Developing and strengthening the local debt markets formed the focal point of Mexico's 2004 funding objectives. These they met with aplomb. Standard & Poor's rewarded what it describes as "Mexico's meticulous development of its local capital markets" with an upgrade for the country in February this year to BBB from BBB-.
"In 2004 we worked hard to develop and deepen the local debt markets. We succeeded in replacing significant external debt with domestic debt. We also aggressively promoted our local markets to foreign investors and undertook road shows across Europe and the US to share with them our strategy going forward," says former Mexican funding official Andres Conesa, who left the ministry of finance in December last year and is now working at Cintra, the holding company of Mexico's two largest airline carriers.
Foreign investors clearly liked what they heard, and there was a net inflow of close to $6 billion of new foreign investment into the local bond market last year.
In order to attract foreign investors, Conesa says that the ministry worked on implementing several structural changes to the local market.
Tax change
Pivotal to this was implementing changes to the tax regime making it comparable to that of developed markets. "In 2004 we promoted abroad a favourable fiscal regime for offshore participants. Now no withholding tax applies to foreign investors on their investments on government securities."
Mexico is now also included in JP Morgan's government bond index (at the beginning of 2003) and Lehman Brothers Global Aggregate index (at the beginning of 2005).
Capitalizing on this, Conesa and his team took to the skies to spread the word, with three road shows in 2004 and early 2005 across Europe and the US.
"The fact that Mexico is now included in these indices forces the investors who track the indices on a passive basis to participate in the Mexican market, and that draws greater global attention to the market," says Conesa's replacement, Gerardo Rodriguez.
Rodriguez says that attracting these investors is critical to the long-term success of Mexico's local markets. "Typically these buyers want longer-term bonds and that is consistent with what we are doing on the supply side."
Domestic debt
In 2004 the ministry worked to build the domestic debt curve to 20 years, as well as boosting liquidity in all tenors. One way they achieved this was by adopting a policy of re-opening bonds, rather than launching a series of new bonds. "The idea is that we have benchmark bonds of around $8 billion to $9 billion in every part of the curve. The idea is to have fewer benchmarks, more liquidity and less volatility," says Conesa.
Rodriguez believes that foreign participation will also help with technology transfer. "We have a relatively young asset management industry here in Mexico, and the hope is that foreign participants will bring more sophisticated tools and strategies into the market and also encourage greater quantitative and strategic research."
There has been a positive knock-on effect for Mexican corporates. "This has also been hugely beneficial to the private sector," says Conesa. "Before, they had to rely on either short-term or non-peso funding. They now have many more options available in the local markets."
Repo market changes
Conesa says that in 2004 final adjustments were also made to enable foreign participants to finance their positions in the repo market for the first time.
An important regulatory change came with the development of a strips market. The ministry of finance and the central bank issued the Strips Market Operation Rules, which allow market participants to strip any of the existing bonos and udibonos. "Market participants are starting to strip their securities and trade them on a separate basis," says Rodriguez.
He adds that the government is also making a concerted effort to reduce their reliance on floating-rate paper. "Historically this has been an important source of funding for us, but we reduced levels in 2004 and in 2005 we are cancelling all floating-rate issuance in the local market."
S&P report
In a report from January this year S&P stated: "Growing domestic debt markets are allowing Mexico to sidestep one of the historic weaknesses of most Latin American sovereigns, namely the inability to raise fixed-rate, long-term debt in local currency."
It continues: "About two-thirds of the central government's debt stock is now denominated in local currency, reducing rollover risk and the impact of adverse external developments in financial markets. Furthermore, about one-half of this debt carries fixed nominal interest rates of one year or longer, compared with only 14% in 2000."
Positive developments in the local market meant that the Mexican government was in the privileged position of cherry picking the size and timing of its international transactions.
It remained mainly an exercise in liability management, with Mexico buying back about $3 billion of higher yielding global debt by adding $2 billion to its 2033s and $815 million to its 2014s. Although international issuance was limited the sovereign did succeed in its objective of diversifying its investor base.
In November, Mexico issued the longest ever euro-denominated bond by an emerging market issuer (since surpassed by Pemex), with a †750 million 5.5% 15 year, arranged by CSFB.
Sterling
Mexico also dipped its toes into the sterling market with a £500 million of 6.75% 2024's, arranged by Barclays and HSBC, making it the largest and longest sterling bond issued by an emerging market credit. This was the first time Mexico has tapped the sterling market since 1997.
"With this deal we accessed some of the UK's core high-grade investor base. It was a successful re-entry into that market," says Rodriguez.
In 2005 the sovereign will continue to diversify its investor base. "We now have the time and opportunity to develop new markets as funding sources, and we are looking at the smaller non-core markets. As we have moved up the credit curve new issuance opportunities have opened up and we are looking at all of them, including the Canadian dollar and Swiss franc markets," says Rodriguez.