1 june, 2003 mexican ministry of finance and public credit regulatory framework and development of...

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June, 2003June, 2003

Mexican Ministry of Mexican Ministry of Finance and Finance and Public CreditPublic Credit

REGULATORY FRAMEWORK AND DEVELOPMENT REGULATORY FRAMEWORK AND DEVELOPMENT OF DERIVATIVES MARKETS IN MEXICOOF DERIVATIVES MARKETS IN MEXICO

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AgendaAgenda

I.I. Conditions PrecedentConditions Precedent Macroeconomic StabilityMacroeconomic Stability

Development of the Government Bond MarketDevelopment of the Government Bond Market

II.II. Regulatory FrameworkRegulatory Framework Banking InstitutionsBanking Institutions

Pension Funds (Afores)Pension Funds (Afores)

III.III. Development of Derivatives Markets Development of Derivatives Markets OTCOTC

Exchange TradedExchange Traded

3

-1.25 -1.24

-1.10

-0.61

-0.50

-0.73

1998 1999 2000 2001 2002 */ 2003 p/

Fiscal DeficitFiscal Deficit(% of GDP)(% of GDP)

Fiscal DisciplineFiscal Discipline

To achieve a smaller fiscal deficit, the Federal Government is carrying out an effort in order to improve the tax administration, to reduce the government expenses and to achieve a better fulfillment of the fiscal laws.

*/ Excluding Banrural*/ Excluding Banrural

pp// ProjectedProjected

4

Inflation and Monetary Policy Inflation and Monetary Policy 1999-Apr 20031999-Apr 2003

Monetary DisciplineMonetary Discipline

The Central Bank has tightened monetary policy aggressively in order to bring down inflation and keep it under control.

0

100

200

300

400

500

600

700

800

Feb

-99

Apr

-99

Jun-

99

Aug

-99

Oct

-99

Dec

-99

Feb

-00

Apr

-00

Jun-

00

Aug

-00

Oct

-00

Dec

-00

Feb

-01

Apr

-01

Jun-

01

Aug

-01

Oct

-01

Dec

-01

Feb

-02

Apr

-02

Jun-

02

Aug

-02

Oct

-02

Dec

-02

Feb

-03

Apr

-03

3%

5%

7%

9%

11%

13%

15%

17%

19%

"Corto" Inflation Core Inflation

5

Fiscal and Monetary Discipline have contributed to the Fiscal and Monetary Discipline have contributed to the economic stability environment, which has been reflected economic stability environment, which has been reflected in an important decrease in long term interest rates.in an important decrease in long term interest rates.

Daily Secondary Market Rates 2000- May 2003 (%)

Evolution of Local Interest RatesEvolution of Local Interest Rates

6

8

10

12

14

16

18

20

De

c-0

0

Jan

-01

Jan

-01

Fe

b-0

1

Ma

r-0

1

Ap

r-0

1

Ma

y-0

1

Jun

-01

Jul-

01

Au

g-0

1

Se

p-0

1

Oct

-01

No

v-0

1

De

c-0

1

De

c-0

1

Jan

-02

Fe

b-0

2

Ma

r-0

2

Ap

r-0

2

Ma

y-0

2

Jun

-02

Jul-

02

Au

g-0

2

Se

p-0

2

Oct

-02

No

v-0

2

De

c-0

2

De

c-0

2

Jan

-03

Fe

b-0

3

Ma

r-0

3

Ap

r-0

3

Ma

y-0

3

1-year Cete 3-year Bono 5-year Bono

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The Federal Government has undertaken a number of different steps to The Federal Government has undertaken a number of different steps to promote the development of the domestic Government Bond Market, promote the development of the domestic Government Bond Market, including the following:including the following:

1. 1. Announcement of the quarterly auctions scheduleAnnouncement of the quarterly auctions schedule: this announcement : this announcement gives certainty to the market regarding the supply by type of instrument.gives certainty to the market regarding the supply by type of instrument.

SecurityDate

Short-term fixed rate Long-term fixed rateFloating

RateInflationindexed

April 1 Cetes 1, 3, 6 and 12 months 10-year bond BondesApril 8 Cetes 1 and 3 months 5-year andApril 14 Cetes 1, 3, 6 and 12 months Bondes

April 22 Cetes 1 and 3 months3-year Bond7-year Bond

April 28 Cetes 1, 3, 6 and 12 months 10-year bond BondesMay 6 Cetes 1 and 3 months 5-year Bond UdibonosMay 13 Cetes 1, 3, 6 and 12 months Bondes

May 20 Cetes 1 and 3 months3-year Bond7-year Bond

May 27 Cetes 1, 3, 6 and 12 months 10-year Bond BondesJune 3 Cetes 1 and 3 months 5-year BondJune 10 Cetes 1, 3, 6 and 12 months Bondes

June 17 Cetes 1 and 3 months3-year Bond7-year Bond

Udibonos

June 24 Cetes 1, 3, 6 and 12 months 10-year Bond Bondes

Auction Calendar April-June 2003

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2. Modification of primary auction timetable: starting in August 6, 2002, participants know the results of the auction while the markets are still open.

Previous Current

Bid submission 13:30 13:00General Results 15:00 13:30Specific Results 15:00 14:00

Market Makers Green Shoe 18:00 14:00

EventSchedule

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3. Issuance of long term fixed rate bonds: starting in 2000, the Government has been issuing regularly three and five year fixed rate bonds, ten year bonds since July 2001 and seven year instruments since August 2002.

Net Domestic Borrowing by type of SecurityNet Domestic Borrowing by type of Security

17.20% 17.40%41.30%

18.40%

66.50%89.10%

29.80%

16.30%29.20%

68.60%96.50%

5.30%

1.90%12.50%

-3.70%-6.60%

-20%

0%

20%

40%

60%

80%

100%

120%

1998 1999 2000 2001 2002

Cetes Floating Rate Notes Inflation Indexed Fixed Rate Bonds 3, 5 and 10 year

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4. Extension of yield curve out to ten years.

Evolution of the Interest Rate CurveEvolution of the Interest Rate Curve

4

6

8

10

12

14

16

18

20

0 1 2 3 4 5 6 7 8 9 10

Nov, 1999 Jan, 2000 May, 2000 Jul, 2001 May, 2003

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5. Reopening of outstanding issues: the reopening of Benchmark issues has given more liquidity to the market.

0

5,000

10,000

15,000

20,000

25,000

7 28 56 112 728 980 1645 3234Days to maturity

Mill

ion

pe

so

s

Cetes and Bonos outstanding issues

Cetes 364

Cetes 364

Cetes 364

Cetes 182Cetes 182

Cetes 182

Cetes 182

Cetes 91Cetes 91

Cetes 91Cetes 28 Cetes 28

Bono 03

Bono 03

Bono 05

Bono 05 Bono 10

Dif

fere

nt

Pla

cem

ents

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6. Improvement in the composition of Domestic Debt: as a result of the issuing strategy, the proportion of floating rate instruments as a component of the domestic debt has been reduced, whereas the proportion of fixed rate instruments has been increased.

Internal Debt Composition by Type of Instrument

53%39%

30% 32% 29% 23%

31%41% 53% 48%

43%36%

15%30%

15% 13% 11%

6%

20%16% 17%

0%

20%

40%

60%

80%

100%

1997 1998 1999 2000 2001 2002

Cetes Floating Rate Fixed Rate Inflation-Indexed Bonds

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7. Improvement of maturity profile: the amortization profile has been improved significantly, reducing refinancing risk.

0%

10%

20%

30%

40%

50%

1 2 3 4 5 6 7 8 9 10 11years

1998 2002

Amortization Profile of Domestic DebtAmortization Profile of Domestic DebtDec 31 each yearDec 31 each year

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8. Introduction of the Market Makers Program (Oct 2000): The objectives of the program are:The objectives of the program are:

-- To increase the liquidity and depth of the secondary To increase the liquidity and depth of the secondary market of domestic debt.market of domestic debt.

-- To promote the investment on government securities To promote the investment on government securities among the general publicamong the general public.

The Market Makers have the following obligations:The Market Makers have the following obligations: Place bids for the minimum of 20% and the ratio 1/(number of Place bids for the minimum of 20% and the ratio 1/(number of

market makers) of the auctioned value for each of the Cetes and market makers) of the auctioned value for each of the Cetes and Bonos issues.Bonos issues.

Maintain bid-offer quotes for Cetes and Bonos with authorized Maintain bid-offer quotes for Cetes and Bonos with authorized brokers for a minimum amount of 20 million pesos.brokers for a minimum amount of 20 million pesos.

Provide authorities with all necessary information to quantify Provide authorities with all necessary information to quantify their activity in the markets.their activity in the markets.

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8. Introduction of the Market Makers Program (Oct 2002):

In exchange for the following rights:In exchange for the following rights: An option to buy additional securities after the primary auction An option to buy additional securities after the primary auction

(Green Shoe). (Green Shoe). Borrow Securities from the Central Bank.Borrow Securities from the Central Bank. Periodic meetings with Government Officials.Periodic meetings with Government Officials.

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AgendaAgenda





III.III. Development of Derivatives Markets Development of Derivatives Markets OTCOTC


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Banking InstitutionsBanking Institutions The Central Bank is the entity responsible for regulating The Central Bank is the entity responsible for regulating

derivatives operations of Banking Institutions.derivatives operations of Banking Institutions. In 1996 the Central Bank issued a new regulation for derivatives In 1996 the Central Bank issued a new regulation for derivatives

(known as the 31 points) based on the following concepts:(known as the 31 points) based on the following concepts:

• Breakdown of Breakdown of geographic barriers to geographic barriers to the provision of the provision of financial services.financial services.

• Users of financial Users of financial services as well as services as well as intermediaries are intermediaries are global corporations. global corporations. National linkages are National linkages are replaced by corporate replaced by corporate structures.structures.

The wave of trade liberalization and

deregulation of the 1980´s is now followed by a

revolution in the financial sector

GlobalizationGlobalization InnovationInnovation

• New and more New and more complex financial complex financial products.products.

• New forms of New forms of financing, hedging financing, hedging and savings and savings appear everyday appear everyday with remarkable with remarkable speed.speed.

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Criteria of new regulationCriteria of new regulation

The two basic building blocks for a modern regulatory framework The two basic building blocks for a modern regulatory framework are the development of a culture for effective risk management and are the development of a culture for effective risk management and a set of basic rules conducive to the self-regulation of participants a set of basic rules conducive to the self-regulation of participants and markets.and markets.

Self-regulationSelf-regulation

Increasing role of Increasing role of marketsmarkets

Developing a culture for Developing a culture for risk management within risk management within

institutionsinstitutions

Risk Risk ManagementManagement

18The “31 points” were designed to make sure that banking The “31 points” were designed to make sure that banking institutions were fully aware of the risks involved in institutions were fully aware of the risks involved in derivative transactionsderivative transactions

These Guidelines were inspired on best practice principles and These Guidelines were inspired on best practice principles and recommendations of international institutions. Specifically, rules and recommendations of international institutions. Specifically, rules and regulations closely follow international standards set by the G-30 regulations closely follow international standards set by the G-30 concerning derivatives transactions, recommendations of IOSCO, concerning derivatives transactions, recommendations of IOSCO, FIBV, IOMA, the Futures Industry Association and the IFC.FIBV, IOMA, the Futures Industry Association and the IFC.

Banco de Banco de México’s 31México’s 31

requirements in requirements in derivative derivative

managementmanagement

Among others, institutions have to comply with:

1. Requirements of administration

• Creation of risk units independent from trading areas in charge of measuring and evaluating credit and market risk.

2. Requirements of operation

• Have systems to measure and evaluate risk in real time.

3. Requirements for internal control

• Risk management committee;

• Efficient internal oversight mechanisms;

• Periodical reports. Evaluation by an Evaluation by an independent firm.independent firm.

1995: Banco de Mexico 1995: Banco de Mexico issued first risk management issued first risk management regulation. regulation.

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As a complement, the National Banking and Securities As a complement, the National Banking and Securities Commission (CNBV) has issued additional regulationCommission (CNBV) has issued additional regulation

In 1999, the CNBV published a new regulation (Circular In 1999, the CNBV published a new regulation (Circular 1423) for banks, establishing conditions for better risk 1423) for banks, establishing conditions for better risk management activities:management activities:

Independence of risk management unit, daily reports to Independence of risk management unit, daily reports to senior management, elaboration of manuals.senior management, elaboration of manuals.

Sets more detailed internal procedures for risk Sets more detailed internal procedures for risk management than those mentioned in the “31 points”management than those mentioned in the “31 points”

Distinguishes between credit, market, liquidity, legal and Distinguishes between credit, market, liquidity, legal and operational risk.operational risk.

Covers all banks operations.Covers all banks operations.

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Pension FundsPension Funds The regulation for derivative operations by Pension Funds The regulation for derivative operations by Pension Funds

was issued recently by the Central Bank and then was issued recently by the Central Bank and then complemented by more detailed guidelines issued by the complemented by more detailed guidelines issued by the Consar.Consar.

This new regulation takes an open and modern approach This new regulation takes an open and modern approach towards derivative operations:towards derivative operations:

- The Central Bank established general rules which do The Central Bank established general rules which do not set limits by type of operation.not set limits by type of operation.

- The limit for the Value at Risk measure set by Consar The limit for the Value at Risk measure set by Consar cannot be exceeded with the use of derivatives.cannot be exceeded with the use of derivatives.

- The Consar guidelines established additional legal and The Consar guidelines established additional legal and operational requirements.operational requirements.

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Legal Requirements

OBJECTIVEOBJECTIVE OBLIGATIONSOBLIGATIONS

Define legal framework to operate Define legal framework to operate with derivative instruments and with derivative instruments and select appropriate counterparts in a select appropriate counterparts in a safe environment.safe environment.

With respect to Organized Exchanges:With respect to Organized Exchanges:

a) Define markets in which they are allowed to a) Define markets in which they are allowed to operate (Chicago Mercantile Exchange, operate (Chicago Mercantile Exchange, Chicago Board of Options Exchange, Mid Chicago Board of Options Exchange, Mid America Commodity Exchange, MEXDER America Commodity Exchange, MEXDER y Commodity Exchange Incorporation).y Commodity Exchange Incorporation).

b) Sign contracts with clearing houses.b) Sign contracts with clearing houses.

c) Require a letter of Confirmation for each c) Require a letter of Confirmation for each transaction.transaction.

With respect to OTC Markets:With respect to OTC Markets:

a) Only operations with counterparts that a) Only operations with counterparts that qualify in their Investment Regime are qualify in their Investment Regime are allowed.allowed.

b) Celebrate ISDA Contract.b) Celebrate ISDA Contract.

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Operational Requirements

OBJETIVEOBJETIVE OBLIGATIONSOBLIGATIONS

The AFORE does not depend on one The AFORE does not depend on one person to operate and assign person to operate and assign derivatives appropriately.derivatives appropriately.

Have two operators and two back Have two operators and two back officers of derivatives trained and officers of derivatives trained and certificated by a third party.certificated by a third party.

If the AFORE no longer has the If the AFORE no longer has the appropriate front office staff, new appropriate front office staff, new derivatives operations can not be derivatives operations can not be closed.closed.

If the AFORE no longer has the If the AFORE no longer has the appropriate back office staff, existing appropriate back office staff, existing derivative positions may have to be derivative positions may have to be closed based on the possibility of closed based on the possibility of guarantees follow up.guarantees follow up.

All Afore employees involved in All Afore employees involved in derivative operations (from the one derivative operations (from the one who closes the operation to the one who closes the operation to the one who quantifies the risk) must have the who quantifies the risk) must have the required training programs and know required training programs and know and fulfill the ethic code related to the and fulfill the ethic code related to the celebration of Futures and Options celebration of Futures and Options Contracts.Contracts.

Continuous Training Programs for Continuous Training Programs for operators, back-office staff and risk operators, back-office staff and risk management unit.management unit.

Reduce operational risk at minimum Reduce operational risk at minimum levels and have all investment levels and have all investment processes well documented.processes well documented.

Have an ISO 9002 quality certification Have an ISO 9002 quality certification for the investment process from the for the investment process from the front office to the back office. Including front office to the back office. Including the Risk and Investment Committees in the Risk and Investment Committees in the process of decision making.the process of decision making.

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Operational Requirements

OBJECTIVEOBJECTIVE OBLIGATIONSOBLIGATIONS

OPERATION SYSTEMSOPERATION SYSTEMS

Have appropriate systems to record, Have appropriate systems to record, valuate and measure the risk of all valuate and measure the risk of all positions in their portfolio, which allow positions in their portfolio, which allow them to verify the status of margin and them to verify the status of margin and collateral requirements.collateral requirements.

Such systems have to manage Such systems have to manage appropriately all collateral sent or appropriately all collateral sent or received.received.

Fulfill the accounting rules issued by the Fulfill the accounting rules issued by the CONSAR about derivatives registration.CONSAR about derivatives registration.

a) Operation systems capable of a) Operation systems capable of recording and accounting for recording and accounting for derivative operations including all derivative operations including all collaterals sent or received.collaterals sent or received.

b) On-line communication form the b) On-line communication form the operation system to the risk operation system to the risk management unit.management unit.

c) Existence of appropriate c) Existence of appropriate mechanisms to avoid violating the mechanisms to avoid violating the limits and “stop loss” triggers for limits and “stop loss” triggers for each type of operator and each type of operator and operation.operation.

Establish procedures to guarantee that Establish procedures to guarantee that OTC operations are protected by a OTC operations are protected by a contract and those from MEXDER and contract and those from MEXDER and exchange traded ones by confirmation exchange traded ones by confirmation letters.letters.

Design a system to keep track of all Design a system to keep track of all executed operations.executed operations.

Afores must be certified by Consar in order to guarantee that they comply with all this Afores must be certified by Consar in order to guarantee that they comply with all this requirements.requirements.

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AgendaAgenda





III.III. Development of Derivatives MarketsDevelopment of Derivatives Markets OTCOTC


25

A market for medium and long term derivatives is A market for medium and long term derivatives is developingdeveloping

•FX DerivatesFX Derivates

-OptionsOptions

-ForwardsForwards

-Swaps Swaps --- Up to 5 years--- Up to 5 years

•Interest Rate DerivatesInterest Rate Derivates

-Swaps Swaps --- Up to 5 years--- Up to 5 years

-Nominal Rate Caps & Floors Nominal Rate Caps & Floors --- Up to 5 years--- Up to 5 years

-Real Rate Caps & Floors Real Rate Caps & Floors --- Up to 5 years--- Up to 5 years

26The OTC volume of FX Forwards has increased The OTC volume of FX Forwards has increased significantly in the last two yearssignificantly in the last two years

0

500

1,000

1,500

2,000

2,500

Mill

ion

Do

llars

Ju

n-9

5

Ju

n-9

6

Ju

n-9

7

Ju

n-9

8

Ju

n-9

9

Ju

n-0

0

Ju

n-0

1

Ju

n-0

2

Daily AverageTurnover in Forwards

27The Mexican Derivatives Exchange (Mexder) recently The Mexican Derivatives Exchange (Mexder) recently introduced new operational features that gave rise to introduced new operational features that gave rise to an impressive increase in operated volumean impressive increase in operated volume

• Introduction of Market Makers.Introduction of Market Makers.

• Less legal requirements for Banks and Brokerage Firms Less legal requirements for Banks and Brokerage Firms to operate.to operate.

• Changes in the TIIE 28 and 91-day Cetes futures Changes in the TIIE 28 and 91-day Cetes futures contracts, allowing a rate based quotation.contracts, allowing a rate based quotation.

• Introduction of a 3-year Bono futures contract.Introduction of a 3-year Bono futures contract.

• New types of operations which allow to handle larger New types of operations which allow to handle larger volumes (“camas”, “rondas” and bundles) .volumes (“camas”, “rondas” and bundles) .

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0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

10,000,000

11,000,000

12,000,000

13,000,000

14,000,000

15,000,000

En

e-99

Mar

-99

May

-99

Jul-

99

Sep

-99

No

v-99

En

e-00

Mar

-00

May

-00

Jul-

00

Sep

-00

No

v-00

En

e-01

Mar

-01

May

-01

Jul-

01

Sep

-01

No

v-01

En

e-02

Mar

-02

May

-02

Jul-

02

Sep

-02

No

v-02

En

e-03

Mar

-03

Nu

mb

er o

f C

on

trac

ts

Volume operated in Mexder has increased Volume operated in Mexder has increased substantially during the past several monthssubstantially during the past several months

Derivative Contracts traded in the Mexican Market

29Long term derivatives have a positive Long term derivatives have a positive impact in overall market developmentimpact in overall market development

• They can be used as a reference to price new They can be used as a reference to price new instruments.instruments.

• They increase liquidity and play an important role in the They increase liquidity and play an important role in the price discovery process.price discovery process.

• They facilitate the development of “tailor made” products They facilitate the development of “tailor made” products that increase the demand for long term instruments.that increase the demand for long term instruments.

• They generate a positive feedback loop with the cash They generate a positive feedback loop with the cash market, increasing market depth and liquidity in the market, increasing market depth and liquidity in the secondary market of government securities.secondary market of government securities.

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1 june, 2003 mexican ministry of finance and public credit regulatory framework and development of...

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