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PUBLIC DEBT REPORT6

MINISTERO DELL’ECONOMIA E DELLE FINANZE III

CONTENTS

I. DEBT MANAGEMENT OBJECTIVES FOR 2016 1

I.1 Treasury's objectives and International Debt Management practice 1

I.2 The institutional framework 4

I.3 Containing debt cost while paying attention to cost/risk profile 7

I.4 Monitoring and managing the cash account to stabilise the balance 16

II. TREND OF ITALIAN GOVERNMENT SECURITIES MARKET IN THE

INTERNATIONAL FRAMEWOK 19

II.1 Monetary policy and the euro area money market 19

II.2 Euro area bond markets 21

II.3 Trends in the Italian government bond market 25

III. PUBLIC FINANCE 43

III.1 Trend of the central government's borrowing requirement 43

III.2 Redemptions, issues and funding of the central government borrowing

requirement 44

III.3 Public sector borrowing requirement 45

III.4 General government debt and debt-to-GDP ratio 50

III.5 Net borrowing 52

IV. PUBLIC DEBT MANAGEMENT IN 2016 53

IV.1 Government bond transactions on domestic and foreign markets 53

IV.2 Management of the derivatives Portfolio 73

IV.3 Results of debt issuance and debt management activity in relation to the

objectives 76

IV.4 Treasury's cash management 89

APPENDIX 97

Organisational Structure of Public Debt Directorate at the

Treasury Department 97

2016 PUBLIC DEBT REPOTR

IV MINISTERO DELL’ECONOMIA E DELLE FINANZE

TABLES

Table I.1: Domestic government securities

Table III.1 Central government - consolidated cash account (in euro million)

Table III.2: Issues, redemptions and funding of central government borrowing

requirement (in euro million)

Table III.3: Public sector – consolidated cash account (in euro million)

Table III.4: Main general government aggregates (in euro million)

Table IV.1: Summary of 2016 debt exchange transactions (nominal amounts in euro

million)

Table IV.2: Redemptions made at maturity via the Sinking Fund in 2016 (nominal

amounts in euro million)

Table IV.3: Private placements under the MTN program

Table IV.4.a: Composition of 2014-2016 issues in absolute and percentage terms net

of debt exchanges (in euro million)

Table IV.4.b: Composition of 2014-2016 issues in absolute and percentage terms

gross of debt exchanges (in euro million)

Table IV.5: Average life of stock of government securities (in years)

Table IV.6: Duration and ARP trend in the years 2014-2016 for the stock of

government bonds, pre-derivatives (in years)

Table IV.7: Duration and ARP trends in the years 2014-2016 for government bonds,

post-derivatives (in years)

Table IV.8: market performance OF stocks of government bonds (amounts in euro

million)

Table IV.9: Derivative instruments Portfolio years 2015 and 2016 (in euro million)

Table IV.10: Month-end cash account balances and placement of liquidity – year

2016 (in euro million)

CONTENTS

MINISTERO DELL’ECONOMIA E DELLE FINANZE V

CHARTS

Chart I.1: Maturity of medium-long term securities outstanding as at 31-12-2015

(in euro million)

Chart I.2: Monthly profile of maturities – medium-long term securities for 2016-

2017 outstanding as at 31-12-2015 (in euro million)

Chart I.3: Issuance portfolios analysed for 2016

Chart II.1: Interest rate corridor of the ECB monetary policy 2014-16 (percentage

values)

Chart II.2: Performance of the main money market rates in 2016 (percentage

values)

Chart II.3: Trend of European government bond yields - 10-year maturity

(percentage values)

Chart II.4: Market rates on government bonds– 2-3-5-10-15-30-50 years

(percentage values)

Chart II.5: Yield spread between 10-year and 2-year bonds (basis points)

Chart II.6: Yield differential between 30-year and 10-year maturity bonds (basis

points)

Chart II.7: BTP-Bund, OAT-Bund and Bonos-Bund spread - 10-year benchmark

(basis points)

Chart II.8: Monthly trading volumes on the MTS platform (in euro million)

Chart II.9: Quarterly traded volumes on the MTS platform, by segment (in euro

million)

Chart II.10: Monthly trading volumes on the MTS platform by maturity (in euro

million)

Chart II.11.a: Bid/ask spread in basis points on 10, 15,20, 30 and 50 year benchmark

BTPs, recorded on the MTS platform

Chart II.11.b: Bid/ask spread in basis points on benchmark 3, 5 and 7 YEAR CTZ,

CCTeu, BTP, recorded on the MTS platform

Chart II.11.c: Bid/ask spread in basis points on benchmark 5 and 10 year BTP€i, as

recorded on the MTS platform

Chart II.11.d: Daily slope on benchmark 10-year BTPs (logarithmic scale) as recorded

on the MTS platform data

Chart II.12: Monthly trading volumes by contract deadline on the MTS platform (in

euro million)

Chart II.13: Yearly volumes traded by Specialists on the MTS platform (percentage

rate)

Chart II.14: Monthly volumes traded by Specialists on platforms other than MTS (in

euro million)

Chart II.15: Quarterly volumes traded by Specialists by type of counterparty (in euro

million)- fund managers, banks, pension and insurance funds, hedge

funds

Chart II.16: Quarterly volumes traded by Specialists by geographic location of the

counterparty (in euro million)


VI MINISTERO DELL’ECONOMIA E DELLE FINANZE

Chart II.17: Price development of BTP futures and performance of the benchmark

BTPs with 10-year maturity (right-hand reversed scale in percentage

rate).

Chart II.18: Volumes and open interest of BTP futures contracts traded on ten-year

maturity on the EUREX exchange (number of batches and open

contracts)

Chart II.19: Developments in the price of Credit Default Swaps on Italian debt ($) at

5-year maturity and of the 5-year BTP-Bund spread (in basis points)

Chart III.1: Change in Debt/GDP ratio in the period 2005-2016

Chart IV.1: The yield curve of government bonds 2015-2016 (percentage rates)

Chart IV.2: Average rates at auction of 6 and 12 months BOTs - 2011-16

(percentage rates)

Chart IV.3: Yields at issuance of 6-month bots versus Euribor 6 month rate - 2015-

16 (percentage rates)

Chart IV.4: Yields on CTZs at issuance - 2016 (percentages)

Chart IV.5: BTP 1 March 2047 - distribution by type of investor

Chart IV.6: BTP 1 March 2047 - geographic distribution

Chart IV.7: BTP 1 September 2036 - distribution by type of investor

Chart IV.8: BTP 1 September 2036 - geographic distribution

Chart IV.9: BTP 1 March 2067 - distribution by type of investor

Chart IV.10: BTP 1 March 2067 - geographical distribution

Chart IV.11: Yields at auction for BTPs maturing between 3 and 10 years - 2016

(percentage values)

Chart IV.12: Yields at auction for long term BTPs - 2016 (percentage values)

Chart IV.13: Actual yields on BTP€is at auction - 2016 (percentage values)

Chart IV.14: BTP€i 15 May 2022 - distribution by type of investor

Chart IV.15: BTP€i 15 May 2022 - geographical distribution

Chart IV.16: Composition by type of investor of orders placed at auctions of

conventional BTPs by Specialists in government bonds - 2015-2016

Chart IV.17: Composition by geographic provenance of orders placed at auctions of

conventional BTPs by Specialists in government bonds

Chart IV.18: Amount repurchased in buybacks - 2012-16 (nominal amounts in euro

million)

Chart IV.19: Composition of the stock of government securities at 31 December 2015

and at 31 December 2016

Chart IV.20: Structure of stock of domestic government securities 1999-2016

Chart IV.21: Maturities for residual life classes 2014-2016

Chart IV.22: Euro swap rates and Italian government bond curves

Chart IV.23: Expected changes in notional amount of the derivatives portfolio if

swaptions are exercised (in euro million)

Chart IV.24: Structure by maturity of the derivatives portfolio if the swaptions are

exercised (in euro million)

Chart IV.25: Weighted average cost at issuance of government securities – 2005-

2016

CONTENTS

MINISTERO DELL’ECONOMIA E DELLE FINANZE VII

Chart IV.26: Average cost of pre- and post-derivatives government bonds stock -

2005-2016

Chart IV.27: Average intra-monthly variations in treasury liquidity: deviations from the

monthly low - 2016 (in euro million)

Chart IV.28: Difference between the monthly maximum and minimum treasury cash

balance - 2015-16 (in euro million)

Chart IV.29: Average use at daily OPTES auctions (in euro million)

Chart IV.30: Overnight rates on the monetary market and at OPTES auctions 2014-16

(percentage rates)

Chart IV.31: Average use at daily OPTES auctions - 2013-16 (in euro million)

Chart IV.32: Average cash distribution by type of placement – year 2016 (in euro

million and percentage rates)

Appendix: Organisation of the Public Debt Directorate


VIII MINISTERO DELL’ECONOMIA E DELLE FINANZE

MINISTERO DELL’ECONOMIA E DELLE FINANZE 1

I. DEBT MANAGEMENT OBJECTIVES FOR 2016

I.1 TREASURY'S OBJECTIVES AND INTERNATIONAL DEBT MANAGEMENT PRACTICE

Debt management objectives and risks in the international practice

As already mentioned in previous editions of this report, Treasury's public

debt management is in line with best international practices, therefore fully

matching main multilateral financial institutions recommendations and practices

followed by Debt Management Offices (DMOs) managing national debt in advanced

countries.

The international best practices have developed over time, thanks to sharing

and analysis of experiences in wholly different economic and legal contexts; they

are based upon unanimous recognition of an inverse relationship between debt

cost and risk (both refinancing and interest rate risk) and define goals based on

the need to minimise costs subject to maintaining risk levels that - in a medium to

long term view1 - may be considered acceptable.

Indeed, public finances require the highest degree of predictability and

perspectives certainty about budget items, in order to limit the risk of having to

suddenly resort to significant fiscal measures to cope with unforeseen expenses (in

practice, the bigger the size and the more sudden the need, the less likely it

would be that such a fiscal effort would be a realistic option). For this reason,

international best practices, despite awareness of generally heavier burden of

long-term debt at fixed rates, consider debt structures excessively relying on

shorter maturities or floating rate as a substantial factor in increasing a country's

vulnerability2, since – notably at a time of declining interest rates - it may seem

(apparently) desirable to reduce debt servicing cost (and therefore deficit) in the

short term, but this implies a substantial increase in market risks inherent in debt

portfolio and therefore in public finances.

Under the normally prevailing financial markets conditions, and irrespective

of the creditworthiness of the particular issuer, debt cost is higher for longer

maturities. In fact, therefore, pursuing the goals to reduce debt cost and, at the

same time, contain market risks entails DMOs to make a trade-off, by selecting

1 The International Monetary Fund and the World Bank guidelines, published in 2001 and updated in 2014

and 2015, state (page 8 of the Revised Guidelines for Public Debt Management, 2015): "The main objective of public debt management is to ensure that government funding needs and its payment obligations are met at the lower possible cost over the medium to long term, consistent with a prudent degree of risk” and “Governments should try to minimise expected debt servicing costs ... subject to an acceptable level of risk, over a medium- to long-term horizon."

2 Summary considerations on this subject can be found in the Guide to the Debt Management Performance Assessment (DeMPA) Tool, World Bank 2009.

2016 PUBLIC DEBT REPORT

2 MINISTERO DELL’ECONOMIA E DELLE FINANZE

among available alternatives a cost/risk combination deemed satisfactory3 with

regard to portfolio’s features and overall strategies. This trade-off is defined by

DMOs of all countries according to distinguishing features of their portfolio and of

markets they are dealing with; in Italy, as will be seen later, orientation has been

of a particularly prudential nature.

Of course, the task of pursuing the containment of debt cost subject to an

acceptable level of underlying risk – a task which international best practices

assign to DMOs - is not limited to the issuance time and prevailing market

conditions at that time, but involves an ongoing action even after issuance, taking

in account market developments.

Main types of risk faced by DMOs are typical market risks and include interest

and exchange rate risks, refinancing, liquidity, credit and operational risks.

As it can be seen, the various risks summarised above mostly point, albeit in

different ways, to a concern that a sudden rise in debt cost could make it

unsustainable.

Thus, exposure of a public debt portfolio to the above-mentioned risks

depends on the composition of the portfolio itself, notably on the share of short-

term vs mid-long-term, fixed-rate vs floating-rate as well domestic- vs foreign-

currency denominated debt. Further pivotal elements to be taken into account

when assessing the above-mentioned risks are availability and support of a broad,

deep and liquid market for the placement and trading of government bonds.

The Treasury and International Forums on Debt Management

As already stated, international best practices have been informed by an

ongoing sharing of experience among DMOs and other involved stakeholders or

institutions. Identifying and calibrating Treasury’s objectives benefits from

constant international coordination with relevant foreign and supranational

institutions, as well as from regular exchanges with international institutional

investors and rating agencies.

In particular, steady relations with European DMOs are assured through the

relevant Sub-Committee (European Sovereign Debt Markets – ESDM) of the EU

Economic and Financial Committee, which is a consultative body to the EU

Commission and the EU Council, having the task to define coordination actions of

Member States' economic and financial policies. In addition, regular attendance of

working groups of supranational institutions such as OECD, IMF and World Bank is

ensured. Treasury also participates in the OECD Working Party on Public Debt

Management, which is a stable forum for the comparison of public debt

management policies and techniques among Organisation’s member countries, as

well as in the Government Borrowers’ Forum annually organised by the World

Bank to share actual experiences among the approximately 40 participating

countries. An implicit recognition of Treasury's standing in government debt

3 On this point, the International Monetary Fund and the World Bank guidelines observe that (page 8)

"Minimizing cost, while ignoring risk, should not be an objective. Transactions that appear to lower debt servicing costs often embody significant risks for the government and can limit its ability to repay lenders. Managing cost and risk therefore involves a trade-off."



management is provided by the Public Debt Management Network4, a joint

initiative promoted by OECD, World Bank and Treasury Department (as the only

State institution alongside the two multilateral ones) which aims to share

knowledge and information about public debt management issues. Another key

institutional co-ordination opportunity is the participation in Eurostat statistical

working groups and the involvement in drafting half-yearly notifications under the

Excessive Deficit Procedure (EDP), notably about correct recording of items

directly related to public debt according to European national accounting

standards (ESA). The Public Debt Directorate's involvement in these activities is

not only a factor that strengthens awareness of the impacts - according to

European-level harmonised accounting - of debt management activity, but can in

turn influence debt management choices depending on the constraints and the

implications resulting from it, in addition to general considerations of a financial

nature and the effects on State finances.

The organisational model adopted by Treasury for debt management

Managing public debt is the responsibility of the Second Directorate at

Treasury Department, whose organisational structure is depicted in an attachment

to this Report, along with some brief notes illustrating activities carried out.

Widely matching the model generally adopted by DMOs in advanced countries,

identification and monitoring of objectives are carried out by staff involved in

Middle Office functions. These include: a) analyses, which can be used to identify

the cost/risk framework that will delimit operations and to choose the most

suitable issuance and hedging strategies; b) multi-annual forecasts on government

interest spending and debt levels to underlay planning documents and institutional

reporting5; c) monitoring of counterparty risk, which determines certain

constraints to be met in managing derivatives and for cash management6

purposes.

4 See www.publicdebtnet.org. 5 In particular, the Economic and Financial Document (DEF) provided for by Law no. 39 of 7 April 2011

(where the contribution of the Public Debt Management Directorate is included in Part One "Stability Program" and Part Two "Public Finance Analysis and Trends"), the DEF Update, the Budget Programming Document (DPB) established by EU Regulation no. 473/2013, the Appendix to the so-called Quarterly Cash Report (with Article 14 of Law 196/2009 referred to as the Report on the Consolidated Cash Account of the Public Administration), the Parliamentary Report on the Sinking Fund for government bonds (attached to the General National Accounting Report) pursuant to Article 44, Paragraph 3 of Presidential Decree 398/2003, and the half-yearly report to the Court of Auditors on the management of public debt, established by the Ministerial Decree of 10/11/1995.

6 Front Office activities relate to debt issuance through domestic and foreign programs, short-term cash management, debt exchange and buybacks as well as derivatives transactions. To these purposes, Front Office activities also include monitoring government bonds secondary market and the selection and assessment of Specialists in Government bonds.

Back Office's role entails the preparation of issuance decrees, any other borrowing-related documentation - such as prospectuses for international issues (Global Bond, Medium Term Note) and for other securities to be placed with methods other than auction - and completion of derivatives. The Back Office also carries out payment execution.

Other functions carried out by the Public Debt Management Directorate include activities that can be defined as communication tasks: real-time information on issuance activities; production of statistics about structure, dynamics and composition of government bonds and relevant market; production of statistics on debt monitoring and derivatives’ exposure of local entities. The Directorate also carries out any extraordinary transaction on local authorities debt, according to specific rules.

http://www.publicdebtnet.org/



I.2 THE INSTITUTIONAL FRAMEWORK

Broad definition of public debt encompasses consolidated gross liabilities of

all public administrations (Central Government, Local Authorities and public Social

Security institutions), while a narrower concept coincides with the amount of

outstanding government bonds, thus concerning only securities issued by the

State, both on domestic and foreign markets.

This Report, as in previous years, refers to this second and narrower concept,

which is moreover the scope of dedicated legislation, i.e. the Consolidated Public

Debt Act7 (TUDP). As of 31 December 2016, government debt securities were

approximately 84% of total public debt.

Main features of outstanding government securities - maturity, interest rate

type, mode and frequency of issuance - are summarised in Table I.1.

TABLE I.1: DOMESTIC GOVERNMENT SECURITIES

BOT CTZ CCT/CCTeu BTP BTP€i BTP Italia

Treasury Bills

Zero-coupon

Treasury bonds

Treasury

Certificates Treasury Bonds

Treasury Bonds

Indexed to

European

Inflation

Treasury Bonds

Indexed to

Italian Inflation

Maturity

3, 6 & 12

months and

under 12

months

(flexible

BOTs)

24 months 5 & 7 years

3,5,7,10,15,

20, 30 & 50

years

5,10,15 & 30

years 4,6 & 8 years

Remuneration Issued at a

discount

Issued at a

discount

Semi-annual

floating coupons

indexed to the 6-

month BOT

auction rate or to

the 6-month

Euribor, possible

issue at a

discount

Semi-annual

fixed coupons,

possible issue

at a discount

Semi-annual

coupons indexed

to European

inflation (HICP

index, net of

tobacco

products),

possible issue at

a discount and

revaluation of

principal on

maturity.

Semi-annual

coupons

indexed to

Italian inflation

(FOI index, net

of tobacco

products),

semi-annual

revaluation of

principal and

loyalty bonus*

on maturity

Issuance

Method

Competitive

auction on

yield

Marginal

auction with

discretionary

determination

of price and

quantity issued

Marginal auction

with discretionary

determination of

price and quantity

issued

Marginal

auction** with

discretionary

determination

of price and

quantity issued

Marginal

auction** with

discretionary

determination of

price and

quantity issued

Through the

MOT (Borsa

Italiana’s

Electronic

Bond Market)

Issuance

Frequency Monthly Monthly Monthly

Monthly; based

on market

conditions for

15-, 20-, 30-and

50-year BTPs

Monthly One/two times

a year

*) For individual investors and other similar investors who buy the security at issuance during the first phase of the placement period. **) First tranches of new long-maturity BTPs (exceeding 10 years) or BTP€is may be offered on the market through a placement syndicate

7 Consolidated Text of the legislative and regulatory provisions on public debt (Decree of the President of

the Republic No.398 of 30 December 2003).



Public debt management activity, as precisely regards tradable government

securities, was carried out in accordance with the 2016 provisions of the Minister's

policy statement (“Atto di indirizzo”), the General Directive on administration

and management of Ministry of the Economy and Finance (MEF) and the Ministerial

Decree (the so-called "Framework Decree8") which set the benchmarks for

administrative activities concerning financial transactions related to public debt

management. Contents of these provisions were then translated into operational

goals in the "Public Debt Management Guidelines" (hereinafter "the Guidelines9").

Also for 2016 - as was clearly set out in the first "Public Debt Report" referring

to 2014 - the Minister’s policy statement included amongst political priorities the

continuation of "... the commitment to manage public debt with the aim of

containing its cost and stabilising or lengthening average maturity". The General

Directive translated this policy priority into the two strategic objectives of

limiting debt cost, while paying particular attention to its cost/risk profile, and

monitoring and managing the Cash Account10, all with the goal of stabilising the

overall balance.

The 2016 Framework Decree, as in previous years, provided more details

about operational tools the Public Debt Directorate has been authorised to use to

achieve its goals. In particular, Article 2 provides for the issuance of debt "in

compliance with the annual limit established by the Law approving the national

Budget", being sufficient to fund securities maturing in the year and Central

Government’s borrowing requirement, taking care to "... reconcile the need to

meet markets requirements with that of reducing the overall cost of debt in a

medium- to long-term perspective, considering the need to protect against

refinancing risk and exposure to interest rate changes".

To this end, in the same article specific percentage quotas were defined for

debt composition to be reached at the end of 2016, as follows:

BOT (short-term securities) between 3% and 8% (down from the 5% to 15%

range set for previous year);

BTP (“conventional” fixed-rate securities) between 55% and 75% (unchanged

from the range set for previous year);

CCT/CCTeu (“conventional” floating-rate securities) between 5% and 10%

(unchanged from the range set for previous year);

CTZ not more than 5% (slightly lower than the limit of 6% set for previous

year);

BTP€i and BTP Italia (“linkers” securities) not more than 15% (slightly lower

than the limit of 17% set for previous year).

Furthermore, it was stipulated that the stock of securities issued on foreign

markets would not exceed 5% of total outstanding securities by the end of 2016.

In order to pursue "containment of the overall cost of debt, protection

against market and refinancing risks and the proper functioning of government

8 Decree of 23 December 2015 published in the Official Gazette no. 1 of 2 January 2016. 9 Dublic Debt Guidelines are published on the MEF / Treasury Department's website at

http://www.dt.mef.gov.it/en/debito_pubblico/presentazioni_studi_relazioni/dettaglio.html?resourceType=/modules/debito_pubblico/presentazioni_studi_relazioni/elem_0007.html

10 Information on the nature of the Cash Account and the context of related operations is provided in Section I.IV below.



securities secondary market ", Article 3 authorised, as in previous years, the use

of debt restructuring on a consensual basis, i.e. buybacks, debt exchanges or early

redemption of securities, as well as derivative transactions.

Lastly, Article 6 of the Framework Decree stated that Cash Account

management aims "to efficiently move liquidity, in relation to government bonds

issuance strategy, prevailing market conditions and monetary policy constraints ".

The same Article refers back to the Ministerial Decree of 25 October 2011, which

regulates movement of Treasury liquidity and selection of transactions’

counterparties.

To sum up, the objectives set by the Framework Decree for managing public

debt in terms of "desired" composition by the end of 2016 were intended to favour

medium- to long-term maturities and to reduce short-term ones, in line11 with

international best practices. The aim was to continue to reduce both interest rate

and refinancing risk, resulting in a further rise in average life of government bonds

compared to what had been already achieved in 201512, even though lower volume

of maturities in 2016 compared to the previous year made this a particularly

ambitious goal. In the Guidelines for 2016, therefore, in full compliance with the

above-mentioned measures, Treasury has specifically committed to:

1. Increase average life of government bonds stock, subject to market

conditions;

2. Reduce volumes of offered BOTs, when compatible with market needs;

3. Favour medium- to long-term maturities for Eurozone inflation-indexed issues,

while for BTP Italia the objective was to restore two placements, mainly

aiming at offering retail investors the opportunity to reinvest cash stemming

from securities maturing within the year;

4. Favour a 7-year maturity for the CCTeu;

5. For nominal BTPs, reduce the overall proportion of annual issuance of 3- and

5-year maturities, keeping issues of 7- and 10-year maturities to volumes in

line with those of 2015 while achieving - for even longer maturities - volumes

in line with the overall objective, following a careful analysis of final

demand’s depth and quality;

6. Carry out a significant volume of debt exchanges and buybacks, mainly aiming

to manage maturity profile scheduled in coming years (mostly 2017); buybacks

were also intended to facilitate debt stabilisation and reduction, in line with

public finance planned commitments;

7. As for derivatives, any active management of the existing transactions

portfolio was only envisaged should market solutions and market conditions

had emerged to improve its performance, while new transactions were

exclusively limited to hedge foreign currency liabilities for any not euro-

denominated security, subject to a bilateral guarantee system.

During 2016, as in previous years, the Public Debt Directorate was therefore

called upon to ensure that management of debt, including the issues needed to

cover maturing securities and Central Government borrowing requirements, would

be such as to contain the cost of debt, considering the main categories of risk to

11 Cf. I.1 above 12 In 2015, the average life of the stock of Government bonds went from 6.38 to 6.52 years.



be kept under control, while at the same time helping to ensure adequate

stability and predictability in the overall balance of the Cash Account.

I.3 CONTAINING DEBT COST WHILE PAYING ATTENTION TO COST/RISK PROFILE

The cost/risk trade-off: specific features of the Italian case

In the case of Italy, the management of the above mentioned cost/risk trade-

off is underpinned by a previous analysis of various available debt issuance

strategies, at first calculating their relevant cost in terms of debt servicing, which

in turn depends on the interest rates at which securities are placed on the

market. For each examined strategy, entailed risks are also assessed; since these

may take multiple forms, multiple risk measures are adopted13.

As was already reported in previous years' reports, debt management in Italy

has focused on two main risks: interest rate risk, in order to minimise the impact

on debt burden of market interest rate changes; and refinancing risk, with the aim

to allocate redemptions timetables more uniformly over time in order to facilitate

new issues, being on the market with issuance volumes suitable to its absorption

capacity and thus avoiding undesirable increases in financing costs.

In Italy this approach to debt management, in itself already aligned with

international practice, historically has had - and still nowadays has - to take into

account the huge size of debt, both in absolute figures and in relation to GDP,

thus necessarily leading to an even more prudent attitude towards risk, for two

kinds of reasons.

The first of these - as already set out in the previous edition of this Report - is

the fact that, as to Italy, a significant component of the level of interest rates at

issuance of government bonds is the credit risk premium required by investors to

fund a highly indebted entity14. This component is largely unrelated to economic

cycles, as opposed to countries with a lower debt and higher credit rating, where

interest rate movements on debt are far more consistent with the economic cycle,

making the management of interest rate risk less pivotal in relation to debt-to-

GDP ratio’s dynamics. In Italy, instead, the risk premium in the medium-term

tends to be negatively correlated with economic growth, precisely because of the

perception of debt sustainability. This is why it is necessary to strive for a debt

composition that is the least vulnerable, whenever possible, to market interest

rate fluctuations.

Secondly, given the high level of debt, it is more important for Italy than for

other countries to stabilise interest expenditure and make it more predictable, in

order to better manage public finances in accordance with EU requirements,

largely based upon deficit and debt dynamics control.

13 For details on cost and risk measures, see next paragraphs in this chapter. 14 Following the introduction of the single currency, perception and quantification of credit risk for high-

debt countries in the Euro area declined greatly; however, they reappeared after the 2007-2008 global financial crisis had started and moreover with the following sovereign debt crisis, after which credit spreads between high-debt countries and others have not yet returned to the same degree of convergence than before the crisis.



In both of the above respects, it is then paramount to Italy to place market

risks control (mainly interest rate and refinancing) at the very heart of its debt

management strategy.

Measuring refinancing risk and tools for its management

The benchmark indicator to quantify this risk is average life of government

bonds stock: an average of maturities of all outstanding securities is calculated,

weighted for each security’s face value15

. After a decline that started in 2011, by

the end of 2014 average time to maturity of Italian government bonds had almost

stabilised at 6.38 years, then starting to rise again to 6.52 in 2015.

In accordance with the above mentioned Policy Statement and the Ministerial

Directive, the objective of containing debt cost while also paying particular

attention to cost/risk profile has therefore been operationally defined, even in

2016 Guidelines, as the implementation of debt issuance and debt management

policies aiming to increase average time to maturity, if allowed by market

conditions.

At the same time, management of refinancing risk needed to be pursued

through a gradual reduction in volume of securities maturing in years of highest

concentration of repayments, aiming to smooth redemptions profile. In particular,

given the annual maturity profile at the end of 2015 (see Chart I.1), a need was

found to mainly reduce volumes maturing in 2017, by the means of reducing as far

as possible - and always taking market conditions into account - the issuing of

BOTs maturing in that year while also preferably focusing buybacks and debt

exchanges transactions on securities maturing in 2017.

15 Definition of “nominal value” used in this report is that adopted by EC Council Regulation No 479/2009 of

25 May 2009: “The nominal value of a liability outstanding at the end of the year is the face value. The nominal value of an index-linked liability corresponds to its face value adjusted by the index-related change in the value of the principal accrued to the end of the year. Liabilities denominated in the national currency and exchanged through contractual agreements to a foreign currency shall be converted into the foreign currency at the rate agreed on in those contracts and shall be converted into the national currency on the basis of the representative market exchange rate prevailing on the last working day of each year. Liabilities denominated in a foreign currency and converted through contractual agreements into the national currency at the rate agreed on in those contracts”.



CHART I.1: MATURITY OF MEDIUM-LONG TERM SECURITIES OUTSTANDING AS AT 31-12-2015 (in euro million)

In the short term, 2016 and 2017 monthly redemptions profile (Chart I.2)

made it clear that issuance policy needed to focus on managing April, August and

September 2016 and February, May, June, August and November 2017 timetables,

mainly by leveraging on volumes of BOTs to be issued, as well as through buybacks

and debt exchanges transactions. In addition, in 2016 the above-mentioned

instruments were also to aim at stabilising the balance of the Cash Account,

smoothing out as much as possible the short- and very short-term fluctuations in

Treasury cash availability.

CHART I.2: MONTHLY PROFILE OF MATURITIES – MEDIUM-LONG TERM SECURITIES FOR 2016-2017

OUTSTANDING AS AT 31-12-2015 (in euro million)

Interest rate risk measures and managing tools

Interest rate risk is mainly quantified by three measures, namely duration (or

financial duration), average refixing period (average time for the debt to

incorporate market interest rates changes), and Cost-at-Risk, which quantifies

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

220,0002016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

2035

2036

2037

2039

2040

2041

2042

2043

2044

2045

2046

2053-2

063

BTP BTP€i BTP Italia CCTeu CTZ Foreign

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

Jan-1

7

Feb-1

7

Mar-

17

Apr-

17

May-1

7

Jun-1

7

Jul-

17

Aug-1

7

Sep-1

7

Oct-

17

Nov-1

7

Dec-1

7

BTP BTP€i BTP Italia CCTeu CTZ Foreign



maximum additional cost of interest expenditure in case of adverse rates

scenarios, together with the probability of actually having to bear this additional

cost as a result of the likelihood of such adverse scenarios16.

The Framework Decree for 2016 (Article 2, Par. 2) once again explicitly refers

to the need to manage exposure to interest rate changes. Therefore, also for the

year 2016 the implementation of the goal of containing debt cost while also

considering cost-risk profile made it necessary to continue to increase debt’s

financial duration and average refixing period, subject to financial markets

conditions, taking into account outstanding derivative transactions.

Cost-at-Risk (CaR) analysis was used, by way of an internally-developed

model in use for some years now by the Public Debt Directorate, called SAPE17

(Software di Analisi dei Portafogli di Emissione - Issuance Portfolios Analysis

Software), to identify - with a predetermined degree of probability - an expected

cost level not to be exceeded, as well as all those mix of securities issuance whose

cost-risk combinations are located at an efficient frontier, that is to say they are

dominant - for a given level of cost or risk - compared to any other hypothetical

composition of the issuance portfolio.

In order to test features of hypothetical issuance portfolios, for each of them

an estimate was made, for a given future time period, of both cost (in terms of

interest expenses) and its Cost-at-Risk (calculated for different possible scenarios

of trend in interest rates and inflation). The outstanding debt database used by

SAPE at the end of 2015 included domestic securities, USD denominated securities

and derivatives. Given the constraints on both USD issues and derivatives over the

coming years, it was assumed that refinancing of maturities in future years would

only take place via domestic securities and that no any new derivative transaction

would be entered into for interest rate risk management purposes. This hypothesis

should not be viewed as opposed to the option of also considering possible issues

under foreign currency programs, since these can be placed subject to financial

conditions that are generally better than, or at least the equal of, those

obtainable with equivalent domestic instruments; so they make no substantial

difference in simulating future issues.

The role of issuance strategy in managing rate/cost risk trade-off in 2016

A debt portfolio featuring long-term principal repayment and stable interest

rates (hence with relatively high values of indicators such as average life, average

refixing period or financial duration) entails lower refinancing and interest rate

16 See Focus entitled “The main quantitative indicators of interest rate

risk”, in Public Debt Report 2014, p. 23, available at http://www.dt.tesoro.it/export/sites/sitodt/modules/documenti_en/debito_pubblico/presentazioni_studi_relazioni/Public_Debt_Report_2014.pdf.

17 The model used by the Treasury and the development of the relevant SAPE software were established thanks to a financing of the Ministry of Education’s 2003 Fund for Investment in Basic Research, disbursed to the Calculation Applications Institute (CAI) of the National Research Council (as leader of a Group that included other academic institutions, such as Bocconi University, University of Milan, and Tor Vergata University of Rome). Over the years, the model has gone through various stages of further development, which have been coordinated by the CAI itself and the Ministry of Economy and Finance, which, in recent years, also made use of the analytical and IT support of SOGEI. For further information about SAPE, see the relevant in-depth Focus in Public Debt Report 2014, p. 27, see above.

http://www.dt.tesoro.it/export/sites/sitodt/modules/documenti_en/debito_pubblico/presentazioni_studi_relazioni/Public_Debt_Report_2014.pdf

http://www.dt.tesoro.it/export/sites/sitodt/modules/documenti_en/debito_pubblico/presentazioni_studi_relazioni/Public_Debt_Report_2014.pdf



risks but, at the same time, higher costs because of the higher rates usually

associated with longer maturities. In order to evaluate available alternatives in

view of the above considerations, in late 2015 and early 2016 the Public Debt

Directorate tested, as now usual practice, several domestic debt issuance

portfolios, judged as suitable to market conditions and key features of Italian

public debt management. These portfolios were selected for their feasibility, also

taking into account market analyses produced by financial research centres,

banks, Central Banks and other financial institutions.

As a prerequisite, all the portfolios had to allow to finance:

a) medium/long-term securities maturing in 2016 (equivalent to just over € 181

billion),

b) outstanding BOTs (amounting to just over € 115 billion), along with the so-

called roll-over of BOTs during the year, i.e. the BOTs issues needed to fund

BOTs 2016 redemption of BOTs issued in the same year,

c) the Central Government's 2016 net borrowing (then estimated at around € 40

billion18),

as well as securing availability of adequate Treasury liquidity to meet all cash

management needs. Features of the nine portfolios analysed are summarised

below:

CHART I.3: ISSUANCE PORTFOLIOS ANALYSED FOR 2016

2015 Portfolio: composition of domestic issues adopted in 2015;

Portfolio B: compared to the 2015 Portfolio, it shows a slight reduction in

CTZ and 3-5 year BTP segments, a moderate increase in 7-10 year BTP and 15-30

year BTP segments, a share of inflation-indexed securities to slightly rise on longer

maturities, a significant drop in BTP Italia and a minimal reduction in CCTeu; with

this portfolio, keeping the same volume of BOTs issues, the focus has slightly

shifted towards issuance of longer maturities both in conventional and linkers

segments, with a simultaneous increase in BTP Italia - considering the new 8-year

maturity - and a slight reduction in CCTeu.

18 This was the figure underlying public finance 2016 forecasts included in 2015 EFD Update.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2015Portfolio

B C D E F G H

BOT CTZ BTP 3-5 years BTP 7-10 BTP 15-30 years BTP€i BTP Italia CCTeu



Portfolio C: compared to Portfolio B, there is a more significant increase in

the 7-10 year nominal BTP segment, zeroed issues of BTP€i, a further increase in

BTP Italia and finally an increase in CCTeu; this portfolio aimed to capture the

effects of possibly divergent European and Italian inflation trends, by increasing

exposure to the second with respect to the former, while also keeping a stance

oriented toward medium- to long-term fixed-rate maturities;

Portfolio D: compared to Portfolio C, there are no issues of BTP Italia, but

rather of BTP€i; underlying reasons are thus a mirror-image of Portfolio C;

Portfolio E: compared to the 2015 Portfolio, this has an increase in BOTs but

at the same time a reduction in CTZs and, at large extent, in 3-5-7 year BTPs and

CCTeu; moreover, again compared to the 2015 portfolio, the portions of 10-15-30

year BTPs and BTP Italia are increased; this portfolio is representative of those

strategies that favour the extreme (short- and long-term) parts of the yield curve,

underweighting all the intermediate maturities;

Portfolio F: compared to the 2015 Portfolio, there is a drastic reduction in

BOTs, CTZs and 3-5-7 year BTPs, a massive increase in 10-15-30 year BTPs, an

increase in BTP Italia, given their 8 year maturity, and a reduction in CCTeu; this

Portfolio is highly unbalanced toward long-term maturities in order to test its

properties in terms of reducing interest rate risk, in exchange for an expected

increase in average cost at issuance;

Portfolio G: compared to the 2015 Portfolio, there is a substantial increase in

BOTs and CTZs, a broad reduction across the BTP segment (more marked in longer

maturities) and a modest reduction in linkers; in this case, selecting a portfolio

highly focused on short-term instruments was intended to assess its properties in

terms of potential rise in interest rate risk, in exchange for an almost certain

reduction in average costs at issuance;

Portfolio H: compared to the 2015 Portfolio, here there is an increase in BOTs

and a shift of issuance shares from nominal BTPs with a maturity of 10 years or

more, and from CCTeu, to BTP€i and BTP Italia; the Portfolio obviously aims to

test the effects of an increase in debt exposure to inflation (both domestic and

European), with a similar reduction in long-term conventional securities issues,

including 10-year maturity.

The analysis was carried out, for each issuance Portfolio, over a 30 year

period and the effects in the first four-year period 2016-2019 were examined. All

the Portfolios were examined under one hundred scenarios - generated by the

model - for the Italian government yield curve, the zero coupon inflation swap19

curves for linkers and the 6-month Euribor. The generation of interest rate

scenarios took into account information on the duration of the PSPP program,

which would certainly extend at least until the end of 2016. In addition, three

alternative scenarios were used for European and Italian inflation: the first a basic

one - consistent with the scenario the ECB was using at the end of 2015 - while the

other two assumed changes at a slower and faster pace respectively, compared to

the basic scenario.

19 Zero coupon inflation swap curves are commonly used to price swap contracts in which two

counterparties exchange a nominal fixed flow for an inflation-indexed variable one, so as to equal the present values of the two flows. These curves are crucial to the SAPE model because they allow to model future indexed securities issues starting from nominal yield curves.



The selected cost measure was the expected change in average monthly

interest expenditure in the four-year period considered. The measure for risk was

given by the difference between (i) the trend in average monthly interest

expenditure in the four-year period which allows only a 5% probability that this

might increase and (ii) the one expected above (Relative Cost-at-Risk).

Among the examined portfolios, cost and risk features of those allowing an

increase in average life in 2016 were the first to be analysed.

The 2015 Portfolio was found to be one of the most efficient in the sense that

- with only one exception - it was found that all the others could achieve a lesser

risk, but only at a significantly higher expected cost. This was the case for the B,

D, E, and G Portfolios. Portfolio H, on the other hand, allowed to achieve the

same expected cost as for the 2015 Portfolio, but at a higher risk. Instead, the

Portfolio C allowed for a cost/risk combination that to the issuer was better -

albeit very close - than the 2015 Portfolio.

Compared with the 2015 actual Portfolio, main characteristics of Portfolio C

are as follows:

1) equal weight of BOTs issues;

2) a slight reduction in the CTZ segment and an increase in the CCTeu;

3) a downsizing of the 3 and 5 year BTP segment;

4) an increase in the 7 and 10 year BTP segment;

5) an increase in the 15 and 30 year BTP segment;

6) a reduction in European inflation- linked securities, in favour of those indexed

to Italian inflation .

Thus, model outputs led to conclude that in 2016 it would have been optimal

to reduce the 2-5 year conventional segment, to uniformly increase the 7-30 year

conventional BTPs, and to keep a valuable weight of CCTeu and BTP Italia at the

expense of the BTP€i.

The role of derivatives in managing the trade-off between rate risk and

cost for 2016

As already pointed out20, the objective of containing the cost of debt subject

to an acceptable risk level of outstanding debt structure, that international best

practices assign to DMOs, far from being accomplished once and for all at the time

of issuance and with reference to market conditions existing at that time, is

rather a practical, dynamic activity, still ongoing even after issuance. Among the

instruments held by DMOs to manage those risks after issuance, there are - in

addition to debt exchanges and buybacks - interest rate derivatives. Indeed, these

allow to contain interest rate risk by modifying composition of portfolio’s rates

without changing features of debt already placed among investors21. Possible gaps

between the portfolio structure stemming from the outcome of capital market

placements and the management objectives considered as suitable can be covered

20 For an essential and wider analysis of the objectives aimed for with derivatives in such a debt

management perspective see above, I.1, as well as the documents mentioned there. 21 For a synthesis on the types of derivatives carried out by Public Debt Directorate inside the Treasury

Department, see section III.3 of the Public Debt Report for 2014, available at the address reported on Note 16 of this Chapter.



by derivatives22, thus increasing DMOs’ ability to meet targets and partly

disengaging the achievement of those goals from trends prevailing at the time of

placements. Derivative transactions are independent of a predetermined

timetable, unlike the issuing activity, which in the Italian case - considering the

size of the debt - must be managed with continuity and predictability, in order to

create the technical framework for securities’ potential buyers to rely on

necessary investment liquidity. Thus, they can be carried out at any time, when

market conditions allow the specific issuer’s needs to be met, by this way

contributing to remove some rigidity in debt management.

The Framework Decree, in authorising the use of derivative instruments,

stipulated that they contribute to achieve the general management goals of

containing total debt cost and protect from market and refinancing risks, on the

basis of available information and market conditions.

Since 2015, in particular, following the publication in September 2014 of new

Eurostat rules for accounting for market value of swaps stemming from swaps

restructurings or exercised “swaptions”, the subordination of derivatives to debt

management targets has inevitably led to further management constraints, since

the impact of these rules on debt stock level cannot be ignored, even though it is

a mere matter of accounting and does not correspond to actual market borrowing.

Derivatives should therefore complement issuance activity, also taking into

account the more general public finance targets in the light of the accounting

implications produced by EU rules, while continuing to contribute to an increase in

debt average refixing period and financial duration23.

In 2016, consequently, liability management and interest / exchange rate

risks management focused on restructuring of some already existing derivative

transactions, in cases where some critical issues had stemmed from the above-

mentioned statistical-accounting changes. Specifically, the pursued target was

mainly to work on “swaptions” expected to be exercised in the year, in order to

reduce the increase in debt that - as stipulated by the new harmonised EU

accounting scheme SEC 2010 - would have risen from the generation of underlying

off-market swaps.

Methods of implementing the goal of containing debt cost while paying

attention to the cost/risk profile

To pursue the set goals, Treasury’s strategy for 2016 was structured in two

phases of debt management as follows:

22 A 2008 document jointly drafted by experts at the OECD, the IMF and the World Bank outlines this

practice adopted by many sovereign DMOs, emphasising that “The implementation of the debt strategy may include the use of derivatives to separate funding decision from the optimal portfolio composition decision, reduce the cost of borrowing, and manage risks in the portfolio (in particular interest rate refixing risk and refinancing risk).” OECD (2008) “Use of Derivatives for Debt Management and Domestic Debt Market Development: Key Conclusions”.

23 Pursuant to 2005 Budget Law (Law No. 311 of 30 December 2004), certain derivatives contracts were executed with reference to public entities loan receivables transferred to the Treasury from the budget of the Cassa Depositi e Prestiti, following the transformation of the latter into a stock company (Article 5 of Decree-Law No. 269 of 2003 – a decree attached to the 2004 Budget law - converted, with amendments, by Law No. 326 of 2003). The notional amount of these contracts is just over 2 percent of the Treasury’s whole derivatives portfolio, as shown in detail in Table IV.9 (Chapter IV). These contracts are not a part of the management of the Central Government debt and, accordingly, are not addressed in this Report.



Policies at issuance of domestic and foreign securities

In line with 2016 Guidelines’ statements and in view of the above-mentioned

targets as for average life, duration and average refixing periods, and following

the cost/risk trade-off analysis, the issuance policy for 2016, considering the

smaller volumes to be offered to the market compared with 2015, needed to aim

to as follows:

a. adjust BOT issues to obtain at end 2016 a lower stock compared to 2015,

while also ensuring regular placements of 6 and 12 months tenors; quarterly

or flexible BOTs were instead to be proposed only in case of specific cash

needs;

b. reduce CTZ issues in order to achieve moderately negative net issues in the

segment - considering the reduced volume of maturities compared to 2015 -

and a reduction in CTZ's share of debt;

c. reduce issues in the 3- and 5- year BTP tenors, both in absolute terms and in

relation to total issues compared to 2015, always ensuring steady issues;

d. depending on demand patterns, increase volumes of 7- and 10- year BTP

issues, while ensuring steady placements;

e. increase offered volumes of 15- and 30- year BTPs with respect to the overall

mix of issues compared to 2015, always taking demand conditions into

account;

f. given the historically very low level of rates, contemplating introduction of

new long term tenors for BTPs to tap new segments of demand;

g. keep continuity of CCTeu issues with 7-year maturity, thus also increasing

their share on total issues, stabilising their share of debt at year-end;

h. partially reduce BTP€i issues both as a percentage of total ones and in

absolute value, so as to stabilise their share of debt at year-end;

i. propose BTP Italia in two placements, with maturity also longer than 6 years,

in order to increase offered volumes to partly offset the reduction in BTP€i

and contain the reduction of the segment's share on debt, as first redemptions

were scheduled in the year;

j. assess, according to market conditions, the possibility of return to issue under

the Global Program, in order to satisfy a presumably high demand from

institutional investors, notably on the USD market; assess the benefits of

continuing to issue securities under the MTN program to meet the demand of

primary institutional investors, following specific requests and subject to a

lower financing costs than comparable domestic instruments, while also

avoiding adverse effects on standard public format issues;

k. finally, debt exchanges and buybacks also needed to contribute to achieve

2016 issuance objectives, in order to change redemptions profile, namely by

reducing issues redeeming in 2017.

Post-issuance debt management operations

In order to achieve the objectives set out above with the outstanding debt

portfolio, Treasury may also make use of debt exchanges and buybacks of

government bonds. as well as of derivatives.



Debt exchanges and buybacks are debt management tools designed to curb

refinancing risk, by reshaping redemptions profile while, at the same time,

boosting liquidity and efficiency of government bonds secondary market. Unlike

ordinary issuance activities, these transactions does not follow a scheduled

timetable, but depend on Treasury's specific needs and on market conditions.

Participating in debt exchanges is reserved to Specialists in government securities.

In more detail, debt exchanges consist of the issuance of a bond in return for

one or more existing securities. It is therefore an exchange of government bonds

having different maturities, which may help to limit the refinancing risk. For such

operations, Treasury may use the Bank of Italy's auction system or the electronic

trading system.

Buyback transactions, instead, allow the Treasury to early redeem

outstanding government bonds. To this purpose, financial resources can be taken

from the Cash Account or from the government bonds Sinking Fund. Buyback

execution may take place via an auction at the Bank of Italy or through bilateral

transactions.

The 2016 Guidelines notably mentioned debt exchanges and buybacks among

the main Treasury's tools in view of the high concentration of redemptions

scheduled in 2017. The Guidelines further specified that buybacks could also be

carried out directly on regulated market (as in the case of debt exchanges

transactions) and would also be aimed at facilitating the process of reducing

outstanding debt stock.

Finally, given actual constraints stemming to banks from prudential

supervisory rules failing a collateralisation agreement, entering into new

derivatives would be limited to cross-currency swaps for any new foreign-currency

issue, in a framework including a bilateral guarantee system. There was also a

need to monitor the existing derivatives portfolio, actively intervening - albeit

marginally - only after identifying useful solutions to improve portfolio's

performance in the light of current market conditions.

I.4 MONITORING AND MANAGING THE CASH ACCOUNT TO STABILISE THE BALANCE

Cash Account for the Treasury Service

In recent years the Treasury, in collaboration with the Bank of Italy, has set a

liquidity management framework aiming to improve the ability to forecast

Treasury cash flows and related balances. This management - called OPTES - also

helps meet ECB requirements, driving to facilitate monetary policy through sound

forecasts of liquidity stocks held by public entities at national Central Banks in the

Eurozone.

In Italy, such liquidity is mainly held on the Cash Account, the Treasury's

account at the Bank of Italy where receipts and payments made under the State

Treasury service are recorded. In essence, the balance of this account is the sum

of all open Treasury accounts. In line with EU legislation, which prohibits Central

Banks of Member States from funding Governments under any form, the Account

may not be overdrawn.



Cash Account’s balance records strong volatility, due to both the wide range

of entities enabled to move funds at the State Treasury and the huge size of some

flows, which cyclically repeat, typically on a monthly basis. In particular, on the

revenue side, tax revenues have a strong impact, concentrating in a few days in

the second half of the month, while big outflows are linked to pensions

disbursement, mainly concentrated in the month’s first working day. Large

fluctuations in the Account can also be caused by government bond issuances and,

even more, redemptions.

Such critical aspects led the Treasury, in 2016 as in previous years, to pursue

the objective of achieving with this Account an "efficient management of

liquidity, considering the issuance strategy for government securities, prevailing

market conditions and constraints imposed by monetary policy provisions".

How OPTES works

Cash management consists of daily operations to ensure that multiple

movements of the State Treasury enjoy adequate liquidity. This activity is closely

linked to public debt management, being the tool for linking medium- to long-

term securities issues and the daily fluctuations in the Cash Account. As

mentioned, cash management takes place within the so-called OPTES operational

framework, which consists of tracking balances and cash flows and carrying out

money market operations.

Monitoring relies on a continuous information exchange between Bank of Italy

and MEF (General Accounting Office and the Treasury Department - Public Debt

Directorate), featuring estimated and actual data on all receipts and payments

affecting the accounts held at the State Treasury and consequent estimation of

the Cash Account balance. Information exchanges include repeated updates during

each business day, with the purpose of estimating end-of-day account balance;

MEF’s and Bank of Italy’s liquidity forecasts also include longer-term scenarios,

weekly shared, with a time horizon consistent with monetary policy requirements.

Cash management tools, on the other hand, consist of money market

operations, through daily auctions and any bilateral transactions, under which

Treasury is usually a lender of its own liquidity. Treasury's available assets are

therefore composed both of liquidity in the Cash Account and of loans granted to

financial intermediaries within the daily Treasury OPTES framework.

The regulatory framework for cash management in 2016

MEF's General Directive on administration and management for 2016 provided

that monitoring and management of the Cash Account, aimed at stabilising its

balance, should be based on a careful assessment of the account’s itself

performance, the use of cash management tools and the credit risk monitoring

relating to such transactions, taking into account government bond issuance

strategies.

In this regard, with reference to cash management operations, the Guidelines

stated that Treasury would have maintained its constant presence in the short-

term and very-short-term money market by way of OPTES, which entails a daily

activity. It was further specified that transactions would consist mainly of auctions



or bilateral liquidity transactions, with overnight or longer duration, depending on

cash requirements and market conditions.

From a regulatory point of view, the Framework Decree regulated cash

management essentially by referring to the relevant Ministerial Decree of 25

October 2011.

After a two-year period of main regulatory innovations24 following the ECB's

monetary policy interventions of 201425, in 2016 no new amendments to liquidity

management rules were introduced. Cash management activities in 2016 were

therefore unchanged from the previous year, given that all regulatory framework

remained unaltered and the last years ECB-promoted quantitative easing

interventions have been strengthened. Operations were mainly aimed at curbing

the effects of monetary policy decisions that, moreover, penalise government

deposits held at Central Banks, by applying the deposit facility rate if negative,

and - only for the part not exceeding 0.04% of GDP (in 2016, equal to € 661 million

for Italy) - to the EONIA rate, which also was in negative territory for the whole

year. Thus, 2016 too looked like being a challenging year for cash management,

heading at implementing the regulatory environment set in previous years while,

at the same time, operating in a difficult-to-deal-with money market, as interest

rates have been steadily in negative territory for several years.

24 For more information about the new regulatory framework of liquidity management, see Sections I.4 and

IV.4 of the Public Debt Report for 2014 and to the same Sections of the Report for 2015, both available at http://www.dt.mef.gov.it/en/debito_pubblico/presentazioni_studi_relazioni/dettaglio.html?resourceType=/modules/debito_pubblico/presentazioni_studi_relazioni/elem_0008.html.

25 See BCE Decision 2014/23 and BCE Guideline 2014/22.



https://www.ecb.europa.eu/ecb/legal/pdf/oj_jol_2014_168_r_0015_en_txt.pdf

https://www.ecb.europa.eu/ecb/legal/pdf/oj_jol_2014_168_r_0017_en_txt.pdf


II. TREND OF ITALIAN GOVERNMENT SECURITIES

MARKET IN THE INTERNATIONAL FRAMEWOK

II.1 MONETARY POLICY AND THE EURO AREA MONEY MARKET

Monetary policy in the Euro area

2016 was characterized by modest growth in the countries of the Euro area

and by an inflation rate still below the European Central Bank's target (below but

close to 2%), even though the risk of deflation that had been looming over the

economies was averted over the course of the year.

Outlooks for weak inflation, still far off target, led the ECB to set a wide

range of monetary stimulus measures in the first quarter of the year. At its March

meeting, the Governing Council announced a number of measures aimed at

further increasing the extent of monetary expansion which was already well

underway. More specifically, the following measures were announced: an increase

to € 80 billion (from previous € 60 billion) of the monthly purchases made under

the Asset Purchase Programme (APP); the introduction of new targeted longer-

term refinancing operations (so-called T-LTRO II); an expansion of the asset

purchase programme, thus including investment-grade bonds issued by non-bank

corporations established in the Euro area; a cut in benchmark rates and, in

particular, a cut in the deposit facility rate to -0.40%. Besides announcing this

broad package of measures, the ECB reaffirmed its intention to continue with the

bond purchasing programme at least until March 2017 and in any case until prices

trend would be durably improved.

These measures, in addition to previous monetary policy actions, had a direct

impact both on financial markets - as they contributed to further push down the

monetary market main rates and increased surplus liquidity in the Eurosystem -

and on the credit market, as they improved lending conditions for businesses and

households.

June referendum in UK and uncertain growth prospects in emerging countries

were serious challenges for economic growth in 2016. However, towards the end

of the year, positive price dynamics - albeit largely supported by the increase in

energy costs - and the resilience of the euro-area economy led the ECB to partially

change its monetary policy. At its December 2016 meeting, the Governing Council

announced it would continue its Asset Purchase Programme at least until

December 2017, even though as of April it would reduce the pace of monthly

purchases to € 60 billion. The range of securities that can be bought under the

Public Sector Purchase Programme was extended, and the residual maturity of

securities was reduced from two to one year, also allowing to purchase bonds with

yields to maturity lower than the deposit facility rate. At the same time, the

Governing Council reaffirmed its intention to continue its Asset Purchase



Programme if the evolution of inflation was not satisfactory, but left its official

rates unchanged.

The overall impact of these measures was a further increase in liquidity

exceeding the reserve requirements in the Eurosystem - surplus liquidity reached €

1,200 billion at the end of the year - mainly as a result of the purchase of

Government securities and the new liquidity injected into the system under the T-

LTRO II, whereas the role of the main refinancing operations became ever more

marginal.

Euro area money market

As mentioned, at the March 2016 meeting the interest rate corridor was once

again adjusted downwards. Interest rates on main refinancing operations (MRO)

and on marginal lending facility (MLF) were reduced by 0.05%, reaching 0% and

0.25% respectively, while the rate on marginal lending facility was cut by 0.10% to

-0.40%.

GRAPH II.1 : INTEREST RATE CORRIDOR OF THE ECB MONETARY POLICY 2014-16 (percentage values)

These decisions had immediate effects on the interbank market rates,

especially on EONIA rate (Euro OverNight Index Average) which, as known, moves

close to the deposit facility rate and in parallel to it in situations characterized by

surplus liquidity. As can be seen from Chart II.2, when changes in rates occurred in

March, EONIA immediately decreased by approximately 10 bp, hovering around -

0.35% and fluctuating around that level for the rest of the year, with rare

exceptions. Action on rates, abundant liquidity and expectations that rates would

stick around those levels for a long time also had an impact on different

maturities of EURIBOR rates (EURIBOR - EURo Inter Bank Offered Rate), which

slowly but steadily declined over the year. For example, the 3-month Euribor rate,

which in January remained slightly above -0.15%, gradually declined below -0.30%,

thus also reducing its gap from EONIA rate.

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

Jan-1

4

Feb-1

4M

ar-

14

Apr-

14

May-1

4

Jun-1

4

Jul-

14

Aug-1

4

Sep-1

4

Oct-

14

Nov-1

4

Dec-1

4

Jan-1

5

Feb-1

5M

ar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6M

ar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

DF MRO MLF

II. TREND OF ITALIAN GOVERNMENT SECURITIES MARKET IN THE INTERNATIONAL FRAMEWOK


CHART II.2 - PERFORMANCE OF THE MAIN MONEY MARKET RATES IN 2016 (percentage values)

Repo benchmark rates followed a similar path, driven by (i) reduction in

official rates, (ii) ever more abundant liquidity and (iii) operators seeking high-

quality collateral.

More specifically, the General Collateral Repo rates for securities issued by

the main countries of the Euro area were in negative territory for the whole year

and - in the case of France and Germany - reached levels even below the ECB

marginal deposit facility, which confirms extremely soaring demand for high-

quality collateral with a high degree of liquidity.

II.2 EURO AREA BOND MARKETS

Last few months of 2015 were characterised by great uncertainty about

worldwide interest rates trends, thus leading a large number of national and

international investors to remain moderately cautious in their portfolio decisions.

More specifically, this market approach was shaped by a number of factors: the

Federal Reserve Bank's decision to raise interest rates by 25 basis points on 16

December (the first increase since June 2006); a number of economic and political

events in Europe (such as political crises in Portugal and Spain), as well as outside

Europe, i.e. fears of a possible hard landing of Chinese economy – with all its

potential impacts on emerging economies - and complex situation in the Middle

East.

Government bonds interest rates in the Euro area steadily declined (See Chart

II.3) in the early months of 2016, in spite of long periods of daily (and intraday)

volatility, stemming from the mentioned risk factors - already present in the last

few months of 2015 - as well as from other more technical factors that affected

investment strategies for the rest of the year. There is no doubt, however, that

medium-term declining trend was allowed by the steady action of the ECB with its

accommodative monetary policy and continuation of the PSPP.

-0.50

-0.40

-0.30

-0.20

-0.10

0.00

0.10

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

DF rate MRO EONIA EURIBOR 3M



As for economic developments, beside the mentioned worsening of China's

growth prospects, risks of deteriorating growth indicators emerged in Europe as

well, coupled by a further prolonged drop in raw material prices. The result of

these developments was a renewed downward revision of inflation expectations,

which led ECB to re-adjust its PSPP.

At political and geopolitical level, in addition to the mentioned crisis in

Portugal and Spain, markets began to carefully assess the risk of UK exiting from

EU (“Brexit”), after a referendum was called to allow UK voters to choose

whether to remain or leave the EU. Moreover, 2016 was a year in which the

willingness of EU member states to uphold cohesion was sorely tested, not only by

the so-called Brexit, but also by rise in a number of European countries of many

political movements and parties which are openly hostile to EU integration project

and its common currency. The rise of these movements and parties - often the

result of failures of both EU and member States’ institutions to jointly build

effective ways to deal with the main crises and challenges facing Europe - helped

fuel investors' fears of an institutional crisis in the EU.

Lastly, with regard to efforts in financial and banking regulations, some

supranational fora continued their discussions, which had been ongoing for a

number of years, assessing the impact of a possible review of the way in which

Government bonds held by Banks as part of their assets are treated in terms of

capital requirements1.

The debate looks far from having identified common guidelines, and as yet no

measures - not even preliminary ones - have been taken; moreover, no

assumptions can be made about a possible final orientation or about the fact that

a review might be actually introduced.

1 At present, under Basel III and the Capital Requirements Directive and Regulation (CRD IV 36/2013 and

CRR 575/2013), special treatment is allowed for Government bonds issued in the currency of the debtor country in terms of the risk coefficients to be used for calculating capital requirements.

CHART II.3: TREND OF EUROPEAN GOVERNMENT BOND YIELDS - 10-YEAR MATURITY (percentage values)

-0.50

0.00

0.50

1.00

1.50

2.00

2.50

01-J

an-1

5

01-F

eb-1

5

01-M

ar-

15

01-A

pr-

15

01-M

ay-1

5

01-J

un-1

5

01-J

ul-

15

01-A

ug-1

5

01-S

ep-1

5

01-O

ct-

15

01-N

ov-1

5

01-D

ec-1

5

01-J

an-1

6

01-F

eb-1

6

01-M

ar-

16

01-A

pr-

16

01-M

ay-1

6

01-J

un-1

6

01-J

ul-

16

01-A

ug-1

6

01-S

ep-1

6

01-O

ct-

16

01-N

ov-1

6

01-D

ec-1

6

Spain

France

Germany

Italy



During the first half of 2016, all the above-mentioned factors affected

developments in Government bond yields, mainly causing increased volatility,

while the basically declining trend was not substantially altered. Indeed, as

already mentioned, the decisive factor was the ECB's steady presence in

government bonds markets, which later included additional actions: already in

January, the ECB had not ruled out the possibility - which actually occurred later -

of monetary policy even more oriented to exploit all available tools in order to

bring inflation expectations closer to target. On March 10, actually, the ECB

positively surprised markets, not just by further reducing benchmark rates

(deposit facility rate from -0.3% to -0.4% and refinancing rate from 0.05% to

0.00%), but also by resolutely strengthening PSPP, as monthly purchase volume

was raised from € 60 to € 80 billion.

During the second quarter, fundamental issues affecting investment behaviour

and trends in European government bonds yields did not change. As UK

referendum and general election in Spain drew closer, nervousness intensified in

the markets and climaxed when on Friday morning, June 24, it was certain that

British people had voted to leave EU. General election in Spain, the second one in

just a few months, which was held two days after the British referendum, was just

as critical for investors: as it was the case after previous election, this vote

resulted in an extremely fragmented Parliament, which managed to form a new

cabinet only in October, following a series of no-confidence votes and the

Socialists’ painful choice to abstain. All these political events affected foreign

exchange and stock markets as well as - of course - government bond markets,

resulting in a so-called fly-to-quality process, which mainly concerned core euro-

area countries, where yields to maturity of outstanding government bonds

declined further. One only needs to think that in those days yield to maturity of a

10-year German government bond had dropped below 0% and even reached -0.20%

in the early days of July.

However, the downward trend in rates continued unabated also for non-core

countries. Against this backdrop of political uncertainty, expectations of market

operators about ECB's ability to continue its PSPP and use additional monetary

policy tools at its disposal - both conventional and non-conventional - to reach

inflation targets in the medium-term and curb possible financial turmoil had a

strong stabilizing effect.

In the second half of the year, European rates seemed to be basically

stabilizing, even though investors were still grappling with political (and moreover

economic) impact analyses of Brexit. However, additional elements of geopolitical

uncertainty were soon to emerge. In mid-July, attempted coup in Turkey had

potentially destabilising effects in the Mediterranean area, already hit by the

migration crisis which, due to geographical reasons, mainly affects coastal

countries in Europe.

In this situation, it was again the ECB that acted as a stabilizer, especially at

the end of July when it released its new macroeconomic forecasts, with growth

and inflation indicators both revised downward after incorporating the impact of

Brexit in estimates. These revisions actually resulted in a consolidation of

expectations that the ongoing public sector purchase programme, due to end in

March 2017, would be extended.



FO

CU

S

DETAILS ON EVOLUTION OF Public Sector Purchase Programme (PSPP) IN 2016

The Public Sector Purchase Programme (PSPP), a programme to purchase bonds issued by Central

Government and agencies in the countries of the Euro area and by supranational institutions,

announced by the Governing Council of the ECB on 22 January 2015, started in March 2015 and

was expected to last until March 20172. Following are the main changes to the programme made

during 20163:

a) with the monetary policy decision of 10 March 2016:

- the monthly purchases under the APP will be made at a monthly pace of € 80 billion instead

of € 60 billion as of 1 April 2016;

- As part of the APP, a new CSPP is established under which, as of 1 July 2016, some

corporate securities will be purchased (investment-grade, euro-denominated bonds issued

by non-banks corporations and included in the list of eligible securities);

- Under the PSPP, the limit for individual issuers and securities is increased to 50% for

international organisations and multilateral development banks, while monthly purchase of

this kind of securities will be reduced from 12% to 10%. With a view to keeping the risk-

sharing regime unchanged at 20%, purchases under PSPP directly made by ECB will be

raised from 8% to 10%;

b) with the monetary policy decisions of 8 December 2016:

- the Governing Council decided to extend the purchase programme at least until December

2017. However, with regard to the APP, it will continue to make purchases at a monthly

pace of € 80 billion until the end of March 2017, while as of April 2017 the purchase

programme will resume its previous monthly pace of € 60 billion until the end of December

2017.

- As of January 2, 2017, asset purchases under the PSPP will be extended to include

securities with residual time to maturity of less than two years and up to residual time to

maturity of one year. The maximum maturity of securities that will continue to be purchased

is set at a residual time to maturity equal to or less than 30 years.

- Under the APP, asset purchases can be made of bonds with a yield to maturity even lower

than the deposit facility rate set by the ECB.

- Changes to the securities lending facilities were introduced: it will be possible to use cash as

collateral, accepted up to the limit of € 50 billion; the cost is function of the lower between

the deposit facility rate minus 30 basis points and the prevailing market repo rate.

With regard to activity carried out by the ECB under the PSPP in the Italian Government bond market,

in 2016 the volume of Italian securities purchased was € 130.398 billion in nominal terms. Since the

start of the programme till the end of 2016, the overall volume of Italian securities purchased by the

ECB was reported to be € 209.607 billion in nominal terms. As for 31 December 2016, this stock of

securities had an average maturity of 8.92 years.

2 More specifically, in its decision of January 2015 the ECB announced a period of action that would last 'at

least until September 2016'; this period was then extended to March 2017 by the 10 March 2016 decision. The March 2017 deadline was not meant to be unchangeable, as the action period was due to continue until the Governing Council of the ECB would note a durable adjustment in the path of inflation, consistent with its target of achieving inflation rates of below but close to 2% in the medium term. The overall size of the programme for the purchase of Government and private securities (ABS and bank covered bonds) was € 80 billion a month until April 2017. For further details on the introduction of the PSPP, its market impact and changes made during 2015, see the relevant focus in the 2015 Public Debt Report. 3 https://www.ecb.europa.eu/press/pr/date/2016/html/pr160310_2.en.html, http://www.ecb.europa.eu/press/pr/date/2016/html/pr161208.en.html, http://www.ecb.europa.eu/press/pr/date/2016/html/pr161208_1.en.html e http://www.ecb.europa.eu/press/pr/date/2016/html/pr161208_2.en.html

https://www.ecb.europa.eu/press/pr/date/2016/html/pr160310_2.en.html

http://www.ecb.europa.eu/press/pr/date/2016/html/pr161208.en.html

http://www.ecb.europa.eu/press/pr/date/2016/html/pr161208_1.en.html

http://www.ecb.europa.eu/press/pr/date/2016/html/pr161208_2.en.html



However, the above trend started to reverse in the last quarter of 2016 and

increase in government bonds yields began to consolidate in the Euro area. On the

one hand, the increase reflected the disappointment of investors with the ECB

Governing Council's failure to announce further action at its September meeting.

On the other hand, it reflected two developments occurring in the United States:

i) statements by Fed that conditions for a new rates hike were approaching; the

news non only affected U.S. Fed funds, but European interest rates also, starting

from intermediate bond maturities (2-5 years) and ii) U.S. presidential election of

November 9, which triggered expectations of greater fiscal stimulus in the US,

that would impact growth and inflation. These developments shifted portfolios

composition in favour of equity, pushing up long-term bond yields in the United

States and hence in Europe.

II.3 TRENDS IN THE ITALIAN GOVERNMENT BOND MARKET

Yield curve evolution

In 2016, Italian Government bond yield curve (Chart II.3) showed trends

which, as already mentioned, for most of the first half of the year were influenced

by international geopolitical events that also affected other European issuers to

differing degrees. In the second half of the year, even if international politics,

economics and financials events continued to have repercussions on Italian debt

yield, major domestic political developments started to prevail and played an

increasing role in shaping Italian yield curve.

Despite the many sources of volatility mentioned in previous paragraph, in

the early months of 2016 shifts in the yield curve of Italian 10-year benchmark

were quite moderate, with variations of few basis points around an average rate

of 1.50%. From the end of June onwards, thanks to post-Brexit fly-to-quality

reaction, also affecting non-core euro-area countries, and to expectations of

further ECB action, rates declined and in mid-August even got close to 1.00% in

the case of 10-year bonds. However, the falling trend came to a sudden stop in

September, showing an upward trend which continued throughout the rest of

2016. Yields increase affected all main countries of the Euro area, due to the

mentioned risks of a benchmark rate increase in the U.S. and also because of

investors' reaction to the ECB's failure to announce further stimulus in those

months; the rate increase in Italy was also due to idiosyncratic factors of a

political nature which began to be felt precisely in those weeks. Indeed, as shown

in Chart II.7, the 10-year spread between BTP and German Bund - which

throughout 2016 up to that moment had fluctuated within a 20 basis point range

and in line with bond spreads in other European countries - began to follow an

independent trend since September 2016, gradually widening and eventually

reaching a 185 basis point peak at the end of November.

Two issues drove international investors’ portfolio and investment choices in

Italian government bonds: on the one hand, concerns about soundness of Italian

banking system, especially with regard to some specific banks (large institutions in

terms of size, but a very small number of specific cases) facing insolvency risks

and an overall non-performing loans ratio higher than that of European peers; on



the other hand developments in Italy's political scene, once a date was set for the

Constitutional referendum (which was eventually held on December 4).

To improve soundness of the Italian banking system, in addition to a series of

reforms carried out over the past few months mainly affecting mutual and

cooperative banks, a number of actions were taken by the Government to enable

Italian banks to speed up capital ratios’ consolidation. More specifically, these

actions focused on new measures aimed at reducing time needed to recover bad

or impaired debts (insolvency law reform) and which would facilitate transfer of

non-performing loans through the setting up of private vehicles (Atlante Fund) or

of State guarantees (so-called GACS).

However, despite measures implemented by the Government, market

sentiment remained basically unchanged.

As for Italy's political situation, fears of a possible fall of the incumbent

Government - after polls found an increasing support for rejection of

Constitutional reform and risks of a stalemate and a period of lack of governability

following the vote - led investors to further reduce exposure to Italian economy,

in some cases by lowering securities held, and in other cases by failing to support

when bond prices were slipping.

CHART II.4: MARKET RATES ON GOVERNMENT BONDS– 2-3-5-10-15-30-50 YEARS (percentage values)

During 2016, all yields of bonds with up to 1 year maturity steadily stayed in

negative territory, remaining stuck with benchmark rates set by ECB: although

here, too, some volatility peaks caused substantial fluctuations in rate levels, the

overall trend of the year resulted in a further contraction, reaching -0.25%

approximately at year end. The interesting aspect was that monetary segment

gradually dragged down all the others up to the 3-5 year maturity, which showed

remarkable resilience, continuing a slow but relentless downward trend which

caused the 3-year BTP to move into negative territory for the first time in August

and September. Later, this strong link among the two segments of the curve

disappeared, with the 3-5 year bonds more closely correlated with the rest of the

BTP curve - which in the last quarter registered a significant upward trend - while

bonds up to 1 year maturity firmly remained in negative territory. By the end of

-0.250.000.250.500.751.001.251.501.752.002.252.502.753.003.253.50

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

BTP 2 years BTP 3 years BTP 5 years BTP 10 yearsBTP 15 years BTP 30 years BTP 50 years



November, after the market had already formed a consolidated opinion about the

negative outcome of the constitutional referendum, BTP yields began to decline

again, reaching their October levels.

In particular, the 5-year maturity point followed the same path of shorter

maturities points for most of the year, but then showed signs of weakness at the

peak of volatility, as the yield rose within few trading sessions from 0.25% to 1%.

Following retracement was also less strong, picking up only in part, to eventually

stand at 0.50% at the end of the year.

Unlike what happened in 2015 - when it showed signs of greater weakness

than the 5-year maturity - in 2016 the 10-year point trend was basically in line

with the 5-year one, showing some fragility only towards the end of the year,

when spread between the two maturities reached its highest point at around 120

basis points against an annual average of 100 basis points approximately.

Looking at the slope of Italian bond yields along the 2-10 year section of the

curve (See Chart II.5), one can see that it followed a downward path during the

whole first half of 2016, declining from 150 basis points approximately until it

reached its lowest value at 120 basis points in August. When the first signs of

strain appeared, the slope soon became steeper and exceeded 210 basis points

during early December sessions.

It is therefore clear that, while in the first half of the year the effects of the

ECB action (mainly through the lengthening of the average maturities of BTP

securities purchased under the PSPP) was felt through a relatively higher

reduction of the 10-year point compared to the 2-year one, in the second half of

the year, when specific issues of Italian banking system as well as those of Italy's

political situation became apparent, search for less risky instruments, such as

short-term ones, caused a bear steepening of the yield curve (i.e. steepening of

the curve with rising interest rates).

CHART II.5: YIELD SPREAD BETWEEN 10-YEAR AND 2-YEAR BONDS (basis points)

Also in 2016, the long-term segment of the Italian yield curve continued to

show its positive trend, which had already begun in 2015, also thanks to the

inclusion of 30-year maturity bonds into the PSPP. Indeed, 30-year bonds yields

lowered for the first half of the year (from 2.75% at the start of the year to 2% in

90

120

150

180

210

240

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6



early August). Later, trend reverted, as the whole curve of Italian bond yields did,

thus reaching 3% at the end of the year. It should be noted that this evolution

occurred during a year in which Treasury, in order to be able to set historically

low rates, was very active in primary market for long- and very long-maturity

instruments: starting with a new 30-year bond in February to a new 20-year

instrument in April and even launching a new 50-year BTP in October. The latter,

placed at a spread of over 50 basis points above the 30-year benchmark, stood at

a spread of just 35 basis points as early as the end of 2016. Given that Italy’s extra

cost for very long-term maturities has been traditionally much higher than that of

other European issuers, 2016 is - seen from this perspective - an absolutely

extraordinary year, as Treasury was able to issue large volumes of debt with

maturities of more than 10 years while securing a much lower extra cost than

historical average. These issuance choices became possible mainly thanks to two

factors: on the one hand - obviously - PSPP that can absorb a substantial quantity

of bonds of all maturities including the longer term ones (up to 31 years of

residual maturity); on the other hand, a relatively high number of investors

shifting to very long maturities, as a result of the strong reduction of yields on

shorter maturities traditionally chosen by these investors.

CHART II.6: YIELD DIFFERENTIAL BETWEEN 30-YEAR AND 10-YEAR MATURITY BONDS (basis points)

As mentioned above, spread between Italian BTP and German Bunds (Chart

II.7) followed a path which can only partly be compared to that of absolute yields.

Indeed, while in the second half of the year political risk which affected absolute

rate levels translated into an equivalent spread widening, in the first half of the

year - contrary to expectations - spread volatility was greater than that of

absolute rates. Indeed, while Italian absolute yields were driven by opposing

forces (on the one hand the ECB's action, on the other hand international and

domestic political developments), German securities – as usual in risk aversion

climate - were the most demanded assets, thus fostering conditions for the spread

to widen, as can be inferred from the whole period March to end of June.

60

90

120

150

180

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6



CHART II.7: BTP-BUND, OAT-BUND AND BONOS-BUND SPREAD - 10-YEAR BENCHMARK (basis points)

Performance in secondary market

General remarks

Besides being influenced by the above-mentioned international and domestic

political and economic developments, in 2016 secondary market for government

securities continued to show steady structural trends, some of which had already

been widely described in past editions of this Report and briefly mentioned in the

previous paragraphs of this chapter, relating to banking and financial regulation as

well as supervision rules and changes in asset management industry. Moreover,

mention should be made of the continuous and important action of the ECB with

its bond-buying programme, through its Central Unit and through the Bank of

Italy4.

Also in 2016, the ECB's action in the market, characterized by regular,

predictable and sufficiently transparent purchase practices, which included the

whole range of maturities along the Government curve (from 2 to 30 years),

ensured that market makers could play in a sustainable way their role as

intermediaries between issuers and final investors. As a matter of fact, on the one

hand the steady presence of a buyer of last resort enabled dealers to lower the

risk of managing any major long positions built up during their activity, thus

facilitating their propensity to quote more efficient prices; on the other hand, in

2016 the fact that a growing portion of Italy's debt and of each security flowed

into the Central Bank's portfolio did not give rise to shortages that could have

undermined the liquidity of the secondary market, thereby making more difficult

the dealers’ task to provide securities to investors. In addition, the high number of

securities forming Italy's debt and the large average outstanding of each of them5

4 For an in-depth analysis see the 'Focus' paragraph at the beginning of this chapter. 5 It is also worth mentioning that in May 2015 the Bank of Italy launched a securities lending mechanism

through which it can lend to the market the securities it holds in its portfolio following the purchases made under

0

20

40

60

80

100

120

140

160

180

200

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

Spread BTP-Bund Spread FRTR-Bund Spread SPGB-Bund



made ECB's task undoubtedly easier than with respect to some other European

Sovereigns, which issue fewer securities and with a lower single average

outstanding amount.

Interdealer wholesale market and contribution by Specialists in government bonds

The regulated MTS Italia platform, allowing only dealers and market makers

to operate (so-called interdealer market), is the platform through which Treasury

currently monitors and assesses a relevant share of the activities performed by

Specialists in government bonds in the secondary wholesale market; as such, it is a

reference point used to assess developments in this market.

Cash market

Volumes traded on the platform recorded rather similar performance over the

various months of 2016, while also having a sharp rise compared to 2015,

especially in the second and third quarter of the year (+39% and +51%

respectively), whereas in 2015 they were negatively affected by fears of Greece

exiting the euro. However, volume growth suffered a setback in the last quarter of

2016 (-17%), when market trading was less buoyant not only because of the

seasonal - and therefore expected - tendency of banks to consolidate results

achieved during the year by reducing movements in their portfolios and limiting

changes in exposure, but due to growing prudence shown by investors waiting for

the December 4 constitutional referendum outcome, as well as for clearer input

by ECB at its meeting of December 8 (Chart. II.8). However, overall volumes

traded in 2016 in the interdealer market failed to fully recover the 2015 decline,

thus remaining 7% below 2014 levels.

the PSPP (see the Insight Focus at the beginning of this chapter). This mechanism was developed through the Clearstream central depository.

CHART II.8: MONTHLY TRADING VOLUMES ON THE MTS PLATFORM (in euro million)

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

Jan

Feb

Mar

Apr

May

Jun

Jul

Auh

Sep

Oct

Nov

Dec

Overa

ll v

olu

mes

traded b

y a

ll

counte

rpart

ies

2015 2016



In the various segments (Chart. II.9) - except for CCTeu and BTP€i –a rise

averaging 17% vs. 2015 was recorded, with a slight preference for the BTP

segment, where growth reached 19%. BTP€i segment, due to negative

expectations of a rise in inflation, recorded smaller trading volumes over 2015,

with an annual change of -36% approximately. CCTeu segment, albeit to a much

lesser extent, attracted slightly less interest from investors (-6% on a yearly basis),

probably also due to the impact of very cautious expectations of a possibly

anticipated increase in monetary rates.

Infra-annual performance of the various segments is similar to their overall

performance, with regular volumes in the first three quarters and marked declines

in the BOT and BTP segments in the fourth quarter. Conversely, in the case of

segments where trading volumes were smaller than in 2015, such as the CCTeu

and BTP€i segments, last quarter showed signs of recovery compared to the

downward trends of first three quarters. With regard to the CCTeu segment, this

trend can be accounted for by a returning interest from retail investors and, in

the case of the BTP€i segment, by expectations of the ECB to reduce its

quantitative and monetary easing, due to renewed outlooks of rising inflation.

Conditions for a rise of inflation-linked segments in the last quarter were also

supported by some essentially technical market factors, such as break-even-

inflation rates which showed a downward trend for the whole first half of the

year, reaching a low in mid-July (about 0.5% at the 10-year point) later followed

by a trend reversal, similarly to the ten-year “euro inflation swap” contract,

eventually peaking at 1% at the end of December 2016.

Generally speaking, it should be noted that also in 2016, albeit to a lesser

extent than in 2015, interdealer market for Italian government bonds experienced

days of weakness in terms of efficiency of quotations and traded volumes, despite

ECB’s steady quantitative easing action. This evidence seems to confirm that

ECB’s activity did not fundamentally change spontaneous mechanisms of securities

market price formation.

CHART II.9: QUARTERLY TRADED VOLUMES ON THE MTS PLATFORM, BY SEGMENT (in euro million)

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

BOT CTZ CCTeu BTP BTPi

Overa

ll v

olu

mes

trade b

y a

ll

counte

rpart

ies

1°Q 2015 2°Q 2015 3°Q 2015 4°Q 2015 1°Q 2016 2°Q 2016 3°Q 2016 4°Q 2016



Unlike 2015, in 2016 short-term and very-short-term maturity bonds (i.e.

BOT, CTZ and partly also the BTP segment with residual maturity of up to 4

years), whose traded volumes were substantial in the first two quarters, bore the

brunt of the volume decline in the second half of the year. All the other segments

actually showed much more homogeneous performance; in fact, in some cases,

such as the 5-year maturity segment and the extra-long one (more than 17 years),

traded volumes recorded a slight increase.

CHART II.10: MONTHLY TRADING VOLUMES ON THE MTS PLATFORM BY MATURITY (in euro million)

An interesting phenomenon relating to conventional bonds with maturities of

more than 10 years, which appeared towards the end of the year (and partly

continued also in 2017), were differences in performance among bonds with a

close maturity, but bearing very different coupons. The substantial rise of the

Italian yield curve in the last few months of 2016 actually determined an equally

substantial drop in prices of all longer-term bonds, which, for any given shock on

rates, tend to decrease more because of their longer financial duration. However,

the drop was much stronger for bonds bearing a lower coupon, in line with current

market rates, than for higher coupon bonds, issued several years earlier. This is

due to the relation between coupon level and financial duration: residual maturity

being the same, a bond bearing a lower coupon has a longer financial duration,

therefore its price is more reactive to rate shocks than a bond bearing a higher

coupon.

Thus, such a different reaction to market rates increase of bonds with very

similar maturities made those with lower coupons more attractive, leading to

differences in market performance which inevitably affected the yield curve,

causing clear dislocations. These were compounded by activity of more

speculative investors keen to take advantage of this purely technical market

phenomenon. Issuance decisions made by the Treasury in those months, together

with some debt exchanges, partly contributed to curb it6.

6 It should be noted that this phenomenon, even though in different ways and to varying degrees, had

already occurred on other occasions. A case in point is what happened during the sovereign debt crisis in a context of clearly rising rates on Italy's debt. On that occasion, however, this phenomenon showed different

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

0-12mth 12mth-2y 2y-4y 4y-6y 6y-8y 8y-12y 12y-17y 17y-30y

Overa

ll v

olu

mes

traded b

y a

ll

counte

rpart

ies

by m

atu

rity

1°Q 2015 2°Q 2015 3°Q 2015 4°Q 2015 1°Q 2016 2°Q 2016 3°Q 2016 4°Q 2016



In order to assess general evolution of liquidity in the secondary market, a

number of measures may be used, each of which from its own perspective

highlights specific phenomena, since liquidity is a broad concept that can be

monitored from different angles. Most common measure, which with its simplicity

and immediacy provides a first and prompt perception of this phenomenon, is the

bid-ask spread, i.e. the difference between the price for the purchase and the

price for the sale of each security in the market.

Below are graphical representations of this measure for a series of maturities:

impact of liquidity deterioration became evident in the final part of 2016 for all

classes of government bonds. As can be inferred from Charts II.11.a, 11.b and

11.c, while until September bid-ask spreads remained fairly stable – or even

declining in the case of shorter-term securities – as of September a widening

becomes evident at all points of the curve. The only point that showed some

resilience - or that showed signs of a smaller widening – was the conventional 10-

year BTP.

Analysis of bid-ask spread can highlight quite significant phenomena. As can

be seen from the following Charts, the whole short-to-medium term segment of

the curve and all the way up to the 10-year maturity showed a bid-ask spread

(calculated in basis points so that these differences on the various maturities can

be compared) that was basically small, hovering on average around 1 basis point.

Conversely, in segments exceeding 10 years to maturity, bid-ask spreads - even

though very close to one another - were all higher than that of the 10-year bond,

by values ranging between half and one basis point. It should be stressed,

however, that this gap partly narrowed in the first three quarters of 2016, to then

widen again in the last quarter7.

CHART II.11.a: BID/ASK SPREAD IN BASIS POINTS ON 10, 15,20, 30 and 50 YEAR BENCHMARK BTPs,

RECORDED ON THE MTS PLATFORM

characteristics, such as the participation of buy-and-hold investors (mainly insurance companies and pension funds) that had purchased securities at prices below par and which, for accounting reasons, could not sell them in the Repo market, thereby contributing to heighten tensions which from the repo market reverberated in the cash market, generating some dislocations in the yield curve. In 2016 this same phenomenon reappeared with different characteristics, i.e. without major tensions in the Repo market.

7 This performance might also have been affected by the 2016 yearly update of assessment criteria of Specialists in Government bonds, implemented by the Ministry of the Economy and Finance, that might have laid greater emphasis on quotation of bonds with a residual maturity exceeding 10 years.

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

Jan-1

5

Mar-

15

May-1

5

Jul-

15

Sep-1

5

Nov-1

5

Jan-1

6

Mar-

16

May-1

6

Jul-

16

Sep-1

6

Nov-1

6

Basi

s p

oin

ts

BTP 10y BTP 15y BTP 20y BTP 30y BTP 50y



CHART II.11.b: BID/ASK SPREAD IN BASIS POINTS ON BENCHMARK 3, 5 AND 7 YEAR CTZ, CCTeu, BTP,

RECORDED ON THE MTS PLATFORM

As in 2015, also in 2016 linkers - besides accounting for only a moderate share

of total government bond trading - showed a fairly downward trend with regard to

the bid/ask spread for the first half of the year, as was the case for conventional

bonds, mainly in the 5-year segment which went back to levels in line with those

of the 10-year segment. After September, spreads significantly widened for both

the points. It should be noted that linkers showed, on average, a bid/ask spread

that was several basis points wider than conventional bonds: indeed, linkers’

segment is structurally less liquid, due to a smaller investors base and an

outstanding stock of securities accounting for only a fraction of conventional

bonds stock.

CHART II.11.c: BID/ASK SPREAD IN BASIS POINTS ON BENCHMARK 5 AND 10 YEAR BTP€i, AS RECORDED

ON THE MTS PLATFORM

Less common, but more sophisticated indicators may also be used to measure

liquidity in secondary market, taking into account not only width of bid/ask

0.00

0.50

1.00

1.50

2.00

2.50

3.00

Jan-1

5

Mar-

15

May-1

5

Jul-

15

Sep-1

5

Nov-1

5

Jan-1

6

Mar-

16

May-1

6

Jul-

16

Sep-1

6

Nov-1

6

Basi

s p

oin

ts

CCTeu CTZ BTP 3y BTP 5y BTP 7y

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

Jan-1

5

Mar-

15

May-1

5

Jul-

15

Sep-1

5

Nov-1

5

Jan-1

6

Mar-

16

May-1

6

Jul-

16

Sep-1

6

Nov-1

6

Basi

s poin

ts

BTP€i 5y



spreads but also other aspects, such as price variations caused by larger

transactions or depth of quotations on each side of the order book of every bond8.

These are the Price impact indicator and the Slope indicator. The two

measures are conceptually similar, even if the Slope indicator is a measure

calculated on the basis of buy and sell orders, while the Price impact indicator is

based both on price proposals and trading activity. Price impact indicator

measures the ratio of a (buy or sell) order to price change following the trade9,

whereas the Slope is the ratio of the absolute difference between the best and

the worst quote of a given bond at a given moment and the difference between

the total volume of all quotes in the order book and the volume of the best one.

Plotted as a graph, this ratio generates a straight line for each side (bid and

ask) of the order book - showing performance of bid and ask prices as a function of

quantity sought to be bought/sold by market makers.

Hence, the indicator measures marginal increase/decrease in price that will

be asked by a dealer to negotiate one more unit in addition to the quantity listed

on the best price. Hence, relation between the Slope and market liquidity is clear:

the higher the indicator (the steeper the straight line) the lower the liquidity of

the bond. In order to provide a picture as complete as possible, while drawing the

Slope of a bond for a trading day, the Slope of several individual snapshots is

calculated during the same day and an average is calculated on the basis of these

snapshots.

CHART II.11.d: DAILY SLOPE ON BENCHMARK 10-YEAR BTPs (logarithmic scale) AS RECORDED ON THE MTS PLATFORM DATA

8 An order-book is the list of orders relating to financial instruments available in the market at a given time

and broken down into purchase orders and sale orders, shown in a decreasing and increasing order respectively. 9 In the literature there are a number of studies dealing with this topic, which is quite difficult to monitor

and quantify, as it requires a huge amount of intraday data and is based on subjective assessments, including the threshold to determine the quantity above which price impact of trading is to be assessed; determining the time lag within which price variation due to trading occurs, etc.

0.05

0.50

5.00

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6



As can be inferred from Chart II.11.d, in 2016 the indicator for benchmark 10-

year BTPs grew very moderately, rising from an average value of 0.13

approximately in January 2016 to 0.19 in December 2016.

Repo segment

Government securities Repo market continued to play a key role in ensuring

orderly trading conditions in the spot (cash) market also in 2016. In the last few

years, European legislator substantially reviewed regulation and supervision rules

of financial markets and intermediaries; these reviews often affected Repo

trading, making it more expensive. Notwithstanding this, trading volumes were in

line with those of 2015, with a marginal increase of 1.5%. Market makers played a

major role in total trading volume, even though it is worth recalling that liquidity

in this segment benefits from the participation of a much wider range of operators

than that of the cash market. Compared to 2015, two trends can be observed:

overnight contracts markedly declined (-23%) while Spot/Next contracts increased

further (+5%). Volumes of Tomorrow/Next transactions remained stable (Chart

II.12)10.

CHART II.12: MONTHLY TRADING VOLUMES BY CONTRACT DEADLINE ON THE MTS PLATFORM (in euro million)

Specialists in government bonds on the platform selected for their assessment

Specialists in government bonds play a major role (as for volumes traded on

total traded volumes) on the MTS platform, i.e. the platform selected to assess

them, holding a stable share close to 90%. The remaining 10% was mainly traded

10 Tomorrow/Next contracts become effective the day after they are entered into and expire the following

working day; Spot/Next become effective two days after they are entered into and expire on the following working day; lastly, Overnight contracts become effective on the same day they are entered into and expire the following working day.

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1/2016

2/2016

3/2016

4/2016

5/2016

6/2016

7/2017

8/2018

9/2019

10/2016

11/2016

12/2016

1/2016

2/2016

3/2016

4/2016

5/2016

6/2016

7/2017

8/2018

9/2019

10/2016

11/2016

12/2016

1/2016

2/2016

3/2016

4/2016

5/2016

6/2016

7/2017

8/2018

9/2019

10/2016

11/2016

12/2016

Overnight Spot/Next Tomorrow/Next



by other (non Specialist) Market Makers11, even though their share gradually

declined over the years, from 16% in 2012 to less than 10% in 2016. A residual

share slightly above 1% is traded by dealers other than Market Makers.

CHART II.13: YEARLY VOLUMES TRADED BY SPECIALISTS ON THE MTS PLATFORM (percentage rate)

Specialists in government bonds trading activity with investors

Negotiated volumes

In assessing performances of Specialists in government bonds, Treasury

considers all trading activities in Italian government bonds, i.e. not only including

transactions made on the interdealer platform selected for monitoring purposes,

but also taking in account transactions made on several other trading platforms.

Main source of information about trading activity on these other platforms are the

HRF (“Harmonized Reporting Format”) reports, an EU-wide highly standardised

type of report, which is drawn up by Specialists themselves and in which they

systematically record all activity they do with their clients. This activity may be

performed on trading platforms or at bilateral level, through electronic or voice

communications. As of 2014, this report also include all information on individual

trades made by Specialists (report trade by trade), i.e. security ID and amount

involved in each transaction, counterparty’s type and country, as well as platform

or trading type that has been used.

Unlike the regulated platform, on which 2016 traded volumes picked up over

2015 (mainly thanks to an excellent performance in the middle of the year),

volumes traded on other platforms - whether electronic or not - significantly

11 Under art. 1 paragraph 5-quater of the TUF (Testo unico finanza), a “Market maker” is a dealer or broker

providing services on a continuous basis who undertakes to buy or sell financial instruments at a given price it sets. In order to become a registered Government securities specializing dealer/broker, thus being included in the relevant list of Specialists under Art. 23 paragraph 1 of Ministerial Decree No. 216 of 2009, a candidate must be qualified as a Market maker.

0

10

20

30

40

50

60

70

80

90

100

2008 2009 2010 2011 2012 2013 2014 2015 2016

SPECIALISTS IN GOV BONDS MARKET MAKERS (OTHER THAN SPECIALISTS) OTHER OPERATORS



declined in 2016, mainly in the first part of the year (Chart. II.14), dropping by

over 20% in the first half of the year to then close the whole year with an overall

smaller lowering around 13%.

CHART II.14: MONTHLY VOLUMES TRADED BY SPECIALISTS ON PLATFORMS OTHER THAN MTS (in euro million)

Trading by type of counterparty

Data acquired through HRF reports has become quite important, mainly since

trade-by-trade reports were made available in 2014, allowing to conduct in-depth

analyses on the ongoing developments concerning government bonds investors.

Data featured in the reports can be aggregated to monitor performance by

segments, geographical areas and types of investors as well as liquidity available

on various trading platforms.

With regard to the evolution of demand by type of investor, Charts below

show performance in absolute volumes and net quantities (purchases minus sales)

traded by Specialists with main categories of investors – banks, investment funds,

pension funds and insurance companies, hedge funds. As can be seen from Chart

II.15, also in 2016 main Italian Government bonds investors - both in terms of

absolute volumes and net flows of purchases/sales - were investment funds and

banks. More specifically, trading flows of banks were in line with those of 2015,

whereas net purchases increased slightly over the previous year. Lastly, trading

flows of investment funds remained at the same levels as in 2015 in terms of

turnover, while net purchase volumes - unlike those of banks - showed a regular

downward trend, although remaining always in positive territory.

While maintaining their trading flows steady as for absolute values, pension

funds and insurance companies accounted for small shares of total transactions. In

terms of net purchases/sales, first three quarters saw a positive flow of net

purchases, while in last quarter net sales’ balance exceeded € 2 billion.

Finally, the share of total trading accounted for by hedge funds remained in

line with 2015 level, despite showing an upward trend. Even more important,

hedge funds were, on the whole, large net sellers of government securities, which

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000


2015 2016



became especially evident towards the end of the year, as perception of country

risk worsened.

CHART II.15: QUARTERLY VOLUMES TRADED BY SPECIALISTS BY TYPE OF COUNTERPARTY (in euro million) - FUND MANAGERS, BANKS, PENSION AND INSURANCE FUNDS, HEDGE FUNDS

-10,000

-8,000

-6,000

-4,000

-2,000

0

2,000

4,000

6,000

8,000

10,000

-100,000

-80,000

-60,000

-40,000

-20,000

0

20,000

40,000

60,000

80,000

100,000

IQ 2015 IIQ 2015 IIIQ 2015 IVQ 2015 IQ 2016 IIQ 2016 IIIQ 2016 IVQ 2016

Hedge Funds:Turnover Hedge Fund: net bought amount

-3,000-2,400-1,800-1,200-60006001,2001,8002,4003,0003,6004,200

(15,000)(12,000)(9,000)(6,000)(3,000)

03,0006,0009,000

12,00015,00018,00021,000


Insurance/Pension Funds: turnover Insurance/Pension Funds: net bought amount

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000


Banks: turnover Banks: net bought amount

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000


Investment Funds:Turnover Investment Funds: net bought amount



Trading by geographical locations of counterparties

With regard to trends in demand by geographical area, some differences in

behaviour between Italian and foreign investors were observed in 2016 (see Chart

II.16). Italian investors traded volumes in line with the pace of the last quarters of

2015, i.e. ranging between € 200 and 250 billion per quarter. No major trend to

report as for net traded volumes, which basically remained steady over all

quarters, ranging between 10 and 20 billion euros. Performance of absolute

volumes quarterly traded with foreign investors was identical with that of 2015, as

lowest figures were recorded in the third quarter, followed by an increase in the

fourth quarter. Net volumes’ performance was different: unlike domestic

investors, it followed a downward path that almost completely wiped out the

overall balance in the last quarter.

CHART II.16: QUARTERLY VOLUMES TRADED BY SPECIALISTS BY GEOGRAPHIC LOCATION OF THE COUNTERPARTY (in euro million)

Evolution of the BTP Futures market

As for the price trend of 10-year BTP Futures (by far more liquid compared to

those with 3-year and 5-year maturities), Chart II.17 shows that it was tightly

correlated to the 10-year benchmark BTPs’ trend and performance.

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000


Italy:Turnover Italy: net bought amount

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000


Foreign: turnover Foreign: net bought amount



CHART II.17: PRICE DEVELOPMENT OF BTP FUTURES AND PERFORMANCE OF THE BENCHMARK BTP WITH 10-YEAR MATURITY (right-hand reversed scale in percentage rate).

Moreover, the 10-year BTP Future contract further increased its liquidity in

2016, as can be clearly noticed not only by traded volumes - basically in line with

those of 2015, except in the last quarter of the year when an upward trend was

recorded - but also from developments in open interest12, which showed high

peaks in the last quarter of 2016 (Chart. II.18). These developments plainly

indicate how in a strongly directional market – as in the last quarter of 2016 – an

ever increasing portion of operators (not necessarily Specialists only) uses Futures

contracts to hedge risk instead of selling (or purchasing) securities in the cash

market.

CHART II.18: VOLUMES AND OPEN INTEREST OF BTP FUTURES CONTRACTS TRADED ON TEN-YEAR MATURITY ON THE EUREX EXCHANGE (number of batches and open contracts)

12 Open interest is the number of outstanding (hence not yet expired) future contracts traded in the

market. It can be defined as the sum of all long or short positions open on 10-year BTPs via a future contract at a given time. A strong rise usually suggests a trend in the same direction in a large portion of market operators.

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

Jan-1

7

Feb-1

7

Mar-

17

Apr-

17

May-1

7

Traded volumes Open Interest

1

1.5

2

2.5

3

3.5

4120

125

130

135

140

145

150

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

BTP Future 10y, price BTP 10y, yield



Hence, the use of this instrument by holders of BTPs to hedge risk has grown,

thus making the purchase of Italian bonds more appealing to an ever larger pool of

investors. However, during the year market operators reported that, in their

trading flows in the Futures market, several counterparties had investment

strategies based on macroeconomic analyses, or aimed at hedging risk assumed by

holding positions on domestic asset classes other than public debt. Thus, it cannot

be ruled out that a certain amount of activity on BTP-Futures contracts could not

stem from needs strictly linked to actual transactions on Italian government

bonds; this inevitably had repercussions on the pricing of the latter, as the two

instruments (bonds and Futures contracts) necessarily show a high correlation. The

result is that at some market stages, when the Futures market leads the cash

market and not vice versa, the latter may feel the impact of strategies based on

macroeconomic outlooks (so-called macro-hedges) and/or risk hedging resulting

from operators whose assets belong to some national economy sector13 other than

government securities.

Performance of Italian Credit Default Swaps

CHART II.19: DEVELOPMENTS IN THE PRICE OF CREDIT DEFAULT SWAPS ON ITALIAN DEBT ($) AT 5-YEAR MATURITY AND OF THE 5-YEAR BTP-BUND SPREAD (in basis points)

As can be seen from Chart II.19, in 2016 the price of Credit Default Swap

(hereinafter CDS) on Italian Sovereign bonds with 5-year maturity (shown in USD)

showed a similar trend to that of the 5-year BTP-Bund spread. It should be noted,

however, that the volatility of the BTP-Bund spread was lower than that of CDSs.

Hence, credit risk (which is included in both lines plotted in the Chart) seems to

be lower in the bond market than in the CDS market. A possible explanation for

this difference may be the action of the ECB, which, as already said, steadily

purchased substantial volumes, thus fostering containment and stabilization of

yield spreads between securities involved in the same purchase policy.

13 Such as banks or nationally significant companies.

0

20

40

60

80

100

120

140

160

180

200

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

ITALY CDS USD SR 5Y D14 Corp Spread 5Y BTP


III. PUBLIC FINANCE

III.1 TREND OF THE CENTRAL GOVERNMENT'S BORROWING REQUIREMENT

In 2016 Central government's deficit amounted to € 47,765 million (2.8% of

GDP), down € 11,138 million from the figure recorded in 2015.

The above significant improvement is attributable to the trends of cash

balances between current expenditure and revenue (+€ 3,871 million), capital

balance (+€ 2,399 million), but also to financial transactions (+€ 4,868 million)1.

Among current income items, national tax revenues grew, mainly VAT2 (+€

4,926 million) and gaming taxes (+€ 2,335 million). On the other hand, receipts

from stamp duty3 and EU current transfers (-€ 1,419 million) recorded a decrease.

The latter reduction in particular is due to higher funding provided by EU in 2015

for the closure of EU programming period 2007-2013. Finally, also capital account

revenues increased (+ € 2,779 million)4.

As for outflows, in 2016 there was an increase in transfers to households (+€

2,051 million) due to the cost of the € 80 bonus which, although being a 2015

accrual item, became an actual cash outlay in the 20165 balance sheet. Other

outflows include amounts for overpaid tax refunds and offsets (+€ 1.350 million).

On the other hand, a reduction was recorded in transfers to Poste S.p.A. (-€ 772

million), due to arrears in the service contract dating back since 2012 paid in

October 2015. Lastly, between 2016 and 2015 a significant decrease was recorded

in interest payments on debt (-€ 2,792 million); conversely, interest expenditure

for Treasury accounts slightly increased.

1 In 2015 an outlay of about € 2,900 million was recorded stemming from liquidity lines granted to Local

Authorities to pay commercial debts (Decree Law No. 35 of 8 April 2013, converted with amendments to Law no. 64 of 6 June 2013), in addition to funding to the Regions for early redemption of their bonds (about € 2,800 million). In 2016, granted liquidity lines totalled about € 556 million.

2 The increase in VAT receipts is due to the application of the "Split Payment" mechanism (Law No. 190 of 23 December 2014) and the revenue from advances due 2015 actually paid to the State's residual account in January 2016. The VAT Split Payment mechanism provides that General government’s suppliers receive fees net of VAT; the Public entity will disburse VAT directly to the State Treasury, thus allowing suppliers to avoid the task of first receiving and then repaying VAT amounts.

3 Less revenue from installment payments of virtual stamp duty for the year 2017 compared to the same month of 2015. As explained in Circular no. 16/E/2015 of the Tax Office, the reduction in stamp duty revenues, caused by new ways of discounting the advance, will be recovered in the following months via bimonthly payments.

4 This increase is due to the proceeds from the Italian auction for the L band, the renewal of the Lotto concession, a payment by licensed pharmaceutical companies in order to ensure compliance with public finance requirements relating to the Healthcare deficits for the years 2013, 2014 and 2015 (Decree Law No. 113 of 24 June 2016, converted with amendments to Law No. 160 of 7 August 2016).

5 2016 also includes a sum of about € 600 million for refugees reception expenses.



TABLE III.1 – CENTRAL GOVERNMENT - CONSOLIDATED CASH ACCOUNT (in euro million)

2015 2016

Total receipts (a) 546.027 549.214

Current expenditure 577.184 573.721

including: interest expenditure 74.063 71.271

Capital expenditure 21.316 21.696

Total expenditures (b) 598.500 595.417

Financial transactions: net primary balance -52.473 -46.203

Financial Transactions - Proceeds (c) 1.894 1.573

Financial Transactions - Payments (d) 8.234 3.135

Final Proceeds (a + c) 547.921 550.787

Final Payments (b+d) 606.824 598.552

Central Government Balance -58.903 -47.765

Net interest expenditure 73.361 70.489

Primary balance 14.458 22.724

III.2 REDEMPTIONS, ISSUES AND FUNDING OF THE CENTRAL GOVERNMENT BORROWING REQUIREMENT

Maturities and Redemptions

In 2016, total maturing government securities were € 345,193 million, down

of 8.7% from € 378,204 million in 2015.

In the short-term segment, maturing BOTs amounted to € 160,655 million, a

significantly lower volume than the amount of € 174,552 million repaid in 2015.

In the medium to long-term segment, amounts maturing totalled € 184,539

million, of which domestic securities accounted for € 176,385 million and foreign

securities for € 8,154 million. Again, a decrease was recorded compared to 2015

figure, when total amount of securities redeemed in this segment reached €

203,652, of which € 195,958 million of domestic securities and € 7,694 million

foreign securities.

To the above volume of maturing bonds it must be added the principal

amount of some bonds repurchased in exchange transactions (CTZs, BTPs, BTP€is

and CCTeus), that in 2016 totalled € 11,860 million. Therefore, overall volume of

securities redeemed in 2016 reached € 357,054 million.

However, since the Sinking Fund for government securities was used to the

extent of € 5,659 million, total 2016 expense for securities redemption amounted

to € 351,394 million.

Bond Issues

Government securities issued6 in 2016 amounted to € 399,449 million (down

of 2.58% from € 410,058 million issued in 2015), of which € 3,036 million were

6 The aggregate is calculated by settlement date, not by auction date.

III. PUBLIC FINANCE


placed on foreign markets, while in 2015 foreign issues amounted to € 4,000

million.

In the short-term segment, BOTs issues amounted to € 152,694 million, of

which € 76,669 million on the 6-month tenor and € 76,025 million on the 12-month

one; Treasury did not find it necessary to issue BOTs with non-standard tenors

(quarterly and/or flexible BOTs) to meet temporary cash requirements.

Taking into account also issues resulting from debt exchange transactions (€

9,037 million), total nominal amount of issues in 2016 reached € 408,486 million.

Net issues7 in the year (i.e. cash funding raised by the way of government

securities) amounted to € 63,365 million, thus some € 15.6 billion higher than

Central government's cash balance. This allowed an increase in Treasury's liquidity

of about € 8 billion, while some € 7.6 billion was used to repay other forms of

financing.

A considerable part of these flows is in fact linked to variations in treasury

balance of entities outside General government and, in particular, changes in

treasury account held by Cassa Depositi e Prestiti (CDP S.p.A.) whose total 2016

disbursements exceeded 2015 figures by about € 5 billion. In addition, the above

treasury aggregate takes include redemption of the MEF's share of Buoni Postali

Fruttiferi (Postal Savings bonds) principal amount, whose cash effect in 2016 was

over € 700 million. However, it should be pointed out that, as in previous years,

final figure of about € -7.6 billion was influenced by other flows (for example,

loans granted by European Investment Bank).

TABLE III.2: ISSUES, REDEMPTIONS AND FUNDING OF CENTRAL GOVERNMENT BORROWING

REQUIREMENT (in euro million)

2016

Nominal issues (*) 408.486

Issues net proceeds (*) (a) 415.134

Redemptions (b) 351.769

Net issues (*) (c) = (a) – (b) 63.365

Other sources of funding held at State Treasury (f) = -(d) + (e) – (c) -7.618

Total funding (c) + (f) 55.747

Central Government cash balance (d) -47.765

Change in Treasury's Cash Account 31-12-2016 vs. 31-12-2015 (e) 7.982

(*) Calculated for the full year using settlement date, not auction date

III.3 PUBLIC SECTOR BORROWING REQUIREMENT

Public Sector borrowing requirement (balance), as largely coinciding with the

whole General government8 borrowing requirement, is the reference aggregate to

7 Net issues are calculated by subtracting redemptions and buybacks from issues amount, valued at net

proceeds. In calculating net proceeds, BOTs are included at face value (price 100), since any gap with 100 is paid in advance by State Treasury. Values are calculated as net proceeds for securities repurchased in debt exchanges as well as for CTZs, because the interest component is already accounted for in the Central government's borrowing requirement; finally, redemptions funded with the Sinking Fund (€ 5,659 million) are obviously not included.

8 The two aggregates are calculated on the basis of the same chart of accounts, but differ in the criteria to calculate proceeds stemming from financial asset sales (privatizations). In addition, the Public Sector balance is calculated by State General Accounting Department (MEF) on the generating side (i.e. revenues and payments),



explain intra-annual changes in General government total debt. It is calculated

starting from the Central government balance, with which it shares same criteria

for accounting and classification of transactions, but also includes, with any

necessary accounting consolidation, cash balances of all entities falling within

General government classification.

In 2016, Public Sector borrowing requirement was € 46,278 million (2.8% of

GDP), down by about € 5,800 million from 2015 figure (€ 52,008 million, or 3.1% of

GDP). Decrease is attributable to favourable trends recorded in both final

revenues and payments. In particular, final receipts, amounting to € 811,603

million, were up by € 5,100 million compared to 2015 (+0.6%), as both current and

capital revenues increased, while final payments, amounting to € 857,881 million,

slightly reduced compared to 2015 (€ 858,510 million).

Interest expenditure, which is a factor of Public Sector's cash balance, fell

further compared to 2015, amounting to € 74,261 million, down by some € 2.6

billion from 2015. This reduction was entirely recorded in Central government

interest expenditure, which decreased by about € 2.9 billion compared to 2015,

despite an increase in financial flows directly and indirectly linked to derivative

financial instruments (up from approximately € 3.8 billion in 2015 to € 5.2

billion).9

TABLE III.3: PUBLIC SECTOR – CONSOLIDATED CASH ACCOUNT (in euro million)

2015 2016

Current revenue (a) 796.144 801.402

Capital revenue 5.118 7.540

Financial Transactions proceeds 5.240 2.660

Final Receipts (b) 806.502 811.603

Current expenditure (c) 804.007 807.251

Of which interest expenditure (d) 76.899 74.261

Capital expenditure 44.640 39.900

Financial Transactions proceeds 9.863 10.730

Final Payments (e) 858.510 857.881

Current account balance (a-c) -7.863 -5.849

Primary balance (b-e+d) 24.891 27.983

Balance* (b-e) -52.008 -46.278

*) Balance may not correspond to the difference between the components because of rounding.

while General government balance is calculated by Bank of Italy on the funding side (i.e. the sum of newly issued liabilities).

9 The € 5.2 billion amount of financial flows relating to derivatives include approximately € 275 million of interest on loans arising from the reclassification of derivatives transactions under SEC 2010 Regulation and Eurostat Decision of 2008. This amount, classified as interest expenditure, is therefore included in both General government deficit and Public Sector borrowing requirement. The remaining € 4.9 billion is the net financial balance between derivatives’ outflows and inflows: this directly feeds into the Public Sector borrowing requirement (and not debt under SEC 2010). From an accounting point of view, this amount includes approximately € 730 million to be considered as the 2016 portion of the amortization of loans arising from reclassification of derivatives transactions under the SEC 2010 and Eurostat 2008 decision. Not including this component, net cost of 2016 outstanding derivative transactions was equal for the General Government aggregate at Euro 4.250 million. See Tables 2A and 3A annexed to the "Notification of General government deficit and debt according to the excessive deficit procedure " - Years 2013-16, published by ISTAT on 24 April 2017. For all 2016 details on derivative transactions refer to Chapter IV.

III. PUBLIC FINANCE


FO

CU

S

Effects of eurostat rules on classification of derivative instruments transactions

On 1 September 2014, the new European System of National and Regional Accounts (ESA

2010), adopted as the European Parliament and Council Regulation of 21 May 2013, came

into force. Instructions on how to apply it were gathered into the new Manual on

Government Deficit and Debt (MGDD), which filled out and revised accounting rules for

some financial transactions.

Firstly, swap transactions nettings were definitively excluded from calculation of interest

expense. In fact, even in the previous version of the Accounting System - SEC95 - these

flows were already considered as financial items completely neutral on the "net borrowing"

balance of income account; however, for the purposes of the Excessive Deficit Procedure

(EDP), the relevant balance was calculated including the effect of these flows. All financial

movements originating from other types of derivatives (such as options), on the other hand,

have always been excluded from net borrowing (deficit) without any exceptions.

The other significant change concerned definition of off-market swaps, i.e. swaps that start

with non-zero market value, and extension of this concept to various previously

unaddressed cases.

In the MGDD Manual in force until August 2014 it was clearly established that if a

swap was traded at inception at an off-market rate (thus at a non-zero, negative initial

value for the public entity), that imbalance was to be considered as a loan by the

contract counterparty (typically a bank) therefore being classified as a debt*. This loan

had to be accounted for as an amount owed with amortising instalment to be spread

over the life of the swap, divided into principal and interest,. Should the swap be fully

or partly cancelled, the original "accounting loan" had to be cancelled accordingly. The

issue of such a type of debt appeared as a result of a deliberate choice to underwrite

an unbalanced swap transaction underlying a clear lending component.

In the new MGDD, Eurostat has revised this approach in different ways:

It has decided to leave out of consideration any implicit – even if clear – will of

incorporating lending purposes in a swap. Instead, it exclusively focused on economic

effect at swap inception. Thus, both in the case of swaps bearing a different start date

from the date of signature of the contract (so-called forward starting) and in the case a

swap is the result of an exercised swaption, the fact that financial conditions agreed at

the signature were aligned with market - hence with zero initial mark to market -

becomes ineffective. The value of a swap must therefore be considered from the

moment it begins to actually produce its financial effects, irrespective of the date on

which the contract was signed, and the fact that the derivative value at that date was

zero.

It has for the first time thoroughly considered the issue of swap restructuring, deciding

that contractual aspects prevail over the past history of a transaction. As restructuring

a swap requires a new contract to be signed, whose conditions are of course affected

by changes that initial market parameters have recorded, if at restructuring time the

relevant mark to market is negative for the public entity, the new swap starts off-

market and at that moment a new debt is incurred that is equal in value to the mark to

market, thus generating the synthetic loan described above, even if the original swap

was contracted at market at inception (hence with an initial value of zero)

The only exception to this approach, which was later introduced (the SEC 2010 MGDD

Manual was amended a few months after its first publication), is simple novation, i.e.

replacement of the contractual counterparty, without any change in the derivative

financial conditions: in this case, the principle of contractual discontinuity does not

apply.

The above new rules also affect the way in which the various items that are calculated for

public finance monitoring purposes interact with each other: State budget, Central and

General government working balances, General government net borrowing, Central



government gross debt. Below are shown indications on how to trace the effects of Treasury

derivatives activity in the various official papers that, aiming at different purposes and

under different forms, deal with this issue.

A first source of information can be found in the tables that, in the 6-monthly notification

sent to Eurostat featuring the public finance data required under the Excessive Deficit

Procedure (EDP), combine:

the working balance of Central government with the economic balance – net borrowing

or lending – of the same administration level (Table 2A);

the General government net borrowing or lending with the change in General

government consolidated gross debt (Table 3A). However, evidence of items regarding

Treasury activities, ought to be found in Table 3B, which makes the same link between

Central government net borrowing or lending and change in Central government

consolidated gross debt.

These two tables highlight the flows that take place annually for each required item. In

order, the following is a summary of Table 2A.

TABLE 2A: PROVISION OF THE DATA WHICH EXPLAIN THE TRANSITION BETWEEN THE PUBLIC ACCOUNTS BUDGET BALANCE AND THE CENTRAL GOVERNMENT SURPLUS/DEFICIT (€ millions)

Italy Year

2014 2015 2016

Working balance in central government accounts -74.874 -59.899 -47.831

Financial transactions included in the working balance 18.442 12.656 9.264

Loans, granted (+) 13.684 7.195 2.687

Loans, repayments (-) -1.834 -1.945 -3.154

Equities, acquisition (+) 3.447 350 419

Equities, sales (-) 0 0 0

Other financial transactions (+/-) 3.144 7.056 9.312

of which: net settlements under swap contracts (+/-) 3.314 3.584 4.918

Difference between interest paid (+) and accrued (D.41)(-) 2.561 1.803 -402

Other accounts receivable (+) 4.121 -1.046 -1.705

Other accounts payable (-) -2.621 1.580 -4.186

Net lending (+)/ net borrowing (-) of other central government bodies -356 -108 71

Other adjustments (+/-) 287 -7.229 -2.042

Net lending (+)/ net borrowing (-) (B.9) of central government (S.1311) -52.440 -52.243 -46.831

The purpose of this table - featuring April 2017 Notification data - is essentially to move

from cash accounting, as required in the Central government (the starting line) to an accrual

basis accounting, under which flows stemming from financial entries must be deducted.

Specifically, every year Chapter 2219 of the State Budget records outflows resulting from

swaps, which ought to be deducted, since these flows are not a part of net borrowing

calculation. A specific line in Table 2A** details the amount of these flows: in 2016 € 4,918

million.

In Table 3B***, instead, the starting point is precisely net borrowing (or lending), while the

point of arrival is change in the gross debt level. Thus, it is required to add again those cash

flows that were deducted in the previous calculation. However, adjustments ought to be

made to account for these items that, although being derivative transactions under a purely

juridical point of view, are no longer classified as such under Eurostat accounting rules,

having been classified as debt in previous years.

III. PUBLIC FINANCE


TABLE 3B: PROVISION OF THE DATA WHICH EXPLAIN THE CONTRIBUTIONS OF THE

SURPLUS/DEFICIT AND THE OTHER RELEVANT FACTORS TO THE VARIATION IN THE DEBT LEVEL

AND THE CONSOLIDATION OF DEBT (central government - € millions)

Italy Year

2014 2015 2016

Net lending (-)/ net borrowing (+) (B.9) of central government (S.1311) 52.440 52.243 46.831

Net acquisition (+) of financial assets 29.030 -14.340 10.987

Currency and deposits (F.2) 8.231 -9.993 9.355

Debt securities (F.3) 22 364 0

Loans (F.4) 13.216 -369 -297

Equity and investment fund shares/units (F.5) 87 -6.233 -557

Financial derivatives (F.71) 3.354 2.940 4.188

Other accounts receivable (F.8) 4.121 -1.046 -1.705

Other financial assets (F.1, F.6) -2 -3 4

Adjustments -6.988 578 -6.837

Net incurrence (-) of liabilities in financial derivatives (F.71) 1.829 3.562 4.074

Net incurrence (-) of other accounts payable (F.8) -2.621 1.580 -4.186

Net incurrence (-) of other liabilities (F.1, F.5, F.6 and F.72) -609 -818 -1.160

Issuances above(-)/below(+) nominal value -6.149 -5.234 -6.568

Difference between interest (D.41) accrued(-) and paid(+) -237 1.010 55

Redemptions/repurchase of debt above(+)/below(-) nominal value 299 246 472

Appreciation(+)/depreciation(-) of foreign-currency debt 500 233 20

Changes in sector classification (K.61) (+/-) 0 0 456

Statistical discrepancies 1.389 1.315 -1.919

Change in central government (S.1311) consolidated gross debt 75.871 39.797 49.062

* Please note that the sign convention for net lending/net borrowing is different from Table 2A

As it was mentioned at the beginning of this Focus, when an accounting debt is incurred

under the new MGDD, it is recorded as a loan to be repaid over time, whose instalments

include principal and interest. Hence, this debt profile is declining over time as the principal

instalments become due. In 2016, the sum of the principal instalments relating to

accounting loans resulting from restructured swaps or swaptions exercised in previous

years was approximately € 730 million. Thus, in the linking line named “Financial

derivatives (F.71)” an amount of € 4,188 million (4,918 – 730) is recorded. If, during the

year, for the same reasons, a new merely accounting debt - which does not stems from an

actual borrowing in the market – is incurred, this is recorded in a subsequent adjustment

item named "Net incurrence of liabilities in financial derivatives (F.71)". In 2016 it

amounted to € 4,074 million. However, it must be remembered that the "new debt" items

that were created in the previous year are already included, as loans, in the relevant stock;

so, for example, the € 3,562 million incurred in 2015 are already included in the amount of

that year's stock, already recorded under the item "long-term loans" in Table 1 of the same

notification document.

Moreover, the total cumulative amount of the new accounting loans created by these

reasons accounts for the difference between the mark to market figure of the derivatives

portfolio published in this Report (and also featured in other Treasury statements) and the

stock of derivatives published quarterly by the Bank of Italy in its Financial Accounts

statistics. These being aligned with the Eurostat classification rules, they no longer classify

as derivatives the now crystallised amounts of accounting debt created by off-market swaps



of any nature. Treasury, instead, when it reports the market value of its portfolio, does not

eliminate the reclassified components, since they are formally and financially inseparable

within their relevant contracts.

Thus, for example, given a total mark to market amount at end 2016 of € 38,292 million, a

stock of derivatives of €28,964 million is displayed in the financial accounts.

* In applying this principle to actual cases, even in the case of swap forward starting, the liability has been

accounted for as of the date of signing of the contract.

** Sub-category of “Other financial transactions” called “of which: net settlements under swap contracts”.

*** In this table all the signs are inverted compared with Table 2A, for changes in stocks a negative sign indicates

a reduction rather than an increase.

III.4 GENERAL GOVERNMENT DEBT AND DEBT-TO-GDP RATIO

Following revisions made by ISTAT on GDP10 and by the Bank of Italy11 on

government debt12, debt/GDP ratio for the year 2015 was 131.5%, down by 0.6%

compared to the final figure featured in the April 2017 DEF, and also down 0.3%

from 2014 (after 7 years of steady growth). Specifically, this reduction is

attributable almost entirely to the upward revision of GDP (by about 0.6%), as the

upward revision of debt has been such that it does not affect the change in the

ratio.

The amount of consolidated General government debt at the end of 2016 was

about € 2,218 billion, thus increasing of around € 45 billion compared to the

previous year.

In the light of the above-mentioned revisions made by ISTAT and the Bank of

Italy on GDP and debt respectively, the debt/GDP ratio for 2016 became 132.0%, a

modest increase of 0.5% compared to the revised figure for 2015 and of 0.2%

compared with 2014. Considering that this ratio increased on average by about

4.6% annually from 2008 to 2014, it can be said that in the two-year period 2015-

2016 a substantial stabilisation was achieved.

This result can be mainly attributed to the following factors: nominal GDP

growth, at 1.7% (the GDP deflator was 0.8%); improvement in General Government

borrowing requirement, accounting for about 2.8% of GDP (down € 5 billion

compared to 2015, as described above); a progressive decline in market interest

rates that allowed significant volumes of debt placements to be made at prices

above par (in 2016, issues above par allowed a reduction in debt of approximately

€ 6,500 million, a higher figure than in 2015).

Also important was the use of resources available at the Sinking Fund for

government securities, into which flowed the proceeds stemming from

10 See the ISTAT "National Accounts" Statement of 22 September 2017 11 Source: statistical publications of the Bank of Italy 12 The General government consolidated debt consists of the debt liabilities registered at nominal value

regarding this sector. Sectorial and methodological calculating criteria include the EU Council Regulation n. 549/2013, concerning the European System of National and Regional Accounts (SEC2010) and, more specifically, the EU Regulation n. 79/2009 concerning the Excessive Deficit Procedure (EDP), as modified by Regulations n. 679/2010 and n. 220/2014.

III. PUBLIC FINANCE


privatisations plus other minor proceeds The Fund allowed to redeem some

securities due during the year, amounting to € 5.659 million, equivalent to 0.3% of

GDP. This element more than offset the direct accounting impact on debt - not

captured by the borrowing requirement of General government - due to

derivatives transactions, largely due to the above application of Eurostat rules

(SEC 2010) regarding the inception of interest rate swap (IRS) transactions

originating from the exercise of swaptions. In gross terms, this impact for 2016

equalled 0.24% of GDP13.

As mentioned above, by comparing the final 2016 debt-to-GDP ratio with the

provisional figures included in the April 2017 DEF, it can be seen how this figure

was lower by about 0.6%. This difference can be attributed almost entirely to the

aforementioned upward revision of GDP. Instead, by comparing the 2016

debt/GDP ratio in the April 2017 DEF with the year-end forecasts in the September

2016 DEF Update Note, it can be observed how this had already fallen by 0.2%.

This reduction is mainly due to the downward revision of the debt stock amount,

which was lower than the estimates.

In particular, the reduction in the amount of the debt stock compared to the

forecasts contained in the DEF Update Note of September 2016 is mainly due to

the improvement in public finance balances, with a reduction in General

government borrowing requirement of around 0.4%, and to the proceeds from

privatisations and divestments leading to a reduction of about 0.3%. The debt

reduction due to these factors more than offset an increase of around 0.5% due to

some other circumstances, such as the effect of bringing forward the greater debt

from the previous year and the reclassification as a General government entity of

the National Resolution Fund - established for the rescue of certain banks

pursuant to Article 78 of Legislative Decree No. 180 of 16 November 2015, in

addition to other ordinary statistical revisions.

GRAPH III.1: CHANGE IN DEBT/GDP RATIO IN THE PERIOD 2005-2016

13

In gross terms, the impact was € 4.074 million, as shown in Table 3 annexed to the “Notification of

General government deficit and debt according to the excessive deficit procedure” – Years 2013-16, published by ISTAT on 24 April 2017. In net terms, the impact was slightly above € 3.300 million (about 0,20% of GDP) if loans installments generated by the reclassification of derivative transactions of previous years – as result of SEC 2010 and of previous accounting revisions - are taken into account.

101.9% 102.6% 99.8%

102.4%

112.5% 115.4% 116.5%

123.3%

129.0% 131.8% 131.5% 132.0%

60%

70%

80%

90%

100%

110%

120%

130%

140%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016



III.5 NET BORROWING

The General government net borrowing13, calculated on accrual basis in

accordance with the harmonised European criteria defined in the European System

of National and Regional Accounts (ESA 2010), was approximately € 42 billion in

2016, down of around € 800 million compared to 2015. The ratio of net borrowing

to GDP, equal to 2.5%, was slightly higher (by one tenth of a percentage point)

than the figure indicated in the Economic and Finance Document (DEF) of April

2017, though still being an improvement of a tenth of a point compared to the

previous year.

In 2016, interest expenditure (calculated on the basis of the above-mentioned

accrual basis criterion) has furtherly reduced - - continuing on the downward path

recorded in 2014 and 2015: it amounted to € 66.3 billion, down by about € 1.8

billion compared with 2015. As a percentage of GDP, this aggregate has gone from

4.1 to 3.9%, thus falling by 0.2 percentage points compared with 2015 and a tenth

of a percentage point compared with the figure reported in the April 2017 DEF

(due to the upward revision of the 2016 GDP contained in the data released by

ISTAT in September 2017). The reduction in interest expenditure was almost

entirely due to the Central government and concerned in particular Government

securities for an amount exceeding € 2 billion, a figure that more than offset the

increase in on cash stock held at the State Treasury by non-General government

entities. This trend mainly stems from lowering interest rates, largely due to the

continuation of the BCE's PSPP program14.

TABLE III.4: MAIN GENERAL GOVERNMENT AGGREGATES (in euro million)

2015 2016

Net Borrowing -42.702 -41.937

as a percentage of GDP -2,6 -2,5

Consolidated Gross Debt 2.172.850 2.217.910

as a percentage of GDP 131,5 132,0

Interest expenditure (consolidated)

68.066 66.272


Primary Balance 25.338 24.538


GDP 1.652.153 1.680.523

13 See ISTAT Communique “National Economic Accounts” of 22 September 2017. For data regarding the

reconciliation between the general government net borrowing and the Central government borrowing requirement see the ISTAT tables annexed to the “Notification of general government deficit and debt according to the excessive deficit procedure”, released on October 2017.

14 On the Public Sector Purchase Program (PSPP) see the Focus in previous Chapter. II.


IV. PUBLIC DEBT MANAGEMENT IN 2016

IV.1 GOVERNMENT BONDS TRANSACTIONS ON DOMESTIC AND FOREIGN MARKETS

Treasury issuance policy was primarily geared towards continuing the trend of

reducing exposure to refinancing risk and other market risks - including interest

rate and inflation risks - while maintaining as a guiding principle the regularity and

predictability of issues, in order to ensure the refinancing of debt and allow for a

reduction in its cost over the long term. As has already been pointed out1, this

policy is in fact fully consistent with international best practices and takes into

account the specific feature of the Italian public debt position in terms of size. In

this context, particular attention was paid to lengthening the average debt life

which, after having essentially stabilized in 2014, had started to increase again

since 2015.

Issuing decisions were influenced by the macroeconomic and market context

outlined in Chapter II, as well as by the ECB's extension to 2016 of its Expanded

Asset Purchase Program (APP). Since April 2016, this program has seen an increase

from € 60 to 80 billion in the total amount of monthly purchases and, since June

2016, the opening of a new line for the purchase of Corporate sector securities,

which has been added to the pre-existing ones while leaving the overall ceiling

unmodified. After the first quarter of 2016, the above changes led to an increase

in purchases made via the Public Sector Purchase Program (PSPP) program, which

was launched in March 2015, these making up the major portion of the program.

As far as our country is concerned, these purchases are mainly made by the Bank

of Italy on behalf of the European System of Central Banks2. Moreover, this

increase was only temporary, since - as officially announced on 8 December 2016 -

since April 2017 the ECB again reverted to total net monthly purchases of € 60

billion on all the lines of the program. During 2016, average total monthly amount

of Italian Government bonds purchased via PSPP was the equivalent of about €

10.9 billion.

After the turmoil that had affected much of the two-year period 2011-2012

and the following normalisation of primary and secondary markets in Italian

Government bonds over the two-year period 2013-2014, 2015 saw a general

strengthening, while 2016 recorded a further, significant consolidation.

Since 2015, improvements in market conditions had already translated into a

gradual reduction in borrowing costs, the repositioning of investor demand toward

longer maturities, as well as a full return to normality in those sectors - BTP€i and

1 Cf. I.1 above. 2 On 10 March 2016, ECB announced that purchases via PSPP made directly by the ECB itself were to be

increased from 8% to 10%; the rest being handled by National Central Banks.



CCT/CCTeu – that had been most severely penalised during the worst moments of

the crisis.

CHART IV.1: THE YIELD CURVE OF GOVERNMENT BONDS 2015-2016 (percentage rates)

In this context, yields on short maturities in 2016 recorded new historical low

after they had been already become negative for the first time in 2015, while the

average annual cost of funding - measured on the basis of weighted average yield

at issuance for all types of government bonds - also hit a new absolute low of

0.55%, even below the previous minimum of 0.70% achieved in 2015. Compared

with the previous year, in 2016 it was also possible to reduce the share of

placements in short-term segments by simultaneously increasing long-term ones,

both in the conventional and inflation terms. With regard to the floating rate

segment, the share of CCT/CCTeu compared with total debt was slightly

increased.

Domestic Bonds

BOTs

The 2016 Guidelines did not foresee substantial changes in issuance policy for

the shortest part of the curve. In the light of greater concentration of

redemptions scheduled for 2017, the main objective was to curb the short-term

amounts to be issued, in line with the trend followed in previous years. To achieve

this, Treasury planned to make placements only for the traditional 6- and 12-

month maturities, reserving the right to issue securities with quarterly or flexible

maturities in case of specific cash requirements. No modification occurred in

auction procedures, where operators express their bids in terms of yield, nor in

the scheduling of placements or the percentage reserved for Specialists, which

was still equal to 10% of the amount offered in the ordinary auction.

So over the course of the year the Treasury was able to pursue the objectives

set out in the Guidelines, underpinned by good performance of long-term

-0,11 0,02 0,03

0,62

1,60

2,69

-0,27 -0,17 -0,06 0,36

1,27

2,33

-0,58 -0,29 -0,14

0,62

1,84

2,94

-1,00

0,00

1,00

2,00

3,00

4,00

3 months 1 year 2 year 5 year 10 year 30 year

End of december '15 End of June '16 End of December '16



placements and available cash balances, which remained high for most of the

year.

In 2016 € 152,294 million of BOTs were issued, compared to € 164,130 million

in 2015, resulting in a 7% reduction in the total placed amounts. Gross issues for

the two maturities were nearly identical (€ 76,669 million for the 6-month BOT

and € 76,025 million for the 12-month BOTs). However, due to higher

redemptions, net issuance was negative, especially for the 12-month bond (€ -

7,149 million), while the reduction was more modest for the six-month bond (€ -

812 million), meaning a total reduction of € 7,961 million. Due to high cash

availability, no quarterly or flexible BOT auctions took place during the year.

Total amount of outstanding BOTs was therefore reduced by about € 8 billion,

ending the year at 5.74% of total government bonds which was within the target

range ranging from 3% to 8% as set in the Framework Decree. Compared to

previous years, a quite marked decline has been recorded: in 2012, BOTs' share of

total government bonds was 9.22%, a share that has steadily declined in recent

years.

As is well known, ECB's expansionary monetary policies have resulted in

significantly negative money market interest rates and this was inevitably

reflected in the BOT segment. Indeed, all placements recorded average yields

below zero for both maturities during the year. Weighted average yield showed a

downward trend, with the exception of some auctions where rates recorded

momentary increases. Specifically, the 6-month BOT had the highest yield in the

end-of-February auction (-0.042%) and the lowest in the October auction (-

0.295%). The 12-month maturity BOTs performance was similar: highest yield was

recorded in the February auction and fell to the year-low in the October auction (-

0.238%), then rose marginally in the last two placements of the year3. Downward-

trending rates have led to a fall in demand from traders, which is reflected in a

lower bid-to-cover ratio. Even given equal or slightly reduced offered quantities

compared to 2015, bid-to-cover averaged 1.65 for the 6-month BOTs and 1.60 for

the 12-month, as against 1.74 and 1.70 respectively in the previous year.

Still, demand from buyers remained solid even at the end of June 6-month

BOTs auction, the first after the result of the referendum in favour of Great

Britain's leaving the European Union, which had created a fair bit of volatility even

for short-term maturities. On that occasion, while recording a yield increase of

around 11 basis points compared to the previous auction, bid-to-cover ratio

remained very good at 1.58.

3 During 2017 there were even lower levels, both for 6-month and 12-month BOTs.



CHART IV.2: AVERAGE RATES AT AUCTION OF 6 AND 12 MONTHS BOTs - 2011-16 (percentage rates)

The ECB's government bonds purchases, although not directly involving short-

term securities such as BOTs, continued throughout 2016 and contributed to the

compression of auction yields. Chart IV.2 clearly shows this trend which carries on

without interruption since 2011: in the last year, average interest rate of BOTs

sold at auction was -0.14% for the 12-month and -0.16 % for the 6-month BOTs.

Lastly, relative performance of the short-term segment versus the main

money market rates can be shown by comparing the weighted average yield at

auction with the interbank market rate for the same maturity observed on the

auction day on the Euribor curve. Chart IV.3 clearly shows that in 2016 the curve

for the 6-month BOTs, while alternating in positive or negative territories,

continued to follow the downward trend of the 6-month Euribor, highlighting a

significant correlation between the two rates.

CHART IV.3: YIELDS AT ISSUANCE OF 6-MONTH BOTS VERSUS EURIBOR 6 MONTH RATE - 2015-16 (percentage rates)

^ Chart is based on the auction settlement dates; the end-December issues are settled on the first business day of the following year.

2,41 1,88

0,80

0,43

0,05 -0,16

3,17

2,3

2,30

0,48

0,07 -0,14

-0,50

0,00

0,50

1,00

1,50

2,00

2,50

3,00

3,50

2011 2012 2013 2014 2015 2016

6-month BOT 12-month BOT

-0,40

-0,30

-0,20

-0,10

0,00

0,10

0,20

0,30

0,40

Jan-1

5

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Jan-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

BOTs simple yield Euribor 6 m rate



CTZ

In the CTZ segment, the objective of reducing redemptions for maturities

under two years and extending the average life of the debt stock led the Treasury

to reduce the frequency of issuance of these securities which in 2016 was made

bimonthly rather than monthly, but without significantly modifying usual

quantities placed in each auction.

Treasury therefore issued € 18,991 million of CTZ, a 30.66% reduction

compared to € 27,388 million in 2015. Given redemptions of more than € 26

billion4 (about 5 billion less than in the previous year), net issuance amounted to €

-7,249 million. Past choices on Treasury issues, i.e. a reduction in total amounts

placed in that segment and the introduction of fewer 2016 lines, allowed for an

easing in the total volume to be refinanced in the year. As with BOTs, yields on

CTZs at issuance were consistently negative during 2016 and reached a new

historic low (-0.216%) in September.

Outstanding CTZs fell by € 9,044 million over the twelve months. By the end

of 2016, CTZs accounted for 2.12 % of government securities, compared with

2.68% at the end of 2015.

Therefore, the objective of reducing the share of CTZ in the debt stock by the

end of 2016 compared to 2015 was fully achieved, remaining significantly below

the maximum 5% threshold set in the Framework Decree.

The auction bid-to-cover ratio was always satisfactory, albeit fairly

diversified, with a clear inverse correlation between the offered volumes and the

ratio values. In fact, the highest coverage ratio (2.28) was recorded in the auction

held at the end of December 2015 and settled on 4 January 2016, while the lowest

(1.47) was recorded at the end of November's auction, as the offer of new CTZs

expiring on 28/12/2018 was the highest of the year (€ 3,500 million).

CHART IV.4: YIELDS ON CTZS AT ISSUANCE - 2016 (percentages)

Note: Chart is based on the auction settlement dates; in January two auctions were held

4 Figures do not include early redemptions via debt exchanges, which in 2016 amounted to about € 2

billion.

-0,109 -0,118

-0,063

-0,137 -0,150

-0,216

0,283

-0,25

-0,15

-0,05

0,05

0,15

0,25

0,35

Jan Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec



BTP

In the conventional BTP segments, gross issues (net of debt exchanges)

amounted to € 170,219 million, an increase of 3.44% compared to the € 164,561

million of 2015. The share of fixed rate medium- to long-term bonds (BTPs) as a

proportion of total government securities was 69.65%, up from 67.74% in the

previous year and fully within the 60-75% range set in the Framework Decree.

In the shorter-maturity segment of BTPs, i.e. the 3-year tenor, Treasury

adopted a policy of reducing issues in absolute terms, in line with the objectives

set out in the Guidelines and the strategy outlined in Chapter I. So (net of debt

exchanges), issuance in this segment was € -16,501 million, while in the 5-year

maturities, despite large redemptions, net issues totalled € + 1,524 million.

With regard to the 7-year BTP, which since 2014 has been integrated into the

monthly auction program and sets a benchmark for the Italian yield curve, gross

issues were fully in line with those of 2015, contributing to offset the reduction in

volumes offered on other shorter types of bonds.

The 10-year BTP confirmed its benchmark role for the entire nominal yield

curve, so gross issues were also, as for the 7-year, kept in line with those of 2015.

Net issues, however, were positive to the tune of € 13,047 million, due to the

redemptions profile during the year.

In 2016, in the segments longer than 10 years, Treasury noticed the

emergence of a substantial demand by institutional investors and market

conditions favouring consolidation, at a low cost, of an issuance policy specifically

aiming at reducing interest rates and refinancing risks. Thus, Treasury widened its

offer on the longest part of the curve by proposing - alongside the usual 15- and

30-year maturities - conventional BTPs having the new tenors of 20 and 50 years.

Taking in account market conditions and redemptions scheduled in the year,

the issuing policies therefore modulated the offered volumes for each of the

above types of security, so as to achieve an overall redistribution of the placed

amounts, aiming at fostering longer durations.

In particular, total issued amount on the 15-year maturity was less by about €

7 billion than the previous year, while € 9.5 billion of the new 20-year maturity

bonds were placed. The 30-year segment recorded figures that were substantially

unchanged from the previous year, going from total issues (including off-the-run

securities) of € 14,391 million in 2015 to € 13,695 in 2016. Finally, € 5,000 million

of the new 50-year tenor were placed.

Good market tone at the beginning of the year, partly related with

expectations about upcoming further quantitative easing measures by the ECB5,

allowed the Treasury to meet strong demand from institutional investors for long-

term securities (bearing less compressed yields) through the launch of new

benchmarks, not only in the traditional 30-year segment, but also in segments

(respectively 20- and 50-year) that were unprecedented under a public format.

5 Measures that have become effective since April 2016, see Chapter IV.1 above.



As is well known, for the launch of new securities with more intrinsic

complexity or sectorial demand, the Treasury's issuance method consists of setting

up a syndicate of banks belonging to the group of Specialists in Government

bonds, led by some lead managers (from four to six), while the other Specialists

participate as co-lead managers.6

Thus, in the 30-year segment, on 9 February, € 9,000 million of a new bond

was issued, maturing on 1 March 2047, interest payable from 9 February 2016 and

a coupon of 2.70%. The placement was handled by a group of banks consisting of

Deutsche Bank A.G., Goldman Sachs Int. Bank, HSBC France, JP Morgan Securities

PLC, Monte dei Paschi di Siena Capital Services Banca per le Imprese S.p.A. as lead

managers, while remaining Specialists in Government bond acted as co-lead

managers.

The issue recorded 340 participating investors for a total demand of around €

25.4 billion. More than half of the placement was subscribed by fund managers

(53.1%), while banks took 24.4% of the issue. Operators with a long-term

investment horizon bought 10.3% of the issued amount, of which 6.2% went to

pension funds and insurance companies and 4.1% to Central Banks and Public

entities. Hedge funds received 8.9% of the new bond while non-financial

corporations were awarded approximately 1.4%.

The 30-year BTP placement was extremely diversified in terms of geography

and saw a preponderance of foreign investors, mainly coming from Great Britain

and Ireland, buying 40.8% of the issue, compared to domestic investors who

subscribed 26.5%. The rest of the placement was largely subscribed in continental

Europe (25.3%), in particular Germany and Austria (12.3%), the Scandinavian

countries (3.8%), the Iberian Peninsula (2.8%), France (2.7%), Benelux (2.2%) and

Switzerland (1.3%). Outside Europe, participation of North American investors

(USA and Canada) was significant, accounting for about 5.1% of the issue. Finally,

Asian investors took up about 1% of the issue.

In April, June and November, other tranches of the same security were placed

at auction, which brought total outstanding at the end of the year to € 12.9

billion.

6 The choice of banks as lead managers for a syndicated issue is based on a variety of factors: (i) position in

the ranking based on the overall performance of the Specialists with respect to all primary and secondary market segments; (ii) specific capacity to penetrate the market segment for the particular operation; (iii) quality of comments about suitability, mode and timing of the operation and the proposed techniques to price the issue. If compatible with the overall success of the operation, a residual rotation criterion applies.



CHART IV.5: BTP 1 MARCH 2047 - DISTRIBUTION BY TYPE OF INVESTOR

CHART IV.6: BTP 1 MARCH 2047 - GEOGRAPHIC DISTRIBUTION

In the new 20-year segment, the BTP 01/03/2016 - 01/09/2036 was launched

through the setting up of a syndicate including Barclays Bank PLC, Citigroup Global

Markets Ltd., Crédit Agricole Corp. Inv. Bank, Société Générale Inv. Banking and

Unicredit SpA as lead managers, while other Specialists in Government bonds

acted as co-lead managers. The issue, amounting to € 6,500 million, was settled

on 26 April and the new bond bears a nominal annual interest rate of 2.25%, paid

in two semi-annual coupons, while actual yield was 2.302%. Approximately 320

investors participated in the operation for a total demand of over € 18.9 billion.

Of the total issued, banks (29%) and fund managers (23.3%) were the main buyers,

while also long-term horizon investors such as pension funds and insurance

companies (18.9%) and Central Banks and Public entities (6.9%) were also large

ones. Hedge funds were allocated approximately 13.5% of the amount of the new

Asset manager and Investment Funds

53,05%

Banks 24,37%

Hedge Funds 8,92%

Pension Funds and Insurance

Companies 6,23%

Central Banks and Public entities

4,11%

Non-financial Corporates 1,40%

Others 1,92%

UK / Eire 40,83%

Italy 26,54%

Germany/Austria 12,34%

Canada/USA 5,14%

Scandinavian countries 3,76%

Spain/Portugal 2,76%

France 2,74% Benelux 2,21%

Switzerland 1,26% Others 1,20%

Asia 1,04%

Eastern Europe 0,19%



security. In addition, non-financial companies also participated in the issue to the

tune of about 7.8%. Investor spread was geographically very diverse, with a

significant presence of foreign investors, accounting for approximately 58%,

compared to domestic ones with a 42% stake. Among foreign investors, the largest

share was subscribed by residents of Great Britain and Ireland (20.4%), while most

of the remaining amount was allocated in continental Europe: Germany and

Austria (9.1%), Scandinavian countries (4.1%), France (3.3%), Switzerland (3.2%)

and the Iberian Peninsula (3.2%). Outside Europe, US investors took up 10.1% of

the issue, while about 2.2% of the placement went to Asian investors.

The Treasury offered another two tranches of this issue in the summer, thus

resulting in a total outstanding of € 9.5 billion at the end of 2016.

CHART IV.7: BTP 1 SEPTEMBER 2036 - DISTRIBUTION BY TYPE OF INVESTOR

CHART IV.8: BTP 1 SEPTEMBER 2036 - GEOGRAPHIC DISTRIBUTION

Banks 29,09%


6,89%


Asset manager and Investment Funds

23,33%

Hedge Funds 13,45%

Others 0,47% Pension funds and

Insurance companies 18,94%

Italy 41,94%

UK/Eire 20,40%

USA 10,13%

Germany / Austria 9,08%


France 3.29% Switzerland 3.24% Spain/Portugal

3,16%

Others 2,46%

Asia 2.17%



Finally, at the beginning of October 2016 the Treasury launched the new 50-

year maturity segment, benefiting from favourable market momentum and

entering an ultra-long segment of the yield curve where, in the first half of the

year, several sovereign European issuers had appeared. Low inflation expectations

and ECB purchases on the secondary market had turned investor demand toward

assets with a more marked risk and yield profile.

The BTP 01/09/2016 - 01/03/2067 was offered through a placement syndicate

consisting of six lead managers (Banca IMI SpA, BNP Paribas, Goldman Sachs Int.

Bank, HSBC France, JP Morgan Securities PLC and Unicredit SpA) while the

remaining Specialists in Italian Government bonds acted as co-lead managers. 370

investors participated in the operation, casting a total demand of approximately €

18.6 billion; an issue amounting to € 5,000 million was settled on 11 October.

Yield at issuance was equal to 2,85%, given the nominal rate of 2.80% to be paid in

two semi-annual coupons.

The above amount was subscribed by fund managers to the tune of about 45%

and by banks for 23%. Long-term horizon investors bought about 17.2% of the

issue, of which 13.3% were pension funds and insurance companies, while Central

Banks and Public entities totalled 3.9%. Hedge funds accounted for about 14.5% of

the amount of the new security. Foreign investors' participation (83.2%) was

considerably higher than that of domestic investors (16.8%). Among foreign

investors, largest share of 32.1% was subscribed by residents of Great Britain,

while about 35.1% was placed in continental Europe, notably Germany and Austria

(11.5%), Scandinavia (7.2%), France (6.3%), the Iberian Peninsula (4.9%) and

Switzerland (2.4%). Outside Europe, North American investors bought around

12.5% of the issue, while Asian investors subscribed to about 3.4% of the

placement.

CHART IV.9: BTP 1 MARCH 2067 - DISTRIBUTION BY TYPE OF INVESTOR

Asset managers and Investiment Funds

45,1%

Banks 23,0%

Hedge Funds 14,5%

Insurance Funds 8,8%

Pension Funds 4,4% Central Banks and Public entities

3,9%




CHART IV.10: BTP 1 MARCH 2067 - GEOGRAPHICAL DISTRIBUTION

With regard to the cost of financing, yields at issuance on conventional BTPs,

which in the past two years had recorded a marked decline for all tenors, further

dropped in 2016. In detail, weighted average yield on nominal BTPs - measured at

issuance - was 0.06% for the 3-year, 0.41% for the 5-year, 0.87% for the 7-year

segment, 1.40% for the 10-year segment, 1.85% for 15-year BTPs, 2.17% for 20-

year BTPs, 2.74% for 30-year BTPs, and 2.85% for the 50-year segment. In 2016,

overall weighted average yield on conventional BTPs was 1.14%, compared to

1.31% in 2015.

Bid-to-cover ratios at auction were basically in line with those of 2015, with a

minimum of 1.28 (recorded in the auction of 5-year BTPs at the end of August,

against a very large offering of € 4.5 billion as it was a new security) and a

maximum of 2.49 for off-the-run BTPs 2030, of which € 706 million were placed at

the mid-April auction jointly with the first reopening of BTP 2047 (an amount of €

1,294 million). For BTPs, too, lower offered volumes generally corresponded with

a higher bid-to-cover ratio.

CHART IV.11: YIELDS AT AUCTION FOR BTPS MATURING BETWEEN 3 AND 10 YEARS - 2016 (percentage values)

UK 32,1%

Italy 16,8%

USA and Canada 12,5%

Germany/Austria 11,5%


France 6,3% Spain/Portugal 4,9% Asia 3,4%

Other European countries 2,8%

Switzerland 2,4%

0,02 0,11

-0,05 0,05 0,04 0,08

-0,04 -0,02 0,03

0,30

0,57 0,42

0,44 0,34 0,49

0,40 0,33 0,26 0,19 0,28

0,57

0,91 0,99 1,05

0,79 0,82

0,87 0,83 0,63 0,69 0,83

1,37

1,59 1,44 1,50

1,24 1,51

1,42 1,35

1,24 1,14 1,21

1,60

1,97

-0,50

0,00

0,50

1,00

1,50

2,00

2,50

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

BTP 3 years BTP 5 years BTP 7 years BTP 10 years



CHART IV.12: YIELDS AT AUCTION FOR LONG TERM BTPS - 2016 (percentage values)

Inflation-Indexed Securities: BTP€i and BTP Italia

In the inflation-indexed segment, Treasury placed both the BTP€i, a bond

indexed to European inflation (net of tobacco products) with revaluation of the

capital at maturity, and BTP Italia, a financial instrument indexed to Italian

inflation (FOI Index, without tobacco - Consumer Price Index), whose capital

revaluation is paid on a 6-month basis together with the coupon.

CHART IV.13: ACTUAL YIELDS ON BTP€is AT AUCTION - 2016 (percentage values)

As regards the BTP€i, Treasury launched a new 5-year benchmark bond in

May, using a placement syndicate formed by Banca IMI SpA, Nomura Int. PLC,

Royal Bank of Scotland PLC and UBS Ltd as lead managers, while all other

Specialists in Government bonds acted as co-lead managers. Even though, on a 5-

year maturity, a new bond is usually offered directly at auction, in this case a

different choice was made, as it was judged suitable to shift the coupon cycle

2,03

1,84

1,99

1,57

1,77

2,30

1,88 1,91

2,76

2,49 2,49

3,14

50-year ; 2,85

2,08

1,71 1,90

2,44 2,28

3,05

1,00

1,50

2,00

2,50

3,00

3,50


15-year 20-year 30-year 50-year off the run BTP(from 14 to 30 years residual maturity)

2,03

1,84

1,99

1,57

1,77

2,30

1,88 1,91

2,76

2,49 2,49

3,14

30-y BTP €i; 2,85

2,08

1,71 1,90

2,44 2,28

3,05

1,00

1,50

2,00

2,50

3,00

3,50


5-y BTP €i 10-y BTP €i 15-y BTP €i 30-y BTP €i off the run BTP €i (10-y residual maturity)



from the usual March-September to the new May-November, not only aiming at

diversifying interest payment dates, but also because the seasonality of European

inflation has changed and the May-November cycle is now more neutral. Since

inflation-linked segment is more difficult to value, given the new coupon cycle it

was considered appropriate to adopt an issuance mechanism entailing a detailed,

interactive pricing process, such as that provided by a syndicated issue. An

amount of € 3,000 million of the BTP€i 15/05/2016 - 15/05/2022 was issued,

bearing a real annual coupon of 0.10% settlement was on 25 May. Previous issue in

this segment had been in January 2015.

Overall demand, stemming from about 110 investors, was over € 5.7 billion.

Investment funds accounted for approximately 44.4% of the issue, 33.4% was

subscribed by banks and 14.3% by hedge funds. Participation by investors with a

long-term investment horizon was limited, with 3.8% going to Pension Funds and

insurance companies and 1.7% being allocated to Central Banks. Non-financial

firms bought 2.5% of the offered amount.

As for as geographic diversification, foreign investors subscribed about 63.5%,

while domestic investors were awarded the remaining 36.5%. Among foreign

investors, the largest share was subscribed by UK residents (19.9%), while the

remaining amount was allocated mainly in continental Europe, and in particular in

the Netherlands (10%), Switzerland (5%), Germany and Austria (4.8%), France

(3.2%) and the Scandinavian countries (2.7%). Outside Europe, North American

investors bought about 12.7% of the issue and Asian ones about 2.7%.

Further issues during the year, in July and November, led the total issued

amount just below € 5 billion.

Gross nominal issues of BTP€is totalled € 12,422 million, slightly lower than

the amount placed in 2015, while a 5-year bond was redeemed for an amount of €

9,783 million including revaluation. In detail, with regard to on-the-run securities,

placements were made of € 4,942 million in the 5-year segment, € 2,081 million in

the 10-year segment, € 2,691 million with 15 year-maturity and € 707 million in

the 30-year segment. In addition, Treasury re-opened an off-the-run bond with a

residual life of 10 years for a total of € 2,002 million.

Weighted average yield at issuance, including inflation expectations, stood at

1.25% in 2016 compared to 1.76% in the previous year.

The value of outstanding BTP€i revalued for inflation increased by an amount

of € 3,342 million over the twelve months and stood at 7.89% of the stock of

government bonds, which is essentially the same as was recorded at the end of

2015 (7.94%).



CHART IV.14: BTP€i 15 MAY 2022 - DISTRIBUTION BY TYPE OF INVESTOR

CHART IV.15: BTP€i 15 MAY 2022 - GEOGRAPHICAL DISTRIBUTION

Regarding Italian inflation, in accordance with the Guidelines for 2016 which

scheduled two placements per year (mainly to give retail savers the opportunity to

reinvest liquidity stemming from redeeming securities), Treasury offered two new

bonds, once again on the 8-year maturity.

The first bond, maturing in April 2024, and settled on April 11, bears a real

coupon rate of 0.40%, to be paid with two semi-annual coupons. Issued volume

amounted to € 8,014 million, that corresponds to the total value of the contracts

validly purchased at par on the MOT (the Borsa Italiana’s screen-based market for

securities and government bonds) through Banca IMI S.p.A. and UniCredit S.p.A.

During the first phase of the placement, dedicated to retail investors, held

between April 4 and 6, 54,635 contracts were entered into, for a total amount €

4,214 million, of which 45% were transactions of less than € 20,000, while if the

threshold is set at Euro 50,000 it encompasses about 75% of the total. The share

Asset managers and Investment Funds 44,45%

Banks 33,36%

Hedge Fund 14,25%

Insurance Funds 2,77% Non-financial

Corporates 2,50%


1,67% Pension Funds

1,00%

Italy 36,47%

UK 19,87%

USA 12,67%

The Netherlands 10,00%

Switzerland 4,97%

Germany / Austria 4,81%

France 3,23% Scandinavian countries 2,67%

Asia 2,67%

Other European countries 2,65%



subscribed by private banking was higher than that of individual investors, 63%

versus 37%. As for geographical breakdown, about 93% is estimated to have been

subscribed by domestic investors, while 7% was placed abroad.

In the second phase of placement, dedicated to institutional investors,

Treasury decided to limit the offer for this category of investors to € 3,800

million. The session for submission of offers on the MOT platform took place on

the morning of 7 April. Received applications were 550 for a total value of € 5,109

million; demand was only partially met, leading to proportional rationing. Out of

the € 3,800 million actually issued, 53% was allocated to banks, 23% to asset

managers and 19% to medium to long-term horizon investors, i.e. insurance

companies and pension funds (13%) and Public entities (6%). The rest was

allocated to non-financial companies for a total of about 4% of the issue. During

the second phase of the placement, it was estimated that Italian investors played

a major role accounting for about 89%, while the remaining share was mainly

allocated to European investors from the United Kingdom and Ireland (5%), France

(3%) and Benelux (2%).

The second issue of BTP Italia took place on 24 October, also offering a

maturity of 8 years but a definitive annual coupon rate of 0.35%. Issued amount

was € 5,220 million, stemming from the total value of the purchase contracts

validly concluded at par on the MOT through BNP Paribas and Monte dei Paschi di

Siena Capital Services Banca per le Imprese SpA.

During the first phase of the placement, which took place from 17 to 19

October, 31,019 contracts were signed for a value of € 2,220 million, of which 46%

were below € 20,000 and 76% below € 50,000 euros. In this phase, the share

subscribed by private banking was greater than that of individual investors, 70%

versus 30%. As for the geographical distribution of received orders, about 95% is

estimated to have been subscribed by domestic retail investors, while 5% of orders

came from abroad.

In the second phase of the placement, which opened and closed on 20

October, the number of finalized contracts was 293 for a value of € 3,319 million,

corresponding to an amount actually issued of € 3,000 million, of which about 59%

was placed to banks, 24% to asset managers, 14% was subscribed by insurance

companies and pension funds, while the remaining 3% was allocated to non-

financial corporations and foundations. At this stage of the placement of this BTP

Italia, too, Italian investors played a decisive role (98%), while the rest of this

phase of the issue was placed with European investors residing in the United

Kingdom and Germany.

During 2016, the stock of BTP Italia fell by € 13,814 million euros, given the

redemption of three bonds issued in 2012 for a revalued capital of over € 27

billion. At the end of the year, this segment represented 4.82% of the stock of

government securities, compared to 5.72% at the end of 2015.

Overall, the linkers segment, made up of BTP€i and BTP Italia, totalled Euro

237,350 million at year-end, an amount – taking inflation into account - which was

down by 4.23% on the € 247,821 million of 2015. This segment represented 12.71%

of total stock of government bonds at the end of 2016, compared with 13.66% in

the previous year. It has therefore remained well below the 15% threshold set by

the Framework Decree for 2016, while overall exposure to inflation has declined.



CCTeu

In the floating rate segment, broad normalisation of quotations and

transactions on the secondary market led to conditions favourable both to run

regular monthly CCTeu issues and to offer new benchmark securities with a 7-year

maturity.

Overall, gross CCTeu issues amounted to € 28,854 million as against

redemption of € 13,395 billion of an old CCT, thus increasing of 4.91% compared

to the € 27,503 million placed in 2015.

Weighted average yield, measured at issuance, was 0.54%, down from 0.76%

in 2015. This segment, too, was affected by increasing uncertainty arising from

the approaching of the date set for the constitutional referendum: last tranche of

CCTeu, settled at the beginning of December 2016, was placed at a 0.99% rate.

Total amount of outstanding CCT and CCTeu increased by € 13,526 million

over the twelve months. At the end of 2016, floating rate securities amounted to

7.21% of the stock of government bonds, compared with 6.68% at the end of 2015.

This share remained well within the range of 5-10% provided for in the Framework

Decree and is consistent with the announced strategy of keeping it at low level,

while taking into account market conditions.

Characteristics of buyer demand at auction for nominal BTPs

HRF data received by Specialists (mostly those related to trading activities

with end customers immediately before and after each auction) allow to monitor

and evaluate the dynamics of the composition and evolution of the types of

investors involved in government bonds subscription. In fact, more than 99.5% of

total volumes issued at auction were purchased and traded through the

Specialists. This section focuses on auctions of conventional BTPs, which account

for over 44% of total bonds issued in 2016.

From the point of view of the composition by type of investors demand,

banks, investment funds and hedge funds have generally purchased between 80%

and 90% of total issued amount. In particular, investment funds continued to

represent on average about 40% of demand at auction and, with the exception of

December (when the offering of BTPs was considerably lower due to the

cancellation of the mid-month auctions), their range was always between 30% and

50%. Data do not, in fact, show any particular trend in the participation of this

type of investor.

Participation of banks was equally important, averaging 30%, though with a

much more volatile presence. On average, hedge funds accounted for about 16%

for the whole 2016, a slightly higher level than in 2015. These investors peaked in

May, June and October, all months marked by significant movement, either up or

down.

The role of Central Banks7 was not negligible, standing at an average of 7%,

mainly concentrated in March, June and December. The role for pension funds and

insurance companies was marginal, contributing to overall demand by less than

7 Purchases under the PSPP are not included, not only because the Central Banks of the Eurozone cannot

buy on the primary market but also because the HRF report excludes the related flows on the secondary market.



1%. Conversely, participation of non-financial corporates and retail investors was

more significant, representing about 7% of overall auction volumes.

CHART IV.16: COMPOSITION BY TYPE OF INVESTOR OF ORDERS PLACED AT AUCTIONS OF CONVENTIONAL BTPs BY SPECIALISTS IN GOVERNMENT BONDS - 2015-2016

Characteristics of auction demand for conventional BTPs in terms of geographic

residence

2016 demand stemming from domestic investors can be divided into three

different periods: the first four months, which recorded increasing participation

until reaching a peak in April; the second four months, featuring less active

domestic investors, averaging around 28%; and the last four months which,

starting with a particularly high share (more than 41%), had a markedly declining

trend eventually ending at a share of just over 22% in December. Annual average

percentage of domestic demand was 31% of the total. Foreign demand, then,

moved mirroring: net of the above months, it grew, albeit somewhat unevenly by

geographic areas of the world. In 2016, too, the share of North American

investors, which averaged around 32% of total demand at auction, was very

significant and continuous; this share also increased significantly - as a percentage

of final demand - in the final months of the year. Demand from Europe-based

investors was more unstable, usually showing a complementary profile to domestic

demand. During the year, net of notable fluctuations, this component accounted

on average for about 30% of the total. Demand stemming from other areas of the

world averaged 5% of the total one, with a significant peak in June and very low

values in April, May, July and November.

0%

20%

40%

60%

80%

100%

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

Investment Funds Banks Hedge Funds

Central Banks & other public entities Insurance Companies Pension Funds

Corporate&Retail



CHART IV.17: COMPOSITION BY GEOGRAPHIC PROVENANCE OF ORDERS PLACED AT AUCTIONS OF CONVENTIONAL BTPs BY SPECIALISTS IN GOVERNMENT BONDS

Debt exchanges and buybacks

Consistent with what was announced in the 2016 Guidelines, Treasury carried

out several operations aimed at reducing the concentration of redemptions

scheduled in 2017, taking advantage of favourable market windows that opened

during the year.

More specifically, Treasury did not undertake buyback transactions, but

carried out five debt exchange transactions in March, May, June, September and

November. As usual, the electronic trading system was used to operate directly

and dynamically on the Wholesale Regulated Secondary Market (MTS) platform.

Main goals of these transactions are to correct any secondary market dysfunctions

- caused, for example, by the scarcity of a certain bond on the cash or Repo

market - and to smooth out redemptions profile, in order to avoid redemptions’

overcrowding and to curb Treasury's refinancing risk.

As was already mentioned, in choosing bonds to be bought back, Treasury

preferred to focus on securities maturing in 2017 and, to a lesser extent, in 2018.

Issued bonds, on the other hand, were selected among the most demanded on the

secondary and in the repo markets. The choice of issuing securities with longer

maturities than those repurchased also helped extend the average life of

Government bonds.

During the year, five BTPs were issued with maturities ranging between 2023

and 2034. On the repurchase side, securities were selected in the 2017-18 area,

mainly BTP (about 69% of the total redeemed), in addition to CCTeu (16%) and CTZ

(15%).

In each debt exchange transaction, prices of issued securities - largely above

par and above the prices of the bonds withdrawn from the market - resulted in a

nominal reduction in the stock of debt, repurchased nominal amount being higher

than nominal issued amount by almost € 2,792 million in total (as shown in the

following Table IV.1).

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Jan-1

5

Feb-1

5

Mar-

15

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Oct-

15

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Mar-

16

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Nov-1

6

Dec-1

6

Italy Europe America Others



TABLE IV.1: SUMMARY OF 2016 DEBT EXCHANGE TRANSACTIONS (nominal amounts in euro million)

Settlement Date Issued Bond Redeemed Bond Issued Amount Redeemed Amount

Type Year of Maturity Type Year of Maturity

08/03/2016 BTP 2028 BTP e CCTeu 2017-18 1.627 2.055

10/05/2016 BTP 2034 BTP, BTP€i e CCTeu

2017-18 1.910 2.562

21/06/2016 BTP 2023 BPT, CTZ e CCTeu

2017-18 2.000 2.363

09/09/2016 BTP 2028 BPT, CTZ e CCTeu

2017-18 2.000 2.685

08/11/2016 BTP 2033 BTP, CCT e CCTeu

2017-18 1.500 2.164

The above-mentioned debt exchanges allowed to repurchase outstanding

government securities for a total amount of almost € 12 billion (of which € 7.1

billion were maturing in 2017), an increase over the € 5.7 billion euros of 2015. As

was the case in 2015, there were no bond buybacks in the market during the year

(Chart IV.18).

CHART IV.18: AMOUNT REPURCHASED IN BUYBACKS - 2012-16 (nominal amounts in euro million)

In 2016, the resources of the Sinking Fund were used, in April and November,

for the partial redemption of two maturing BTPs, for a total amount of € 5,659

million. The two transactions had a positive effect on Treasury liquidity

management, enabling it to reduce redemptions funded with the Cash Account

thus avoiding a further increase in the amounts issued in 2016.

0

2.000

4.000

6.000

8.000

10.000

12.000

14.000

2012 2013 2014 2015 2016

Debt exchanges Buybacks (via Cash Account) Buybacks (via Sinking Fund)



TABLE IV.2: REDEMPTIONS MADE AT MATURITY VIA THE SINKING FUND IN 2016 (nominal amounts in euro million)

Maturity Date Redeemed Bond Redeemed Amount

Type Year of Maturity

15/04/2016 BTP 2016 3,707

15/11/2016 BTP 2016 1,952

Foreign Bonds

In order to diversify the base of institutional investors in Italian government

bonds and reduce issuance costs, Treasury may issue securities on international

markets using various channels under standard international documentation: the

Commercial Paper, the Global Bond Program and the Medium Term Note Program.

The first instrument is designed to be a complement of BOTs in the international

market because of its characteristic: indeed, it is a short term security and it is

highly flexible in duration, amount and currency. The Global Bond Program is

geared towards high profile institutional investors in the USD market and is very

diversified as for geographic spread. Lastly, through the MTN Program Italy may

issue securities, both in a public or private format, that are mainly directed to

European and Asian investors who are interested in holding euros or other

currencies in their portfolio.

Commercial Paper

Treasury used to tap foreign money markets through its Commercial Paper

Program in recent years. Thanks to its extreme flexibility, terms and maturity, CP

have been structured precisely to meet both the Treasury cash-flow needs and the

investors amount and/or credit requirements. The Notes may be issued at a

discount (so they will not bear interest) or may bear fixed, floating or index-linked

rate of interest.

However, no Commercial Papers were issued during 2016, given the absence

of specific very short term Treasury cash requirements, in line with the objective

of lengthening the average life of debt and as a consequence of the reduction in

the BOTs issues (linked to Commercial papers): this segment, as mentioned above,

resulted in net negative issuance of about € 8 billion.

Global and MTN Programs

During 2016, financial market conditions have not been favourable to Global

Bond issues, in particular because Treasury is not equipped with a system of

collateralisation able to reduce the hedging cost of cross currency swaps.

Four private placements under the MTN Program were transacted, all

denominated in euros, three executed during the first half and one in the second

half of the year. One of the bonds is linked to European inflation (Harmonised

Index Excluding Tobacco - HICP exTo) with the same indexation as the BTP€i.

This latter is a 30-year bond, while the others were fixed-rate bonds with a

duration ranging from 13 to 15 years. All these issues benefited from an interest



rate discount with respect to the corresponding domestic bonds yield curve, thus

reducing the cost of debt.

Issued volumes amounted to € 3,036 million. As of 31 December 2016, actual

foreign bonds outstanding after currency swap was 2.56% of the stock, slightly

below the 2.89% recorded at the end of 2015.

TABLE IV.3: PRIVATE PLACEMENTS UNDER THE MTN PROGRAM

Notional (€m) Settlement Date Maturity Type Coupon

636 04/05/2016 04/05/2046 Nominal 1,483%

800 18/05/2016 18/05/2029 Nominal 1,913%

700 22/06/2016 22/06/2031 Inflation 1,901%

900 17/10/2016 17/04/2027 Nominal 1,448%

IV.2 MANAGEMENT OF THE DERIVATIVES PORTFOLIO

As described in greater detail in Section IV.3 below, the debt-related

derivatives portfolio includes: cross-currency swaps (CCS) to hedge foreign

currencies bonds and interest rate swaps (IRSs) to hedge bonds issued under the

MTN program, mostly denominated in euros. In addition, it includes euro-

denominated transactions aimed at lengthening duration and average refixing

period, to hedge against the risk of an interest rate rise on the entire debt

portfolio: IRS, which in some cases are associated with cancellation or extension

swaptions, and stand-alone receiver swaptions, i.e. not linked to pre-existing IRS.

Lastly, the portfolio includes IRS to hedge liabilities of the Infrastrutture Stock

Company, a responsibility that was passed on to Treasury by the 2007 Budget Law.

In 2016, mark-to-market of the derivatives portfolio remained markedly

negative, as well as the government bond portfolio that showed a market value

far above the nominal value8 due to same reasons, as will be better explained

later. The aforementioned trend, in current market phase, is the inevitable and

direct consequence of the assurance policy of mitigating - in accordance with

international best practices9 - the risk of interest rates on the debt, by increasing

the long-term fixed interest rate on the total debt portfolio, both at time of

securities issuance and later on using derivative instruments, where necessary. In

fact, Treasury’s derivatives portfolio is intended to contribute - along with

issuance policies - to mitigate interest rate risks, therefore contributing to

increase the share of long-term fixed rate instruments in the overall debt

portfolio, rather than floating rate instruments that are subject to interest rates

changes. Its rates were set at levels consistent with the market conditions of the

periods during which. over the years, transactions were settled. A portfolio of

derivatives geared towards this purpose tends to have longer financial duration

and average refixing period than the underlying debt10, by this way increasing

8 Cf. Tab- IV.8 below. 9 Cf. Chap. I.1 above. 10 Given that increasing financial duration and average refixing period are key goals in managing Treasury's

Derivatives Portfolio, these transactions are, for the sake of brevity, referred to in Treasury's own documentation as “duration IRS”, so as to summarize in the same brief definition the types of transactions that make up the



these risk indicators for the entire debt portfolio (thus reducing risk), to the

extent that will be analytically described in following paragraphs.

This increase occurs even though the derivatives notional total amount is a

minor share of the overall debt notional; on the other hand, however, the

extremely low level of interest rates in 2016 led to a negative value of the

derivatives portfolio even this year (as well as, at the same time, to a market

value of government securities portfolio exceeding nominal amount).

In the light of these market developments and the debt management goals for

2016, given the actual constraints of banking regulations coupled with the lack of

collateralisation, 2016 Guidelines limited any derivative transaction only to

operations intended to improve the overall structure of the existing portfolio in

the light of current market conditions. As a consequence, actions carried out

mainly concerned swaptions to be exercised within the year, in order to reduce

the (purely accounting) increase in debt arising from the generation of the

underlying off-market swaps, as would be the result of the application of the

European Harmonised System of Accounts SEC 201011 (approved after the

execution of the transactions).

In this Section, information on 2016 derivative transactions is provided, while

the overall results of Treasury derivatives management and issuance activities are

shown in the following Section IV.3.

Firstly, in the early months of the year, the Treasury worked jointly on a

cross-currency swap and a receiver swaption with the same bank counterparty.

Specifically, the positive mark-to-market of a cross currency swap expiring on 12

June 2017 was used to repurchase an option held in portfolio and sell a new one

with a lower strike. The CCS in question is a dollar/euro swap through which a $2

billion bond bearing a coupon of 5.375% was converted via a derivative into a

fixed-rate, euro-denominated liability. The action taken was to make the euro

leg's notional equal to spot value (by changing the reference dollar/euro exchange

rate), starting from 12 December 2015 (in order to modify the coupon in its

entirety).

As a result of this euro leg reshaping, the swap market value was almost

cancelled, and the difference between pre and post operation mark-to-market

was used to restructure the option in the portfolio.

Basically, this was a repurchase of a swaption with exercise in 2016 with a

3.5% strike and an underlying 30-year swap of € 1 billion, which had a negative

mark-to-market. The new option entailed a swap with same characteristics except

for the fixed rate to be paid by Treasury, which was reduced by 130 basis points.

Though this swaption too was exercised, the resulting debt increase was just over

€ 300 million, thus about half of what it would have been without this

intervention. It should also be noted that the new 30-year swap helps to extend

the duration of the entire debt portfolio and provides protection against a rise in

interest rates, at an extremely low rate which is below the average rate of the

"duration IRS" strategy in which the swap has been included.

A second restructuring took place on a receiver swaption, with a notional

amount of € 4 billion, with exercise within the year, 4.225% strike and with a 7-

main part of the IRS portfolio, without need to repeatedly explain in detail concepts, goals and results that are deeply described in this document.

11 Cf. Chap. I.1 above.



year underlying swap. Again, the exercise of the swaption and the consequent

start of the underlying off-market swap would have given rise to a considerable

increase in debt (even if only in accounting terms) according to the new SEC 2010

accounting standards, corresponding to the mark-to-market of the underlying

swap (over € 1 billion).

The pursued strategy was to replace the old option with a new instrument,

specifically a 30-year par interest rate swap coupled with a payer option. The

notional of the new 30-year IRS, on which the Treasury every six months receives

6-m Euribor and pays a fixed rate of 1.11646%, was € 4 billion. This swap was

coupled to a payer swaption, which can be exercised by the bank at the following

sixth year (15 June 2022). In the event that it is exercised, the swap will be

deleted: the exercise of the option will give rise to a new swap (mirror swap) with

equal but opposite flows with respect to the original one, therefore essentially

cancelling the original swap.

In the case that the option is not exercised, the swap will remain in force

until its maturity, but with a resetting mechanism for the paying leg. Every six

months, the fixed rate will be reset at ATM (at the money) rate of a swap with the

corresponding maturity, cancelling the value of the derivative and accordingly

settling its mark-to-market: if negative, the amount will be paid by the Treasury,

if positive the Treasury will receive it.

However, the premium of the new swaption was not enough to fully fund the

repurchase of the original one already in the portfolio. Thus, for the residual

value, payment to the counterparty was agreed on in five instalments, to be paid

from 2016 to 2020 without interest.

Again, according to the Guidelines goals, the operation has been put in place

to curb the accounting debt increase (an increase of € 500 million instead of € 1

billion).

Finally, a € 2 billion swap maturing in March 2016 but extendable by the

counterparty for 20 years was terminated early by that counterparty. In fact,

there was an early termination option (ETO) linked to a credit event, which could

be exercised from 2011 and every five years thereafter. While in 2011 conditions

required for the clause to be exercised were not fulfilled, in 2016 - as a result of

the 2012 change in the Italian Republic's credit rating- the clause became

actionable. Therefore, at the earliest possible date - March 2016 - the

counterparty was able to avail itself of the right established in the ETO by

notifying at first the extension of the swap and immediately afterwards its

cancellation; therefore, the Treasury paid the bank the value of the contract at

the time of early termination (€ 1,017 billion). All this despite the Treasury's

having made any possible effort to reach different agreements. However, all the

proposed solutions were unsatisfactory because of the significant costs entailed,

being even greater due to the lack of collateralisation.



IV.3 RESULTS OF DEBT ISSUANCE AND DEBT MANAGEMENT ACTIVITY IN RELATION TO THE OBJECTIVES

Final composition of the year's gross issues

Chapter I illustrated the Treasury's proposed issuance portfolio of issues to be

implemented in 2016 in order to contain the cost of financing, to effectively

manage interest rate and refinancing risks and to achieve higher efficiency

margins - given a large number of future scenarios of interest rates and inflation -

compared to a set of other possible issuance portfolios that could be considered

"realistic" on the basis of their feasibility in the market.

This portfolio, compared with that of 2015, included the following actions:

1. Reduced offerings of BOTs;

2. Stability in the CTZ and CCTeu segments with a shift towards 7-year

maturities of these latter;

3. Overall reduction of the shorter-maturity BTP segment (3 and 5 years);

4. Offerings tending to be in line with 2015 volumes - taking into account

changes in demand - in the 7- and 10-year BTP segments;

5. An increase in the over 10-year segment, being consistent with the general

goal of lengthening maturities, by issuing not only traditional BTPs at 15 and

30 years, but possibly even different or longer maturities, after analysing the

depth and quality of demand;

6. A slight reduction in the segment of inflation-indexed bonds (both Italian and

European), while at the same time returning to two BTP Italia auctions, in

order to meet reinvestment needs coming from redeeming bonds.

From Table IV.4 figures, the following conclusions can be drawn (amounts and

percentages do not take debt exchanges into account).

The BOT target was fully achieved, since the 38.2% gross issues share is lower

than the previous 39.5% share.

As for CTZs, their share of the issuance portfolio dropped from 6.7% to 4.8%;

lower volume of redemptions meant that the issuance flow was also reduced

compared with the previous year. Supply frequency in the segment was decreased

in 2016, becoming bimonthly rather than monthly, while keeping almost

unchanged the quantities placed at each auction.

Overall reduction in issuance of conventional BTPs of shorter duration (from 3

to 5 years) was achieved, with a shift to the longest maturities in the segment:

the 3-year BTPs went from 7.1% in 2015 to 6.3% in 2016, and 5-year BTPs from

8.2% in 2015 to 8.4% in 2016. Issued volumes remained virtually unchanged both

for 7-year BTPs, from 7.6% in 2015 to 7.8% in 2016 (no redemptions have yet been

recorded in this segment), and 10-year BTPs, from 9.5% in 2015 to 9.8% in 2016 (in

this case net issued volumes were largely positive). The over-10-year conventional

BTP segment has grown as desired - therefore strongly. Its relative size - although

still limited within the overall issuance portfolio - has nearly doubled in only two

years from about 5.3% of gross issues in 2014 to about 10.25% in 2016. The

conventional BTP segment also grew in absolute terms (about € 5.7 billion more

than in 2015) and furthermore, thanks to the widening of the offered maturities

range, it saw a net redistribution of issued amounts towards longer tenors, which



also included - for the first time as public issues - a 20-year and 50-year maturity.

As a result of this shift, conventional BTPs issued with maturity longer than 15-

year, which in 2015 accounted for 45.7% of BTP issues with over 10-year maturity,

in 2016 accounted for 72.1%. On the linkers segment, the goals - also reached -

were to introduce a new benchmark in the 5-year BTP€i segment (the previous one

having been launched in 2013), to re-propose two BTP Italia placements in the

year (in order to meet reinvestment needs stemming from redeeming securities),

and to ensure a major role for medium- to long-term maturities. The share of

BTP€i issues in total government bonds issues remained unchanged at 3.1%, while

that of BTP Italia rose from 2.3% in 2015 to 3.3% due to the return to two

placements. The share of linkers in total issues therefore slightly increased and

this was a marginal deviation from the initial targets, largely due to demand

conditions for BTP€I, that did not allow for a greater reduction in issues.

In absolute terms, issued volumes were slightly lower in the BTP€i segment

(from around € 13.1 billion in 2015 to around € 12.4 billion in 2016), but higher in

BTP Italia, growing from approximately € 9.4 billion issued in 2015 to € 13.2 billion

in 2016.

As far as the CCTeus are concerned, their share of gross issues compared to

the total remained virtually stable, while reduced volume of redemptions caused

net issues to be broadly positive. Nevertheless, the announced target of stabilising

the share of such instruments in total debt was substantially achieved. On the

foreign securities side, there was no return to issue publicly traded securities, as

in the previous year, and overall issues declined. Specifically, four placements

were made within the EMTN Program under a private placement format, this

strategy being in line with the goals of the beginning of the year. Issued securities

were, in fact, all long-term; in particular, there was a € 636 million issue of a 30-

year bond indexed to European inflation and three conventional bonds of tenor

ranging between 10 and 15 years, some with an annual coupon and others with a

6-monthly coupon, totalling € 3,036 million. For all, moreover, interest rates were

lower than levels observed on the secondary market for BTPs with same

characteristics.

Therefore, looking at the overall portfolio, it can be stated that the goals in

terms of composition of the issuance portfolio have been almost wholly reached.

The two following tables summarize the issuance composition from 2014 to

2016, respectively excluding (Table IV.4.a) or including (Table IV.4.b) debt

exchanges, already described above (possible missing misalignments of totals are

due to rounding).



TABLE IV.4A: COMPOSITION OF 2014-2016 ISSUES IN ABSOLUTE AND PERCENTAGE TERMS NET OF DEBT EXCHANGES (in euro million)

2014 Issues % of total 2015 Issues % of total 2016 Issues % of total

BOT mini 0 0,00% 0 0,00% 0 0,00%

BOT 3 months 0 0,00% 0 0,00% 0 0,00%

BOT 6 months 91.934 19,80% 80.956 19,74% 76.669 19,19%

BOT 12 months 90.472 19,50% 83.174 20,28% 76.025 19,03%

Commercial Paper 481 0,10% 0 0,00% 0 0,00%

Total short term 182.888 40,17% 164.130 40,03% 152.694 38,23%

32.969 7,24% 27.388 6,68% 18.991 4,75%

CCTeu 24.452 5,37% 27.503 6,71% 28.854 7,22%

BTP 3 years 38.046 8,36% 28.924 7,05% 25.215 6,31%

BTP 5 years 41.709 9,16% 33.729 8,23% 33.747 8,45%

BTP 7 years 28.180 6,19% 31.340 7,64% 31.328 7,84%

BTP 10 years 39.064 8,58% 39.049 9,52% 38.977 9,76%

BTP 15 years 16.482 3,62% 17.129 4,18% 11.410 2,86%

BTP 20 years 1.977 0,43% 1.150 0,28% 10.105 2,53%

BTP 30 years 5.725 1,26% 13.241 3,23% 14.436 3,61%

BTP 50 years 0 0,00% 0 0,00% 5.000 1,25%

BTP€i 5 years 4.170 0,92% 692 0,17% 4.942 1,24%

BTP€i 10 years 9.792 2,15% 3.823 0,93% 4.082 1,02%

BTP€i 15 years 0 0,00% 8.019 1,96% 2.691 0,67%

BTP€i 30 years 525 0,12% 562 0,14% 707 0,18%

BTP Italia 28.071 6,17% 9.379 2,29% 13.234 3,31%

Foreign 1.250 0,27% 4.000 0,98% 3.036 0,76%

Total medium-long term 272.412 59,83% 245.927 59,97% 246.756 61,77%

TOTALE 455.300 410.057 399.449

* Securities have been classified within the nearest residual life category

TABLE IV.4B: COMPOSITION OF 2014-2016 ISSUES IN ABSOLUTE AND PERCENTAGE TERMS GROSS OF

DEBT EXCHANGES (in euro million) 2014 Issues % of total 2015 Issues % of total 2016 Issues % of total

BOT mini 0 0,00% 0 0,00% 0 0,00%

BOT 3 months 0 0,00% 0 0,00% 0 0,00%

BOT 6 months 91.934 19,80% 80.956 19,49% 76.669 18,77%

BOT 12 months 90.472 19,50% 83.174 20,03% 76.025 18,61%

Commercial Paper 481 0,10% 0 0,00% 0 0,00%

Total short term 182.887 39,47% 164.130 39,52% 152.694 37,38%

CTZ 32.969 7,12% 27.388 6,59% 18.991 4,65%

CCTeu 24.452 5,28% 29.503 7,10% 28.854 7,06%

BTP 3 years 38.046 8,21% 28.924 6,96% 25.215 6,17%

BTP 5 years 46.543 10,04% 33.729 8,12% 33.747 8,26%

BTP 7 years 30.411 6,56% 31.340 7,55% 33.328 8,16%

BTP 10 years 40.064 8,65% 40.712 9,80% 42.604 10,43%

BTP 15 years 16.482 3,56% 18.703 4,50% 12.910 3,16%

BTP 20 years 1.977 0,43% 1.150 0,28% 12.015 2,94%

BTP 30 years 5.725 1,24% 13.241 3,19% 14.436 3,53%

BTP 50 years 0 0,00% 0 0,00% 5.000 1,22%

BTP€i 5 years 4.170 0,90% 692 0,17% 4.942 1,21%

BTP€i 10 years 9.792 2,11% 3.823 0,92% 4.082 1,00%

BTP€i 15 years 0 0,00% 8.019 1,93% 2.691 0,66%

BTP€i 30 years 525 0,11% 562 0,14% 707 0,17%

BTP Italia 28.071 6,06% 9.379 2,26% 13.234 3,24%

Foreign 1.250 0,27% 4.000 0,96% 3.036 0,74%

Totale medium-long term 280.476 60,53% 251.164 60,48% 255.793 62,62%

TOTALE 463.363 415.294 408.486

* Securities have been classified within the nearest residual life category



Composition of securities’ stock at year-end

Considering the totality of domestic and foreign government securities, the

composition of debt by class of instrument confirms the trend towards a reduction

in short-term and floating-rate components and an increase in medium and long-

term bonds and fixed interest rates (Chart IV.18).

Indeed, within the total stock of outstanding securities, a reduction was

recorded in 2016 versus 2015 of approximately 3% in short- and medium-term

instruments (including BOTs, CTZs, BTPs with 3 and 5 year maturity and BTP€is

maturing at 5 years); while the share of the portfolio consisting of long-term (i.e.

maturing in 10 years or more) conventional and linkers segments increased by

about 2%.

In reducing the short-medium term segment, BOTs' played a minor role, in

line with targets, going from 6.34% at the end of 2015 to 5.74% at 31 December

2015. Similarly, 24-month CTZs were down from 2.68% at the end of 2015 to 2.12%

at the end of 2016. The remaining part of the short-medium term reduction was

largely recorded in BTPs with a maturity of 3 and 5 years, around 1.5 percentage

points. As for the growth of long-term maturities, the share of the BTP portfolio

with maturities over 10 years increased by about 1.8%, with a major role for the

conventional BTP segments at 15 and 30 years, alongside the new maturities at 20

and 50 years. Overall, conventional BTPs’ share rose from 67.74% to 69.65% of

total stock.

Floating rate component (CCT and CCTeu) stood at 7.21% of debt stock,

marginally higher than value recorded at the end of 2015 (6.68%).

The segment linked to the European HICP inflation index (BTP€i) showed a

slight decrease compared to 2015 (from 7.94% to 7.89% in revalued terms), while a

larger decrease was seen in the share of BTP Italia (from 5.72% to 4.82% in

revalued terms). Overall, also due to the redemptions profile, the linkers segment

fell in 2016 by about 1% of total stock - from 13.66% in 2015 to 12.71% at the end

of 2016 - in line with Treasury's portfolio choices aimed at ensuring continuity of

issues over all tenors, while keeping exposure to inflation under control.

As in the last few years, a further reduction in foreign bonds was recorded

(including euro- and foreign-currency denominated), from 2.89% of total stock in

2015 to 2.56% in 2016.



CHART IV.19: COMPOSITION OF THE STOCK OF GOVERNMENT SECURITIES AT 31 DECEMBER 2015 AND AT 31 DECEMBER 2016

Lastly, the structure of the debt stock at the end of 2016 was affected by

redemptions at maturity using the Sinking Fund and debt exchanges as described

above.

With reference only to the aggregate of domestic government bonds, Chart

IV.20 depicts the trends shown over a longer time-frame: a progressive decline in

the floating-rate component; the major role and the tendency to growth of the

fixed-rate component; the creation in 2003 and the stabilisation within an 8%

threshold of the segment linked to European inflation; the creation in 2012, the

development in the years 2013-14 and the stabilisation in 2015-2016 of the

component linked to the Italy's FOI inflation index (BTP Italia).

BOT 6,34% CCT

1,17% CCTeu 5,51%

CTZ 2,68%

BTP 67,74%

BTP €i (indexed) 7,94%

BTP Italia (indexed) 5,72%

Foreign Debt Euro 2.76%

Foreign Debt Currency

0.13%

31.12.2015

BOT 5,74%

CCT 0,42%

CCTeu 6,79%

CTZ 2,12%

BTP 69,65%

BTP €i (indexed) 7,89%

BTP Italia (indexed) 4,82%

Foreign Debt €uro 2,43%

Foreign Debt Currency

0.13%

31.12.2016



CHART IV.20: STRUCTURE OF STOCK OF DOMESTIC GOVERNMENT SECURITIES 1999-2016

Exposure to refinancing and interest rate risk

As it has already been mentioned12, the objective of containing the cost of

debt, subject to prudent risk management - attributed by international best

practices to public debt management - requires an ongoing action, both in

issuance policies and at different times by way of debt exchanges and buybacks or

interest rate derivatives.

Tables IV.5 and IV.6 show the main synthetic measures regarding the

exposure of Italian government bonds portfolio to refinancing and interest rate

risks, as stemming from the choices of issuance policies, debt exchanges and

buybacks carried out during 2016 (thus excluding the effects of debt management

transactions executed at times other than issuance). These indicators show that

the evolution of these risks is in line with the objectives set out in Chapter I.

TABLE IV.5: AVERAGE LIFE OF STOCK OF GOVERNMENT SECURITIES (in years)

31/12/2014 31/12/2015 31/12/2016

Domestic bonds 6.26 6.38 6.62

Foreign bonds 10.16 11.01 12.07

Stock of government bonds 6.38 6.52 6.76

With reference to the refinancing risk, it should be noted that the total

average life of all Government bonds as of 31 December 2016 was 6.76 years, with

a further increase compared to 31 December 2015 (6.52 years). In 2016,

therefore, the average life of debt, which had undergone a progressive reduction

from 2011 to 2013 and substantially stabilised in 2014, continued the lengthening

that had already began in the course of 2015.

12 See above, Chapter I.1 – Paragraph: The objectives and risks of debt management in international

practice.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Floating rate Fixed rate BTP€i BTP Italia



Chart IV.21 shows changes in the structure for the residual maturity of the

stock of government bonds at the end of each of the last three years (excluding

BOTs and Commercial Papers). In summary, then, the Chart shows how in each

financial year the portfolio distribution by classes of residual maturity has

changed, as a result of the combination of the "original" structure of the securities

expiring in the year and the maturity structure of the securities issued that same

year. First of all, it shows an increase in securities with a residual maturity of less

than one year, which is more than offset by a significant decline in securities with

a maturity ranging between 1 and 3 years. The situation is basically stable for 3 to

5 years, while there are slight increases – progressively tightening as maturities

become longer - on classes with residual life of between 5 and 7 years and

between 7 and 10 years, while the situation remains unchanged for the segment

with a residual life of more than 10 years. In summary, in 2016 a redistribution of

almost 1% of the overall profile of residual maturity classes was recorded, from

the classes with less than 5 years towards those with longer duration. This trend

reflects the multi-year repositioning effort towards medium- to long-term

maturities.

CHART IV.21: MATURITIES FOR RESIDUAL LIFE CLASSES 2014-2016

Note: The stock of inflation-indexed securities takes into account the revaluation of the accrued capital at the end of each year and securities in foreign currencies are valued after currency swaps.

With reference to interest rate risk, it should be noted that the figure of the

duration of the stock of government bonds at 31 December 2016 further increased

compared to the end of 2015, from 5.48 to 5.54 years, thanks to issuance policy

and general level of interest rates. The objective set out in Chapter I is thus

achieved.

0%

5%

10%

15%

20%

25%

< 1 year 1 - 3 years > 3 - 5 years > 5 - 7 years > 7 - 10 years > 10 years

2014 2015 2016



Table IV.6 shows the figures for duration and ARP with reference to the end

of the last three13 years.

The ARP on the stock of Government bonds went from 5.41 at the end of 2015

to 5.64 at the end of 2016 The increase in this indicator highlights an associated

reduction in the portfolio risk profile, which also in this case is in line with the

objectives described in Chapter I.

TABLE IV.6: DURATION AND ARP TREND IN THE YEARS 2014-2016 FOR THE STOCK OF GOVERNMENT BONDS, PRE-DERIVATIVES (in years)

Duration ARP

31/12/2014 31/12/2015 31/12/2016 31/12/2014 31/12/2015 31/12/2016

Domestic bonds. before derivatives

5.25 5.45 5. 50 5.30 5.39 5.62

Foreign bonds before derivatives

5.46 6.45 7.11 5.32 6.11 6.69

Total stock of Government bonds. before derivatives

5.26 5.48 5.54 5.30 5.41 5.64

Management of the derivatives portfolio during 2016 was also consistent with

targets. The derivatives portfolio in fact contributed to lengthen the overall debt

duration in 2016, bringing it from 5.54 pre-swap to 6.11 post-swap, an increase of

about 7 months.

On the same path, the derivatives portfolio also contributed to lengthen debt

ARP, as shown in the following Table IV.6: at the end of 2016, total post-swap ARP

stood at 6.21 years, higher than the corresponding pre-swap value of 5.64 years by

about 7 months and further increasing over the post-swap value of 6.05 years

recorded at 31 December 2015.

TABLE IV.7: DURATION AND ARP TRENDS IN THE YEARS 2014-2016 FOR GOVERNMENT BONDS, POST-DERIVATIVES (in years)

Duration ARP

31/12/2014 31/12/2015 31/12/2016 31/12/2014 31/12/2015 31/12/2016

Domestic bonds. post-derivatives

5.91 6.04 6.09 6.01 6.04 6.19

Foreign bonds. post-derivatives

5.64 6.55 7.13 5.76 6.50 7. 07

Total stock of Government bonds. post-derivatives

5.90 6.06 6.11 6.01 6.05 6.21

13 In 2015, the methodology for calculating contribution of derivative instruments to duration and ARP of

overall debt was further refined and aligned with criteria being adopted in the ESDM for countries participating in the European Union. In the light of this change, both post-swap risk indicators for overall debt referring to 31 December 2014 have been recalculated. For further information about the methodological changes involved, refer to the corresponding chapter of the Public Debt Report 2015.



As was already mentioned in Section IV.2 above, the well-known inverse

relationship between interest rates and market values structurally implies that, all

other conditions being equal14, when market interest rates fall, all fixed rate

financial instruments that were previously settled at higher rates show a negative

market value for the fixed-rate payer and a positive one for the receiver. This is

irrespective of the contractual nature of the instrument, i.e. regardless of

whether the fixed rate is paid on bonds or via different instruments such as

derivatives. In the current market situation – as interest rates continue to show

historically unprecedented low levels - this actually results in a current negative

value of any fixed rate payer position that was previously settled15. Consequently,

given the structure of the relevant portfolios:

mark to market of the derivatives portfolio was negative by € 38.3 billion at

31 December 2016 against € 37.1 billion at 31 December 2015. Taking into

account only the debt-related derivatives16 (see Table IV.9), market value

was negative by € 37.9 billion at the end of 2016 against € 36.7 billion at the

end of 2015;

market value of the stock of government bonds (excluding the effect of the

derivatives portfolio) over the same period went from about € 2,086.3 billion

in 2015 to € 2,106.0 billion at the end of 2016. As shown in Table IV.8,

difference between market value and nominal value of the stock of

government bonds was of approximately € 272 billion at the end of 2015 and

approximately € 239 billion at the end of 2016, thus decreasing by about € 33

billion compared to the previous year. Therefore, the increase in the market

value of government bonds, amounting to approximately € 19.7 billion, is due

to the combined effect of two separate dynamics: (i) an increase of about €

52.8 billion in the stock nominal value and (ii) a reduction of about € 33.1

billion in market value due to government bonds interest rates.

TABLE IV.8: MARKET PERFORMANCE OF STOCKS OF GOVERNMENT BONDS (amounts in euro million)

MTM Nominal Value MTM – Nominal Value

31/12/2016 2,106,030 1,867,214 238,816

31/12/2015 2,086,319 1,814,445 271,874

Variation 19,711 52,769 -33,058

14 The phenomena described here are those that relate to the market component of interest rates, while

the variations in the credit component of interest rates have range and direction independent from market rates and therefore can, in the case of very significant and/or lasting changes in credit spreads, amplify or mitigate (depending on the direction of credit spread changes) the effects of changes in market rates.

15 As can be seen, therefore, the mere existence of a negative (or positive) mark to market does not represent for the issuer either a loss or a gain, nor is it an indication of the suitability of choosing to "lock-in" the rate or not. Formation and trend of mark to market value are linked to the relationship between the characteristics of the portfolio (set over time on the basis of the known trade-off between costs and risks, which the DMO has addressed in relation to the portfolio’s characteristics, the absorption capacity of the market and the fiscal objectives of the moment) and the subsequent trend - entirely exogenous - of market rates. For the public debt manager, the choice of "locking in" the debt rate is a function of the objectives of limiting the risks to the public budget, and is not intended at taking a position aiming to "beat the market".

16 In this case, derivatives contracts entered into with respect to loan receivables under the Budget Law for 2005 are excluded.



Trend of market values of the two portfolios (derivatives and bonds) reflects

the combination of different trends in reference yield curves (i.e. swap curve for

the derivatives portfolio and government bonds yield curve for the stock of

government bonds). These curves can move in different directions and/or with

different magnitudes and shapes, thus generating effects that may diverge from

year to year. Following Chart IV.22 shows the Euro swap rates curve and the yield

curve of Italian government bonds () with reference to the dates of 31/12/2015

and 31/12/2016.

CHART IV.22: EURO SWAP RATES AND ITALIAN GOVERNMENT BOND CURVES

Table IV.9 shows notional amount and market values of all segments into

which the derivatives portfolio can be broken down. Concerning debt-related

derivatives, the cross-currency swaps refer to foreign-currency denominated

securities, while hedging IRSs refer to euro-denominated securities, issued under

the MTN Program. The "Duration IRS" group includes all the positions related to

the hedge of interest rate risk which, in some cases, consist of IRSs associated to

the sale of a receiver swaption. The "IRS ex-ISPA" segment includes all derivatives

associated with the liabilities of the Infrastrutture stock Company, which were

transferred to Treasury by the Budget Law for 2007. The Swaption category shows

stand-alone receiver swaptions, i.e. those unrelated to pre-existing IRSs.

Finally, the Table includes values of both derivatives on loans receivables and

the whole derivatives portfolio.

-1

-0,5

0

0,5

1

1,5

2

2,5

3

3,5

3M 6M 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y 15Y 20Y 25Y 30Y 50Y

Swap rates curve 31/12/2015Swap rates curve 31/12/2016Italian Government bonds yields curve 31/12/2015Italian Government bonds yields curve 31/12/2016



TABLE IV.9: DERIVATIVE INSTRUMENTS PORTFOLIO YEARS 2015 AND 2016 (in euro million)

Derivative instruments on debt

31/12/2015 31/12/2016

Instrument Notional in % MTM in % Notional in % MTM in %

IRS ex-ISPA 3,500 2.32% -1,375 3.75% 3,500 2.44% -1,542 4.06%

CCS (Cross Currency Swap) 13,771 9.13% 1,570 -4.28% 8,992 6.26% 875 -2.31%

IRS (Interest Rate Swap) for hedging

purposes

10,338 6.85% 665 -1.81% 10,357 7.21% 808 -2.13%

IRS (Interest Rate Swap) for duration

purposes

108,282 71.76% -31,527 86.01% 113,782 79.24% -34,437 90.75%

Swaption 15,000 9.94% -5,988 16.34% 6,959 4.85% -3,650 9.62%

Total derivatives on debt 150,891 100% -36,655 100 % 143,590 100% -37,946 100%

Government securities outstanding 1,814,445 1,867,214

Derivatives on debt/Government

securities

8.32% 7.69%

Derivative instruments on assets (2005 Budget Law)

Instrument Notional MTM Notional MTM

IRS (Interest Rate Swap) 2,899 -448 2,341 -346

Total derivative instruments Portfolio

Instrument Notional in % MTM in % Notional in % MTM in %

Derivatives on debt 150,891 98.11% -36,655 98.79% 143,590 98.40% -37,946 99.10%

Derivatives on assets 2,899 1.89% -448 1.21% 2,341 1.60% -346 0.90%

Total derivative instruments 153,790 100. % -37,103 100% 145,931 100% -38,292 100%

N.B.: The market value (MTM) does not include statistical calculations carried out by the Bank of Italy for the purpose of

publishing financial accounts.

More in detail, during 2016 the following transactions expired or were

entered into:

Three CCSs expired, following the maturity of the related foreign currency

denominated issues. Total notional value of these three transactions was €

5,017,739,160.

A further CCS was re-aligned to current market conditions as previously

described in this Chapter.

As for IRS and swaptions aimed at macro-hedging ofinterest rates risk, two

swaptions expired (of which: (i) one was not exercised and (ii) the other

exercised but followed by an immediate termination of the newly generated

swap as early termination was applicable, as explained above), and an IRS

matured: in all, a total notional amount of € 7 billion.

Four IRSs for a total notional amount of € 4,5 billion were generated by the

exercise of swaptions;

A position consisting of a resettable IRS for € 4 billion and a payer swaption

for another € 4 billion was derived from the restructuring of a swaption of the

same notional value, as was detailed earlier in this Chapter. With reference to

this restructuring, the residual share of the repurchase of the premium is

included in the swaption’s notional value.

With regard to the debt related derivatives (thus excluding transactions

pursuant to 2005 Budget Law on assets), the following two Charts show changes in

notional amount year by year, respectively starting from 31/12/2015 and from

31/12/2016 until the portfolio final maturity (2062), should all receiver swaptions



in the portfolio be exercised. After the year 2048, when the last IRS with a

significant notional value (€ 1 billion) matures, there will remain only one position

related to a security under the MTN Program, with a notional amount of € 250

million, expiring in 2062. Large redemptions, in terms of underlying notional

amount, are mainly scheduled between 2017 and 2019.

CHART IV.23: EXPECTED CHANGES IN NOTIONAL AMOUNT OF THE DERIVATIVES PORTFOLIO IF SWAPTIONS ARE EXERCISED (in euro million)

CHART IV.24: STRUCTURE BY MATURITY OF THE DERIVATIVES PORTFOLIO IF THE SWAPTIONS ARE EXERCISED (in euro million)

Debt cost

Weighted average cost of new issues in 2016 fell further to 0.55% from 0.70%

in 2015. Changes in market rates, then, as described in Chapter II, more than

offset the effects of the gradual rebalancing of issues towards longer maturities,

usually bearing higher rates at issuance.

-

15.000

30.000

45.000

60.000

75.000

90.000

105.000

120.000

135.000

150.000

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

2035

2036

2037

2038

2039

2040

2041

2042

2043

2044

2045

2046

2047

204…

31/12/2015

31/12/2016

0

2.000

4.000

6.000

8.000

10.000

12.000

14.000

16.000

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

2035

2036

2037

2038

2039

2040

2041

2042

2043

2044

2045

2046

2047

2048

2049-2

062

Derivatives on foreign debt 31/12/2015 Other derivatives 31/12/2015

Derivatives on foreign debt 31/12/2016 Other derivatives 31/12/2016



CHART IV.25: WEIGHTED AVERAGE COST AT ISSUANCE OF GOVERNMENT SECURITIES – 2005-2016

Average cost of debt, calculated as the ratio between the interest paid on

government bonds in the year t on the stock of government bonds in the year t-1,

was 3.17% in 2016 compared to 3.39 % the previous year17.

Taking into account the overall derivatives transactions, 2016 figure rises to

3.40%, with an additional impact of 0.23%, slightly above those recorded in 2014

(0.19%) and 2015 (0.16%) and basically in line with the forecasts at the beginning

of the year.

In fact, in drafting public finance forecasts to be included in Government

financial planning documents, and in provisional budget, the effect produced by

derivatives is taken in account, based on hypotheses underlying simulations that

are entirely consistent with the rest of the estimates. Likewise, all final data also

include the effects of outflows and inflows stemming from derivatives.

Cost differential between pre-derivative and post-derivative debt portfolio

represents the additional cost incurred by Treasury to achieve a longer duration

(hence better hedging against interest rate rises) than that made possible just by

bond issuances.

At the end of 2016, average rate paid under derivatives transactions to

manage the duration of domestic debt stock was 4.19%, significantly down from

4.35% in 201518; at the same date, debt stock issued bearing coupons of over 4.19%

was approximately € 658 billion, thus confirming that average rate paid under

interest rate derivatives is well within the range of the historical cost of the

country's fixed-rate debt.

17 It is not possible to make this comparison on the expenditure on accrual basis (SEC 2010) as this, by

definition, does not include derivatives transactions flows. 18 The improvement is essentially due to two components: • the inception of 5 new swaps, following the exercise or restructuring of swaptions, all paying fixed rates

lower than the portfolio average; • the fixing in negative territory of the 6-m Euribor which is paid in two transactions.

2,47%

3,32%

4,14% 4,09%

2,18% 2,10%

3,61%

3,11%

2,08%

1,35% 0,70%

0,55%

0,00%

0,50%

1,00%

1,50%

2,00%

2,50%

3,00%

3,50%

4,00%

4,50%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016



CHART IV.26: AVERAGE COST OF PRE- AND POST-DERIVATIVES GOVERNMENT BONDS STOCK - 2005-2016

IV.4 TREASURY'S CASH MANAGEMENT

Treasury's cash management is carried out within the framework of broader

management of debt and is designed to ensure an adequate level of liquidity in

relation to the multiple daily movements of the State Treasury, while at the same

time seeking to optimise the timing of maturities and Government bond issues,

which is partly dictated by prevailing conditions on financial markets.

Cash management activity in 2016 was basically a continuation of that of the

previous year, since all the quantitative easing interventions by the ECB in the

past few years were continued and strengthened. While on the one hand

expansionary monetary policies have brought major benefits to the Government

bond market in terms of demand and declining yields, on the other hand this has

produced undeniable challenges in managing Treasury liquidity, entailing

movement of large amounts of funds within a very challenging context, featuring

minimal demand for liquidity and negative remuneration. Operations, therefore,

were essentially aimed at curbing costs stemming from the highly negative

conditions applied to liquidity held at the Bank of Italy and from a market

situation where negative interest rates are nowadays a rule.

In 2016, too, Treasury's liquidity levels were historically high, albeit lower

compared to the average recorded in previous year. Such high balances benefited

from ECB decisions, partly already launched in 2014 and intensified in 2015 and

2016, with the extension of the Quantitative Easing (QE) program. Monetary policy

measures resulted in a significant increase in liquidity available in the system,

fostering a market climate that was favourable to declining yields and supportive

demand for Government bonds. Treasury's strategy was to exploit this situation by

issuing expansively in most favourable moments. In this way, more resources were

also set aside to match Government bonds redeeming in 2017, a highly crowded

year in redemptions.

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

before derivatives 4,12 4,11 4,27 4,29 3,79 3,61 3,75 3,85 3,73 3,70 3,39

after derivatives 4,06 4,15 4,31 4,37 3,85 3,73 3,88 4,09 3,90 3,89 3,55

0,00

0,50

1,00

1,50

2,00

2,50

3,00

3,50

4,00

4,50

%



Treasury's cash management was carried out, as in the past, through the so-

called OPTES operations described in Chapter I, which involve the monitoring of

balances and cash flows through a continuous exchange of information between

MEF and Bank of Italy, as well as the use of cash management tools including daily

auctions and bilateral operations – raising or placement of money - carried out

with selected external parties.

Monitoring of the Cash Account and the daily and monthly situation of

liquid balances

During 2016, MEF (State General Accounting Department and Treasury

Department) and Bank of Italy continued in their commitment to monitor cash

balances and cash flow forecasts, which was done on all business days of the year.

As was mentioned in Chapter I, this activity is based on the daily exchange of

information between the above institutions, with provisional and final figures

relating to all receipts and payments affecting the accounts being held at the

State Treasury, thus making possible the estimate of the balance of the Cash

Account.

The above-mentioned information exchanges are updated by the Bank of Italy

6 times a day and validated by the MEF in order to estimate end-of-day balance on

a daily basis. The two institutions also share a longer-term, 30- to 60-day

forecasting scenario, updated weekly. This latter exchange plays a major role for

monetary policy, since Treasury communicates to the Bank of Italy, and through it

to the ECB, its forecasts on liquidity utilisation and stocks of Government deposits

over the considered period.

In spite of the complexity of Treasury flows, mainly due to large number of

entailed entities and size of some movements, the monitoring of the Cash Account

during the year 2016 once again gave satisfactory results as for forecasts

reliability, as daily average gap with actual figures was just over 4%19. Thanks to

Cash Account monitoring and management activity was then possible to achieve

sound balances forecasts, despite the fact that, on some days of the month, huge

Treasury flows cause variations in liquidity balance to reach several billion Euros.

Such a strong volatility of the Account over an average month is shown in the

Chart below, providing the oscillations observed in 2016, these being similar to

those recorded in previous years20.

19 This value is calculated as an average of percentage changes (in absolute value) between the forecast of

the stock of the Liquidity Account as estimated at 6 p.m. of the day t-1 and the actual balance registered at 9 a.m. of the day t. This percentage gives a measure of the average gap of the daily forecast.

20 On this subject, read the Section IV.4 of the Public Debt Reports for 2014 and for 2015.



CHART IV.27: AVERAGE INTRA-MONTHLY VARIATIONS IN TREASURY LIQUIDITY: DEVIATIONS FROM THE MONTHLY LOW - 2016 (in euro million)

As it can be seen from Chart IV.27, the two most evident oscillations occur in

the first few days of the month, as balances are lowered due to social security

payments, and between the 16th and 21st of the month, when balances suddenly

rise because of tax receipts. Operations meet a further constraint in the need to

hold very large amounts of liquidity to meet the redemptions of Government

bonds, that are not always balanced by same-time issuances, especially for

medium and long-term securities. Indeed, according to market practice, issuance

of securities other than BOTs is normally spread over a number of months in

several tranches, while their reimbursements are made in a single settlement on

the maturity date. Fluctuations shown in the previous Chart are therefore also

attributable to issues and, above all, to the reimbursement of securities which

sometimes contribute to significant drops at the beginning, middle and end of the

month.

The Account volatility is not only noticeable within a single month, but also at

a whole year scale. As to this, Chart IV.28 shows the differences between the

minimum and maximum balances observed within each of the months of 2015 and

2016; this Chart gives different results from those in the previous one, which

collected average monthly data and thus tended to partially smooth fluctuations

(since the minimum and maximum days do not coincide in all months, mainly for

calendar reasons). Monthly data show a slight reduction in volatility, since in 2016

the gap between the monthly low and peak reaches about € 29.7 billion, down

from about € 32.3 billion in 2015.

0

5.000

10.000

15.000

20.000

25.000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31

Day of the month



CHART IV.28: DIFFERENCE BETWEEN THE MONTHLY MAXIMUM AND MINIMUM TREASURY CASH BALANCE - 2015-16 (in euro million)

At the same time, some annual cyclical trends in demand can also be

observed, having significant effects on liquidity levels. The June peak, for

example, is present in both 2015 and 2016, since it is mainly a result of high tax

revenues that are concentrated in that month. In general, monthly trends appear

to be similar in the two years observed, while significantly diverging in August.

The gaps among the curves in the other months are attributable to different

timetable of Government bonds redemptions.

The challenge of cash management is therefore to manage large variations

caused by mismatching cash inflows and outflows, so as to reduce net daily

variations and allow Treasury to hold a lower reserve of liquidity for prudential

purposes. At the same time, it is necessary to keep in mind the need to maintain,

at certain times, an adequate liquidity cushion in order to face considerable

redemptions and payments.

Cash management operations and the market context

As has been stated, 2016 market context was heavily influenced by the ECB's

monetary policy moves which had already begun in 2014 and were significantly

extended in the following two years by strengthening the Quantitative Easing

Program and lowering official rates. The effect of these decisions was to increase

liquidity held by Treasury while, at the same time, depressing demand from

banks, given abundant availability of money in the market, at historically low

rates. OPTES operations in 2016, therefore, were essentially a continuation of

those of the previous year, in which the effects of the ECB's decisions had already

been largely observed. In order to cope with low participation in OPTES auctions,

also in 2016 too Treasury made extensive use of bilateral operations, which

became an important means of lending liquidity which otherwise would have

remained in the Cash Account, being penalised at the deposit facility rate.

0

10.000

20.000

30.000

40.000

50.000

60.000

January

Febru

ary

Marc

h

Apri

l

May

June

July

August

Septe

mber

Octo

ber

Novem

ber

Decem

ber

2015 2016



Chart IV.29 shows links between the average use of liquidity at Treasury

auctions and some major monetary policy episodes since the launch of the new

OPTES operations in November 2011. It also shows gradual decrease in demand,

which had begun with the June 2014 ECB decisions, then further accentuated

following the introduction of the Program for purchase of Government bonds and

its further extensions. Low participation of buyers at auction led Treasury to

suspend the afternoon auctions.

CHART IV.29 – AVERAGE USE AT DAILY OPTES AUCTIONS (in euro million)

In Chart IV.30 it can be seen the steady decline in money market yields since

2014, mainly due to the reduction in official rates by the ECB. Until mid-2014 it

was still possible to observe a temporary increase in interest rates at the end of

the month, when interested parties increased their demand for cash on the

market, leading yields to rise. Progressive increase in excess liquidity within the

Eurosystem has gradually caused this cyclical phenomenon to disappear, due to

the collapse of operators’ demand.

0

1.000

2.000

3.000

4.000

5.000

6.000

Nov-1

1D

ec-1

1Jan-1

2Feb-1

2M

ar-

12

Apr-

12

May-1

2Jun-1

2Jul-

12

Aug-1

2Sep-1

2O

ct-

12

Nov-1

2D

ec-1

2Jan-1

3Feb-1

3M

ar-

13

Apr-

13

May-1

3Jun-1

3Jul-

13

Aug-1

3Sep-1

3O

ct-

13

Nov-1

3D

ec-1

3Jan-1

4Feb-1

4M

ar-

14

Apr-

14

May-1

4Jun-1

4Jul-

14

Aug-1

4Sep-1

4O

ct-

14

Nov-1

4D

ec-1

4Jan-1

5Feb-1

5M

ar-

15

Apr-

15

May-1

5Jun-1

5Jul-

15

Aug-1

5Sep-1

5O

ct-

15

Nov-1

5D

ec-1

5Jan-1

6Feb-1

6M

ar-

16

Apr-

16

May-1

6Jun-1

6Jul-

16

Aug-1

6Sep-1

6O

ct-

16

Nov-1

6D

ec-1

6

Second LTRO auction

Beginning of LTRO

redemptions

BCE decisions of June 5,

2014 First

TLTRO auction

Second TLTRO auction

First LTRO

auction

Beginning of BCE QE

Increase in QE

purchases



CHART IV.30: OVERNIGHT RATES ON THE MONETARY MARKET AND AT OPTES AUCTIONS 2014-16 (percentage rates)

The observable dissociation between EONIA rate and weighted average yield

at auction is attributable to the minimum rate accepted by Treasury in such

transactions, which from June 2014 to December 2015 had been kept at zero.

When two further cuts in monetary policy rates were announced in December 2015

and March 2016, Treasury was no longer able to keep the accepted minimum rate

at zero and reduced it, although maintaining it at higher levels that than those

prevailing in the market for the same one-day maturity. Consequently, for the

whole of 2016, with the exception of rare episodes, weighted average rate stayed

some basis points above EONIA rate, levelling out at the agreed minimum rate.

Use of Treasury Liquidity

Participation in the OPTES auctions for placement of Treasury liquidity, which

already had severely scaled back since the second half of 2014, recorded a further

slight reduction in allocations compared to the previous year, especially in the

summer months. Scarcity in traders participation led the Treasury to suspend the

afternoon auctions in the second half of the year.

In detail, the OPTES auctions allowed Treasury to lend overall about € 120

billion overnight, as against € 145 billion in the previous year, in which a drop in

demand had already been recorded.

Most significant portion of liquidity was therefore invested through bilateral

operations aimed at placing the most stable base of available cash, which until

the middle of 2014 had mainly been held in term deposits with the Bank of Italy.

From then on, OPTES operations do not include term deposits, since those

instruments have become unprofitable following the entry into force of European

rules penalising deposits held by Governments at Central Banks.

-0,60

-0,40

-0,20

0,00

0,20

0,40

0,60

0,80

Jan-1

4

Jan-1

4

Feb-1

4

Mar-

14

Mar-

14

Apr-

14

May-1

4

Jun-1

4

Jul-

14

Jul-

14

Aug-1

4

Sep-1

4

Oct-

14

Oct-

14

Nov-1

4

Dec-1

4

Jan-1

5

Feb-1

5

Apr-

15

May-1

5

Jun-1

5

Jul-

15

Aug-1

5

Sep-1

5

Nov-1

5

Dec-1

5

Jan-1

6

Feb-1

6

Apr-

16

May-1

6

Jun-1

6

Jul-

16

Aug-1

6

Sep-1

6

Oct-

16

Dec-1

6

Weighted average rate Eonia



CHART IV.31 - AVERAGE USE AT DAILY OPTES AUCTIONS - 2013-16 (in euro million)

In 2016, cash invested using bilateral transactions averaged € 41.7 billion at

month end, as against € 51 billion in the previous year. These operations had an

average duration of 27 days, up from 14 in the previous year. Increase in average

duration, made possible by the stabilisation of balances, allowed to curb the

effect of negative rates, which was huger on very short-term maturities.

Given high amount of available cash, in 2016 no fund-raising OPTES operations

or auctions were needed.

CHART IV.32 AVERAGE CASH DISTRIBUTION BY TYPE OF PLACEMENT – YEAR 2016 (in euro million and percentage rates)

The above Chart summarises the types of placement of Treasury liquidity,

subdivided as for the average observed distribution over the whole year. As was

already seen in the previous year, due to this particular market situation, auctions

for overnight deposits were entirely marginal and, on the contrary, the larger part

of the liquidity was invested in longer-term bilateral operations (about 73% of the

total). Significant amounts remained in the Cash Account (26%) and yielded the

deposit facility rate.

0

1.000

2.000

3.000

4.000

5.000

6.000January

Febru

ary

Marc

h

Apri

l

May

June

July

August

Septe

mber

Octo

ber

Novem

ber

Decem

ber

2013

2014

2015

2016

Cash Account 14.866

26%

Long-term bilateral operations

41.717 73%

Overnight auctions 465 1%



To allow to observe the trend of liquidity stocks during the year, the

following Table IV.10 shows the total amount of Treasury liquidity at the end of

each month of 2016, with the breakdown between market operations and the cash

account.

TABLE IV.10 – MONTH-END CASH ACCOUNT BALANCES AND PLACEMENT OF LIQUIDITY – YEAR 2016 (in euro million)

Month Cash Account Balance OPTES Liquidity

Operations Total Treasury Cash

Available

January 10,494 52,070 62,564

February 21,183 52,570 73,753

March 11,349 54,620 65,969

April 13,021 51,370 64,391

May 25,788 46,570 72,358

June 36,070 56,070 92,140

July 54,112 46,560 100,672

August 18,294 46,000 64,294

September 6,369 32,060 38,429

October 11,236 35,560 46,796

November 12,612 33,060 45,672

December 9,734 33,000 42,734

The Table shows a high level of liquidity in the Cash Account, in particular in

June and July, partly due to tax revenues performance and also prudentially held

to deal with the large Government bond redemptions, mainly concentrated in the

second half of the year. As part of the wider strategy to minimise impact of

substantial bond redemptions scheduled in 201721, Treasury continued to maintain

a notable liquidity margin through the last months of the year, while always

respecting the limits allowed by the policy of reducing public debt.

Conclusions

Cash management in 2016 was highly challenging, due to prevailing monetary

conditions. However, Treasury always guaranteed its daily presence in the market

through OPTES operations, in order to reduce as far as possible the impact of

negative rates on its liquidity. In any case, despite the above mentioned

difficulties, it must be recalled that the effect of low interest rates and other

quantitative easing measures is overall beneficial to the management of our

country's debt.

21 On this aspect, see the above paragraph “debt exchanges and buybacks transactions”.


APPENDIX

ORGANISATIONAL STRUCTURE OF PUBLIC DEBT DIRECTORATE AT THE TREASURY DEPARTMENT

The Second Directorate of the Treasury Department, in charge to manage

public debt, is divided into eleven Offices. The Directorate's responsibilities are

carried out in close institutional collaboration with other entities, including other

divisions of the Treasury Department, the State General Accounting Department

and the Bank of Italy. The chart below shows the responsibilities of the Debt

Management Division grouped by function.

ORGANISATION OF THE PUBLIC DEBT DIRECTORATE

The Directorate features the typical functions of financial market operators

normally included in other Debt Management Offices – DMOs managing public debt

in advanced countries: Front, Middle and Back Office functions.

The Front Office gathers all activities entailing direct contact with market.

The main ones are these related to issuance of securities in the primary market

Ministry of the

Economy and

Finance

Department of the

Treasury

Public Debt

Directorate

General Affairs,

legal/administrative

issues

Programs and

prospectuses for

National and

International issues

Legal documentation for

derivatives

FRONT OFFICE

Markets monitoring,

assessment of Specialists in

government bonds

Issuance of domestic

securities

Issuance of international

securities

Liquidity management

Debt exchanges and

buybacks (including Sinking

Fund for government

securities)

Derivatives

MIDDLE OFFICE

Portfolio risk indicators

Simulation of debt

management strategies with

cost/risk scenarios

Counterparty risk

management

Development of interest

rate scenarios

Forecasts for planning

documents

Institutional reporting

BACK OFFICE

Issuance Decrees

Transactions settlement

Accounting management

Communications:

Public debt website

Government securities

statistics

External relations:

International institutions

(EU, IMF, OECD) and

national institutions

(ISTAT, Bank of Italia,

CONSOB)

Investors / Rating

Agencies

Monitoring of the debt

of Local Authorities

Potential non-recurring

financial transactions

with Local Authorities



(both domestic and foreign) after considering funding needs and following a

market analysis to support the decisions about the types of securities to be

offered and the placements’ characteristics and timing. Front Office's operations

also include very short-term cash management, debt exchanges and buybacks, as

well as derivatives transactions.

Front Office activities also include monitoring the several segments of the

Government bonds secondary market, as well as selecting and assessing Specialists

in Government bonds.

Middle Office functions include all analysis activities to be used to draw the

cost/risk profile that will drive Front Office in selecting / rejecting operations.

Assessment of different issuance portfolios with their respective cost / risk

combinations thus allows Front Office to select the most suitable issuance and

hedging strategies, while monitoring counterparty risk sets the constraints to be

satisfied for both managing the derivatives portfolio and for liquidity lending

operations.

Multi-year estimates about interest expenditure and debt redemptions for the

purposes of planning documents and institutional reporting1 are also included in

Middle Office duties.

Back Office's functions include drafting issues authorization decrees and the

(more strictly accounting) activities relating to procedures for a timely payments

execution.

All debt management duties are underpinned by legal documentation drafting

activities for bonds and derivatives, as well as for prospectuses, both for

international issuance programs (Global, MTN) and for other securities placed in

other ways than auctions. Likewise, since the Public Debt Directorate falls within

the administrative context of the Department of the Treasury, all other legal-

administrative and accounting functions that are shared with the Ministry

structure are carried out here.

Other pivotal functions are also carried out by the Public Debt Directorate.

Among these, very noteworthy ones are those that can be classified as

communication tasks, focusing on real-time information about issuance activities

as well as statistics about structure, dynamics and composition of Government

securities and relevant market. Public Debt's website is the main channel for

handling this. Statistics produced about Local Authorities’ debt and exposure to

derivatives also fall within this function.

In addition to the aforementioned monitoring, any extraordinary (i.e.

according to specific rules) transaction regarding Local Authorities debt is also a

task of this Directorate.

Of great importance is also the task of keeping up liaisons with other (mainly

international) institutions, which includes: participating in European DMOs co-

1 In particular, the Economic and Financial Document (DEF) provided for by Law no. 39 of 7 April 2011

(where the contribution of the Second Directorate is included in Part One, "Stability Program", and in Part Two, "Public Finance Analysis and Trends"), the DEF Update Note, the Budgetary Programming Document (DPB) established by Regulation EU no. 473/2013, the Appendix to the so-called Quarterly Cash Report (with Article 14 of Law 196/2009 referred to as the Report on the Consolidated Cash Account of the Public Administrations), the Parliamentary Report on the Sinking Fund for Government Securities (attached to the General Budgetary Statement) as per Article 44, Paragraph 3 of Presidential Decree 398/2003, and the half-yearly report to the Court of Auditors on the management of public debt pursuant to the Ministerial Decree of 10/11/1995.

APPENDIX


ordination within a special sub-committee (European Sovereign Debt Markets -

ESDM) of the Economic and Financial Committee of the European Union2;

participating in Eurostat's statistical working groups and contributing to draft half-

yearly notifications under the Excessive Deficit Procedure (EDP); attending the

several working groups in supranational institutions such as OECD and IMF3; co-

managing the Public Debt Management Network among Italian Treasury, OECD and

World Bank about public debt management4 topics; keeping up liaisons with

institutional investors and rating agencies.

Finally, IT provides cross-functional support that affects all the Directorate

offices, since virtually all of the Directorate's work processes are computerised:

those that are common to the whole Administration, by sharing applications with

the Treasury Department or the entire Ministry, while those that are specific to

Public Debt tasks enjoy dedicated tools. Indeed, applications5 are designed on the

basis of the needs of the Directorate (see, for example, particularly important

aspects in the processing and management of SAPE – the Issue Portfolio Analysis

Software illustrated in Chapter I). Received data come from both internal sources

and from data flows from the Bank of Italy, Monte Titoli SpA - the company that

guarantees the centralised management of Government securities - or the

company that manages the Government bond market (MTS S.p.A.).

2 The Economic and Financial Committee is a body of the European Union in charge of fostering

coordination of economic and financial policies of the Member States. It performs a consultative function for the Council of Europe and the European Commission.

3 Among other things, the Directorate also participates in the OECD's Working Party on Public Debt Management, which is a permanent forum for comparing and coordinating public debt management policies and techniques among the Organisation’s member countries.

4 The Public Debt Directorate is in charge to manage a multilateral network for the dissemination of public debt management best practices following the 2004 signing of a Memorandum of Understanding (MoU) with the OECD's Financial and Tax Affairs Department, which was later joined by the World Bank's Treasury Department (see Chapter I). Latest MoU renewal was signed in 2017.

5 Databases design and maintenance, as well applications development are carried out in collaboration with the Treasury Department's IT coordination office and with SOGEI, as a provider of digital architectures and support services. SOGEI - Società Generale d’Informatica S.P.A. is an IT company 100% owned by the Ministry of Economy and Finance.

Documents

PUBLIC DEBT REPORT - dt.mef.gov.it