The development of local financial markets: the Mexican experience

1
The development of local financial markets the
Mexican experience
October 2008
2
Index

• Foundations
• Development
• Challenges
• Conclusions

3
Foundations

• Macroeconomic Stability
• Sound Monetary and Fiscal Policies
• Structural Reforms
• Market determined exchange rate
• Unrestricted capital mobility
• Pension system reforms
• Strengthening of the legal framework for the
  banking system
• Development of derivate market
• Secondary Reforms
• Improvement in liquidity and payment systems
• Investor protection and transparency
• Credit bureau
• Instrument regulation
• Repo
• Securities Lending
• Strips
• Securitization

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Foundations

• Development of the government local debt market
• Development of local nominal yield curve
• Preference of local vs. foreign debt
• Broadening of investor base
• Enhanced liquidity
• Transparency
• "Benchmark" securities
• Market makers program

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Development Foreign exchange market

• The degree of development reached by local
  markets has fostered the participation of foreign
  investors.
• Currently, the Mexican peso is the most actively
  traded emerging currency and exhibits the lowest
  volatility.

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Development Foreign exchange market
7
Development Local debt market

• The extension of the yield curve, market friendly
  debt management practices and a broader investor
  base have contributed to the development of the
  local debt market.

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Development Local debt market
January to September.
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Development Local debt market
10
Development Local debt market
10
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Development Local debt market
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Development Derivatives market

• 1977 The first Mexican financial instrument
  similar to a derivative was the Petrobono (a
  government bond whose value was linked to
  international oil prices and the MX/US exchange
  rate)
• 1978-1982 Currency futures on the MXN were
  initially listed on the Chicago Mercantile
  Exchange (CME).
• 1983-1987 Stock futures traded on the Mexican
  Stock Exchange (BMV). Did not survive due to
  insufficient volumes.
• 1987-1994 Short-run hedging FX mechanism.

13
Development Derivatives market

• Early 1990s Mexican derivatives developed, but
  legal framework was still inadequate
• Warrants
• 1995 Mexican peso derivatives traded in CME.
• 1996 Mexican Interest Rate derivatives in CME,
  with futures and options on Brady Bonds.
• 1996-1997 Banxico issued regulation allowing
  banks and brokerage houses to carry out OTC
  forward operations on interest rates and Mexican
  pesos. Swaps and other type of forward
  transactions were later added to the OTC scheme.
• Thereafter Options and futures on CETES and
  TIIE.
• The main volume of derivative contracts is linked
  to 28-day TIIE futures contracts.

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Development Derivatives market

• The Mexican Derivatives Exchange (MexDer) was
  officially launched on late 1998.
• The purpose was to create an organized
  derivatives exchange inside Mexico.
• One of the problems for the development of
  derivatives was the lack of (underlying)
  financial instruments and sufficiently sizeable
  markets to allow participants to diversify their
  portfolios and hedge risks.

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Development Derivatives market
16
Development Derivatives market
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January- August.
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Development Derivatives market

• The extension of the yield curve and the enhanced
  liquidity have allowed a higher degree of
  sophistication in the market through the use of
  derivatives.

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Development Derivatives market
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Development Corporates

• Private issuers have benefited from the
  development of the local government debt market
  and the participation of institutional investors
  like pension funds and mutual funds.

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Development Corporates
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Development Asset backed securities market

• An additional evidence regarding the degree of
  sophistication in the local market has been the
  securitization of loans.

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Development Asset backed securities market
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Challenges Securities lending

• There is a great potential for a securities
  lending market to develop.
• At the moment there is a facility at the central
  bank which is fully used and its only available
  for market makers.
• Recently, financial authorities have promoted
  this figure among financial institutions.

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Challenges Credit derivatives market

• An additional challenge will be the development
  of a safe credit derivatives market.
• Current regulation allows only banks to
  intermediate credit derivatives operations.
• Recent financial volatility in the global markets
  has made financial authorities more conservative
  with regards to regulation.

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Conclusions

• The development of the Mexican financial markets
  had been favored by a friendly international
  environment that includes abundance of liquidity,
  low interest rates and, a consequent search for
  yield by a wide variety of market participants.
• Recently, this environment has changed. As
  opposed to other volatility episodes, this time
  the financial turmoil came from developed
  markets.
• The degree of development in the local market has
  mitigated the impact of the global financial
  turmoil. This situation is not exclusive to
  Mexico, those countries committed with the
  development of their markets have shown a better
  resilience to the credit crisis.
• Important progress has been made and the main
  building blocks of the financial system are now
  close to being fully operational.
• The recent developments on the international
  financial markets, especially in the U.S., call
  for a review of supervision and regulation. On
  the one hand, it should continue to allow market
  initiative, but on the other hand, give
  sufficient capitalization and strength to cope
  with market adjustments when necessary.