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”.