Mexico
29 May 2012
SLT looks closely at a market that, despite reforms, is still proving
remarkably stubborn when it comes to securities lending.
Image: Shutterstock
When the most recognisable names in the financial industry skirt around the Mexican market, you know it’s for a good reason.
There are some programmes in Mexico that are run by local players, but the stalwarts that make up the majority of the sector there—Santander and J.P. Morgan, among others—could not be reached for comment on a market that, despite the best of efforts, is refusing traction on securities lending.
Up until 1994, the only foreign bank in operation in Mexico was Citibank, before the North American Free Trade Agreement (NAFTA) opened the securities markets to US and Canadian firms.
Large international banks, such as BBVA, Banco Santander, HSBC and Scotiabank, along with Citibank, acquired most of the largest Mexican banks and began lending, and are now described by an industry insider as “the most aggressive players on the market”.
In 1995, more foreign banks entered the market, including ABN Amro, Fuji and Societe Generale. Tokyo Commercial Bank began participating in 1997 and Deutsche Bank in 2000. Despite the industry being more than a decade old, many lenders are only now establishing a presence in the country.
A source from Banco de México, who did not wish to be named, says that although Mexico was ahead of its Latin American counterparts in the securities lending game, the finishing line is not in sight.
“We put in place a complete set of regulations to really try and kick-start the market. I don’t know exactly how we compare with other emerging markets in Latin America—my feeling is that they are not that developed. At the Central Bank we examine international research and securities lending. What we do is see what procedures are in practise in developed markets, and how we can apply these principles to the Mexican securities lending market.”
Mexico reformed its pension system in 1997, transforming it from a pay-as-you go, defined benefit scheme, to a fully funded, private and mandatory defined contribution scheme. The reform was modelled after the pension reforms in Chile in the early 1980s and was a result of recommendations from the World Bank. The comprehensive set of reforms that Mexico has implemented since the middle of the 1980s has changed the evolution of the country’s economy. The period of economic reforms from 1987 to 1993 was one of the most intense in the country’s experience. Among other reforms, the external debt was renegotiated, many government enterprises were privatised, a profound fiscal and financial reform was carried out, and greater attention was paid to foreign trade as a source of economic growth. A particularly important event was the reprivatisation in 1991 of the banking sector, which had been nationalised in 1982.
“Since we did the pension reform more than 10 years ago, we have large local institutional holders which are pension funds, whose assets under management are currently close to $100 billion (this figure is compromised of fixed income and equity markets as well),” says SLT’s source.
He adds that after the reforms of 2007, increased investment guidelines meant pension funds were turning away from ‘traditional’ opportunities such as securities lending. A move in 2005 by Banco de México to open up the local markets to foreign entities and to encourage mortgage companies to start lending gave the market a boost. However, this was stilted when ambiguities around tax regulations caused many of these new lenders to pull out of Mexico.
“Let’s say that they [the pension funds] have a large proportion of the local government debt. What has happened is that even when we made the regulatory changes in 2007, we have been increasing the investment guidelines that they have, so instead of looking to more traditional opportunities, such as securities lending, they are looking more at starting an optimised exposure to foreign markets, or investing different products like equity, so the change has been quite important, and securities lending has not been the priority.”
However, the clouds have been lifted somewhat by the changing sentiment around short-term returns and their importance. Says SLT’s source: “At one point, pension funds were so concerned with short term profits that they were not lending their securities to banks because they didn’t feel comfortable. Now that the pension regulator has been making changes to implement longer-term practices, things are set to change.”
Recent reforms have been less drastic, but still hopeful of marching the market forwards. In March 2011, Consar, the Mexican pensions regulator, issued a directive that allows pension schemes (Afores) to employ external managers to look after a portion of their assets. This came as good news for the asset management industry, considering that Mexican pension funds have now roughly $120bn of assets under management, corresponding to 10 percent of Mexico’s gross domestic product. “It is a positive development for the system, because it will allow workers’ funds to be invested in a better way and be in a better position to take advantage of the current limitations to investments,” says Isaac Volin, country head for Mexico at BlackRock.
SLT’s source adds that the Banco de México has also been making some changes to the market makers programme with the Ministry of Finance. “In the past, you could obtain any securities on loan—with certain limits—and the cost for these securities was standardised, and there were no specials in the market. Whatever you were requesting, you would pay the same fee. Two or 3 years ago we changed that. If you are a market maker and you can demonstrate that you are conducting securities lending outside of this particular window of the programme, you will have a reduction in the cost you have to pay to the central bank. So the idea is to incentivise market makers to trade outside of this facility, and if they start to borrow and lend securities that are not coming from the window of the Central Bank, they will have a reduction in cost. Today we have a somewhat spread-out cost structure. Over time hopefully it will be something we end up doing more.”
Depositories
“We have two systems that can be used for securities lending. The central depositories system in Mexico is called Indeval, and that is owned by all commercial banks, and this depository was the first one to offer a system to trade securities lending. A few years ago Banamex, which is a subsidiary of Citigroup, developed their own system which is called Accival, to compete with which is a good sign because it means people are seeing value in securities lending,” says SLT’s source.
In 2009, Mexico’s central securities depository launched Dali, a new securities settlement system, with the help of IBM.
Indeval’s system, three years in the making, replaced more than a dozen prior settlement systems. The move also allowed to switch from a Model I settlement system, where securities and cash positions are settled on a trade-by-trade basis, to a Model III system, where cash and securities positions for many trades are netted at the end of a settlement cycle.
“There can be many such cycles in a trading day; and such continuous netting can happen nearly in real time, using IBM’s Ilog CPlex optimisation software which matches thousands of transactions simultaneously,” explains international editor at Securities Technology Monitor, Chris Kentouris.
The benefits are potential savings of $240 million in potential interest fees, which is the estimate of Mexico’s central bank for more than 100 financial institutions using Indeval over the past eighteen months.
In a case study issued by IBM in December 2010, Indeval’s chief executive Hector Anaya was cited as praising the new settlement system. He said: “It holds the unique distinction of being the world’s only securities depository to have achieved near-real-time settlement in a Model III process. It will certainly be applied broadly by other central securities depositories, including corporations as they become aware of our success.”
Collateral types
In Mexico, eligible collateral is set out by the Mexican authorities. While corporate bonds are still being accepted, the global financial crisis has highlighted that these bonds have lower liquidity than federal bonds. Therefore, the acceptance of corporate bonds depends on their own liquidity ratios and credit worthiness.
Typically, federal bonds have far higher levels of acceptance in regards to collateral. And in spite of the advantages of cash, for example, no haircuts or interest accrual, the current rules and regulations do not include accepting cash as collateral.
In addition, people are becoming far more cautious in terms of the types of collateral they accept. Locally, clients lending securities are being more careful about the collateral they will accept; they usually ask for government bonds or liquid shares, when in the past, they were more open to receive mutual fund shares.
“We have a pretty particular fixed income market in Mexico,” said SLT’s source. “We are different from other markets, most particularly the US market, which has a broad range. In our local market, most transactions are collateralised with government debt.”
Manuel Torres Barajas, the executive director of treasury and short term interest rates for BBVA Bancomer, Mexico, notes that the volume of securities lending transactions has decreased from 2009-2011. “Securities lending was of course affected by the global crisis, which led to a loss of participation of many market makers. Before this, the daily average was MXN50 billion, compared to MXN35 billion, at which it currently stands.”
“There’s been some efforts from the Ministry of Finance, from the Central Bank, and the pension fund regulator to try and promote the use of securities lending amongst investors,” concludes SLT’s source. “So far, we have not been successful. If you look to a number of transactions made among private institutions, it is still quite low. Some of the pension funds have started to use securities lending, but its taking time—much more time than we thought when we published the regulation in 2007.”
There are some programmes in Mexico that are run by local players, but the stalwarts that make up the majority of the sector there—Santander and J.P. Morgan, among others—could not be reached for comment on a market that, despite the best of efforts, is refusing traction on securities lending.
Up until 1994, the only foreign bank in operation in Mexico was Citibank, before the North American Free Trade Agreement (NAFTA) opened the securities markets to US and Canadian firms.
Large international banks, such as BBVA, Banco Santander, HSBC and Scotiabank, along with Citibank, acquired most of the largest Mexican banks and began lending, and are now described by an industry insider as “the most aggressive players on the market”.
In 1995, more foreign banks entered the market, including ABN Amro, Fuji and Societe Generale. Tokyo Commercial Bank began participating in 1997 and Deutsche Bank in 2000. Despite the industry being more than a decade old, many lenders are only now establishing a presence in the country.
A source from Banco de México, who did not wish to be named, says that although Mexico was ahead of its Latin American counterparts in the securities lending game, the finishing line is not in sight.
“We put in place a complete set of regulations to really try and kick-start the market. I don’t know exactly how we compare with other emerging markets in Latin America—my feeling is that they are not that developed. At the Central Bank we examine international research and securities lending. What we do is see what procedures are in practise in developed markets, and how we can apply these principles to the Mexican securities lending market.”
Mexico reformed its pension system in 1997, transforming it from a pay-as-you go, defined benefit scheme, to a fully funded, private and mandatory defined contribution scheme. The reform was modelled after the pension reforms in Chile in the early 1980s and was a result of recommendations from the World Bank. The comprehensive set of reforms that Mexico has implemented since the middle of the 1980s has changed the evolution of the country’s economy. The period of economic reforms from 1987 to 1993 was one of the most intense in the country’s experience. Among other reforms, the external debt was renegotiated, many government enterprises were privatised, a profound fiscal and financial reform was carried out, and greater attention was paid to foreign trade as a source of economic growth. A particularly important event was the reprivatisation in 1991 of the banking sector, which had been nationalised in 1982.
“Since we did the pension reform more than 10 years ago, we have large local institutional holders which are pension funds, whose assets under management are currently close to $100 billion (this figure is compromised of fixed income and equity markets as well),” says SLT’s source.
He adds that after the reforms of 2007, increased investment guidelines meant pension funds were turning away from ‘traditional’ opportunities such as securities lending. A move in 2005 by Banco de México to open up the local markets to foreign entities and to encourage mortgage companies to start lending gave the market a boost. However, this was stilted when ambiguities around tax regulations caused many of these new lenders to pull out of Mexico.
“Let’s say that they [the pension funds] have a large proportion of the local government debt. What has happened is that even when we made the regulatory changes in 2007, we have been increasing the investment guidelines that they have, so instead of looking to more traditional opportunities, such as securities lending, they are looking more at starting an optimised exposure to foreign markets, or investing different products like equity, so the change has been quite important, and securities lending has not been the priority.”
However, the clouds have been lifted somewhat by the changing sentiment around short-term returns and their importance. Says SLT’s source: “At one point, pension funds were so concerned with short term profits that they were not lending their securities to banks because they didn’t feel comfortable. Now that the pension regulator has been making changes to implement longer-term practices, things are set to change.”
Recent reforms have been less drastic, but still hopeful of marching the market forwards. In March 2011, Consar, the Mexican pensions regulator, issued a directive that allows pension schemes (Afores) to employ external managers to look after a portion of their assets. This came as good news for the asset management industry, considering that Mexican pension funds have now roughly $120bn of assets under management, corresponding to 10 percent of Mexico’s gross domestic product. “It is a positive development for the system, because it will allow workers’ funds to be invested in a better way and be in a better position to take advantage of the current limitations to investments,” says Isaac Volin, country head for Mexico at BlackRock.
SLT’s source adds that the Banco de México has also been making some changes to the market makers programme with the Ministry of Finance. “In the past, you could obtain any securities on loan—with certain limits—and the cost for these securities was standardised, and there were no specials in the market. Whatever you were requesting, you would pay the same fee. Two or 3 years ago we changed that. If you are a market maker and you can demonstrate that you are conducting securities lending outside of this particular window of the programme, you will have a reduction in the cost you have to pay to the central bank. So the idea is to incentivise market makers to trade outside of this facility, and if they start to borrow and lend securities that are not coming from the window of the Central Bank, they will have a reduction in cost. Today we have a somewhat spread-out cost structure. Over time hopefully it will be something we end up doing more.”
Depositories
“We have two systems that can be used for securities lending. The central depositories system in Mexico is called Indeval, and that is owned by all commercial banks, and this depository was the first one to offer a system to trade securities lending. A few years ago Banamex, which is a subsidiary of Citigroup, developed their own system which is called Accival, to compete with which is a good sign because it means people are seeing value in securities lending,” says SLT’s source.
In 2009, Mexico’s central securities depository launched Dali, a new securities settlement system, with the help of IBM.
Indeval’s system, three years in the making, replaced more than a dozen prior settlement systems. The move also allowed to switch from a Model I settlement system, where securities and cash positions are settled on a trade-by-trade basis, to a Model III system, where cash and securities positions for many trades are netted at the end of a settlement cycle.
“There can be many such cycles in a trading day; and such continuous netting can happen nearly in real time, using IBM’s Ilog CPlex optimisation software which matches thousands of transactions simultaneously,” explains international editor at Securities Technology Monitor, Chris Kentouris.
The benefits are potential savings of $240 million in potential interest fees, which is the estimate of Mexico’s central bank for more than 100 financial institutions using Indeval over the past eighteen months.
In a case study issued by IBM in December 2010, Indeval’s chief executive Hector Anaya was cited as praising the new settlement system. He said: “It holds the unique distinction of being the world’s only securities depository to have achieved near-real-time settlement in a Model III process. It will certainly be applied broadly by other central securities depositories, including corporations as they become aware of our success.”
Collateral types
In Mexico, eligible collateral is set out by the Mexican authorities. While corporate bonds are still being accepted, the global financial crisis has highlighted that these bonds have lower liquidity than federal bonds. Therefore, the acceptance of corporate bonds depends on their own liquidity ratios and credit worthiness.
Typically, federal bonds have far higher levels of acceptance in regards to collateral. And in spite of the advantages of cash, for example, no haircuts or interest accrual, the current rules and regulations do not include accepting cash as collateral.
In addition, people are becoming far more cautious in terms of the types of collateral they accept. Locally, clients lending securities are being more careful about the collateral they will accept; they usually ask for government bonds or liquid shares, when in the past, they were more open to receive mutual fund shares.
“We have a pretty particular fixed income market in Mexico,” said SLT’s source. “We are different from other markets, most particularly the US market, which has a broad range. In our local market, most transactions are collateralised with government debt.”
Manuel Torres Barajas, the executive director of treasury and short term interest rates for BBVA Bancomer, Mexico, notes that the volume of securities lending transactions has decreased from 2009-2011. “Securities lending was of course affected by the global crisis, which led to a loss of participation of many market makers. Before this, the daily average was MXN50 billion, compared to MXN35 billion, at which it currently stands.”
“There’s been some efforts from the Ministry of Finance, from the Central Bank, and the pension fund regulator to try and promote the use of securities lending amongst investors,” concludes SLT’s source. “So far, we have not been successful. If you look to a number of transactions made among private institutions, it is still quite low. Some of the pension funds have started to use securities lending, but its taking time—much more time than we thought when we published the regulation in 2007.”
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