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THE MEXICAN GOVERNMENT SECURITIES MARKET

BANCO DE MÉXICO

Gavin Brendan Abreu-Goodger

María Rebeca Acosta-Arellano

Claudia Álvarez-Toca

Jaime José Cortina-Morfín

María Daniela Gallardo-García

Juan Rafael García-Padilla

Lorenzo Jiménez-Vázquez

Julio Alfonso Santaella-Castell

Claudia Tapia-Rangel

Marie Shantall Tegho-Villareal

AUTHORS

Jaime José Cortina-Morfín and Claudia Álvarez-Toca

GENERAL COORDINATORS

Adolfo Gutiérrez-Chávez

EDITORIAL COORDINATION

Patricia Vila-Farfán

TRANSLATION

María Esperanza Zoreda-Lee

TRANSLATION AND TRANSLATION OVERSIGHT

The information contained in this publication is updated to April 30, 2014,

except where otherwise stated.

First edition, 2014

Edited by Banco de México

D.R. © Banco de México, 2014

Av. 5 de mayo, no. 2,

Colonia Centro

Delegación Cuauhtémoc

06059, México, D.F.

IEBN: 484-132-000003-11

This publication is protected by Mexico’s Copyright Act and international treaties related to copyright. No part of this e-book may be reproduced or transmitted in any form or by any means, except as may be expressly permitted by Article 27 of the Copyright Act and in writing by Banco de México. The authors of this publication are staff of Banco de México. Their opinions are exclusively of their own and not necessarily represent those of Banco de México. Due to the various sources of information and the variability in the figures consulted, Banco de México does not guarantee the accuracy, precision, timeliness and reliability of the figures contained in this publication, and therefore is not responsible or liable for any differences in the figures herein used that may result when using other kind of official, public or private information, nor is responsible or liable for any past, current or future variations the information may have or how it may be used by third parties.

From the editor

The information contained in this e-book is updated to April 30, 2014, except where otherwise indicated. You can subscribe by RSS here for information on news and updates.

All charts displayed in this e-book allow interaction with the reader: the selection of time series and the zoom functions are available by clicking directly on the charts.

If you have any questions, please contact the editor at comunicacion_interna@banxico.org.mx

The coordinators acknowledge the interest and unconditional support from the authors of the chapters of this work, without which this project would not have been possible. Coordinators are also grateful for the time invested in revising this book by Gerardo Rodríguez-Regordosa, Juan Manuel Pérez-Porrúa, Alonso García-Tamés, and Alejandro Díaz de León-Carrillo. Their feedback was extremely valuable.

They also thank the support of Banco de México’s Internal Communications Division, especially Alejandra Pinedo-Carriedo, Andrés Millán-González, José Luis Domínguez-Ferreyra, María Esperanza Zoreda-Lee, Montserrat Gómez-Gorbeña, and Ricardo González-Lecumberri in the editing, publishing and translating work involved.

This e-book is protected by Mexico’s Copyright Act and international treaties related to copyright. No part of this e-book may be reproduced or transmitted in any form or by any means, except as may be expressly permitted by Article 27 of the Copyright Act and in writing by Banco de México. The authors of this e-book are staff of Banco de México. Their opinions are exclusively of their own and not necessarily represent those of Banco de México. Due to the various sources of information and the variability in the figures consulted, Banco de México does not guarantee the accuracy, precision, timeliness and reliability of the figures contained in this e-book, and therefore is not responsible or liable for any differences in the figures herein used that may result when using other kind of official, public or private information, nor is responsible or liable for any past, current or future variations the information might have or how it may be used by third parties.

In memoriam

In memory of Javier

The sadness of your farewell is overwhelming,

but the gratitude for your legacy transcends it.

There is nothing more but to thank life

for giving us the opportunity of knowing you.

You were able not only to instill in us

the passion for our endeavor,

but to give us life lessons in every step of the way.

You stood out for your strong personality,

always ready to defend your standpoint and face hardship,

but also for being a noble heart

that fought for the well-being of the people around you.

You had the immense virtue of bringing the best out of people,

of turning demanding work precision into vital learning.

Your enthusiasm and strength of spirit will be hardly matched.

A legacy like yours shall undeniably persist throughout time.

You will always, dear Javier, be present

until the day we are fortunate enough to meet again.

Until then,

May You Rest in Peace

Foreword

The Mexican government securities market has undergone significant developments in the last 15 years. Most of you will probably recall that until the end of the past century, one-year T-bills (Cetes) were the longest fixed nominal-rate instruments, and the most extended term for a government security did not exceed seven years. In contrast, today, the Federal Government enjoys a nominal and effective yield rate of up to a 30-year term, with a liquid and deep secondary market in all of its terms, and a broad participation of diverse domestic and foreign institutional investors. A mature debt market provides more financing alternatives, for both the government and the private sector, which reflects in longer terms and lower financing costs. At the same time, domestic and foreign investors also benefit from more alternatives to invest their resources according to their specific investment profile.

Undoubtedly, all these achievements are the result of a joint and coordinated effort by many agents who, facing a highly dynamic process, have endured in providing continuity to Mexico’s macroeconomic and financial stability, which represents the foundation upon which rests the Federal Government’s credibility as a debt issuer. All the above has been supported by the persistence of responsible fiscal and monetary policies and by appropriate legal, tax, and regulatory frameworks, which have contributed to the current status of the Mexican government securities market.

For Banco de México, having a liquid and deep government securities market is key to achieve its goals and duties as a central bank. On the one hand, the debt market represents one of the most immediate and significant transmission channels of monetary policy, as it is in this market where the central bank directly conducts its open market operations. On the other hand, Banco de México acts, in pursuance to the Law, as the Federal Government’s financial agent in operations involving the placement of government debt instruments in domestic markets. For this specific reason, strengthening this market has become a central bank priority. Banco de México’s role in the growth of the government securities market has not only taken place through the conduction of a responsible monetary policy (which has allowed to lower inflation to levels below four percent and therefore contributed to a much more adequate macroeconomic setting for the expansion of such markets), but also through establishing a suitable infrastructure and regulation to promote its development. In this regard, noteworthy are the different systems the central bank has implemented for the primary placement of securities, the transparency of auctions, the central bank’s role in managing the “Market Makers Program”, the regulations issued by the central bank for operating government securities, including security lending, repos and derivatives, and the mechanisms and infrastructure for their settlement (jointly with Indeval).

The main purpose of this book is to offer a document that helps students, academics, and local and foreign investors become familiar with the level of development and major characteristics of Mexico’s government securities market, by describing first the instruments currently issued by the Federal Government, the most important features of its primary and secondary markets, the most relevant regulation issued in this matter, and the securities clearing and settlement process.

Personally, as a witness to this process, I am certain this work will be mostly useful.

Javier Duclaud

(1963 –2014)

I. Risk-free issuers

Claudia Álvarez-Toca and Julio A. Santaella-Castell[1]

In only a few years, the Mexican debt market has experienced an outstanding growth, extending the yield curve from one year in 1999 to 30 years in less than a decade. This extension was due to the rapid growth of more domestic and foreign participants, with various investment horizons and strategies. The purpose of this chapter is to offer an overview of the government bond market and its development. The first part of this chapter covers the benefits of developing government bonds denominated in domestic currency, while the second one refers to the pre-requisites to achieve this possibility successfully in any country. The strategy followed by Mexico for this purpose is described next. A final section includes the results of this strategy.

1. Benefits of developing a government securities market

2. Pre-requisites for successfully developing a government bond market

3. Strategy for developing a government bond market in Mexico

4. Strategy results

5. Other risk-free issuers

6. Conclusions

7. References

8. Notes

1.1 Benefits of developing a government securities market

The benefits offered by financial intermediation in general, and of the securities market in particular, are well known.[2] The debt market is the main vehicle through which economic resources are channeled between economic participants with a surplus of loanable funds and those having a deficit. This market also works as a complement for lending and savings through banks, the second major vehicle of financial intermediation.

In 1999, Alan Greenspan (then Chairman of the United States Federal Reserve Board) referred metaphorically to this issue when he stated that the cause of the East Asian markets crisis at that time was that they lacked a “spare tire”.[3] This statement is useful in explaining that those economies depended exclusively on banks for financing and had no alternative for intermediation such as a debt market in their countries.

How is a government securities market developed? Karacadag, Sundararajan, and Elliott (2003) symbolically represented in a pyramid the hierarchical order domestic financial markets follow to achieve their development (Figure 1.1). They recognized the interdependence existing among each market and identified the markets located at the base as fundamental to achieve the development of those at the top. According to this hierarchy, the government securities market is located on the second and third levels (government and treasury bonds).

Figure 1.1

Hierarchical order of domestic financial markets

Source: Karacadag, Sundararajan, and Elliott (2003).

In any of these markets, issuers in need of financing converge with investors that are seeking to put their resources to work in an instrument bearing a yield. The contact between issuers and investors is facilitated by intermediaries. For this to occur, an infrastructure is needed that facilitates the settlement of transactions, which is used in the price formation process, that guarantees the legal ownership of instruments. Finally, the regulatory regime completes the regulatory framework of these financial operations. Under this scheme, the degree of efficiency in the intermediation process will determine, to a great extent, the degree of development of the market.

According to World Bank experts, “an efficient government securities market is characterized by a competitive market structure, low transaction costs, low levels of fragmentation, a safe and robust infrastructure, and a high level of heterogeneity among participants.”[4] To the extent that the debt market is fully developed, it will offer a wider range of financial alternatives for both the government and the private sector. This range of alternatives will generally represent a lower financial cost for issuers as compared to that in a less developed government securities market. Likewise, a more developed securities market will provide to investors access to a broader range of possibilities to place their resources based in their own investment profiles.

Typically, government securities (denominated in local currency) are considered as “risk-free” instruments for private investors, since they are backed by both the confidence and credit of the country’s government,[5] i.e., the sovereign issuer is considered to have enough tax collection and, consequently, payment capacity for its obligations to be completely safe for the investor or debt holder, at least in theory. Usually, the opportunity for issuing debt instruments arises when government bonds are issued and, for this reason, the latter are considered as the center or origin of the fixed-income securities markets available in a country. The government yield curve[6] is the basis for creating the reference interest rate curve for other debt issues. Government bonds also serve as underlying assets for various types of derivatives.[7]

In line with the aforementioned, authorities seek to boost the development of an efficient government bond market in their own countries which, as Greenspan said, serves as a “spare tire” for financing. From a macroeconomic perspective, a government debt market also allows financing budget deficits, helps to reduce government dependence on bank and foreign financing, and strengthens the monetary policy transmission channels.[8] From a microeconomic perspective, it fosters financial stability and improves the channeling of financing funds, as it involves higher competition in the intermediation and development of related infrastructure, products and services. This supports the development of the financial system in general from a system centered on bank financing to a multi-level system in which debt and capital markets complement financial intermediation.

1.2 Pre-requisites for successfully developing a government bond market

Among other organizations, the World Bank and the International Monetary Fund have set out the different elements that favor the development of debt markets.[9] From these recommendations it may be concluded that the development of the government debt market is a dynamic process where continuity and perseverance in macroeconomic and financial stability are essential to build and keep the government’s credibility as a debt issuer. Besides having a credible and stable government as an issuer, the debt market must also be backed by sound fiscal and monetary policies, an adequate legal, tax and regulatory framework, a safe and efficient security settlement system, and an open financial system with competitive intermediaries. To facilitate competition, actions must be taken to strengthen the disclosure of information, the surveillance and regulation of market participants, and to prevent abusive practices and any other action that threatens free competition.

Domestic and foreign investors are reluctant to purchase government debt instruments, particularly those at mid and long terms, if there is a considerable credit risk, a restrictive regulatory framework, a complex and barely transparent fiscal regime, high inflation expectations or considerable volatility in exchange rates. Preventing all the previous factors must go hand in hand with designing attractive instruments for an investor base with long term investment horizons (the so-called buy-and-hold investors). In this way, the government can solve its long-term financing requirements.

In general, an investor would rather not purchase instruments of a government which is perceived to have a high risk of default. This scenario arises when a government is referred to as either lacking the ability to manage public expenditures and/or collecting taxes, or having a high level of debt (explicit or implicit) that puts its payment capacity at stake.[10] Moreover, a simple and transparent fiscal regime, both for the management of interest payments and capital gains for debt holders will help to attract potential investors.

The fact that inflation expectations are directly reflected in the nominal yield of government instruments limits governments from issuing debt not hedged against inflation, particularly when inflation expectations are considerably high particularly at medium and long terms. When this happens, governments are forced to issue exclusively short-term instruments at floating or indexed-to-inflation rates. Additionally, the foreign exchange regime and restrictions to capital flows (which frame the capital account policy) also have an effect on the degree of development of debt markets in terms of their ability to attract foreign institutional investors with structural investment needs. Finally, an important requirement is to have healthy financial intermediaries that can provide liquidity and efficiency to the debt market.

A sufficiently liquid and developed money market, as the repo market,[11] is another factor that favors the development of long term instruments issued by the government. A sound money market feedbacks the bond market by increasing its liquidity. In other words, it simplifies the process of covering short-term liquidity needs for financial institutions and therefore makes less risky and expensive to keep government securities.

The development of domestic debt markets is particularly relevant for a central bank “as they enable the use of short term interest rates to convey monetary policy signals across the whole maturity spectrum”.[12] This means that the debt market is an integral part of the monetary policy transmission channels. On the other hand, the way in which the central bank implements monetary policy has a significant influence on the structure and development of government debt markets. For instance, the central bank may help foster the money market through its open market operations or prevent the fragmentation of a not-so-developed government debt market by placing the same instruments issued by the government for its monetary operations.[13]

Box 1.1

Central bank autonomy and coordination with the fiscal authority

Having an independent central bank that provides a credible nominal anchor (such as an inflation target) is fundamental for the development of debt markets. To achieve this, monetary policy must first be formulated with a sufficient level of consistency. Second, a high level of coordination must prevail between the fiscal and monetary authorities, despite the fact that both have different economic policy objectives.[14] While the practically universal goal of the central bank is to maintain price stability and a sound financing system, the goal of the government is to minimize the cost of its long-term financing, taking into account the risk associated with cash flow management.

Nonetheless, both authorities –as well as the debt market– will be interested in attaining their respective goals, because a monetary policy that it is not credible would affect the perception of investors regarding inflation and the risk of devaluation and, therefore, the cost of government financing. Moreover, the monetary authority would not be able, in the long term, to curb inflationary expectations if the government faces a fiscal or funding problem of such magnitude as to represent risk of monetization and having the central bank financing the government.

1.3 Strategy for developing a government bond market in Mexico

As discussed in the previous section, in the finance theory of investment portfolios, a risk-free rate is the yield rate of an investment that has no risk of loss originated by default in payment. In the case of Mexico, risk-free issuers include, besides the Federal Government, the Bank Savings Protection Institute (Instituto para la Protección al Ahorro Bancario, IPAB) and Banco de México (the central bank, also known as Banxico). Their debt issues represent the broad-government securities market.[15]

As for the Federal Government, the Ministry of Finance (Secretaría de Hacienda y Crédito Público, SHCP) is fully responsible for managing the federal debt, with Banco de México acting as its financial agent or broker. The Ministry also coordinates the activities with other bodies of the federal public sector to determine their overall debt strategy, including the type of debt instruments placed, their maturities, and issue amounts and timing of placements, etc.

The IPAB was created and began operations in 1999. The institute is responsible for managing the debt resulting from the bank bailout originated by the 1994-1995 crisis. Before the creation of IPAB, the Federal Government supplied an implicit guarantee for bank liabilities. However, when the cost of rescuing the bank sector became explicit, IPAB practically assumed the total cost of this resolution.[16]

Besides serving as the financial broker for the Federal Government, Banco de México (the central bank), is also a major participant in the debt market denominated in domestic currency. Traditionally, the central bank uses the instruments issued by the Federal Government to add/withdraw liquidity from the money market through its open market operations. However, between 2000 and 2006, Banco de México issued its own monetary regulation bonds (known as BREMs) for the purpose of regulating liquidity in the money market and facilitating the conduct of monetary policy. These bonds where replaced by bondes D issued by the Federal Government[17] in August 2006.

Chart 1.1 shows the composition of broad-government bonds placed in the market, according to its issuer for the period 2001 to March 2014. It is evident that the Federal Government is the main issuer of risk-free instruments in domestic currency. As for Banco de México, the graph shows both the bonds issued on its behalf (BREMs), and the government instruments placed by the central bank for monetary regulation purposes, i.e., to withdraw liquidity on a long term basis and to finance the central bank assets (cetes and bondes D, both for monetary regulation).

The origin of the government bond market in Mexico dates back to 1978, when the Federal Government issued cetes[18] for the first time. At the beginning, the number and amount of transactions was small, the term was very short, there was no secondary market, and the government used a considerable control to determine the yield in primary auctions –for example, allocating a smaller quantity of instruments than that announced at the auction. The first issue of 1-year cetes took place in 1990; however, at times when financial markets became distressed, the government was capable of placing only 7-day cetes.

As for the secondary market,[19] as Sidaoui (2002) explained, it began developing in 1982, when the government allowed banks and brokerage firms to present bids in the public auctions of cetes. During this period, Banco de México gradually began to conduct monetary policy by withdrawing or injecting liquidity through the sale or purchase, respectively, of government bonds. Currently, pension and mutual funds, as well as insurance companies, may also participate in primary auctions for government securities.[20]

As discussed previously, macroeconomic instability hinders the development of financial markets. Periods of high inflation, exchange rate devaluations (linked to balance of payments’ crises), and significantly high levels of external debt were factors that hampered the development of the debt market in Mexico. Chart 1.2 shows how, during most of Mexico’s recent history, inflation and interest rates where at levels above one-digit values. In turn, Chart 1.3 demonstrates how the exchange rate value of the Mexican peso vs. the U.S. dollar practically rose by four in a period of 20 years.

The other aspect of macroeconomic stability that had to be considered to allow a healthy development of the debt market was the fiscal front. Fiscal policy probably constitutes the foundations for building this market. Consequently, all along the 1980s and 1990s, the Federal Government embarked on a major adjustment of public finances in order to maintain the budgetary balance (Chart 1.4).

1/ The (+) sign means deficit and the (-) sign means surplus.

As public finances improved, public sector borrowing requirements decreased which, in turn, allowed stabilizing the public debt balance first, and then reducing it as a percentage of GDP (Chart 1.5).

1/ In December 2008, the Federal Government absorbed the fiscal cost of the Reform to the ISSSTE Law, which amounted to 270.5 billion pesos. As a result, in that month, the public sector debt shows a hike as compared to the level registered during the previous months.

2/ The Federal Budget Law of November 13, 2008 modified the Pemex Pidiregas investment scheme. As a result, in January 2009 Pidiregas liabilities were reclassified from Pemex non-budgetary debt to budgetary debt for a total of 898.6 billion pesos. This change is illustrated in the chart as a hike in the Public Sector's Net Debt since 2009. However,  the figure that represents the amount resulting from the "Public Sector Debt" plus the item "any additional liabilities" does not change because the latter item decreases in the same proportion as the Public Sector Debt increases as a result of liabilities from Pemex Pidiregas being registered in the past under the item "any additional liabilities".

Despite the progress in the pursuit of macroeconomic stability, during 1994-1995 Mexico underwent a severe twin crisis of its balance of payments and its banking system. This crisis evidenced the problems of being extremely dependent on external financing (the so-called “original sin”[21] represented in Chart 1.5 due to the considerable share of external debt in the total debt) on the one hand, and having a maturity pattern extremely concentrated on short term instruments. Also, having financial intermediation in Mexico being almost exclusively undertaken through banks, it certainly worked against the national economy.

After this crisis, the need to carry out a thorough transformation of the debt market became evident, particularly for the Federal Government. The strategy the government adopted, as of this time, consisted in decidedly attacking a series of factors that were limiting the growth of its debt market, focusing mainly, according to Jeanneau and Pérez-Verdía (2005), on improving the conditions of demand for government debt and reforming the conditions of institutional investment, among others.

The first condition was to consolidate the process of macroeconomic stabilization, which was supported by the fiscal and monetary policies adopted since the 1980s. It was essential to put public finances in a path of clear and perceptible sustainability after the fiscal cost of the bank rescue. A series of fiscal adjustment actions and reforms were undertaken. The public sector deficit was decidedly reduced (previous Chart 1.4). The aforementioned strategy included considering both the total amount of public debt issued, and the exchange rate risk implicit in its denomination. The consolidation of fiscal discipline has been a fundamental pillar for the development of the public debt market.

In terms of monetary policy, macroeconomic stabilization involved the adoption of an inflation targeting framework in 2002, with all its attributes in terms of accountability and communication. This strategy, based on the appropriate stance of monetary and fiscal policies, represented the possibility of reducing inflation significantly until a low and stable rate was achieved.

The adoption of a free-floating exchange rate at the end of 1994 was also a fundamental element for the change in macroeconomic policy. The Mexican exchange rate history had been based on fixed-type exchange rate scheme with adaptations; therefore, the new regime represented a radical change that allowed, for the first time, to show the benefits of having a free exchange rate market, in which the limited interventions by the Foreign Exchange Commission through the central bank are done on the basis of clear rules. Within this context, since 1994 the exchange rate has evolved according to market forces, including a sharp adjustment during the international financial crisis of 2008.

Since 2000, the government began to implement a clear strategy to manage the public debt focused on favoring the development of the debt market and reducing the Federal Government’s financial weaknesses. Among some of the elements of this strategy that have been implemented are the following:

1. Improving the predictability and transparency of primary issuance. This is undoubtedly one of the most important elements of the strategy and is aimed at providing certainty to the market by accepting market conditions at the moment of allocating funds. One of the main steps towards predictability and transparency was taken in 2002 when the Federal Government openly gave away its right to determine the allocated interest rates in the primary auctions for its bonds. Additionally, since 2004, the government publishes an annual financing plan as a supplement to its quarterly announcements where both the intended amounts to place by type of instrument, as well as the specific auction calendar for the period are defined.[22]

2. Reducing the rollover risk by gradually increasing the maturity profile of government bonds. Bonds with longer terms were therefore gradually placed: fixed-rate bonds with 3 to 5 year maturities were issued in 2000; the first 10-year bond was issued in 2001, the 7-year bond in 2002 and the 20-year bond in 2003; finally, the 30-year bond was issued for the first time in 2006.

3. Reducing the interest rate risk for public finances. This involved trying to concentrate the greater possible quantity of fixed-rate bond issues instead of placing instruments with floating or adjustable rates (indexed to inflation, for instance). Once the adequate mix of maturities was achieved, the goal now is to have a sufficiently diversified portfolio that simultaneously covers the Federal Government’s financing needs and the demand of the different investor niches.

4. Creating benchmarks. In a yield curve there is a wide set of securities issued at different maturities. Among the measures adopted to foster the government securities market is selecting only certain issues that will serve as benchmarks. This is done by increasing the outstanding amount in circulation through a re-opening process for the purpose of building a critical outstanding amount.[23] In fact, the first evidence of a re-opening dates back to June 1996. However, it was not until 2000 when re-openings began to operate as a usual component of the public debt management strategy by having international financial institutions include benchmarks issues in debt indexes that are now replicated by many investors worldwide.

5. Introducing a market makers scheme. Another critical element for the development of the government bond market in Mexico, designed to increase its liquidity, depth and healthy development, was the introduction of the market maker scheme in 2000. Market makers enjoy the option of purchasing from Banco de México government bonds at the last primary auction price and of borrowing any instrument of the government portfolio.[24]

6. Issuing a zero-coupon bond yield curve. In order to meet the investment needs of a certain type of institutional investors interested in longer term bonds that only pay interest at maturity, Mexican financial authorities issued zero-coupon bonds by stripping certain bonos[25] and udibonos[26] issues in which the payment of the principal is stripped from that of coupons.[27] The first instruments were stripped in 2005, and later, in November 2012, the first auction for the placement of the 30-year Udibono stripped principal and interest was carried out.[28]

7. Introducing the swapping of instruments. As part of this strategy, and to prevent maturity dates of instruments with significant amounts outstanding to concentrate on certain dates, the government adopted a strategy of swapping instruments as of October 2005.[29] This strategy has allowed extending the average maturity date of government bonds and having a better cash management. Nevertheless, swapping has been used in certain cases merely to reinforce benchmark issues and to redistribute bond maturities in a more homogenous manner throughout the yield curve.[30]

8. Introducing structured debt instruments (warrants). As described by Sidaoui (2009), the increasing presence of foreign investors encourages innovation in debt instruments such as warrants, i.e. structured instruments that offer the option of swapping instruments. With these warrants, investors had the alternative, but not the obligation, to exchange Federal Government UMS (United Mexican States) sovereign bonds –denominated in foreign currency– for government fixed-rate bonds –in domestic currency– at a predetermined price and within the term specified in the warrant’s issue.

9. Buying government securities in the secondary market. For the purpose of relieving the financial crisis and to maintain order in the public debt market, the Federal Government bought from April to December 2008 some of its instruments in the secondary market, at market prices, through transparent and clear programs. In fact, these purchases were announced in advance and included fixed-rate bonos and both medium and long-term udibonos.[31]

10. Placing government securities through syndicated auctions. Finally, as of February 2010, syndicated auctions for some issues of bonos and udibonos have taken place. In these auctions, government bonds may be sold to a group or syndicate of financial institutions that buy a specific volume of bonds at market prices for a fee. In this way, a broader investor base is reached, as compared to a traditional primary auction.[32]

All the previous measures correspond mainly to the Federal Government in its role as an issuer or supplier of bonds. The other relevant arm for market development refers to fostering the demand for debt instruments. In this regard, the implementation of certain structural reforms also helped to set sound bases to support the growth of the demand for government instruments. For example, eliminating restrictions to capital flows mobility in 1988, and the previously discussed adoption of a free-floating exchange regime in 1994, fostered the participation of foreign investors in the local debt market. Similarly, the pension reform of 1997, which modified the pension system from one based on defined benefits, to another based on defined contributions, worked as a fulcrum for debt market development. During the reform, private pension fund managers (Afores, for its acronym in Spanish) were created. Later, in 2008, with the reform to the ISSSTE Law, which had a similar purpose in terms of public sector pensions, an additional boost was given to retirement savings. These reforms to the pension system have helped to create a local institutional investor base and a natural supply of long-term funds to finance the government through the securities market.

Together with the previously described measures, a series of reforms to the financial system have also been adopted, some of which have favored indirectly the development of financial markets in general, and the debt market in particular. For example, within this new regulatory framework, the Bankruptcy Law approved in 2000 had an indirect positive impact on government bonds. Indeed, since most repurchase agreement (repo[33]) operations are carried out using government bonds, the new provisions of the Bankruptcy Law provided legal certainty to this market by allowing repo bondholders (or buyers) to conclude their operations in advance by settling rights and obligations if a counterpart goes into default. Before the law was implemented, it was necessary to face obligations first and then receive the corresponding proceedings according to the amount obtained in the bankruptcy settlement. In addition other prevailing laws were amended in 2003, when Congress approved the exclusion of repurchase agreements in the deposit insurance of IPAB, which also reduced the transaction cost of repos. Another example is the Securities Market Law in 2005, which was aimed, among other things, to relax the regulatory framework applicable to brokerage firms and various financial bodies participating in the market (brokerage firms, security deposit institutions, central counterparties, brokers, price vendors and other security rating agencies, among others). The fiscal regime was also considerably simplified to ease the development of the government bond market. In fact, foreign investors are not currently subject to tax withholding for accrued interest by their government bond holdings.

From a regulatory perspective, some changes have supported the development of the government bond market. One of the most relevant was authorizing commercial and development banks, in 1990, to trade instruments in the secondary market with no intermediation whatsoever from brokerage houses. In addition, the regulation regarding the limits for pension funds in terms of investing resources at different terms and types of instruments has also become more flexible.

As discussed before, the characteristics of the systems and mechanisms used to set up and settle transactions are another basic element for the development of debt markets. The growth of brokers that offer efficient trading systems has been relevant for price discovery.[34] Similarly, and in order to standardize and provide more precision to portfolio valuation, price vendors were introduced in Mexico. Price vendors should calculate updated valuation prices for the most important instruments and, since they must value instrument at market prices for most portfolios of financial intermediaries, they play a key role in the securities market.[35]

The central bank, who is responsible in Mexico for the functioning of the payment systems, has made efforts to operate according to international standards and better practices over the last few years. Among the changes enforced is the implementation of the Delivery Versus Payments (DVP) system, which guarantees that instruments are delivered only when the cash covering their purchase is received in return (and vice versa), a fundamental element to reduce settlement risk. In addition, international companies providing services of settlement of securities transactions and custody, such as Euroclear and Clearstream, have agreements with the local banks to settle with them operations with government bonds denominated in pesos (including cetes, bondes D, udibonos, bonos, and shares).[36] Also, to ease the DVP process, Banco de México issued regulations that now allow securities lending. In fact, as stated before, the central bank, as the financial agent of the Federal Government, offers a securities lending window for market makers.[37]

Summing up, Mexican authorities adopted a government bond market promotion strategy as the backbone for the financial and economic development of the country. This strategy addressed a broad range of measures covering different market settings: demand, supply, legal and technical infrastructure, transparency, risk control, among others.

1.4 Strategy results

The results achieved to date by Mexico in the development of its government debt market helped to break certain paradigms in financial theory, such as the “original sin” previously mentioned, which considered that developing countries were unable to issue debt in their currency. As can be confirmed in previous Chart 1.5, the Federal Government has been able to replace its external financing with domestic debt, receiving now more resources from the domestic than from the external market. Besides, a yield curve has also been developed in the process. It is remarkable that in only seven years (1999-2006), the government bond yield curve has extended up to a term of 30 years for bonos and udibonos (Chart 1.6). This yield curve has served as a reference for placing debt in pesos to many national, and even foreign, issuers, as mentioned by Sidaoui (2009), and by Sidaoui, Santaella and Pérez (2012).

The combination of stability and financial reforms had a positive impact in financial savings, which, doubled as a percentage of GDP in a period of fifteen years (Chart 1.7). In fact, pension funds (Siefores) started to play a central role in the expansion of saving (Chart 1.8), becoming the most important sector of institutional investment in the country.[38] Indeed, as stated in Banco de México’s Financial System Report (2011), the growth of the institutional investor’s base “has contributed to maintaining stability and liquidity in the national financial markets”.

1/ Defined as M3 excluding banknotes and coins.

The composition of public domestic debt and the set of its investors’ holdings have also changed. As a consequence, these have contributed concurrently to the development of markets. While in 1999 two thirds of the Federal Government domestic debt was placed at floating rate (bondes) and another fourth was short-term (cetes), by March 2014 half of the outstanding balance of government instruments were in fixed-rate and long-term bonds (Chart 1.9). This new composition in the type of instruments placed has meant a significant increase in both the term and duration of the government debt over the last decade and a half. For example, the average maturity date of the government debt increased from 288 to 1,070 days during the period between 1995 and 2004 (Jeanneau and Pérez-Verdía, 2005) and to more than 2,950 days in March 2014 (Chart 1.10). In turn, duration increased from a little more than a year in 2002 to 4.81 years in March 2014. The extension of both maturity profile and duration has significantly reduced rollover and interest rate risks for the Federal Government.

Chart 1.11 illustrates how the investor base has grown. In 2005, the main holder of government bonds was the Mexican banking system, holding 13% of the outstanding total for its own accounts and an additional 39% for various customers (mainly individuals and corporations participating in the market through banks). These two sectors (banks and other) limited their influence by March 2014 by having only 30% of the instrument holdings at that time. As for Mexican institutional investors (Siefores, mutual funds and insurance companies) they kept a share of between 33% and 40% for the period 2005 to March 2014. Meanwhile, foreign investors increased their share in the total of outstanding instruments from 8% to 36% in the same period. This change in the composition of the investor base has provided the Mexican market with more stability and depth, since the most important holders now trade for longer terms. Regarding the most recent expansion of foreign investment in the government bond market, Sidaoui, Santaella and Pérez (2012) tentatively argue that it could be an additional factor contributing to the stability of this market.

The development of the government debt market is reflected in its trading volume (Chart 1.12), which has grown considerably, even in periods of high financial volatility. As for market liquidity, it has increased significantly, as reflected by the lower spreads or bid-ask differentials in government bond prices. In this way, the development and depth of the Mexican securities market, together with its institutional and operational characteristics, allowed the inclusion of government debt denominated in pesos in the main global fixed-income indexes (Table 1.1). This inclusion, in turn, has contributed to a wider participation of foreign investors, from those who passively replicate those indexes, to those who discover these assets by being included in prestigious or globally accepted portfolios.

Table 1.1

Inclusion of Mexican government debt denominated in pesos

in Global Fixed-income Indexes

Index

Inclusion

Government Bond Index Broad

(JP Morgan GBI - Broad)

2001

Universal Government Inflation-linked Bond Index

(Barclays)

2003

Government Bond Index EM

(JP Morgan GBI - EM)

2005

Global Aggregate Index

(Lehman/Barclays)

2005

Global Government Bond Index

(ML-GGBI)

2006

Global Government Inflation-linked Index

(ML)

2007

Global Emerging Markets

(GEMX)

2008

EM Government Inflation-linked Bond Index

(Barclays)

2008

World Government Bond Index

(Citi - WGBI)

2010

Source: Ministry of Finance (SHCP).

As mentioned previously, the existence of a risk-free yield curve has been used as a reference by the different issuers. On the one hand, this curve has facilitated the granting of mortgage credits for up to 30 years by financial institutions. This has occurred due to the need to establish long-term, risk-free financing cost, as well as for risk management purposes by banks. On the other hand, some corporations, besides enjoying access to credits through the bank sector, have managed to finance productive projects by issuing bonds and securitizing assets. In fact, the yield curve is the main anchor for floating-rate issues, the most common instrument for corporate issues (Chart 1.13).

Before the 2008 crisis, foreign issues in the “Europeso”[39] market where growing at significant rates based on the domestic market yield curve.

The development of the government debt market in Mexico has also fueled the emergence of the derivatives market.[40] The Mexican Derivatives Market, also known as MexDer, began operations in December 1998. This market, together with its clearing house Asigna Compensación y Liquidación (known as Asigna), are self-regulated bodies operating under the supervision of the Ministry of Finance, Banco de México and the National Banking and Securities Commission (CNBV, for its acronym in Spanish). Having a consolidated derivatives market sets the basis for adequate risk management.[41] Additionally, the derivatives market strengthens the monetary policy transmission channels by allowing an expansion of the credit channel. Finally, thanks to these instruments it is possible to have better financial tools and indicators for the central bank to evaluate market expectations.

As can be seen in Charts 1.14 to 1.17, the most important contracts in MexDer are those of futures for fixed-income securities, among which the TIIE and government bond futures (cetes and bonos) stand out. This market experienced significant growth prior to the 2008 financial crisis, although recently it has been rather modest. In its place, interest rate swaps (IRS), market referenced to the TIIE, have been growing. Being a highly liquid, OTC market, has allowed an efficient hedging of interest rate risk.[42] It is important to mention that this over-the-counter market is quoted outside stock exchanges, like the MexDer.

1/ March 2014, annual accrued.

1/ Includes 3-month cetes and 3-year, 10-year and 20-year bonos.

1.5 Other risk-free issuers

As shown previously in Chart 1.1, other free-risk issuers in Mexico include Banco de México and IPAB. The central bank has participated in the debt market through the auction of securities aimed at funding the accumulation of international reserves with long-term liabilities. From 2001 to 2006, Banco de México placed its own instruments but, since then, it has used government bonds.[43] In the case of IPAB, it manages the debt originated by the restructuring and support granted to commercial banks after the 1994-1995 crisis and which were taken over by the Institute. It is for this purpose that IPAB places its own instruments in the debt market.

Maybe the most important consideration regarding other risk-free issuers is that they are perfectly coordinated with the Ministry of Finance in terms of instrument placing. Indeed, coordination among the different issuers has been such that several niches have been reserved for each of them: while the Federal Government has a wider placement of both nominal (short and long terms) and real (only long term) fixed-income securities, Banco de México and IPAB have issued solely floating rate securities. Hence, the three issuers participate in a coordinated way in the quarterly announcements of auctions of securities (where both the intended amounts to place by type of instrument as well as the specific auction calendar for the period are defined).

1.6 Conclusions

This chapter discussed the main elements needed for the development of the government debt market, a mainstay for the remaining financial markets in any economy. Then, the strategy followed by the Mexican financial authorities to develop the debt market was introduced, together with its main results. Undoubtedly, the development of the market for instruments issued by the Federal Government has been successful.

The rest of the book provides detailed descriptions of the characteristics of the types of instruments currently available in the Mexican securities market and the way in which they are placed among investors (Chapter 2). Then, it moves to discussing the currently available investor base (Chapter 3) and how the secondary market operates (Chapter 4). The figure of market makers, key to the development of the market, is also analyzed (Chapter 5). It also describes the operation of settlement systems in Mexico (Chapter 6). Finally, relevant regulatory and fiscal aspects are reviewed (Chapter 7) and conclusions are made (Chapter 8).

1.7 References

- BANXICO. Official notice (circular) 1/2006.

- BANXICO. Technical Description of Banco de México’s Monetary Regulation Bonds (Descripción Técnica de los bonos de Regulación Monetaria del Banco de México). 2000.

- BANXICO. Financial System Report. 2011.

- BIS. The role of the central bank in developing debt markets in Mexico. Sidaoui, José Julián. June 2002.

- BIS. Reducing financial vulnerability: the development of the domestic government bond market in Mexico. Jeanneau, Serge and Pérez-Verdía, Carlos. 2005.

- BIS. The impact of international financial integration on Mexican financial markets. Sidaoui, José Julián. January 2009.

- BIS. Banco de México and recent developments in domestic public debt markets. Sidaoui, José Julián; Santaella, Julio, and Pérez, Javier. 2012.

- IBRD/World Bank, IMF. Developing government bond markets a handbook. 2001.

- IMF Working Paper. Managing risks in financial market development: The role of sequencing. Karacadag, Sundararajan, Elliott. June 2003.

- Mohanty and Turner. Monetary policy transmission in emerging market economies: what is new? 2008.

- NBER Working Papers No. 10036. Currency mismatches, debt intolerance and original sin: why they are not the same and why it matters. Eichengreen, Hausmann and Panizza. October 2003.

- Greenspan, Alan (Remarks by Chairman). Do efficient financial markets mitigate financial crises? Before the 1999 Financial Markets Conference of the Federal Reserve Bank of Atlanta, Sea Island, Georgia. October 19, 1999.

- SHCP. El crédito público en la historia hacendaria de México, sus protagonistas y su entorno. Rodríguez Regordosa, Gerardo. November 2012.

- SHCP. Official notice (Oficio) no. 305.-065/2008.

- Sidaoui and Ramos Francia. The monetary transmission mechanism in Mexico: recent developments. 2008.

- Turner. Bond markets in emerging economies: an overview of policy issues. 2002.

1.8 Notes

[1] Claudia Álvarez-Toca has a Bachelor degree in economics (summa cum laude) from Universidad Iberoamericana (UIA) and a Master degree in business administration (summa cum laude), with a major in finance from Instituto Panamericano de Alta Dirección de Empresas (IPADE). Since 2007 she has been senior economist at Banco de México, now reporting directly to the Directorate General of Central Bank Operations. Since she first started working at the central bank in 1993, she has held different positions, always in the Operations Department, among which stands out her position as head of the desk in charge of the implementation of currency exchange policies and later, as head of foreign reserves management. During a period where she worked outside Banco de México (2002-2007), she did so as an academic in Finance at IPADE, where she also held managerial positions and offered consulting services to corporations and individual investors.

Julio A. Santaella-Castell holds a Bachelor degree in economics from Instituto Tecnológico Autónomo de México (ITAM) and a Doctorate in economics from the University of California at Los Angeles (UCLA). He currently is Operations Support Director at Banco de México. Among his main responsibilities are providing economic and financial analysis to the central bank operations, processing all central bank operations, and offering operating systems to perform these operations. Prior to Banco de México he worked at the Ministry of Finance (1984-1987), the International Monetary Fund (1992-1997), and the Instituto Tecnológico Autónomo de México (1997-2001). He is the author of several articles published in academic journals and books.

The authors would like to thank Javier Duclaud, Jaime Cortina and Oscar Palacios for their comments, as well as the valuable technical and research assistance of Claudia Tapia, Rodolfo Mitchell and Germán Mirassou.

[2] Turner (2002) states that the development drivers for debt markets are specific (related to effectively satisfying credit needs) and general (related to a better market functioning).

[3] “Before the crisis broke out, there was little reason to question the three decades of incredibly solid East Asian economic growth, largely financed through the banking system. The rapidly expanding economies and bank credit growth kept the ratio of nonperforming loans to total bank assets low. The failure to have backup forms of intermediation was of little consequence. The lack of a spare tire is of no concern if you do not get a flat tire. East Asia had no spare tires…” in Greenspan (1999).

[4] IBRD / World Bank, International Monetary Fund. Developing Government Bond Markets a Handbook. 2001, p.4.

[5] In the case of Mexico, risk-free issuers comprise the Federal Government, the Bank Savings Protection Institute (Instituto para la Protección del Ahorro Bancario, IPAB), and Banco de México (the central bank also known as Banxico).

[6] YIELD CURVE: Graphic representation of interest rate levels of different bonds with different maturity terms, but with the same credit rating, in a certain moment. Represented graphically from the shortest to the longest maturity term.

[7] DERIVATIVE: Security whose price depends on or derives from one or more underlying assets. A derivative is nothing more than a contract between two or more parties. Its value is determined by fluctuations in underlying asset prices. Futures contracts, forwards, options and swaps are the most common type of derivatives.

[8] For more information on the general theory of monetary policy transmission, see Mohanty and Turner (2008), and for a comprehensive analysis of the monetary policy transmission channels in Mexico, see Sidaoui and Ramos Francia (2008).

[9] For more information, see IBRD/World Bank, International Monetary Fund (2001), op.cit.

[10] This was most evident during the recent European crisis, where issuers with high debt indexes lost access to markets.

[11] For details on the repo market, see chapter “Secondary market” in this book.

[12] BIS Papers no. 11. The role of the central bank in developing debt markets in Mexico. José Julián Sidaoui, June 2002, p.151.

[13] In Mexico, competition among different risk-free issuers for the same investments has been prevented by making both government and Banco de México instruments fungibles with each other. For more details, see chapter “Types of instruments and their placement”.

[14] In the specific case of Banco de México, coordination also includes aspects related to its role as sole financial broker of the Federal Government.

[15] The term “broad government bonds” is regularly used to refer to the instruments placed by these three issuers and the term “government bonds” corresponds to those issued exclusively by the Federal Government.

[16] The chapter “Types of instruments and their placement” describes thoroughly the characteristics of the instruments issued by IPAB.

[17] For more details on the instruments issued by the central bank, see Technical Description of Monetary Regulation Bonds of Banco de México at www.banxico.org.mx. The chapter “Types of instruments and their placement” also refers to the characteristics of bondes D.

[18] CETES: Federal Treasury Certificates. They belong to the family of zero-coupon bonds, i.e., they are traded at a discount (below their nominal value), bear no interest along their term and their nominal value is settled at maturity. For more information, see the chapter “Types of instruments and their placement.”

[19] SECONDARY MARKET: Market in which securities already placed are bought and sold and where trades are carried out among investors (instead of being dealt directly with the issuer). For more information, see chapters “Secondary market and “Investor base”.

[20] For more information, consult the chapter “Investor base”.

[21] The advocates of this theory argue that this condition increases a country’s vulnerability by being forced to use foreign currencies to finance its debt and to face depreciations in its currency (Eichengreen et al. 2003).

[22] In the chapter “Types of instruments and their placement”, reference is made to “Transparency and predictability” with more detail.

[23] The chapter “Types of instruments and their placement” describes in more detail “Reference issues and openings”.

[24] For more information, see Ministry of Finance official notice no. 305.- 065/2008.

[25] BONOS: Federal Government fixed-rate development bonds that are issued and placed at terms of over one year, pay interest every six months and their interest rate is determined at issue date and remains fixed all along the life of the bond. For more information, see chapter “Types of instruments and their placement”. Also known as bonos M.

[26] UDIBONOS: Federal Government development bonds denominated in investment units. They were created in 1996 and protect their holder from unexpected changes in the inflation rate. Udibonos are placed at long terms and pay interest every six months on the basis of a real fixed-interest rate determined issue date. For more information, see the chapter “Types of instruments and their placement”.

[27] COUPON: The term “coupon payment” is known as an advance interest payment of debt (that is, prior to the instrument’s maturity date).

[28] The chapters “Types of instruments and their placement” and “Secondary market” describe in detail the stripped instruments auction and the secondary market, respectively.

[29] SWAP (of instruments): A swap of government bonds is a financial operation through which certain government bonds are swapped or exchanged with other of different characteristics.

[30] In the chapter “Types of instruments and their placement” “swaps” are described in more detail.

[31] The chapter “Types of instruments and their placement” describes these “purchases” in more detail.

[32] In the chapter “Types of instruments and their placement” the “syndication” process is described in detail together with other security placement schemes.

[33] REPO: Repo operations are those where the repurchasee (lender) acquires credit instruments for a certain amount of money and is obliged to transfer to the repurchaser (borrower) those instruments on a previously agreed date against the same amount of money plus a premium. The chapter “Secondary market” describes extensively repo operations.

[34] PRICE DISCOVERY: Process through which the price of an instrument is determined considering its supply and demand. The instrument’s price is therefore the result of the appetite for the instrument at any given time and the willingness to sell it by its holders.

[35] See the chapter “Secondary market” for more details on “Price vendors”.

[36] This subject is broadly discussed in the chapter “Instruments settlement”.

[37] The chapter “Secondary market” describes this window in more detail.

[38] The chapter “Investor base” provides information and charts that show the development of the various investor segments, pension funds included.

[39] Europesos are instruments denominated in pesos but issued outside Mexico.

[40] DERIVATIVE: Security whose price depends on or derives from one or more underlying assets. The derivative is a contract between two or more parties. Its value is determined by fluctuations in the underlying asset price. Futures contracts, forwards, options and swaps are the most usual type of derivatives.

[41] RISK MANAGEMENT: Refers to the process of identifying, analyzing and accepting or mitigating of uncertainty in investment-related decisions. It takes place whenever a potential loss in an investment is quantified in order to take (or not) the proper decision, considering its investment goals and risk tolerance.

[42] INTEREST RATE SWAP: Agreement between two parties that consent to exchange in the future a series of interest payments for a predetermined nominal amount. Interest rate swaps usually exchange a fixed rate-based payment for a floating rate-based payment (in the case of Mexico, for a TIIE-based payment). A company will normally use these kinds of swaps to limit their exposure to fluctuations in the interest rate levels of their debt.

[43] The process by which Banco de México acquires government bonds without granting financing to the Federal Government is established in Banco de México’s Law and in the Financial Broker contract signed between Banco de México and the Ministry of Finance (SHCP). These regulations state that Banco de México must match the purchase of government bonds with Federal Government deposits in cash obtained from the placement of the referred bonds. These deposits cannot be used or withdrawn by the Federal Government until the value backing up such deposits matures. For a detailed description of this process, see the box included in the chapter “Types of instruments and their placement”.

II. Types of instruments and their placement

Ma. Rebeca Acosta-Arellano and Claudia Álvarez-Toca[1]

This chapter describes the structure and functioning of Mexico’s primary market of government securities. First, the types of instruments that are currently issued and placed in the local market are discussed. Then, reference is made to the physical aspects and the ownership of instruments, as well as the creation of benchmark lines using re-openings. Following are the different ways these securities are placed among investors and, finally, a section is included which details the relevance of transparency and predictability in the placement of these securities for the development of the market.

1. Types of instruments

2. Physical securities and their holdings

3. Reference issues and reopenings

4. Placement of government securities

5. Other operations

6. Transparency and predictability

7. References

8. Appendices. Technical description of government securities

9. Notes

2.1 Types of instruments

In Mexico, the Federal Government issues and places four different instruments in the local debt market. These include cetes, bonos,[2] bondes, and udibonos. The Institute for the Protection of Bank Savings (Instituto para la Protección al Ahorro Bancario or IPAB, for its acronym in Spanish) also places bonds known as Bonos de Protección al Ahorro (Savings Protection Bonds, BPAs) which, although being issued by this Institute, are covered by a credit guarantee from the Federal Government[3] Banco de México acts as a financial broker in the placement of both Federal Government and IPAB securities. Below is a brief description of each of these instruments.[4]

Table 2.1

Current government debt instruments issued in Mexico

Instrument

Name

Face value

Term

Used

term 2/

Interest period

Interest

rate

Security id. 1/

First isuue

Cetes

Federal Treasury

Certificates

10

pesos

Min: 7 days.

Max: 728 days

28 and 91 days,

and close to 6 months

and 1 year

Zero-coupon bonds

Yield rate

referenced to

discount rate

BIAAMMDD

Jan-19-78

Bondes D

Federal Government Development Bonds

100

pesos

28 day-multiple

3, 5 and 7 years

28

days

Weighted bank

funding rate for

the interest period

LDAAMMDD

Aug-17-06

Bonos

Fixed-interest Federal Government

Development  Bonds

100

pesos

182 day-multiple

3, 5, 10, 20

and 30 years

182

days

Fixed at issue

by Federal

Government

M AAMMDD

Jan-27-00

Udibonos

Federal Government Development Bonds denominated in

Investment Units

100

udis

182 day-multiple

3, 10

and 30 years

182

days

Fixed at issue

by Federal

Government

S AAMMDD

May-30-96

BPA182

Savings Protection Bonds with interest payable

at six months and

inflation-hedged

100

pesos

182 day-multiple

5 and 7 years

182

days

182-day Cetes or

change in UDI

value during

the period

ISAAMMDD

Apr-29-04

BPAG91

Savings Protection Bonds with interest payable

at three months and additional reference rate

100

pesos

91-day multiple

5 years

91

days

Max [91-day Cetes, weighted government

funding rate]

effective at the beginning of the

interest period

IQAAMMDD

Apr-26-12

BPAG28

Savings Potection Bonds with interest payable

at one month and

additional reference rate

100

pesos

28-day multiple

3 years

28

days

Max [28-day Cetes, weighted government

funding rate]

effective at the beginning of the

interest period

IMAAMMDD

Apr-26-12

1/ The security ID is formed by 8 characters. The first two characters are for identifying the type of security and the remaining six to show the maturity date (year, month, day).

2/ Most frequently used.

Source: Banco de México.

- Cetes: Federal Treasury Certificates (Certificados de la Tesorería de la Federación) are the oldest debt instruments issued by the Federal Government. They were first issued in January 1978 and, since then, have become a fundamental pillar in Mexico’s money market. These instruments belong to the family of zero-coupon bonds, i.e., they are discount traded (below their nominal value), pay no interest, and are settled at nominal value at maturity date. Currently, their maximum term is one year, although previously they were issued for up to two years. Cetes are fungible[5] among themselves as long as they mature on the same date, regardless of their issue date.[6]

- Bondes: Federal Government Development Bonds (Bonos de Desarrollo del Gobierno Federal) are floating-rate government securities, i.e., they pay interest and their rate is revised periodically (the terms at which the rate is periodically revised have changed along their history). They were first issued in October 1987. Since August 2006, the type of bondes that is placed in the market is known as bondes D, and pays monthly interest in pesos (every 28 days or the corresponding term that substitutes it in the event of holidays). Currently, these bonds are traded at 3-, 5- and 7-year terms. The interest rate paid by these securities is determined by compounding[7] on a daily basis the rate at which banks and brokerage firms carry out their overnight trades and repo transactions with banking instruments. This rate is known as “weighted bank-funding rate” (Tasa ponderada de fondeo bancario).[8] Bondes D are fungible among themselves as long as they mature on the same date, regardless of their issue date.[9]

- Bonos: Fixed-rate Federal Government Development Bonds (Bonos de Desarrollo del Gobierno Federal con Tasa de Interés Fija) were first issued in January 2000. Today, they are issued and placed at 3, 5, 10, 20 and 30 years. Bonos pay interest every six months and, contrary to bondes, their interest rate is determined on the issue date and remains fixed all along their term. Bonos are not fungible among themselves except if they pay the exact same interest rate.[10]

- Bonos are susceptible to being stripped, i.e., the principal’s interest payment may be segregated in “stripped coupons” and, even when already stripped, they may be reconstituted by integrating again the “stripped coupons”, the accrued interest, and the corresponding principal, therefore returning it to the initial issue format.[11]

- Udibonos: Federal Government Development Bonds denominated in Investment Units (Bonos de Desarrollo del Gobierno Federal denominados en Unidades de Inversión) were created in 1996 and are inflation-hedged instruments. Udibonos are issued and placed at 3, 10 and 30 years and pay interest every six months at a real fixed interest rate determined at their issue date. They pay interest in udis that is payable in Mexican pesos (MXP).[12] Since each issue has the same real fixed interest rate from issuance to maturity date, udibonos are not fungible among themselves unless they pay the exact same interest rate.[13]

- Udibonos are susceptible to being stripped (the principal’s interest payment may be segregated in “stripped coupons”). Like bonos, they may be reconstituted by integrating again the “stripped coupons”, the accrued interest, and the corresponding principal.[14]

- BPAs: The Institute for the Protection of Bank Savings (Instituto para la Protección al Ahorro Bancario, IPAB) issues Savings Protection Bonds (Bonos de Protección al Ahorro, BPAs) using Banco de México as its financial agent. These instruments are issued at 3-, 5- and 7-year terms and pay interest on the same terms as cetes. The one that pays interest every month is identified as BPAG28, the one that pays interest every three months is identified as BPAG91, and the one paying interest every six months is identified as BPA182. These instruments pay interest in pesos (MXN). IPAB instruments are fungible among themselves as long as the mature on the same date and they are of the same type (BPAG28, BPAG91 and BPA182, respectively), regardless of the date they were issued.[15]

Although today the Federal Government and IPAB only issue and place the seven types of previously described securities, since 1978 a broad range of securities had been issued and placed in the market. Table 2.2 summarizes some characteristics of the different government instruments since they began to be issued up to now.

Table 2.2

Timetable of local government securities issues

(Federal Government, Banco de México and IPAB)

Instrument

First issued

Characteristics

Interest rate

Outstanding

Cetes

Federal Treasury Certificates

Jan. 19,

1978

Zero-coupon bonds

Yield rate referenced to discount rate

Yes

Pagafes

Federal Treasury Notes

Aug. 21,

1986

Zero-coupon bonds denominated

in controlled USD and payable in MXP

Yield rate referenced to discount rate

No

Bondes

Federal Government Development Bonds

Oct. 15,

1987

28-day coupon

The highest between 28-day Cetes and promissory notes with yield payable at maturity (PRLVs, for their acronym in Spanish)

No

Tesobonos

Federal Treasury Bonds

Jul. 13,

1989

Zero-coupon bonds denominated

in free USD and payable in MXP

Yield rate referenced to discount rate

No

Ajustabonos

Federal Government Adjustable Bonds

Jul. 20,

1989

Adjustable nominal value (INPC,

for its acronym in Spanish).

Fixed interest rate set at issue date

No

Udibonos

Federal Government Development Bonds denominated in Investment Units

May 30,

1996

182-day coupon

Fixed interest rate set at issue date

Yes

Bondes 91

Government Development Bonds with interest payable at three months and inflation-hedged

Oct. 23,

1997

91-day coupon

91-day Cetes or the change in UDI value for the period

No

Bonos

Fixed-interest Federal Government Development Bonds

Jan. 27,

2000

182-day coupon

Fixed interest rate set at issue date

Yes

BPAs

Savings Protection Bonds

March 2,

2000

28-day coupon

28-day Cetes

No

Bondes 182

Government Development Bonds with interest payable at six months and inflation-hedged

Apr. 19,

2000

182-day coupon

182-day Cetes or the change in UDI value for the period

No

BREMS

Banco de México’s Monetary Regulation Bonds

Aug. 3,

2000

28-day coupon

Daily “weighted overnight interbank rate”

No

Bondes T

Government Development Bonds with interest payable at three months

Nov. 1,

2000

91-day coupon

91-day Cetes

No

BPATs

Savings Protection Bonds with interest payable at six months

Jul. 4,

2002

91-day coupon

91-day Cetes

No

BPA182

Savings Protection Bonds with interest payable at six months and inflation-hedged

April 20, 2004

182-day coupon

182-day Cetes or the change in UDI value for the period

Yes

Bondes D

Government Development Bonds

Aug. 17,

2006

28-day coupon

Daily “weighted overnight interbank rate”

Yes

BPAG28

Savings Protection Bonds with interest payable at one month and additional reference rate

Apr. 26,

2012

28-day coupon

Max [28-day Cetes, Weighted government funding rate] effective at the beginning of the period of interest]

Yes

BPAG91

Savings Protection Bonds with interest payable at three months and additional reference rate

Apr. 26,

2012

91-day coupon

Max [91-day Cetes, Weighted government funding rate] effective at the beginning of the period of interest]

Yes

Source: Banco de México.

2.2 Physical securities and their holdings[16]

Security holding is controlled by Indeval,[17] who keeps an accounting record of the instruments held by financial institutions. In turn, these financial institutions keep an accounting record of their customers’ holdings. By operating in this way, the control on the holding of securities is assured.

Nevertheless, in Mexico, for each government security there is physically a global note (multiple certificate) for the total of each issue. Government securities in Mexico are therefore not dematerialized (uncertified) but rather immobilized; that is, they are deposited exclusively in one location (entity). Global notes of government security issues are physically kept at Banco de México while IPAB securities, at Indeval.

By keeping all accounting records of its operations, Indeval prevents any inefficiencies or high costs that might derive from physically moving the government securities that are traded.

2.3 Reference issues and reopenings

In the last years, both the Federal Government and IPAB have adopted the policy of reopening outstanding issues of practically all types of securities issued in order to increase their size and thus promote the development of a more liquid secondary market.

Table 2.3

Government securities outstanding by type and term

Billion pesos at nominal value

Months

Years

1

3

6

1

3

5

7

10

20

30

Cetes

129

222

326

255

-

-

-

-

-

-

Bonos

-

68

-

117

476

450

88

307

450

278

Udibonos

-

-

-

118

148

64

145

111

44

355

Bondes D

26

28

27

126

432

371

78

-

-

-

BPAs

-

-

1

11

-

-

-

-

-

-

BPAT

2

-

-

-

5

-

-

-

-

-

BPA182

-

30

26

47

48

152

102

-

-

-

BPAG28

-

-

-

17

97

-

-

-

-

-

BPAG91

6

6

11

25

122

-

-

-

-

-

TOTAL

173

354

392

700

1,405

1,165

413

418

494

633

Source: Banco de México.

Table 2.4

Breakdown of government securities outstanding

Number of instruments and billion pesos at nominal value

Number of

instruments

%

Amount

outstanding

%

Bonos

22

11.8

2,234.2

36.3

Cetes

23

12.4

932.2

15.2

Udibonos

9

4.8

985.1

16.0

Bondes D

41

22.0

1,089.6

17.7

BPA182

27

14.5

404.3

6.6

BPAT

13

7.0

6.6

0.1

BPAs

7

3.8

12.3

0.2

BPAG28

18

9.7

170.3

2.8

BPAG91

26

14.0

313.1

5.1

TOTAL

186

100

6,147.7

100

Source: Banco de México.

2.4 Placement of government securities

In Mexico, government securities have been traditionally placed in the primary market through auctions.

2.4.1 Auctions[18]

An auction is the public sale of goods to the best bidder. Auctions are carried out at multiple, uniform, and fixed prices (see Box 2.1).[19]

Currently, Mexican government securities are placed through multiple and single price auctions (see Table 2.5 and Table 2.6). In both cases, these auctions are “closed” systems, i.e., the allocation price is only disclosed after the auction is closed.[20] Only Banco de México bondes D auctions use an “interactive” system in which the marginal allocated price for the entire issuance is disclosed in real time, allowing bidders to improve their bids as long as the pre-established time for such purpose has not ran out.

Box 2.1

Types of auctions

In a typical primary auction of government securities, bids received are assigned according to a descendent arrangement of the corresponding unit prices, without exceeding the maximum amount offered. In other words, the issuer orders bids according to price, from higher to lower, and starts accepting the ones less expensive for him until the amount auctioned is covered completely. The most common types of auctions used to place securities in financial markets are multiple price and single price auctions. However, fixed price auctions also exist.

Multiple price auctions: The winning bids are allotted at the price offered by each bidder. The advantages of this type of auctions include maximizing the profit to be received by the issuer by obtaining the maximum price each bidder is willing to pay.[21] The main disadvantage of this type of auctions for issuers, however, is that the incentives for bidders to collude are higher.

Single price auctions: All winning bids are allotted at the corresponding price of the last bid assigned. In the end, the price paid by the bidder may be lower than the price he is willing to pay, which represents a disadvantage for the issuer. An advantage of single price auctions for issuers is that the incentives for bidders to collude are lower.

When there are tied bids and the amount left to be assigned is insufficient to cover them completely, for both multiple price and single price auctions, these are prorated relative to the size of the bid (in order to determine the proportion of the amount to be allotted).

Fixed price auctions: This type of auctions has been used in Mexico for the Federal Government to buy its own securities. Bids are assigned at the price determined by the Federal Government and up to the amount stated in the bids.

Tabla 2.5

Instruments by type of auction

Multiple rate/price

Single rate/price

Federal Government

Cetes

X

Bondes D

X

Bonos

X

Udibonos

X

Banxico (Monetary regulation)

Bondes D

X

Cetes

X

IPAB

X

Source: Banco de México.

Announcements of auctions of Federal Government and IPAB securities take place on a weekly basis. They are released on the last working day of the week prior to the auction.[22]

Government security auctions always take place two working days before the settlement date, which regularly falls on Thursdays, except on holidays, in which case, securities are settled on the closest previous or following working day (preferably the previous day).[23] For IPAB securities, auctions take place on the working day prior to their settlement date, which also regularly falls on Thursdays, except on holidays.

Box 2.2

Process through which Banco de México acquires Federal Government securities for monetary regulation purposes*

To achieve its monetary policy operational target (overnight interbank interest rate), Banco de México may use different instruments to manage the liquidity in Mexico’s financial system. These instruments may be classified according to the term used in the sterilization process:

Short-term instruments:

1. Open market operations

2. Credit and deposit facilities

3. Government securities sales

Medium- and long-term instruments:

1. Monetary regulation deposits

2. Direct sale and purchase of government securities

Sale of debt securities for monetary regulation purposes

One of the main instruments traditionally used by Banco de México to sterilize the surpluses of liquidity in the financial system is the sale of securities. These surpluses come mainly from the accumulation of international reserves. From 2000 to 2006, Banco de México used its own instruments to sterilize the accumulation of international reserves. Monetary regulation bonds (BREMs, for their acronym in Spanish) were instruments yielding an interest rate referenced to the daily weighted bank-funding rate. In 2006, the Federal Government and Banco de México agreed to substitute the central bank’s instruments for securities issued by the Federal Government (bondes D) with the same characteristics of BREMs. Since 2006, Banco de México has used bondes D for the long-term sterilization process. Banco de México currently conducts auctions of cetes for the short-term sterilization process. It is important to note that monetary regulation operations carried out by Banco de México are in no way related to other activities performed by the central bank on behalf of the Federal Government and the Instituto para la Protección al Ahorro Bancario (IPAB).

The process through which Banco de México acquires Federal Government securities for monetary regulation purposes is set forth in Articles 7 and 9 of Banco de México’s Law and in the Financial Broker Agreement between Banco de México and the Ministry of Finance (SHCP, for its acronym in Spanish). These legal principles establish that the central bank must reconcile the acquisition of these securities with cash deposits which cannot be withdrawn before their maturity date. These deposits should have the same size, terms and yield of to the securities of the respective operation.

Additionally, operations for monetary regulation purposes also comply with Article 11 of the aforementioned Law, which prohibits the central bank from granting financial support to the Federal Government through the acquisition of its securities.

From an accounting standpoint, once the Federal Government transfers instruments to Banco de México, a liability is entered in the central bank balance as a deposit on behalf of the Federal Government with the resources obtained from the sale of securities. This accounting procedure is defined in Article 38 of Banco de México’s Bylaws. Such deposit shall not be used or withdrawn by the Federal Government until the instrument backing such deposits matures. On the assets side, Banco de México enters the value of this holding. Deposits and instruments are valued on a daily basis at market prices. For instruments with coupons, the accrued interest is calculated and provisioned both on the assets side (government securities holdings) and the liabilities side (deposits on behalf of the Federal Government) in Banco de México’s balance sheet. At the time of settlement, Banco de México eliminates the securities from the assets side of the balance, but keeps them as a liability on behalf of the Federal Government.

* Prepared by García-Padilla, Juan Rafael with information from Sidaoui J., Santaella J., and J. Pérez. “Banco de México and recent developments in domestic public debt markets”. BIS Papers no. 67 (October 2012).

2.4.2 Syndications[24]

Another way to place securities is a “syndication”. In this type of placement, government securities are sold to a pool or syndicate of financial institutions which commit to purchase a certain amount of market-priced securities for a fee. These securities are then sold by the members of the syndicate to the other participants in the market.[25]

Since February 2010, syndicated placements of bonos and udibonos new issues are carried out in Mexico, where “distributors” are appointed from among “market makers”.[26] By adopting this placement mechanism, the Federal Government has access to a broader base of investors as compared to what it usually attains through a traditional primary auction. The advantages of using this placement method include the following:

- It insures that new issues have a considerable initial outstanding amount which, in turn, makes easier for those investors following global index principles to replicate them.[27]

- The global indexes include this type of issues from its syndication, without having to reach the minimum outstanding amount.

- A more diversified and broader distribution is achieved among domestic and foreign investors.

- Better liquidity conditions are achieved in the secondary market.

Table 2.7

Placements through syndication

Instrument

Interest rate (%)

Issue code

Maturity date

Placement date

Placement yield (%)

Amount placed 1/

Number of distributors

Bonos

8.00

M 200611

Jun-11-20

Feb-25-10

7.66

25,000

4

Udibonos

4.00

S 401115

Nov-15-40

Mar-25-10

4.27

3,500

4

Bonos

6.00

M 150618

Jun-18-15

Jul-08-10

6.13

25,000

4

Bonos

6.50

M 210610

Jun-10-21

Feb-01-11

7.44

25,000

4

Udibonos

2.50

S 201210

Dec-10-20

Mar-01-11

3.50

3,500

4

Bonos

6.25

M 160616

Jun-16-16

Jul-20-11

6.00

25,000

8*

Bonos

7.75

M 310529

May-29-31

Sep-09-11

7.11

25,000

8

Bonos

6.50

M 220609

Jun-09-22

Feb-17-12

6.30

25,000

8

Bonos

7.75

M 421113

Nov-13-42

Apr-20-12

7.46

15,000

8

Bonos

5.00

M 170615

Jun-15-17

Jul-20-12

4.88

30,000

8

Udibonos

2.00

S 220609

Jun-09-22

Sep-07-12

1.55

3,000

8

Bonos

4.75

M 180614

Jun-14-18

Aug-30-13

5.49

25,000

8

Bonos

7.75

M 341123

Nov-23-34

Apr-11-14

7.08

15,000

8

* It included all market makers for the first time.

1/ Million pesos/UDIs.

Source: Banco de México.

2.4.3 Retail investors (Cetesdirecto)[28]

As of December 2010, the Federal Government started selling securities directly to the public through the Cetesdirecto program. This program provides small and middle investors access to all types of government securities besides cetes. Investors buy directly instead of purchasing such securities through brokerage firms or credit institutions (from 100 MXP and with no commission). To operate the program, the government granted a mandate to the development bank Nacional Financiera (Nafinsa). The public counter is the Bank for National Savings and Financial Services (Banco del Ahorro Nacional y Servicios Financieros, BANSEFI), but direct telephone and Internet trading is also available.

Since the launch of Cetesdirecto up to April 2014, 107,000 customers have registered of which 36.7% have signed a contract.

As Banco de México’s Governor, Agustín Carstens, stated: “Through the Cetesdirecto program, cetes are already considered a popular saving and investment tool, affordable by any person; [this program] provides housewives, low-income employees and workers access to very competitive interest rates in the money market,[29] with no further intermediation or burdensome fees or commissions”.[30]

The introduction of this mechanism is very useful for the Federal Government since it promotes middle and long term domestic saving as well as the use of financial services among the general population, while providing the country’s financial system with higher levels of competition, efficiency, and depth. By giving the general public access to purchase government securities, it fosters a better understanding of public debt and its management and contributes to expanding and making more heterogeneous the Federal Government’s investor base.

Up to April 30, 2014, holdings through the Cetesdirecto program amounted in nominal value to 1,122.872 million MXP in cetes, 74.550 million MXP in bonos, 14.001 million udis in udibonos, and 10.801 million MXP in bondes D.

Presently, 75.11% of the amount invested in cetes is at a 1-month term, 14.32% is at a 3-month term, 8.94% is at a 6-month term, and the remaining, at a 1-year term. In bonos, 27.40% is invested at a 3-year term, 20.19% at a 5-year term, 12.67% at a 10-year term, 13.59% at a 20-year term, and 26.15% at a 30-year term. Of the investors holding udibonos, 39.85% invest at a 3-year term, 23.93% at a 10-year term, and 36.22% at a 30-year term.

2.5 Other operations

2.5.1. Swaps[31]

The Federal Government also uses swaps as an additional instrument in the management of domestic debt. Government securities swaps are a financial operation through which the government exchanges certain government securities for other with different characteristics. Banco de México also acts as a financial broker for the Federal Government in these operations.

Swaps were adopted as a mechanism to improve the management of domestic debt (to improve the maturity profile of government securities and promote higher liquidity in the secondary market). Swaps took place for the first time in October 2005. These operations improve the level of efficiency in the price formation process, contribute to reduce the financial cost and risk of the Federal Government and favor the use of better international practices in the negotiation of securities. Swaps were originally intended only for bonos, but as of January 2008 they also started being used from time to time for udibonos. Finally, in 2011, cetes were included in swap operations and, by October 2011, IPAB carried out its first securities swap.

At the closing of April 2014, a total of 71 swaps had been carried out, of which 24 were for extending the maturity term and 47 for extending the outstanding amount of some issues.

1/ Negative figures represent a withdrawal; positive figures represent a placement.

1/ Negative figures represent a withdrawal; positive figures represent a placement.

2.5.2 Purchases

Another tool used by the Federal Government from time to time for managing domestic debt has been purchasing its own securities following transparent and clear programs aimed at withdrawing from the market insufficiently liquid issues or minimizing liquidity problems resulting from the financial crisis. In this regard, the operations conducted during the 2008 crisis, when purchases of debt government securities were announced, including fixed-rate bonos and middle- and long-term udibonos (that were not being placed through primary auctions) deserves mention.

Table 2.8

Bonos, udibonos, and IPAB instruments purchases

(Figures in million MXP or UDIs at nominal value)

Repurchase date

Instruments to be purchased

Purchased amount

ID

Maturity (days)

Yield (%)

Objetive

Efffecive

Difference 2/

Apr-23-08

M 081224 1/

243

7.61

28,428

28,428

0

Jul-09-08

M 081224 1/

166

8.33

50

50

0

Nov-04-08

BPAs

0.22

49,880

23,976

25,904

BPAT

0.21

38,837

20,066

18,771

BPA182

0.32

30,182

2,824

27,358

Nov-11-08

BPAs

0.22

55,445

20,797

34,648

BPAT

0.21

36,549

25,205

11,344

BPA182

0.30

38,753

3,832

34,921

Nov-18-08

BPAT

0.26

55,684

55,684

0

BPA182

0.30

49,407

49,407

0

Dec-03-08

M 131219

1,841

-

8,610

0

8,610

M 141218

2,205

-

10,335

0

10,335

M 151217

2,569

-

5,762

0

5,762

Dec-10-08

M 131219

1,834

8.36

2,792

1,792

1,000

M 141218

2,198

8.39

4,200

2,000

2,200

M 151217

2,562

-

0

0

0

M 161215

2,926

-

2,400

0

2,400

M 231207

5,474

8.56

50

50

0

M 241205

5,838

8.61

3,181

500

2,681

Dec-17-08

S0131219

1,827

3.72

491

370

121

S 141218

2,191

3.79

605

343

262

S 160616

2,737

-

88

0

88

S 251204

6,195

-

257

0

257

1/ The auction conducted with the purpose of purchasing the bond maturing December 24, 2008 was done through two fixed-rate auctions (see Box 2.1).

2/ In the column "Difference", a positive figure means that the authorities decided not to assign the total objective amount due to evident distortions in the prices of the bids as compared with the current market prices at the time.

Source: Banco de México.

2.5.3 Stripping of instruments[32]

As mentioned in the description of the different types of instruments in Mexico included in section 2.1., long-term fixed rate securities, both in MXP and in udis, can be stripped. This means that the payment of interest (coupon) and principal may be documented individually as zero-coupon securities. For instance, a five-year term bono paying interest at 10 different dates and paying principal at maturity may be segregated into 11 different zero-coupon bonds (each for 10 interest payments and one for the principal). When an instrument is stripped, its market risk profile is modified, although not its credit risk. The main advantage of stripping fixed-rate bonds is offering investors the possibility of having access to a broad range of short, medium and long term zero-coupon government securities. This segregation may be particularly useful for institutional investors, such as insurance companies, looking for investments that adjust to the market risk of their liabilities. The government’s discipline of creating instruments with the same coupon dates facilitates the payment of stripped interests to be later fungible.

In November 2012, “Banco de México, in its role of financial broker for the Federal Government, and with the purpose of fulfilling the need of various market investors to negotiate the interest and the principal of a security separately (to cover their long and middle-term liabilities for different amounts), as well as to strengthen the liquidity of Federal Government development bonds denominated in investment units, resolved celebrating auctions to place the stripped interest and principal payments of these securities.”[33] The first auction offered separately the principal and the interest of the 30-year udibono with a maturity date of November 2040.

Table 2.9

Auction of stripped principal and interest of udibonos

Lots

Amount 1/

Offered

Alloted

Offered

Alloted

Nov-14-12

Principal

2,500

2,500

225.00

225.00

Coupons

2,500

1,391

259.35

144.30

Feb-06-13

Principal

2,500

2,500

225.00

225.00

Coupons

2,500

398

254.80

40.56

Apr-30-13

Principal

2,500

2,500

225.00

225.00

Coupons

2,500

760

254.80

77.46

Jul-24-13

Principal

2,500

2,500

225.00

225.00

Coupons

2,500

296

250.25

29.63

Oct-16-13

Principal

2,500

2,339

225.00

210.51

Coupons

2,500

330

250.25

33.03

Jan-08-14

Principal

2,500

2,301

225.00

207.09

Coupons

2,500

600

245.70

58.97

Apr-02-14

Principal

2,500

2,500

225.00

225.00

Coupons

2,500

-

245.70

-

1/ Million UDIs.

Source: Banco de México.

2.6 Transparency and predictability

To the extent that a government is predictable, transparent and organized in terms of debt securities placement, it will be likewise rewarded by investors (with a reduction in its financing costs and an extension of its debt maturity term). To achieve these goals, it is essential for the government to have a clear financing objective, to define auction calendars, and to have a consistent debt management that offers more liquidity to these securities.

Since 2002, the Federal Government stopped reserving its right to determine the minimum price at which it was willing to place its securities in auctions.[34] During the months of March, June, September and December, the Quarterly Program of Government Securities Auctions is announced for instruments to be placed in the local financial market, which must be consistent with the Economic Program of the current fiscal year and with the Annual Borrowing Plan presented in December (to be applied during the immediate following year).[35] For instance, on March 2014, the Ministry of Finance (SHCP), Banco de México (Banxico) and the Institute for the Protection of Bank Savings (Instituto para la Protección al Ahorro Bancario, IPAB) jointly submitted their Government Security Auctions Program for the second quarter of 2014 (see Table 2.10).

Table 2.10

Auction of government securities for Q2 2014

Amounts offered per auction in million MXP

Instrument

Maturity date

Amount to place

Frequency

Federal Government 1/

Cetes

1 month

5,000 a 9,000

Weekly

3 months

8,000 a 12,000

Weekly

6 months

11,000

Weekly

1 year

11,000

Every 4 weeks

Fixed interest rate bonos

3 years

11,000

Every 4 weeks

5 years

10,500

Every 4 weeks

10 years

8,500

Every 6 weeks

20 years

3,500

Every 6 weeks

30 years

3,000

Every 6 weeks

Udibonos 2/

3 years

950

Every 4 weeks

10 years

800

Every 4 weeks

30 years

550

Every 4 weeks

Bondes D

5 years

3,000

Every 2 weeks

Banxico

Bondes D

3 years

1,500

Weekly

5 years

1,500

Weekly

Cetes

To be defined

To be defined

Extraordinary

IPAB

BPAG28

3 years

1,200

Weekly

BPAG91

5 years

1,200

Weekly

BPA182

7 years

1,000

Weekly

1/ The Ministry of Finance may carry out swap operations during Q2 which may involve fixed-rate bonos, udibonos, and cetes.

2/ Million UDIs.

Source: Ministry of Finance (SHCP).

2.7 References

- BANCO DE MÉXICO. Annual Report. 2000.

- BANCO DE MÉXICO. Inflation Report, October-December 2008 and Monetary Program 2009. January 2009.

- BANCO DE MÉXICO. Financial System Report. 2006.

- BANCO DE MÉXICO. Financial System Report. 2008.

- CENTER FOR CENTRAL BANK STUDIES / BANK OF ENGLAND. Government securities: Primary issuance (Handbooks in Central Banking No. 11). Gray, Simon . July 1997.

- Australian University of Canberra. Central bank securities and government debt. Hawkins. April 2004.

- IBRD/World Bank, IMF. Developing government bond markets a handbook. 2001.

- SHCP. El crédito público en la historia hacendaria de México, sus protagonistas y su entorno. Rodríguez Regordosa, Gerardo. 2012.

- BIS Papers no. 67. Banco de México and recent developments in domestic public debt markets. Sidaoui J., Santaella J. and Pérez J. October 2012.

- www.bansefi.gob.mx

- www.banxico.org.mx

- www.cetesdirecto.com

- www.ipab.org.mx

- www.sat.gob.mx

- www.shcp.gob.mx

2.8 Appendices. Technical description of government securities

Download appendices here (available only in Spanish).

2.9 Notes

[1] María Rebeca Acosta-Arellano has a Bachelor degree in actuarial sciences from Universidad Anáhuac del Norte. She also has several postgraduate studies: in principles of economic analysis, by ITAM; in international finances and bond valuation, by IMERVAL; in risk management, fixed instrument valuation and in market risk management, by UIA; and in computer finances, by Universidad Anáhuac del Norte. She has worked in Banco de México since 1982, where she first held the position of market analyst in the Monetary and Credit Regulation Division and then she was appointed as researcher for markets, credit, legal deposit and stock market. She was later promoted to leader of the Primary Market Operations Office in today’s Domestic Operations Department, which is in charge of Banco de México’s activities as financial agent for the Federal Government and IPAB in connection with the issuance, placement and redemption of its securities, as well as of Banco de México’s securities.

Claudia Álvarez-Toca has a Bachelor degree in economics (summa cum laude) from Universidad Iberoamericana (UIA) and a Master degree in business administration (summa cum laude), with a major in finance from Instituto Panamericano de Alta Dirección de Empresas (IPADE). Since 2007 she has been senior economist at Banco de México, now reporting directly to the Directorate General of Central Bank Operations. Since she first started working at the central bank in 1993, she has held different positions, always in the Operations Department, among which stands out her position as head of the desk in charge of the implementation of currency exchange policies and later, as head of foreign reserves management. During a period where she worked outside Banco de México (2002-2007), she did so as an academic in Finance at IPADE, where she also held managerial positions and offered consulting services to corporations and individual investors.

The authors would like to thank Javier Duclaud, Jaime Cortina, Alfredo Sordo and Juan Rafael García-Padilla for their valuable comments, and Gilberto Montaño-Calvillo for the excellent technical and research assistance provided.

[2] Also known in the market as bonos M. The term used throughout the book to refer to these instruments is “bonos”.

[3] An explicit guarantee means that, in the event that IPAB is unable to fulfill its obligations, securities are to be paid directly from Mexico’s Federal Treasury account.

[4] For more information on the technical descriptions of the main types of government securities, including valuation methodologies and practical examples refer to http://www.banxico.org.mx/sistema-financiero/material-educativo/intermedio/subastas-y-colocacion-de-valores/subastas-colocacion-valores.html

[5] FUNGIBILITY: Instruments of the same type and sharing the same maturity date are not distinguishable for the security holder. In Mexico, fungible instruments are always issued by the Ministry of Finance and Public Credit (SHCP, for its acronym in Spanish) regardless if they are placed by the Ministry of Finance or by Banco de México. However, each of the placing authorities is independently liable to paying both interest and capital.

[6] http://www.banxico.org.mx/sistema-financiero/material-educativo/intermedio/subastas-y-colocacion-de-valores/subastas-colocacion-valores.html (cetes).

[7] The term “to compound” refers to reinvesting both capital and accrued interests. In this case, it refers to reinvesting every day the accrued interest of the previous day.

[8] The weighted bank funding rate is calculated and announced by Banco de México through its web page.

[9] http://www.banxico.org.mx/sistema-financiero/material-educativo/intermedio/subastas-y-colocacion-de-valores/subastas-colocacion-valores.html (bondes).

[10] http://www.banxico.org.mx/sistema-financiero/material-educativo/intermedio/subastas-y-colocacion-de-valores/subastas-colocacion-valores.html (bonos).

[11] Circular notice 2/2004 sets forth the Rules for securities’ stripping and reconstitution. http://www.banxico.org.mx/disposiciones/circulares/%7BF8667E3E-2456-7DFD-6B32-2BA50647ECB8%7D.pdf (available only in Spanish). For more information, see the chapter “Secondary market” which includes a section on instrument stripping.

[12] Investment units (udis) are updated every fifteen days on the basis of the National Consumer Price Index (INPC, for its acronym in Spanish), and according to the procedure determined by Banco de México and published in Mexico’s Federal Official Gazette on April 4, 1995.

[13] http://www.banxico.org.mx/sistema-financiero/material-educativo/intermedio/subastas-y-colocacion-de-valores/subastas-colocacion-valores.html (udibonos).

[14] Circular notice 2/2004 sets forth the Rules for securities’ stripping and reconstitution. http://www.banxico.org.mx/disposiciones/circulares/%7BF8667E3E-2456-7DFD-6B32-2BA50647ECB8%7D.pdf (available only in Spanish). For more information, see the chapter “Secondary market” which includes a section on instrument stripping.

[15] http://www.banxico.org.mx/sistema-financiero/material-educativo/intermedio/subastas-y-colocacion-de-valores/subastas-colocacion-valores.html (BPAs).

[16] For more information, see also the chapter “Instrument settlement”.

[17] INDEVAL: The Securities’ Deposit Institute (Instituto para el Depósito de Valores, Indeval) was created on April 28, 1978 as a government agency in charge of providing the service of custody, management, clearing, settlement and transfer of securities through book entries. It was privatized in 1987. For more information on this institution, see the chapter “Securities settlement”.

[18] The chapter “Legal and regulatory framework. Fiscal considerations” includes a table referring to the circular notice governing the primary placement of both government and IPAB securities.

[19] Regardless of the type of auction, the issuer may disclose the amount he is willing to place and ask bidders to compete according to the price. However, the issuer may also disclose the price he is willing to pay for placing its securities, and then, bidders indicate the amount they are willing to buy at that price.

[20] Currently, it is disclosed 30 minutes after the closing of the auction within the auction system designed by Banco de México.

[21] There are studies stating that in multiple price auctions bidders tend to offer lower bids for the same amount of assets, relative to what they would offer in a single price auction in order to prevent the “winner’s curse”, which refers to receiving allotment in an auction, but at a higher price than that paid by other bidders. The curse refers directly to the difficulties there will be when trying to later sell the securities since the other bidders have better prices to offer. On the contrary, single price auctions tend to minimize uncertainty because bidders are more willing to participate and raise their offered prices as compared to what they would have offered in multiple price auctions by not being threatened by the “winner’s curse”.

[22] In other words, on Friday. If the Friday falls on a holiday, the announcement is done on Thursday, and if the Friday and Thursday fall on a holiday, the announcement must be done on Wednesday, and so on.

[23] For instance, if the Thursday falls on a holiday, the settlement is done on the previous Wednesday; if this day also turns out to be a holiday, it is moved to the Friday of the same week. If the Wednesday, Thursday and Friday are also holidays, the settlement is done on the Tuesday of that same week.

[24] The chapter “Legal and regulatory framework. Fiscal considerations” includes a table referring to a circular notice that regulates syndicated primary placements.

[25] If the market were not deep enough (i.e. when there are no prices available at market levels), syndication participants could collude, hence inhibiting price formation. To prevent this from taking place, financial institutions may also act as underwriters for a fee, and such syndicate would ensure that all securities to be placed at a minimum price are purchased, only if no higher prices are offered during the auction.

[26] See also chapter “Market makers”.

[27] Investors replicating an investment index seek to invest in the securities included in the index. To the extent to which the amounts issued are higher, more securities tend to be available for such replication.

[28] The chapter “Investor base” also refers to the Cetesdirecto program. For more information, refer to www.cetesdirecto.com

[29] In September 2012, the Cetesdirecto Niños program was created for the purpose of teaching children about saving and investing.

[30] Remarks by Agustín Carstens, Governor of Banco de México, during the inauguration of the Cetesdirecto interactive module at the Interactive Museum of Economics (Museo Interactivo de Economía, MIDE), May 23, 2011.

[31] The chapter “Legal and regulatory framework. Fiscal considerations” includes a table that refers to the circular notice that regulates the swapping of government securities.

[32] The chapter “Secondary market” also includes references on the stripping of instruments.

[33] Circular notice 16/2012 auctions for the placement of stripped udibonos dated November 6, 2012.

[34] Previously, bids with prices lower to this “line” were disregarded. Currently, the Federal Government reserves its right to declare the auction as “completely deserted”.

[35] The chapter “Legal and regulatory framework. Fiscal considerations” makes reference to the legal framework the Federal Government must comply with when issuing securities.

III. Investor base

Claudia Tapia-Rangel[1]

This chapter analyzes thoroughly the investor base available in Mexico’s current government securities market. It describes the importance of financial intermediaries, foreign investors, and local institutional investors such as pension funds known as Siefores, mutual funds and insurance companies, among others, in this market.

1. Introduction

2. Impact and advantages of institutional investors

3. Domestic financial investors

4. Foreign investors

5. Non-financial national investors

6. References

7. Notes

3.1 Introduction

The development of a government debt market necessarily involves strengthening both the supply and demand for these securities. After the 1995 financial crisis, Mexico implemented a clear strategy to strengthen the offer of government securities based on four pillars: (i) using domestic instead of external debt to finance the fiscal deficit; (ii) developing a local, long-term yield curve; (iii) promoting higher transparency and predictability in debt issues, and finally, (iv) implementing structural efforts aimed at strengthening the public debt market, such as including pension funds and insurance companies in government securities primary auctions, among others.[2]

The implementation of responsible monetary and fiscal policies led to a reduction in inflation, from 52 percent in 1995 to 3.97 percent in 2013,[3] and the ratio public deficit to GDP declined to levels below 3% during the same period (2.2% at the end of 2013).[4] The latter, together with some reforms including modifications to the pensions system, to regulations on repurchase and securities lending operations, and the creation of a Mexican Derivatives Market (MexDer), strengthened the demand for government securities and fostered a diversified investor base.

Nevertheless, the credibility on the government as debt issuer and macroeconomic and financial stability are not enough to develop a government securities market. The participation of both domestic and foreign investors is essential for achieving a consistent demand and, hence, for lowering the cost of public debt. A broader participants’ base also promotes financial innovation and the development of financial markets, as it contributes to the depth and liquidity of the secondary market.

3.2 Impact and advantages of institutional investors

The participation of institutional investors[5] has played a key role in the development, consolidation, and current operation of the Mexican debt market and, particularly, of the broader government securities market.[6] The amount outstanding of these securities went from 718 billion pesos at the end of 2000, to 5.865 trillion pesos at the end of 2013, a 717% increase. In terms of GDP, the ratio shifted from 11% to 35% during this same period.

The pension system reform, the availability of a wider variety of securities to satisfy the needs of institutional investors, and the flexibility of their investment regimes, contributed to the growth of these investors’ portfolios. Total bank assets, investment funds, insurance companies and pension funds accounted for 67% of GDP at the end of 2013, the same figure as in the end of 2000. In 2000, these same investors held 28% of the government debt versus 40% in 2013.

Demand for government securities from institutional investors varies according to their needs and investment regimes. For instance, insurance companies and pension funds generally require long-term securities due to their long-term liabilities, in terms of both nominal and real rates. Mutual funds, on the other hand, are more interested in liquid securities due to restrictions linked to the possibility of their customers demanding their funds at any time.

Table 3.1

Broader government securities holdings by sector*

Percent

Banks

Pension

funds

Insurance

companies

Mutual funds   Foreigners

General public

(Cetesdirecto)

Others

Total 1/

Cetes

3

7

1

9

62

0.11

17

964,019

Bondes

7

5

1

35

0

0.001

52

1,067,452

Bonos

7

15

3

5

56

0.003

13

2,034,372

Udibonos

1

46

15

8

10

0.006

20

898,779

IPAB

8

2

1

40

1

0

47

805,773

* Unless otherwise specified, all figures and charts of this chapter are up to the end of December 2013.

1/ Million pesos.

Source: Banco de México.

Such demand has enabled the creation of new securities. The development of a long-term reference yield curve (up to 30 years) has set the basis for the development of derivatives markets, which have interest rates as underlying, a corporate debt market, stripped bonds[7] market and an asset-backed securities market.[8]

This broader base of local institutional investors has contributed to stabilizing local debt markets in financial turmoil episodes during which foreign investors withdraw their capital from the country, particularly if this capital flight is not related to fundamental economy factors but to external factors that generate outflows chain. The aforementioned is the backbone for the local market during periods of risk aversion.

Finally, the constant search for better investment opportunities by institutional investors has increased the depth and liquidity of the broader government securities market. It has also fostered the implementation of new tools, such as securities lending, with an increasing active involvement of Siefores,[9] mutual funds,[10] and insurance companies. The presence of institutional investors promotes competition and greater transparency in the price formation process, hence facilitating the work of price vendors.[11]

3.3 Domestic financial investors

3.3.1 Commercial banks

At the end of 2013, there were 47 banking institutions operating in the country, 15 of which were mostly foreign-owned and 32, domestic-owned. Assets from this sector added up to 6.5 trillion pesos, accounting for 59.5% of total financial sector assets and 39.1% of GDP. The major seven banks[12] managed 78.4% of total bank assets, while the 24 medium and small banks[13] managed 11.7%. The four banks linked to commercial chains (Bancos Asociados a Cadenas Comerciales, BACC)[14] managed 2.2% and, finally, the twelve small foreign banking[15] subsidiaries, the remaining 7.7%.[16]

Commercial banks are one of the most important participants in the government securities market. They have evolved in this market along time hand in hand with financial innovation and have diversified both their functions and customer portfolio. In 1978, when the first government securities were issued, commercial banks held 3% of total outstanding. By the end of 2013, their total government securities holdings accounted for 5% of the total outstanding.

According to the IADB (2007), banks’ activity in the government debt market plays a double role: on the one hand, they keep securities in their portfolios as any other asset for the purpose of managing their balance sheets and, on the other, they are the main market operators and market makers[17] for these securities, i.e., banks actively participate on primary auctions, on the price formation process, and in providing liquidity to the secondary market.

Among the reasons for banks to keep government securities in their balances are:

1. To guarantee financing. Government securities (mainly short-term Treasury bills) are ideal for this purpose since they generally have a liquid secondary market and can be used for repurchase operations with the central bank or other commercial banks.

2. To obtain profits using the interest rate spread between passive rates and rates of instruments they invest. Generally, banks purchase longer term government securities and keep them until their maturity date. From an accounting point of view, these securities are seen as long-term investments that should be included in the “permanent-portfolio” based on their purchase price.

3. To purchase and sell securities and to act as market makers in the secondary market for these securities. Their holdings are mostly small and mark to market.

1/ The figure is 10 times the indicated.

The business sector on which different banks specialize also has an influence on the type of government securities they demand. For instance, at the end of 2013, medium- and small-size banks mainly devoted to commercial credit, kept most of their holdings in bondes D[18] and IPAB securities (BPAs) at floating rates. To date, BACC mainly involved in household lending for consumer goods acquisitions keep their holdings mostly in cetes and BPAs, while foreign bank subsidiaries, focused on securities and derivatives, invest their resources in cetes, bondes D and BPAs.

1/ The figure is 10 times the indicated.

There is not an investment regime for banks. The Law of Credit Institutions (LIC), the General Regulations Applicable to Credit Institutions (Disposiciones de Carácter General Aplicables a las Instituciones de Crédito), and the Regulations Applicable to Credit Institutions and Mexico’s Rural Credit Government Agency (Disposiciones Aplicables a las Operaciones de las Instituciones de Crédito y de la Financiera Rural), issued by Congress, the National Banking and Securities Commission (CNBV, for its acronym in Spanish), and Banco de México, respectively, include the guidelines banks must follow regarding the type of instruments on which they can invest. Each bank determines the structure of its portfolio based on of its own risk departments and/or on headquarters’ (foreign banks) criteria and recommendations.

3.3.2 Pension funds

Since the nineties, the Mexican pensions system has undergone significant reforms that have endow it with two relevant features: first, it is a sustainable system that protects and maximizes the value of pensions posing no risks for public finances; the second quality is related to this system’s structure, as this system is a long-term source of capital that can be used for financing both public and private infrastructure projects.

The transformation of the pension regime began in 1992 with the creation of the Retirement Savings System (SAR, for its acronym in Spanish), for the purpose of complementing the Disability, Old Age, Aging Unemployement and Death (seguro de Invalidez, Vejez, Cesantía en Edad Avanzada y Muerte, IVCM) insurance scheme, which was created by the Mexican Social Security Institute (IMSS) and operated since its founding in 1943. Unlike IVCM resources, which were linked to a sharing scheme, SAR resources had defined property rights allowing each employer to open an individual bank account for each worker, where it would deposit the employer’s contributions, which were to be paid to the worker completely at the time of retirement.

In 1997, a new reform divided the IVCM insurance scheme in two concepts: Disability and Life (Invalidez y Vida, IV) and Retirement, Aging Unemployement, and Old Age (Retiro, Cesantía en Edad Avanzada y Vejez, RCV). The basis for this new mandatory system for IMSS-insured workers is an individual savings and capitalization scheme under which each worker now pays for his/her own pension by opening an individual account in specialized financial institutions known as Pension Funds Administrators (Administradoras de Fondos para el Retiro, Afores). The worker’s contributions accumulated in this account together with those from his/her employer and from the Federal Government are then paid completely at the time of retirement.

At the closing of 2013, there were 12 authorized pension funds administrators. Their assets, at the closing of 2013, added-up to 2.1 trillion pesos, equivalent to 19.2% of the total assets of banks, mutual funds, insurance companies and pension funds and to 12.8% of GDP. The number of registered workers to that same date was 33.9 million.[19]

The characteristics of pension funds liabilities determine to a great extent the type of assets selected to invest. Due to the future obligations to be paid, these funds are traditionally considered as long-term investors. Bonos and udibonos[20] usually constitute the dominant asset in their portfolios.

Due to the long-term horizon of their investments, pension funds are natural candidates for investing in long-term assets. Nevertheless, their investment in other instruments has become more flexible along the years, hence benefiting from diversification.

Afores invest workers’ resources through Specialized Mutual Funds for Retirement (Sociedades de Inversión Especializadas en Fondos para el Retiro, Siefores). When the individual accounts system was created in 1997, Afores relied on two types of Siefores: the Basic Investment Fund and the Voluntary Contributions Investment Fund. The investment regime of both types was limited to inflation-indexed instruments (udibonos) or floating instruments (bondes), with yields sufficient to account for inflation (at least 51% of their total assets); at least 65% of securities with a maturity (or term when a variable rate is fixed) up to 183 days, no more than 10% in foreign currencies (either government debt securities or Banco de México securities), no more than 35% maximum of corporate issues and no more than 10% in AA-rated or higher rated securities.[21]

Currently, each Afore has at least a family of four Siefores on which resources are invested in different assets classes, based on the workers’ age. This approach allows offering various risk-return options: the higher the age of the worker, the more conservative the investment regime, thus reducing risks.

Table 3.2

Classification of Siefores by age of workers

Básica 1

Básica 2

Básica 3

Básica 4

Age

60 years and over

46 to 59 years

37 to 45 years

36 years or less

Source: CONSAR.

Contrary to the above mentioned, the current regime is focused not only on safeguarding the workers’ resources, but on allowing workers to diversify their investments and to take calculated risks to maximize the yield of the resources managed by each Siefore.

The entire Siefores family may invest all its assets in AAA-rated securities and government securities, as well as 50% and 20% in AA-rated and A-rated securities, respectively. Siefores may also invest up to 30% in foreign currencies and 20% in foreign instruments. Likewise, and within the limits authorized for each type of Siefore, they may invest in equities, structured instruments, asset-backed securities, FIBRAs,[22] and derivatives.

Besides serving as a guide on the type of securities Siefores may invest in, the investment regime also sets limits to risk of market, credit, concentration, and counterparty they may assume. The following table summarizes the current investment regime:

Table 3.3

Siefores investment regime

Percent

Limits by type of Siefore Básica 1/

1

2

3

4

Market risk

Differential of the conditional value at risk 2/

≤ 0.3

≤ 0.45

≤ 0.7

≤ 1

Equity 3/ 4/

5

25

30

40

Foreign exchange instruments (USD, euros, yens and/or others

for stock market indexes) 3/

30

30

30

30

Concentration risk by issuer or counterparty 3/

On the same issue (Max.) 5/

{35; 300 mp}

{35; 300 mp}

{35; 300 mp}

{35; 300 mp}

Domestic 6/

Common debt from mxBBB to mxAAA or in foreign currency from BB to AAA

5

5

5

5

Subordinated debt from mxBB+ to mxBBB- or in foreign currency from B+ to BB-

1

1

1

1

International

Foreign securities from BBB- to AAA single issuer or counterparty 7/

5

5

5

5

Other limits 3/

Foreign securities (debt rating at least A-)

20

20

20

20

Asset-backed securities 8/

10

15

20

30

Structured instruments 9/

0

15

20

20

Inflation linked 10/

Yes (51 min)

No

No

No

Commodities

0

5

10

10

Conflicts of interest 3/

Inter-entity instruments

15

15

15

15

Instruments from entities with a patrimonial link to Afore 11/

5

5

5

5

Vehicles and contracts

Mandates

Yes

Yes

Yes

Yes

Mutual funds

Yes

Yes

Yes

Yes

Derivatives

Yes

Yes

Yes

Yes

1/ All limits are maximum percentages, except for inflation linked coverage, which is the minimum percentage of assets (see note 10/).

2/ As a percentage of the assets managed directly by the Siefore. The Risk Assessment Committee (Comité de Análisis de Riesgos,CAR) might fix tighter limits. Insofar as the criteria set out in the First Transitory Rule of the IR is fulfilled, Siefores must maintain the following VaR limits on the assets managed by the Siefore: SB1 = 0.7, SB2 = 1.1, SB3 = 1.4 and SB4 = 2.1.

3/ As a percentage of total assets of the Siefore, incuding assets managed by asset managers.

4/ Includes individual equities, IPOs, authorized stock market indexes (domestic and international) and mandatory convertible securities in domestic issuers' equity.

5/ Applies to the holdings of all Siefores Básicas managed by the same Afore, for domestic and foreign debt and structured securities. This limit might be exceeded by CKDs if the criteria foreseen in IR are fulfilled.

6/ Rating of mid-term and long-term issuances and of the issuer and guarantor, when necessary. Repos and derivative operations are included within these limits.

7/ For foreign securities with ratings under A- and no less than BBB-, the Afore shall comply with the IR.

8/ Including asset-backed securities that comply with the Ninth Transitory Rule of IR, which are considered to be issued by an independent entity.

9/ Includes CKDs and FIBRAs. Structured securities are divided in a) Infrastructure or real estate, and b) Others.

10/ Minimum limit of investment in financial assets that ensures at least the same performance as Mexico's inflation.

11/ Restriction included in the SAR Law (Ley del SAR), art. 48, section 10. Increased exceptionally to 10%. When the entities have patrimonial link to the Afore, the limit is 0%.

Source: CONSAR.

3.3.3 Insurance companies

Insurance companies represent an important segment of institutional investors. They also have a significant role in financial markets as long-term financing providers for banks and other sectors.

At the closing of 2013, there were 103 insurance companies in Mexico, 58 of which were mostly foreign-owned and 45 domestic-owned.[23] At this same date, the resources managed by these companies were 727 billion pesos, equivalent to 6.5% of the total assets of banks, mutual funds, insurance companies and pension funds, and 4.4% of GDP.

In Mexico, the insurance sector concentrates its activity on life insurance, which accounted for 41% of the total portfolio at the closing of 2013, followed by automobile insurance, with 20% of the portfolio, damages (excluding automobiles) with 19%, accidents and medical insurance with 15%, and finally, pensions, with 6%.

Like pension funds, asset management in the insurance sector relies considerably on their liabilities and on the type of risks covered by its business model. In general terms, insurance companies may cover risks related to property and accidents, life risks and credit risks related to investment in financial instruments. Life insurances regularly cover the financial aftermath in the event of death or disability of the insured and also include other products that foster saving in order to have financial solvency at retirement. Property insurance coverage includes events or disasters affecting property, either personal or real estate; home insurance and insurance against damages are examples of insurances protecting family or business assets from disasters like earthquakes, floods, theft and fire, among others.

Medical insurances cover hospital expenses resulting from a disease or accident that affects the health of the insured, while accident insurances cover the resulting loss of body parts or death. Credit insurances protect both the portfolio and risk of a company in the event of default from its customers due to insolvency, encumbrances and delinquency, among others.

Since most liabilities of insurance companies are long term, they are natural candidates for investing in long-term assets. They are thus major participants in both government long-term securities and inflation-linked bonds (udibonos) markets.

The assets on which insurance companies invest are determined by the Technical Reserves Investment Rules[24] of Mutual Insurance Institutions and Insurance Companies (also known as the Rules) issued in 2000. The main purpose of the Rules is to set an investment framework ensuring liquidity and solvency of insurance companies through an adequate diversified portfolio, without letting aside the financial risks they face.

In an effort to adapt to the constant financial innovation and development of new markets, the Rules include more flexible investment criteria for products such as derivatives, instruments replicating stock indexes, debt instruments, asset-backed securities and structured instruments,[25] among others. Besides promoting new markets participation, the Rules also ensure that the provisions to face assumed obligations are backed-up by safe, profitable and liquid investments.

Regarding investment in government securities, the regime allows an investment of up to 100% of the technical reserves in securities issued or backed-up by the Federal Government. Likewise, it points out that repo transactions can only be done when the companies are acting as repo buyers[26] and exclusively for government securities.

The Rules also set limits per type of securities, instruments, goods, credits, repurchases or other assets to prevent excessive concentration on any, as well as limits per issuer or debtor to prevent risks by sector of economic activity and patrimonial nexus.

3.3.4 Mutual funds

Mutual funds play a key role in Mexico’s money market as they represent an access to stock market for the small and medium investor. Currently, there are four types of mutual funds:[27] Equity Investment Funds (Sociedades de Inversión en Renta Variable, SIRV), Debt Investment Funds (Sociedades de Inversión en Instrumentos de Deuda, SIID), Capital Investment Funds (Sociedades de Inversión en Capitales, SIC) and Special Purpose Investment Funds (Sociedades de Inversión de Objeto Limitado, SIOL). Those accounting for the highest shares in the Mexican financial markets are SIRV and SIID.

At the closing of 2013, there were 28 mutual funds operators[28] and 565 mutual funds in Mexico. The assets managed by these funds added up to 1.7 trillion pesos at the end of 2013, equivalent to 14.8% of banks, mutual funds, insurance companies and pension funds’ total assets and to 9.9% of GDP. At the end of 2013 there were 267 SIRV with assets amounting to 357 billion pesos, and 298 SIID, with assets worth 1.3 trillion pesos.[29]

Table 3.4

Limits of insurance companies' investment regimes 1/

Percent

Limits

I. Market risk

a) Government-backed or government-issued securities

100

a.1) Securities issued by descentralized agencies, state-owned companies and local/municipal govts.

60

b) Securities denominated in local currency or issued by credit institutions and international financial agencies 2/

60

c) Securities issued by entities other than those specified in  a), a.1) and b)

40

c.1) Securities issued by foreign issuers

10

c.2) Structured notes

10

c.3) Securities linked to the same economic activity

20

c.4) Securitized instruments placed by an independent issuer

10

c.5) Structured instruments

10

d) Discount, rediscount, real estate, mortgage-backed credit or collateralized operations

30

d.1) Discount and rediscount operations

5

d.2) Collateralized credits

5

d.3)  Mortgage-backed securities

5

d.4) Real estate

25

e) Repos and securities lending

30

f) Securities issued by mutual equity funds and vehicles to capitalize domestic enterprises 3/

2

g) Premiums 4/

*

h) Reinsurance companies' share 5/

*

II. Concentration risk by issuer and counterparty  6/

a) Government-backed and government-issued securities

100

a.1) Securities issued by decentralized agencies, state-owned companies and local/municipal govts.

a.1.1) Securities with acceptable rating

3

a.1.2) Securities with good rating, including a.1.1)

7

a.1.3) Securities with high rating, including a.1.1) and a.1.2)

12

a.1.4) Securities with outstanding rating, including a.1.1), a.1.2) and a.1.3)

18

b) Securities denominated in local currency issued by international financial groups in local currency 2/

b.1) Securities with acceptable rating

3

b.2) Securities with good rating, including b.1)

7

b.3) Securities with high rating, including b.1) and b.2)

10

b.4) Securities with outstanding rating, including b.1), b.2) and b.3)

18

c) Securities issued by entities other than those listed in  a), a.1) and b)

c.1) Securities with acceptable rating

2

c.2) Securities with good rating, including c.1)

4

c.3) Securities with high rating, including c.1) and c.2)

7

c.4) Securities with outstanding rating, including c.1), c.2) and c.3)

10

d) Equity issued  by private firms and vehicles replicating stock market indexes 7/

7

e) Principal unprotected structured notes

5

f) Senior trust bonds

5

g) Equities from sectors with common institutional risks 8/

10

h) Equities and securities issued, endorsed or accepted by institutions belonging to the same financial group

5

i) Equities and securities issued, endorsed or accepted by interrelated funds

10

j) Securities issued by mutual equity funds and vehicles to capitalize country's companies 9/

0.5

1/ Estimated based on net investor base; i.e., on the sum of balances of technical reserves, deposit premiums, and resources from life insurance funds minus risk reserves for premiums ceded to reinsurers for damages and/or accidents and illness at the end of the month.

2/ Covering all financial organizations to which Mexico belongs as long as the Ministry of Finance (SHCP) authorizes such investment.

3/ Not exceeding in total the 40% as set in item I.c)

4/ Receivable for life insurance, and debtor for damage and/or accidents or illness premiums.

5/ For ongoing risk of damages and/or accidents and illness, transferred to reinsurers registered in the General Registry of Foreign Reinsurers authorized to take Reinsurance and Rebonding for the country (Registro General de Reaseguradoras Extranjeras autorizadas para tomar Refinanciamiento y Reafianzamiento del país, RGRERRP).

6/ The rating levels in this section are published by the CNSF through administrative regulations.

7/ Different from those listed in a), a.1) and b).

8/ Except for the processing sector, which has a limit of 20%, not exceeding 10% for each of its components.

9/ Not exceeding in total the 7% set forth in item II.d).

* According to the risk reserve.

Source: Based on information from the National Insurance and Bonding Commission (CNSF, for its acronym in Spanish).

Securities on which mutual funds invest depend to a great extent on their diversification criteria and on the type of fund. Most times, in view of the fact that mutual fund stockholders may demand at any time the amount invested, mutual funds are very cautious regarding the liquidity of their investment instruments. Additionally, their high concentration in short-term securities is due, on the one hand, to the investment patterns of savers in Mexico, who are always seeking liquidity and, on the other, to mutual funds’ obligation to keep a minimum percentage in 3-month or less than 3-month securities and operations.

Mutual fund regimes vary according to the type of fund. However, there are certain general criteria established by the CNBV: maximum limits in the concentration of securities from the same issuer; minimum limits in securities and operations of 3-month or less-than-3-month maturity (SIRV and SIID), and minimum percentages of investment in shares and other equities (SIRV). The regime is also subject to the conditions set forth in the fund’s bylaws and public information brochures. SIRVs and SIIDs may invest the resources managed in values listed in the National Register of Securities and Brokers (Registro Nacional de Valores e Intermediarios, RNVI) and the Quotations International System (Sistema Internacional de Cotizaciones, SIC). Investment in foreign securities, derivatives, structured securities, capital trust certificates[30] and asset-backed securities are also allowed and 100% of their total asset may be invested in securities issued or guaranteed by the Federal Government.

Tabla 3.5

Mutual funds investment regime 1/

Percent

Limits

Mutual equity and debt funds 2/

Financial securities and  instruments related to the same issuer or financial organization

40

Total issuers or financial entities that individually represent more than 15% of the total assets

60

Securities of the same issue or series

20

Must maintain a minimum percentage in liquid securities and securities with maturities under 3 months 3/

Mutual debt funds

Long term (duration of assets that qualify for investment above 3 years) 4/

Medium term (duration of assets that qualify for investment between 1 and 3 years)

Short term (duration of assets that qualify for less than 1 year)

Money market mutual funds

a) Government- and Banco de México-backed securities

100

b) Bank deposits and debt instruments issued by credit institutions with either of the highest short-term ratings

100

c) Overnight repos

At least 40

d) Bank deposits and debt instruments issued by the same credit institution

5

e) Bank deposits and debt instruments issued by the same development bank

10

Assets duration under 1 month. Maturity of  a) and b) shall not exceed 1 year.

Mutual equity funds

Specialized in shares

At least 80 in shares 5/

Mostly shares

80 maximum, 50 minimum in shares 5/

Mostly debt securities

80 maximum, 50 minimum in debt securities

Specialized in debt securities

80 minimum in debt securities

Specialized mutual funds

Specialized in government, private, sectorial, regional and other types of securities

At least 80 of the specialized assets

Specialized in replicating the performance of a certain index, interest rate, exchange rate or collective investment mechanism operating in stock markets

At least 80 of the specialized assets and beta 6/ between the specialized variable and the price of its share between 0.95 and 1.05 units

Discretional mutual funds

Structure based on an exposure limit relative to a risk or yield target

The model or methodology used to select the asset for investment must be clearly and precisely specified in its prospectus

1/ Limits acoording to total assets of mutual funds.

2/ Excluding the securities authorized by the securities commissions of the selected countries, those issued by central banks (including the European Central Bank), those issued by international organizations or institutions to which Mexico belongs, those issued or backed by the Federal Government and Banco de México, those acquired to replicate the performance of a public index, the capital stock of mutual equity funds or mutual debt funds, the notes with yield payable at maturity, and certificates of deposit for terms under 1 year, demand cash deposits in banks, and securities issued by banks for terms under a year. It does include unsettled repo and securities lending transactions and positions on derivatives settled with the same financial institution.

3/ Those representing up to 50 percent of the daily average trading volume during the last 60 working days on the relevant market.

4/ The duration of assets for investment is the sum of the average weighted maturity flows of each asset allocated in the funds' portfolio, determined by the price vendor selected by the mutual fund, weighted by its share on it.

5/ Comprises shares and other securities or agreements representing securities or referred to them.

6/ Refers to the measure of price volatility of a mutual fund share, due to changes in the referred variable and is estimated taking into account the last one hundred observations.

Source: Based on information from the National Banking and Securities Commission (CNBV, for its acronym in Spanish).

3.4 Foreign investors

After the sudden flight of foreign capital in the mid-nineties, the government’s efforts to reduce its dependency on foreign financing gave way to the strengthening of the local debt market. The implementation of structural reforms and of a clear and defined debt management strategy by the Federal Government contributed to increase foreign investors’ interest in participating in the local debt market.

Since 1999, foreign investors’ participation in the broader government securities market has included the purchase of cetes. In 1991, foreign investors held 6.9% of the total outstanding broader government securities. By 2006, their share decreased to only 1.7%, but by the end of 2013, it rose again to 62%.

Mexico has become one of the best alternatives for foreign investors due to its attractive investment regime that includes a friendly fiscal scheme and no restrictions for the entrance and exit of foreign capitals. The sound macroeconomic foundations recently observed, the responsible management of public finances, and the development of financial markets that allow for risk hedging of both derivatives and foreign exchange, have also contributed. As a result, the foreign holding of long-term fixed rate securities denominated in pesos (bonos) has also increased.

Foreigners’ holdings of bonos shifted from 95 billion pesos at the closing of 2005 to 1.1 trillion pesos at the closing of 2013, a 1,101% growth. To this last date, foreigners’ holdings in bonos accounted for 62% of their total holdings in government securities, 56% of the total bonos outstanding and 20% of the total domestic debt instruments.

Various factors account for the increased interest of foreign investors in the Mexican government debt market. One of them is related to the higher interest rates in Mexico as compared to those in other countries where investors try to find financing to later invest with better conditions in Mexican government securities (carry trade). But the most important factor is global investors’ constant search for benefits from diversification. As a result, international financial institutions publish investment indexes which global investors seek to replicate. In the beginning, emerging market global indexes only included their foreign debt (EMBI) and equities (MSCI-EM). Later, with the creation of global investment indexes referenced to fixed-rate government debt a new segment began to operate in the asset management sector, which triggered the participation of global funds and therefore raised the potential demand of foreign investors for these instruments.

The Mexican Federal Government debt is included in the following indexes:

- Government Bond Index Broad-JP Morgan

- Government Bond Index Emerging Markets-JP Morgan

- Universal Government Inflation-Linked Bond Index-Barclays

- Global Aggregate Index-Lehman/Barclays

- Emerging Markets Government Inflation-Linked Bond Index-Barclays

- Global Government Bond Index-Merrill Lynch

- Global Government Inflation-Linked Index-Merrill Lynch

- Global Emerging Markets-Markit Group

- World Government Bond Index-Citigroup

Box 3.1.

World Government Bond Index (WGBI)

The World Government Bond Index (WGBI) is one of a series of investment benchmarks for the government debt market calculated and published by Citibank. Its main purpose is to provide investors with a global reference for this market while at the same time give them access to purchase any of the issues that make up the Index.

The WGBI consists of approximately 958 bonds issued by sovereign issuers which have highly developed and liquid markets. The index is currently made up of the debt instruments of 23 countries, which include the European Government Bond Index (EGBI) and debt instruments of 14 additional countries: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Malaysia, the Netherlands, Norway, Poland, Singapore, South Africa, Spain, Sweden, Switzerland, United Kingdom, United States, and Mexico.

According to Citibank figures, at the end of April 2014 the market value of funds referenced to the WGBI totaled approximately 20.9 trillion dollars.

Mexico was issuer number 24 in entering the WGBI (Portugal was later removed) and the first Latin American country to be included in this index. The initial weight of Mexican securities in the index was 0.64%, with a market value of around 100 billion dollars. The weight of each country is reviewed every month together with the rebalancing of the index.

The criteria issuers must maintain to be part of the WGBI include requirements in terms of issues size, issuers credit rating, and barriers to entry in each market.

As for the size of issues, they must total at least 20 billion dollars of yearly amount outstanding. In Mexico, due to the method of syndication for new benchmarks, new issues are rapidly gaining liquidity. As for credit ratings, they should be BBB-/Baa3 (at least) as granted by S&P or Moody’s for all issuers. S&P has rated the local long-term Mexican debt as A and Moody´s as A3. Finally, fixed-rate long-term Mexican securities may be settled through Euroclear, ensuring access to foreign investors and therefore complying with the requirement of lower access barriers.

The Ministry of Finance announced Mexico’s inclusion in the WGBI on February 11, 2010. From that date and up to its formal inclusion on October 2011, the holdings of long-term securities by foreign investors increased by 109 billion pesos.

The significant participation of foreign investors in the local debt market brings along several benefits, both for the Federal Government and the development of markets. The growing interest of foreigners in Mexican securities provides the government with enough resources to reduce its financing costs. At the same time, the inflow of foreign capital allows national investors to channel the resources used to finance the government to other productive activities through, among others, the purchase of corporate bonds.

The participation of foreign investors also increases the investor base for the broader government securities market and promotes depth and liquidity, fostering the development of the debt market. By promoting higher levels of competition in financial services, foreign investors also contribute to financial innovation, triggering technology transfer and the adoption of better practices.

Nevertheless, there are risks associated with their participation in the government securities market. One of the risks is the growing interdependency of the Mexican economy, which makes it more vulnerable to volatility in international financial markets.

In this regard, foreign investors are more susceptible to lose confidence in a country’s solvency when they perceive a deterioration of the economy or unhealthy fiscal policies, a weak banking system or political instability. In those scenarios, they can abruptly withdraw their investments and generate distortions in the market.

3.5 Non-financial national investors

Companies and individuals in Mexico may invest in the government securities market through brokers and mutual funds. Both of these often require a minimum amount for opening and keeping an account and most of them charge fees for account management and operation.

Nonetheless, by the end of 2010, and in order to offer more alternatives for small and medium investors, the Federal Government launched the Cetesdirecto[31] program. It is a mechanism in which retail investors may purchase and sell government securities[32] through electronic means (Internet), by phone (call centers) or through a customized customer service window (Bansefi,[33] for its acronym in Spanish).

Cetesdirecto offers several advantages, both for the Federal Government and small investors. For the government, the introduction of this mechanism promotes medium and long-term domestic saving, as well as the use of financial services among the population. At the same time, it provides higher competitiveness, efficiency and depth to the financial system. Also, by providing the general population with an opportunity to purchase securities, it fosters a better understanding of the management and characteristics of the government’s debt and contributes to broaden and diversify the Federal Government’s investor base.

For the small and medium investor, Cetesdirecto represents an investment alternative that before was available only through banks, brokers and mutual funds. These institutions required a minimum investment amount and securities were only available through a basket or portfolio comprising instruments and maturity dates that not always adapted to the customer’s needs. Not to mention that yield was also subject to discounts due to account management and operation fees.

This type of government securities selling scheme has already been implemented in other countries such as the U.S., Brazil and Sweden. In the U.S., for instance, the total holding of government securities by small investors accounted for 0.22% of the total outstanding government securities at the end of 2013;[34] in Brazil, 0.56%,[35] and in Sweden, 3.66%.[36]

In Mexico, the total outstanding amount of this program up to the closing of 2013 was 1.141 billion pesos, which accounts for 0.02% of the total outstanding. As for the distribution of securities acquired by the general population, 89.5% corresponds to cetes, 0.8% to bondes D, 4.8% to bonos, and 4.9% to udibonos.

3.6 References

- BANXICO / SIE / CIF. [Retrieved from: www.banxico.org.mx]

- Inter-American Development Bank (IADB). Los inversionistas institucionales y el mercado de deuda interna, vivir con deuda: Cómo contener los riesgos del endeudamiento público. Borensztein, Eduardo; Devoto, María Laura; Eichengreen, Barry; Fernández-Arias, Eduardo; Izquierdo, Alejandro; Levy Yeyati, Eduardo; Panizza, Ugo; Powell, Andrew; Zuccardi, Igor, and Giannoni, Gerardo. 2007.

- BIS Quarterly Review. Reducing financial vulnerability: the development of the domestic government bond market in Mexico. Jeanneau, Serge and Pérez-Verdía, Carlos. 2005.

- CNBV Disposiciones Aplicables a los Proveedores de Precios (CNBV Regulations Applicable to Price Vendors) [Retrieved from www.cnbv.gob.mx]

- Tesouro Nacional (Brazil National Treasury) [Retrieved from www.tesouro.fazenda.gov.br]

- Fondo de Cultura Económica (FCE). La Reforma y la Desincorporación Bancaria. Ortiz Martínez, G. 1994.

- IBRD/World Bank, IMF. Developing government bond markets a handbook. 2001.

- Swedish National Debt Office [Retrieved from: www.riksgalden.se]

- Federal Reserve Bank of Atlanta. Nuevas tendencias de financiación en América. Tovar, Camilo E. and Quispe-Agnoli, Myriam. 2008.

- www.amib.com.mx

- www.cnsf.gob.mx

- www.consar.gob.mx

- www.shcp.gob.mx

- www.sifma.org

- www.treasurydirect.gov

3.7 Notes

[1] Claudia Tapia-Rangel has a Bachelor degree in actuarial science from the National University of Mexico (Universidad Nacional Autónoma de México, UNAM). She also holds a Master degree in operations research by the London School of Economics and Political Science (LSE). She began working at Banco de México in 1993. From the time she entered the central bank she has occupied several positions in the Central Bank Operations Department, in particular, being the head of Government Securities Auctions and Financial Programming. Currently, she is the head of the Securities Market Information and Analysis Department.

The author would like to thank Javier Duclaud, Jaime Cortina, Claudia Álvarez-Toca, Carlos Pérez-Verdía and Javier Pérez-Estrada for their valuable comments, as well as Ramón Figuerola, Germán Mirassou, Rodolfo Mitchell and Roberto Ramírez, for the excellent technical and research assistance.

[2] For more information, see Jeanneau and Pérez-Verdía “Reducing financial vulnerability: the development of the domestic government securities market in Mexico”, BIS Quarterly Review, December 2005.

[3] Statistics obtained from INEGI’s Economic Information Bank [Retrieved from http://www.inegi.org.mx/sistemas/bie/]

[4] Ministry of Finance (SHCP, for its acronym in Spanish) statistics from “Informe sobre la situación económica, las finanzas públicas y la deuda pública – Cuarto trimestre de 2012” [Retrieved from http://shcp.gob.mx/POLITICAFINANCIERA/FINANZASPUBLICAS/ITSSEFPDP/2012/cuarto_trimestre_2012/Informe%204o%20Trimestre%20de%202012.pdf]

[5] INSTITUTIONAL INVESTORS: Institutions having considerable investment resources as compared to the general public, such as banks, mutual funds and insurance companies, among others.

[6] BROADER GOVERNMENT SECURITIES: Securities issued by the Federal Government, the Institute for the Protection of Bank Savings (Instituto para la Protección al Ahorro Bancario, IPAB) and Banco de México. The terms government securities or broader government securities will be used irrespectively henceforth.

[7] TO STRIP: To separate interest and principal payments of a security, thus generating several zero coupon bonds that mature on the same date in which interest and principal are paid. For more information, see the Rules for Stripping and Reconstituting Government Securities “Reglas para la Segregación y Reconstitución de Títulos Gubernamentales” (available only in Spanish) http://www.banxico.org.mx/disposiciones/circulares/%7BF8667E3E-2456-7DFD-6B32-2BA50647ECB8%7D.pdf

[8] SECURITIZATION: securitization of an asset (goods, mortgages and bank loans) means selling or assigning it to a special purpose vehicle. Trusts are commonly used in Mexico for this means.

[9] SIEFORE: Mutual funds specialized in pension funds. These are mutual funds on which Pension Fund Managing Companies (Administradoras de Fondos para el Retiro, Afores) invest workers’ resources to obtain a yield. There are four different types of Siefores based on worker’s age.

[10] According to the CNBV, mutual funds “are intended to purchase and sell investment assets using the resources obtained from the placement among general investors of stock representing their capital stock, as well as the procurement of services contracted and the activities set forth in the Mutual Funds Law (LSI, for its acronym in Spanish).” [Retrieved from http://www.cnbv.gob.mx/SECTORES-SUPERVISADOS/SOCIEDADES-DE-INVERSION/Paginas/Descripci%C3%B3n-del-Sector.aspx]

[11] PRICE VENDOR: According to CNBV, a price vendor is “a company whose sole purpose is to offer estimation, determination and provision of updated prices for valuing securities, financial documents and instruments.”

[12] The classification includes banks with total assets over 200 billion pesos in the balance sheet, adjusted by Repo operations. These include Banamex, Banorte, BBVA Bancomer, HSBC, Inbursa, Santander, and Scotiabank Inverlat.

[13] ABC Capital (formerly Amigo), Actinver, Afirme, Agrofinanzas, Autofin, Banca Mifel, Banco Base, Bancrea, Banco del Bajío, Banregio, Bansí, CIBanco, Compartamos, Consubanco, Dónde Banco, Forjadores, Inmobiliario Mexicano, Inter Banco, Interacciones, Invex, Ixe, Monex, Multiva, and Ve Por Más.

[14] Azteca, Bancoppel, Famsa, and Wal-Mart.

[15] American Express, Bank of America, Bank of New York, Barclays, Credit Suisse, Deutsche, ING, JP Morgan, RBS, Tokyo-Mitsubishi, UBS, and VW Bank.

[16] Figures and data from “Información Estadística de Banca Múltiple” by the CNBV [http://www.cnbv.gob.mx/SECTORES-SUPERVISADOS/BANCA-MULTIPLE/Paginas/Informaci%C3%B3n-Estad%C3%ADstica.aspx]

[17] MARKET MAKERS: Credit institutions and trading companies approved by the Ministry of Finance. Among their main duties are to offer minimum bids in each auction for cetes, bonos and udibonos as well as to list purchasing and selling prices for all terms of these securities through brokers.

[18] Bondes D are securities issued by the Federal Government denominated in pesos and with a $100-peso nominal value. They may be issued at 3, 5 and 7 years and pay a floating monthly rate.

[19] According to data and figures from CONSAR statistical information and the SAR overview [Retrieved from: http://www.consar.gob.mx/panorama_sar/panorama_sar.aspx y http://www.consar.gob.mx/SeriesTiempo/Series.aspx?cd=160&cdAlt=False]

[20] Instruments denominated in “Investment Units” (udis). Their value in pesos is revised by following the bi-weekly growth rate of the National Consumer Price Index (INPC).

[21] As published on June 1997 in the Federal Official Gazzette (Diario Oficial de la Federación), CONSAR 15-1 Regulatory Letter, Modifications to the General Rules determining the investment regime governing Specialized Mutual Funds for Retirement (Siefores), which portfolio must comprise mainly securities that preserve the purchasing power of workers’ savings.

[22] FIBRAs (Fideicomisos de Infraestructura en Bienes Raíces): Articles 223 and 224 of the Income Tax Law (Ley del Ingreso sobre la Renta, LISR) define FIBRAs as “trusts created for purchasing or building real estate intended for lease, or purchase of the right to receive income arising from lease of such property, as well as to provide financing for such purposes”.

[23] According to data from the National Insurance and Bonding Commission (Comisión Nacional de Seguros y Fianzas, CNSF [Retrieved from: http://www.cnsf.gob.mx/Estructura/Paginas/ASectorAsegurador2.aspx]

[24] The National Insurance and Bonding Commission (Comisión Nacional de Seguros y Fianzas, CNSF), in its “General Solvency Criteria”, defines technical reserves as “reserves linked directly to ongoing risks, including pending payments, provisions for contingencies and disaster funds”.

[25] STRUCTURED INSTRUMENT: A combination of financial instruments seeking to replicate a certain yield and schedule payments. Structured instruments offer payments based on stock prices, interest rates, commodity prices or foreign exchange rates (McDonald, Robert L.; Derivatives Markets; 2nd Ed.; Pearson International Edition).

[26] Repurchasee: The person purchasing the property of various debt instruments for a certain amount. The Repurchaser is the person selling the property of various debt instruments of the same type in an agreed term at the same price plus a premium. A box providing the definition of Repo is included in the chapter “Secondary market”.

[27] According to the National Banking and Securities Commission (CNBV, for its acronym in Spanish), Equity Investment Funds (SIRV) operate with securities and equities (shares and options) and debt instruments. Debt Investment Funds (SIID) operate only with public and private debt bonds and documents. Capital investment Funds (SIC) manage bonds and documents issued by companies promoted by the mutual fund and which need long-term resources. Finally, Special Purpose Investment Funds (SIOL) can invest only in assets defined in their bylaws and public information brochure.

[28] The General Rules Applicable to Mutual funds and their Service Providers (Disposiciones de Carácter General Aplicables a las Sociedades de Inversión y a las Personas que les Prestan Servicios) define operators as institutions operating the underlying assets of each mutual fund to which they provide asset management services.

[29] According to data published by the National Banking and Securities Commission (CNBV) [Retrieved from: http://portafoliodeinformacion.cnbv.gob.mx/si1/Paginas/default.aspx]

[30] According to the General Rules Applicable to Security Issuers and to Other Participants in the Securities Market (Disposiciones de Carácter General Aplicables a las Emisoras de Valores y a Otros Participantes del Mercado de Valores), published in the Federal Official Gazette of March 19, 2003, trust certificates are those that entail “…the right to participate in part of the earnings or yields of the assets or rights, or the sale of assets or rights, which are part of the equity incorporated in the trust (up to their residual value) for the purpose of investing in activities or projects of one or several firms or in the acquisition of certificates representing the capital.”

[31] See chapter “Types of instruments and their placement”.

[32] This program only considers government bonds issued by the Federal Government; it does not include IPAB or Banco de México bonds.

[33] Banco del Ahorro Nacional y Servicios Financieros, S.N.C.

[34] Treasury Direct and Securities Industry and Financial Markets Association (SIFMA).

[35] Tesouro Nacional (Brazil National Treasury).

[36] Office of the Swedish National Debt.

IV. Secondary market

Juan Rafael García-Padilla[1]

This chapter describes the structure and development of the government securities secondary market in Mexico. It presents a definition of the daily transactions carried out in the secondary market of these securities, such as spot, repo and securities lending operations. It also describes the role played by price vendors and brokers in the development of the government securities market in Mexico.

1. Background

2. Development of the secondary market

3. Current developments in Mexico’s secondary market

4. Repurchase agreements (repos)

5. Securities lending operations

6. Stripped securities

7. Market makers

8. Price vendors

9. Brokers

10. References

11. Notes

4.1 Background

At the end of the nineties, domestic government debt was composed basically of 28-day or 91-day floating rate bondes,[2] of cetes[3] of terms greater than one year, and of udibonos[4] that had a maximum 10-year term. In those years, cetes interest rates were between 15% and 20%, the concept of market makers had still not been introduced, and resources managed by Siefores[5] were limited.

The primary goal at the time was to develop a fixed-rate, long-term government securities market. Following that purpose, since the mid-nineties, financial authorities promoted various initiatives to establish the bases for the development of the debt market in México. These efforts, fostered by conditions of low inflation, fiscal discipline and Banco de México’s credibility, allowed for developing a government debt market. The yield curve of nominal fixed-rate government securities thus moved from a maximum term of one year in 1999, to 30 years by the end of 2006. This extension in the yield curve has been the most evident achievement in terms of government debt market development.

1/ The chapter “Market makers” includes the chart “Development of the fixed-rate yield curve”, which also includes the years since the concept of market makers was created and complements the chart shown above.

4.2 Development of the secondary market

The primary market is where negotiable securities are issued for the first time in the market. In the primary market, the securities placed by debt issuers (governments, companies, etc.) are purchased by investors seeking a yield. There is also a secondary market where issued securities are sold and purchased, although these transactions take place among investors themselves instead of directly with the issuer. In the secondary market, securities can be exchanged through direct, pre-sale and repo operations.

A well-developed government bond market must rely on an efficient and liquid secondary market. In this regard, the Federal Government has promoted major reforms to adjust the debt market microstructure and foster the secondary market.

Pension system reform is one of the most important structural reforms promoted in 1997, that allowed the construction of a considerably strong local institutional investor base. The creation of the market maker[6] concept set the bases for the development of a liquid inter-bank market for government securities. The concept of price vendor,[7] first introduced in the Mexican market in 1998, responsible for setting daily a fair price for all outstanding issues, including government securities, brought along considerable transparency into the market.

The greater debt management discipline applied by the Federal Government was also fundamental. In this regard, worth highlighting is the publication of quarterly issuance calendars, the adoption of the reopened issues that may be rapidly converted into market benchmarks, the incorporation of syndicated placements[8] and securities swaps.

Other change introduced in 2004 was a regulation allowing the stripping of bonos and udibonos which allows to trade separatecoupons and principal. Finally, the development of a repo and securities lending market, has been fundamental to the market depth and liquidity. All these initiatives have led to a more liquid and efficient government-debt secondary market.

4.3 Current developments in Mexico’s secondary market

The trading volume of the secondary market of Mexican government securities has reached liquidity levels similar to those observed in other international markets. A survey conducted by the Emerging Markets Traders Associations (EMTA) during 2013 revealed that Mexico reached the second highest trading volume in debt instruments for a total of 748 billion dollars accumulated during the period. This amount represents a 7% drop as compared to the 806 billion dollars recorded in 2012. Eighty percent of the trading volume comprised instruments in pesos. Brazil was the first market with the highest trading volume for a total of 902 billion dollars. Mexico ranked above countries such as South Africa, Russia, and Poland, which have also developed local government securities markets.

The data obtained by Banco de México shows that the average daily trading volume of government securities[9] in 2013 reached an estimated 98.414 billion pesos, equivalent to a daily average of approximately 7.570 billion dollars.[10] Bonos[11] account on average for nearly 50% of this volume. Cetes are the second highest trading volume security with a total of 26.800 billion pesos (2.061 billion dollars), while udibonos account only for 10% of the total operation.

A stronger and more active investor base and, consequently, a higher trading volume, has contributed to see spreads between purchase (bid) and sale (offer) prices for government bonds in the Mexican market come close to those of other developed economies. The spreads for bonos M are, on average, 3 basis points and for udibonos, 4 basis points. The average trading volume has also increased substantially to 50 million pesos. Nevertheless, on highly active days, this amount reaches up to 150 million pesos per transaction.[12]

Agreed upon operations are settled on the second working day after the transaction, i.e., the Mexican market uses a t + 2 agreement. It was not until lately that all operations were settled based on this convention. However, since Mexico became a member of various global market indexes, such as Citibank’s WGBI,[13] Banco de México authorized operations with bonos with a t + 8 date settlement without having them considered as derivative operations. This decision is in line with the developments in several Asian countries, which close their financial markets for long periods (under the former regulation, this type of transactions would have been considered similarly as derivatives operations).

Table 4.1

Secondary market trading volume

Daily average in million pesos; April 2014

Instrument

Interbank

Customers

Total

Broker

Phone-service

Broker

Phone-service

Udibonos

2,344

781

755

4,906

8,786

Dec-14

222

61

52

566

902

Jun-16

832

174

154

1,828

2,987

Dec-17

132

26

36

175

370

Jun-19

92

148

21

76

338

Dec-20

40

7

16

141

204

Jun-22

56

28

15

173

272

Dec-25

76

19

18

330

442

Nov-35

120

55

45

106

325

Nov-40

775

262

398

1,511

2,947

Bonos

15,192

7,244

1,914

24,556

48,906

Jun-14

108

2

0

332

442

Dec-14

222

33

29

647

931

Jun-15

474

1,049

68

913

2,504

Dec-15

124

39

59

234

456

Jun-16

257

195

55

1,624

2,132

Dec-16

564

451

232

864

2,111

Jun-17

336

56

46

3,341

3,778

Dec-17

1,144

359

67

1,034

2,604

Jun-18

1,330

119

117

1,809

3,375

Dec-18

506

1,412

36

497

2,451

Jun-20

383

99

38

277

798

Jun-21

302

64

24

464

853

Jun-22

688

821

11

1,095

2,614

Dec-23

723

172

41

841

1,777

Dec-24

3,444

876

315

4,068

8,702

Jun-27

221

123

2

487

833

May-29

399

293

18

852

1,563

May-31

1,839

553

266

1,292

3,951

Nov-34

0

0

161

1,271

1,431

Nov-36

186

27

16

228

458

Nov-38

816

324

108

1,150

2,398

Nov-42

1,126

176

207

1,236

2,745

Source: Banco de México.

4.4 Repurchase agreements (repos)[14]

According to Mexican regulations, repos are defined as transactions through which the lender buys, for a certain amount, the legal ownership of debt securities ensuring to transfer to the borrower the ownership of the same type and amount of securities on the agreed upon date and upon payment, at the same price plus a premium. Such premium is for the benefit of the lender, unless otherwise stated.[15] Maturity dates for repo transactions are determined freely and depend on the parties involved. However, they must expire not later than one working day before the due date of the securities used in the transaction. Both the price and premium received by the lender may be denominated in local or foreign currencies or in udis,[16] regardless of the securities’ denomination.

One of the benefits of the repo market is that the lender receives a “customized” investment instrument that allows him to invest at the maturities and for the amounts preferred, always through a collateral. For the borrower, this transaction represents a quite efficient financing mechanism.

In 2000, the regulations for securities lending and securities repo operations was modified in order to be in line with the best international practices. Transactions were therefore documented using international master agreements. The new regulation even allowed foreign customers to sign ISMA PSA[17] agreements for these transactions. Another goal of the reform was collateralizing repo operations in order to reduce the credit risk on these transactions.

Currently, the daily trading volume of government securities repos is of 720 billion pesos. However, this volume is concentrated in short terms: 97% is for 1- to 3-day terms, while the remaining 3% is for terms shorter than one month. As for government securities that are mostly used in repo operations, bondes D account for 44.6% and BPAs for 26.5%. Banco de México publishes daily information on the repo market trading volume.[18]

Credit institutions and brokerage firms are the main participants of the Mexican repos market. These institutions may act either as lenders or borrowers.[19] Generally, banks and brokerage firms use repos as an instrument to finance through their customers their open positions with securities. In addition, many of them also take advantage of repos flexibility to invest their liquidity. Sometimes they use this tool for short positions buying government securities through repo agreements and simultaneously selling them directly.[20] Other major participants of this market are the corporate treasuries of the main national companies and treasuries of many of the public agencies which generally invest their cash surpluses in these instruments. Mutual funds and, to a lesser extent, Siefores and insurance companies, are also key players in this market.

Finally, Banco de México also plays an important role in this market, since a significant part of the liquidity that is being regulated in the financial system is performed through short-term credits collateralized with government securities, and which are quite similar to repos.

Box 4.1

Monetary policy implementation through the secondary market

Introduction

The main goal of Banco de México is to guarantee the peso’s purchasing power stability, i.e., to guarantee price stability.

Conceptual framework

Central banks have no direct control over inflation or its determining variables. Based on this premise, central banks have the necessary tools to directly affect a group of nominal variables which, in turn, have an impact on inflation determinants. In economic theory, these nominal variables are known as operational targets and include, among others, the exchange rate, the short-term interest rates, and the banks’ accounts in the central bank. When implementing monetary policy, the central bank must select one of these operational targets. For Banco de México, the operational target is the overnight (1-day) interbank interest rate.[21]

This interest rate operational target offers several advantages:

1. It facilitates the understanding of monetary policy actions and their effectiveness.

2. It provides greater stability to short-term interest rates and greater relevance to monetary policy all along the yield curve.

3. It adjusts monetary policy implementation to that of other central banks worldwide.

Monetary policy tools

In order to meet its monetary policy operational target, Banco de México has several instruments available to manage the liquidity in the Mexico’s financial system and prevent it from affecting negatively money market interest rates and, eventually, inflation. At present, the bank uses the following tools to achieve its target:

1. Monetary Regulation Deposits (Depósitos de Regulación Monetaria, DRMs)

2. Open Market Operations (Operaciones de Mercado Abierto, OMAs)

1. Auctions of short- and long-term government securities for monetary-regulation purposes.

2. Liquidity-providing and funding auctions.

A. Monetary Regulation Deposits (DRMs, for their acronym in Spanish)

DRM is one of the instruments available by Banco de México to “sterilize” the excess of liquidity in Mexico’s financial system. These are mandatory long-term deposits from national credit institutions in the central bank. These deposits have an indefinite maturity date and generate yields equivalent to the interbank funding rate. They differ from the reserve requirement used by other central banks.[22] DRM may be used as collateral in Banco de México’s transactions with banking institutions such as in liquidity–providing auctions, for instance, or when a credit operation is performed using the quote of the interbank equilibrium interest rate (Tasa de Interés Interbancaria de Equilibrio, TIIE), in the payment systems, to prevent overdrafts.

B. Open Market Operations (OMAs, for their acronym in Spanish)

1. Short-, medium- and long-term government securities for monetary-regulation purposes auctions.

The purpose of the auctions for short- and long-term government securities for monetary regulation is to withdraw liquidity from the money market. At present, Banco de México sells in auction instruments issued by the Federal Government.[23] Cetes auctions are used to withdraw excess liquidity in terms of up to 1 year. On the other hand, 3-, 5-, and 7-year bondes D auctions are used for withdrawing liquidity in the medium- and long-term. The amount of these transactions is fixed according to liquidity management forecasts and policies set by Banco de México’s Governing Board. The sale of securities for monetary regulation purposes is completely independent from the operations the central bank carries out in its role as financial agent of the Federal Government and IPAB.

2. Liquidity-providing and deposit auctions

Banco de México balances the excess or lack of liquidity in the interbank market through its liquidity-providing and deposit auctions. The conditions under which Banco de México supplies or withdraws liquidity ensure the fulfillment of the overnight interbank funding rate target. These auctions balance liquidity in the system so that the accrued balance of the bank’s current accounts in Banco de México totals zero at the end of every day. Credit auctions must be collateralized through government securities, monetary regulation deposits or dollar deposits in the central bank.

4.5 Securities lending

Securities lending is a financial transaction through which the legal property of securities is transferred by the holder, or lender, to the borrower. The later must restore, at the maturity of the agreed upon term, the corresponding value in securities (from the same issuer and, if applicable, for the same nominal value, type, class, series, and maturity date), as well as a premium on behalf of the lender, unless otherwise agreed.[24]

Figure 4.1

Securities lending diagram

Source: Prepared by the author.

Securities lending operations in Mexico must be performed using the master agreement jointly approved by the Mexican Banking Association (Asociación de Bancos de México, ABM), the Mexican Brokers’ Association (Asociación Mexicana de Intermediarios Bursátiles, AMIB), and the Mexican Pension Funds Administrators’ Association (Asociación Mexicana de Administradoras de Fondos para el Retiro, Amafore. This contract must be structured according to the best international practices and therefore include the guidelines established in the contracts for such transactions approved by the Public Securities Association (PSA), the Bond Market Association, and the Securities Industry Association (SIA). Also, the lender’s obligation to collateralize the loan transaction must be agreed upon, as well as the procedure to follow in the event the securities loaned or used as collateral are no longer listed at the stock exchange.

A deep and liquid securities lending market is crucial for the development of the secondary market. Particularly, securities lending is the most important tool used by institutional investors to lend their securities and obtain and additional yield. For financial intermediaries, it represents the most adequate instrument to request borrowed instruments and take short positions in some securities.

Nowadays, there are two private agencies in Mexico that provide securities lending services to banks, brokerage firms, and investors in general: Indeval,[25] through its Valpre system, and Accival, through its Accipresval system, which is focused mainly on institutional investors, Siefores, insurance companies, and mutual funds operators. Besides, there is also the securities lending facility of Banco de México which, in contrast with other facilities, is only available for market makers.

4.5.1 Private institutions offering securities lending services

The institutions offering the securities lending service do not borrow or lend securities on their own behalf; their role is to provide and manage the system through which the various intermediaries can carry out lending transactions. By means of these institutions, brokerage firms, banks or any investor may enter positions offering or requesting securities in loan, establish or manage the necessary collaterals to carry out the securities lending, verify the number of operations generated and, finally, determine the premium, the amount and term of the securities requested for each position.

All instruments participating in securities lending must be listed in the National Register of Securities and Brokers (Registro Nacional de Valores e Intermediarios, RNVI) and deposited at Indeval. In order to carry out securities lending operations involving low or nule trade volume securities or securities that are not classified according to the Mexican Stock Exchange criteria, (Bolsa Mexicana de Valores BMV), the borrower must obtain and submit before Indeval the previous authorization from the National Banking and Securities Commission (Comisión Nacional Bancaria y de Valores, CNBV).

As in any loan, collaterals backing up the loan granted must be created for each and every type of securities. For each registered transaction, the collateral may be constituted using securities (through the institution providing the service) or cash (through a trust). Government securities, high and low traded securities (according to the trading volume indexes of the Mexican Stock Exchange), mutual funds’ equity and securities, and bank securities may be used as collateral.

The amount the borrower must leave as collateral depends on the security granted in loan, since each instrument has a coverage factor. Indeval values collaterals daily at the close of transactions and may carry out “margin calls” for the collaterals to be covered or may instruct the release of excess collateral to use them, as needed, on the next working day.

At the time the securities lending transaction takes place, the institutions offering this service are in charge of delivering and safekeeping the securities in loan as well as of managing the collateral submitted. In the event the securities are not delivered 48 hours after the loan matures (typically over the collateral), the institution providing the securities lending service is responsible for selling the collateral and delivering the cash to the lender. The transaction requirements of each institution include the signing of a trust adherence contract and of a contract setting forth the rights and duties of both borrowers and lenders in the securities lending transaction. It is worth pointing out that in order to participate in securities lending transactions, the interested party must necessarily have access to the Indeval system and have a securities custody account. Lenders must also specify the authorized counterparties, the credit lines with each and the collateral they are willing to accept in each case. These specifications are entered into the system and the institutions monitor the compliance to each and every parameter.

In a securities lending transaction, institutions (Valpre and Accipresval) charge a fee additional to the premium agreed upon in the transaction. This fee is equivalent to 15% of the premium value in the case of lenders (usually Siefores), and to 5% in the case of borrowers (usually brokerage firms and banks).

4.5.2 Banco de México’s securities lending facility[26]

The securities lending facility of Banco de México is only accessible to market makers. The market makers interested in this facility sign a contract that establishes the details of the transactions, the duties and obligations of the parties and the procedure to create and cancel the corresponding collateral. The term for securities lending transactions is of one working day and they may be renewed daily. Each market maker may request a loan for any effective issue of cetes, bonos or udibonos. The maximum amount of each instrument that may be requested is 4% of the amount outstanding of the corresponding issue, as long as the requested total lending amount does not exceed 2% of the amount outstanding. The maturity of the requested government securities must be at least two working days after the loan’s maturity date.

The premium to be paid to Banco de México for each cete or bono lending transaction is calculated by multiplying the weighted government funding rate by a factor determined on the basis of each market maker’s operation in repos and securities lending transactions. The calculation of this factor is carried out monthly, starting on the 16th day of each month and concluding on the 15th day of the following month, in order to apply it as of the first working day of the following month. In the case of banks that become part of the market maker list, the factor applicable during the first two months after being incorporated to the list is of 5%.

In the case of udibonos, the premium to be paid for each securities lending transaction is 7% of the weighted government funding rate.

4.6 Stripped securities

In Mexico, long-term fixed rate instruments, both in pesos and udis, may be stripped. This means that the payment of interest (coupons) and of principal can be documented independently as a zero-coupon instrument. For example, a 5-year bono that pays interest on 10 different dates and the principal at maturity can be documented and stripped into 11 different zero coupons (one per each interest payment and one for the principal).

When an instrument is stripped, its market risk profile changes, although its credit risk remains unchanged. The main advantage of stripping interest and principal of fixed rate bonds is offering investors the possibility of choosing from a wide range of short, medium and long term zero-coupon government securities. This segregation may be particularly useful for institutional investors, such as insurance companies, who are looking for investments that adapt to the market risk of their liabilities. Nevertheless, this market has developed slower than expected in Mexico.

4.7 Market makers[27]

One of the most important actors in the development of the Mexican market has been the market maker figure, which was created for the first time in 2000. Market makers have helped to increase secondary market liquidity substantially since they are forced to provide bid and ask prices of government securities.

4.8 Price vendors[28]

In order to ensure a fair valuation of financial instruments, a valuation committee was established in the mid-nineties, which comprised both authorities and members of the financial sector. The main role of such committee was to establish the estimation guidelines and criteria for price valuation. Estimations were carried out by the Mexican Stock Exchange (Bolsa Mexicana de Valores, BMV). By the end of the nineties, however, and in order to standardize and provide higher accuracy in the valuation of financial intermediaries’ holding of securities, the concept of price vendor was introduced.

Price vendors are in charge of calculating the updated valuation prices for outstanding securities in the market. They must therefore display two main characteristics: they must be widely recognized experts in financial instruments’ valuation and have no conflicts of interest. There are two price vendors in Mexico: Proveedor Integral de Precios (PIP) and Valuación Operativa y Referencias de Mercado (Valmer).

Price vendors in markets may facilitate the development of local market reference indexes. For example, PIP has two government bond indexes, while Valmer has six indexes referenced to bonos. Regarding cetes, PIP has seven indexes and Valmer six. These indexes are extremely useful tools in the construction and maintenance of investment portfolio, which may be used by investors as benchmarks.

In Mexico, price vendors are regulated by the CNBV. Among their obligations are:

- To inform the CNBV daily the prices calculated for the instruments, as well as any unforeseen changes in the valuation procedures.

- To keep for as long as five years the standard valuation prices and the inputs used in the calculations.

- To have a valuation committee that reviews methodologies, settles disputes and proposes improvements.

- To offer information to customers through different media.

4.9 Firms that operate over-the-counter trading systems (brokerage firms or “brokers”)[29]

The Mexican bond market is operated either through telephone services or by brokers. The later offer interbank intermediation or brokerage services in financial markets. By means of electronic platforms, brokers facilitate the transactions among banks, stock markets, Siefores and insurance companies, by providing timely access and generating valuable information for these institutions.

Brokers take no positions themselves, they only facilitate the operations between intermediaries and customers when selling and buying securities. In certain cases, they substitute the most basic contact sources, such as phones. These companies foster competition by facilitating the communication between supply and demand in the market. Moreover, the services of brokers have increased the speed at which real-time information on market prices and transactions is spread, hence improving transparency in markets and creating new structures for the automatic realization of transactions.

According to the definition of the International Monetary Fund (IMF), the Mexican market may be classified as a periodic market, with working hours from 7:00 a.m. to 2:30 p.m. Most transactions take place during these hours, as compared to most developed country markets, which operate nearly for 24 hours. However, since the entrance of Mexico to several investment indexes, some trading offices implemented 24-hour trading services, although their activity after 2:30 p.m. is reduced.

Brokers have also contributed to increase the liquidity and depth of government securities’ markets. In electronic markets, quotes are centralized in a network that discloses on-screen information. Purchase and sales orders are also entered in this network and performed automatically.

Some of the advantages offered by this type of infrastructure include higher transparency in price formation and the use of the best price available in the market and real-time auditing, which means a better market surveillance.

Brokers maintain their customers’ information confidential, protecting them from the risk that could result if other banks or customers get to know the nature and size of the transactions performed or to be performed. Their income comes from the fees charged to customers. Some brokers use different collection systems, from fixed fees, for a limited number of transactions, to floating fees, depending on the number of transactions agreed upon for a certain period, usually a month.

There are five brokers in the Mexican market. Enlace was the first, starting operations in the foreign exchange market in October 1993; Remate Lince, which began operations in 1996 and Servicios de Integración Financiera (SIF) S.A. de C.V., which began operations in August 1998. There is also Eurobrokers, which started its brokerage services in Mexico in 1996 and stands out because it also operates securities known as CEDEVIS,[30] and Tradition, incorporated in May 2004.

4.10 References

- AMIS. Presentation “Préstamo de Valores” by Navarro, Eduardo. Market and Securities Lending Director of Accival, Banamex. May 2007.

- BANAMEX. Mexico’s local markets and bonos M: A primer. July 2010.

- BBVA BANCOMER. Handbook of Mexican financial instruments. 2010.

- BIS, Committee on the Global Financial System (CGFS). Financial stability and local currency bond markets. June 2007.

- BIS. The role of the central bank in developing debt markets in Mexico. Sidaoui, José Julián. June 2002.

- CONSAR. Glossary of the National Commission for the Pension System (Glosario de la Comisión Nacional del Sistema de Ahorro para el Retiro) (available only in Spanish). Last update: August 31, 2010.

- CREDIT SUISSE. Guide to Mexico local markets. September 2010.

- DEUTSCHE BANK. Guide to Mexico’s local markets. March 2008.

- HSBC. Latin America rates. Exploring LatAm instruments, regulations and market conventions. March 2010.

- JP MORGAN. Mexico 101. The 2010 country handbook. February 2010.

- SHCP. Press release on the syndicated placement of the peso-denominated fixed rate 10-year bono (Comunicado de prensa referente a la colocación sindicada del bono a tasa fija a plazo de 10 años en moneda local) (available only in Spanish). February 23, 2010.

- www.banxico.org.mx

- www.consar.gob.mx

- www.shcp.gob.mx

- www.infonavit.gob.mx

- www.bmv.com.mx

- www.indeval.com.mx

- www.mexder.com.mx

4.11 Notes

[1] Juan Rafael García-Padilla has a Bachelor degree in economics from Instituto Tecnológico y de Estudios Superiores de Monterrey, Campus Estado de México (ITESM-CEM), and a Master degree in business administration with a major in financial administration, from the University of North Carolina. He has worked in Banco de México since 2001, where he has held several positions. First, he was trader at the peso-dollar market desk, then he became head trader. Later, he became head of the Secondary Market Operations Office and deputy manager of the Market Operations Division. Currently, he is the Market Operations manager, responsible for implementing Banco de México’s monetary and exchange rate policy and Banco de México’s activities as financial agent for the Federal Government.

The author would like to thank Javier Duclaud, Jaime Cortina, Alfredo Sordo and Claudia Álvarez-Toca for their valuable comments, as well as Fernanda Ríos-Cruz, Luis Mata-Roch, Gilberto Montaño-Calvillo, and Gabriel Anaya-González for the excellent technical and research assistance.

[2] BONDES: One-month coupon government development bonds. They belong to the family of floating-rate government securities, i.e., they pay and adjust their interest rate every month. For more details, see chapter “Types of instruments and their placement”.

[3] CETES: Federal treasury certificates. They are the oldest stock market debt instrument issued by the Federal Government. They were first issued in January 1978 and since then have been a fundamental pillar in the development of the Mexican money market. These certificates belong to the family of zero-coupon bonds, which are sold at discount (below their nominal value), bear no interest and are settled at maturity. For more information, see chapter “Types of instruments and their placement”.

[4] UDIBONOS: Government development bonds denominated in investment units. They were created in 1996. Udibonos are investment instruments hedged against inflation. They are placed at long terms and pay interest every six months based on a real fixed rate determined at issuance. For more information, see the chapter “Types of instruments and their placement”.

[5] SIEFORE: Mutual fund specialized in pension funds. Siefores are mutual funds on which pension funds’ administrators (Administradoras de Fondos para el Retiro, Afores) invest workers’ resources in order to generate yields. There are four different Siefores depending on workers’ age. In the chapter “Investor base”, a table with this classification is included.

[6] Market makers are institutions that must continuously trade securities in such a way as to help investors to easily find counterparties to purchase or sale such securities at prices fixed by the market. In Mexico, market makers are credit institutions or brokerage firms that permanently use, on their own behalf, purchase and sale quotation prices of government securities and continuously carry on transactions to provide greater liquidity to the government securities market. See chapter “Market makers” for more details.

[7] Both in this chapter and in the chapter “Legal and regulatory framework. Fiscal considerations” a section referring to price vendors is included.

[8] Syndication is a placement practice regularly used for major issues, through which brokers are appointed for the distribution of securities for a fee. In this way, a broader investor base is covered, as compared to that achieved through a traditional primary auction. Some of its advantages include the following:

- New issues are ensured to have a higher initial outstanding amount.

- With a considerable placed amount, the new issues become eligible from the beginning to be included in the global fixed-rate indexes.

- A broad distribution is achieved among local and foreign investors.

- Better liquidity conditions are guaranteed in the market.

The chapter “Types of instruments and their placement” refers to this type of government securities placement.

[9] Including bonds known as BPAs. These bonds are issued by Banco de México and the Institute for the Protection of Bank Savings (Instituto para la Protección al Ahorro Bancario, IPAB). The IPAB, as set in Article 2 of the Federal Revenues Law (Ley de Ingresos de la Federación, LIF) for the fiscal period of 2007, is authorized to issue bonds for savings protection purposes (Bonos de Protección al Ahorro, BPAs) through Banco de México as government broker, for the purpose of exchanging or refinancing its financial liabilities, of providing liquidity to securities and, in general, of improving the terms and conditions of its liabilities in order to meet its financial obligations. At the end of July 2011, these instruments were issued at 3-, 5- and 7-year terms and bear interest every 28, 91 and 182 days, respectively. For more details, see chapter “Types of instruments and their placement”.

[10] At a conversion exchange rate of 13.00 pesos per dollar.

[11] BONOS M or BONOS: Fixed-rate government development bonds. They are issued and placed at over-a-year maturities, bear interest every six months and, contrary to bondes, their interest rate is determined at issue and remains fixed over the life of the instrument. For more details, see chapter “Types of instruments and their placement”.

[12] Previously, the average differential between bid and offer operations was of approximately 5 or 6 basis points and the average trading volume was between 5 or 10 million pesos per transaction.

[13] The chapter “Investor base” includes a box describing the WGBI index.

[14] The chapter “Legal and regulatory framework. Fiscal considerations”, includes a box explaining the provisions set forth by Banco de México for repo and securities lending operations.

[15] Although the ownership is transferred legally, the risk of surplus or loss is entitled solely to the borrower.

[16] UDIs: “Investment units”. Their variation is in line with that of the National Consumer Price Index (Índice Nacional de Precios al Consumidor, INPC), in compliance with the procedure established and published by Banco de México in the Official Gazette of April 4, 1995.

[17] ISMA/PSAs are master repurchase agreements used as standards in the international repos market. The International Securities Market Association (ISMA) developed these contracts.

[18] http://www.banxico.org.mx/portal-mercado-valores/informacion-oportuna/operaciones-en-el-mercado-de-valores/index.html

[19] Repos are ruled in Mexico by Banco de México through circular note 33/2010, which sets forth the coverage and limitations of this type of transaction. The chapter “Legal and regulatory framework. Fiscal considerations” includes a box explaining Banco de México regulations related to this matter.

[20] Short positions are carried out when the counterparty purchases securities he is obliged to later return. If during the term agreed to return them the interest rates decrease, the counterparty will incur in a loss, as he will have to acquire the instruments to be returned at a higher price. On the contrary, if interest rates increase, he will obtain a yield.

[21] For an historical background, see Inflation Report (July-September 2007), Annex III, published by Banco de México.

[22] Reserve requirement occurs when a central bank requires commercial banks to deposit a mandatory and minimum amount of the deposits received from their saving customers (i.e., bank liabilities). The purpose is to keep these amounts as reserves to cover withdrawals by depositors. No reserve requirement is applicable in Mexico. Instead, Banco de México keeps a monetary regulation deposit over banking institutions.

As compared to the reserve requirement, such deposit does not adjust continually to the fluctuations in banks’ reference liabilities. The amount of the deposit is fixed on the basis of the target amount of liquidity that Banco de México needs to withdraw from the market and is prorated using certain bank’s reference liabilities at a predetermined date (e.g., total cash term deposits).

[23] Up until the third quarter of 2006, Banco de México issued and placed its own monetary-regulation instruments. These instruments, known as BREMs, had a floating interest rate referenced to the interbank funding rate. In 2006, both the Ministry of Finance and Banco de México agreed that the central bank would use floating-rate instruments placed by the Federal Government in its short-, medium- and long-term liquidity withdrawal operations.

[24] Although the property of securities is legally transferred, the appreciation or depreciation risk remains the same for the original security holder.

[25] INDEVAL: Private institution authorized by the law to perform as central securities depository (CSD) that offers protection, custody, management, clearing and settlement services within a setting of maximum trust and safety. For a more thorough description, see chapter “Instruments settlement”.

[26] The chapter “Legal and regulatory framework. Fiscal considerations” includes a box explaining the regulations set forth by Banco de México for repos and securities lending operations.

[27] For a broad description on the subject, see chapter “Market makers”.

[28] For information on the regulation governing price vendors, see chapter “Legal and regulatory framework. Fiscal considerations”.

[29] The section “Fiscal considerations” of the chapter “Legal and regulatory framework. Fiscal considerations” deals with the regulation imposed on brokers.

[30] CEDEVIS: Mortgage-backed securities issued by the Mexican Federal Institute for Workers’ Housing (Instituto del Fondo Nacional de la Vivienda para los Trabajadores, INFONAVIT). Cedevis (Certificados de vivienda) are an alternative source of financing for INFONAVIT, since the resources resulting from their placement are reinvested in new credit lines granted to workers.

V. Market makers

María Daniela Gallardo-García[1]

In 2000, the Ministry of Finance (Secretaría de Hacienda y Crédito Público, SHCP) created the Market Makers Program in order to foster the development of the fixed-rate government securities market. Its purpose was to create a liquid and strong yield curve that would provide the government access to financing in financial markets more efficiently. The program has been in place for the last 14 years, and during this time it has undergone several modifications. This chapter describes the role of market makers, their eligibility criteria, and the rights and duties of participants. It also includes a brief review of the Market Makers Program and its achievements.

1. The Market Makers Program

2. Market makers’ development and contribution

3. References

4. Appendix 1. Measurement of market makers of cetes and bonos

5. Appendix 2. Measurement of market makers of udibonos

6. Notes

5.1 The Market Makers Program

Market makers in Mexico are credit institutions and brokerage firms –appointed by the Ministry of Finance– conferred with the obligation of participating very actively in the fixed-rate government securities market. These institutions must present bids at competitive prices in each primary auction of securities, and must also permanently quote purchase (bid) and sale (offer) prices in the secondary market in order to provide liquidity and facilitate investment in this market.

Since its beginning, the program has had a voluntary character. To participate, the interested institutions must comply with certain eligibility criteria, and once accepted, they acquire both special rights and duties. Banco de México, in its role as financial agent of the Federal Government, administrates The Market Makers Program by measuring the level of qualification of the participants and the special transactions they are entitled to.

The Market Makers Program guidelines have been reviewed on several occasions, including the selection criteria, the types of securities and transactions considered, as well as the rights and duties of participants. The rules in force as of March 2011 are described in the sections below.[2]

5.1.1 Eligibility criteria

To be designated as market maker (of cetes and bonos[3]), banks and brokerage firms must first declare their interest in participating in this program. They must also fulfill a series of requirements determined by the Ministry of Finance. The main requirement is to show and maintain a significant and diversified level of trading in these securities.

The selection of market makers is unbiased and based on an index (see Appendix 1 here) which measures the activity of the participants in the primary and secondary markets. Activity in the primary market is included in the index to promote market makers’ participation in the Government auctions and to ensure it obtains competitive financing rates. On the other hand, the measurement of the activity in the secondary market, includes both interbank trading and trading with the clientele, and the later has a higher weight on the index. The rationale for this case is to promote securities distribution among investors. The index is calculated as the participation of market makers in these three markets. Points for activity in the derivatives market and for diversifying transactions all along the yield curve may be added to each participant's index or likewise subtracted for concentrating all the trading in only a few issues.

To be appointed market maker of udibonos[4], participants must be first market makers of cetes and bonos. The activity is measured quite similarly to that of bonos trading (see Appendix 2 here). Activity in the primary market has a higher weight in the index, since banks usually keep no positions of these securities and their participation needs to be incentivized in primary auctions in order to ensure competitive rates and reduce financing costs for the Federal Government. As for the secondary market, both interbank, and with a greater weight, clientele trading, are considered in order to offer final investors various trading options and to promote competitiveness in this market. The same as with the index of market makers of cetes and bonos, a market share of at least 7% must be achieved and maintained.

5.1.2 Duties

Market makers have duties in both the primary and secondary markets. The commitment to participate in primary auctions seeks to ensure the total placement of the target amount, and therefore, to obtain the best possible financing conditions for the Federal Government. Duties in the secondary market are more oriented to the Market Makers Program’s reason and rationale, i.e., to keep bid and offer quotes along the day for the securities they are market makers of.

Primary market: Market makers are requested to present a minimum amount of bids in each primary auction for the type of securities they are market makers of. This minimum amount is the lowest amount resulting from:

- 20% of the amount offered by the Federal Government.

- 1/(number of market makers for the security).

By having five market makers for each instrument, the amount bidded is guaranteed to be at least the same as that offered by the Federal Government in each primary auction. If a market maker does not comply with this duty in the auctions of cetes and bonos, it will not be able to exercise the next day his purchase option[5] for none of both instruments regardless of the auction in which he did not comply with his duty; however, he will be able to do so in the auction of udibonos. On the other hand, if a market maker that does not comply with this duty in the auction of udibonos, it will not be able to exercise his purchase option for these instruments, but will be able to do so in that for cetes and bonos.[6]

Secondary market: Market makers must “create” this market. This means that they have to present quotes (both for bid and offer) for each of the securities they are market makers of, in all their maturities. Quotes are presented through brokers systems, for interbank trading, and trading with the clientele. Market makers are expected to comply with healthy practices and establish trading mechanisms to carry out transactions among each other.

5.1.3 Rights

Market makers not only have to fulfill certain duties, they also enjoy special rights. These rights comprise transactions they may carry out with the Ministry of Finance and Banco de México, which include the following: (1) additional purchase of securities by exercising an option for the amount originally placed in the weekly primary auction; (2) access to securities lending through the central bank facility and (3) exclusive participation in syndicated placements.

Exercising an option: On the next working day after the primary auction takes place, market makers of each security (cetes, bonos, and udibonos) may jointly buy up to an additional 25% of the amount placed at the same allocation price.[7] If the combined demand of all market makers is higher than this amount, the option is prorated on the basis of the admissible bids each market maker presented at the primary auction (see Box 5.1). An admissible bid should have a yield rate which is equal or lower to the result of multiplying the highest allocation rate for a specific factor. In the case of cetes and bonos, there are different factors by market maker, depending on the ranking obtained in the last quarterly announcement by the Ministry of Finance.[8] In the case of udibonos, the factor is 1.01 for all market makers.

It is convenient to exercise this right when market makers need additional securities, either for their own investment or to cover their clients’ needs, or when interest rates decrease the next day of the auction, which implies an alternative to purchase auctioned securities at a price lower to the one prevailing in the market at the time the option is exercised. Exercising this right by market makers also implies that the Federal Government will raise more debt than the one scheduled in the quarterly securities auction calendar. This higher level of resources obtained responds to the need and conditions of the market; however, it never exceeds the net indebtedness ceiling set in the Federal Income Law (Ley de Ingresos de la Federación, LIF) for the corresponding year.[9] Table 5.1 presents the history on the use of this option by market makers. As shown, this option has been used mostly for fixed coupon rate instruments (bonos and udibonos) rather than for cetes. From October 2000 to April 2014, the amount of debt placed through this additional allotment totaled over 2 trillion pesos.

Box 5.1

Prorating the market makers’ option

If the combined demand of all market makers exceeds 25% of the auctioned amount, the option amount is allocated according to the following procedure:

1. Each market maker receives the amount it requested multiplied by the percentage it represents of the total admissible bids of the market makers that want to exercise the option.

2. In the event of a residual amount without allotment, each market maker receives an additional amount equal to the minimum of what remains to be allocated of the amount requested by each market maker and the remaining amount multiplied by the percentage the amount requested per market maker represents of the total amount requested.

3. If a total amount is not yet allocated, the residual is prorated according to the percentage that for each market maker the amount to be yet allocated represents out of the total not allocated of the rest of the market makers. The market makers that have already received their requested total are not considered anymore at this stage.

Table 5.1

Market makers' option exercising

Million pesos and percentage of the primary auction amounts

Year

Cetes

Bonos

Udibonos

Amount

%

Amount

%

Amount

%

2000*

11,359

2

1,448

5

n.a.

2001

36,384

6

8,529

14

n.a.

2002

45,920

7

12,490

15

n.a.

2003

32,191

5

14,590

13

n.a.

2004

42,009

6

18,630

14

n.a.

2005

59,835

7

16,050

11

n.a.

2006

95,968

11

29,024

14

n.a.

2007

129,215

14

25,613

11

n.a.

2008**

102,596

11

26,726

12

626

1

2009

190,345

14

24,688

13

11,508

15

2010

220,585

18

22,850

10

11,305

14

2011

134,195

13

28,885

13

10,670

12

2012

184,250

14

39,365

13

20,521

17

2013

231,453

17

45,075

13

22,958

16

2014

79,352

13

16,847

11

8,634

14

*Since October 9, when market makers for cetes and bonos began to operate.

**Since December 1, when market makers for udibonos began to operate.

Source: Banco de México.

Securities lending facility: To facilitate the duty of market makers of continuously quoting purchase (bid) and sale (offer) prices for fixed-rate government securities in the secondary market, market makers have access to a securities lending facility, for a term of one working day, for the securities they act as market makers. Securities loans may be renewed for as long the market maker requires it and up to two days previous to the security’s maturity. In this way, they may satisfy the demand for a certain security even if they have none in their inventories at the date when they sell it. For the purpose of stimulating the development of the long-term securities lending and repos market, the cost of cetes and bonos lending for market makers varies by participant, according to their activity in the securities lending with the market and in the facility. This cost depends directly on the use of the facility and indirectly on the securities lending activity outside the facility, as well as of the repo activity in the market with term higher than 11 days. The cost of the securities lending facility represents between 3% and 7% of the government funding rate.[10] The facility cost for udibonos lending is 7% of the government funding rate. The right to the securities lending facility is cancelled for those market makers with positions for a single issue of bonos or udibonos that exceed 40% of the amount placed in each issue. In this way, any likely manipulation of prices originated by a dominant position in the concentration of securities is avoided.

5.2 Market makers’ development and contribution

Market makers have contributed both to make the primary market of securities more efficient and sophisticated and to develop the securities’ secondary market. When the Market Maker Program was first implemented in 2000, the government domestic financing revolved around short-term instruments and floating-rate coupon bonds. After analyzing Table 5.2 it is evident that more than 80% of the government debt securities complied with these features. Likewise, the level of domestic debt placed through market instruments accounted for only 8% of GDP.

At the beginning, the Market Maker Program, considered only cetes and fixed rate nominal bonos created at the beginning of that same year. The first placement of fixed rate nominal bonos took place in January 2000, with a 3-year tenure. In May, a 5-year bono was placed. In tandem with the development of the Market Maker Program, the maturities of fixed rate placements extended to 10, 20 and 30 years, respectively (Chart 5.1). At the end of 2013, and having the entire fixed rate yield curve developed, these instruments accounted for 53% of the total amount of government securities and 23% of GDP.

Table 5.2

Government domestic debt

Development of domestic government debt securities since the creation of the Market Makers Program (percent)

Year

Zero-coupon

Coupon

Total as % of GDP

Floating rate

Fixed

Nominal

Real

1999

28

55

n.a.

18

8

2000

30

49

6

15

9

2001

27

44

15

13

10

2003

22

37

33

9

12

2006

22

23

45

10

15

2010

16

7

56

21

19

2011

16

7

55

22

20

2012

17

6

54

23

21

2013

17

6

53

24

23

2014

16

5

54

24

25

Prepared by Banco de México with data from the Ministry of Finance (SHCP) and INEGI.

1/ The chapter “Secondary market” includes the chart “Historic development of the yield curve”, which complements the chart included here.

The Market Maker Program guidelines have been reviewed on several occasions to adapt it to the new circumstances and requirements and to align participant incentives to better market practices.

In order to foster the development of securities lending in the secondary market, a difference in cost for the securities lending facility for market makers was established in October 2007. As stated above, the cost of this facility for cetes and bonos is determined by applying a factor to the government funding rate. The differential cost implies that such factor is particular for each market maker and is reduced on the basis of each market maker’s securities lending activity in the market.[11] As shown in Chart 5.2, from being practically inexistent at the beginning of 2008, securities lending increased in the market to such an extent that during 2013 it represented 25% of the total lending granted with broad government securities, including the market makers’ securities lending facility.

In line with the aforementioned actions, and in order to incentivize the trading of udibonos in the secondary market, the Market Maker Program was extended to include these instruments as of December 2008. In its beginning and until March 2011, the criteria for being chosen as a market maker of udibonos included only participation in primary auctions. Although transactions in the secondary market were not measured, the liquidity in the market for these instruments doubled (from 500 to 1,000 million udis daily, on average) after the announcement was made of the extension of the program in April 2008 (Chart 5.3). The selection criterion in place as of March 2011 includes transactions in the secondary market.

Market makers’ importance in the secondary market trading varies according to the instrument and the market segment. The segment with the highest share of market makers’ participation is interbank activity through brokers (Chart 5.4). This likely responds to their obligation to keep bid and offer quotes through this channel and to the segment’s weight in the selection criteria. In terms of instruments, market makers stand out in transactions with bonos, as they participate in more than 70% of the interbank trading through any channel.

Market makers have also reinforced the primary placement of securities. Ever since there are market makers for each type of instrument, no auction of cetes, bonos and udibonos has been declared void.

Market makers have recently played a key role in the new way of placing domestic government debt as well. Traditional primary auctions have an average amount of 5,000 million pesos (MoP) for bonos and 500 million udis (MoU) for udibonos and take place at a staggered frequency (not less than every four weeks). As of 2010, and with the purpose of increasing more rapidly the size and relative liquidity of the new issues of bonos and udibonos, the Ministry of Finance began carrying out syndicated placements,[12] where market makers acted as primary and secondary underwriters. In July 2011, this scheme was modified to a syndicated auction, where market makers act as distributors presenting their clients’ bids. In any of the two modalities, in this novel way of placing new issues, such issues reach a higher outstanding amount (up to 30 billion pesos in the case of bonos and 3.5 billion udis in the case of udibonos) in a single exhibition. Table 5.3 includes a summary of these types of transactions for on-the-run issues of 10 bonos and 3 udibonos. This type of transactions favored the inclusion of bonos in Citigroup’s World Government Bonds Index (WGBI). One of the conditions to participate in this index is that issues must have an outstanding amount equivalent to 1 billion dollars, at least. In October 2010, Mexico became the first Latin American country to be considered in this index.

Table 5.3

Syndicated placements/auctions of Bonos and Udibonos

Date

Instrument

and reference

Maturity date

Alloted amount 1/

Bid to cover ratio

Syndicated placement

Feb-23-10

10-year bono

Jun-20

25,000

2.95

Mar-23-10

30-year udibono

Nov-40

3,500

3.50

Jul-06-10

5-year bono

Jun-15

25,000

2.20

Feb-01-11

10-year bono

Jun-21

25,000

2.50

Mar-01-11

10-year udibono

Dec-20

3,500

2.70

Syndicate auction

Jul-20-11

5-year bono

Jun-16

25,000

2.50

Sept-07-11

20-year bono

May-31

25,000

1.26

Feb-15-12

10-year bono

Jun-22

25,000

1.80

Apr-18-12

30-year bono

Nov-42

15,000

2.60

Jul-18-12

5-year bono

Jun-17

30,000

1.40

Sept-05-12

10-year udibono

Jun-22

3,000

2.20

Aug-28-13

5-year bono

Jun-18

25,000

1.02

Apr-09-14

20-year bono

Nov-34

15,000

1.82

1/ Million pesos/million UDIs.

Source: Banco de México / Ministry of Finance (SHCP).

All along the program’s existence, 13 institutions have been appointed as market makers, including two brokerage firms. Some of the intermediaries have merged and continue participating in the program as a new corporate group. A maximum number of 10 market makers has been achieved (from September 2007 to February 2008) and a minimum number of five (from May 2001 to July 2002). Currently, there are eight banks appointed as market makers of cetes and bonos, of which four are also market makers of udibonos (Table 5.4).

Table 5.4

Market maker participants (2000-2014)

Current

Banamex*

Deutsche Bank

Bank of America*

HSBC

Barclays

JP Morgan

BBVA Bancomer*

Santander*

Previous

Chase Manhattan Bank**

ING

Citibank**

Invex (Brokerage firm)

Credit Suisse

Merrill Lynch (Brokerage firm)**

*Udibonos market maker.

**Merged with a current market maker.

Source: Banco de México.

Other countries have also implemented similar programs for government securities. For example, in the U.S., the Federal Reserve Bank trades with certain institutions known as “primary dealers”, which participate in its open market operations (OMOs)[13] and must concur in the primary auctions of U.S. Treasury securities, although they have no obligation to participate in the secondary market. In Spain there are different market makers for government bills, bonds and notes, and their main purpose is to provide liquidity in the secondary market of each type of instrument.

5.3 References

- Fry, Maxwell J. Emancipating the banking system and developing markets for government debt. 1997.

- IMF and the World Bank. Guidelines for public debt management: Accompanying document and selected. 2003.

- OECD. Public debt markets: Trend and recent structural changes. 2002.

- The World Bank. The emerging Asian bond market. 1995.

- www.banxico.org.mx

- www.shcp.gob.mx

5.4 Appendix 1. Measurement of market makers of cetes and bonos

Download appendix here (available only in Spanish).

5.5 Appendix 2. Measurement of market makers of udibonos

Download appendix here (available only in Spanish).

5.6 Notes

[1] María Daniela Gallardo-García holds a Bachelor degree in economics from Instituto Tecnológico y de Estudios Superiores de Monterrey, Campus Ciudad de México (ITESM-CCM). She also has a Master degree in international economics by the University of New York. During most of her professional career she has worked at Banco de México in various tasks, such as financial programming; evaluating and designing the Market Makers Program; in market monitoring; in international reserves; and in central bank accounting. She is currently in charge of the central bank’s financial programming. She also works as a professor at ITESM-CCM.

The author would like to thank Javier Duclaud, Jaime Cortina-Morfín, Raúl Álvarez del Castillo Penna and Claudia Álvarez-Toca for their comments, as well as Dafne Ramos-Ruiz, Gabriel Anaya-González, Renata Turrent-Hegewisch, and Andrea Paredes-Alva for the technical and research assistance.

[2] The circular note on these guidelines is available at: http://www.banxico.org.mx/disposiciones/circulares/%7BCF43FEC3-23D9-62F4-E8E3-55D66819AF6B%7D.pdf (available only on Spanish).

[3] Cetes (zero-coupon bonds) and bonos (fixed nominal rate bonds) are securities issued by the Federal Government. The maximum term for cetes is one year, while bonos’ terms range between 3 and 30 years. For more details on these instruments, see “Types of instruments and their placement”.

[4] UDIBONO is a long-term government bond (3-30 years) denominated in investment units (known as Unidades de Inversión or udis). Its value is updated biweekly referenced to the rate of growth of the national consumer price index. For this reason, its fixed rate is in real terms. For more details, see chapter 2 “Types of instruments and their placement”.

[5] The bid option or overallotment facility (known as “greenshoe option”) provides holders, in this case market makers, the right to buy additional securities at the auction’s price but on the following day.

[6] The option exercise is further explained in section 5.1.3 (Rights) of this chapter.

[7] From its inception and up to February 2006, the bid option was of up to 20% of the amount placed and could be used the same day of the primary auction. The modification, as of March 2006, has provided additional value to this market makers’ right. Since February 2014, during the weeks that a syndicated auction is carried out for bonos or udibonos, the option right to buy additional securities of the type of instrument that is syndicated is suspended for all market makers (without any consideration of the term being auctioned).

[8] The first three enjoy a higher factor, allowing them to have their bids quantified as admissible even though they have relatively higher rates than the rates bidded by other market makers. The factor for the first place is 1.0035, for the second place is 1.0030, and for the third place is 1.0025. From the fourth place and on, the factor applied is the same: 1.0020.

[9] According to the Federal Budget and Tax Responsibility Law (Ley Federal de Presupuesto y Responsabilidad Hacendaria, LFPRH), net indebtedness is the difference between debt use and repayment at the end of the fiscal year.

[10] GOVERNMENT FUNDING (RATE): The rate at which banks carry out among themselves one-day repo operations with government securities.

[11] The formula used to determine this factor can be consulted in Annex 4 of the market makers’ current regulations, available at: http://www.banxico.org.mx/disposiciones/circulares/%7BCF43FEC3-23D9-62F4-E8E3-55D66819AF6B%7D.pdf (available only on Spanish).

[12] SYNDICATION: Practice usually applied to place sizable issues. Brokers are appointed to distribute securities for a fee. In this way, a broader investor base is covered than through a traditional primary auction. The chapter “Types of instruments and their placement” describes this type of auction.

[13] OMOs: In open market operations, the central bank supplies or withdraws liquidity to reach a desired level of its reference rate established by the monetary policy decision making authority. The transactions carried out by Banco de México to implement monetary policy are described in a box in the chapter “Secondary market”.

VI. Securities settlement

Lorenzo Jiménez-Vázquez[1]

The purpose of this chapter is to provide an overview of the central securities depository (CSD) in Mexico, as well as of the securities settlement system. In the first section, some basic concepts relevant to securities settlement are addressed, identifying the risks involved in such activities. Then, the concept of the central securities depository in Mexico is covered. A thorough description of the role played by Indeval is presented, which is the securities deposit agency (the Mexican CSD) that also manages - the Securities Deposit and Settlement System (Sistema de Depósito y Liquidación de Valores, also known for its acronym in Spanish as DALÍ), a settlement system for government debt securities issued locally. Finally, the manner in which clearing and settlement systems are linked worldwide is discussed, outlining particularly how operations are settled in Mexico.

1. Introduction

2. Basic concepts applicable to securities settlement

3. Risks involved in securities settlement

4. Mexico’s central depository

5. Cross-border connections between clearing and settlement institutions

6. Operations settled through DALÍ

7. References

8. Annex 1. Indeval statistics

9. Notes

6.1 Introduction

Efficient settlement procedures are essential for the development of securities markets, particularly for the government securities market. The efficiency of both the settlement system and the deposit institutions is fundamental for promoting investors’ trust in market infrastructure, since both are determining factors to (1) achieve an adequate securities flow between primary and secondary markets, and (2) to foster the market’s capacities to grow and expand.

Central securities depositories (CSD) are crucial to the financial infrastructure of any country. They represent the central axis or backbone of financial operations in several ways. A CSD regularly has two main roles:

1. It provides a central securities custody service. The custody of financial assets may be either immobilized (through a physical document back-up) or immaterialized (entirely through electronic records).

2. It is a securities settlement system, i.e., a system that transfers both securities and cash among participating accounts, hence achieving irrevocability[2] of such transfers.

These two functions translate into greater efficiency, since intermediaries are provided access to diverse operations with securities through a single link, which in turn is safer and less expensive than using several links. For example: through a centralized custody service, a debt issuer may distribute the accrued interest among tens, dozens, hundreds or thousands of holders by means of a single payment to the CSD from where the corresponding amounts are transferred to the accounts managed (banks, brokers, mutual funds, pension funds and others), which in turn distribute the funds among the holders.

The settlement system managed by the CSD is also expected to incorporate the best practices to reduce risks and ensure a safe management of transactions. The most fundamental of these practices is the so-called delivery versus payment (DVP), by means of which securities are delivered upon the corresponding payment, i.e., securities are delivered only if the final payment has been made.

6.2 Basic concepts applicable to securities settlement

This section includes some basic concepts related to securities settlement that are widely used in specialized literature, in the respective operational and legal regulations, and in the settlement systems themselves.

- Settlement asset: The asset used to settle obligations according to the specifications set forth in the standards, guidelines and common practices of a settlement system. The best international practices recommend considering the central bank funds as the first choice asset.

- Clearing: An act through which obligations are substituted by means of an agreement among participants. It may be bi- or multi-lateral. Clearing takes place when two agents perform both as debtors and creditors to each other and by their own right. The purpose of the clearance is to extinguish two debts, up to the smallest amount, and hence requires both debts to be equally liquid and payable. Clearing allows the parties to apply their rights unconditionally and extinguishes all correlative obligations.

- Delivery versus payment: In any operation, there is always the risk of a counterparty delivering the agreed assets, securities or cash while the other does not. A delivery versus payment (DVP) scheme ensures that securities are delivered only if payment takes place or payment is made only when securities are delivered. For a DVP to work properly, the securities settlement system must be closely related to a payment system or include one.

- Settlement: The transfer of funds or securities among two or more parties to settle obligations.

- Securities settlement system (SSS): A mechanism through which funds and/or securities are transferred among two or more parties. It is a sale/purchase operation where the buyer acquires from the seller the rights over a certain amount of securities, for an agreed price. The securities are generally kept on a CSD, which provides a custody service and transfers securities among depositors’ accounts according to their instructions. A CSD can also be regarded as a securities settlement system, since operations are settled among the accounts managed by the CSD.

- Types of settlements: There are different methods by which settlement systems clear securities. A classification of these methods is provided in Table 6.1.

Table 6.1

Types of settlement systems

Advantages

Disadvantages

Real-time gross settlement systems

Payments are settled one by one, as soon as participants request them. If a payment cannot be settled (due to insufficient funds or other reasons), it is rejected or remains as pending. Payments are not settled partially, but only totally.

(i) Timeliness, since the payment is settled immediately if the issuer has enough funds.

(ii) It extinguishes obligations, helps participants to manage their risks.

(iii) It is safe, as it does not accumulate considerable amounts of pending payments instead of waiting until they can all be settled, which can generate a risk when the market closes and defaults. These advantages are especially clear in the case of high-value payments.

(i) Requires considerable liquidity, since the participant must have each penny that needs to be paid (payments sent are not offset by pending payments).

Deferred net settlement systems

Payments are accumulated and settled at the end of pre-established periods, i.e., at the end of the operation day, through a multi-lateral clearing process of participants’ obligations. The settlement is only final once all participants have covered their obligations.

(i) The process reduces the liquidity needed by participants.

(i) If a participant is unable to cover all its obligations, several operations also agreed upon with other participants would not be settled, hence pushing the others into defaults.

(ii) Risk accumulates and problems are often not evident until financial markets close.

(iii) The time between the payment instruction and its final clearance is long. Most low-value markets use this settlement system.

Hybrid

systems

They include mixed features of both, such as frequently settling a set of payments that may be cleared or covered with the liquidity available. They often include also algorithms to offset operations to use the available liquidity better, leaving outstanding payments for later when more funds are received. They include the features of safe and timely final settlement of RTGS, with the efficiency of DNS in terms of liquidity.

(i) Settlements are done in a safer and timely manner; they also optimize the use of liquidity.

(i) They are more complex, and therefore, more difficult to design and maintain.

Source: Banco de México.

6.3 Risks involved in securities settlement

Participants in securities settlement systems are constantly exposed to a variety of risks. In order to apply risk reduction and adequate control measures, the risks must be clearly understood:

- Systemic risk: The failure to comply with the obligations by a participant may lead to failure from other participants, generating a source of instability for the financial system.

- Credit risk: The loss resulting from the failure to comply with obligations (default) by a participant. Such loss may refer to:

- Principal. It becomes evident during the settlement process when cash is delivered without receiving any securities or either when securities are delivered without receiving any cash.

- Replacement cost. Loss due to price fluctuations in securities when operations are not settled. The replacement cost will be larger as the period between agreement and settlement becomes longer.

- Liquidity risk: The risk resulting from a lack of sufficient resources (either cash or securities) by a participant to comply with its obligation timely. This risk implies no insolvency, but it may have an effect at the systemic level.

- Custody risk: The potential loss of securities faced by users of the securities custody and management service, due to negligence or fraud by the service provider.

- Legal risk: The risk resulting from a deficient or uncertain legal framework that causes or exacerbates credit and liquidity risks, or due to laws and regulations that prevent the contracts or agreements from being met as specified by the rules of a system.

- Operational risk: The risk of an increase in credit or liquidity risks due to operation factors, such as technical failures, IT system deficiencies, internal controls, or human and operational mistakes.

To reduce these risks, the manager of the securities settlement system (SSS) must carry out an in-depth identification analysis of the weaknesses to which the system is exposed. This analysis involves a complete and thorough description of each of the processes and standards ruling its operation, as well as the identification of participants’ practices. As a result of this analysis, it will be necessary to set:

- Action plans to eliminate, limit, reduce, control or mitigate risks within the SSS.

- Clear rules that provide certainty, properly allocate risks, guarantee definite settlement, limit risk exposure for other participants, and request guarantees, when needed.

- Back-up systems and contingency plans that ensure the SSS efficiency; therefore, these plans must be tested regularly.

- A reasonable compliance to international standards.

Box 6.1

Recommendations for securities settlement systems

Various recently developed international initiatives aim to keep stability and strengthening the infrastructure of financial systems. The International Organization of Securities Commissions (IOSCO) published in 1988 the Objectives and Principles of Securities Regulation, while in 2001 the Committee on Payment and Settlement Systems (CPSS) of the Bank for International Settlements, released the Core Principles for Systemically Important Payment Systems.

The aforementioned Organization and Committee established the CPSS/IOSCO working group to promote the application of measures to improve international financial stability, reduce risks, increase efficiency and protect investors by recommending them on the design, operation and surveillance of such systems. Consequently, in November 2001, they jointly published the Recommendations for Securities Settlement Systems* that include the following 19 recommendations, the compliance of which should desirably be fulfilled within these systems:

Legal risk

1. Legal framework: Securities settlement systems should have a well-founded, clear and transparent legal basis in the relevant jurisdictions.

Pre-settlement risk

1. Trade confirmation: Confirmation of trades between direct market participants should occur as soon as possible after trade execution, but no later than trade date (T+0). Where confirmation of trades by indirect market participants (such as institutional investors) is required, it should occur as soon as possible after trade execution, preferably on T+0, but no later than T+1.

2. Settlement cycles: Rolling settlement should be adopted in all securities markets. Final settlement should occur no later than T+3. The benefits and costs of a settlement cycle shorter than T+3 should be evaluated.

3. Central counterparties (CCPs): The benefits and costs of a CCP should be evaluated. Where such a mechanism is introduced, the CCP should rigorously control the risks it assumes.

4. Securities lending: Securities lending and borrowing (or repurchase agreements and other economically equivalent transactions) should be encouraged as a method for expediting the settlement of securities transactions. Barriers that inhibit the practice of lending securities for this purpose should be removed.

Settlement risks

1. Central securities depositories (CSDs): Securities should be immobilized or dematerialized and transferred by book entry in CSDs to the greatest extent possible.

2. Delivery versus payment (DVP): CSDs should eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment.

3. Timing of settlement finality: Final settlement should occur no later than at the end of the settlement day. Intraday or real-time finality should be provided where necessary to reduce risks.

4. CSD risk controls to address participants’ failures to settle: CSDs that extend intraday credit to participants, including CSDs that operate net settlement systems, should institute risk controls that, at a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle. The most reliable set of controls is a combination of collateral requirements and limits.

5. Cash settlement assets: Assets used to settle the ultimate payment obligations arising from securities transactions should carry little or no credit or liquidity risk. If central bank money is not used, steps must be taken to protect CSD members from potential losses and liquidity pressures arising from the failure of the cash settlement agent whose assets are used for that purpose.

Operational risk

1. Operational reliability: Sources of operational risk arising in the clearing and settlement process should be identified and minimized through the development of appropriate systems, controls and procedures. Systems should be reliable and secure, and have adequate, scalable capacity. Contingency plans and backup facilities should be established to allow for a timely recovery of operations and the completion of the settlement process.

Custody risk

1. Protection of customers’ securities: Entities holding securities in custody should employ accounting practices and safekeeping procedures that fully protect customers’ securities. It is essential that customers’ securities be protected against the claims of a custodian’s creditors.

Other issues

1. Governance: Governance arrangements for CSDs and CCPs should be designed to fulfill public interest requirements and to promote the objectives of owners and users.

2. Access: CSDs and CCPs should have objective and publicly disclosed criteria for participation that allow fair and open access.

3. Efficiency: While maintaining safe and secure operations, securities settlement systems should be cost-effective in meeting the requirements of users.

4. Communication procedures and standards: Securities settlement systems should use or accommodate the relevant international communication procedures and standards in order to facilitate an efficient settlement of cross-border transactions.

5. Transparency: CSDs and CCPs should provide market participants with sufficient information for them to identify and evaluate accurately the risks and costs associated with using the CSD or CCP services.

6. Regulation and oversight: Securities settlement systems should be subject to transparent and effective regulation and oversight. Central banks and securities regulators should cooperate with each other and with other relevant authorities.

7. Risks in cross-border links: CSDs that establish links to settle cross-border trades should design and operate such links to reduce effectively the risks associated with cross-border settlements.

* BIS, IOSCO. Recommendations for Securities Settlement Systems, 2001, pp. 4-6. (Exhibit 1) Available at: http://www.bis.org/cpmi/publ/d46.pdf

6.4 Mexico’s central depository

6.4.1 Legal, regulatory and surveillance considerations[3]

The relevant provisions applicable to securities settlement in Mexico are described below. There is a set of additional regulations contained in specific communications issued both by the Ministry of Finance (SHCP, for its acronym in Spanish), the respective surveillance commissions, and Banco de México. The laws[4] governing both the securities clearing and settlement systems in Mexico are:

- Banco de México Law (Ley del Banco de México, LBM): It is applicable since one of the central bank purposes is to promote the healthy development of the financial system and foster the adequate performance of the settlement systems.

- Law on Settlement Systems (Ley de Sistemas de Pagos, LSP): Its purpose is to regulate the performance of payment systems set forth by the law itself, by establishing the definite and irrevocable character of transfer orders, clearing and settlement processed through such systems, including those related to securities.

- Securities Market Law (Ley del Mercado de Valores, LMV): Its purposes are to promote stock market development in a fair, efficient and transparent manner; to protect investors’ interests; to minimize systemic risk, and to foster healthy competition.

- General Law on Securities and Credit Operations (Ley General de Títulos y Operaciones de Crédito, LGTOC): It regulates both settlement instruments and financial transactions carried out with such instruments.

The regulations applicable to securities markets and their operations are issued by Banco de México, the Ministry of Finance and the surveillance agencies appointed for that purpose by the Ministry of Finance, such as the National Banking and Securities Commission (Comisión Nacional Bancaria y de Valores, CNBV), the National Insurance and Surety Commission (Comisión Nacional de Seguros y Fianzas, CNSF), the National Commission for the Pension System (Comisión Nacional del Sistema de Ahorro para el Retiro, CONSAR), and the National Commission for the Protection of Financial Services Users (Comisión Nacional para la Protección y Defensa de los Usuarios de Servicios Financieros, CONDUSEF).

In accordance to the CNBV Law, the purpose of this institution is to survey and regulate financial institutions in order to guarantee their stability and proper performance, as well as to maintain and foster a healthy and balanced development of the financial system as a whole, while protecting public interests. Financial institutions are defined as companies managing financial groups, as credit institutions, brokers, stock exchange specialists, brokerage firms, stock exchanges, securities depository institutions, and securities rating agencies, among others.

Both the Ministry of Finance and the surveillance agencies set forth the main regulations, including those of preventive nature to which the financial system is subject, while Banco de México sets the operation standards applicable to participants of the government securities market, the money market, the settlement systems, and the foreign exchange markets.

As for the clearing and settlement institutions, the CNBV is entitled to authorize their constitution and operation, as well as to surveil their electronic systems. This last responsibility is complemented by the powers that Banco de México exerts in accordance to the Law on Settlement Systems (LSP).

The CNBV has also established, through general rules, the guidelines for issuing and operating securities and documents submitted to the regime determined by the LMV.

The LGTOC includes several regulations regarding the legal representation of debt instruments, a broad concept including securities and other instruments, such as bills of exchange and checks. These regulations consider only the representation of debt instruments through physical securities. In this regard, it is set forth that the debt instrument holder must submit it in order to apply the right it has on them.

However, the LGTOC establishes that in the case of public debt instruments, banknotes, mutual fund shares and other documents ruled by special laws, the rules set forth by the related regulations shall apply. In this regard, the LMV states that when issues deposited in a securities depository institution or securities derived from property rights are received directly from the issuer, the issuer may deliver multiple listed securities or one security covering a part or all the bonds related to the issue and the deposit. Then, the securities depository institution will record the necessary entries in order to determine the rights of the respective depositors.

As per requirement of the Mexican Stock Exchange (Bolsa Mexicana de Valores, BMV), all bonds to be traded, either debt securities or equities, public or private, must be deposited in S.D. Indeval S.A. de C.V, the Securities Depository Institution.

6.4.2 Securities clearing and settlement: Indeval[5]

The purpose of securities depository institutions is to provide the deposit service for securities received from banks, brokerage firms, stock exchanges, central counterparties, insurance and bail institutions and mutual funds, among others. They can also manage these securities, according to the terms set forth by the LMV, and carry out transfers, clearings and settlements of operations related to the deposited securities.

The LMV sets forth that providing securities custody, management, clearance, settlement and transfer services are of public interest. The delivery of these services may only be performed by entities authorized by the Ministry of Finance for that purpose, upon previous favorable opinion of the CNBV. Securities depository institutions are entitled to perform, among others, deposit, management, transfer, clearing and settlement activities of the securities kept in the depositories.

According to the LMV, securities depository institutions are subject to inspection and surveillance by the CNBV. They must therefore establish house rules that include, among others, standards applicable to the delivery and withdrawal of securities in the depository, the physical protection and management of deposited securities, the procedures for transfers, clearings and settlement of securities, and for applying property rights and setting penalties, in the case of non-compliances. The house rules and any amendments to them must be submitted for joint authorization by the CNBV and Banco de México.

There is only one securities depository institution currently operating in Mexico: Indeval. It keeps in deposit the securities traded in the Mexican market and performs their clearance and settlement through a delivery versus payment (DVP) scheme using the DALÍ Securities Deposit and Settlement System, which is linked to the payment systems operated by Banco de México.

Indeval was first founded in April 28, 1978, under the name of “Instituto para el Depósito de Valores” (Bond Deposit Institute), as a government agency that provided custody, management, clearing, settlement and transfer services via book entries.

In 1987, the agency became a private corporation with the legal name of S.D. Indeval, Institución para el Depósito de Valores, S.A. de C.V., and began operating in October 1, 1987. Today, Indeval provides the following services:

- Securities custody and deposit

- Property and corporate rights management

- Securities transfers

- Securities clearing and settlement

- Guarantees management

- Securities lending

- Repos

- Securities lending for market makers

6.4.3 Securities holding and immobilization[6]

The LGTOC sets forth that the ownership of a security is transferred by transferring a negotiable instrument stating such ownership. Nevertheless, since the securities traded in the Mexican securities markets are deposited and immobilized at Indeval, securities are legally transferred through an accounting procedure between accounts, using the corresponding entries made in the accounts managed by Indeval with no need of physical delivery of any document or negotiable instrument of the corresponding issue.

Indeval's house rules state that the deposit of securities comprises their material delivery/receipt, their transfer between accounts, their allocation to a depositor’s account and, in the case of government securities, their virtual delivery.[7]

In order to differentiate between the broker or custodian and the customer assets, the LMV entitles the possibility of opening both “own” and “third party” accounts in Indeval, in which case, in the event of default/failure to pay on the part of the intermediary or custodian, the authority shall only use the assets of the defaulting part to pay debts and not those of its customers.

6.4.4 Securities custody

As aforementioned, Indeval is the only entity authorized in Mexico to operate as a central securities depository. It provides the deposit and custody services in the form of physical protection of securities and it is the centralized depository for all securities listed in the National Register of Securities and Intermediaries (Registro Nacional de Valores e Intermediarios, RNVI), whether they are listed or not in the BMV.

Indeval is entitled to keep all securities in its facilities, in any credit institution or in Banco de México. The securities deposited may also be kept in foreign banking institutions or in other central depositories, Mexican or foreign, such as Euroclear and Clearstream, when authorized by the CNBV.

Banks and brokerage firms are also entitled to provide securities custody and management services in their own facilities, in a centralized depository or in the institution designated by CNBV. In practice, banks and brokerage firms operate as sub-custodians of Indeval for investors that do not have their own account in Indeval.

A deposit at Indeval comprises the delivery of documents formalizing the issue of securities. Then, Indeval opens accounts on behalf of depositors which are identified by type of security and by the serial number of the securities deposited.

Indeval receives depositors’ securities for any of the types of deposit (custody, management, or guarantee). Its house rules state that the deposit comprises the material delivery of securities, their transfer from a depositor’s account to another, by allocating securities to a depositor’s account and, in the event of government securities, their virtual delivery.

In order to hire the deposit and management services provided by Indeval, an agreement by which depositors agree to the Indeval’s house rules must be signed.

Participants must deposit securities on their own behalf, stating which are on their own account and which are on behalf of third parties, being Indeval responsible for recording them separately as per the aforementioned difference.

Indeval deposits physical government securities at Banco de México. Nevertheless, as a result of primary auctions of these securities, Indeval registers with a book entry the securities allocated by Banco de México to each of the depositors’ accounts who received allotment, once Banco de México makes the corresponding deposit in its own Indeval account.

Pursuant to the house rules and operations manual of Indeval, Indeval shall provide the services in compliance with the obligations arising from operations agreed among its depositors only if such operations are recorded in the DALÍ system.

Depositors may record their operations directly or instruct Indeval to do so, as in the case of some corporations that provide mechanisms aiming to facilitate operations (electronic trading floors) or of central counterparties.

6.4.5 Deposit accounts

Indeval receives securities either for their custody, management or in guarantee. The relevant features of each type of deposit are:

- Custody: Indeval is only responsible for the custody of securities.

- Management: Indeval must perform the necessary actions to preserve rights conferred to the holders of the securities deposited and is entitled to enforce the patrimonial rights stemming from these securities; consequently, it may collect redemptions, dividends in cash or shares, interests and other patrimonial concepts for as long as the securities are deposited. Securities management is subject to the timely provision by issuers of the necessary resources to settle the corresponding patrimonial rights.

- Guarantee: Indeval is required to keep the deposited securities as a guarantee until the obligations stemming therefrom are fulfilled, in accordance to the applicable laws and regulations. All guarantees constituted with securities deposited in Indeval are considered as granted as pledge,[8] except for the cases expressly stated by the applicable laws and regulations. To open guarantee accounts, depositors must provide Indeval a copy of the securities pledge agreement undersigned with the counterparty. Indeval enforces the property rights stemming from the pledge securities affected, in pursuance to the terms of the resolutions included in the corresponding securities pledge agreement. The securities deposited in guarantee may also be substituted and released according to the terms agreed upon in such agreements.

6.4.6 Transfer of deposited securities

The operations agreed upon with securities are regularly settled through securities transfers using DVP procedure; however, depositors, under their own responsibility, may request Indeval to transfer securities free of payment (FOP) in the cases that may be proper by law, in compliance with the applicable regulations.

For the case of settlements through the transfer of securities under the DVP modality, Indeval adopted a model in which operations are included in its system and settled at the value date determined by the depositor, following the procedure described below:

- Once the operation is accepted in the system, it is verified that the account that delivers instruments has the securities and the account that pays has enough cash.

- In the case of operations that require the delivery of a guarantee (such as securities lending), it is also verified that the corresponding guarantees have been transferred.

- If the previous conditions are fulfilled, obligations are settled through charges and payments in the securities accounts and, simultaneously, in the cash accounts of the depositors participating in the operation.

Both the house rules and the operations manual of Indeval establish special settlement procedures that include the mechanisms to extinguish obligations stemming from unfulfilled obligations on their settlement date. These special procedures for fulfilling obligations include:

- The arrangement of securities lending for which Indeval acts as borrower on behalf and account of the defaulting depositor.

- The mandatory purchase carried out by the complying depositor.

- Cash arrangements between complying and defaulting depositors.

Regardless of these mechanisms, Indeval´s house rules impose conventional penalties on any depositor that does not comply with the obligations stemming from agreed operations in due time and proper form.

6.5 Cross-border connections between clearing and settlement institutions

Indeval offers direct accounts to foreign institutions that keep securities issued in Mexico, like the American Depositary Receipts (ADRs) of Mexican corporations that are traded in New York. These custody accounts are free of payment (FOP), i.e., the settlement of operations made with such instruments takes place outside the Interactive System for Securities Deposit (Sistema Interactivo para el Depósito de Valores, SIDV), currently replaced with DALÍ (see Box 6.2).

When Indeval receives free of payment (FOP) transfer instructions from/to its foreign depositors, it double-checks the operations by telephone with the Mexican counterparty and enters a free of payment (FOP) instruction in the DALÍ system. The securities transfer is thus processed and confirmation is sent, both to the foreign depositor and the Mexican counterparty. Cash settlement takes place bilaterally among counterparties.

Since certain Mexican eurobonds denominated in US dollars are kept in securities accounts at the central depositories Euroclear and Clearstream, Indeval has a global account in these depositories. Some of these securities are listed in the BMV and traded mainly by mutual funds and pension funds. If a Mexican investor wants to purchase one of these securities, its holder carries out a transfer in Euroclear or Clearstream, as appropriate, from his own account to the account of Indeval which, in turn, credits the securities in the Mexican investor account. Any later operations with the same securities in the Mexican market will be settled through Indeval following the same rules applicable to other securities, as long as they are denominated and settled in Mexican pesos.

DVP operations performed with international custodians and other central securities depositories are settled using bank accounts with international coverage.

Besides Euroclear and Clearstream, Deutche Bank, Bank of New York, Banco Santander and Banco BBVA also participate as custodians in the aforementioned mechanisms.

Box 6.2

Replacing SIDV with DALÍ[9]

The Securities Depository Institution, the first centralized depository in Mexico, was created in 1978. This institution operated as a government agency until 1987, when it became privately-owned and legally incorporated under the name S.D. Indeval, Institución para el Depósito de Valores, S.A. de C.V. (Indeval). Up to 1996, the role of Indeval in settlements was limited to the transfer of the securities involved in its depositors’ operations and the parties agreed upon the means to be used in the settlement. In 1997, Indeval began operating the Interactive System for Securities Deposit (Sistema Interactivo para el Depósito de Valores, SIDV), through which the delivery vs. payment (ECP, for its acronym in Spanish) practice was implemented for settlement operations.

In 2004, Indeval began developing a new settlement system to replace the SIDV. Due to the relevance of SIDV in the Mexican financial system, Banco de México was actively involved in this project. The main objectives of the new system were: automating Indeval’s operation processes; modernizing communication mechanisms between Indeval and its depositors; improving the operation’s safety and reliability, and renewing the technological platform and the system’s architecture. As a result, in November 2008, Indeval began operating the Securities Deposit, Management and Settlement System (Sistema de Depósito, Administración y Liquidación de Valores, DALÍ).

Many of Indeval’s manual processes became automated and simplified with DALI; several settlement processes used by the SIDV concentrated on one single component, which considerably improved operational reliability. Consequently, updating the technological infrastructure of Indeval, together with more appropriate information architecture for such system, have improved its performance and made it scalable.

DALÍ offers participants two new communication mechanisms to access Indeval services in a safer and orderly manner. The first of these mechanisms, known as the Indeval Financial Protocol (Protocolo Financiero Indeval, PFI), is designed to establish a communication from one computer to another (host to host or H2H). This protocol is based on the exchange of messages that allows participants full automation of their processes, thus reducing the cost and frequency of errors. The second, the DALÍ portal, is an interface that allows depositors access to DALÍ services from their computer browsers. All instructions transmitted through DALI are digitally signed, hence providing safer communications.

DALÍ settles operations more frequently than the SIDV, thus representing a nearly real-time settlement system. Moreover, it provides more efficient communication links to the SPEI and SIAC,[10] payment systems, therefore improving resource mobility between these systems.

Replacing SIDV with DALÍ

Feature

SIDV

DALÍ

Settlement cycle frequency

15 minutes

2 minutes maximum

Continuous timetable

No

Sí

Use of open communication protocol (ISO-15022)

No

Sí

Operational risk

High

Low

Use of electronic signatures for operations

No

Yes

Percent of the amount settled during the day cycle in relation to the daily amount settled

< 1%

20% aprox.

Source: Banco de México.

6.6 Operations settled through DALÍ

Through the DALÍ modules, Indeval receives and processes financial instructions sent by participants. The average daily amount settled in 2014 is approximately 3 trillion pesos, of which 2.5 trillion account for government securities. As for the number of daily operations, there is an average of 14,200 operations, of which 9,400 are government paper.

1/ DALÍ replaced SIDV on November 2008.

1/ DALÍ replaced SIDV on November 2008.

A transaction’s cycle includes the following four notifications:

- Presented: The instruction was received by Indeval, which has validated and acknowledged receipt.

- Confirmed: The negotiating terms and instructions have been confirmed among the parts, i.e., there is a “match”.[11]

- Accepted for settlement: The instruction is already on the settlement queue, waiting to be processed as soon as possible.

- Settled: The instruction has been settled and the obligations it represents are definite.

In each of these steps, several risk and integrity validations are performed (Table 6.2).

Table 6.2

DALÍ instruction settlement process

Reception

Indeval records all instructions received from participants on an electronic log. Then, it performs the following validations on the message received to determine the nature of the acknowledgement receipt to be handed back by the participant:

Sequence

The message folio must be consecutive regarding the folio of the immediately prior message of the same participant. The sequence of each participant is independent from that of others.

Integrity

Transaction messages, i.e., those implying cash or securities movements, must be electronically signed, versus queries. Therefore, the digital signature attached to transaction messages is verified.

Syntax

The message should be interpretable.

Semantics

Basic data validations that ensure the message would be correctly interpreted by the next processes in the system.

Match

Negotiation terms are expressed in the values of the instruction data fields. The match process compares the values in the instructions fields (e.g., a purchase) against the values in the fields of a related instruction (e.g., a sale). If the values in both instructions are equivalent, it means that the instructions sent by both parties “match”. The result of such comparison may lead to one of the following status:

No match

The related instruction was not found or does not exist.

Match

The related instruction was found.

Canceled

No match was found and the limit date and time for the settlement have expired or the instruction was canceled by the issuer.

Acceptance

The acceptance or optimizing process prepares instructions for settlement. It consists on the application and verification of compliance with business rules and the subsequent settlement packages are sent to the instructions queue of the pre-settlement component. This process may lead to one of the following status:

Rejected

Business rules were applied and the instructions did not meet the validations.

Pending settlement

The business rules were applied successfully and the corresponding settlement packages were created.

Settlement

Pending settlement instructions on queue are settled. Most instructions are cleared, while others are sent for direct settlement, depending on the best solution determined by the optimizing algorithm built in the system. The status of this final phase are:

Settled

The instruction is settled.

Pending settlement

It was not possible to settle the instruction.

Rejected

The instruction remained on the pending settlement queue, but the settlement limit date and time have expired.

Source: Banco de México.

6.7 References

- BIS. “Statistics on payment, clearing and settlement systems in the CPSS countries - Figures for 2010 - preliminary release”. 2011.

- BIS. “Statistics on payment, clearing and settlement systems in the CPSS countries - Figures for 2012 - preliminary release”. 2013.

- BIS. “Statistics on payment, clearing and settlement systems in the CPSS countries - Figures for 2013 - preliminary release”. 2014.

- BIS / IOSCO. Recommendations for securities settlement systems. 2001.

- IBRD/World Bank, IMF. Developing government bond markets a handbook. 2001.

- WORLD BANK, CEMLA. Payment and securities clearance and settlement systems in Mexico. 2003.

6.8 Annex 1. Indeval statistics[12]

Download Annex here.

6.9 Notes

[1] Lorenzo Jiménez-Vázquez has a Bachelor degree in public accountancy by Instituto Politécnico Nacional (IPN). Along his professional career at Banco de México’s back office he has participated in various projects related with the implementation of securities issuance and monetary policy, from both the accounting and legal approaches. He was involved in the work groups created for designing, implementing and starting up the SIAC and SPEI payment systems managed by Banco de México, and the DALÍ system managed by the security deposit SD Indeval. He is currently Operations Processing manager, and is responsible for the implementation, registry and settlement of monetary policy and currency exchange operations performed by the central bank, as well as those involving international reserves.

[2] According to the Law of Settlement System (LSP, for its acronym in Spanish), a transfer order, involving either cash or bonds, is considered accepted when it has already passed all the risk controls established according to the standards of the appropriate payment system and, hence, can be settled. Transfer orders are then considered as firm, irrevocable and collectible before third parties.

[3] For a more detailed reference of legal aspects, see the chapter “Legal and regulatory framework. Fiscal considerations”.

[4] For an updated version of these regulations, refer to http://www.diputados.gob.mx/LeyesBiblio/index.htm

[5] For statistics related to Indeval, see Annex 1 of this chapter.

[6] This subject is also covered in the chapter “Types of instruments and their placement”.

[7] Federal government debt securities locally issued are physically kept at Banco de México, while securities issued by IPAB are deposited at Indeval. The securities holding control is performed through Indeval, which carries an accounting record of the instruments held by the various financial institutions which, in turn, also carry an accounting record of their customers’ holdings.

[8] PLEDGE: A person known as “security pledge grantor” affects certain securities deposited in the depositary institution on behalf of another person known as “creditor” to insure the fulfillment of his own or of third parties’ obligations, even agreeing on an extrajudicial action by the “grantor” in the event of non-compliance.

[9] Financial System Report. Banco de México, July 2009, p.197.

[10] The Accountholders Customer Service System (Sistema de Atención a Cuentahabientes, SIAC) is the payment system managed by Banco de México that includes, among others, the “unique accounts” of local credit institutions. For this reason, monetary policy is implemented through this system and liquidity is provided from SIAC to other payment systems. The Interbanking Electronic Payments System (Sistema de Pagos Electrónicos Interbancarios, SPEI) allows users to transfer funds “in real time”, together with information for the receiver to credit the transfer in its customers’ accounts. The customer of one bank can then transfer funds from his account to the account of a customer from a different bank through SPEI.

[11] MATCH: If the fields of both instructions are equivalent, the instructions sent by both parties are considered as a “match”.

[12] Source: “Statistics on payment, clearing and settlement systems in the CPSS countries - Figures for 2012 - preliminary release”. Bank for International Settlements 2013.

VII. Legal and regulatory framework. Fiscal considerations

Gavin Abreu-Goodger and Shantall Tegho-Villarreal[1]

Asound legal and regulatory framework along with a simple and transparent fiscal regime that barely distorts price formation and securities operations are fundamental pillars for the development of a government securities market in any country. This chapter explains, in general terms, the legal and regulatory framework of the Mexican government securities market, as well as the applicable fiscal regime. The chapter is divided into four sections. The first section deals with the process ruling the issue of securities, from authorization to subscription, going through meticulously describing the internal placement processes, and up to the financial agent. The second section describes the authorities and laws that regulate and supervise financial intermediaries’ operations with government securities. Furthermore, the third section describes the regulatory measures related to secondary market operations including settlement and valuation issues. Finally, the fourth section describes the fiscal regime applicable to these securities.

1. Legal framework ruling the issuance of Federal Government securities

2. Regulation and surveillance of financial intermediaries

3. Legal and regulatory framework for the secondary market

4. Fiscal considerations

5. References

6. Notes

7.1 Legal framework ruling the issuance of Federal Government securities

7.1.1 Limits on government borrowing

As set forth in Article 73, section VII of the Mexican Constitution, during the implementation of public budget the Congress has the authority to first determine the basis on which the Executive branch of the government may request borrowing on national credit and then must approve such loans. This financing process is fully stated in the General Law on Public Debt (Ley General de Deuda Pública, LGDP), which remains in force since January 1, 1977. As provided by the LGDP, the Congress authorizes the amount of both domestic and external net debts[2] needed to finance the Federal Government and public sector institutions included in both the country’s Income Law Ley de Ingresos de la Federación, LIF) and Expenditures Budget (Presupuesto de Egresos de la Federación, PEF), the Congress also has to approve the Federal District’s borrowing.

According to the LGDP, the Executive sends to Congress the bill proposals of the LIF and the PEF for their annual approval. The LIF sets limits for both domestic and external debt, as well as any additional conditions on government borrowing. On the other hand the PEF includes the financial cost of the public debt.

In the LIF for the fiscal year 2014, the Congress authorized the Federal Government to issue domestic currency debt securities up to a limit of 570 billion pesos. In the event that the net external debt turns out to be lower than its authorized amount, the difference between the authorized limit and its amount issued can be used to increase, in the same amount, the limit approved for the domestic debt and vice-versa.[3] For that same year, the PEF determined a financial cost for government securities of 248.8 billion pesos (see Table 7.1).

Once the Congress approves the domestic and external net debt amounts, the Executive branch, through the Ministry of Finance (SHCP, for its acronym in Spanish), determines the financing conditions. The SHCP, as set forth by the LGDP, is the Executive branch’s institution in charge of issuing securities and borrow the funds that are used for public productive investment, swapping or refinancing Treasury´s debt or for monetary regulation purposes. It also has the authority to determine the currency, term and rates of those securities, depending on the conditions prevailing in financial markets. The SHCP not only manages and secures government financing, but also authorizes and coordinates financing for public sector institutions.

Each year, the Executive, through the Ministry of Finance, prepares a public sector borrowing program which sets the strategies and guidelines for the management of public debt. The main objectives of the finance program are raising funds to meet the existing liabilities, financing the needs of the public sector at the lowest possible cost –while keeping a risk level consistent with the management of public finances– and fostering the development of financial markets.

Table 7.1

Federal Income Law (LIF, for its acronym in Spanish) and Expenditures Budget (PEF, for its acronym in Spanish) for 2014

Million pesos

LIF for fiscal year 2014

A. Federal government revenues

2,709,961.1

B. Revenues from public entities and enterprises

1,106,786.7

C. Revenues from financing mechanisms

650,478.0

I. Federal government net debt

580,757.3

1. Domestic

580,757.3

2. External

0.0

II. Other financing

30,062.8

1. Deferred payments

30,062.8

2. Other

0.0

III. Deficit from public enterprises or entities under direct control

39,657.9

PEF for fiscal year 2014 (Field 24: Public debt)

Financial cost of debt

307,646.1

Domestic public debt

254,626.8

Government securities

248,857.9

Other financing

5,769.0

External public debt

53,019.3

Bonds

38,369.2

Other financing

14,650.1

Source: Ministry of Finance (SHCP).

7.1.2 Domestic debt management

The Public Credit Unit (Unidad de Crédito Público, UCP) is the Ministry of Finance’s management body in charge of issuing securities and authorizing the debt levels of all government administration agencies (Administración Pública Federal, or APF) in order to meet the limits approved by Congress.

The UCP proposes the funds raising programs in the money and capital markets, implementing actions to optimize the structure and financial cost of the government debt bonds. This unit is entitled to negotiate, issue and subscribe public debt instruments. In this regard, the LGDP also has set a Public Sector External Financing Advising Commission, comprised by the Ministry of Finance, Banco de México, the National Foreign Trade Bank (Banco Nacional de Comercio Exterior, S.N.C., Bancomext) and other agencies – which acts as an auxiliary technical advising body in topics related to external financing and evaluates the government’s borrowing requirements.

Box 7.1

Annual Borrowing Plan 2014

In order to achieve the public credit policy goals for 2014, the following strategy guidelines were set:

1. Finance the Federal Government mainly through domestic debt markets maintaining most liabilities in local currency. Issue domestic debt orderly, at market conditions, and with low refinancing and interest rate risks, favoring the issuance of long-term fixed rate instruments currency.

2. Actively use external markets, diversifying funding sources, improving financial conditions of foreign currency liabilities, and broadening the access to international financial markets.

3. Promote a comprehensive risk management strategy for the debt portfolio, which should allow dealing with a broad range of shocks that could affect the terms of available financing.

4. Develop benchmarks and yield curves, both in domestic and external markets, to facilitate financing of public and private agents on better terms and conditions.

5. Promote a public debt communication and transparency policy that allows investors and the general public to know the Federal Government’s goals and strategies as a debt issuer.

In compliance with Banco de México’s Law (Ley del Banco de México, LBM), the central bank acts as a financing agent for the Federal Government for issuing, placing, acquiring and selling securities representing the government’s domestic debt and, in general terms, for servicing such debt. Banco de México also acts as advisor for the Federal Government in terms of economic and, particularly, financial matters.

To pay for the financial cost of the domestic debt, Banco de México may, with no previous authorization from the Federation Treasury (Tesorería de la Federación, TESOFE), may debit the current account the Treasury has at the central bank. If there is an overdraft in this account that exceeds a pre-established limit (1.5 percent of government’s expenditures as provided in the PEF for the respective fiscal year), the central bank may proceed to sell government securities to cover the excess amount.

7.1.3 Other issuers: IPAB

The LIF authorizes the Institute for the Protection of Bank Savings (Instituto de Protección al Ahorro Bancario, IPAB) to issue securities for the sole purpose of refinancing its financial obligations, in order to face its liabilities, provide liquidity to its instruments and, in general, to improve the terms and conditions of its financial obligations. Specifically, in accordance to the Bank Savings Protection Act (Ley de Protección al Ahorro Bancario, LPAB), if an emergency affects the solvency of an institution and IPAB resources are not sufficient to comply with the guaranteed obligations, after reporting this situation to the Executive branch, IPAB may resort to financing. There is a limit for this financing of 6% of the aggregate liabilities of commercial bank every three years (as published by the National Banking and Securities Commission –Comisión Nacional Bancaria y de Valores, CNBV– the previous month).

Besides acting as financial broker for the Federal Government, Banco de México also performs this role for IPAB when issuing, settling, selling and repurchasing debt securities in the domestic market and, likewise, for servicing such debt. If IPAB does not have sufficient funds, Banco de México, in its capacity of financial broker, may issue securities on behalf of IPAB to pay for the financial cost of its existing debt securities.[4] While the debt issuance is being prepared, Banco de México has the authority to take from TESOFE’s account the necessary funds to pay for the obligations.

7.1.4 Other issuers: Banco de México

As stated by the LBM,[5] the central bank has the authority to issue Monetary Regulation Bonds (BREMs). These credit certificates, either registered or paid to the bearer, are used to level liquidity in the banking system: Banco de México sells them when liquidity must be withdrawn and repurchases them in the opposite case.

These monetary regulation instruments are sold exclusively through auctions. Likewise, Banco de México may sell and, when applicable, issue Federal Government’s securities to manage the financial programming of its own balance.

7.1.5 Transparency and accountability

In compliance with the LGDP, the Executive must inform the Congress the status of the public debt during its annual budget revision and when sending the income proposal for the following fiscal year. These amounts do not include any monetary-regulation movements.

Likewise, every three months the Ministry of Finance reports to Congress the outstanding amounts of debt instruments and relevant operations through the Economic Situation, Public Finances and Public Debt Quarterly Reports, as set forth by the Law on Fiscal Budget and Responsibility (Ley Federal de Presupuesto y Responsabilidad Hacendaria, LFPRH). In addition, local governments are required to provide tax collection and indebtedness information to the Ministry of Public Administration (Secretaría de la Función Pública, SFP) and to the Federal Auditor General (Auditoría Superior de la Federación, ASF).

Banco de México and IPAB are also hold accountable before Congress for debt-related operations. The central bank’s governor must appear before the Senate Commissions every year during the second ordinary period of sessions to account for the central bank mandate´s compliance. He may also be called by any of the Congress Chambers to submit reports on Banco de México’s policies and activities,[6] while IPAB must submit quarterly reports.[7]

The Federal Government not only informs Congress, it also has a public-friendly policy that favors disclosing information to national and foreign financial investors. According to the Annual Borrowing Plan for 2014, the government must “maintain a close communication with investors in international financial markets to promote their participation in Federal Government debt securities.”[8] Therefore, every quarter the SHCP discloses the securities issuance calendar for the next three months. The calendar includes information regarding the dates for auctions and settlement of the instruments, as well as their characteristics, such as maturities and amounts. Extraordinary operations such as syndicated issues,[9] swaps[10] or buybacks[11]of government securities are also included in these quarterly reports. Also for transparency purposes, and as set forth by the LGDP, the SHCP must publish the most significant financial data related to public debt. The law, however, does not specify in particular date or a minimum set of indicators regarding this information.

7.2 Regulation and surveillance of financial intermediaries

To promote the development of the securities market within a setting of healthy competition and investor protection that aims to reduce systemic risk, the government issued the Securities Market Law (Ley del Mercado de Valores, LMV), published on the Official Gazette in December 30, 2005. This law regulates securities market participants, as well as the obligations of individuals trading with securities and the faculties of its regulatory authorities.

In order to have a better-organized market, the National Register of Securities (Registro Nacional de Valores, RNV) was created, an institution ruled by the CNBV where all publicly traded securities must be listed. While any individual may purchase and sell securities, intermediary operations of securities listed in the RNV can only be done by entities fully authorized to act as securities market intermediaries such as credit institutions, brokerage firms, mutual funds, pension funds (Afores), and financial agencies authorized to act as distributors.

7.2.1 Credit institutions

According to the Law on Credit Institutions (Ley de Instituciones de Crédito, LIC), in force since July 19, 1990, banking and credit service may only be provided by commercial and development banking institutions. The purpose of this service is to receive resources from the public in domestic markets which will be later placed among other market customers through operations generating direct or contingent liabilities, being the intermediary responsible for covering the principal and, if applicable, the financial accessories of the resources received.

Development banks are government administration agencies (Administración Pública Federal, APF) with legal capacity and their own assets, constituted as national credit firms specializing in the productive activities that are determined by Congress. They are ruled by the LIC and its respective bylaws.

Commercial banks, on the other hand, are corporations approved by Banco de México and authorized by the Federal Government through the CNBV. If a foreign financial institution wishes to operate a subsidiary in national territory, it also must be authorized to do so by the CNBV, having previously consulted Banco de México. These subsidiaries may perform the same operations as commercial banks.

Credit institutions are regulated and monitored by the CNBV, which, besides issuing regulations, can also pay inspection visits to such institutions. Credit institutions must comply with the regulations issued by Banco de México as well. On the other hand, the National Commission for the Protection and Defense of Financial Services Users (Comisión Nacional para la Protección y Defensa de los Usuarios de Servicios Financieros, CONDUSEF) protects the rights of credit institutions’ customers. In the event of any irregularity, CONDUSEF must immediately inform the CNBV for proper assessment.

The regulations issued by the CNBV applicable to credit institutions are aimed to preserve solvency, liquidity and stability of these institutions. For that purpose, measuring tools have been developed to reflect credit, market and operational risks in an accurate manner.[12] In these risk measurements, the operations carried out with the Federal Government, IPAB or Banco de México are calculated on a credit risk of 0% (zero percent), i.e., they are considered risk-free. In this same regard, credit institutions have limits on the total financing they are allowed to provide to one customer (or group of customers), except when financing is guaranteed with government bonds or when financing is granted to the Federal Government, Banco de México or IPAB, in which cases the institutions are not required to comply with the aforementioned financing limits.

To supervise its capital requirements, commercial banks are required to provide all relevant information to Banco de México, who estimates capital adequacy ratios, using all operations in national territory as well as operations of their subsidiaries and agencies abroad. In the event that the CNBV considers that an institution's capital measurements are insufficient, it may impose corrective measures and even request a capital increase, always taking into account Banco de México’s recommendations. Another obligation of commercial banks is to cover the ordinary and extraordinary fees[13] determined by IPAB, which are used to ensure the banking system’s solvency.

Credit institutions may trade securities according to the terms stated by the LIC and the LMV and their respective secondary provisions. Repurchase agreements (repos), securities loans, and derivative operations must comply with Banco de México’s regulations (see Box 7.2).[14]

Box 7.2

Regulation on repurchase agreements (repos) and securities lending issued by Banco de México

When engaging in securities lending and repo operations, credit institutions, brokerage firms, mutual funds, pension funds (Siefores), and Mexico’s Rural Financial Agency (Financiera Rural) must comply with the regulations issued by Banco de México, which define the following:

Securities lending: transaction where the ownership of shares or securities is transferred by its holder or lender to a borrower who is liable to return back, at the end of the loan period, other shares or securities from the same issuer and, of the same face value, type, class, series and maturity date.[15]

Repo: the borrower acquires for a certain amount of money the securities' ownership and agrees to transfer to the seller the ownership of the same number of securities of the same type against reimbursement of the same amount of money plus a surcharge, at the agreed upon term. The surcharge is for the benefit of the borrower, unless otherwise agreed upon. Securities of the same type are those having the same issuance code.[16]

Credit institutions and brokerage firms may undertake security lending operations on their own account with any counterparty. In the case of repo operations, they may act as sellers with any individual or corporation, or as buyers only with Banco de México, other credit institutions and brokerage firms, or with foreign financial institutions. When acting as sellers in repo trades with institutions belonging to their same financial group or when selling foreign securities to qualified investors or individuals, the securities must obey certain restrictions. Depending on their term, these instruments must have at least two credit ratings which must comply with the minimum ratings shown in Table A. It is worth mentioning that if the Federal Mortgage Agency (Sociedad Hipotecaria Federal, SHF) guarantees at least 65% of the security’s outstanding balance of principal and interest, it does not need to comply with the aforementioned minimum ratings.

Table A

Minimum ratings for repo operations

Scale

S&P

Moody’s

Fitch

HR Ratings

Short term

Local

mxA-3

MX-3

F3 (mex)

HR 3

Global

A-3

3

F3

HR 3 (G)

Long term

Local

mxAA-

Aa3.mx

AA- (mex)

HR AA-

Global

AA-

Aa3

AA-

HR AA- (G)

Source: Banco de México.

In securities lending trades, mutual funds may act as lenders and borrowers but in repos they can only act as sellers and operate solely with credit institutions or brokerage firms. Pension funds (Siefores) may only lend securities or sell them through repos and operate only with credit institutions, brokerage firms, and foreign financial institutions authorized for such purposes by CONSAR.

The prices and surcharges on repo and securities’ lending operations may be freely denominated in domestic currency, udis or foreign currency, regardless of the security’s denomination. They can also have any term as long as the trade ends at least one day before the security matures. If during the term of the operation there is profit sharing or interest payment, it should be transferred to the security owner.

When acting on their own behalf, an institution may not accept shares’ loans issued by members of their same financial group; moreover, they may not carry out security lending operations with institutions of their financial group unless they do it through a public trading system. For credit institutions, this restriction extends to repo and security lending operations with their own banking securities. In repo trades, those credit institutions and brokerage firms that are not specifically authorized for operating futures, options or swaps on interest rates, may not act as sellers of fixed-rate securities with a maturity date of over a calendar year or of floating-rate securities with interest rate revision periods that last more than a year.

Commercial banks are required to submit their financial statements, including information referring to their capital and risk adequacy, on the basis of the credit rating given by two rating firms (see section “Rating firms”).

7.2.2 Brokerage firms

Brokerage firms are companies authorized by the CNBV. According to the LMV, they may perform, among others, the placement of securities through public offers, as well as purchases, sales, repos and loans of securities, on their own behalf or for third parties. Besides, they may also operate as market makers,[17] manage portfolios and act as financial advisors.

The CNBV will determine, through general rules, the preventive and corrective measures brokerage firms must comply with. Regarding repo and security lending operations, they must abide by the corresponding regulations issued by Banco de México (see Box 7.2 above).

As determined by law, brokerage firms must have an automated system for receiving third parties instructions regarding operations with securities, which sends these instructions to the trading systems they operate in. Securities traded by brokerage firms are kept in a securities depository institution.[18]

Brokerage firms must comply with the trading secrecy in force.[19] In the event that a brokerage firm fails to comply with such secrecy, it shall compensate for the losses incurred. In addition, Brokerage firms can only use a customer’s resources for the purposes specified or contracted by the customer.

7.2.3 Mutual funds

Mutual funds are corporations authorized by the CNBV to invest the resources received from investors in the acquisition or sale of assets. These resources are raised through the purchase of shares representing the capital stock of the fund. These companies are ruled by the Law on Mutual Funds (Ley de Sociedades de Inversión, LSI), while pension funds are ruled by the Pension System Law (Ley de Sistemas de Ahorro para el Retiro, LSAR). Depending on the types of instruments they manage, mutual funds are classified into:

- Equity investment funds: authorized to invest in shares, obligations and other securities, certificates or documents representing the debt of a third party. Formerly known as common funds.

- Debt investment funds: authorized to invest in securities, certificates or documents representing the debt of a third party.

- Capital investment funds: authorized to invest mainly in shares, obligations or bonds from corporations that the mutual fund promotes.

- Limited purpose mutual funds: may only invest in those instruments defined in their investment guidelines and specified in their prospectus for investors.

To attract more investors, mutual funds must prepare a prospectus brochure regarding investment guidelines that will contribute to better decision making by investors. This prospectus must be approved by the CNBV and include at least the policies on liquidity and asset diversification or specialization, as well as the limits per financial instrument (complying with the general investment limits for each type of asset determined by the CNBV). The maximum limits established for investment do not apply to financial instruments issued by the Federal Government or by Banco de México. Those mutual funds belonging to a corporate group may not acquire investment assets issued by entities belonging to the same group; however, the CNBV may approve such operations in the event of extraordinary market conditions.

The CNBV issues general regulations for mutual funds to comply and it is in charge of examining and surveying these funds, which must provide the information and documents the CNBV may require for such purposes. Moreover, according to the LBM, resolutions regarding mutual funds’ acquisitions of Federal Government or Banco de México securities, issued by any authority, must be submitted to the central bank’s approval before being implemented. Repo and security lending operations, as well as those involving derivatives or foreign currencies, must comply with the general regulations issued by Banco de México (see Box 7.2 above).

7.2.4 Siefores

According to the LSAR, the National Commission for the Pension System (Comisión Nacional del Sistema de Ahorro para el Retiro, CONSAR) is in charge of coordinating, regulating, supervising and monitoring the retirement savings systems. In the case of credit institutions, supervision by CONSAR is limited to their participation in retirement savings systems.[20]

CONSAR is in charge of issuing the investment guidelines that Pension Funds (Sociedades de Inversión Especializadas en Fondos para el Retiro, Siefores) must comply with. The main objective of this regime is to increase the returns and protect the workers’ resources. When financial markets face abnormal conditions, CONSAR has the authority to implement extraordinary measures to endure such conditions more effectively, as well as to prohibit securities acquisitions or to issue regulations for restructuring investments in cases of violations to the investment guidelines. These flexible rules were particularly useful during the 2008 financial crisis, as they avoided an increase of the stress that the national financial markets were suffering at the time (see Box 7.3).

Box 7.3

Siefores: Rules for portfolio restructuring

As set by law, Siefores must compensate for losses due to breaches to their investment regimes by causes other than changes in valuations,[21] for instance, when the risk level allowed in their investments, as measured by the Value at Risk (VaR), is exceeded.[22]

Besides compensating for the losses generated, if a Siefore fails to comply with the limits established in its investment regime, its managers have to restructure its investment portfolio following the rules provided by CONSAR on that matter.[23] These rules set forth the mechanism that Siefores that exceed or do not meet the limits due to changes, among others, in their asset prices, credit ratings or that have exceeded the VaR on total assets must follow in order to return to the established limits.

During the last quarter of 2008, financial markets suffered an episode of extreme volatility after Lehman Brothers’ collapse. In less than a month, the Mexican peso depreciated from around 10.50 pesos per US dollar to more than 13 pesos (see Chart A), while the stock market fell over 30%, reaching levels not seen since two years prior to the episode (see Chart B). This made Siefores’ VaR levels escalate and even some Afores exceed their allowed limits (see Chart C).

According to the rules in force at the time, Siefores had to restructure their portfolios in order to return to acceptable levels. However, in October 2008, CONSAR decided to include an additional rule in its portfolio restructuring rules which allowed, in “events of extreme volatility”, to continue with the investment strategies in force at the moment despite exceeding the VaR limits. This prevented a generalized sale of risky assets and the greater financial stress that would have probably ensued.

As part of their corporate governance, Siefores have a risk committee that overlooks the management to make sure the risk limits and policies are obeyed. Siefores must operate following the general rules set forth by CONSAR, with the recommendations of Banco de México and the CNBV. If a deviation from the investment guidelines causes a loss, the Afore must refund it.

Siefores may perform security lending operations and repo operations on securities issued by the Federal Government, acting solely as lenders or buyers. When performing such operations, they must comply with the regulations issued by Banco de México (see Box 7.2 above). Besides, they are not allowed to carry out short selling[24] or any operation other than securities’ outright purchases, except if proposed by CONSAR and authorized by Banco de México.

If a Siefore intends to enter into transactions with entities of its same group, they must be settled in exactly the same way as if they were carried out with independent parties and, if applicable, must include a study issued by an independent third party to verify its compliance. Likewise, CONSAR may reprimand or lay off the personnel working in the Siefores.

To guarantee transparency regarding the condition of the pension systems, CONSAR submits quarterly reports to Congress, as well as an annual report on its activities to the Ministry of Finance who can also summon CONSAR at any time to explain particular matters. CONSAR also publishes the fees charged and the returns earned by the Afores in order to provide timely information to workers whenever they decide to choose or change their Afore.

7.3 Legal and regulatory framework for the secondary market

7.3.1 Financial and over-the-counter trading systems

The activities performed for the purpose of providing access to trading systems that link securities supply and demand, centralizing offers to carry out operations, are ruled by the LMV. They may be developed by stock exchanges, brokerage firms, and by individuals or corporations that develop over-the-counter trading systems.

7.3.1.1 Stock exchanges

Stock exchanges are corporations under Federal Government concession, granted through the Ministry of Finance, with the recommendation of the CNBV.[25] They provide, among other services, a platform where securities supply encounters their demand, through the development of trading and dissemination systems.

The fees for listing securities, maintenance services and market operations charged by stock exchanges must be approved by the CNBV.

Only stock operators may operate in the stock exchange. The stock exchange must allow its members to participate in its operating systems on an equal basis. Likewise, the stock exchange is not allowed to take part as counterparty in the operations traded in its systems.[26]

No individual or group of individuals can have more than 10% of the shareholders capital of a stock exchange, unless authorized by the Ministry of Finance. Stock exchanges must also have a Board of Directors (comprised of at least 25% of independent advisors) and a Chief Executive Officer.

7.3.1.2 Firms that operate over-the-counter trading systems (brokerage firms or “brokers”)[27]

These firms manage systems that facilitate securities operations and are authorized, regulated and monitored by the CNBV. They use automated systems to disclose quotes and orders for the purpose of performing securities operations and cannot, under any circumstances, act as counterparties in any operation. These operations are considered as performed outside the stock exchange. If the security exchanged is not listed in the RNV, no approval from any authority is required.

The information sent from these systems to price vendors (see section “Price vendors” of this chapter), must be identical, with the same characteristics, opportunity, cost and means.

7.3.2 Securities depository institutions[28]

The LMV sets forth that the centralized securities deposit, custody, management, clearing, settlement and transfer service is public and may only be performed by securities depository institutions and by Banco de México. The clearing service may additionally be provided by central securities depositories. A securities depository institution may only be incorporated by means of a concession from the Federal Government, through the Ministry of Finance, and following the recommendations of the CNBV and Banco de México.

Shareholders of these institutions may only comprise brokerage firms, credit institutions, Afores, mutual funds, insurance and surety institutions, holding companies of financial groups, stock exchanges, central counterparties, Banco de México and other entities authorized by the Ministry of Finance. The number of partners shall not be less than twenty and each shareholder shall only have one share.

Securities depository institutions must have a Board of Directors where a representative of Banco de México must participate, as well as representatives from development banks if they are partners of the securities depository institution in question. Securities depositories may create their own internal rules as long as the CNBV and Banco de México authorize them.

7.3.3 Central counterparties

The LMV allows for the creation of a central counterparty, i.e., a company that has received a concession by the Federal Government to operate as such. This concession is granted through the Ministry of Finance, based on previous recommendations of the CNBV and Banco de México. A central counterparty may act as buyer or seller in securities operations; in another words, it may perform as the counterparty in any operation, in order to reduce any default risks on the part of financial intermediaries. In this regard, when financial intermediaries agree on an operation, they must state whether they shall clear and settle the operation with the support of a counterparty.

Besides having a main role as counterparties, they may also set forth the procedures to manage risks, as well as to require from their clearing partners[29] the resources needed to reduce operational risks.

The CNBV is the authority in charge of supervising the central counterparty, while CNBV and Banco de México issue jointly all regulations to guarantee its appropriate performance.

Currently, in Mexico there is a central counterparty of government securities only in MexDer.[30]

7.3.4 Price vendors[31]

Price vendors are companies authorized by the CNBV to provide regularly professional pricing estimation, determination and updated market prices used for securities valuation. The updated valuation price is the market or theoretical price calculated on the basis of algorithms, technical and statistical criteria and evaluation models for each security, financial derivative or index, including those agreed upon in securities purchases, repo and security lending operations, as well as those from operations with financial derivatives. As additional services, these companies may also publish the securities ratings issued by the rating agencies, measure financial investment risks, and determine and publish interest rate and debt instruments’ indexes.

Price vendors are regulated by the LMV. When estimating prices they must notify the CNBV of the securities valuation on the very same estimation day.

To prevent conflicts of interest, price vendor officers and shareholders cannot hold shares from the financial bodies to which they provide their pricing services, except for shares of mutual funds. Services must also be provided exactly alike for all of their users.

7.3.5 Securities rating firms

As set forth by the LMV, these are companies authorized by the CNBV to provide habitually professional studies, analysis, opinion, evaluation and determination services regarding securities credit risk.

Rating services cannot be provided to financial institutions of which the rating institution officers hold shares, except for the case of mutual funds shares.

7.3.6 Securities market general code of conduct

Financial intermediaries must provide the information and documents required by the CNBV, the Ministry of Finance and Banco de México, in compliance with the terms and conditions they set forth.

According to the LMV, individuals that have privileged information shall not perform or instruct operations, provide or disclose this information or issue recommendations regarding securities whose price may be affected by this information.[32]

Likewise, securities market participants are forbidden, among other things, to agree or perform operations that manipulate such market, carry out simulations or distort the adequate performance of trading systems or computer equipment. In this case, manipulation is defined as any act interfering with the free interaction between supply and demand in order to artificially modify securities value or volume for their own benefit.

Intermediaries are forbidden to use customer’s resources without their previous authorization or for purposes other than those for which their services were hired. They shall not perform any securities brokerage without the previous authorization from clients.

Non-compliance with everything stated in the above paragraphs is punished by law and any omission shall be liable to penal sanctions.

Table 7.2

Regulation issued by Banco de México

Description

Link

Primary placement auctions of government securities

Issues of government securities in the primary market are carried out through auctions by Banco de México in its capacity of financial broker of the Federal Government. The respective regulation is found in Circular note 5/2012 (available only in Spanish) issued by Banco de México.

- www.banxico.org.mx>Disposiciones>Sistema Financiero>For Instituciones de Crédito (banca múltiple y banca de desarrollo) or Casas de Bolsa u Otras Entidades Financieras>Sociedades de inversión especializadas en fondos para el retiro>Subastas para colocación de valores gubernamentales y valores del IPAB - Circular 5/2012

Syndicated placement

Syndicated placement is a specific type of securities placement in which institutions acting as main distributors are in charge of presenting the offers of the remaining syndicated institutions. The rules applicable to this placement procedure were issued in Circular note 16/2011 (available only in Spanish) by Banco de México in its role of financial broker for the Federal Government.

- www.banxico.org.mx>Disposiciones>Sistema Financiero>For: Formadores de Mercado>Reglas para la colocación sindicada de valores gubernamentales

Primary placement of monetary regulation bonds

Monetary regulation bonds are instruments issued by Banco de México to regulate liquidity in the financial system. Circular note 6/2012 (available only in Spanish) issued by Banco de México includes the regulation applicable to these bonds.

- www.banxico.org.mx>Disposiciones>Sistema Financiero>For: Instituciones de Crédito (banca múltiple y banca de desarrollo) or Casas de Bolsa u Otras Entidades Financieras>Sociedades de inversión especializadas en fondos para el retiro>Subastas de BREMs y valores gubernamentales - Circular 6/2012

Repurchase agreements (repos)

Repurchase agreements carried out by financial intermediaries with government securities or with monetary regulation bonds (BREMs) are subject to the regulation issued by the central bank (available only in Spanish).

- www.banxico.org.mx>Disposiciones>Sistema Financiero>For: Casas de Bolsa>Reglas de reportos>Texto compilado

Securities lending operations with market makers

Banco de México, acting as financial broker for the Federal Government, grants securities loans to credit institutions and brokerage firms previously authorized as market makers by the Ministry of Finance. (available only in Spanish)

- www.hacienda.gob.mx>Política Financiera>Crédito Público>Deuda Interna>Operaciones de financiamiento en el mercado local>Formadores de Mercado>Anuncio de los Formadores de Mercado

Market makers are entitled to purchase securities additional to those placed in the corresponding primary auctions. The procedure to exercise this additional operation is outlined in the regulation included in Circular note 7/2011 (available only in Spanish) issued by Banco de México.

- www.banxico.org.mx>Disposiciones>Sistema Financiero>For: Formadores de Mercado>Compra-venta y préstamo de valores gubernamentales

Government securities swap auctions

Circular note 2/2011 (available only in Spanish) of Banco de México sets forth the regulation for swap auctions carried out by Banco de México acting as financial broker for the Federal Government.

- www.banxico.org.mx>Disposiciones>Sistema Financiero>Dirigidas a Casas de Bolsa>Permuta de valores gubernamentales

Securities buyback auctions

The regulation on Federal Government securities purchase auctions was issued in Circular note 9/2008 (available only in Spanish) of Banco de México.

- www.banxico.org.mx>Disposiciones>Sistema Financiero>For: Casas de Bolsa>Compra de Bondes - Circular 9/2008

Temporary liquidity facility

The mechanism through which Banco de México provides temporary liquidity to credit institutions is regulated as provided in Circular note 48/2008 (available only in Spanish).

- www.banxico.org.mx>Disposiciones>Sistema Financiero>For: Instituciones de crédito>Disposiciones dirigidas a las instituciones de banca múltiple>Facilidades de liquidez - Circular 48/2008>Texto compilado

Source: Banco de México.

7.4 Fiscal considerations

This section outlines the existing guidelines related to the tax treatment that government holdings receive for Mexico-based and foreign-based residents. The main purpose is to provide a brief description of the fiscal regime applicable to these instruments.

Along this section, references will be made to the Income Tax Law (Ley del Impuesto sobre la Renta, LISR), the Value Added Tax Law (Ley del Impuesto al Valor Agregado, LIVA), the LIF, the LMV, and the Federal Fiscal Code (Código Fiscal de la Federación, CFF).

Table 7.3[33]

Fiscal regime applicable by type of investor

Concept

Mexico-based residents

Foreign-based residents

Interest

0.6% on interest income.

4.9% on interest income as long as the beneficiary resides in a country with which Mexico has an agreement to prevent double taxation. If this is not the case, the applicable rate is 10%.

Capital gains

Earnings that arise from realized gains are subject to the same tax regime than interest income, which is equivalent to 0.6% on the principal amount.

Earnings that arise from realized gains are subject to the same tax regime than interest income, which is equivalent to 4.9% on realized gains.

Inflation adjustment

All companies must carry out an annual inflation adjustment.[34]

Foreign-based residents do not carry out an annual inflation adjustment.

Mutual funds

Retirement mutual funds, fixed income mutual funds, and equity mutual funds are not subject to any type of income tax.

Fixed income mutual funds and equity mutual funds are not subject to any type of income tax.

Government bonds

Tax-free if issued before 2003. For securities –cetes and IPAB– issued after this year, the rate is 0.6%.

Interests that derive from government debt instruments and/or Banco de México instruments are tax-free.

Derivatives operations

Derivatives operations are subject to the same regime as debt instruments, equivalent to a tax-rate of 0.6%.

Financial instruments using debt derivatives referred to the interbank lending rate (Tasa de Interés Interbancaria de Equilibrio, TIIE) and/or instruments issued by the Federal Government or Banco de México are tax-exempt.

Repurchase agreements (repos)

4.9% if the collateral does not comprise government securities.

If the operation is between a financial institution and an individual, the rate is 0.6%.

4.9% if the collateral does not comprise government securities.

Source: Banco de México.

7.4.1 Mexico-based residents

As set forth in the CFF, the following individuals are considered as Mexico-based residents:

- Individuals (national or foreign) living in a residence located in Mexico. If they additionally own a residence in another country, they are considered residents of Mexico if their main operations are located in Mexico, i.e., if more than 50% of their annual income is generated in Mexico and if their main business or professional activities are located in the country.

- Mexican government officers or workers, regardless if their main operations are located abroad.

- Companies that have established their main business management center or their business headquarter address in Mexico.

Unless proven otherwise, individuals with Mexican nationality are presumed to be Mexico-based residents.

7.4.2 Foreign-based residents

During the last decade, the Mexican financial system has undergone several transformations that have consolidated its complete opening to international markets. This has triggered the incorporation of foreign participants to the Mexican financial system, which have provided additional support. A clear outline of the fiscal regime for foreign-based participants thus becomes extremely important as it facilitates decision making.

To differentiate a foreign investor from a local investor, the LISR defines as foreigners those companies or individuals ruled by the legislation of another country, due to nationality, address, residence and business headquarters, among others.

Individuals and companies residing in Mexico are required to pay income taxes, regardless of the location of the source of their income. Likewise, individuals and companies residing abroad that have permanent business premises in the country must pay taxes on all income attributable to such premises, as well as on income arising from sources located in national territory if they have no permanent business premises in the country or when such income is not attributable to such permanent business premises.

Consequently, both Mexican and foreign nationals (individuals or companies) are required to pay taxes on the income paid or received in Mexico.

7.4.3 Taxation applicable to interest

The LISR considers as interest bonds the bonds or the yields on public debt, including discounts, premia, premia on repo and swap securities’ operations, as well as earnings from the sale of bonds, securities and other credit certificates, as long as they are the type placed among the main investors. Interests also include foreign exchange earnings and losses resulting from foreign currency fluctuations, i.e., the losses arising from exchanges in foreign currencies.

The fiscal regime varies depending on the investor’s nationality. If the income comes from interests generated by sources located in Mexico, the LIF states that, for purposes of income tax, the annual withholding shall be of 0.6%.[35] However, when foreign banks (including investment banks) are the beneficial owners, they shall pay a rate of 4.9% on income from interests received from capital placed or invested in Mexico.[36] It is worth mentioning that the beneficial owner of such interest must be a resident of a country with which there is an agreement in force to prevent double taxation. If this is not the case, then the tax rate to pay is of 10%.

The following interest is income tax-exempt for residents of Mexico:[37]

1. Interest paid to:

- The Federation, states, federal district and municipalities.

- Decentralized entities performing non-business activities, as well as those subject to budgetary control as determined by the SAT.

- Legally acknowledged political parties or associations.

- Companies authorized to receive tax-deductible donations in compliance with the terms set forth in the LISR.

- Retirement mutual funds, pension funds or personnel retirement funds additional to those set forth by the Social Security Law (Ley del Seguro Social, LSS) and to the pension insurance companies authorized to operate pension insurances only, as well as to the investment accounts created for personal retirement plan purposes.

- Foreign countries in cases of reciprocity.

2. Interest paid among Banco de México, institutions included in the financial system, and retirement mutual funds.

3. Interest paid to economic development funds or Federal Government trusts.

4. Interest paid by financial brokers to pension funds and seniority premia; those paid to fixed income mutual funds and which manage only investments of such funds or are exclusive investors of the Federation, the Federal District, the States, the Municipalities, the decentralized non-business organizations, and the legally acknowledged political parties and associations.

5. Interest paid to workers’ saving funds and local savings banks or to companies managing exclusively those saving funds or local savings banks.

6. Interest paid to mutual funds.

Additionally, the following interest is income tax exempt:[38]

- That arising from credits granted to the Federal Government or Banco de México, as well as interest from securities issued by either one, purchased and paid abroad.

- Those resulting from credits with 3-year or longer terms, granted and guaranteed by financial institutions residing abroad and devoted to promoting exports by granting preferential loans or guarantees, as long as such institutions are registered for such purposes in the Registry of Foreign Banks, Financing Institutions, Pension and Retirement Funds, and mutual funds of the respective foreign countries.

- Interest that derives from credits granted or guaranteed under preferential conditions by financing institutions residing abroad to institutions authorized to receive tax-deductible donations, as long as they use such donations for assistance or charity and if they are registered for such purpose before the fiscal authorities.

- Interest that derives from credits granted to the Federal Government and Banco de México and related to credit certificates issued by the Federal Government or Banco de México, placed in Mexico, as long as the beneficial owners are foreign-based residents.

7.4.4 Taxation applicable to government securities[39]

In 2003, the LISR introduced for the first time a tax for individuals on Federal Government debt instruments. However, the payment of interest on government debt remained tax exempt for those instruments issued before that year.

As for bonds and other Federal Government instruments, cetes and IPAB instruments, the tax withholding rate for Mexico-based residents (individuals and companies) is of 0.6% on the value of the investment.

Instruments issued before January 1, 2003 are tax exempt in this regard.

The LISR sets forth that interest from credits granted to the Federal Government or to Banco de México, and that from securities they have issued, acquired and settled abroad are tax exempt. Interest from credits issued by the Federal Government or by Banco de México, placed in Mexico among the general investors, as long as the beneficial owners are foreign-based residents are tax exempt as well.[40]

7.4.5 Taxation applicable to repos

As stated above, the LISR considers as interest the yields on all types of credits. Hence, the yields on public debt instruments, on bonds and liabilities as well as the risk premia on repo operations and on securities lending operations are considered as interest.

Since premia on repo and securities lending operations are considered as interest, they are subject to a tax rate of 0.6%. Nevertheless, this rate is applicable only if a financial institution agrees on a repo operation with an individual. In the case of repo operations between financial institutions residing in Mexico, no tax withholding is applied (e.g.: a repo operation between “Bancomer” and “Banamex”).

In the case of a repo operation between a financial institution residing in Mexico and an individual or a company residing abroad, the tax rate is of 4.9% if the guarantee is not a government security.[41] When there is a repo operation between a financial institution residing in Mexico and an individual or company residing abroad, and the guarantee comprises government securities, then the repo is tax exempt.

7.4.6 Fiscal incentives to promote savings

As of 1997, the savings of Mexican workers are managed by Pension Funds Management Companies (Administradoras de Fondos para el Retiro, Afores). These financial companies are duly authorized by CONSAR and specialized in the management of worker’s retirement savings. These savings are subject to the tax regime set forth by the LISR and the Law of Retirement Savings Systems (Ley de los Sistemas de Ahorro para el Retiro, LSAR).

It is important to understand that the LISR considers the earnings from voluntary contributions as interest income. However, in an effort to promote savings, the government approved that no tax withholding shall be applied in regards to interest paid to Siefores, as well as interest from investment accounts created for personal retirement purposes.

Finally, seeking to provide individuals with an opportunity to save and increase their wealth by investing in government instruments, in a simple and safe manner and with affordable amounts, the Federal Government implemented the program Cetesdirecto.[42] This program is also subject to compliance with fiscal obligations. The income arising from this program must pay an annual tax rate of 0.6%.

7.5 References

- CFF (http://www.diputados.gob.mx/LeyesBiblio/pdf/8.pdf)

- CONGRESO DE LA UNIÓN. Constitución Política de los Estados Unidos Mexicanos. DOF 13 de abril de 2011.

- CONSAR. Disposiciones de carácter general en materia financiera de los Sistemas de Ahorro para el Retiro (http://www.consar.gob.mx/normatividad/pdf/normatividad_emitida/circulares/Disposiciones_caracter_general_financiera_SAR.pdf)

- LBM (http://www.diputados.gob.mx/LeyesBiblio/pdf/74.pdf)

- LGDP (http://www.diputados.gob.mx/LeyesBiblio/pdf/136_110814.pdf)

- LIC (http://www.diputados.gob.mx/LeyesBiblio/pdf/43.pdf)

- LIF 2014 (http://www.diputados.gob.mx/LeyesBiblio/pdf/LIF_2014_131114.pdf)

- LISR (http://www.diputados.gob.mx/LeyesBiblio/pdf/LISR.pdf)

- LIVA (http://www.diputados.gob.mx/LeyesBiblio/pdf/77.pdf)

- LMV (http://www.diputados.gob.mx/LeyesBiblio/pdf/LMV.pdf)

- LPAB (http://www.ipab.org.mx/docs/doctos-oic/lpab.pdf)

- LSAR (http://www.diputados.gob.mx/LeyesBiblio/pdf/52.pdf)

- LSI (http://www.diputados.gob.mx/LeyesBiblio/pdf/69_130614.pdf)

- PEF 2014 (http://www.diputados.gob.mx/LeyesBiblio/pdf/PEF_2014.pdf)

- Reglas de préstamo de valores (http://www.banxico.org.mx/disposiciones/circulares/reglas/%7B73F01DEF-8E49-57A0-6CC9-47424B25BEF6%7D.pdf)

- Reglas de reporto (http://www.banxico.org.mx/disposiciones/circulares/reglas/%7B67DC537C-E5CB-0B9E-3961-340B5322BB96%7D.pdf)

- SHCP. Informe sobre la Situación Económica, las Finanzas Públicas y la Deuda Pública. Cuarto trimestre de 2010.

7.6 Notes

[1] Gavin Brendan Abreu-Goodger has a Bachelor degree in economics from Instituto Tecnológico Autónomo de México (ITAM). In 2006, he began working at Banco de México as an analyst in the areas of financial programming, monetary policy and securities market monitoring. He was later responsible for Banco de México’s open market operations with the financial system as well as of the issuance of debt instruments for monetary-regulation purposes. He has recently been included as part of the staff that manages foreign reserves and is about to start his Master degree program at the University of California at Berkeley.

Shantall Tegho-Villareal has a Bachelor degree in economics from Universidad Iberoamericana (UIA) and is currently enrolled at the Master in Public Policy at the University of Chicago. She began working at Banco de México in 2009, in the Domestic Operations Division, in the area of domestic government debt market analysis. In this area she specialized in monetary policy implementation tasks. She also worked in the International Operations Division, in the area of currency and precious metals trading desk, managing the central bank foreign reserves’ portfolio.

The authors thank Fernando Corvera, Eduardo Aurelio Gómez Alcázar and Gabriela Arévalo Carmona for their valuable comments.

[2] According to the Law on Federal Budget and Fiscal Responsibility (Ley Federal de Presupuesto y Responsabilidad Hacendaria, LFPRH), net debt is the difference between debt issuance and amortization at the end of the fiscal year.

[3] For instance, net amounts of up to 380 billion pesos and up to 8 billion US dollars for domestic and external debt, respectively, were authorized for 2010. However, during the year it was deemed necessary to contract external net debt for up to 14,006 million US dollars, which was possible because only 149,583 million pesos was issued of domestic net debt, hence leaving around 230 billion pesos or 18.6 billion dollars to be used for external debt purposes.

[4] According to Section 2 of the Federal Income Law (Ley de Ingresos de la Federación, LIF).

[5] Article 7, paragraph VI, and article 17 of Banco de México’s Law.

[6] Article 47, paragraph XIII, and article 52 of Banco de México’s Law.

[7] Article 26 of the Law on the Protection of Bank Savings (LPAB, for its acronym in Spanish).

[8] According to the Annual Borrowing Plan, which may be reviewed in: http://www.diputados.gob.mx/LeyesBiblio/pdf/PEF_2014.pdf

[9] SYNDICATION: A practice usually followed in larger volume issues, in which dealers are appointed to distribute securities for a certain fee. This practice enables a broader investors’ base than that reached through a traditional primary auction. The chapter “Types of instruments and their placement” gives further details on this type of placement.

[10] SWAPS: Bonds exchanged (“swapped”) for the purpose of improving maturity profiles and promoting more liquidity of issues placed. For more details on this type of placement, see chapter “Types of instruments and their placement”.

[11] BUYBACKS: Purchase of bonds (bonos) and udibonos in the secondary market to lengthen the maturity profiles.

[12] CREDIT RISK: Potential loss due to default of a counterparty. MARKET RISK: Loss that may occur due to adverse changes and/or fluctuations in risk factors. OPERATIONAL RISK: Losses due to failures in the institution’s internal processes. See the chapter “Securities settlement” for further references on other potential risks.

[13] In order to guarantee the refund of a bank depositors’ savings (up to 400,000 udis), IPAB charges a minimum ordinary fee of 40 basis points of a subset of an institution's liabilities. If the fees’ amount is not enough to pay for its liabilities, IPAB can charge a special quota of up to 30 basis points, on the same base. Under no circumstance can the ordinary and special fees together exceed the 80 basis points.

[14] Repos are described extensively in the chapter “Secondary market”.

[15] Rules that credit institutions, brokerage firms, mutual funds, pension funds (Siefores), and the Mexican Rural Financial Agency (Financiera Rural) must comply when engaging in security lending operations (Security lending regulations).

[16] Rules that credit institutions, brokerage firms, mutual funds, pension funds (Siefores), and the Mexican Rural Financial Agency (Financiera Rural) must comply when engaging in securities’ repurchase agreements (Repo regulations).

[17] In 2000, the Ministry of Finance created the Market Makers Program. Participating banks and brokerage firms must constantly trade securities, in a way that allows investors to easily find counterparties to purchase or sell such securities at market prices. The chapter “Market makers” explains this subject extensively.

[18] The chapter “Securities settlement” gives further details on securities’ depositories.

[19] TRADING SECRECY: According to Article 17 of the LIC, in an effort to protect their customers and users secrecy, credit institutions shall only provide information on deposits, trades or any other service to the account/operation holder.

[20] Article 5º section VII of the LSAR.

[21] As set in Article 44 of the LSAR.

[22] Value at Risk (VaR): Provides information on the loss to be ensued in a certain period of time; however, since losses and profits are uncertain, probabilities must be associated with the different potential losses.

[23] General financial regulations on pension systems (Disposiciones de carácter general en materia financiera de los Sistemas de Ahorro para el Retiro).

[24] SHORT SELLING: Involves the sale of a not-owned asset with the intention of purchasing it later at a lower price.

[25] Article 234 of the LMV.

[26] Article 265 of the LMV.

[27] The chapter “Secondary market” provides a thorough description on the role of brokers.

[28] For more information, refer to chapter “Securities settlement”.

[29] CLEARING PARTNER: A stock exchange participant whose purpose is to execute and settle contracts.

[30] MEXDER: Mexican derivatives market, a standardized market on which futures and options in Mexico are traded.

[31] In the chapter “Secondary market”, reference is also made to pricing suppliers.

[32] Article 364 of the LMV.

[33] In the remaining sections of this chapter, some items from the table “Fiscal regime applicable by investor type” are thoroughly described.

[34] The LISR sets forth that all companies must do an annual inflation adjustment at the end of each fiscal year. The annual inflation factor is therefore applied to the difference between the credits’ annual average balance and the debts’ annual average balance. The annual inflation factor is calculated by dividing the Consumer Price Index for the month of December of the current year by the Consumer Price Index of the previous year minus one unit.

[35] LIF Chapter III. Administrative Facilities and Fiscal Benefits. Article 21.

[36] Article 166 of the LISR.

[37] Artice 54 of the LISR.

[38] Article 166 of the LISR.

[39] Includes Federal Government and IPAB instruments.

[40] Article 166 of the LISR.

[41] Federal Government bonds and instruments issued by IPAB.

[42] For more details, see chapter “Types of instruments and their placement”.

VIII. Conclusions

Claudia Álvarez-Toca and Jaime Cortina-Morfín[1]

1. Conclusions

2. References

3. Notes

8.1 Conclusions

The successful development of the Mexican government securities markets observed in the last fifteen years certainly does not end here. As mentioned in the introductory chapter, the development of the government securities market is a dynamic process, where continuity and perseverance in macroeconomic and financial stability are essential for building and keeping the government’s credibility as a debt issuer. It is imperative that responsible fiscal and monetary policies persist and that legal, fiscal, and regulatory frameworks are suitable. Domestic and foreign investors will certainly be more reluctant to purchase government debt instruments in those scenarios where the government credit risk is considerable, the regulatory framework is more restrictive, the fiscal regime becomes more complex and not much transparent, and inflation expectations are high. In a few words, all these factors work as an auto-corrective element in the framing of macroeconomic policy.

The benefits of developing a liquid and deep primary and secondary market of government securities have been discussed in detail in the different chapters comprising this book. The benefits for both, the government and the private sector are evident, since both will enjoy more financing alternatives at a lower cost as they have more access to a mature debt market. At the same time, a more developed securities market also benefits investors by providing them access to a broader range of investment possibilities according to their own investment profiles.

The development process of the government securities market in Mexico made clear that opportunities for the placement of any kind of debt instruments are created by issuing and developing a market for bonds issued by the Federal Government. For this reason, government securities are considered as the backbone or base for other debt markets.

Indeed, it is from the yield curve of government bonds that the yield curve of other issuer’s reference interest rates originates. Besides, government securities work as underlying assets for various derivatives, and also serve as collateral for different types of loans and financial operations.

Efforts have been made in Mexico so that the financial system in general may evolve from a system centered in bank financing to a multi-level system in which debt and capital markets complement financial intermediation. From the central bank’s perspective, the development of local debt markets is particularly relevant as it “enables the use of short-term interest rates to convey monetary policy signals across the whole maturity spectrum.”[2] In other words, the debt market is part of one of the most immediate and relevant monetary policy transmission channels for a central bank, which may carry out its open-market operations through the purchase and sale of these bonds.

The strategy adopted in Mexico regarding the development of the government securities market has consisted in decidedly attacking a series of factors which had limited its growth, focusing on both improving supply and demand conditions and on reforming the rules with which the most important institutional investors must comply. Hence, the different authorities have striven to coordinate among themselves to consolidate the macroeconomic stabilization process, adopt a free-floating exchange rate regime, design and implement a strategy for managing public debt, carry out structural reforms –such as the pensions reform- eliminate restrictions to capital mobility, conduct financial system reforms, and simplify the fiscal regime, among many others.

The results achieved to date have helped break with some financial theory paradigms, such as that of the “original sin”, which considered that some countries were unable to issue debt in their own currency.[3] This new approach has set not only the basis for different economic agents to improve their access to financing in better conditions, but also for having a deep and liquid interest rate yield curve, with maturities of up to 30 years.[4] The existence of a risk-free curve has served as benchmark for the issuance and development of other Mexican issuer’s debt markets.

There is no doubt that all these achievements are the result of a joint and coordinated effort of many agents. The purpose of compiling this work is to provide a useful reference for other countries seeking to develop their government debt markets and, at the same time, to offer a guide for students, academics, and domestic and foreign investors to determine the level of development and major features of our market.

8.2 References

- BIS Quarterly Review. Reducing financial vulnerability: the development of the domestic government bond market in Mexico. Jeanneau, Serge and Pérez-Verdía, Carlos. 2005.

- BIS. The impact of international financial integration on Mexican financial markets. Sidaoui, José Julián. January 2009.

- BIS. The role of the central bank in developing debt markets in Mexico. Sidaoui, José Julián . June 2002.

- IBRD/World Bank, IMF. Developing government bond markets a handbook. 2001.

- NBER Working Papers no. 10036. Currency mismatches, debt intolerance and original sin: why they are not the same and why it matters. Eichengreen, Hausmann and Panizza. October 2003.

8.3 Notes

[1] Claudia Álvarez-Toca has a Bachelor degree in economics (summa cum laude) from Universidad Iberoamericana (UIA) and a Master degree in business administration (summa cum laude), with a major in finance from Instituto Panamericano de Alta Dirección de Empresas (IPADE). Since 2007 she has been research specialist manager at Banco de México, now reporting directly to the Directorate General of Central Bank Operations. Since she first started working at the central bank in 1993, she has held different positions, always in the Operations Department, among which stands out her position as head of the desk in charge of the implementation of currency exchange policies and later, as head of foreign reserves management. During a period where she worked outside Banco de México (2002-2007), she did so as an academic in Finance at IPADE, where she also held managerial positions and offered consulting services to corporations and individual investors.

Jaime Cortina-Morfín received his Bachelor degree in economics from Instituto Tecnológico Autónomo de México (ITAM). He also has a Master degree in business administration from the University of Rochester. He currently is general director of Central Bank Operations at Banco de México. Among his main responsibilities are managing the international reserves, leading the monetary operations, implementing the currency exchange policy, and monitoring the local financial markets. Although his professional experience has mainly evolved around the central bank, he worked for three years (2004-2007) as deputy chief financial officer (CFO) at the Federal Mortgage Society (Sociedad Hipotecaria Federal, SHF), developing the mortgage-backed securities market in Mexico, and later, from 2007 to 2010, in the Treasury Department at Banco Nacional de México S.A. de C.V. (Banamex).

Most of the arguments stated herein are explained in more detail in the introductory chapter “Risk-free issuers”.

[2] BIS papers no. 11. The role of the central bank in developing debt Markets in Mexico. José Julián Sidaoui, June 2002, p. 151.

[3] Advocates of this theory argue that this condition increases a country’s vulnerability as it is forced to finance itself in foreign currencies, facing along strong depreciations of its own currency (Eichengreen et al. 2003).

[4] The chapter “Risk-free issuers” includes charts and data supporting these statements.

Glossary of acronyms

ACCIPRESVAL

Sistema de Préstamo de Valores de Accival S.A. de C.V. (Accival’s brokerage firm platform for securities lending operations)

ADR

American Depositary Receipt

AFORE

Administradora de Fondos para el Retiro (Pension Funds Administrator)

AMAFORE

Asociación Mexicana de Administradoras de Fondos de Retiro (Mexican Pension Fund Administrators' Association)

AMIB

Asociación de Intermediarios Bursátiles (Mexican Association of Securities Intermediaries)

AMIS

Asociación Mexicana de Instituciones de Seguros (Mexican Association of Insurance Companies)

APF

Administración Pública Federal (Federal Government Administration)

ASF

Auditoría Superior de la Federación (Federal Auditor General)

BACC

Bancos Asociados con Cadenas Comerciales (Banks associated with retail chain stores)

BANSEFI

Banco del Ahorro Nacional y Servicios Financieros (Financial Services and National Savings Bank)

BANXICO

Banco de México (Mexico’s central bank)

BID

Banco Interamericano de Desarrollo (Inter American Development Bank, IADB)

BM

Banco Mundial (World Bank)

BMV

Bolsa Mexicana de Valores (Mexican Stock Exchange)

BONDES

Bonos de Desarrollo (Development bonds)

BONOS

Bonos de desarrollo con tasa de interés fija (Fixed-interest rate development bonds)

BPAs

Bonos de Protección para el Ahorro (Savings protection bonds)

CEDEVIS

Certificados de Vivienda (Mortgage-backed securities)

CETES

Certificados de la Tesorería (Treasury certificates, T-bills)

CFF

Código Fiscal de la Federación (Federal Tax Code)

CIF

Central de Información Financiera Banxico (Banxico Financial Information Server)

CNBV

Comisión Nacional Bancaria y de Valores (National Banking and Securities Commission)

CNSF

Comisión Nacional de Seguros y Finanzas (National Surety and Insurance Commission)

CONCAMIN

Confederación Nacional de Cámaras Industriales (National Industrial Chambers’ Confederation)

CONDUSEF

Comisión Nacional para la Defensa de los Usuarios de Servicios Financieros (National Commission for the Protection of Financial Services’ Users)

CONSAR

Comisión Nacional del Sistema de Ahorro para el Retiro (National Commission for the Pension System)

CROC

Confederación Revolucionaria de Obreros y Campesinos (Rural and Industrial Workers’ Revolutionary Union Confederation)

CROM

Confederación Regional Obrera Mexicana (Mexican Regional Industrial Workers’ Union Confederation)

CTM

Confederación de Trabajadores de México (Mexican Industrial Workers’ Union)

DALI

Sistema de Depósito, Administración y Liquidación de Valores (Securities Deposit and Settlement System)

DCV

Depósito Central de Valores (Central Securities Depository, CSD)

DNF

Deferred Net Settlement System

DOF

Diario Oficial de la Federación (Federal Official Gazzette)

ECC

Entidad Contraparte Central (Central Counterparty)

ECP

Entrega Contra Pago (Delivery Against Payment, DAP) (Delivery Versus Payment, DVP)

FEA

Firma Electrónica Avanzada (lo mismo que FIEL) (Advanced Electronic Signature-for tax purposes, the same as FIEL)

FIEL

Firma inteligente electrónica (lo mismo que FEA) (Electronic signature for tax purposes, the same as FEA)

FMI

Fondo Monetario Internacional (International Monetary Fund)

IMSS

Instituto Mexicano de Seguridad Social (Mexican Social Security Institute).Provides social security to private sector and autonomous agencies’ workers

INDEVAL

SD Instituto para el Depósito de Valores S.A. de C.V. (Privately owned securities depository that acts as a clearinghouse for Mexican Stock Exchange transactions)

INEGI

Instituto Nacional de Estadística Geografía e Informática (National Institute of Statistics and Geography). Autonomous agency of the Mexican Government dedicated to coordinating the country’s national system of statistical and geographical information

INFONAVIT

Instituto del Fondo Nacional de la Vivienda para los Trabajadores (National Workers’ Housing Fund Institute)

INPC

Índice Nacional de Precios al Consumidor (National Consumer Price Index)

IPAB

Instituto para la Protección al Ahorro Bancario (Institute for the Protection of Bank Savings)

ISR

Impuesto Sobre la Renta (Income tax)

ISSSTE

Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado (Institute for Social Security and Services for State Workers). Provides social security only to state workers

IV

Invalidez y Vida (Disability and Life). Referring to disability income insurance and life insurance

IVCM

Invalidez, Vejez, Cesantía en Edad Avanzada y Muerte (Disability, Old age, Severance pay, and Death). Referring to disability, old age, severance pay, and life insurance)

LBM

Ley del Banco de México (Banco de México’s Law)

LFPRH

Ley Federal de Presupuesto y Responsabilidad Hacendaria (Federal Budget and Fiscal Responsibility Law)

LGDP

Ley General de Deuda Pública (Public Debt Law)

LGTOC

Ley General de Títulos y Operaciones de Crédito (Securities and Credit Operations Law)

LIC

Ley de Instituciones de Crédito (Credit Institutions Law)

LIF

Ley de Ingresos de la Federación (Federal Revenue Law)

LISR

Ley del Impuesto Sobre la Renta (Income Tax Law)

LIVA

Ley del Impuesto al Valor Agregado (Value Added Tax Law)

LMV

Ley del Mercado de Valores (Securities Market Law)

LPAB

Ley de Protección al Ahorro Bancario (Law for the Protection of Bank Savings)

LPCGP

Ley de Presupuesto, Contabilidad y Gasto Público (Budget, Accounting, and Public Expenditure Law)

LSAR

Ley de los Sistemas de Ahorro para el Retiro (Pension Systems Law)

LSI

Ley de Sociedades de Inversión (Mutual Funds Law)

LSP

Ley del Sistema de Pagos (Payment Systems Law)

LSS

Ley del Seguro Social (Social Security Law)

MEXDER

Mercado Mexicano de Derivados (Mexican Derivatives Market)

MXP

Mexican peso

NAFIN

Nacional Financiera (Development Banking Institution)

PEF

Presupuesto de Egresos de la Federación (Federal Budget related to Expenditures)

PFI

Protocolo Financiero INDEVAL (Indeval’s financial protocol)

PIP

Proveedor Integral de Precios, S.A. de C.V. (Multinational private firm in charge of valuations, independent of financial assets in Latin America. It is the source of timely and auditable information of Latin-American financial markets that distribute official closings through the PIP Latam application)

PRLV

Pagarés con Rendimiento Liquidable al Vencimiento (Promissory notes payable at maturity)

RCV

Retiro, Cesantía en Edad Avanzada y Vejez (Retirement, Severance pay, and Old age). Referring to retirement and old age insurance and severance pay.

RNVI

Registro Nacional de Valores e Intermediarios (National Registry of Securities and Financial Intermediaries)

RTGS

Real Time Gross Settlement

SAR

Sistema de Ahorro para Retiro (Retirement Savings’ System). Mexican pension system.

SAT

Servicio de Administración Tributaria (Mexico’s Tax Administration Service)

SFP

Secretaría de la Función Pública (Ministry of Public Administration)

SHCP

Secretaría de Hacienda y Crédito Público (Ministry of Finance and Public Credit)

SHF

Sociedad Hipotecaria Federal (Federal Mortgage Agency)

SIAC

Sistema de Atención a Cuentahabientes (Real time settlement system operated by Banco de México)

SIC

Sistema Internacional de Cotizaciones (International Quote System)

SIC

Sociedades de Inversión en Capitales (Capital investment funds)

SIDV

Sistema Interactivo para el Depósito de Valores (sustituido por Dalí) (Interactive Securities Deposit System that was substituted by the DALI system)

SIE

Sistema de Información Económica (Banxico). (Banxico’s Economic Information System)

SIEFORE

Sociedades de Inversión Especializada en Fondos para el Retiro (Mutual funds specialized in pension funds)

SIF

Servicios de Integración Financiera (Financial Integration Services)

SIFMA

Securities Industry and Financial Markets Association

SIID

Sociedad de Inversión en Instrumentos de Deuda (Debt investment funds)

SIOL

Sociedad de Inversión de Objeto Limitado (Special purpose investment funds)

SIRV

Sociedad de Inversión de Renta Variable (Equity investment funds)

SLV

Sistema de Liquidación de Valores (Securities settlement system)

SPEI

Sistema de Pagos Electrónicos Interbancarios (Interbank electronic payment system)

STPS

Secretaría de Trabajo y Previsión Social (Ministry of Labor and Social Welfare)

TESOFE

Tesorería de la Federación (Federal Treasury Office)

TIIE

Tasa de Interés Interbancaria de Equilibrio (Interbank Equilibrium Interest Rate)

UCP

Unidad de Crédito Público (Office of Public Credit)

UDI

Unidad de Inversión (Investment unit). UDIs are units based on price increases and are used to settle mortgage obligations or commercial acts

UDIBONOS

Bonos de Desarrollo del Gobierno Federal Denominados en udis (Federal Government development bonds denominated in udis)

USD

United States Dollar

VALMER

Valuación Operativa y Referencias de Mercado, S.A. de C.V. (Company that provides daily updated prices for the valuation of financial instruments, as well as comprehensive calculation, reporting, analysis, and risk management associated with these prices)

VALPRE

Sistema de préstamo de valores utilizado por Indeval (Indeval’s electronic procedure for securities lending operations)

WGBI

World Government Bond Index (Citibank)

Table of Contents

About the ebook

From the editor

In Memoriam

Foreword

I. Risk-free issuers

1.1 Benefits of developing a government securities market

1.2 Pre-requisites for successfully developing a government bond market

1.3 Strategy for developing a government bond market in Mexico

1.4 Strategy results

1.5 Other risk-free issuers

1.6 Conclusions

1.7 References

1.8 Notes

II. Types of instruments and their placement

2.1 Types of instruments

2.2 Physical securities and their holdings[16]

2.3 Reference issues and reopenings

2.4 Placement of government securities

2.4.1 Auctions[18]

2.4.2 Syndications[24]

2.4.3 Retail investors (Cetesdirecto)[28]

2.5 Other operations

2.5.1. Swaps[31]

2.5.2 Purchases

2.5.3 Stripping of instruments[32]

2.6 Transparency and predictability

2.7 References

2.8 Appendices. Technical description of government securities

2.9 Notes

III. Investor base

3.1 Introduction

3.2 Impact and advantages of institutional investors

3.3 Domestic financial investors

3.3.1 Commercial banks

3.3.2 Pension funds

3.3.3 Insurance companies

3.3.4 Mutual funds

3.4 Foreign investors

3.5 Non-financial national investors

3.6 References

3.7 Notes

IV. Secondary market

4.1 Background

4.2 Development of the secondary market

4.3 Current developments in Mexico’s secondary market

4.4 Repurchase agreements (repos)[14]

4.5 Securities lending

4.5.1 Private institutions offering securities lending services

4.5.2 Banco de México’s securities lending facility[26]

4.6 Stripped securities

4.7 Market Makers[27]

4.8 Price vendors[28]

4.9 Firms that operate over-the-counter trading systems (brokerage firms or “brokers”)[29]

4.10 References

4.11 Notes

V. Market Makers

5.1 The Market Maker program

5.1.1 Eligibility criteria

5.1.2 Duties

5.1.3 Rights

5.2 Market Makers’ development and contribution

5.3 References

5.4 Appendix 1. Measurement of Market Makers of cetes and bonos

5.5 Appendix 2. Measurement of Market Makers of Udibonos

5.6 Notes

VI. Securities settlement

6.1 Introduction

6.2 Basic concepts applicable to securities settlement

6.3 Risks involved in securities settlement

6.4 Mexico’s central depository

6.4.1 Legal, regulatory and surveillance considerations[3]

6.4.2 Securities clearing and settlement: INDEVAL[5]

6.4.3 Securities holding and immobilization[6]

6.4.4 Securities custody

6.4.5 Deposit accounts

6.4.6 Transfer of deposited securities

6.5 Cross-border connections between clearing and settlement institutions

6.6 Operations settled through DALÍ

6.7 References

6.8 Annex 1. INDEVAL statistics[12]

6.9 Notes

VII. Legal and regulatory framework. Fiscal considerations

7.1 Legal framework ruling the issuance of Federal Government securities

7.1.1 Limits on government borrowing

7.1.2 Domestic debt management

7.1.3 Other issuers: IPAB

7.1.4 Other issuers: Banco de México

7.1.5 Transparency and accountability

7.2 Regulation and surveillance of financial intermediaries

7.2.1 Credit institutions

7.2.2 Brokerage firms

7.2.3 Mutual funds

7.2.4 Siefores

7.3 Legal and regulatory framework for the secondary market

7.3.1 Financial and over-the-counter trading systems

7.3.1.1 Stock exchanges

7.3.1.2 Firms that operate over-the-counter trading systems (brokerage firms or “brokers”)[27]

7.3.2 Securities depository institutions[28]

7.3.3 Central counterparties

7.3.4 Price vendors[31]

7.3.5 Securities rating firms

7.3.6 Securities market general code of conduct

7.4 Fiscal considerations

7.4.1 Mexico-based residents

7.4.2 Foreign-based residents

7.4.3 Taxation applicable to interest

7.4.4 Taxation applicable to government securities[39]

7.4.5 Taxation applicable to repos

7.4.6 Fiscal incentives to promote savings

7.5 References

7.6 Notes

VIII. Conclusions

8.1 Conclusions

8.2 References

8.3 Notes

Glossary of acronyms