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18 January 2005
Mexican retirement mutual funds (RMFs) may now access international markets for investment purposes.(1) RMFs manage over $40 billion in assets. This update analyzes some of the key features of the applicable legal framework. It focuses on investment opportunities and risks involved in such access through, for instance, derivative transactions.
In 1995 the Mexican social security system was amended to introduce a mandatory retirement savings system based on a two-category scheme formed by managing entities(2) and investment funds. Hence, retirement savings administrators manage individual retirement accounts and invest public savings through RMFs. The previous 'pay as you go' system was based on collective funds which were distributed to individuals commencing their retirement.
The retirement savings system is governed by the following:
The commission's General Rulings 15-12 and 56-1 set out the new RMF investment regime, while the bank's Ruling 1/2002 governs derivative transactions entered into by RMFs.
Federal government goals may be considered to be the starting point of this legal framework. An expansion of the investment regime seeks to:
The commission's General Ruling 56-1 mandates the need to conduct a legal review or due diligence. This legal due diligence (as opposed to a financial or accounting due diligence) focuses on analyzing the compliance of RMFs with the legal framework applicable to investments abroad.
The incorporation of an RMF requires the commission's authorization and a prior positive opinion by the ministry. RMFs must be organized as variable capital corporations.
RMFs are divided into two basic categories: Basic 1 and Basic 2. The criteria for this distinction are based on the following:
Thus, the commission's General Ruling 15-12 implements general distinctive criteria for RMFs as provided by the Law on Retirement Saving Systems, namely risk levels, terms, and origin and destination of funds.
Moreover, General Ruling 15-12 provides for two types of additional RMFs. These types are available only for certain employee funds.
General Ruling 15-12 focuses on the value at risk as a fundamental market risk indicator. This term is defined as the RMF's net asset depreciation given a 95% confidence level. By contrast, foreign regulators concentrate on and even list a series of risks, including market, credit, settlement, liquidity, operations and systems, and legal risks.(4)
Any RMF must keep an upper limit of value at risk. Such limit is defined as the depreciation that the net assets of an RMF may experience given a certain level of confidence within a certain period. Specifically, the risk or upper limit of value at risk for Basic 1 and Basic 2 is 0.6% of the aggregate net assets, calculated pursuant to a specific methodology.(5)
RMFs themselves must identify and keep track of the level of their value at risk. Rule 4 of General Ruling 15-12 is thus in line with the role of foreign regulators:
"in supervising capital markets and trading activities...[in order] to evaluate management's ability to identify, measure, monitor and control the risks involved in these activities and…ensure that institutions have sufficient capital to support the risks they take."(6)
The primary objective of investment regimes as stated in the Law on Retirement Saving Systems is to provide the highest security and profitability to employee funds.
Each RMF may determine its investment regime in accordance with the limits which are set forth in General Ruling 15-12. The regime must be contemplated in the corresponding prospectus. The Law on Retirement Saving Systems requires minimum information standards for these prospectuses (eg, on risk, term, investment requirements and rights).
The investment regime follows the type of RMF. General Ruling 15-12 provides one regime for Basic 1 and another for Basic 2, which is also applicable mutatis mutandis (ie, with the necessary alterations) to the additional RMFs. Foreign securities comprise a significant difference between the regimes. Basic 1 RMFs may invest up to 20% of their net assets in foreign debt securities, known in the market as fixed rent or fixed income securities, while Basic 2 RMF portfolios may also include foreign issuers' variable rent securities.
Compliance with the applicable investment regime must be monitored on a daily basis. The specific instruments, foreign securities and derivatives to be traded shall be selected by each RMF's investment committee, and debt securities must meet minimum credit ratings.
Value at risk is also used for control purposes. Should depreciation fall below permitted levels, RMFs must adjust to reach permitted levels.(7)
In addition to investment limits and prospectus provisions, RMFs must observe guidelines regarding best industry practices. These guidelines are intended to minimize and control RMF custody risks derived from derivative and other transactions (eg, involving cash).
According to General Ruling 15-12, the size and characteristics of the Mexican financial markets are the main reasons for expanding the scope of the RMF investment regimes. The commission points to a reduced domestic offer and its insufficient growth rate as the imperative to open the RMF investment regime to foreign securities, denominated in certain foreign currencies (ie, the euro, yen and US dollar).
The achievement of the government's goals depends on access to international markets. Beyond sound risk management practices, ethics and compliance, proper legal advice and good contacts with the regulators may play key roles in the avoidance of losses recently experienced by mutual funds on, for instance, the US financial market. A thorough insight in this regard may provide valuable criteria for investors' decision-making processes and eventual approach to the regulators.
Relevant US experience
The success of the investment opportunities presented by the new access to international markets by RMFs also depends on establishing an adequate balance between risks and applicable regulation. The results of the Sarbanes-Oxley Act(8) are illustrative. In other words, overregulation does not (necessarily) lead to efficient market control. Actually, it can affect market performance adversely.
Foreign experiences should be considered by the Mexican Congress and the executive branch, as these are beginning to develop a complex legal and administrative framework to govern RMFs.(9)
Complexity can be understood by the need to control RMFs and protect public savings. However, complexity should not entail excessive regulation that hinders or even prevents the intended governmental goals. On the contrary, it should facilitate the regulator's ability to accomplish its objective to:
"determine when risk exposures either become excessive relative to the financial institution's capital position and financial condition, or have not been identified to the extent that the situation represents an unsafe and unsound…practice."(10)
Market players have been preparing diligently to take advantage of the opportunities which the new investment regime presents.
For further information on this topic please contact Agustín Berdeja or Stephan Tribukait at Berdeja y Asociados SC by telephone (+52 55 2591 1100) or by fax (+52 55 2591 1106) or by email (firstname.lastname@example.org or email@example.com).
(2) At least 51% of the retirement savings administrators' capital stock must be held by (i) Mexican individuals, or (ii) Mexican entities, the capital stock of which must be effectively controlled by Mexicans pursuant to Article 21 of the Law on Retirement Saving Systems.
(4) See Board of Governors of the Federal Reserve System, Trading and Capital Markets Activities Manual (1998), available at http://www.federalreserve.gov.
(7) This must be done by cancelling from the RMF's position the number of variable capital stock resulting from dividing the depreciation amount by the fair market value of the RMF's stock. See Rule 7 of General Ruling 15-12.
(8) See http://news.ft.com/home/us.
Despite better than expected results, these figures may hardly be considered
to be an incentive for the US financial markets. For further evidence, see the
recent decision by US authorities to extend a relevant deadline in favour of
small and medium-sized enterprises.
(9) Four new general rulings were published in the Federal Register on January 17 2005. These deal with, among other things, prudential rules for derivate transactions, notes, account individualization, and capitalization requirements. An accord implementing General Ruling 15-12 was published on the same date. This accord broadens the list of authorized indexes.
(10) Board of Governors of the Federal Reserve System, Trading and Capital Markets Activities Manual, Section 2000.1. Note that this manual "seeks to provide the examiner with guidance for reviewing capital markets and trading activities at all types and sizes of financial institutions." Id.
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Agustín Berdeja Prieto