Mexican Ministry of Finance and Public Credit. Government Bond Markets: Crisis Impact and Role in Financial Sector Development

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1 Mexican Ministry of Finance and Public Credit Government Bond Markets: Crisis Impact and Role in Financial Sector Development Washington D.C. June 2010

2 Global Crisis The economic crisis was developed gradually from a mortgage and credit problem in industrialized countries into a systematic financial crisis and a generalized collapse of confidence which affected the world economy. The international crisis was the deepest in the post-war period and was characterized by the following: A global financial crisis A process of deleveraging in the international financial system A run in favor of more liquid and less risky financial instruments A generalized lack of confidence An adjustment in households balance sheets, with an increase in savings and lower consumption Negative growth was expected for the main economies in the world, followed by a slow recovery given the weakness in the balance sheets of households and financial intermediaries. 2

3 Effect of the Crisis in the Mexican Economy The Mexican economy, which in the beginning had resisted the effects of the crisis, was affected through the following channels: Real External Demand Remittances Commodity Prices Exports Consumption Public Revenues Effects of the International Crisis Tourism FDI Services Investment Financial Confidence International Financing and Markets Higher Risk Perception: Local Markets and Domestic Intermediaries Investment Consumption & Investment Consumption & Investment 3

4 Effect in Financial Variables in the Local Market The sovereign risk crisis observed in Europe this year, so far has had a smaller impact than that of the Lehman Brothers bankruptcy which was announced in September EMBI+ EMBI+ Mexico Embi+ (bps) 37,000 35,000 Mexican Stock Exchange (Units) MSE , , , Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 27,000 25,000 23,000 21,000 19,000 17,000 15,000 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Source: Bloomberg. Source: Bloomberg. 4

5 Effect in Financial Variables in the Local Market The exchange rate have lost some of the ground gained during the first quarter of However the Mexican peso has been less affected than it was during the 2008 crisis. On the other hand, medium and long-term domestic rates have dropped substantially. Exchange Rate (pesos per dollar) M Bonds Benchmarks (%) year M Bond 5-year M Bond 10-year M Bond 30-year M Bond Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Source: Bloomberg. 5 Nov-06 Jul-07 Feb-08 Oct-08 May-09 Jan-10 Source: PIP. 5

6 A Strong Legal and Regulatory Framework Modifications to the legal and regulatory framework for financial markets have been implemented in the past years towards a more efficient performance In the 90s, the financial sector did not contribute to economic growth and in some episodes it was a factor of instability. Rather than a single all encompassing structural reform in the financial sector, between 2000 and 2006 there were over 40 legislative initiatives approved and many regulatory modifications that did not require congressional approval. These incremental changes translated into a far-reaching structural reform on the financial sector. The financial sector was turned from a vulnerability and a drag on the economy into an engine for growth. Its results have become more and more tangible over time. To align legal framework of insurance sector with the current financial sector and develop better corporate governance practices among intermediaries. 6

7 A Strong Legal and Regulatory Framework The legislative initiatives and changes in regulation approved touched on a wide spectrum of financial activities. BANKING SYSTEM Reforms to the Credit Institutions Law (Jun. 01, Jun. 03 & Jun. 04) Law of Bansefi and its reform (Jun. 01 & Jun. 02) Law of Financiera Rural (Dec. 02) Law of the Sociedad Hipotecaria Federal and its reforms (Oct.01, Jun. 02 & Apr. 06) Law of Transparency and Promotion of Competition in Guaranteed Credit (Dec.02 & Jun. 03) Law for the Transparency and Ordering of Financial Services (04) Bank Resolutions (Apr. 06) NON BANK FINANCIAL INSTITUTIONS, INSURANCE AND BONDING COMPANIES Reform to the Securities Market Law (Jun. 01). The New Securities Markets Law (Dec, 05) Reform to the Ley General de Organizaciones y Actividades Auxiliares de Crédito (Jun. 01) Savings and Popular Credit Law (Jun. 01) Reform to the Insurance Law (Jan. 02, Mar. 06) Reform to the Federal Bonding Institutions Law (Jan. 02) Reform to the Law of the Comisión Nacional Bancaria y de Valores (Jun. 01) FIBRAS (Fiscal: Art. 223 y 224 LISR, Jan. 04; Bill, May 04 & Decree, Jan. 05, Dec. 05) FICAPS (Fiscal: Art 227 & 228 LISR, Dec. 05) SOFOMES (Apr. 06) INSTITUTIONAL INVESTORS Reforms to the Law of Saving Systems for Retirement (Dec. 02 & Jan. 04) Mutual Funds Law (Jun. 01) OTHER Payment Systems Law (Dec. 02) Reform to the Law for the regulation of financial institutions (Jun. 01) Law that rules the credit information companies (credit bureau) (Jan. 02) Guarantees Bill (Jun. 03) Money laundering and terrorism financing bill. (Jan. & May 04) 7

8 Local Market Previous to the crisis the Federal Government worked on the necessary conditions (macro) that need to be in place for the local market to develop on a sustainable basis. Once those were in place, other elements (micro) help to determine the level of efficiency of secondary markets. Macro Conditions Micro Conditions Macro stability Demand oriented policies Flexible exchange rate regime Development of local markets Strong banking system Infrastructure a. Institutional Investors b. Growth of domestic financial savings c. Promotion of local market among foreign investors Supply oriented policies a. Communication strategy b. Development of benchmark issues c. Improvement of the market microstructure 8

9 Measures to Aliviate the Impact in the Local Market In the financial area, some important measures were taken to mitigate the effects of the economic and financial crisis. Banco de Mexico (Banxico) began a regular program of dollar auctions in the domestic market The Federal Government adjusted the primary auction calendar, increasing the issuance of short term securities and reducing long term securities amounts Financial Measures The Instituto de Protección al Ahorro Bancario (IPAB) reduced its securities issuance Banxico implemented a repurchase program of instruments issued by the IPAB Financial Institutions were temporarily enabled to provide liquidity to Investment Funds that were part of the same financial group An interest rate swap facility was established through Banxico The establishment of temporary reciprocal currency arrangement (swap line) with the FED The Federal Government s financing from Multilateral Financial Institutions increased in 2008 and 2009 The Federal Government repurchased medium and long term government securities Banxico allowed repo transactions with bonds of lower credit quality (up toaa Mexico scale) The Comisión Nacional Bancaria y de Valores (CNBV) announced changes to the rules associated to infraestructure securities Changes in the investment regime applicable to the private pension funds (AFORES) in order to invest in a greater variety of instruments 9

10 Measures to Aliviate the Impact in the Local Market In order to complement the financial measures, other changes were introduced in the market. Other Measures Several measures were implemented to foster the national development and employment through the availability of credit in the areas of infraestructure, housing, small and medium companies and agricultural sectors National development banks employed their capital to increase the availability of credits to different sectors National development banks supported commercial paper corporate issuance, guaranteeing up to 50% of refinancing issuances. This program was focused on non-banking companies Fonadin was enforced to provide funding to infraestructure projects The Exchange Comission applied for the International Monetary Fund Flexible Credit Line facility. The contingent line was about 47 billion dollars. 10

11 Changes in the Government Securities Primary Auction Calendar In the fourth quarter of 2008, the issued amounts in the medium and long end of the curve, in both nominal and real terms were reduced significantly, meanwhile in the short end the amounts were increased. Although, the recent long-term domestic debt policy considers to return gradually to the amounts observed before this period. Instrument Frequency Initial 4 th quarter 2008 Government Securities Auction Calendar (million pesos) Modified 4 th quarter 2008 Auction 1 st quarter 2009 Auction 2 nd quarter 2009 Auction 3 rd quarter 2009 Auction 4 th quarter 2009 Auction 1 st quarter 2010 Current Auction 2 nd quarter 2010 Cetes 1 month Cetes Weekly 4,500 6,000 7,000 8,000 8,000 8,000 8,000 8,000 3 month Cetes Weekly 6,000 7,000 7,000 8,000 9,000 9,000 9,000 9,000 6 month Cetes Weekly 6,000 7,000 7,000 8,000 8,000 7,500 7,500 7, month Cetes Every 4 weeks 6,000 7,000 7,000 7,500 8,000 7,500 7,500 7,500 Nominal Fixed Rate Bonds 3 year Bond Every 4 weeks 3,100 3,100 4,500 5,000 5,000 5,000 5,500 5,500 5 year Bond Every 4 weeks 4,500 4,500 4,500 4,500 5,000 5,000 5,500 5, year Bond Every 6 weeks 7,650 1,000 2,500 4,000 4,000 4,500 25,000* 6, year Bond Every 6 weeks 4,650 1,000 2,000 2,000 2,000 2,500 3,000 3, year Bond Every 6 weeks 4,650 1,000 2,000 2,000 2,000 2,000 2,500 3,000 Udibonos (Million Udis) 3 year Udibono Every 4 weeks year Udibono Every 4 weeks year Udibono Every 4 weeks ,500* 550 Bondes D 5 year Bondes D Every 2 weeks 1,500 1,500 1,500 1,750 2,500 2,250 2,250 1,500 * Placed through the Debt Syndication Scheme, only once during the first quarter of

12 Activity in the Primary Market The changes in the primary auction calendar adjusted the market demand. During 2009, the Federal Government continued monitoring demand of Government Securities. M Bonds auctions during 2008 and year M Bond YTM (left) Demand ratio (right) year M Bond YTM (left) Demand ratio (right) year M Bond YTM (left) Demand ratio (right) Source: SHCP Auctions Auctions Auctions 12

13 Current Development of Financial Variables The measures taken during the crisis period helped to overcome the negative effects in Mexican capital markets. The main financial indicators moved towards the levels presented before September Embi+ (bps) Mexican Stock Exchange (Units) EMBI+ EMBI+ Mexico Announcement of FCL request 37,000 35,000 IPC Announcement of FCL request , Announcement of measures regarding influenza 31,000 29,000 27,000 Announcement of daily auction , , Announcement of daily auction Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Source: Bloomberg. 21,000 19,000 17,000 15,000 Announcement of measures regarding influenza Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Source: Bloomberg. 13

14 Current Development on the Local Market The exchange rate has also stabilized and long-term domestic rates are even below the levels observed before Lehman s bankruptcy in September Exchange Rate (pesos per dollar) M Bonds Benchmarks (%) Announcement of FCL request Announcement of daily auction Announcement of FCL request Announcement of measures regarding influenza Announcement of measures regarding influenza Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Source: Bloomberg. Announcement of daily auction 3-year M Bond 6 5-year M Bond 10-year M Bond 30-year M Bond 5 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Source: PIP. 14

15 Liquidity in the Secondary Market The traded amounts of M Bonds in the secondary market was significantly reduced as a result of less exposure to long term securities. As of the end of 2009, the activity in the bond market started to increase M Bonds trading (15-day moving average) 0 to 5 years 5 to 10 years > 10 años 600 Million of instruments Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Source: Banxico. 15

16 Developing Local Markets The deepness of the public debt yield curve in pesos has allowed it to work as a reference for long-term financing operations by the private sector. The rapid growth of corporate debt and asset-backed securities (ABS) markets in Mexico could hardly be explained without the existence of a risk free referential. o o The issuance of long-term debt by the private sector (Certificados Bursátiles) has grown at an annual average rate of 33 percent (2000 and 2007) Also, the outstanding volume of ABS has expanded at an annual pace of 1.2 billion dollars, in the same period. These funding possibilities have also contributed to the fast expansion of banking and non-banking credit for consumption, mortgages, and private investment, as financial firms are now able to use capital markets as a term funding alternative. 16

17 Government Securities Holdings Foreign investors participation in the local market is today at 358 billion pesos. The interest of foreign investors in the local market is a sign of their confidence in the economic policy that has been implemented during the last years. Foreign Holding in M Bonds Pension Fund Holding in M Bonds 400,000 30% 400,000 30% 360,000 28% 360,000 28% 320,000 26% 320,000 26% Million pesos 280, , ,000 24% 22% 20% 18% Million pesos 280, , ,000 24% 22% 20% 18% 160,000 16% 160,000 16% 120,000 14% 120,000 14% 80,000 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 12% 80,000 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 12% Foreign Holding (left) % of total M Bonds (right) Pension Fund Holding (left) % of total M Bonds (right) Source: Banxico. Source: Banxico. 17

18 Global Index Inclussion of Domestic Bonds Citibank announced the inclussion of Mexican Government local bonds in the World Government Bond Index as of October 2010, bringing incremental demand of Government Securities in the local market. 360, % 320, % 280,000 Incorporation to JP Morgan's GBI-EM 10.5% Million pesos 240, , , year bond Incorporation to Lehman Global Aggregate Index Mexican additional market to WGBI 10.0% 9.5% 9.0% Yield 120, % 80,000 40,000 Merryl Lynch's Global Emerging Market Sovereing Incorporation to Plus GBI-JP Morgan Active foreign investors promotion 8.0% 7.5% - Jan/01 Nov/01 Sep/02 Jul/03 May/04 Mar/05 Jan/06 Nov/06 Sep/07 Jul/08 May/09 Mar/10 7.0% Source: PIP. Foreign Holding (left) 10y Bond yield (right) 18

19 Market Makers The Market-Makers played an important role in providing liquidity in the secondary market during the crisis. Overall objective of the Market-Makers program is to promote investment in government securities, to increase liquidity in the secondary market, to promote the development of other markets associated with debt markets (derivatives, repo & securities lending) and to introduce international best practices. Maker-Makers must participate actively in primary auctions and in the secondary market, as well as comply the following obligations: benefits: A. Quote two-way rates for government securities (daily) B. Participate in primary auctions A. Green shoe option (option to buy securities one day after the auction results were disclosed) B. Borrowing facility of Government Securities with the Central Bank In September 2008, inflation linked bonds (Udibonos) were incorporated in the Market Makers Program to enhance its liquidity. 19

20 New Issuance Method: The Syndicated Debt Issuance Recently the Federal Government introduced a new issuance method in the Government Securities bond market. Debt syndication is an issuance process designed to place an adequate amount of security with a broad universe of investors. This strategy has gained popularity among a number of Eurozone countries which have used this method with the aim of accelerating the creation of domestic benchmark bonds. With the Government Auction Calendar for the fourth quarter of 2009, it would take more than 4 months to reach an adequate outstanding amount for the new benchmark bonds to have reasonable liquidity in the local secondary market. Some of the advantages of the syndication method are as follows: New benchmark bonds reach an adequate outstanding amount at the initial issue time Benchmark bonds become eligible for inclusion in the fixed income indices The issuance process is strengthened given the certainty of price, amount and broad investor distribution A broad investor base ensures liquidity of the new benchmark in the secondary market 20

21 Syndicated Debt Results Aiming at continuing with the local market development, the Federal Government decided to implement during the first quarter of 2010 this method of issuance for the new 10 year M Bond and the 30 year Udibono. Results of the Syndicated Debt Transactions Instrument Issue Date Maturity Coupon Amount (Million pesos) M % 25, % 3.0 S % 3,500* 4.27% 3.5 *Million udis. YTM Demand Bookrunners Santander, J.P. Morgan, BBVA Bancomer and BofAML Banamex, BofAML, HSBC and ING 21

22 Syndicated Debt Results M (February 23rd, 2010) S (March 23rd, 2010) Source: SHCP. 22

23 ANNEX 23

24 Development of benchmark issues The debt strategy has allowed to strengthen the fixed rate and inflation indexed benchmarks by maintaining an important outstanding amount of each reference and a reduced number of bonds along the yield curve in order to provide enough liquidity for the efficient performance of the yield curve. 30,000 Inflation-Linked Bonds 140,000 Fixed Rate Bonds 25, ,000 20, ,000 Million udis 15,000 10,000 Million pesos 80,000 60,000 40,000 5,000 20,000 0 dic-10 ene-11 jun-12 dic-12 dic-13 dic-14 jun-16 dic-17 jun-19 dic-25 nov-35 nov-40 0 dic-10 jun-11 jul-11 dic-11 jun-12 dic-12 jun-13 dic-13 jun-14 dic-14 dic-15 dic-16 dic-17 dic-18 jun-20 dic-23 dic-24 jun-27 may-29 nov-36 nov-38 On the run Off the run On the run Off the run Source: Banxico. Source: Banxico. Figures as of June 8 th Figures as of June 8 th

25 Evolution of the local yield curves Better domestic market conditions have meant a reduction in the yield curve in pesos, as well as in the real yield curve. This fact have allowed other participants on the market to issue debt bonds in better conditions. Yield Curve in Pesos (%) Real Yield Curve (%) Oct-08 Dic-08 Dic-09 Current Source: PIP. Source: PIP. Oct-08 Dic-08 Dic-09 Current 25