Mexican markets are famous for food and hand-crafted goods. But those
two words – “Mexican markets” – are increasingly evoking images of stocks
and derivatives, at least among global financial market participants. Greater
access to derivatives, economic stability and pension fund reform – which
have led to growing investments in a variety of asset classes – are
among the factors reshaping markets in Mexico.

“When the United States sneezes, Mexico catches a cold” is a saying that illustrates the interconnectedness of the Mexican and U.S. economies. But the nature of that relationship is changing, and becoming more sophisticated, as the Mexican economy diversifies and matures.

“Mexico and Latin America look good to investors, given the political risks in the Middle East and debt crisis in the European Union,” says Alfonso Garcia, president and chief executive officer of GAMAA Derivados, a brokerage firm. “Mexico has strong economic fundamentals and fiscal policies and offers good yields to foreign investors.”

Mexico boasted the world’s 14th-largest economy in 2010. Its trade with the United States and other countries has benefited from rising prices of oil and agricultural commodities. The national debt is just $108 billion – or about 30 percent of gross domestic product – and its reserves exceed $120 billion, excluding a credit line from the International Monetary Fund (IMF). Inflation is stable, at about 3 percent for the 12 months ended March 2011. Although the Mexican peso was pressured by the financial crisis – the floating exchange rate went from about 10 pesos to the U.S. dollar in August 2008 to more than 15 in March 2009 – the peso has since strengthened closer to 2008 levels.

Mexico’s growth averaged more than 3.5 percent from 2003 to 2007, according to the IMF, which also says Mexico weathered the financial crisis “relatively well.” Post-crisis, the economy is expected to grow 4.3 percent in 2011. So what is the underlying reason for the positive trends?

“We learned from the crises of the past century,” says Guillermo Camou, listed derivatives director for Scotia Capital Mexico. “Our central bank, as a regulator, is very strict in doing surveillance for best practices in risk management of the financial entities and watching for good performance of inflation. Foreign investors can be safe in Mexico.”

Markets boosted by pension fund reform

Mexico’s pension system for private sector workers was created in 1997, following reform of a separate pension system for federal workers. Mexico currently has 14 private pension fund managers – or “Afores” – which
originally invested conservatively in fixed-income instruments. Step by cautious step, regulatory limits on other asset classes were liberalized as inflation declined and investment management became more sophisticated. Today, the Afores can invest a significant percentage of assets under management in equities, derivatives, and even “capital development certificates” – private equity linked to infrastructure projects.

“The Afores have about $117 billion in assets under management, representing 13.4 percent of the Mexican financial system, and have grown by nearly 17 percent per year for the past five years,” says Pedro Ordorica, president, CONSAR, Mexico’s National Commission for the Retirement Savings System. “The Afores provide a local basis of liquidity that contributes to the efficiency, depth and liquidity of domestic markets. For example, before the Afores, it was difficult to participate in the long end of the yield curve in Mexican bonds. Today, investors know there is more liquidity in the local markets.”

In October 2010, investors’ confidence in Mexico reached new highs when the country sold $1 billion in 100-year bonds in the largest offering of century bonds to date. Also in October, Mexico became the first Latin American country to join Citigroup’s World Government Bond Index, which the bank estimates helped foreign investment in peso bonds to reach $10 billion over the previous 11 months.

BMV Group, which owns both the Mexican Derivatives Exchange (MexDer) and the stock exchange, Bolsa Mexicana de Valores, is working to increase volume and liquidity in both markets. In 2010, BMV permitted direct market access to facilitate trading by brokers who are not BMV members, and also allowed high-frequency traders to house their data servers at the stock exchange to reduce latency. Plans for 2011 include technology improvements to facilitate more complex equity trades. To foster derivatives liquidity, BMV and CME Group recently launched the first phase of an order-routing connection which will lower the cost to connect and trade (see sidebar).

In 2010, MexDer traded nearly 42.6 million contracts with a notional value of $1.6 billion, due to both domestic and international demand. Mexico’s Ministry of Agriculture offers a program to educate and incentivize Mexican farmers to hedge their risk. Large foreign banks are active MexDer participants through their Mexican bank subsidiaries, as are independent brokers in Mexico. Furthermore, foreign investors pay no Mexican withholding tax; they can trade through omnibus accounts via their home country futures commission merchants (FCMs) rather than registering in Mexico as investors; and MexDer’s triple-A-rated clearing house, Asigna, allows margins to remain in U.S. dollars. Top MexDer contracts include the 28-day Interbank Interest Rate futures, 91-day Mexican Treasury bill (“Cetes”) futures, 10- and 20-year bond futures, and the Mexican Stock Exchange Index (IPC) futures and options on futures.

“If I were an American investor, I would be very interested in Mexico’s derivatives market for diversification and profit opportunities,” summarizes Guillermo Ochoa, director, exchange-traded derivatives for Banco Santander. “We know we have to go outside Mexico to grow, so we are reaching out to new audiences – FCMs and arcades and proprietary traders. We have very reliable institutions, top-notch clearing services and global connectivity, and we are prepared to offer global service.”

In April 2011, Mexican investors found it easier than ever before to access the U.S. derivatives markets, thanks to a new direct “south-to-north” order-routing connection between CME Group and the Mexican Derivatives Exchange (MexDer). A new CME Group telecommunications hub in Mexico City enables MexDer participants to use their existing front-end trading platform or application program interface to route and execute on the CME Globex electronic trading platform. This lowers the cost to diversify investments, hedge risk across multiple exchanges, or arbitrage prices between markets and/or securities.
The second phase of cross-border access, “north-to-south,” will provide CME Group market participants with access to MexDer’s benchmark interest rate and equity index derivatives starting in the third quarter of 2011. To date, U.S. traders have expressed the strongest interest in the Mexican Stock Exchange Index (IPC) futures, U.S. dollar-Mexican peso currency futures and Mexican government bond futures.

“South to north, Mexico has developed a large institutional investor base over the past 10 to 15 years that now has direct access to CME Group markets to hedge commodities produced in Mexico, such as agricultural products, metals, oil and natural gas,” says Luis Téllez, chairman and chief executive officer of BMV Group, which owns MexDer and Bolsa Mexicana BMV. “North to south, the changes in volatility implied by normal capital flows create interesting possibilities to use MexDer to diversify financial instruments and tap new markets … Markets that are fully integrated through CME Globex will create value for investors in both countries.”

“We are confident in growth,” concludes Gloria Roa, director, BBVA Bancomer Derivatives. “Seminars and courses here in Mexico will increase demand for commodity derivatives. North to south, customers abroad will be able to trade on MexDer using CME Globex platform they are familiar with. It makes it very, very easy for foreigners.”