A new bourse and diversified instruments to increase investment in Mexico's capital markets

Despite having a diversified economy and the second-most actively traded emerging market currency in the world, Mexico’s capital markets have remained underdeveloped relative to its potential. The same regulatory caution that helped strengthen the banking industry after the 1994-95 financial crisis also designed a tight oversight framework for the bourse. As the system was reinforced, new investment vehicles brought dynamism and added variety to the menu of investment options.

While corporate bond issuances have only expanded at a moderate rate, Mexico’s sovereign bond market has long been a central component of the bourse’s activity, attracting a growing volume of foreign players. An assortment of new structured products launched over recent years has helped channel market investment towards infrastructure development in areas such as transport and energy.

Competition is also likely to spark further interest in the local markets. The Mexican Stock Exchange (Bolsa Mexicana de Valores, BMV) will be joined by a new bourse, the Institutional Stock Exchange (Bolsa Institucional de Valores, BIVA), whose operations are slated to begin at the end of July 2018.

Room to Grow

It is hoped that the arrival of a new player will boost trading activity, as the market is currently not an accurate reflection of the stable economic performance Mexico has displayed over the past decade, and some important sectors are still not represented on the exchange. Contrary to the healthy development witnessed in the currency and fixed-income markets, activity in the equity market remains relatively low. “The value of capitalisation on the BMV is about 39% of GDP, compared to 89% on the Santiago Stock Exchange in Chile,” Álvaro Meléndez Martínez, chief economist at the National Securities and Banking Commission, told OBG.

Part of the reluctance of some companies to enter the stock exchange is based on cultural perceptions about going public. Many Mexican entrepreneurs and business owners believe the stock market is exclusively geared towards companies with largescale operations and the ability to absorb the added costs and compliance work associated with listing.

Underutilisation

Another key factor that has dissuaded firms from joining is a strong banking sector with an appetite for corporate lending, which means local businesses can easily access bank financing. Loans to businesses rose by 14.3% between January 2017 and January 2018, surpassing MXN2.2trn ($118.9bn). These loans accounted for 74.6% of all commercial credit facilities originated by the banking system at the start of 2018 (see Banking chapter). The majority of corporate loans, at 80.7%, were channelled to big corporations, underscoring the fact that even for larger businesses with the capacity to establish strong governance structures and adhere to market requirements, going public is not necessarily the first option when seeking capital. “The rate of credit extension to companies has not slowed even with higher interest rates, but listings have slowed down because the appetite for risk on the stock exchange is lower,” Montserrat Antón Honorato, capital markets analyst at INVEX, told OBG.

There increase in the number of listed companies and trading volumes has been gradual and moderate, recording around 255,000 accounts as of end-2017. However, the trend of underutilisation is likely to change over the medium term. In addition to the implementation of a second stock exchange and an increasingly diversified array of investment vehicles, a generational shift in the management mindset of the country’s businesses is taking place, and the benefits of listing are becoming more accepted. The combination of these factors is expected to bring a new wave of energy to the capital markets, albeit within a context of heightened macroeconomic uncertainty in terms of foreign trade and investment.

Risk Factors

Mexico’s capital markets have faced additional external pressure since the election of US President Donald Trump in November 2016. The strong economic links between Mexico and its northern neighbour – 80% of exports are sent to the US, for example – have been called into question, resulting in some volatility in Mexican markets. Fears surrounding an abrupt change in trade and investment arrangements have increased investor caution and brought about a wait-and-see approach.

An early result of the uncertainty was the negative impact on the peso, which reached record lows following the election, peaking at MXN22:$1 in February 2017. The currency then recouped part of its value to reach MXN19:$1, but fell to around MXN17:$1 in the third quarter of 2017. To counter the macroeconomic environment and help tame inflation, Banco de Mé xico, the central bank, raised interest rates by 0.25 percentage points in December 2017, and again by the same amount in February and June 2018, taking the benchmark rate to a nine-year high of 7.75%. A positive conclusion to the ongoing renegotiation of the North American Free Trade Agreement (NAFTA) would likely strengthen the economy and ensure the continuation of trade patterns. Indeed, the majority (64%) of CEOs surveyed by OBG cited renegotiation of NAFTA as the top external event that could impact the economy in the short to medium term (see Business Barometer). However, as of mid-2018 the end of discussions was not in sight.

The Mexican presidential election on July 1, 2018 was also a source of investor caution during the first half of the year, as is the case in many countries. Another factor with the potential to influence the domestic market’s performance is recent reform and fiscal incentives enacted in the US, which could prompt corporations and investors to re-think their business strategies in Mexico.

Thinking Positive

Given mounting internal and external pressure, Mexican financial markets proved resilient in 2017 and early 2018. “The behaviour of the exchange has been exemplary in the sense that market agents have participated in an orderly way,” Guillén Lara, COO of the BMV, told OBG. “Volatility always presents an opportunity, and the market has, for the most part, behaved in a very mature way.”

With NAFTA renegotiations and the expected effects of presidential elections already priced into the markets during the first quarter of 2018, several analysts echoed the belief that only unforeseen consequences or disruptive outcomes of these two factors would negatively impact the domestic financial markets in a meaningful way.

However, a prolonged period of uncertainty regarding the future of trade relations between Mexico, the US and Canada would likely weigh on the local economy to some degree, mostly because it would require a revision to business continuity plans for many companies that have come to rely on free trade between the three North American countries. While a full collapse of NAFTA is unlikely, if the agreement is scrapped, it may not result in an entirely catastrophic scenario for Mexico, according to some observers. “All the confusion around NAFTA has brought volatility, but international commerce accords are the second line of defence, and in some cases those criteria are not that far from where the treaty stands today,” Rodrigo Velasco, director of operations at BIVA, told OBG.

Peso Pressures

Until a final trade deal is agreed upon, market observers will likely keep their eyes on how the peso reacts to external headwinds in the second half of 2018, a period when the country will also be transitioning to the newly elected administration. The peso remains one of the most widely traded emerging market currencies, with an average daily over-the-counter foreign exchange turnover of $97bn in April 2016, according to the latest edition of a triennial report published by the Bank of International Settlements.

There are additional trade concerns beyond NAFTA, however, with the US imposing tariffs on aluminium and steel products imported from Mexico, Canada and the EU in May 2018. When US officials hinted that no final agreement on changes to NAFTA would be completed before the end of 2018, the peso reached its lowest point since February 2017, trading at MXN20.03:$1 as of June 4, 2018. Any further volatility stemming from long-lasting trade negotiations is likely to impact the domestic market and decrease investor interest. “If there are expectations of a steep depreciation of the peso, investors might choose not to invest in pesos,” Héctor Alfonso Suárez, vice-president of investment banking at Actinver, a financial services firm, told OBG. “Although Mexico may be paying around 7.8% on a sovereign bond for 10 years, the return is reduced by depreciation. An investor looking at returns in dollars would not be inclined to put money into the Mexican economy.”

Equity Driver

The primary equity market of the BMV was created by the merger of the three capital markets based in Mexico City, Guadalajara and Monterrey in 1975, and now lists around 150 firms. Market capitalisation of the BMV has grown from MXN6.9trn ($372.9bn) to MXN8.2trn ($443.1bn) in 2013-17. However, the average daily traded value of equities has stagnated, falling marginally from MXN15.6bn ($843m) in the first quarter of 2013 to MXN15.2bn ($821.4m) in the fourth quarter of 2017.

The 35 largest firms by market capitalisation make up the Standard & Poor’s/BMV Índice de Precios y Cotizaciones (S&P/BMV IPC), the exchange’s most important group for performance-measurement purposes. The index reached 45,643 points at the end of 2016 before rising to an all-time high of 51,713 on July 24, 2017. It finished the year at 49,354 points, an 8.1% increase over 2016. In June 2018 the S&P/ BMV IPC stood between 46,000 and 47,000 points.

New Player

In the second half of 2018 the BMV will be joined by BIVA, an institution that aims to deepen and broaden the country’s financial markets. The platform was created by private company Central de Corretajes (Cencor) after it applied for an operating licence from the Ministry of Finance in October 2015; however, the launch has faced repeated delays. In February 2018 Cencor reported that it had secured the necessary connections to 15 brokerage firms out of 36, and was running the last set of tests on the system, expecting it to come on-line in late July.

However, whether a new exchange will encourage more companies to list or bring additional investors to the stock market remains somewhat dependent on local business culture. “In more-developed economies, companies are born with the goal of going public, of reaching the stock exchange,” Velasco told OBG. “We think that this is happening more frequently in Mexico – there is a change in mentality of business owners and more are aiming to go public.”

BIVA has set ambitious goals for its impact on the market environment, expecting the total number of listed companies on both stock exchanges to increase by 30% in three years. Over that same period, the average daily traded value on both platforms could increase by 50%, Velasco said.

Listing Hurdles

Despite the benefits that can come from added competition, attracting more firms to the capital markets faces a host of challenges, chief among them being a family-controlled mentality and the tradition of bank funding. “Family companies are very important to the Mexican economy,” Antón Honorato told OBG. “Getting the necessary governance systems in place is a problem for these firms, so many companies go with the easier option of obtaining financing through the banking system.” While competition may also drive down the price of listing, one clear deterrent for medium-sized companies is not so much the cost, but the added work that is required. “Even if you have a small structure, compliance can be difficult,” he added.

In addition to opening a new board, analysts believe that further measures could help increase trading volumes, such as giving more regulatory flexibility to pension fund investment (see analysis). The country’s pension funds remain a veritable force of investment potential. As of March 2018 the vehicles represented roughly 15% of the country’s GDP, and are estimated to comprise 30% of GDP by 2025, according to figures by the Mexican Association of Pension Fund Administrators.

Bond Markets

Around half of pension fund assets are made up of Mexico’s sovereign debt, which has transformed into a sought-after investment vehicle due to the country’s economic stability over the past several years. This status has been reinforced through positive credit ratings from a number of key agencies. S&P upgraded Mexico’s foreign currency rating from “BBB+” with a negative outlook to “BBB+” with a stable outlook in July 2017, citing the government’s efforts to contain the currency shock sustained after the 2016 US elections.

Mbonos, standard fixed-rate bonds, remain the primary sovereign debt issue, with maturity terms that vary from three to 30 years. The percentage of Mexican sovereign bonds held by foreign investors as of March 2018 was 62%, up from 17.4% in 2007, a sign of the market’s mounting appeal. However, foreign participation has decreased since March 2017, when 66% of bonds were held by non-local investors. This fall, according to Bloomberg, was the result of market worries about a reverse in the peso’s performance during the rest of 2018, after the currency climbed roughly 6% in value against the dollar in the first quarter of the year.

Mexico’s corporate debt market remains comparably less developed. With banks allocating financing under competitive conditions, the bulk of corporate debt issuance has been driven by large-scale, government-backed organisations, such as mortgage bodies like the National Workers’ Housing Fund and the Fund for Housing, Security and Social Services of State Workers, as well as state-owned entities such as Petróleos Mexicanos and the Federal Electricity Commission (Comisión Federal de Electricidad, CFE). Some large private companies, however, have been increasingly turning to the capital markets to finance expansion or acquisition plans.

There were 175 issuances of long-term debt on the BMV in 2017, comprising both sovereign debt and corporate debt, for a total of MXN296.3bn ($16bn), up from MXN158.4bn ($8.6bn) and 110 long-term issuances in 2016. The number of short-term debt issuances fell slightly to 765 transactions in 2017, worth MXN228.3bn ($12.3bn).

Initial Public Offerings

In 2017 the BMV saw five initial public offerings (IPOs), testing the impact that unfavourable macroeconomic conditions would have on a firm’s ability to raise capital through the stock exchange. José Cuervo, the world’s largest tequila producer, held its IPO in February 2017, raising MXN18.64bn ($1bn). The company’s launch on the BMV had been twice delayed in 2016 due to uncertainty related to the US elections, according to international media reports.

In mid-2017 Banco del Bajío launched an IPO that placed about 24% of its capital on the market. The bank was able to raise MXN8.8bn ($475.6m), putting 50% of offered stock on the local exchange and the other 50% onto international markets.

Another awaited entrant to the bourse was Grupo México Transportes, a transportation subsidiary of mining conglomerate Grupo México. The firm operates the country’s biggest railway network concession and garnered $869m in its November 2017 IPO. Months after joining the exchange, the firm made it to the top ranks by being added to the S&P/BMV IPC, replacing pharmaceutical firm Genomma Lab.

Another transport company that listed in 2017 had a less successful debut. Traxión, Mexico’s largest trucking and logistics firm, launched an IPO in September, aiming to raise MXN6.9bn ($372.9m). Its market reception, however, fell below expectations, raising MXN4.5bn ($243.2m) worth of capital. Some 75% of the offered shares were put on the BMV, with the remaining 25% distributed in international markets, according to local media reports.

The fifth IPO was an innovative development: Vista Oil & Gas was the first energy company to reach the BMV and the first special purpose acquisition company (SPAC) to be listed on a Latin American bourse. The company raised $650m through the sale of 65m stocks priced at $10 each.

Acquisition Vehicles

SPACs facilitate companies in acquiring existing businesses under a specific timeline. “SPACs are a great idea because they allow investors to bet on the quality of management and the belief that the company will make good purchases,” Activer’s Suárez told OBG. “With private equity funds generally geared towards large-scale institutional investors or high-net-worth individuals, SPACs allow smaller investors to be part of acquisition plans and invest in an idea.”

Although SPACs are floated before having specified their acquisition targets, the mechanism has to abide by agreed timeframes for executing investment plans. SPAC investors have the option to withdraw from the investment vehicle if they disagree with the planned acquisitions.

The first quarter of 2018 saw an additional SPAC listing by financial services and private equity firm Promecap, which was able to raise MXN5.6bn ($302.6m) to invest across several sectors. The new instrument is expected to be an increasingly popular option for mobilising investment.

Real Estate

Other instruments have already established a track record. Since their inception on the BMV in 2011, real estate investment trusts (fideicomisos de inversión y bienes raíces, FIBRAs) have secured a strong place on the exchange. Similar to how the instrument works in the US, Mexican FIBRAs allow trusts to develop real estate assets for leasing purposes and generate a stable income over time. In addition to becoming an attractive vehicle for heavyweight institutional investors such as Mexico’s pension funds, FIBRAs have opened up real estate investment to small individual investors who are attracted by the regular income provided by rents – in addition to capital gains – as well as the possibility of investing in large-scale projects.

Between 2011 and 2017, 12 FIBRAs debuted on the stock exchange, raising MXN150bn ($8.1bn) through both primary and subsequent share offerings. In 2014 alone five new FIBRAs raised a combined MXN53.8bn ($2.9bn), though the speed of new transactions cooled thereafter. In 2015 FIBRA HD launched with a transaction value of MXN1.4bn ($75.6m), with a portfolio that included industrial, commercial and educational real estate. This was followed a year later by FIBRA Plus, with a MXN1.6bn ($86.5m) transaction value. Five of its initial nine properties were shopping malls.

The only new FIBRA to reach the market in 2017 was FIBRA Nova, launched by food company Grupo Bafar in a MXN1.2bn ($64.8m) listing, below the firm’s expectation of MXN2.2bn ($118.9m). Several earlier FIBRAs also went back to the stock exchange that year to gather additional capital: Terrafina, FIBRA Monterrey, FIBRA Uno and FIBRA Hotel raised a combined MXN24.4bn ($1.3bn).

Despite the innovation they have brought to the market, the fast rise of FIBRAs may have worked against their own interests. “Due to the way they are legally structured, FIBRAs must invest at least 70% of their assets in real estate, and they need to do it quickly. They have an incentive to make purchases fast, pushing up the price of real estate assets,” Suárez told OBG. “As the price of real estate went up, the yield on some of these FIBRAs went down. The dividend yield they are paying is now very close to what the sovereign bonds pay.”

Large Infrastructure

Nonetheless, interest in FIBRAs was strengthened with the creation of the FIBRA E, a new instrument designed like a FIBRA, but specifically geared towards energy and infrastructure. In October 2016 Promotora y Operadora de Infraestructura listed the first FIBRA E. The company is an infrastructure developer that was already listed on the BMV, but used the financial vehicle as a means to securitise a revenue stream for its energy infrastructure.

In February 2018 the CFE established its own FIBRA E for MXN16.4bn ($886.3m). Another large-scale infrastructure firm, Grupo Aeroportuario de la Ciudad de México, prepared a FIBRA E in March 2018 for MXN30bn ($1.6bn). The group, which operates the capital’s airport, said it would use the investment vehicle to secure additional financing for the construction of Mexico City’s new airport, budgeted at $13bn and expected to be completed in 2020 (see Transport & Logistics chapter).

Development Capital

An earlier means to support development and attract institutional investors to projects with long-term returns began in 2009, with instruments known as development capital certificates (certificados de capital de desarollo, CKDs). CKDs issued on the BMV between 2009 and 2017 raised a combined MXN106.3bn ($5.7bn) for energy projects and other infrastructure plans.

After reaching a record 22 transactions valued at some MXN17.8bn ($961.9m) in 2015, CKD issuances fell to 13 in 2016, raising a total of MXN8.5bn ($459.3m). In 2017 the market saw a slight rebound in CKD listings, which increased to 16 and raised MXN11bn ($594.4m). The trend was reinforced in the first quarter of 2018, with an additional MXN2.5bn ($135.1m) secured by five new CKDs.

Due to their focus on institutional investors, CKDs’ success hinges heavily on attracting the interest of Mexico’s pension fund administrators ( administradoras de fondos para el retiro, AFORES). “There are only 10 AFORES, and of those, four of them have roughly 70% of the resources,” Suárez told OBG. “If one of the big AFORES does not like your CKD project and the other three do not go in, then the small remaining AFORES are not able to make the listing a success.” Mexican pension fund portfolios have expanded significantly since the system was overhauled in the late 1990s, leading market observers to call for further liberalisation in the investment rules for AFORES (see analysis). There are some signs of liberalisation already taking place, with the authorities amending regulations in January 2018 to allow AFORES to be invested outside of Mexico. Since this change, Mexico’s most established players have been meeting with asset managers in the US.

Investment Certificates

Another market novelty, which arrived in 2016, was the launch of the first investment project certificate (certificado de proyecto de inversión, CERPI). Created to gain the attention of pension funds, insurers and other institutional investors, CERPIs extend the possibilities allowed by CKDs by allowing investment by Mexican pension funds in foreign assets. The instruments are designed to attract co-financing from long-term investors, which needs to account for a minimum of 30% of the total project value. The first CERPI was launched by Mira Manager to help finance urban development projects, raising MXN800m ($43.2m) and enlisting Canada’s Caisse de Dépôt et Placement du Québec as a co-financier. As of the first quarter of 2018, however, no other CERPIs had been issued.

Outlook

The country’s capital markets are on the verge of a pivotal moment. While diversification has helped to garner new interest in more sophisticated investment products, the BMV has had some difficulties significantly expanding its number of listings, and deepening the link between the stock exchange and the economy. An additional bourse set to enter the arena in late July 2018 is likely to help raise the profile of capital markets and reach more individual investors and businesses that are considering tapping the exchanges for capital, yet the sector could be further supported by regulatory changes that help mobilise more resources from large institutional investors and increase market liquidity. These efforts will continue to be framed by overarching macroeconomic conditions, and while it is too soon to forecast what is in store for the remainder of 2018 and 2019, local financial markets have thus far demonstrated the necessary maturity to deal with surrounding instability.

While the result of the presidential election is predicted to have some impact in the short term, observers expect that the markets will be able to absorb the change in leadership and adapt accordingly. Two external factors, however, are likely to remain pressing issues for the sector. For one, the better-than-expected performance of the US economy has been pushing interest rates higher, which is expected to continue to put pressure on stock exchange valuations in Mexico.

A potentially more disruptive issue, though, is the result of the stalled NAFTA renegotiation process. Although instability resulting from the dealings was mostly factored into share prices during 2017, the US’ decision in mid-2018 to impose new steel tariffs on several trade partners, including Canada and Mexico, has put the prospect of a quick resolution to differing views on the agreement further out of reach. The likelihood of a prolonged period of instability and trade tensions between Mexico and the US will mean less predictability for both domestic firms and foreign companies operating in Mexico, and a resulting degree of volatility on the stock exchange.

Despite external challenges, the BMV has proven effective at introducing innovative products and keeping investors interested in what is on offer. While higher interest rates expected over 2018 and 2019 may make some new products less appealing, the diversification brought about by SPACs, FIBRAs, CERPIs and CKDs is likely to attract new investors and help bridge the gap between capital market utilisation and financing the country’s economic needs.