Professional Documents
Culture Documents
August 6, 2002
Discussion Points
I. Brazil Marketplaces
I Brazil Marketplaces
BM&F concentrates most listed products. CETIP concentrates most OTC derivatives
Brazilian Mercantile & Futures exchange Main products: DI futures; DDI futures; FX futures Daily turnover: USD 12 b Also, provides semi-standard contracts (swaps and flex options)
BM&F
Clearing house where most of the OTC trades are registered and settled Does not guarantee any settlement: players bear the credit risk of their counterparts
CETIP
Bovespa (So Paulo stock Exchange): provides stock options contracts SISBEX (now part of BM&F): provides contracts on government bonds
Others
Daily turnover Exchange-traded derivatives ( USD millions ) 14,000 12,000 10,000 8,000 6,000 4,000 2,000 Brazil Singapore Mexico Korea Poland
Czech Republic
Czech Republic
South Africa
Hungary
South Africa
Singapore
Singapore
Hungary
5
Poland
Mexico
Mexico
Poland
Brazil
Korea
Brazil
Korea
9,272
2,680 8 167 200
55
9 16 15 56
Listed options
Flex options
Swaps
CETIP
Swaps (3)
682
83
Others
Listed Options
N/A
DI and DDI futures Mainly FX and Ibovespa futures FX NDFs are traded at CETIP, but with very low volume (open interest was USD 270mm in July 2002). FX forwards are usually traded as swaps
Government bonds
3,300
217
Debentures
22
13
Certificates of Deposit
100
23
Stocks
237
145
Foreign Exchange
400
Stocks Commodities (gold, cotton, coffee, and others) Ibovespa stock index
Asset Prices
CDI is the average daily inter-bank overnight rate SELIC is the one-day repo rate of government bonds. IDI is the result of the accrued daily CDI, based on an initial amount of 100,000 on January 2nd 2000. The IDI basis is reset to 100,000 from time to time. Several derivatives are referenced to CDI, to the IDI index, or the accrued return of the daily CDI rate The CDI rate can be viewed as a daily Libor
Physically-settled FX derivatives are rare or non-existent Most FX derivatives are cash settled in Reais, and the foreign FX return is generally calculated according to a fixing rate published by the Brazilian Central Bank (the PTAX rate)
FX Variation
Others
Several indexes were used as alternative currencies during the hyperinflation years IGP-M: inflation index TR, TJLP: interest rates indexes
IV Taxonomy: Futures
Most traded futures are FX and Ibovespa futures
All futures are traded at BM&F Mainly dollar/real futures The fixing price is the PTAX rate published by the Central Bank on the business day prior to the contract expiration Standard swaps take as base FX rate the PTAX rate of the business day prior to the trade date, thus creating dirty and clean quotes:
FX Futures
dirty quotes are based on previous days PTAX, and vary according to the spot FX clean quotes are based on spot FX
EUR, ARS and JPY futures are available, but are not used Most of the volume on dollar/real futures is captured by USD-linked interest rate contracts (DDI and FRA). Hence, only the first future is generally traded Daily turnover: USD 2.4 b; Open interest: USD 8.3 b
Ibovespa Futures
Ibovespa is a stock index calculated by the So Paulo stock exchange and comprised of approximately 50 of the most liquid stocks (currently 57 stocks) The fixing price is the average Ibovespa price during the last half session of the expiration date Daily turnover: USD 245mm; Open interest: USD 309mm
The most traded future in Brazil. Daily turnover: USD 5.7b ; Open interest: USD 28 b. Underlying is not a forward rate. Underlying is the spot rate from trade date to expiration date. DI futures perform the same as a fixed-to-CDI swap Most liquidity for January, April, July, and October contracts, in addition to the next month contract. Currently, DI futures trade maturities up to 2005 Daily settlement formula makes the buyer pay a daily CDI rate to the seller, in addition to price variation. The final fixing price is 100,000 reais. So the price at which DI futures trade is equal to the present value of 100,000 Since January 2002, DI futures ceased to be traded in price and began to be traded in rates. The buyer of price became the seller of rate, and the seller of price became the buyer of rate
DI Futures
DDI Futures
DDI futures trade the local synthetic dollar interest rate (the cupom cambial). They perform the same as a dollar-CDI swap Daily turnover: USD 2.9 b; Open interest: USD 27 b Most liquidity for January, April, July, and October contracts, in addition to the next month contract. Currently, DI futures trade maturities up to 2008
FRA Trading
FRA is not a future, but a mechanism of trading provided by BM&F where each trade is broken and registered as a pair of opposite DDI trades
Was created to avoid dirty rates (rates contaminated by the fluctuations of the spot FX rate) Practically all the DDI volume is originated from FRA transactions
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IV Taxonomy: Swaps
All swaps are semi-standard, index swaps
Swaps
All the swaps are index swaps. Interest rates and FX variation are represented by their returns from trade date to maturity date On CETIP: Daily turnover: USD 682 mm ; Open interest: USD 83 b On BM&F: Daily turnover: USD 200 mm ; Open interest: USD 56 b Traders can combine any two among 16 different indexes:
Reais fixed rate CDI rate TR interest rate TJLP interest rate SELIC rate ANBID rate Dollar variation Euro variation ARS variation JPY variation Floatng Dollar variation IGP-M IGP-DI IGP Ibovespa index Gold
All the indexes are calculated according to standard formulas. For instance, the dollar index is calculated as: [Final PTAX] / [Initial PTAX] * (1 + [coupon rate] * [tenor / 360] )
Optionality Clauses
It is possible to map options to CETIP swaps using one or more optionality clauses
Cash flow swaps are a new product planned by CETIP (not delivered yet) Cash flow swaps correspond to the vanilla international interest-rate swap, or to the vanilla international cross-currency swap Additional rate indexes will be created, as Libor and Jibor
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IV Taxonomy: Options
Listed and Flex options are offered by BM&F
Listed Options
Dollar / Real options (cash settled, fixing is the previous day PTAX) IDI options (cash settled, fixing is the value of the IDI index at expiration)
Other, illiquid options on: Ibovespa futures, gold, coffee (physically settled)
The So Paulo stock exchange provides listed options on stocks (physically settled) and on Ibovespa spot (cash settled)
Flex options are provided by BM&F. Market is OTC, but registration and clearing is exchange-based Traders may choose tenor, strike and fixing method. In some cases, optionality clauses (barrier) are allowed There are flex options on FX and Ibovespa spot Flex options may or may not be guaranteed by BM&F
CETIP swaps may replicate options, if optionality clauses are used In this case, great flexibility may be achieved. Possible products include vanilla European options, outperformers, barrier options and swaptions
12
All swaps and non-standard options between financial institutions have to be registered with an exchange or with other market organizers such as CETIP (reg. 2873) There is a controversy about if non-registered derivatives contracts between non-financial institutions (corporates, individuals) are enforceable (anti-gambling laws)
The reference assets of swap transactions are: interest rates, FX rates, commodities, stocks and stock indexes (reg. 2873) In the case of commodities, stocks or stock indexes, any underlying price or calculation method not immediately available from a semi-standard contract has to be authorized by a regulator (reg. 2873) If an exchange or a market organizer creates a new underlying, it has to the authorized by a regulator (reg. 2873)
CETIP Rules
In any swap transaction, at least one party has to be a market member (a financial institution or institutional investor which has an account with CETIP) Non-market members may trade only through (or with) a market member, which is considered the non-market member administrator If two market members trade, settlement will be commanded by CETIP. If one non-market member trades with its administrator, the settlement is done through deposit in the bank account of the profitable party, executed by its counterpart. All trades between one non-market member and one market member have to be confirmed in writing. Transactions between two market members do not need to be confirmed in writing Confirmations may include additional clauses that complement the standard contract. However, clauses that are in conflict with the standard contract are void
13
In Brazil, netting is still not enforceable Article 30 of provisional measure 2139-67 provides for the netting, but it is not in effect yet. There are significant difficulties to secure control over pledged collateral
BM&F swaps and Flex options can be guaranteed (for one or both parties) or nonguaranteed BM&F margin call system considers the effect of offsetting positions CETIP swaps are always non-guaranteed Banks have included credit mitigators (reset, early termination) in the CETIP swaps contracts they trade with clients
BM&F made several efforts to move the swap contracts to contracts settled daily or monthly A pair of opposite swap transactions at BM&F, if both are exchange-guaranteed, counts as zero exposure for margin requirements A pair of opposite non-guaranteed swap transactions (BM&F non-guaranteed or CETIP) counts as double exposure
Liquidity
14
VI Cross-Border Constraints
Restrictions to the participation of local players in the international derivatives markets
International Derivatives Transactions
A Brazilian resident may trade with non-residents in the international derivatives markets In this case, settlement occurs via non-resident (former CC-5) accounts As CC-5 accounts were heavily associated with money laundry in the past, most banks avoid using them, and the Central Bank maintains strict surveillance of all payments made through CC-5 accounts Income taxes are levied, either if the Brazilian party receives or if the Brazilian party pays (the last is considered a gain for the non-resident, subject to withholding tax)
According to reg. 2012, a Brazilian resident may trade derivatives with non-residents, effect payments through the free FX market (avoiding the CC-5 vehicle) and be exempt of income tax if the transaction is aimed at hedging cash flows commited in a foreign currency and / or foreign interest rate Central Bank maintains strict surveillance over the transactions done under reg. 2012
Non-residents may trade in the local derivatives markets under the provisions of reg. 2689 Non-residents need a Brazilian financial institution to be the administrator of the 2689 account The same rules that apply to residents (including taxation) apply to non-residents trading through 2689. However, from time to time there may be exceptions regarding taxation (e.g. CPMF tax on equities). Tax rates are differentiated for investors based on countries considered tax havens Reg 2689 (from 1998) substituted the former Annex regulations, which specified the type of investment or trade the non-resident could do in the local markets. Before reg. 2689, there were six Annex regulations, each one regulating one type of investment
15
FX Hedge Transactions
Options
FX options are sometimes embedded in best-of products (e.g. best of a percentage of CDI or a dollar-linked return)
In Brazil, debt instruments have to follow a very strict regulation. Structured notes and deposits are not allowed Hence, structured cash products are usually built as funds (principal protected, principal protected with knock-out, etc)
16
IDI options are traded at BM&F The reference asset of an IDI option is the IDI index
17
Regulation
Reg. 2933 Resolution and Reg. Circular 3106 are the framework of credit derivatives transactions in Brazil Currently, only credit default swaps and credit default options are allowed Reg. Resolution 2921 provides for credit-linked deposits Have to be registered (CETIP already started the design of standard contract)
Only financial institutions may trade credit derivatives. However: Money-market funds regulated by the Central Bank (FIF funds) are considered financial institutions.
Concepts
There is a controversy about if non-financial corporates, that are not regulated by the Central Bank, could or not trade credit derivatives (anti-gambling laws)
Broad range of underlying assets are allowed, including derivatives and other credit derivatives. However, the protection buyer has to have an exposure on the underlying asset, or the underlying asset must be a regularly traded instrument Foreign participants and foreign reference assets are not allowed
18
Cash settled or Physically settled The committees are choosing the regularly traded securities (debentures) that better represent the debtor names, so that these become the benchmarks of CDS transactions Discussions with the Central Bank and CVM on accounting, operational and tax issues still have to take place
Cash settled (Swaps cannot be transferred without the consent of the counterpart) Three suggested protection types: a) Market Value; b) Accounting Value; c) Fixed Value
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The need for new reference assets (e.g., market has rejected the official fixing prices for EUR, JPY or ARS, and has used the Fedspot rates to fix settlements in other currencies)
New complex products that are not easily standardized (e.g., Cash flow swaps) Increasing concern with credit risk and the need of provisions that could mitigate it.
Opposite trends: Additional efforts by regulators and exchanges have been taken to bring every initiative into the standardized regulatory framework (e.g., CETIP being the official calculator of mark-to-market and early termination amounts)
Development of the credit derivatives business New, more flexible, contracts provided by CETIP Emphasis on credit risk mitigation
Future Developments
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