Radical innovation in the financial sector is at
odds with a paternalistic, overcautious stance on the part of
regulators, according to Michael Washburn
Mexico's superb economic performance has made it a powerful
draw for investors in the wake of President Enrique Peña
Nieto's easing of regulations, with foreign direct investment
reaching $22.6 billion in 2014. That figure represents a slight
dip from 2013's peak of $35.2 billion, but is markedly higher
than 2012's figure of $15.5 billion and prior years. Meeting
and improving upon 2013's stellar figures depends on a
continued shift away from overregulation.
Much of Mexico's success has to with innovation in its
financial sector. While reforms to the nation's energy
regulations have received their fair share of attention
globally, the hunger for upending old structures and shaking up
the economy – to the extent that regulations allow
– is most visible in Mexico's capital markets.
The $633 million IPO carried out by mortgage REIT
FideicomisoHipotecario (FHipo) in November 2014 signals a new
direction for the capital markets of Mexico and potentially
other Latin American jurisdictions. The implementation of
mortgage REITs, which might have been unthinkable a few years
ago, is reflective of the growing sophistication of the REIT
market globally as it branches out in new directions. Startling
many observers, FHipo's hugely successful IPO came just months
after the collapse of homebuilders DesarrolladoraHomex SAB,
UrbiDesarrollosUrbanos SAB, and Corp. Geo SAB in 2013.
This is not the only recent example of innovation. Global
law firm Paul Hastings, which advised FHipo in the IPO, also
took the lead on the representation of underwriters in toll
road operator PINFRA's $600 million equity offering of Series L
shares in July 2014, a deal expected to inspire many more
equity offerings in coming months.
But the continued success of such novel ventures is
inconceivable without several steps including the further
opening up of Mexico's underpenetrated investment regime; the
related issue of getting investors, in Mexico and beyond, to
dispense with antiquated views of Mexico's capital markets; and
the liberalisation of tax policies.
In a recent exclusive interview with IFLR1000, Alfredo Vara
Alonso, FHipo's CEO, described how he and his colleagues
approached Mexico's largest mortgage lender, INFONAVIT, with
the idea of developing the first mortgage REIT. INFONAVIT in
2008 had developed a program for financial institutions, and
banks in particular, to take advantage of the loan origination
program, and Alonso's radical notion was for such products to
go through the capital markets and become available to
investors, including local pension funds, more directly.
"That's how everything came together for us. It was quite
logical in the international markets, and this is how we
brought to local markets the evolution from traditional REITs
to mortgage REITs," Alonso recounted.
"Regulators have lately
engaged in some innovation of their own, applying new
concepts in tax audits"
For all his success with this innovation, it was only half
the battle, for Alonso had to contend with a steep learning
curve in the local market, where people were far more familiar
with INFONAVIT's workings than with those of mortgage
"In the local market, we needed to do a lot more work,
explaining the concept, what a mortgage REIT is and how it
works," Alonso recounted.
Part of the issue, in Alonso's view, was the serious
underpenetration of a Mexican mortgage market accounting for
only 9% of GDP, compared to roughly 45% for the US and Canada
and 100% for Denmark and Norway.
Although the IPO came off quite well, in terms of revenue,
Alonso and his colleagues had a negative carry for the first
couple of months as they invested part of the $633 million from
the IPO in mortgage portfolios, undertaking new
In spite of these difficulties, Alonso sees potential for a
continuing liberalization of the investment regime in Mexico.
Reform at the regulatory level could make it easier for, say, a
capital fund whose prospectus currently allows it to buy very
narrowly defined number one titles, or in other words equity.
Under current regulations, funds often do not have legal
authorization to buy the number one
FideicomisoHipotecario, or mortgage trust. Alonso and
others yearn for the end of what he calls a "paternalistic"
attitude on the part of regulators who are focused too narrowly
on the events of 1994-1995, when Mexico's central bank took a
"It is like a pendulum. We're on the other side now, too
paternalistic at the regulatory level. We need to make CIO's
and fund managers much more accountable, but at the same time
give them more liberty," Alonso commented.
Mike Fitzgerald, head of the Latin America practice at
global law firm Paul Hastings, has also handled his share of
situations where innovation in the capital markets required
educating market participants. Fitzgerald and his colleague
Taisa Markus took the lead as advisors to the underwriters in
PINFRA's $600 million equity offering of Series L shares, which
are limited voting shares that last enjoyed a vogue among
issues in Mexico more than ten years ago. The offering was
particularly bold in light of the fact that the CNBV –
Mexico's equivalent to the SEC – had pursued a policy
of not accepting for listing any company that sought to list
new Series L shares.
"I think the theory was one of corporate governance. They
wanted all the shareholders to be on a level playing field with
one vote per share," Fitzgerald commented.
In following this policy, Fitzgerald noted, Mexico's
regulators had essentially adopted the same stance as the New
York Stock Exchange, which has grappled over time with the
question and ultimately decided to discourage limited voting
shares in general while allowing them in certain
The fact that the issuers were able to complete the
transaction in the face of regulatory hostility – and
more than ten years after such shares were widely in favour in
Mexico – is remarkable, and the issuance is widely
expected to encourage deals on the part of other companies in
Mexico with a similar character to PINFRA.
"These are family-run companies, and to induce them to enter
public markets, you need to provide something that allows
families to continue to control even if they sell down below
50%," says Fitzgerald.
"They wanted all the
shareholders to be on a level playing field with one
vote per share"
The prospect of such control has proved immensely alluring
and made the offering a major success. Nevertheless, as in the
case of mortgage REITs discussed above, educating the public
about a class of shares that fell out of favor ten years ago is
not a task to take lightly.
"How to describe them, what is the investor going to get,
making sure they understand that L shares are non-voting
shares, those are the kinds of issues that [must] be dealt
with," adds Fitzgerald.
But innovation in the financial sector can only go so far
toward revitalising Mexico's economy, and luring foreign
investment and trade, when the government pursues
self-destructive tax policies.
In the view of Arturo Tiburcio, who rejoined Hogan Lovells
BSTL in Mexico City as a partner in April, Mexico's regulators
have been cracking down, with a view to increasing revenues,
fighting tax evasion, and keeping profits from flowing out of
Mexico. The country has been a member of the OECD since 1994,
and has theoretically been bound since then by OECD guidelines
with respect to tax treaties, royalties, interest, capital
gains, and dividends. But Tiburcio describes how regulators
have lately engaged in some innovation of their own, applying
new concepts in tax audits. Officers at the Mexican SAT are
applying BEPS criteria with a view to protecting the taxable
base, he says. As a result, collection audits have metastasized
into a common practice in the administration of President
"One would think that there is some contradiction in the
current government inviting foreign investors and multinational
companies to invest in Mexico when at the same time and through
complex audits, the SAT is engaged in increasing tax
collections, notwithstanding tax treaties," Tiburcio
Mexico's recent experience proves the adage that an economic
downturn may not be a bad thing at all if it pushes people to
ask questions and find solutions that would never have occurred
to them before. But Mexico in 2015 is a country where radical
innovation in the financial sector is continually at odds with
a paternalistic, overcautious stance on the part of regulators.
Its continued success – and its ability to meet the
record FDI levels of 2013 – requires a convincing and
permanent shift away from outdated statist policies.