead to an overshooting in the exchange rate.

With increased pressure on the BRL and DI curve came forceful action by the Central Bank, which announced a comprehensive FX intervention program on August 22. The main aim of the program was to provide USD liquidity via daily FX swaps auctions for US$500 million (between Mondays and Thursdays) and weekly FX credit lines worth US$1 billion until at least December 31, 2013 (suggesting it could be extended if needed). Our calculations (which exclude weekends and holidays) suggest the total program could reach at least US$35 billion in FX swaps and US$18 billion in FX credit lines, for a total of around US$53 billion, probably the most aggressive such FX program in the EM world. However, the total will depend on whether the program is extended for a longer period (beyond the tentative deadline of December 31, 2013) and the speed at which the Central Bank rolls over the maturing FX swaps. In 2013, the government implemented a dual strategy: (1) eliminating the IOF tax on fixed income securities and FX derivatives to help contain the pressure on the FX market and investor confidence; and (2) supporting economic activity via fiscal incentives for car purchases and to exporters of industrial products. The reduction in the IOF tax was aimed at increasing the attractiveness of Brazilian assets among foreign investors, which in principle seems to have helped modestly on the margin to increase foreign participation in the local sovereign bond market from 13.9% in December 2012, to 14.4% in May 2013 (just before the elimination of the IOF tax), and more recently to around 17.5% in September 2013.

PUBLIC DEBT COMPOSITION

Neither the 2008-09 crisis nor the escalation in the European crisis since 2H11 nor the anticipation of the Feds tapering of QE3 had a very significant impact on debt composition. There was an increase in FX exposure at the end of 2008 that increased the participation of foreign currency in total domestic debt from a low of -2.53% in August 2007 to a multiyear high of 3.4% in January 2009, but this has since been reversed, and the FX participation has hovered around 0.6% since 2010. The latest available data (September 2013) relative to five years ago would actually be a comparison with the month when Lehman collapsed, and it shows a substantial decline in the participation of Selic floaters (18.6 p.p.) along with a significant rise in inflation-linked debt (7.4 p.p.) and a considerable increase in fixed-rate debt (9.2 p.p.). In 2013, the Treasury was able to continue extending the average maturity of the domestic debt stock, mainly because of the supply of longer-duration fixed-rate bonds as well as the reduction in the supply of shorter-dated zero-coupon LTNs (supply as of November 7 declined by about 14%). Overall, the average maturity of the outstanding debt stock increased five months to 51.3 months in September 2013 compared with December 2012, an all-time high.

Avg maturity of domestic public debt (years) Composition of domestic debt stock (% total)

0

1

2

3

4

5

6

Jan-04 Jul-05 Jan-07 Jul-08 Jan-10 Jul-11 Jan-13

-123456789Fix ed-rate debt

TotalSelic-index edInflation-index ed (RHS)

36.1 37.3 32.2 33.7 37.9 38.3 41.2 41.6

22.5 26.3 29.3 28.628.1 29.6

35.5 36.8

40.2 36.6 33.6 35.8 32.530.8 22.2 20.4

-20%

0%

20%

40%

60%

80%

100%

Dec-06 Dec-08 Dec-10 Dec-12

Other

FX

Selic

Inflation

Fix ed

Sources: Bacen and Santander. Sources: Bacen and Santander.

In terms of auctions, after having stabilized to historical norms in the two years after the disruption seen in 2008 amid the global financial crisis, the percentage of bids rejected by the government through the traditional auction mechanism (including first and second rounds) edged up slightly in 2011 and 2012 and increased more strongly in 2013 (through November 14) to 18%, 28%, and 39%, respectively, from a low of 13% in 2010. The rejection rate (the percentage of auctions in which the bids were not accepted out of the total of the amount tendered during a given year) was about 14% in 2007, soared to 26% in 2008 amid the unraveling of the financial crisis, but ended up stabilizing to 18% in 2009. The high rejection rate seen in 2013 probably reflects

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the heightened market anxiety and the governments difficulty in placing bonds under acceptable conditions due to anticipation of the Feds tapering of its QE3 policy and, in particular, concern among investors regarding Brazils rapidly deteriorating fiscal accounts.

Meanwhile, foreign holdings of local debt instruments reached a fresh high of 17.5% in September 2013, from about 11.5% in September 2010 (right before the IOF tax was increased from 2% to 6%) and 14.4% in May 2013 (right before the IOF tax was cut from 6% to zero). Foreign holdings had been growing steadily from June 2007 (2.7%) to September 2010 (11.5%) and lost some momentum after the imposition of the IOF tax on fixed income investments announced in October 2010, stabilizing at around 11.5% of the total through the end of 2011. Although the return of the IOF tax was a significant disincentive for foreign flows, the aggressive easing of monetary policy (between August 2011 and October 2012 it was reduced by 525 bps), pushing the Selic monetary policy rate to a fresh low of 7.25%, helped spur interest in local bonds among the offshore community. This helped drive foreign participation higher from an apparent lethargy in the immediate aftermath of the October 2010 increase in the IOF (offshore participation hovered between 11.1% and 11.9% for seventeen months until it breached the 12% mark in 1Q12).

Although foreign participation has soared from around 12% in 1Q12 to close to 18% in 3Q13, investors ongoing concerns about Brazils fiscal dynamics and a BRL under pressure may set a speed limit going forward. In any case, part of the increase in foreign participation in local bonds may have been driven by an unwinding of offshore exposure via structured notes and other vehicles (local banks use their balance sheets to buy bonds and then replicate their flows to provide exposure to international players) and a substitution to actual exposure in local bonds. This substitution effect is hard to measure, as there in no hard data to confirm it, but anecdotal evidence suggests it may have been considerable.

Composition of domestic public debt (BRL bn) Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Sep-13 DOMESTIC DEBT 1,094 1,225 1,265 1,398 1,603 1,783 1,917 1,898 LFT (Selic Indexed) 412 409 453 500 521 549 425 388 LTN (zero-coupon) 347 325 239 247 355 402 552 583 NTN-B (IPCA indexed) 167 242 299 330 374 454 602 617 NTN-C (IGP-M indexed) 66 66 59 58 65 62 66 67 NTN-D (USD indexed) 1 1 - - - - - - NTN-F (Fixed coupon) 48 132 168 224 254 280 237 207 Securitized debt 19 21 15 12 9 10 8 8 Agricultural debt bonds 4 5 5 5 4 4 3 3 Other 29 24 27 22 22 22 23 25 FOREIGN DEBT 144 109 133 99 90 83 91 91 Bonds 113 85 101 79 69 72 78 82 USD Globals 88 62 76 59 50 55 62 66 BRL Globals 7 11 11 11 7 4 2 3 EUR 16 12 13 9 12 12 14 14 Pre-Brady 1 0 0 0 0 0 0 - Other 2 - - - - - - - Contractual debt 31 24 32 20 21 12 13 9 World Bank & IADB 25 20 27 17 17 7 7 3 Banks & Agencies 6 4 5 3 4 5 6 6 TOTAL (Domestic & Foreign) 1,237 1,334 1,397 1,497 1,693 1,866 2,008 1,989

Data through September 2013. Sources: National Treasury and Santander.

LEGAL BACKGROUND The body that oversees the local markets is the CVM (Brazilian Securities Commission), which is equivalent to the U.S. Securities and Exchange Commission. In 2005, in order to improve the infrastructure of the local markets and make them more attractive to foreign investors, the governmental regulatory bodies (CVM, the National Treasury, and the Central Bank) established a partnership with the main market agents (BM&F, the Futures & Commodities Exchange; Bovespa, the stock exchange; CBLC, the main clearinghouse; and ANBID, the association of investment banks). This partnership is called BEST (BrazilExcellence in Securities Transactions). One important goal achieved by this partnership is that, since November 2006, a

29


nonresident investor can obtain registration with the CVM (and, consequently, be able to trade in the local markets) in less than 24 hours. BEST has a useful website (http://www.bestbrazil.org.br), which includes information about future road shows and comprehensive practical investor guides in English. The Brazilian investment banking association ANBID and the national financial institutions association ANDIMA merged in October 2009 to form a new entity called ANBIMA (Brazil Financial and Capital Market Association). AMBIMA acts as a private regulatory organization and aims to regulate, jointly and constructively with the Brazilian public institutions, those in the financial and capital markets. AMBIMA publishes fund industry statistics and monthly rankings, taking the data sent by market participants on an ongoing basis.

Brazils Central Bank resolution #2689 of January 2000 regulated the flow of foreign investors money to all the products traded in Brazilian financial markets. These products include all the derivatives traded in BM&F, stocks, and government bonds.

There are three main legal requirements to be met by a foreign investor in Brazil:

1. Nominate a legal and fiscal representative in Brazil responsible for updating the registration of all assets within the CVM and the Central Bank. This representative can be a financial institution authorized by the Central Bank.

2. Obtain registrations with CVM, the Central Bank, and the Federal Revenue Service.

3. Choose one or more custodians (authorized by CVM) and brokers. The investor can place investments in more than one safekeeping account and with more than one custodian.

These procedures may look straightforward, but it is important to obtain advice from lawyers and fiscal consultants who are knowledgeable about Brazilian legal requirements.

REGULATORY AND TAX ISSUES Historically there have been three taxes on financial operations in Brazil:

1. Income Tax (IR). Capital gains (earnings on equities and derivatives) are exempt from income tax. Since February 2006, capital gains on fixed income instruments (bonds) and fixed income mutual funds that have at least 98% of their assets allocated in Brazilian government bonds are also exempt. These rules are not applicable to countries that do not have income taxes or where these taxes are less than 20% (i.e., tax havens), in which case the rules are the same as for Brazilian residents: 20% on earnings from shares, mutual funds, fixed income, swaps, and derivatives, and 15% on interest on equity, with an exemption for dividends.

2. Tax on Financial Activities (CPMF): The CPMF tax expired on December 31, 2007, and is no longer collected by the Federal Revenue Service. Up until December 31, 2007, a 0.38% tax rate was charged on some classes of assets (fixed income, swaps, futures, and options) when money was transferred from one asset to another and on FX transactions. When the CPMF tax expired at the end of 2007, in order to replace at least part of the loss in fiscal revenues, the government increased the IOF tax charged on loans, insurance, and FX transactions (exports, imports of goods and services, and credit card payments). Although the CPMF no longer exists, there have been proposals to revive it, and investors should remain aware of this.

3. Tax on Financial Transactions (IOF). The IOF tax is a catch-all tax that may theoretically be levied on any type of financial transaction and is often used for regulatory purposes. The IOF is a regulatory tax and the rates can be increased or decreased by the Executive Branch from zero to 25% (ceiling) whenever officials decide to either contain or foster the inflow of foreign currency funds into the country, in accordance with the monetary and exchange policy goals adopted by the Brazilian government. A brief chronology of the relevant changes faced by nonresident investors entering the local market shows the discretionary nature of the governments usage of the IOF tax as a policy tool and could be summarized as follows:

30

In March-October 2008, an IOF tax of 1.5% was levied on the FX transaction related to a purchase of domestic fixed income securities by nonresidents (although transactions with derivatives remained IOF-exempt). The tax was introduced as a reaction to the BRLs appreciation but was scrapped as part of the governments response to the 2008 global financial crisis.

In October 2009, the IOF tax on portfolio investments was reintroduced at a flat rate of 2%. This time around, however, equity investments were not exempted. Officially, the government said it reintroduced the tax in order to avoid excesses in local asset prices, but the consensus is that the government again felt uncomfortable with BRL appreciation and wanted to contain portfolio (and particularly IPO-related) inflows. However, on December 1, 2011, the government decided to cut the IOF tax on equity investments to zero. As was the case in 2008, this IOF tax is levied once, when foreign currency is converted into BRL before it is invested in the local market. Once their assets are in BRL, cash investors are free to shift from one asset to another. Swaps and other offshore instruments are not under Brazilian jurisdiction and thus are not taxed. In order to avoid distortions in the ADRs market caused by the IOF tax, the government also imposed a 1% tax on new ADR issuance by Brazilian companies.

On October 4, 2010, Finance Minister Guido Mantega announced a new increase in the IOF tax to 4% on fixed income investments. Amid increased market talk about potential additional measures to contain the BRL, the Finance Ministry announced a second increase in the IOF tax to 6% on October 18, 2010, levied on any new inflows coming into fixed income securities. The Ministry clarified that although the impact was not retroactive (existing investments would not be affected), the measure would also apply to margin deposits, effectively raising the IOF tax levied on foreign investors positions in the futures markets from a modest 0.38% to the announced 6%. The low rate on margin deposits seemed to be a loophole that enabled investors to avoid the IOF tax on some margin deposits used in the futures markets. The increase in the tax on margin deposits to 6% only affected incremental inflows to be used as margin, specifically when the FX transaction takes place. However, the measure did not affect the actual BMF margin calculation. In contrast, the IOF tax applied to equity investors remained unchanged at 2%.

Some complementary measures were announced by Brazils Monetary Council (comprising the Finance minister, the Planning minister, and the Central Bank president) to prevent investors from circumventing the higher IOF tax on fixed income securities and funds. The Council decided that investors that were invested in equities and wanted to migrate to fixed income had to pay the new 6% IOF tax, as some investors had been sidestepping the higher 6% rate applied on incoming flows to the fixed income markets by investing first in equities and then switching to rates. In late October 2010, the government clarified some remaining issues: (1) nonresident accounts would not be able to lend securities (i.e., reverse repo) (this highlights the governments resolution to limit leverage, since some offshore accounts had been using lending proceeds as margin deposit to leverage their accounts); and (2) daily adjustments received from futures contracts are not subject to symbolic FX transactions, which left the door open for investors to use the proceeds to buy fixed income assets without being liable to pay the IOF tax.

In 2011 the government decided to impose an IOF tax on other financial transactions that implied additional inflows of foreign currency. In March 2011, the government increased the IOF tax on international bond sales and loans from 5.38% (applicable to liabilities of up to 90 days) to 6.00% (liabilities of up to 360 days and extended to 720 days on April 6). In July the government was even more aggressive, announcing a measure authorizing the CVM to define the trading rules for derivatives markets (margin, collateral, leverage, tenors, etc.) and to collect an IOF tax that could reach as high as 25%, but was initially set at 1%. The tax will apply to the notional value of FX-related derivatives equivalent to an increase of at least US$10 million in short USD positions compared to the previous trading day. The IOF was also used as a macroprudential measure when the government raised the tax levied on consumer loans (excluding mortgages) from 1.5% to 3.0% on April 8, 2011, in order to contain frothiness in the credit market. However, that move was partially reversed in December 2011 and December 2012, as a way to support the local economy given the escalation of the European debt crisis and U.S. fiscal cliff disputes. The government reduced the tax by 2% to zero for portfolio flows in equities.

In 2012, the government continued to extend new restrictions on foreign inflows by imposing the IOF on new transactions. In February, as the BRL tested the 1.7 handle, a four-month high, the Ministry of Finance

31


announced that the 6% IOF tax on international bond sales, intercompany loans, loans abroad or BDRs (Brazilian Depositary Receipts), applicable so far on any transactions with maturity of up to two years, would apply to those with maturity of up to three years starting March 1, 2012. Bacen extended the 6% IOF to loans that Brazilian exporters used to anticipate future proceeds from sales, or the so-called export prepayments. The IOF also applied to any inflows classified under long-term export contracts, which were used as collateral. However, the Central Bank exempted the payment of the IOF in cases of advanced payment agreements or exports prepayments if they are shorter than one year (such as the ACC operations), and Bacen later reversed the IOF tax on all exporters in December 2012 to help alleviate USD availability and support growth. A few days later, the government increased the maturity on international bond sales and loans from three years to five years, and imposed a retroactive payment for those who had executed such transactions in the last three years. This last extension in the duration surprised FX market participants, as the external environment had been deteriorating while the BRL had weakened sharply. In fact, on June 14, 2012, when the BRL flirted with 2.1, the government decided to reverse course and once again reduce the duration of foreign loans from five years to two years, and later reduced it again to 360 days on December 5, 2012.

However, over the course of 2012, the government also started to unwind some of the IOF taxes that it had implemented as macroprudential measures to reignite economic growth, with measures such as: (1) exempting exporters from paying the 1% IOF tax on FX derivatives as long as their currency exposure is 1.2x their exports in the previous year (the amount in excess will be subject to IOF tax); (2) reducing the tax on individual loans (from 2.5% to 1.5%) and cutting the reserve requirements for auto loans, benefiting all banks; and (3) creating an IOF tax exemption on mortgage-backed securities, or Certificados de Recebiveis Imobiliarios (CRIs) as long as at least 67% of a real estate funds assets are CRIs in the first two years of the life of the fund, and they increase to 85% after that.

Finally, in June 2013 the government decided to reduce the IOF tax on fixed income assets from 6% to 0% and cut the IOF tax on FX derivatives from 1% to 0%, effectively dismantling all the actual barriers preventing foreigners from entering the local rates and FX markets. The radical changes were triggered by the increasing pressure on the BRL to depreciate and on DI rates to widen amid anticipation, beginning in May 2013, of the tapering of the Feds QE3 policy.

In addition to these taxes, the CVM charges a quarterly registration fee of BRL7,872 and, at the end of the calendar year, 0.1% on net equities of less than BRL4,100,000.

For a list of countries labeled as tax havens by the Brazilian tax authority, please see Brazils Federal Revenue Service SRF IN 188.

FIXED INCOME MARKET The main Brazilian fixed income markets are the primary and secondary markets for government bonds and the derivatives market at the BM&F Exchange.

The Brazilian Treasury has developed an active and liquid market for its main issues, in both primary and secondary markets. The total amount of local debt in circ

local markets handbook

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