Understanding Brazilian LTNs

Brazil - History, Economics and LTN Overview.

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Brazil inhabited since 9,000 BC in the Amazon regions, is rich in culture from the indigenous peoples and the Europeans. Brazil experienced explosions in slavery, sugar, gold, agriculture, coffee and leaderships from rulers to dictators and now to a stabilized democracy.

A brief ofverview of Brazilian political history, from the military-political coup in 1964 through Fernando Henrique Cardoso's second presidential term and through the transformation culminatring via the Sarney administration circa 1985-1990.

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Brazil has experienced many economic crises, debt rescheduling, hyperinflation and in the past its dependence on commodity exports proved a major vulnerability. However, since the launch of the Plano Real in 1994, Brazil's macroeconomic environment has become increasingly stable.

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The modern Real originally pegged to the US Dollar was introduced in July 1994 as part of a plan to stabilize the Brazilian economy, known as the Plano Real. The Real replaced the "third" Cruzeiro which was used from 1990 - 1993 which also replaced the Second Cruzeiro (Cruzeiro Novo), 1970-1986.

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Brazil's Bond market was incipient until the mid 60's. With formation of Central Bank in 1965 and new indexed ORTN and later fixed rate LTNs, the market rapidly grew. Today LFT's are by far the most widely used instruments, followed by LTN's, and two kinds of inflation indexed NTN's.

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Brazil is the 5th largest country and the 7th largest economy, a population of nearly 200 million, having a GDP of $1.868 trillion in FY 2019 and it shipped $202 billion worth of goods around the globe, up by 21.1% since 2009. The top 5 trading partners are China, US, Argentina, Netherlands and Germany.

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Brazil LTN

  • Zero Coupon, Fixed Rate

The post-1964 reforms and other policies of the military government, together with the state of the world economy, created conditions for very rapid growth between 1968 and 1973. Such growth was financed by running up the foreign debt. The expectation was that the combined effects of import substitution industrialization and export expansion eventually would bring about growing trade surpluses, allowing the service and repayment of the foreign debt. The economic problems were accompanied by political turbulence where by the mid 60's inflation was running at 30% per year and as a result, something needed to be done.

In 1965, Brazil's nascent financial system began from laws no 4,357 and no 4,595, the formation of Brazil Central Bank ("BCB") and National Monetary Council ("NMC") which set out to reshape standards for regulations, currency, new institutions, strengthening existing ones and by shaping Brazils markets for stocks, bonds and tax credit funds, all of which resemble what they are today.

Brazil Creates LTN

As a result of inflation and to protect investors from currency losses, the 1st Federal Public Instrument, no 4,357/64 and no 54,252/64 the ORTN ( later OTN ) was created as an inflation indexed Bond. At that time, inflation indexed securities were the only instruments to implement both monetary and debt policy. However, by the 1970's BCB needed to create new fixed rate instruments which were more suitable for monetary policy. Laws no 1,079 and CMN Resolution no 150 of 1970 were passed thus establishing Letra Tesouro Nacional ("LTN") National Treasury Bills for Monetary Policy. In 1970 LTNS were 5% of the total debt and by 1972 weekly LTN auctions were introduced allowing for market pricing of these securities and as a result LTNs rose to 33.6% of the debt. LTNs became critical short term instruments to fund the Government and to help bring inflation and monetary policy under control.

A Circuitous Path for Historic LTN

LTNs were originally issued as one-year notes and were to expire in 5 years after their original maturity date. Due to large number of LTNs in existence, and to formalize the LTN expiration, in 1987 those LTNs issued in the 1970's were formally declared to no longer exist via a new law Art. 3, of Decree-Law no. 11/25/1987. However, there were a very large number of LTNs in existence which were never redeemed and as a result new laws were enacted to revalue them and extend their maturity dates.

In 1995 under the terms of Art. 5, XXXIV, "b" Art. 37, Art. 70, Sole Paragraph, of the amended Constitution, in accordance with §§ 1 and 2, of Article 5 of the Constitution law No. 9,250, of 12/26/1995, those LTNs issued in the 1970's were granted terms for revaluation, monetary correction, interest in arrears, and adjustments for inflation. This resulted in the process we know today as "Repactuation". Moreover, this process now accounts for the "revalued" LTNs to be listed and accounted for in Brazil's Internal Public Debt obligations.

The process of Repactuation, Certification, issuance of Travel Authorizations, GRU Taxes are all Central Bank and Secretary of Tesouro Nacional fee based requisites for historic LTNs. The process of collecting taxes and fees for these instruments via the terms of Complementary Law No. 101, dated May 4, 2000 and No. 10,179, Of 06/02/2001, mandating Art. 5, XXXVI and §f 1, as well as Art.37, further mandate the Constitutional Guarantees and rights for the titleholders of such LTNs where they can be placed in the open markets.

LTN as Payment for Taxes

Today, according to Article 100 of the Constitution, with new wording by Constitutional Amendment No. 62, dated 9/12/009, and the new CPC, and with precedence, LTN's issued in the 1970's are fully enforceable for the Titleholder to use said LTN for the purposes of Federal Tax Payments, Debts Banking, Labor, Financial Recoveries Bankruptcy etc.

LTN Exchange / Redemption at Maturity

Under Brazilian Law, and as referenced in new LTN title documents, LTNs at maturity are exchangeable into a Financial Certificate of the Treasury a "CFT". Under Law 10,841 of February 18, 2004, conversion by MP No. 137 of 2003, set forth in Article 62 of the Federal Constitution, with wording given by Constitutional Amendment No 32, combined with Article 12 of Resolutions No. 1 of 2002-CN and  Article IV 10.179 of 2001 Securities may be exchanged. CFT's are Privatization Currencies and can, via the privatization exchange process, be subsequently exchanged for cash, all of which provides the lawful mature LTN value.

CFT's ( Certificado Financeiro do Tesouro ) are issues in multiple series from A though H, and sub series 1 through 5 all of which are different categories of interest and indexes and are fully described in Articles 9 through 18 of Decree No. 9,292, of February 23, 2018 of the Constitution. CFT's are created by the Finance Minister and are considered "Privatization Currencies." Privatization currencies are certain Brazilian debt securities which may be used as payment for acquiring the stock of public companies in the privatization process, where Brazil is converting state owned companies to publicly held companies.

One of the key elements of the recent administrations' economic policy has been the extensive transfer of state-owned companies to the private sector. Through law 8031/90, Congress entrusted the sale process to the federal development bank (BNDES); the initial sale of more than twenty state-owned industries, mainly in the steel, petrochemical and fertilizer industries, was authorized. Since May 1997, financial institution privatization processes have been conducted by the Central Bank and authorized by the National Monetary Council. In 1991, the privatization of a major steel manufacturer (Usiminas) was successfully completed. This initial success was regarded as a significant step forward in the privatization process and it enabled the government to privatize other state-owned companies.

From the government's perspective, the purpose of the privatization process is to avoid the use of scarce government resources to fund industries which can be successfully run by private enterprise, as well as eliminate significant volumes of foreign and public debt. For this reason, investors may use Brazilian government debt instruments ( CFT's ) to invest in the privatization of state companies (these instruments trade at a discount in the market, but generally have parity with cash at privatization auctions).

Negotiable instruments available for privatization auctions include Brazilian foreign debt instruments (DCB's) and certain public debt instruments, including Siderbras debentures and rural debt instruments (TDA's). All public debt instruments usually have parity with cash in the auction process, while DCB's are valued at 75% of face value.

Why is this important? Each newly repactuated LTN carries the language of exchange and redemption at maturity into a CFT. This means, repactuated LTNs are listed in Brazil's Federal Public Debt Obligations and are exchangeable into a Privatization Currency and subsequently cash. This creates LTN exit value for which investors (Sovereign, Pension, Hedge, Institutions and Bond Funds) want to institutionally buy via Delivery Vs. Payment.

Brazil LTNs are Legal Federal Debt Instruments

Demonstrably, via the laws of 1970, 1991, 1995, 1997, 2000, 2001, 2002, 2003, 2004, 2009 and 2018 as evidenced herein, LTNs of the 70's and through today are successful legal Federal Debt Instruments with a caveat. Those which stem from the 70's must undergo "GRU" taxation, and be revalued by the Tesouro Nacional. LTNs of the 70's are exchangeble at Maturity and thus can be artfully exchange listed for high value institutional Devlivery Vs. Payment / T2S purchases. Current issue LTNs are traded domestically via B3 Brazil Bolsa Balcao and internationally via the Deutsche Borse and Euroclear.

To learn more about monetization of LTNs, click the button below.

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