PRIVATE SECTOR OFFICIALS COMMENT ON CHALLENGES

UNCLAS SECTION 01 OF 04 MEXICO 006187 SIPDIS SENSITIVE SIPDIS STATE FOR A/S SHANNON STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH STATE FOR EB/ESC MCMANUS AND IZZO USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD USDOC FOR ITA (ISRALY ECHEGARAY) TREASURY FOR IA (ALICE FAIBISHENKO, ANNA JEWEL) TREASURY FOR OCC/IBF (SUSAN QUILL) TREASURY FOR IBSMO (WILBUR MONROE, BILL FOSTER) CFTC FOR OIA (WARREN GORLICK) NSC FOR RICHARD MILES, DAN FISK EXIM FOR MICHELE WILKINS SEC FOR OIA (SHAUNA STEELE) STATE PASS TO USTR (EISSENSTAT/MELLE/SHIGETOMI) STATE PASS TO FEDERAL RESERVE (ANDREA RAFFO/ANN MISBACK) E.O. 12958: N/A TAGS: ECON ELAB EFIN PINR PGOV MX SUBJECT: PRIVATE SECTOR OFFICIALS COMMENT ON CHALLENGES FACING MEXICO'S SECURITIES REGIME REF: MEXICO 5858 -------------- Summary -------------- ¶1. (SBU) Mexico has made great strides in strengthening its securities regime over the past several years, but additional work is needed to develop these markets. Conversations with local experts show that the following issues hold back growth: restrictions on institutional investors; an inefficient repurchase agreement market; a lack of an "equity culture;" lackluster leadership at the stock exchange; lagging financial expertise; high fees; poor enforcement capabilities; and a slow judicial system. Addressing these issues would not only directly benefit these markets, it also would help boost economic growth and create much needed employment. End Summary. -------------- -------------- Securities Regime Has Improved in Recent Years... -------------- -------------- ¶2. (U) Mexico has made great strides in strengthening its securities regime over the past several years. The most important recent advancement is the 2005 Securities Market Law, which further expanded the National Banking and Securities Commission's (CNBV) authority, improved the corporate governance of publicly listed companies, increased the rights of minority shareholders, and created two new corporate vehicles, which were designed to facilitate the ability of small- and medium-sized companies (SMEs) to raise capital and transition to public listed company status. This law brought Mexico's regulatory framework largely in line with international standards. ¶3. (U) Mexico's stock exchange -- the region's largest after Brazil's -- has posted steep gains since 2003. The 47% yield on the primary equity market index (IPC for its Spanish acronym) last year made it the twelfth top performing index among the world's largest 50 markets, and ninth among the 23 leading emerging markets. Moreover, the corporate debt market is growing quickly. The market is deep and the tenure is long -- in part due to the participation of pension fund administrators (Afores). The longest tenure is 30 years at a fixed rate, though most companies have access to 3 to 5-year financing. -------------- ... But Outstanding Issues Hold Back Growth -------------- ¶4. (U) Despite these successes, significant weaknesses remain. The stock market is small, illiquid, and not a major source of financing for most firms. Companies remain wary of listing on the stock exchange, and larger Mexican firms often prefer to list on international exchanges. This usually takes the form of cross listing in the U.S. market through American Depositary Receipts (ADRs). The number of listed companies has fallen from 193 in 1996, to 177 in 2000, and to 132 in mid-December 2007. Daily trading remains highly concentrated in a small number of issuers. The six most heavily traded stocks -- America Movil, Wal-Mart de Mexico, America Telecom, Telmex, Cemex, and Grupo Televisa -- accounted for 64% of trading last year. Moreover, the top ten companies represented 77% of market capitalization in ¶2006. ¶5. (U) Conversations with local experts show that Mexico must MEXICO 00006187 002 OF 004 address the following issues to strengthen its securities markets. Restrictions that Limit Market Depth -------------- ¶6. (SBU) Restrictions on institutional investors impede the development of Mexico's securities regime. A debt and derivatives expert at Merrill Lynch Mexico told econoff and visiting Treasury officials that the playing field needs to be leveled among institutional investors. He said that pension fund investment regimes are fairly developed, while mutual funds are starting to grow and insurance funds are underdeveloped. Meanwhile, investment restrictions create artificial liquidity barriers. Insurance funds are extremely limited by investment restrictions. Afores lack instruments to invest in, investment methodology, and training for employees. An equity markets expert at Accival added that Afores can invest in Mexico's version of real estate investment trusts (Fibras) and a special corporate vehicle called an Investment Promotion Corporation (SAPI),but they cannot invest in individual company stocks, only index funds or exchange-traded funds. Pension funds are limited in how much they can invest in equities, and foreign investments can only account for up to 20 percent of total assets under their management. Accival believes the next step should be to allow pension funds to buy individual stocks. ¶7. (SBU) An investment banking executive at Goldman Sachs said the Mexican authorities need to develop the repurchase agreement (repo) market, which is inefficient, and allow institutional investors to short securities and purchase credit default swaps (CDS) for hedging purposes. He said that investors will be more comfortable holding long positions if they can short. Merrill noted that the Bank of Mexico (BOM) last year allowed banks to participate in the CDS market, but regulated institutional investors still cannot trade derivatives. This limits the latter's ability to hedge. The official from Goldman added that institutional investors own mostly government securities and, therefore, need more options to diversify. Moreover, pension, insurance, and mutual funds have large debt exposures and liquidity problems, making it difficult for them to manage risk. He said that while banks can buy credit derivatives, regulators deter purchases through heavy restrictions. Merrill told econoff and the Treasury officials that the BOM is working on allowing institutional investors access to the CDS market. ¶8. (SBU) Separately, unlike in Brazil, the large state-run oil and utility companies are not publicly traded. Listing these companies would add much needed depth to the market. Government officials in thQast proposed allowing Pemex to issue pseudo-shares giving the bearer a claim on Pemex profits, but some legislators opposed the idea. Lackluster Government Authorities -------------- ¶9. (SBU) Two of the local experts criticized Mexican Stock Exchange (BMV) authorities. One remarked that Guillermo Prieto, the President of the BMV, has been in his position for eight years and is more concerned with his future in politics than with growing the stock exchange. The brokerage houses do not necessarily trust what BMV officials tell investors, and therefore, there is a limited level of trust and weak communication. The official believes that the BMV leadership operates to enforce the law, rather than to promote advancements, which has resulted in a dearth of IPOs. Another official said that the owners of the BMV want complete control over the exchange, adding that this is MEXICO 00006187 003 OF 004 driving the exchange into irrelevance. ¶10. (SBU) One of the officials remarked that while the BOM is very good, it is too risk averse. The shock from the 1994 Peso Crisis still has a strong impact on the organization's philosophy. He believes the BOM is not modernizing the financial markets fast enough. Insufficient Financial Expertise -------------- ¶11. (SBU) Mexico lags significantly behind the U.S. and Brazil with regards to the level of education and training of its financial professionals. Fund managers often lack the skills needed to operate in a sophisticated market. Accival stated that there are only 46 chartered financial analysts (CFAs) in Mexico, compared to twice that in Brazil. Lack of Equity Culture -------------- ¶12. (SBU) The lack of an "equity culture" in Mexico was also cited as an impediment to the stock exchange's development. Accival said that Mexican entrepreneurs are "afraid of lQing." They are reluctant to lose control of family-run businesses, and consider the costs to be much higher than the benefits. ¶13. (SBU) Accival believes Mexican authorities need to do more to educate SMEs about the benefits of equity markets and globalization. He said the average Mexican believes that only the rich benefit from the equity market, but this is not true given that equity markets have had a positive real return in recent years -- something that was not the case as recently as five years ago. Fee Structure -------------- ¶14. (SBU) A series of fees also affect financial sector development. The official from Merrill remarked that the deposit insurance fund (Institute for the Protection of Bank Savings, IPAB) fee needs to be reduced. He said the government collects an annual fee of 40 basis points on deposits and securities that are issued. This creates distortions in the market, but the government has little incentive to remove this tax since it is a big revenue generator. Merrill added that fees to issue debt and equity are also high. While underwriting fees are low relative to the U.S., registration fees from the National Banking and Securities Commission (CNBV) and listing fees from the BMV are high. Enforcement and Legal Issues -------------- ¶15. (SBU) While a senior CNBV official has remarked in private that the government's enforcement capabilities need to be improved through increased resources and training, the official from Merrill said that Mexico is "in a good place" on this issue. He does not see the need to go in the direction of the U.S. with Sarbanes-Oxley. He added, however, that Mexico's legal system "is a mess." Judges are corrupt, the judicial process is very slow, and there is a lack of transparency and professionalism. -------------- Comment -------------- ¶16. (SBU) While recent improvements should not be overlooked, Mexico's securities regime has a long way to go before it corresponds to the economy's size and potential. Work needs MEXICO 00006187 004 OF 004 to be done to improve efficiency, encourage the participation of smaller firms, develop products for more aggressive investors, etc. Hopefully, an eventual IPO of the stock exchange will help Mexico address some of these issues. ¶17. (SBU) The discussions with local experts highlighted the importance of economic reform, competition and educational reform in particular. The exchange is undoubtedly held back by the prevalence of large monopolies and oligopolies, the owners of which retain significant political and economic influence in Mexico. Moreover, a solid educational system is needed if the average Mexican is going to be able to take advantage of opportunities that arise from an improved securities regime. In this context, it is important to stress basic financial literacy and the development of sophisticated financial expertise. Visit Mexico City's Classified Web Site at http://www.state.sgov.gov/p/wha/mexicocity and the North American Partnership Blog at http://www.intelink.gov/communities/state/nap / BASSETT