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

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”.