Recent developments in the

Mexican pension system and challenges ahead

Carlos Ramírez Fuentes Presidente de la CONSAR

15 de Noviembre, 2017

Contents

2

I. Introduction

II. Recent evolution of Mexico´s Pension System

III. How can pension funds invest in infrastructure

IV. Opportunities ahead

V. Challenges

VI. Conclusions

3

Dependency rate (Mexico and Europe)

(population 0-19 and 65+/population 20-64)

Fuente: United Nations, Department of Economic and Social Affairs, Population Division (2015). World Population Prospects: The 2015 Revision,

Mexico´s demography will change

dramatically

50.0

70.0

90.0

110.0

130.0

150.0

1950 1957 1964 1971 1978 1985 1992 1999 2006 2013 2020 2027 2034 2041 2048 2055 2062 2069 2076 2083 2090 2097

México Europa

Demographic bonus

4

Mexico Pension Reforms

The pensions system was reformed in 1997 for private workers and in 2007 for public service workers transforming the traditional defined benefit (DB) system into a mandatory defined contribution (DC).

The system is mandatory for all private and federal government workers.

Workers contribute 6.5% of their monthly salary to their pension fund (private sector workers).

The National Commission for the Retirement Savings System (CONSAR) regulates and supervises the Pension Fund Administrators (AFORE)

5

I. Introduction

II. Recent evolution of Mexico´s Pension System

III. How can pension funds invest in infrastructure

IV. Opportunities ahead

V. Challenges

VI. Conclusions

Contents

3.1 6.0 9.0 13.617.7

22.126.3

32.339.8

45.751.5

63.3

76.186.1

104.6

112.7

130.4

169.7

139.6

0

20

40

60

80

100

120

140

160

180

Aug

-97

Jan-

98M

ay-9

8O

ct-9

8Fe

b-99

Jun-

99N

ov-9

9M

ar-0

0Ju

l-00

Dec

-00

Apr

-01

Aug

-01

Jan-

02M

ay-0

2O

ct-0

2Fe

b-03

Jun-

03N

ov-0

3M

ar-0

4Ju

l-04

Dec

-04

Apr

-05

Sep-

05Ja

n-06

May

-06

Oct

-06

Feb-

07Ju

n-07

Nov

-07

Mar

-08

Jul-0

8D

ec-0

8A

pr-0

9Se

p-09

Jan-

10M

ay-1

0O

ct-1

0Fe

b-11

Jun-

11N

ov-1

1M

ar-1

2A

ug-1

2D

ec-1

2A

pr-1

3Se

p-13

Jan-

14M

ay-1

4O

ct-1

4Fe

b-15

Jul-1

5N

ov-1

5M

ar-1

6A

ug-1

6D

ec-1

6A

pr-1

7Se

p-17

Figu

res

in U

S bi

llion

s

sept

embe

r 201

7

154.3

6

Pension Funds’ assets under management

US $169.7 billion.

Figures in US billion. Currency exchange constant. Data as of september 2017.

Source: CONSAR.

Mexican Pension Funds’ assets under management

Pension Fund’s asset under

management represent 25.49% of

domestic savings

During the last 10 years, Pension Funds’ assets under management have increased 13.94% annually.

Pension Funds’ assets under management represents 15.10% of the GDP

Evolution of Pension funds

Investment Framework

7

1/ Foreign Debt from 2005. Subordinated Debt from 2009. Structured Debt & lower than investment grade debt (local scale) from 2010.

Debt with exposure to and guarantee by real assets and rights from 2013.

2/ Only USD, Euros & Yens until 2010. All other currencies were allowed from 2010.

3/ When launched this investment vehicle was a capital protected note

4/ The first FIBRA was issued until 03/2011, though.

5/ The prior financial and legal structure of the current SPV was issued on 08/2008.

Portfolio Diversification

Portfolios of SIEFOREs

( %)

8

Sep-2005 Dec-2011 Aug-2017

As a consequence, portfolio diversification has improved although much

remains to be done

82.8

0.120.9

16.1

58.8

2.72.9

8.1

9.6

17.90.27

51.35

6.561.13

6.61

14.65

19.42

Commodities Goverment Securities Alternative Investments

International Bonds Equity (Domestic) Equity (International)

Local Bonds

Contents

9

I. Introduction

II. Recent evolution of Mexico´s Pension System

III. How can pension funds invest in real assets

IV. Opportunities ahead

V. Challenges

VI. Conclusions

Type of

CKDs and

CERPIs

Project

Finance

Infrastructure Real Estate Private

Equity

Financial

Assets

CKDs/CERPIs can be used to finance:

Different stages of the development of a real project

Any economic sector or activity

And financial structures can be adjusted

The projects must be developed in Mexico

10

CKDs and CERPIs are very flexible investment vehicles

How can Mexican pension funds

invest in real assets

11

Type of CKD

As a % of

investment by

AFOREs

Infrastructure (Including Energy) 34.3%

Real Estate 27.3%

Capital 25.2%

Financial Services 11.43%

Forestry 1.82%

Through the investment of CKDs, AFOREs have financed a growing

range of projects and firms

investments in CKD’s by sector

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

200,000

jul-0

8se

p-08

dic-

08m

ar-0

9m

ay-0

9ag

o-09

nov-

09en

e-10

abr-

10ju

l-10

sep-

10di

c-10

mar

-11

may

-11

ago-

11oc

t-11

ene-

12ab

r-12

jun-

12se

p-12

dic-

12fe

b-13

may

-13

ago-

13oc

t-13

ene-

14ab

r-14

jun-

14se

p-14

dic-

14fe

b-15

may

-15

ago-

15oc

t-15

ene-

16ab

r-16

jun-

16se

p-16

dic-

16fe

b-17

may

-17

ago-

17

12

4 CKD’s

1 Fibra

Evolution of CKDs and FIBRAs

Positions of AFOREs

(millions of pesos)

Alternative investments by afores

TOTAL: 205,027 MXN million

AFOREs finance 87% of total CKDs/CERPI (147 billion pesos) and 36%

of FIBRAs (58 billon pesos)

9 CKD’s

2Fibra

3 CKD’s

4 Fibra

7 CKD’s

4 Fibra

16 CKD’s

1 Fibra

10 CKD’s

2 Fibra

7 CKD’s

1 Fibra

RECENT REGULATORY CHANGES

13

CONSAR regulation has pushed pension funds’ to focus on increasing their internal capacities:

o Improvement of due-dilligence for the selection of manager

o Increase human capital

o Better use of technology: risk system

o Deepen the understanding of the non-financial risks: legal, technological, political, operational, social, environmental, etc.

o More regulatory space to invest in equity, Reits, and alternatives

o Less restrictive investment limits on alternatives (CKDs and CERPIs): pension funds may now acquire the total amount of the issuance, regardless of its size.

o New prudential measures for CKDs and CERPIs: more responsibility to the Board. AFORE may now set their own prudential limits regarding concentration limits in a project, GP and issuance as well as eligibility policies on co-investors.

Contents

14

I. Introduction

II. Recent evolution of Mexico´s Pension System

III. How can pension funds invest in infrastructure

IV. Opportunities ahead

V. Challenges

VI. Conclusions

Fuente: CONSAR

Structural reforms are opening up new and

major investment opportunities for AFOREs

15

Structural reforms:

Energy 4.

1.

2.

New business opportunities will

open up in several sectors

Financial sector 3.

Pension funds will continue to play a

fundamental role in financing long term

projects

Telecommunications

Competition

16

OPPORTUNITIES AHEAD

It is expected that total AUM of AFOREs will continue to grow* at a

significant pace

*Projections are solely used for the presentation purposes and should only be used as a guidance

17

Mexican pension funds urgently need more diversification

OPPORTUNITIES AHEAD

Fuente: OCDE, 2015.

18

Historic real returns of Mexico’s pension system

(2003-2017)

• ¿Where will future returns come from?

OPPORTUNITIES AHEAD

OPPORTUNITIES AHEAD

19

New investment

opportunities and new

government with

infrastructure needs

Favorable moment to

boost long term

investments

Growth of assets under

management by

SIEFOREs

An environment of

lower returns and

needs for major

diversifications

Favorable environment to boost long term investments:

Contents

20

I. Introduction

II. Recent evolution of Mexico´s Pension System

III. How can pension funds invest in infrastructure

IV. Opportunities ahead

V. Challenges

VI. Conclusions

Demand-side obstacles

21

CHALLENGES FOR PENSION FUNDS

LONG TERM INVESTMENTS

Demand constraints Supply constraints

1. Short term focus: commercial bias 1. Depth of Mexican financial markets

2. Analytical capabilities of AFOREs

// insufficient competition

2. Scarcity of good projects and managers

3. Legal restrictions // pension funds

have to invest through public

offerings

3. Political/social/ legal risks

Supply-side obstacles

• Challenges for long term investment projects in the Mexican Pension

System

Structural challenges ahead

22

Nonetheless, key structural challenges remain:

o Low level of mandatory savings

o Increase coverage

o More flexibility to invest

o Link pillars

o More competition: returns and fees

o Increasing cost of DB systems

Contents

23

I. Introduction

II. Recent evolution of Mexico´s Pension System

III. How can pension funds invest in infrastructure

IV. Opportunities ahead

V. Challenges

VI. Conclusions

CONCLUSIONS

• Mexico’s current conditions offer significant opportunities for the AFOREs to participate actively as Mexico´s main institutional investors in long term projects.

• Recent regulatory changes by CONSAR to the pension system seek to: o More flexibility for active pension funds o Offer more opportunities for diversification o Strengthen the industry´s human capital o Expand investment horizons of the AFOREs industry o Strengthen AFOREs’ corporate governance

• It is imperative to continue with the development of internal capabilities in the

pension fund industry

• Mexico urgently needs another pension reform: opportunity and challenge for new government

24

Recent developments in the

Mexican pension system and challenges ahead

Carlos Ramírez Fuentes Presidente de la CONSAR

15 de Noviembre, 2017