LatAm bond markets: Mexico – the standard bearer
For many reasons Mexico is the envy of its emerging market peers. The next step in its development will require attracting more international investors, but there are big challenges ahead.
Mexico has set the standard for financial markets in the emerging markets, let alone the Latin American region. It has a free-floating exchange rate and a very liquid, fully convertible currency. “Mexico is the poster child of the EM,” says Pablo Cisilino, portfolio manager at Stone Harbor Investment Partners. “It’s an open market, the peso is fully convertible, you can settle locally or you can settle offshore and there is not taxation. The corporate market is behind the sovereign market in terms of issuance but it is growing relatively fast.”
Carlos Corona, director of global finance, Latin America at Barclays, says of Mexico: “It should be a template for Latin America but it is unique in that there are no controls. The size makes it more liquid, even though to this day investors complain about the lack of liquidity once you move away from the MBonos.”
Liquidity concerns are leading America Móvil and Pemex to commit to a series of transactions rather than just single issuances. Pemex has been very vocal about its plans to follow the United Mexican States and build up a curve priced of Mbonos, with between $300 million and $500 million-equivalent a quarter. America Móvil’s global peso transaction bond trades on a fungible basis in the international and local markets and the company also hopes to offer an alternative to the Mbonos – more than 60% of which are currently owned by foreign investors and – by offering a spread pick-up to international investors and providing peso-liquidity competition to the local buyside from abroad.
Juan Claudio, a managing director in the capital financing unit of HSBC covering Mexico, says initiatives by the leading Mexican corporates to boost peso-liquidity from abroad could also extend to other Mexican corporates – even those that cannot commit to quarterly capital raising programmes. “A lot of the international investors already know the credit risk of many of these potential Mexican corporate issuers from participating in their US dollar-denominated transactions,” he says. “Some of those investors can manage different currencies and if they can take risk in dollars I don’t see why they can’t buy in peso if they want to have some exposure to those currencies. But we need to wait and see how it goes. Pemex is the debutant and then ideally we will see some traction and then some of the usual suspects that normally go abroad might think about trying to tap the local markets with the Euroclearable feature.”
There is a local project to expand the credit risk appetite of the afores. It would be a very good step for the country and region
The Euroclearable feature was not the only incentive for international investors in Pemex’s recent transaction. Bankers who worked on the deal said Pemex is ‘grossing-up’ the Mexican withholding tax to compensate for the tax that international investors pay when they buy Mexican local debt. Should the issuer not compensate offshore investors it would mean they would have to pay a 4.9% charge on coupon payments. More than one banker has told Euromoney that they are aware of discussions between the Mexican securities commission and the tax authorities about scrapping international withholding taxes. “It doesn’t make any sense to have that restriction,” says one. “They are very keen in developing the local market and attracting global investors but by keeping the withholding tax they are not helping. It’s more a presentational issue at the moment – no-one wants to be seen making tax cuts – but eventually that will happen.”
Also Pemex included international documentation that is compliant with 144 Reg S transaction, which technically is not a requirement but Pemex added it to facilitate international investors’ participation.
Antonio Castano, head of debt capital markets Mexico at BBVA, worked on the deal. “The structure makes it very easy for international investors to transact – both in the primary and secondary markets – but it will settle in Peso” he says. “Except for clearing, international listing and the gross-up, it’s a traditional Mexican security and it will attract international demand as it addresses the main hurdles that corporate paper has for foreigners.”
The aim to attract foreign investors into the domestic market is largely a function of the concentrated nature of the Mexican buyside. Local mutual funds hold assets of about $140 billion-equivalent, the pension funds (afores) about $120 billion (and are concentrated in the hands of just four large afores) and the insurance sector has AUM of about $45 billion.
The mutual funds tend to buy the shorter floating rate notes (FRNs) with tenors of between three and five years, with the insurance industry and afores buying the longer Mbono-linked paper, with tenors usually between seven and 10 years. With the concentration of the buyside, local bankers report that the best way to try to create pricing tension is in the five year paper, where you see some convergence between these groups.
For longer dated paper, though, there has been criticism that the afores are too powerful. These pension funds are growing very quickly – by law a fixed portion of every Mexican’s salary flows to one of these funds, but they are also limited by regulation by what rating they can buy. The afores will not usually even look at AA- locally rated companies because they are worried that any downgrade will take them below their investment threshold and lead to an enforced sell (and there is very little secondary trading). Unless these rating limits are eased, then this will remain an important characteristic of the local market.
HSBC’s Claudio says this could change. “There is a local project to expand the credit risk appetite of the afores,” he says. “Obviously there will be the need for internal controls – and using certified credit analysts – but they would open the market to opportunities to compete with the high yield market in the US and I think it would be a very good step for the country and the region.”
Also, beyond these regulatory-enforced behaviours, bankers and issuers report that the afores tend to act together – if the leading funds participate in a deal then the others follow – and vice-versa. Also, given rules that limit a single investor’s participation in a single deal exacerbates the concentration of the sector, as all four of the largest afores need to participate in larger transactions to succeed.
Some bankers say this ends up in a ‘club’ environment, with little differentiation in investment strategy or decisions. Bankers stop short of saying they believe the afores discuss potential deals – rather one banker says the level of internal research capability that the afores turn on each other suggest no such informal agreements take place. One says afores invest in internal regressional analysis to try to use public daily reporting data as the basis for regressional analysis to try and understand what assets in the afores funds are likely to have led to their daily fluctuations.
With such intense level of investment fixation between the afores, it is perhaps not surprising that many want foreign investors to come and offer plurality and pricing tension. However, the assumption of better pricing tension may be incorrect, according to Castano. “International investors can be more expensive than locals,” he says. “In many cases international investors demand new issue premiums – sometimes quite hefty amounts of about 25bp – and local markets don’t typically offer this. So when you open an issue to international investors that can potentially become expensive demand. So yes, you have ‘price tension’ but this will not necessarily result in better pricing for the issuer.”
However, Charles Moser, managing director in debt capital markets at Morgan Stanley – which was the structuring agent of Pemex’s Euroclearable deal – says that while Pemex did not necessarily use the international investors to lower local investors’ pricing it did enable Pemex to raise more funds more cheaply. “Pemex more than doubled the size of the deal by bringing in the international investors. If the company had tried to do the same deal size with just local investors they would have had to raise the yield they paid significantly – any time you double or triple the number of investors you get price tension.”
Also, the assumption that international investors will migrate down the risk spectrum misses a key point, according to Max Volkov, managing director of Latin America debt capital markets at Bank of America Merrill Lynch. “Investment grade companies don’t have enough local financing needs in order to attract foreigners – and if they did have large one-off funding needs they will go to the international markets because they would want to diversify away from the local investors,” he says. For Volkov it’s not just that foreign investors aren’t interested in non-government credits, but more about the size of the local deals from corporates. “Before 2013 you could print a US dollar denominated deal of as little as $100 million to $150 million,” he says. “Now if the size is below $250 million you rarely see US investors involved. Ideally, US investors want a size of at least $350 million which is the threshold for CEMBI (the corporate emerging market bond index). So if a company needs to print $350 million-equivalent to attract these guys why not just extend the average life of the corporate debt profile and do an international transaction?”
Even the deep, liquid FX market – it is currently the seventh most traded global currency – isn’t always a benefit for international investors. The depth of the FX liquidity and the proximity to the US economy should in theory make the Mexican peso one of the most stable currencies against the US dollar – particularly among the emerging markets.
However, Barclays’ Corona says the lack of flexibility in other EM currencies sometimes affects the peso through investors using the currency as a proxy for other EM risks. “I think it is more volatile because it is one of the most liquid EM currencies, as people take views on EM through the peso and at times you have seen a devaluation of 10% that has nothing to do with what is happening to the Mexican economy.”