Circular No. 05/EMO/2021, of August 4 - Calculation Formulas for Exchange and Forward Interest Rates for Over-the-Counter (OTC) Financial Derivatives Not Cleared by a Central Counterparty

___ Bank of Mozambique ___

Administration

MONETARY STABILITY DEPARTMENT CIRCULAR NO. 05/EMO/2021

Maputo, August 4, 2021

SUBJECT: CALCULATION FORMULAS FOR EXCHANGE AND FORWARD INTEREST RATES FOR OVER-THE-COUNTER (OTC) FINANCIAL DERIVATIVES NOT CLEARED BY A CENTRAL COUNTERPARTY.

Given the need to review and align the regime concerning the calculation formulas for exchange and forward interest rates in OTC (Over-the-counter) derivative transactions, FX Forward and FX Swap (Currency swap), and Forward Rate Agreement (FRA), the Bank of Mozambique, pursuant to paragraph 3 of Article 8 of the Regulation on Over-the-Counter Financial Derivatives Not Cleared by a Central Counterparty, approved by Notice No. 1/GBM/2021 of March 16, hereby determines:

A. On the calculation of the exchange rate for FX Forward and FX Swap

1. The forward exchange rate for OTC derivatives FX Forward and FX Swap (Currency swap) shall be determined based on the following formula: i. $fwd = spot \times e^{(\frac{i_a}{B_a} - \frac{i_b}{B_b}) \times \text{no. of days}}$ ii. forward points or swap = $fwd - spot$

Where: fwd: forward exchange rate. spot: spot buy or sell exchange rate (average spot buy and sell exchange rate, when calculating the forward exchange rate for FX Swap). ia: interest rate of the second currency in the pair.

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ib: interest rate of the first currency in the pair. Ba: annual basis of the second currency in the pair. Bb: annual basis of the first currency in the pair. no. of days: number of days (term).

2. The spot exchange rate, to be used as the basis for calculating the forward exchange rate for FX Forward, must match the buy or sell exchange rate quoted in the foreign exchange market by the financial counterparty for spot transactions, at the time the FX Forward transaction is negotiated.

3. The spot exchange rate, which must be used as the basis for calculating the forward exchange rate for FX Swap (Currency Swap), shall result from the simple average of the buy and sell exchange rates quoted by the financial counterparty.

4. The interest rates for the external currencies used in FX Forward and FX Swap transactions (ib and ia) must, at a minimum, have a regularly calculated series and be subject to public disclosure by international financial information providers.

5. For the purpose of defining the Metical interest rate, the financial counterparty must observe the single index, and may add a risk premium that is null, negative, or positive, provided it does not exceed the standardized spread of the financial counterparty for short-term corporate loans, published by the Mozambican Banks Association (AMB), under the Agreement for the Harmonization of the Calculation Base (Index) of the Interest Rate in the Banking System for the month of the transaction's contracting.

B. On the calculation of the Cross-currency Swap (fixed to fixed)

6. At the inception of the contract, the notional value of the base currency is exchanged for the equivalent value of the quoted currency, calculated based on the spot exchange rate.

7. On the settlement date of the Cross-currency Swap, the reverse operation is performed based on the initial spot exchange rate, with no interest payment due.

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8. Periodic interest payments follow the periods to be defined by the parties.

9. The interest rates to be used for calculating periodic interest must be fixed during the contract's validity period, have a regularly calculated series, and be subject to public disclosure by international financial information providers.

10. The interest rates for external currencies to be used for calculating periodic interest must comply with the provisions of paragraph 4 of this Circular.

11. The Metical interest rate to be used for calculating periodic interest must comply with the provisions of paragraph 5 of this Circular.

12. Periodic interest shall be calculated using the following formula: iii. $JP = \frac{(VN \times \text{no. of days} \times i_{\text{periodic}})}{\text{annual basis}}$

Where: JP: periodic interest; VN: notional value; no. of days: number of days (term); iperiodic: periodic interest rate agreed upon by the parties (fixed); annual basis: annual basis according to the currency convention.

13. There is no settlement of the monthly installment by difference, as payments are denominated in different currencies.

C. On the calculation of the interest rate for the Forward Rate Agreement (FRA)

14. The FRA may be calculated in any currency with legal tender status in Mozambique, including the quoted currency.

15. The calculation of the FRA interest rate shall be performed using the following formula: $fwd - fwd \text{ rate} = \left( \frac{1 + i_{\text{long period}} \times \text{no. of days}{\text{long period}} / \text{annual basis}}{1 + i{\text{short period}} \times \text{no. of days}{\text{short period}} / \text{annual basis}} - 1 \right) \times \frac{\text{annual basis}}{\text{no. of days}{\text{forward-forward period}}}$

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Where: fwd - fwd rate: FRA interest rate. no. of days: FRA period. iperiod long: interest rate (i) for the period between the FRA contracting date and its maturity. iperiod short: interest rate (i) for the period between the FRA contracting date and its start.

no. of days short period: period between the FRA contracting date and its start. no. of days long period: period between the FRA contracting date and its maturity. no. of days forward-forward period: period between the FRA start and its maturity. no. of days long period - no. of days short period = no. of days forward-forward period annual basis: number of days in the year, according to the convention used.

16. The interest rates in the above formula correspond to the currency of the notional value used for the transaction.

17. For the purpose of defining external currency interest rates, the financial counterparty must comply with the provisions of paragraph 4 of this Circular.

18. For the purpose of defining the Metical interest rate (i), the provisions of paragraph 5 of this Circular must be observed.

19. The calculation of the FRA settlement amount shall be performed two business days before the FRA start date, and its settlement shall be made by difference on the FRA start date.

20. The FRA settlement amount shall be calculated based on the following formula: $\text{FRA settlement amount} = \frac{(\text{FRA interest rate} - \text{settlement interest rate}) \times VN \times \text{no. of days} / \text{annual basis}}{(1 + \text{settlement interest rate} \times \text{no. of days} / \text{annual basis})}$

Where: FRA interest rate: interest rate of the FRA contract.

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settlement interest rate: interest rate in effect in the market on the date of calculating the FRA settlement amount, which corresponds to the interest rate charged by the financial counterparty. VN: notional value of the FRA contract.

no. of days: FRA period. annual basis: number of days in the year, according to the convention used.

D. Final Provisions

21. Any doubts arising from the interpretation and application of this Circular shall be clarified by the Markets and Reserve Management Department of the Bank of Mozambique.

22. Circular No. 02/EMO/2021 of April 15 is hereby repealed.

23. The rates applied to transactions executed prior to the entry into force of this Circular are hereby safeguarded.

24. This Circular enters into force on August 5, 2021.

BANK OF MOZAMBIQUE Monetary Stability Department Silvina de Abreu Administrator