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Cablegate: Private Sector Officials Comment On Challenges

VZCZCXRO3729
PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #6187/01 3511439
ZNR UUUUU ZZH
P 171439Z DEC 07
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 9928
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RHEHNSC/NSC WASHDC
RHMFIUU/CDR USSOUTHCOM MIAMI FL
RHMFIUU/CDR USNORTHCOM
RUEHC/DEPT OF LABOR WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 04 MEXICO 006187

SIPDIS

SENSITIVE
SIPDIS

STATE FOR A/S SHANNON
STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH
STATE FOR EB/ESC MCMANUS AND IZZO
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD
USDOC FOR ITA (ISRALY ECHEGARAY)
TREASURY FOR IA (ALICE FAIBISHENKO, ANNA JEWEL)
TREASURY FOR OCC/IBF (SUSAN QUILL)
TREASURY FOR IBSMO (WILBUR MONROE, BILL FOSTER)
CFTC FOR OIA (WARREN GORLICK)
NSC FOR RICHARD MILES, DAN FISK
EXIM FOR MICHELE WILKINS
SEC FOR OIA (SHAUNA STEELE)
STATE PASS TO USTR (EISSENSTAT/MELLE/SHIGETOMI)
STATE PASS TO FEDERAL RESERVE (ANDREA RAFFO/ANN MISBACK)

E.O. 12958: N/A
TAGS: ECON ELAB EFIN PINR PGOV MX
SUBJECT: PRIVATE SECTOR OFFICIALS COMMENT ON CHALLENGES
FACING MEXICO'S SECURITIES REGIME

REF: MEXICO 5858

-------
Summary
-------

1. (SBU) Mexico has made great strides in strengthening its
securities regime over the past several years, but additional
work is needed to develop these markets. Conversations with
local experts show that the following issues hold back
growth: restrictions on institutional investors; an
inefficient repurchase agreement market; a lack of an "equity
culture;" lackluster leadership at the stock exchange;
lagging financial expertise; high fees; poor enforcement
capabilities; and a slow judicial system. Addressing these
issues would not only directly benefit these markets, it also
would help boost economic growth and create much needed
employment. End Summary.

--------------------------------------------- ----
Securities Regime Has Improved in Recent Years...
--------------------------------------------- ----

2. (U) Mexico has made great strides in strengthening its
securities regime over the past several years. The most
important recent advancement is the 2005 Securities Market
Law, which further expanded the National Banking and
Securities Commission's (CNBV) authority, improved the
corporate governance of publicly listed companies, increased
the rights of minority shareholders, and created two new
corporate vehicles, which were designed to facilitate the
ability of small- and medium-sized companies (SMEs) to raise
capital and transition to public listed company status. This
law brought Mexico's regulatory framework largely in line
with international standards.

3. (U) Mexico's stock exchange -- the region's largest after
Brazil's -- has posted steep gains since 2003. The 47% yield
on the primary equity market index (IPC for its Spanish
acronym) last year made it the twelfth top performing index
among the world's largest 50 markets, and ninth among the 23
leading emerging markets. Moreover, the corporate debt
market is growing quickly. The market is deep and the tenure
is long -- in part due to the participation of pension fund
administrators (Afores). The longest tenure is 30 years at a
fixed rate, though most companies have access to 3 to 5-year
financing.

-------------------------------------------
... But Outstanding Issues Hold Back Growth
-------------------------------------------

4. (U) Despite these successes, significant weaknesses
remain. The stock market is small, illiquid, and not a major
source of financing for most firms. Companies remain wary of
listing on the stock exchange, and larger Mexican firms often
prefer to list on international exchanges. This usually
takes the form of cross listing in the U.S. market through
American Depositary Receipts (ADRs). The number of listed
companies has fallen from 193 in 1996, to 177 in 2000, and to
132 in mid-December 2007. Daily trading remains highly
concentrated in a small number of issuers. The six most
heavily traded stocks -- America Movil, Wal-Mart de Mexico,
America Telecom, Telmex, Cemex, and Grupo Televisa --
accounted for 64% of trading last year. Moreover, the top
ten companies represented 77% of market capitalization in
2006.

5. (U) Conversations with local experts show that Mexico must

MEXICO 00006187 002 OF 004


address the following issues to strengthen its securities
markets.

Restrictions that Limit Market Depth
------------------------------------
6. (SBU) Restrictions on institutional investors impede the
development of Mexico's securities regime. A debt and
derivatives expert at Merrill Lynch Mexico told econoff and
visiting Treasury officials that the playing field needs to
be leveled among institutional investors. He said that
pension fund investment regimes are fairly developed, while
mutual funds are starting to grow and insurance funds are
underdeveloped. Meanwhile, investment restrictions create
artificial liquidity barriers. Insurance funds are extremely
limited by investment restrictions. Afores lack instruments
to invest in, investment methodology, and training for
employees. An equity markets expert at Accival added that
Afores can invest in Mexico's version of real estate
investment trusts (Fibras) and a special corporate vehicle
called an Investment Promotion Corporation (SAPI), but they
cannot invest in individual company stocks, only index funds
or exchange-traded funds. Pension funds are limited in how
much they can invest in equities, and foreign investments can
only account for up to 20 percent of total assets under their
management. Accival believes the next step should be to
allow pension funds to buy individual stocks.

7. (SBU) An investment banking executive at Goldman Sachs
said the Mexican authorities need to develop the repurchase
agreement (repo) market, which is inefficient, and allow
institutional investors to short securities and purchase
credit default swaps (CDS) for hedging purposes. He said
that investors will be more comfortable holding long
positions if they can short. Merrill noted that the Bank of
Mexico (BOM) last year allowed banks to participate in the
CDS market, but regulated institutional investors still
cannot trade derivatives. This limits the latter's ability
to hedge. The official from Goldman added that institutional
investors own mostly government securities and, therefore,
need more options to diversify. Moreover, pension,
insurance, and mutual funds have large debt exposures and
liquidity problems, making it difficult for them to manage
risk. He said that while banks can buy credit derivatives,
regulators deter purchases through heavy restrictions.
Merrill told econoff and the Treasury officials that the BOM
is working on allowing institutional investors access to the
CDS market.

8. (SBU) Separately, unlike in Brazil, the large state-run
oil and utility companies are not publicly traded. Listing
these companies would add much needed depth to the market.
Government officials in thQast proposed allowing Pemex to
issue pseudo-shares giving the bearer a claim on Pemex
profits, but some legislators opposed the idea.

Lackluster Government Authorities
---------------------------------
9. (SBU) Two of the local experts criticized Mexican Stock
Exchange (BMV) authorities. One remarked that Guillermo
Prieto, the President of the BMV, has been in his position
for eight years and is more concerned with his future in
politics than with growing the stock exchange. The brokerage
houses do not necessarily trust what BMV officials tell
investors, and therefore, there is a limited level of trust
and weak communication. The official believes that the BMV
leadership operates to enforce the law, rather than to
promote advancements, which has resulted in a dearth of IPOs.
Another official said that the owners of the BMV want
complete control over the exchange, adding that this is

MEXICO 00006187 003 OF 004


driving the exchange into irrelevance.

10. (SBU) One of the officials remarked that while the BOM is
very good, it is too risk averse. The shock from the 1994
Peso Crisis still has a strong impact on the organization's
philosophy. He believes the BOM is not modernizing the
financial markets fast enough.

Insufficient Financial Expertise
--------------------------------
11. (SBU) Mexico lags significantly behind the U.S. and
Brazil with regards to the level of education and training of
its financial professionals. Fund managers often lack the
skills needed to operate in a sophisticated market. Accival
stated that there are only 46 chartered financial analysts
(CFAs) in Mexico, compared to twice that in Brazil.

Lack of Equity Culture
----------------------
12. (SBU) The lack of an "equity culture" in Mexico was also
cited as an impediment to the stock exchange's development.
Accival said that Mexican entrepreneurs are "afraid of
lQing." They are reluctant to lose control of family-run
businesses, and consider the costs to be much higher than the
benefits.

13. (SBU) Accival believes Mexican authorities need to do
more to educate SMEs about the benefits of equity markets and
globalization. He said the average Mexican believes that
only the rich benefit from the equity market, but this is not
true given that equity markets have had a positive real
return in recent years -- something that was not the case as
recently as five years ago.

Fee Structure
-------------
14. (SBU) A series of fees also affect financial sector
development. The official from Merrill remarked that the
deposit insurance fund (Institute for the Protection of Bank
Savings, IPAB) fee needs to be reduced. He said the
government collects an annual fee of 40 basis points on
deposits and securities that are issued. This creates
distortions in the market, but the government has little
incentive to remove this tax since it is a big revenue
generator. Merrill added that fees to issue debt and equity
are also high. While underwriting fees are low relative to
the U.S., registration fees from the National Banking and
Securities Commission (CNBV) and listing fees from the BMV
are high.

Enforcement and Legal Issues
----------------------------
15. (SBU) While a senior CNBV official has remarked in
private that the government's enforcement capabilities need
to be improved through increased resources and training, the
official from Merrill said that Mexico is "in a good place"
on this issue. He does not see the need to go in the
direction of the U.S. with Sarbanes-Oxley. He added,
however, that Mexico's legal system "is a mess." Judges are
corrupt, the judicial process is very slow, and there is a
lack of transparency and professionalism.

-------
Comment
-------

16. (SBU) While recent improvements should not be overlooked,
Mexico's securities regime has a long way to go before it
corresponds to the economy's size and potential. Work needs

MEXICO 00006187 004 OF 004


to be done to improve efficiency, encourage the participation
of smaller firms, develop products for more aggressive
investors, etc. Hopefully, an eventual IPO of the stock
exchange will help Mexico address some of these issues.

17. (SBU) The discussions with local experts highlighted the
importance of economic reform, competition and educational
reform in particular. The exchange is undoubtedly held back
by the prevalence of large monopolies and oligopolies, the
owners of which retain significant political and economic
influence in Mexico. Moreover, a solid educational system is
needed if the average Mexican is going to be able to take
advantage of opportunities that arise from an improved
securities regime. In this context, it is important to
stress basic financial literacy and the development of
sophisticated financial expertise.


Visit Mexico City's Classified Web Site at
http://www.state.sgov.gov/p/wha/mexicocity and the North American
Partnership Blog at http://www.intelink.gov/communities/state/nap /
BASSETT

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