Proposed changes to the structure of Mexico’s pension system could pave the way to increased participation in securities lending transactions. Ceri Jones reports.
A new Retirement Savings Bill was proposed in January by Mexico’s ruling National Regeneration Movement (MORENA) to liberalise the corporate governance of Pension Investment Companies (Siefores) and replace them with Pension Investment Funds (Fiefores). As well as some worker-friendly initiatives, and the abolition of the 20% investment cap on foreign securities, Fiefores will be allowed to invest in a broader range of financial instruments and enter into securities lending and repurchase agreements, including the ability to receive cash deposits for collateral purposes.
This is a major step forward for the nation’s pension funds which are currently limited to securities issued by the Mexican Federal Government in their lending and repo operations.
Allowing the pension market to enter the securities lending for stocks and bonds introduces a very large inventory of equities and bonds that should boost supply and increase the liquidity of the markets.
“Siefores and Afores, which manage worker contributions registered at the Mexican Institute of Social Security, are the major players in the Mexican economy with funds under management of up to MXN4.88 trillion,” says José Ignacio Rivero Andere, a partner at Gonzalez Calvillo, one of Mexico’s leading law firms. “These reforms are expected to materially incentivise economic activity in Mexico, as well as to improve profits for workers which in turn will boost their retirement funds.”
There is demand for borrowed securities, but relatively few institutions currently participate in the securities lending market, resulting in scant supply. One issue is the lack of hedge funds, as well as a dearth of broker-dealers with active short strategies. Most of the nation’s hedge funds are domiciled outside of Mexico and transact business in the US, so creating a level playing field with the level of flexibility investors have become accustomed to is a tall order. However, the Bill has stoked interest and the recent revelation that Goldman Sachs is considering a stock-trading brokerage in Mexico demonstrates the developing interest in Latin America’s second largest economy.
“Our discussions with beneficial owners indicate a general sense of optimism to participate in securities lending,” says Andrea Cattaneo, head of securities services Brazil and head of sales LATAM at BNP Paribas Securities Services. “The difficulty remains similar to other markets in that the opportunity must become prioritised within each organisation. Certainly the high fees associated with lending equities in the local market are compelling. However, scalability continues to drive decisions for participants. This dilemma is no different for participants when examining entering new lending markets. Therefore, it will take increased volumes along with continued transparency for beneficial owners to become convinced of their participation. Inevitably this process will take time.
“While beneficial owners may become inclined to participate in securities lending in the local market, the demand must increase. The benefits to the beneficial owner and market infrastructure remain compelling to engage in securities lending. But until the demand increases through increased short interest the market will remain idle.”
In the current investment conditions, asset managers and beneficial owners are keen to improve returns, and for Siefores the need is pressing as the new Bill will force them to reduce their charges. The reforms could therefore have a very positive impact on the mandatory pension system, given time.
“Currently, Afores are permitted to lend Mexican Government Bonds, which is the largest and most liquid market,” says Juan Hernandez, head of Vanguard Mexico. “Some of them actively participate in this lending market but given the high liquidity and the fact that the Central Bank also participates as lender of last resource for market makers, the demand and lending rates are not that attractive. It is the expectation of Afores that lending equities and corporate bonds could be an attractive source of return for their funds.
“Specifically, the measures would enhance returns for investors, as current lending rates for Mexican equities are between 2-3%. In addition, it would improve liquidity and market depth in stock and bonds.”
Academic research suggests that securities lending typically increased liquidity in the cash execution markets. Mexico’s nascent market should also be bolstered by the presence of government agencies which have already gained experience in these activities.
“The participation of government and central bank entities throughout Mexico in securities lending should provide a great deal of comfort to potential participants,” explains Cattaneo. “The experience of government entities and the Central Bank can be used as a case study for non-government entities to examine the process of implementing a risk-adverse securities lending program while focusing on generating incremental income through securities lending. Perhaps the greatest impact will be on the lendable balances of equities. Historically, the lending market in Mexico is heavily weighted towards fixed income and proposed regulation will seek to better align the lendable balance of equities.”
Appetite for liberalisation of the financial markets has also been stoked by other initiatives in recent years. For example, the second bourse, Bolsa Institucional de Valores (BIVA), has improved infrastructure which has significantly reduced the costs of securities trading.
However, when BIVA was launched in July last year, there was scepticism over its viability given that just 12 securities traditionally account for over 50% of Mexico’s trading volumes. Backed by four pension funds with a $22 million investment through a private equity firm, BIVA struck a deal with Nasdaq X-Stream technology to access tech that could attract market participants. Transactions are now said to be faster than the Bolsa Mexicana de Valores (BMV), where for example delayed market data or bandwidth during rebalances forced the bourse to close to investors four times in 2016 while it dealt with the outages.
As things stand, the Fiefores regime will be determined by the National Retirement Savings System Commission (Consar), and securities lending and repurchase activities will be the subject of enabling regulation to be issued by Banxico.
However, the Bill, which has already been approved by the finance committee of the lower house of Congress, has yet to move through the full lower house to the senate, and may still be modified. Critics have warned that Lopez Obrador’s leftist government might use freedoms to deploy workers’ pensions to finance its planned infrastructure projects, which could result in the tabling of a range of amendments and modifications to protect funds from risk.
Opening up the securities lending market will also mean that Afores and Siefores, the principal local investor of securities issued by the Mexican Federal Government, will have a broader choice of securities and financial transactions in which they can participate. This could force the Mexican government to search for new investors in domestic and foreign markets, and to modify its paper to satisfy their profit appetite and to be more competitive.
“Furthermore, the reform is expected to provide companies and projects of all sizes with the necessary funds for their implementation and growth, and thus to incentivise these players to issue securities in the Mexican stock market,” adds José Ignacio Rivero Andere. “The existence of new issuers on the market will increase the free-float capital and, consequently, the daily volume of operations.”
Another recent initiative with a similar aim is the two-year fiscal incentive that will enable private companies to become public with a tax rate of 10% versus the current 30%, which should result in more IPOs and, subsequently, more listed companies and increased market depth.
Editor’s note: The Mexican House of Representatives has now approved a revised version of the Retirement Savings Bill. Further amendments may be made when the Bill passes through the Senate.