- International Monetary Fund
- Published Date:
- August 2003
The Brazilian government has been implementing several measures to improve the conduct of public debt management. This document provides an overview of the main guidelines currently followed by Brazilian public debt officials, drawing comparisons to those proposed by the IMF and the World Bank in their joint report, Guidelines for Public Debt Management.
The first section, “Developing a Sound Governance and Institutional Framework,” covers a broad array of issues. It starts with a brief discussion of the objectives and scope of public debt management in Brazil and its coordination with monetary and fiscal policies. Following is a description of the main measures to enhance transparency and accountability by means of well-defined roles and attributions for debt management, comprehensive information disclosure, and frequent examination of debt management activities by external auditors. Concluding the section, the most relevant events regarding governance and the management of internal operations, including recent institutional reforms, are presented.
The second section, “Establishing a Capacity to Assess and Manage Cost and Risk,” focuses on the guidelines that have been considered in determining optimal strategies for keeping the cost and risk of the public debt at sustainable levels. Along with an illustration of the recent behavior of several debt management indicators, this section describes the implementation of an ALM framework and strategies envisaging reductions in refinancing and market risks. The main features of the risk management models currently in place and under development are also described.
The third and concluding section covers the actions that have been taken for developing the markets for government securities. Emphasis is given to the description of some noteworthy measures released by the Brazilian Treasury and central bank in November 1999 and to the continuous effort to stimulate the demand for long-term securities.
Developing a Sound Governance and Institutional Framework
Debt management objectives and coordination
In line with the guidelines suggested by the IMF and the World Bank, the basic directive pursued by the Brazilian government for public debt management is cost minimization over the long term, taking into consideration the maintenance of judicious levels of risks. As a secondary and complementary objective, the Brazilian Debt Management Unit has been taking actions toward the development of its domestic public securities market.
Although debt management officers strive to implement strategies aiming at cost minimization of the Brazilian government debt, special attention is given to the risks embodied in each strategy. Government efforts in the establishment of a solid reputation with creditors, respecting contracts, and avoiding an opportunistic approach in its relationship with the market are also of importance.
Emphasis has been given to the monitoring of refinancing and market risks, most specifically the former. In this respect, the Brazilian Treasury, as reported in greater detail below, has successfully extended the average maturity of the debt and achieved a smoother redemption profile. Close attention is paid to the amount of debt maturing in the short term (12 months), reducing the treasury’s exposure to undesirable events that may occur.
The gradual replacement of floating-rate securities for fixed-rate securities represents another major guideline pursued by the Brazilian debt management office. Nevertheless, although it is an important measure to reduce market risk, changing the composition of debt toward greater concentration of fixed-rate instruments has often diverged from the objective of maintaining refinancing risk at comfortable levels. This dilemma occurs as a result of the still limited demand for long-term fixed-rate bonds. As the demand for these securities becomes more pronounced and macroeconomic policies are kept sound and stable, a more aggressive strategy in favor of those securities will follow.
Finally, the Brazilian Treasury seeks the development of the secondary market as a main venue to achieve these objectives. Some measures are already in effect (see the third section, “Developing the Markets for Government Securities”), such as
- improvement of the term structure of interest rates,
- standardization of financial instruments, and
- fungibility for floating-rate securities.
The scope of Brazilian public debt management is also in line with the IMF and World Bank guidelines. It encompasses the main financial obligations over which the central government exercises control, which include both marketable and nonmarketable debts, domestic and foreign currency debts, and contingent liabilities.2 Given that the Brazilian Treasury has adopted an integrated ALM framework, asset characteristics are also taken into account in the conduct of public debt management.
Relative to the coordination with fiscal policy, borrowing programs are based on fiscal projections established by the federal budget and approved by parliament. The treasury also elaborates and publishes a detailed Annual Borrowing Plan that is submitted to the revision and approval of the minister of finance.
In the coordination with monetary policy, there is close interaction between treasury and central bank officials. Regular meetings with members of both institutions are held, and information on the government’s current and future liquidity needs is shared. Moreover, although the final decisions regarding public debt financing strategies are under the responsibility of the national treasury, officials from the Central Bank of Brazil (CBB) are always consulted in advance to measure the potential impact of such strategies on the conduct of monetary and exchange rate policies.
An important step taken in Brazil is that as of May 2002, the CBB is no longer allowed by the Fiscal Responsibility Law (FRL) to issue its own securities.3 Monetary policy is now conducted through secondary market operations with treasury securities, enhancing the transparency between fiscal and monetary policy.
Transparency and accountability
Brazilian debt management authorities seek transparency and accountability by publicly disclosing the roles and responsibilities for debt management and providing the public with information regarding debt management policies and statistics. In addition, external auditors frequently examine and evaluate the activities of public debt management.
The roles and responsibilities for debt management are clearly and formally defined by legal instruments. A summary of legislation is available at the treasury’s web site.4 Foreign and domestic public debt management is handled by the ministry of finance and, in turn, within the ministry of finance by the National Treasury Secretariat (that is, the Public Debt Office). Similarly, all regulations related to debt management are disclosed, including those on the activities of primary and secondary markets, and on clearing and settlement arrangements for trade in government securities.
Information on debt management policies and operations is publicly disclosed by means of a regular calendar of auctions and regular report publications, all available on the treasury’s web site. Besides publishing its Annual Borrowing Plan, which includes the main guidelines and strategies to be pursued over the year, the National Treasury Secretariat provides detailed public debt statistics through two monthly reports: the Federal Government Domestic Debt Report (in cooperation with the CBB) and the National Treasury Fiscal Results.
Debt management activities are audited annually by external auditors. Two entities are commonly in charge of such attribution: the Secretaria Federal de Controle ([SFC] internal auditing agency—executive branch) and the Tribunal de Contas da União ([TCU] external auditing agency). These agencies are, respectively, affiliated with the executive and legislative branches of the federal government. Although the SFC plays an important role by conducting a preliminary audit of public debt management activities, the TCU is responsible for ultimately approving them.
In addition, some reports required by parliament are related to debt management activities, among which are Report on Fiscal Management—follow-up of debt limits,5 and Account Balance of the Federal Government—a description of all federal expenses throughout the year, forwarded annually to parliament and the TCU.
The National Treasury Secretariat has implemented a new debt management organizational framework since November 1999, based on the international experience of the DMO. The Public Debt Office comprises three main branches:
- The back office, which is in charge of the registry, control, payment, and accounting of both domestic and foreign debts.
- The middle office, which is responsible for the development of medium- and long-term strategies aiming at reductions of debt cost and risk, macroeconomic follow-up, and investor relations.
- The front office, which is responsible for the design and implementation of short-term strategies related to bond issuances in domestic markets. Front office activities associated with international capital market borrowings are currently handled by the CBB, but will be transferred to the treasury in September 2003.
The new institutional arrangement resulted in a substantial improvement in debt management allowing for the standardization of operational controls, monitoring of risks, and separation of functions concerning long-term (strategic) and short-term (tactical) planning. Currently, approximately 90 financial analysts compose the Public Debt Office.
To strengthen internal operations and in response to an increasing number of nonintegrated data systems—making the process of gathering information cumbersome, time-consuming, and highly exposed to operational risk—the treasury has engaged in a cooperative program with the World Bank. The program contemplates three modules:
- IT system development;
- control, internal auditing and security standards, governance and organizational structure; and
- risk management.
Although these modules are interrelated, focus has been given to the development of the IT system. The project is, therefore, mainly directed to the establishment of an integrated platform that will enhance the efficiency and reliability of public debt accounting and reporting, improving the treasury’s capacity and transparency in the conduct of public debt management.
The new institutional framework, mentioned previously, also represents an important step toward the reduction of operational risks. Front and back office functions have been clearly separated, and the middle office has been established to respond to the setting and monitoring of risk analysis independently from the area responsible for executing market transactions. Registry and auction services are presently provided by the CBB, for which a formal agreement has been recently formulated.
The process of hiring personnel was subject to some improvements enacted in the face of competition among different careers within the executive branch. Although there is still some degree of competition with other institutions from both the private and public sectors, the treasury has managed to hire and keep qualified staff by restructuring the career of treasury financial analysts and implementing a strict selection process mostly directed to professionals with strong backgrounds in economics and finance. Considerable resources have also been spent in specialized training for the debt management staff, such as a graduate course in debt management.
Another step taken toward the improvement of debt management was the establishment of a Code of Conduct for Public Debt Managers in February 2001, which contemplates some directives related to their conduct—for example, the prohibition on buying public bonds—and the creation of an Ethics and Professional Conduct Committee of Public Debt Managers.
The main legislation regarding borrowing can be basically specified in four instruments: (1) the Brazilian Constitution—limits on public debt, (2) the FRL regulatory framework for fiscal policy, (3) the Budget Guidelines Law, and (4) the Annual Budget Law (the amount borrowed throughout the year cannot exceed the total established in the specific budgetary sources included in the LOA). Furthermore, a ceiling on new external debt borrowings is determined by a senate resolution.
Among the legal instruments mentioned above, the FRL constitutes a milestone in public finance at all levels of government. By means of a set of rules, it imposes limits on the government’s payroll spending and the amount of outstanding debt,6 requiring higher transparency of public accounts, stricter rules for elected officials of the executive branch at the end of their mandates, and administrative and penalty sanctions on administrators who fail to comply with fiscal legislation.
The FRL reinforced the “golden rule” established in Article 167-III of the Brazilian Federal Constitution, which states that it is forbidden to carry out credit transactions that exceed the amount of capital expenses. It also imposes restrictions on credit operations among government entities, including the national treasury and the CBB, and established that the CBB, as of May 2002, would no longer be allowed to issue its own securities in the primary market.
Establishing a Capacity to Assess and Manage Cost and Risk
Debt management strategy
Brazilian debt management strategy follows guidelines that are initially prepared by the Public Debt Office and submitted for the approval of the secretary of the national treasury and the minister of finance.
The treasury has been gradually moving toward an ALM framework. In this context, the risks inherent in the current debt structure are evaluated, taking into account the characteristics of assets, tax revenues, and other cash flows available to servicing the debt. Net exposures in the balance sheet of the central government are identified by selecting financial assets and liabilities, including guarantees, counter-guarantees, and contingent liabilities.
Results of such analysis under an ALM framework suggest that in Brazil (as is usual in most countries), debt managers should seek a debt composition with heavier reliance on fixed-rate and inflation-indexed instruments. The main mismatches between assets and liabilities of the Brazilian central government, as of December 2001, are presented in Figure II.1.1.
Figure II.1.1.Assets and Liabilities Imbalances, December 2001
Note that the main mismatches concern those related to interest rate and exchange rate exposures. Although there are several difficulties in achieving a debt portfolio that matches the characteristics of assets in the short and medium term, debt management officials find this type of ALM analysis extremely valuable in setting long-term strategies for reaching optimal debt composition.
Along with the objective of gradual minimization of the interest rate and exchange rate exposures, the Brazilian government, in line with IMF and World Bank guidelines, has established among its priorities the reduction of refinancing risk. These objectives, however, are often conflicting, given the still limited demand for long-term fixed-rate and inflation-indexed securities. Meanwhile, the national treasury and the CBB have concentrated efforts in developing secondary markets and stimulating operations with long-term fixed-rate and inflation-indexed instruments. These measures have proven to be helpful in paving the way to a more appropriate composition of the public debt in the future.
Cash management represents another important aspect of the debt management strategy currently adopted by the Brazilian government. The treasury has been keeping enough cash reserves to allow greater flexibility in the pursuit of its financing strategies and, most important, reduce the risk of rolling over the debt under temporarily unfavorable conditions.
The debt management guidelines, which emphasize the reduction in refinancing risk and follow an ALM framework, have already reached good results. With the intent of illustrating the main achievements of such a strategy, and keeping in mind the still long way to attaining a more appropriate debt structure, the recent behavior of several debt management indicators and some of the lessons learned by Brazilian debt management officials over the past years are presented below.
The average term of the outstanding domestic securities debt reached 35 months in December 2001, up from 27 months in December 1999. Behind such an achievement are the efforts to extend the maturity of securities issued through auctions, which represent approximately 70 percent of the domestic debt.7Figure II.1.2 reports the outstanding increase in the average maturity of these securities, growing from 4.6 months in July 1994 to approximately 29 months in December 2001. This rise is linked to the objective of reducing refinancing risk and can be mainly explained by long-term issues of floating-rate (LFT) and inflation-indexed bonds (NTN-C).
Figure II.1.2.Average Maturity—Auction Issued Debt National Treasury
The percentage of public securities maturing in 12 months, which was reduced from 53 percent in December 1999 to 26 percent in December 2001, is a remarkable advance in the Treasury’s financing policy, as shown in Figure II.1.3.
Figure II.1.3.Percentage of Central Government Internal Debt Maturing in 12 Months
In mid-1995, the national treasury started a process aimed at redefining its debt composition. One of the main measures contemplated was the public debt deindexation by means of a gradual increase in the share of fixed-rate debt. The graphs in figures II.1.4 and II.1.5 illustrate the strategy of gradual replacement of floating-rate (LFT) for fixed-rate (LTN securities. Note that fixed-rate securities were issued with increasing maturities up to the wave of crises that hit emerging markets starting in October 1997. Until then, the treasury had been able to suspend new issues of LFT.
Figure II.1.4.Maximum Maturity at Issuance—Fixed-Rate Securities (LTN), in Months Figure II.1.5.Maximum Maturity at Issuance—Floating-Rate Securities (LFT), in Months
Figures II.1.4 and II.1.5 also show the change in focus of debt management strategy in Brazil toward the reduction of refinancing risk and the adoption of a sustainable strategy of issuance of fixed-rate instruments. To reach these goals, starting in 1999, the treasury has implemented benchmark issues of long-term fixed-rate securities issued periodically and has decided to extend the maturity of the debt by issuing floating-rate securities of much longer terms than those observed historically
The composition of the domestic debt has changed dramatically over the past seven years (see Figure II.1.6). The substantial increase in the fixed-rate instruments pursued in the first few years of economic stabilization, which followed the launch of the Real Plan in July 1994, proved to be unsustainable as emerging market economies faced a period of strong turbulence after October 1997. In the new economic environment, the Brazilian government had to accept an increase in the floating-rate share, and a consequent reduction in the fixed-rate portion, to avoid an increase in rollover risk.
Figure II.1.6.Debt Composition per Index
Implicit in the discussion presented so far is a very important lesson drawn from the Brazilian debt management experience. Allied to the need for sound and stable macroeconomic policies, as a precondition for developing high-quality debt management, the development of (long-term) debt markets is also of fundamental importance. In this respect, the measures recently taken to enhance liquidity in the secondary markets and the already mentioned implementation of benchmark issues of long-term fixed-rate and inflation-indexed securities represent important steps toward a sustainable improvement in the debt composition.
In 1995, after 15 years out of the market, the Brazilian government restored its presence in the international capital market, issuing sovereign bonds with great success. Since then, the main measures underlying the Brazilian government strategies regarding the international capital markets have been
- consolidation of Brazilian yield curves in strategic markets (U.S. dollar, euro, yen) with liquid benchmarks,
- paving the way for other borrowers to access long-term financing, and
- broadening of the investor base in Brazilian public debt.
Since 1996, the Brazilian government has also pursued a strategy of buying back restructured debt (the Brady bonds) and replacing them with new bonds.
Figures II.1.7 and II.1.8 illustrate the new money and exchange operations held since 1995, totaling US$25.5 billion of sovereign debt issued in diversified markets. Note that the Brazilian government implemented seven exchange operations from May 1997 to March 2001 that helped to reduce the participation of Brady bonds in external bonded debt from 95.1 percent in December 1996 to 36.5 percent in December 2001.
Figure II.1.7.Foreign Bond Issuance in the International Capital Market Figure II.1.8.External Bonded Debt—Federal Government
Risk management framework
Within the ALM framework, risk analysis is conducted in a model that allows debt managers to project expected and potential costs of the debt under several different refinancing strategies in the medium and long term. Key debt management indicators, such as average maturity, duration, and debt composition, are generated for each strategy, allowing senior management to decide which is the more appropriate strategy to pursue. The main risks monitored are refinancing risk, market risk, and credit risk (most federal government assets are composed of credits from states and municipalities).
A new risk management system customized according to the needs of the risk management group was implemented in the first semester of 2002. Besides allowing the same type of analysis that was conducted, this new system allows for a more integrated examination of assets and liabilities characteristics and the adoption of several types of at-risk models, such as CaR, cash-flow-at-risk, and BaR. At the present time, the risk management group conducts risk analysis based on deterministic and stochastic scenarios. Stress scenarios analysis is also used as a complement.
Besides improving its risk management systems, the Brazilian debt management office has been concentrating efforts in developing the skills of its personnel by means of training, external contacts, and hiring advisers. With this purpose, the aforementioned cooperation with the World Bank contemplates a risk management module that will provide an extensive background on international experience related to best practices of leading sovereign debt offices. The primary objective is to build capacity in assessing and managing the financial risks for a sovereign debt portfolio, and it will initially focus on an ALM framework. The participants will be trained in the various techniques used by the debt offices, and they will learn about future path modeling for market variables. To the extent that several of these techniques are already being developed in parallel by the Brazilian staff, a deeper examination of the risk management tools adopted in other countries will allow useful and valuable comparisons.
Developing the Markets for Government Securities
Improvement measures for the government securities market
During the second semester of 1999, the Brazilian Treasury and the CBB designated a working group with the objective of preparing a diagnosis of the problems related to the markets of public debt securities. Since then, some procedures have been reorganized, and new instruments and norms were introduced, aiming at the recovery of securities market dynamism. The working group also discussed strategies that could enhance the demand for long-term government securities and released several measures, products, and projects directed to the public debt in primary and secondary markets. Some of these actions include:
- reduction in the number of outstanding series of domestic securities debt,
- use of the reoffer and buyback mechanisms,
- implementation of firm bid (price discovery) auctions for issuing long-term fixed-rate securities,
- release of a monthly schedule of auctions of treasury securities,
- regular and comprehensive information disclosure of public debt policies and statistics, and
- regular meetings with dealers, institutional investors, risk-rating agencies, and others.
The firm bid auctions comprise two stages. In the first stage, only primary dealers are allowed to submit bids, committing themselves to buying the securities auctioned at the prices and quantities specified in their bids. This does not guarantee, however, that these institutions have won the auction. The treasury determines the amount of securities to be auctioned at the final phase and releases such information along with the corresponding cutoff price observed in the first stage, acting as a price reference for the second stage. A discriminatory price auction with the participation of all financial institutions is then conducted. This auction procedure plays an important role in reducing the uncertainty regarding the pricing of fixed-rate long-term bonds issued by the treasury, given that references in the Brazilian market for these bonds are still incipient.
Measures undertaken for the development of the government securities market have been favorable. The noticeable improvements in the term structure of interest rates and the establishment of fungibility for floating-rate and inflation-indexed securities have contributed to stimulating negotiations in the secondary market. As a consequence of this latter measure, a reduction was observed in the number of outstanding series of floating-rate (LFT) and fixed-rate (LTN) securities, illustrated in Table II.1.1.
|Floating-rate securities (LFT)a||Fixed-rate securities (LTN)||Inflation-linked securities (NTN-C)||Total|
Only for LFTs issued through auctions.
As of December 1999.
Only for LFTs issued through auctions.
As of December 1999.
The interest rate and inflation-indexed term structures have improved as a consequence of the treasury’s strategy of building benchmark issues of long-term instruments. At the present time, there are parameters for price index curves up to 30 years, whereas price references for fixed-rate instruments reach 18 months.
As part of the recent actions toward the development of the market for government securities, in January 2002, the Treasury began conducting sales of public debt instruments through the Internet. With low minimum and maximum buying limits (approximately US$80 per transaction and US$80,000 per month, respectively), this measure is mainly directed to small investors and tries to stimulate long-term domestic savings.
As shown in Table II.1.2, the amount issued through the Internet as of July 2002 was around US$11 million, of which 77 percent were fixed-rate securities. The number of investors totaled more than 4,000, from 24 of 27 Brazilian states.
|Total amount sold||32,502,739||10,834,246|
|Price index (%)||15|
|Total number of investors||4,481|
|Average amount per investor||7,254||2,418|Figure II.1.9.Yield Curve—NTN-C Figure II.1.10.Yield Curve—LTN
As of December 31, 2001.
The case study was prepared by the Debt Management Unit/Secad III of the Brazilian National Treasury.
For debt management purposes, the national treasury considers the contingent liabilities that have not yet materialized and for which there is a legal or contractual obligation or both, such as government guarantees on foreign exchange borrowings and government programs, among others.
In anticipation of this measure, the CBB stopped issuing its own securities in October 2001.
Debt limits were established by the FRL and are currently being discussed by parliament and the executive branch. The treasury secretary will regularly report to parliament on these limits.
These limits are based on the relation between the debt outstanding and net current revenue.
Besides issuing securities through auctions, the Brazilian Treasury is sometimes required by law to issue debt directly to specific creditors, mainly as a result of debt securitization.