IFR Mexico Roundtable 2017: Part 3
IFR: Is anything being done to address this problem?
Cesar Armando Cortes, CONSAR: At the moment, about 80% of trades are conducted over the phone. As regulators we are trying to make that 80% go through the electronic market where execution is done automatically, so there are no intermediaries. The problem is, even if you want to encourage an electronic market to work better, there aren’t sufficient volumes. This would make the execution process more transparent. It is not that Afores don’t follow the execution process properly, it is their (relatively) large size.
Jorge Mendoza Sanchez, CFE: I have spent a lot of time on this subject. From the sovereign side, a lot has been done to promote this market. Issuers have tried a lot of new formats to get investors from abroad to participate locally. You have the GDN (Global Depository Notes) that Pemex tried and the global Europeso. Last year, Pemex, CFE (and) Telesites (the spinoff of America Movil’s cell tower business) issued the Euroclearable Cerebures. But this hasn’t really changed the dynamics of the sector.
There is a chicken-and-egg problem here. Investors don’t want to participate, because they haven’t seen enough liquidity. And there is not enough liquidity, because we don’t have enough foreign investors in the market. The Afores are not enough. You have issuers like Cemex who cannot issue locally, because they don’t have a high enough credit rating, and Afores cannot buy such credits based on their investment regime.
One of the things I found that could be helpful – but it is still in an initial phase – is an index that targets the local credit markets.
IFR: Which banks are developing these indices?
Jorge Mendoza Sanchez, CFE: Bank of America. As far as I have seen, there is only one bank that has done it. This is followed by international investors investing in local markets.
IFR: Is it comprised of just Mexican credits?
Jorge Mendoza Sanchez, CFE: It is Mexico, and they are adding other countries. The reason I think this is a valuable idea is that not all investors want to take both credit and currency risks.
They feel comfortable investing in the sovereign taking the FX risk, but they didn’t want to take the credit risk. It is too much work for them to cherry-pick credits and spend time on an issuer that will come to the market once a year or a couple of times at most.
There are only a handful of issuers in Mexico that are tapping the market and becoming frequent issuers. It used to be America Movil, but now you have Pemex, CFE and maybe Televisa. But others come to the market, only to disappear for a couple of years. So it is very hard for an investor to put resources into analysing a credit if they are not going to be able to buy it on a continual basis.
But if you put all of these credits into an index, it is much easier to look at credit as a whole, rather than cherry-pick. I think that is an area of opportunity where I hope we will see further developments. Many people don’t even know about these indices. I spoke to two large investors recently who are looking at following these local indices from Bank of America.
Gerardo Vargas, FUNO: You hit the nail on the head. What is lacking in Mexico is that most fixed-income funds are actually sold as if they were money-market funds. And that is why they don’t buy credit, because people put a lot of money into them and as soon as they see some volatility, they take their money out. And since credit or spread (corporate) bonds are highly illiquid, they don’t buy them.
What would be a big development in Mexico is the creation of a credit fund that would complement the Afores. We would have more liquidity and more opinions, because today we have five guys who don’t trade with each other. That is why spreads don’t move. They move in what seem like arbitrary directions sometimes. It is not (the fault of) Afores. It is bankers’ and brokers’ job to change the products that they sell.
Carlos Garcia Moreno, America Movil: I would say that corporate bonds are illiquid anywhere to begin with, and even more so in a market like Mexico. I think what would drive liquidity is to have a greater diversity of investors. When we started issuing the global peso bonds, it was really interesting, as something like 30% of the issue was bought by Afores. We also had Afores from Chile, Colombia and Peru, and we had pension funds from the US and some European investors. We had a little bit of retail from Switzerland, mostly Latin American investors. And I think that helps.
The format does help when there is interest from foreign investors, whether it is a Global Depository Note or Europesos.
The problem is when there is little demand from abroad. When that happens, the format itself makes little difference. That is why I think that we need to focus on what we can do to improve the performance of the local market at a time when we don’t have this foreign demand for local securities.
How can we somehow substitute the impact that foreign demand has in making the market more competitive? How can we assure that this market doesn’t lose its competitiveness by virtue of the foreign investors not being here? At the end of the day, that is what we are talking about. If foreign investors don’t come, then we end up with a monopolistic market, a cartel of five guys to sell to.
One thing that didn’t help is related to this idea of the Mexican peso being used as a hedging instrument. A lot of the moves we saw in the peso over the last couple of years – before Trump spooked investors who were long the peso – they were looking at the peso as an investment. That is the kind of damage that I think was brought into the market, by having our currency behaving in such a way.
Cesar Armando Cortes, CONSAR: Local investors now have more diversified portfolios than they had in 2008 (during the global financial crisis). And the impact of the US election was less dramatic than before. While their portfolios may have lost some value in, say, fixed-income positions, they gained in equity and foreign-exchange positions.
They have also increased their positions in alternative assets such as infrastructure and asset-backed securities.
IFR: What does this mean for infrastructure financing? Just a few years ago, the government said it had a US$600bn plan to improve Mexico’s infrastructure between 2014 and 2018. Does this plan look too ambitious now?
Carlos Albarracin, Milbank: You have government issues related to public spending which impact public infrastructure. But there is a trend for developing private infrastructure – a hybrid infrastructure, if you will. The funding comes from the private sector, while infrastructure is required for the public sector, and the creditworthiness of the infrastructure asset, or the off-taker, is very closely correlated to the public sector, CFE, Pemex or similar entities.
You have the FX issue. The infrastructure particularly around the energy sector, and some of the new CFE model, is going to continue to be structured with some hedging, which takes care of the FX risk.
But in times like this there is a natural flight to safety, particularly (by) fixed-income investors. Every time there is some volatility in the market, everyone goes and buys the very boring utilities and sub-sovereign and private utilities which are linked to economic growth and some of the variables that aren’t changing as dramatically as the FX rate.
Now you have 10 CFE or Pemex-linked pipelines that were financed in the bank markets over the past five to six years, many of which are now reaching the completion phase. So there is a new asset class that didn’t exist five years ago. These could be refinanced in the bond market. I think that is going to create a lot of opportunity in that new asset class, which is a hybrid between private and public sector.
As companies like CFE or Pemex position themselves as a more traditional utility, I think that is going to create more opportunities for some of companies to tap the market with a different story – a utility with stable and predictable cash flows that is highly correlated with economic growth.
The trend in the market is that there will be this need for infrastructure. Plus the revenues are highly linked to US dollars and the producer price indices in the US, which will take care of some of the FX risk. We are seeing a lot of opportunity in that space.
IFR: HSBC helped underwrite the successful Mexico City Airport that was backed by US dollar revenues. I would imagine a lot of these infrastructure projects would prefer to raise local-currency debt. But is there demand there for peso debt?
Juan Claudio Fullaondo, HSBC: I think there is. Obviously in the specific case of the airport, it was linked to the dollar because it is linked to the Tarifa de Uso de Aeropuerto (TUA) – airport tariffs.
But if you analyse the toll roads or other types of infrastructure, even if it has a peso component, as long as you have a good coverage ratio, I think it is feasible. I strongly believe there is a good market.
IFR: What is the state of play of Fibra Es, or Master Limited Partnerships?
Jorge Mendoza Sanchez, CFE: There has been one Fibra E in the market. It was done by Pinfra, related to infrastructure rather than national energy. We are hoping that CFE will do the first energy Fibra E in the first semester of next year.
We are still going through the legal structure of the Fibra and trying to make sure we comply with all the tax regulations. We are planning to use our transmission assets, which have very stable cash flows and are very attractive for a Fibra E investor.
We are hoping to be in the market in the next six months or so. There is still a long way to go. There are other issuers looking at the market as well. Pemex, I know, has been looking at the market. Given the nature of the (CFE) assets and given they are regulated and that there is visibility of the future cash flows, it could be a very attractive for investors.
Carlos Garcia Moreno, America Movil: If you look at the development of capital markets, it has always been in the same way. You start out with sovereigns and supranationals, and then you start developing the lower segments in investment grade, which is basically corporates. And then it takes time to go toward credit – structured securities, securitisations etc.
But it is difficult to have a market that still has not established its first segments of investment-grade paper, and it is already starting to look at many other options.
You don’t have a market with any liquidity. That is a problem in Mexico – namely, that it is not very liquid because it is still very fragmented. If you look at how capital markets developed in Germany or France, it took many years.
There has to be some focus, someone who looks at the domestic market, how it should develop. There has got to be a view on how the markets develop. Rather than have all these small issues, why don’t we focus more on more issuance at the top levels?
I will give you an example. Look at spreads on America Movil paper over the last few years. They were relatively flat in the international markets – stable, even, relative to the Mexican government. Then you look at the same thing in Mexico, and you see spreads widening significantly, even relative to the Mexican government.
(And) this happens to one company that is a prime name in this market. If this is not a change in credit quality, then why is this allowed to happen in Mexico? If this is happening with the bonds of top companies, then you can imagine what happens to a company that is not a top company that is looking to issue.
That is why I think there has to be a view on a) how to control the Afores; and b) how the Afores can be inserted into the development of the market overall.
I think that is what is lacking.
IFR: Have there been any proposed solutions?
Carlos Albarracin, Milbank: There are many legal determinants. The US has traditionally been a capital markets-based financial market, whereas the rest of the world – except maybe the UK – has been a bank-centric capital market.
So when most people look at financing, the first thing they do is go to the bank. In the US, the first thing you do to raise risk capital is go to the capital markets, because investors there are culturally more accustomed to making bets in the capital markets.
In Latin America, or even in more developed markets (in Europe), making a debut issue in the capital markets is almost signaling that you have arrived, not that you are a start-up business and an emerging company. The US market is very unique in that way.
The legal determinants are so much more relevant than people think. Enforcement, rule of law, regulatory reforms to improve bankruptcy laws and the way you enforce and foreclose on collateral – Mexico is 20 years ahead of any country in Latin America in that respect because it is an OECD market; it has to do that. And the more it goes down that path, the conditions are going to be better.
There is no silver bullet for developing a market. Europe is doing it through the European Investment Bank. They are basically trying to promote project bonds by giving out full credit guarantees. Otherwise there is just no way to do project bonds in Europe, as it just isn’t liquid.
Carlos Garcia Moreno, America Movil: That was the same argument we used to hear when we were starting the Mbonos (Mexico’s long-term fixed-rate Treasury bonds). You have to start a new benchmark. There are ways of doing it.
Carlos Albarracin, Milbank: I don’t think it is a failure on Mexico’s part that they haven’t been able to pull it off. Creating a high-yield debt market, where Afores and other local investors can invest ¬¬– that would be a huge step. But it also changes the risk profile of the Afores.
That would be a game-changer for the development of the local capital markets. If you really wanted to develop the capital market, you need to allow those that have the capital to invest it – and not just to invest in the America Movils and Pemex.
Carlos Garcia Moreno, America Movil: Before you have a high-yield market, you have to have a high-grade market. It is not a lack of companies in Mexico; there are plenty of companies that should have graduated, that are already big enough to go to the capital markets. And they are somehow being shut out of the market.
Carlos Albarracin, Milbank: The FX (situation) is a big setback. I think two years ago, every other country in Latin America was facing issues with the currency and hedging. And those who did have dollar-linked cash flows couldn’t really do much in the international markets. That wasn’t an issue for Mexican companies, because the currency was so stable and predictable. But it has (become) more volatile, and it has created this new risk that people have to address more effectively than before.
IFR: I think we will finish there. On behalf of IFR, I would like to thank everyone once again for attending the roundtable this year, and for making this such an interesting discussion.