IFR Mexico Roundtable 2017: Part 2
IFR: Is this something new?
Jorge Mendoza Sanchez, CFE: It is not new, but it is newer for Mexican corporates. I know the sovereign used it for one of their cross-currency swap transactions. CFE has used it several times, and I know that banks are starting to pitch it.
IFR: What is the other type of currency exposure?
Jorge Mendoza Sanchez, CFE: The other type of exposure is on the operation side. Most of our costs are fixed in dollars, especially everything related to the inputs of creating energy. We do have a pass-through to our tariffs in terms of FX. However there are certain tariffs in the market that are fixed and are not adjusted to movements in FX. We currently do not hedge that exposure, which is currently around 30% of our sales. However, we are looking at new strategies to manage that risk going forward.
IFR: What does this new strategy entail?
Jorge Mendoza Sanchez, CFE: We are looking at foreign currency with a more holistic approach, taking into consideration both financial and operating exposure. We have two types of risk, one that is related to what we report to the stock exchange and what is included in our income statement.
And the other risk is in terms of projects approved by the finance ministry (Hacienda) and congress. We need to take a short-term and long-term approach, trying to combine those two factors and make them comply with what the market and Hacienda (each look out for).
IFR: Would it be fair to say that you have had to be more active in managing these kinds of risks, given the recent volatility of the peso?
Jorge Mendoza Sanchez, CFE: We have had to be more active. We are building a risk-management office in CFE. We used to have a small risk-management area inside the finance department, where they did front and back office for every transaction.
Now we are building a separate financial risk-management office, where we are going to put all the best practices in place, and separate it from the front office. And they are going to monitor these risk-management transaction policies that we execute.
IFR: And is this a direct result of recent peso volatility?
Jorge Mendoza Sanchez, CFE: Not a direct result. CFE is going through a lot of changes. We are splitting it up into subsidiaries and affiliates as a result of the energy reform. We need to focus much more on profitability and value creation. And this has pushed us in a direction where we have had to better manage our financial resources and risks. That is not only because of the current volatility. This is the new way CFE is going to operate going forward.
IFR: How exposed is corporate Mexico to FX risks, and do investors need to worry?
Fabiola Ortiz, S&P: We rate about 80 corporates, but we have seen that less than 10% of all corporates are unhedged. There are seven or eight companies that will have some difficulties or their capital structure will change given this volatility, but it is not the majority.
Nathan Moussan, Actinver: Next year up to Ps150bn in Mexican corporate debt is coming due, but only 12% of this amount is based on US dollars, so we think issuers can meet their financial liquidity needs next year.
However, in 2018, which is an election year in Mexico, maturities are double that amount at around Ps300bn. Also 50% is in local currency, with the rest in US dollars. That said, the issuers with exposure to US dollars are mainly corporates (with Triple A local ratings) such as Pemex, CFE and Grupo Carso, so we don’t think they will have difficulties refinancing those maturities. Spreads will widen, though, as the reference rate has moved 200bp in the last 12 months. It will be more costly.
IFR: What does that mean for the supply/demand dynamics in the market? I would imagine Mexican corporates will want to refinance next year to avoid issuing during an election year. But at the same time market conditions in 2017 don’t look particularly attractive.
Juan Claudio Fullaondo, HSBC: We are in a wait-and-see mode to see which issuers come first. But hopefully you will see the sovereigns, the sub-sovereigns and then some corporates.
I think investors are really savvy. Overall they are looking for yield, and they like LatAm. What I have been hearing from them is that they like risks like Chile, Peru – and many have appetite for Mexico. And the ones that don’t like Mexico are not selling their positions, but just going flat. I think once you see the market stabilise and you see clearing levels on sovereigns, you will see everything pick up.
IFR: I would like to ask a broader question about the Mexican peso, which is now one of the most liquid currencies in the region, thanks to government policies instituted following the ‘tequila crisis’ in the 1990s. Because of that, the country’s currency has become a major hedging instrument for investors taking views not just on Mexico but on emerging markets more broadly. This has led to considerable FX volatility, which doesn’t necessarily reflect underlying fundamentals. Are such policies becoming a liability for corporate Mexico?
Carlos Garcia Moreno, America Movil: If you look at the region’s currency markets, you tend to have some friction. If you want to get in or out of Brazil, there are some taxes which are quite substantial. That is one of the reasons why everyone has chosen to use the Mexican market, which is frictionless and liquid. There are no taxes and it is a clean float.
I think sometimes this has been taken to an extreme, and the peso has been affected by things that have nothing to do with Mexico. It is basically investors trying to hedge the currency risk they have in the rest of the region.
It does create damage that will be longer-lasting than anyone had expected. This is a new element that investors in the Mbono (Mexican Treasury) market probably didn’t factor into their thinking when they started taking these positions.
And these are not negligible positions. Foreign investors own more than 50% of all the Mbonos with tenors of 10 years and longer. So it is not immaterial if they eventually lose faith in the currency, saying ‘we did our analysis, and the currency is moving around in a way that has nothing to do with the fundamentals of the country’. That is not something they bought into.
I do think this has to be reviewed by the authorities. This notion that we will have a clean float is something that doesn’t hold very well when there are these massive movements that can create some damage.
Just to give you an idea, last year you had movements in the peso that were completely unwarranted. And you can argue this brings more risk to the environment, affects investment decisions and investor confidence, and helps breed more inflationary expectations.
IFR: Has the genie been let out of the bottle? Is there anything you can do about it at this stage, and do policymakers need to address this issue?
Carlos Garcia Moreno, America Movil: When you have someone like Trump – with everything that it has meant to the markets – it is very different if you already had a run-up like the one that you had last year, and if the (FX) market had been stable over the last few years.
Now there is some stickiness to the new FX levels that have been attained, and it has become more difficult to go back to (prior levels). I think it is an important issue for policymakers.
Gerardo Vargas, FUNO: I agree that all these hedges have had an effect. Today, whether the fundamentals of the country warrant it or not, it is very difficult to find somebody imagining the peso trading below Ps19 (to the US dollar), and that is because there have been some hedges and the peso has become the whipping boy.
However, as Carlos mentioned, around 50% of all the medium and long-term issuance done by the government is owned by foreign investors. That has helped extend the curve, create liquidity, and hence allowed Afores to buy other types of assets. So there are benefits and there are costs.
I agree it is a policy issue. The central bank has to be much more concerned about the currency than it might otherwise have been. This probably translates into a higher interest-rate environment, having to sacrifice growth in exchange for keeping the value of the currency.
But there have been great benefits. This liquidity has not only made the peso a more tradable security, but government debt as well. It is the same as when an issuer is included on the index for the first time. You are happy as people are going to buy (your debt). But then for whatever reason they want to sell Mexico, your stuff gets clobbered –even though I am the same company I was a couple of weeks ago. There are benefits and costs. But I agree with Carlos that this is a major policy issue, and it needs to be addressed.
Jorge Mendoza Sanchez, CFE: From the CFE side, it makes it very hard to make any predictions for 2017. Putting the US elections aside, you still have a lot of external risk that makes it very hard for us to plan.
It doesn’t feel like a normal December. There are a lot of data points coming in the next month. We have the Italian referendum, payrolls are on Friday, and the market is already pricing in a US interest-rate hike. We have the Opec meeting. If you put the US elections on top of this, there are a lot of risk factors away from what is happening in Mexico that could eventually have an impact on the peso and interest rates.
From the peso side, if you look at foreign holdings of Mbonos, which is a much better data point to monitor investors’ long-term view, they are at historical highs. The reduction has come from the Cetes (short-term government securities), which has more to do with arbitrage positions.
Those historical highs have a lot to do with what the government is doing to promote not only macroeconomic stability through fiscal consolidation and through austerity budgets, but also its commitment to maintaining a well-functioning capital market. And this has resulted in a deep and liquid yield curve, a deep and liquid peso market, and no capital controls. All these things give a lot of confidence to foreign investors to be able to come in and out as they please.
Obviously this is a risk, but it also gives them the confidence that there is a window to exit if needed. So instead of selling when they see volatility, those investors hedge their positions, and short the peso using the liquid currency market we have offered them. And this allows them to stay in Mexico. So it is important to take this into account.
IFR: What market changes are required to address this large need to raise pesos at a time when the local market for corporates remains relatively small and dominated by a handful of pension funds, while volatility in the peso gives foreign investors pause?
Nathan Moussan, Actinver: We have been talking to investors, and they don’t want to invest in anything this year. Since Trump was elected, there have not been any debt issues in the local market, not even equity offerings that were in the pipeline.
Gerardo Vargas, FUNO: Lack of issuance hasn’t been for lack of companies wanting to issue. It has been because they have been told that investors are not ready to buy your bonds.
Carlos Garcia Moreno, America Movil: I have always been concerned when the local market is not functioning properly. There isn’t sufficient competition. In the past we were always keen to help develop the market.
The reason we started going into Europesos and then global peso bonds was precisely because we thought the market was not functioning well in Mexico. We were seeing a situation where our spreads were tightening in dollar and international debt markets, but in Mexico they were not moving. They were stagnant.
We thought we needed to bring pressure from international investors to keep the Afores in line and help them really adapt to market conditions.
What I am fearful of now is that international investors are not going to be there for some time, and we are going to see that this cartel will not price issues correctly. Rather than filling in the void, they will take things to an extreme.
Cesar Armando Cortes, CONSAR: As you mentioned, the market is not small. It is the amount of participants that is small, and that is the main problem.
If institutional investors want to add exposure to a certain issuer, they immediately start distorting the pricing … because (the market) knows an Afore is interested in a particularly issuer.