Wealth reserves: The nation’s sovereign wealth fund gets a slow start

On January 1, 2015 the new Mexican Oil Fund for Stabilisation and Development (Fondo Mexicano de Petróleo para la Estabilización y el Desarrollo, FMP) began operations. The FMP was created as part of the package of energy sector reforms and constitutional changes approved by Congress during the course of 2013 and 2014. Technically, it is intended as a sovereign wealth fund, destined to receive, manage and distribute income (excluding taxes) from upstream oil and gas activities. Importantly, apart from covering a proportion of Mexico’s current public expenditure commitments, the fund is designed to invest its income for long-term future savings. Government officials and politicians have acknowledged that it is inspired by the highly successful Norwegian sovereign oil fund, which among other things guarantees that country’s pensions system and is now the world’s largest of its type with around $850bn invested. The idea of creating a sovereign fund is a new departure for Mexico, where oil revenues have traditionally been used solely to fund current public sector spending rather than investment.

Launch

The FMP has been set up by the Ministry of Finance (Secretaría de Hacienda y Crédito Público, SHCP), which acts as the settlor, and the central bank, Banco de México (Banxico), as trustee. It is run by a technical committee of seven members, three of whom are government officials, with a further four independents proposed by the government and subject to ratification by the Senate. The government members are the finance minister, Luis Videgaray; energy minister, Pedro Joaquín Coldwell; and Banxico’s governor, Augustín Carstens. The independents are Arturo Manuel Fernández Pérez, Rafael Rangel Sostmann, Federico Reyes Heroles and Luis Manuel Tellez.

The committee members have varied backgrounds in engineering, academia, journalism and economic analysis. Tellez, for example, is a former president of the Mexican Stock Exchange. During one of its first meetings (in October 2014) Videgaray, who presides the technical committee, ratified FMP’s overall objective, which he defined as administering Mexico’s oil wealth “in a totally transparent fashion, to allow the country to face international economic business cycles in a solid and efficient manner, guaranteeing that revenues generated by oil are, and will continue to be, used for the benefit of all Mexicans”.

While the creation of the FMP as a sovereign fund has been largely applauded by politicians inside Mexico and by foreign financial markets, its initial impact has been somewhat muted by the sharp fall in international oil prices that developed in late 2014 and continued into 2015. It is accepted that the sovereign fund is a long-term project that will take years to gradually accumulate reserves. But analysts have also noted some important differences with the Norwegian fund, which may limit the overall speed of its growth.

Modified Model

Perhaps the key difference from the Norwegian model is that the FMP is required to meet a high threshold of payments to the federal government budget before funds can be assigned to accumulation and long-term saving. The law mandates the FMP use oil revenues in the first instance to make an annual contribution to the federal government expenditure budget of up to 4.7% of GDP. It is also required to contribute to federal and state financial stabilisation funds. It is only after these obligations have been met that full accumulation of reserves can begin. According to Luis Miguel Labardini, a partner at consultancy Marcos y Asociados, this means, “It is going to take a long time for the FMP to become relevant”.

Carlos Serrano, chief economist at BBVA Bancomer in Mexico, told OBG that the 4.7% figure represents the contribution that oil revenues made to the federal government budget in 2013, when oil prices were high and the reforms were first being drawn up. In effect, by fixing it at this level, the government has decided to guarantee itself a relatively high level of oil sector support in GDP terms. Serrano noted that if, as hoped, Mexican GDP growth accelerates, the guaranteed contribution from the fund will also increase in absolute terms.

There are some additional conditions affecting the fund’s operation. Once its financial reserves grow to an amount equivalent to 3% of GDP, surpluses will be reallocated as follows: 40% will remain in the general fund contributing to its accumulation; at least 10% will go to the government’s universal pension fund; 10% will go to science and technology project investments; and another 10% will be spent on scholarships and industry connectivity and development projects.

Transparency

The Norwegian sovereign fund has a code limiting the scope of its investment portfolio to sectors that comply with a range of ethical investment criteria. The FMP does not have a similar code, but Labardini noted that one of the independent members of the technical committee, Federico Reyes Heroles, is known for “a profile committed to fighting corruption and guaranteeing transparency, something which the fund requires”. The Mexican branch of anti-corruption lobby group, Transparency International, has also noted that the Norwegian sovereign fund has additional controls in the shape of a 15-strong independent citizen’s committee, appointed by parliament, with powers to audit and approve the accounts. In contrast, apart from ratifying the independent technical committee members, the Mexican Congress has no other direct involvement in the running of the FMP. The finance minister, who also presides the technical committee, appoints an external auditor.

In line with its commitment to transparency, the FMP is publishing regular financial updates on its website (fmped.org.mx). According to these, in the first four months of 2015 it transferred a total of MXN121.86bn ($8.2bn) to the federal Treasury. In its first quarterly report, January-March 2015, the FMP reported receiving some MXN87.52bn ($5.9bn) in oil and gas revenues. Of that total, the majority (68.4%) was paid to the Treasury for the current expenditure budget, with the remainder going to a variety of specially earmarked sub-funds such as the budget stabilisation fund, which took 19%, the states stabilisation fund, which received 5.5%, and the energy technology fund, Fondo Sectorial CONACYT-Sener-Hidrocarburos, which accounted for 3.7%.

The FMP also noted that it had been agreed that state oil company Petróleos Mexicanos (Pemex) would pay advance transfers into the fund in 2015 equivalent to 1.6% of GDP, down from the original guideline of 2.3% of GDP, due to the fall in international oil prices. The advances exclude a number of other revenue payments due (such as for profit-sharing contracts and exploration rights). Initially, it is only Pemex that is generating revenues for distribution through the FMP; however, as international oil companies begin to participate in the local industry, revenue from their operations will also begin to flow to the fund.

Relatively little has been said about the investment strategy that the FMP will follow for long-term accumulation. The fund has said that investment criteria will be set by the technical committee and must “seek maximum yields at adequate levels of risk”. Investments must be diversified so as to spread risks and there will be limits defined “by assets, countries, regions and economic sectors”. It also said it will avoid short-term and volatile investments, create a “reference portfolio” to measure the effectiveness of its investment strategy and only invest in derivatives when the decision can be justified as part of a risk-management strategy.

Slow Build-Up

For the immediate future, because of the sharp fall in international oil prices and the large share going to fund current government expenditures, it is likely that the FMP will grow at a fairly subdued rate and that it will serve more as a distributor than as an accumulator of oil revenues. According to government statistics, Mexico’s oil revenues in the first four months of 2015 fell by 43.7% to MXN233.6bn ($15.7bn). Hé ctor Villareal, director of the think-tank Centro de Investigación Económica y Presupuestaria, said, “It is going to be difficult, very difficult, at current international oil prices, to achieve the savings that were hoped for at the time the reform was drawn up. It will be a long time before significant oil revenues can be set aside for savings”. Villareal nevertheless stressed the value of the FMP as an organisation supporting public finances.

The finance ministry has itself acknowledged that growth will be slow in the near term. “We are more likely to see a strong savings dynamic on the long term when Mexican oil production increases and, we hope, international prices recover,” Luis Madrazo, head of the economic planning unit at SHCP, said.

Gabriella Siller, an economic analyst at Banco Base, suggested that the FMP might be expected to begin to accumulate reserves after two years. “Oil prices are low, it will take a while for us to adjust to those lower prices and for public sector finances to absorb the new reality. After that happens, that’s when long-term savings may begin to be achieved,” she said.

The future growth of the sovereign fund may depend on whether the government decides to maintain its guaranteed 4.7% of GDP share of budget contributions, or whether as non-oil tax revenues grow as a result of reforms, that proportion might be lowered, allowing more significant annual savings and accumulation.