Annual Report 2004
Board of Directors CHAIRMAN Carlos Levy Covarrubias VICE CHAIRMEN Iñaki de Abiega Pons Gabriel E. Kuri Labarthe EXAMINER Juan C. Salles Manuel SECRETARY Angela Balmori Iglesias SECRETARY PRO TEM Erik Alberto García Tapia MEMBERS Héctor Aguirre Cobo Héctor Madero Rivero Jorge Eduardo Alonso Olivares Javier Nájera Muñoz Francisco Javier Artigas Alarcón Diego Ramos González De Castilla Carlos Bremer Gutiérrez Clemente Reyes Retana Valdés Edgardo Mauricio Cantú Delgado Gonzalo A. Rojas Ramos Francisco Javier De Frutos Arroyo Patricio Tamayo Gómez Jaime A. Fernandez Iglesias Moisés Tiktin Nickin Carlos Gutiérrez Andreassen Javier Valadez Benítez Bulmaro Guzmán Ruíz Eduardo Valdés Acra Carlos Fernando Herrera Prats Felipe Vila González Carlos Ibáñez Estens José Antonio Villa Ávila Mauricio López Velasco Aguirre Carlos F. Villagómez Castro Rafael Mac Gregor Anciola ALTERNATE MEMBERS Arturo Julio Arce Taracena Luis Martínez Arizmendi Andrés Borrego y Marrón José Méndez Fabre Juan Luis Cevallos Almada Gerardo Minjares Calderón Víctor Chávez Longyear Sergio Moreno Vázquez Javier Cortina Azcarraga Luis Murillo Peñaloza José Miguel Díaz Goñi Rafael Ortíz Markivich Patrick Doucet Leautaud Jorge Placido Evangelista Jorge Fernández García Travesi Guillermo Robles Gil Orvañanos Alvaro García Pimentel Caraza Juan Carlos Rosales Hernández Adolfo Herrera Pinto José Antonio Salazar Guevara Pablo F. Hoyos Hoyos Gustavo Salazar Salinas Juan Carlos Jaques Garcés Héctor Sánchez Velez Christian Knudsen Ramos Luis Alonso Villaseñor Blanco Bernardo Llerenas Bracho 1
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Executive Comission PRESIDENT Carlos Levy Covarrubias Iñaki de Abiega Pons Carlos Fernando Herrera Prats Gabriel E. Kuri Labarthe Rafael Mac Gregor Anciola Héctor Madero Rivero Jorge Pérez Sámano Gonzalo A. Rojas Ramos Javier Valadez Benítez 3
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Message to Our Members I am pleased to inform you that 2004 was a very good year for the Mexican economy, for the securities market, and for the securities industry as a whole. To begin, and above all, I must acknowledge the stability and confidence that the federal government has been able to sustain in this country. This fact has made it possible for Mexico to progress toward a more efficient, competitive and secure market, evident in the level attained by the Mexican Stock Exchange's Price and Quotations Index (IPC). The strong performance of the market's leading indicator since 2002 can be observed in three distinct moments. The first, when the trend began at the index's low point of 5,534 points on August 5, 2002; the second, when it closed 2003 at 8,795 points; and the third at the close of 2004, when it reached 12,918 points--a steady advance of 133%, outperforming the average for international markets in the same period.this is a clear sign of the solidity of the Mexican economy. Amid all of this, the most positive aspect is the confidence that investors have shown in the local stock market, and that companies are returning to that market in increasing numbers to seek financing. By taking advantage of this situation, the Mexican market can catch up from its previous lag behind other countries in terms of the number of listed issuers. In the past year, the market saw a number of IPO's by housing companies, and apparently this industry is gaining increasing weight in the market through new offerings.airport company issues are planned for the future, which could bolster this industry's participation in the sectorial classification of the stock market. Also significant is the amount of resources placed on the private medium- and long-term debt market during the year: 137.77 billion pesos, 7.6 times higher than at the start of this presidential administration (only 17.91 billion in the year 2000). 5
Companies, state and municipal governments, and state-owned enterprises, have secured financing through the market in order to fund productive projects and public works and to pay off other liabilities. Following the introduction of securities certificates in 2001, this instrument has become a favorite among this type of issuer, accounting for 88% of the total debt floated on the market. Securities Certificates (known as CB's, by their initials in Spanish) have an additional advantage: they are issued according to the Code of Best Corporate Practices, which means that the issuing states, municipalities and companies have had to substantially improve the quality of their projects, the transparency of their operations, and the consistency of the information they give to investors. This is the direct result of the current government's economic development policy and the growing awareness of the importance of open, above-board corporate governance. In qualitative aspects, last year we said that the market should be developed through the incorporation of other industries and more types of transactions. We also indicated the need for new instruments and for a regulatory, fiscal and operating framework that can support the securitization of mortgage assets and financing for the energy sector and public works. On the demand side, we pointed out that enhancing access to attractive transactions and instruments, for both local and foreign investors, could substantially broaden the base of savers. For the market as a whole, we underscored the need for an effective combination of regulation and self-regulation, with an effort to gradually strengthen the self-regulatory capacities of the securities industry itself. Finally, we set ourselves the task of promoting a comprehensive awareness of the benefits and importance of the securities market, which would expedite the financing of the major projects Mexico needs. 6
In mind of these proposals, I would like to enumerate the most significant achievements of the year. One of the most important projects of 2004 was the publication of the Unified Bulletin for Brokerage Firms, issued by the National Banking and Securities Commission (CNBV), the product of concerted efforts to create a comprehensive regulation for securities brokerage in Mexico. The secondary regulations governing brokerage firms and securities specialists had been previously dispersed among more than one hundred bulletins. AMIB and its committees, including specialists and representatives of its members, worked for more than two years in close collaboration with the CNBV, to streamline, modernize, simplify and update these regulations. Among the innovations introduced were rules of conduct for brokerage firms in public offerings; common representation; categorization of the investing public; global orders and order grouping; centralized accounts; microfiche rules; recording of documents on optical media; assignment and stabilization transactions; and new provisions on risk management. The new Bulletin makes the provisions clearer and simpler and thus expedites the entire brokerage process. There are some concepts that are more clearly defined, such as how customer profiles are prepared. Other points expand brokerage firms' role in trust activity, formerly very limited. These new prospects for brokerage are enriched by new provisions from the authorities, which incorporate the concerns and suggestions of the securities industry on aspects such as repurchase agreements that involve appropriate and versatile collateral, and other rules that afford greater transparency and security to participants in a variety of transactions. Toward a similar end, a new bulletin on securities lending is near completion, and should be published in the next several months. 7
Another key effort of the past year involved a project that will invigorate and make the Mexican market more competitive. The new Securities Market Act is ready to be submitted to Congress for a vote, and its passage should open up a new age in the country's financial industry. The Securities Market Act, originally signed into law in January 1975, was the result of long years of study and joint efforts by the securities industry and the authorities. This law proved an ideal vehicle for the market's development, offering security and instruments to investors and issuing companies. Based on that law, the current Mexican Stock Exchange was shaped, as was the securities depository, S.D. Indeval, brokerage firms, and the industry association in which the Mexican Securities Industry Association (AMIB) originated. At the time, the 1975 law spurred the modernization of the securities market, and through later amendments, additions and adaptations, has helped to build a more modern, competitive, and institutional market, which protects investors and augments the confidence of Mexican and foreign participants. Changes in the economic and international climate, however, forced the market and the authorities to reconsider the legal bases for securities trading. The time had come to move beyond mere amendments and to draft a new law that would incorporate all of the market's facets, facilitate its development, encourage growth and create the tools that all participants needed--issuers, investors and intermediaries. The bill for a new Securities Market Act was the fruit of detailed study by authorities, on constant consultation with and attention to proposals by the securities industry, academics, and specialists from related areas. We at the Mexican Securities Industry Association are proud of having contributed our experience and knowledge of the market in the form of observations and revision of this vital legal document, which will soon be submitted to the Mexican Congress. 8
We are committed to helping continue and strengthen the current situation of economic and financial stability. We are confident that this and the complete revision of the legal framework, for which the year 2004 will surely be remembered, are the pillars of our securities market's future. Amid this context of renewal, the securities industry can assume its proper role in savings, investment, and in financing productivity, and the tremendous vitality it has shown in the recent past can thus coalesce into a solid foundation for growth, and a positive force in the well-being of the families and companies that make up Mexican society. Sincerely, Carlos Levy Covarrubias Chairman Iñaki de Abiega Pons Vice Chairman Gabriel E. Kuri Labarthe Vice Chairman 9
Message from the Chief Executive Officer AMIB's activities in 2004 focused on the conclusion of some projects and initiatives mapped out last year, and drafting new projects that would improve the performance of participants in Mexico's securities and financial markets. In addition to our ongoing and fruitful interaction with the financial authorities, we coordinated our efforts with other trade associations of the financial industry, such as the Mexican Banking Association, the International Association of Financial Intermediaries, and the Mexican Association of Retirement Fund Managers. The results and achievements of 2004 were based largely on the confidence that the local and foreign financial communities have show in the bright future of this country's financial market. This confidence allowed us to complete a series of agreements and mechanisms to give local investors access to a new range of asset classes. These new classes originate in international markets, but can now be acquired and traded in Mexico, thanks to steps taken by the Mexican Stock Exchange and facilities granted by the local authorities to do so. The participation of intermediaries in the committees that make up AMIB's operating structure, together with our work with authorities and other financial sector organizations, allowed us to move ahead on substantive tasks. These included regulatory, trading and security aspects, addressed in a context of continuous innovation of procedures, instruments and self-regulatory rules.the ultimate aim was to create and ensure conditions of fairness and equitable competition between market participants and with the international markets. Among the most significant achievements of 2004 were the active role we played in the study and presentation of financial industry members' comments on bills such as the new Securities Market Act and Mutual Funds Law, both of which are to be voted on soon by the Mexican Congress. As a result of efforts such as these, the opinions of industry brokers and the work of our committees were reflected in the 10
definitive text of the Unified Circular for Brokerage Firms, issued by the National Banking and Securities Commission in September 2004. Another significant aspect was the creation of a system of assetbacked repurchase agreements, which afford greater protection against counterpart risk in the trading of fixed-income instruments. This system was studied in conjunction with specialists from various trade organizations and in close collaboration with Banco de Mexico, which issued Bulletin 1/2003 Bis 3, uniting a broad range of comments and contributions from the industry. We also drafted and proposed a standard contract that would make the securities lending process more efficient and secure. This procedure is very valuable in futures and options settlement, as well as in arbitrage. It will also add vigor to the market by facilitating short sales. The definitions, procedures and prudential rules on the subject will be gathered together by the authorities in a Bulletin to be issued in 2005. Our concern for preserving sound market practices as been channeled into new self-regulatory rules, such as the Self-Regulatory Rule on Advertising and Promotion by Mutual Funds and the Personnel Control Rule, which took effect in February. We also worked to strengthen the role of the compliance officer, and continued to update information on current self-regulatory rules that are sent to interested parties and those that are subject to the self-regulation rules, both brokerage firms and mutual fund managers. In our continuing efforts to ensure that all securities market participants abide by the highest standards of ethics and professionalism, we updated and extended our program to certify the capacities of financial institution employees who buy and sell securities, engage in consulting or promote securities market instruments. At the close of 2004, we had certified close to 16,000 financial institution employees. As part of the certification process, we gave 214 courses on ethics to 5,207 participants in 36 of Mexico's largest cities. 11
In addition, under an agreement with the Instituto Tecnológico y de Estudios Superiores de Monterrey, we have extended certification to graduates of that school's Financial Administration program. These must pass an Investment Strategy Advisors exam in order to graduate and obtain their university degree. In the area of trade representation, our achievements this past year were consistent with our commitment to raising efficiency, lowering costs and strengthening self-regulation. We have made some major improvements in the areas of transparency, minority investor protection, new regulatory focuses, and certification. Finally, we are pleased to report that the Mexican Securities Industry Association (AMIB) continued to adopt plans to further its strategic vision and focus on international competitiveness. With this, members of the financial industry made a concerted effort to position the brokerage industry on increasingly solid footing globally, in close collaboration with the authorities and other organizations representing the financial industry. If 2004 is to be remembered for any one aspect in the securities industry, as our Chairman of the Board notes in his message, it will be the vision evident in the efforts to modernize our market. This vision has encouraged authorities from the Ministry of Finance, the National Banking and Securities Commission, and Banco de Mexico, in discussion with AMIB as industry representative, and with other organizations within Grupo BMV, to completely review the regulatory framework of the Mexican securities market last year. The review encompassed everything from the bases of the Securities Market Act and Mutual Funds law, which were thoroughly revised and prepared for their imminent approval by Congress, to secondary rules that apply to many of the brokerage functions carried out by brokerage firms, fund managers, and money market brokers. In this report, you will hear of many of the actions taken under the vision described above. We believe these actions will help create an increasingly solid place for securities brokerage, and will lay the bases 12
for the future development of the securities market with the passage of the new laws at some point in 2005. This work should serve as recognition of the contributions of all those who have taken part in that modernization effort. Sincerely, Efrén del Rosal Calzada Chief Executive Officer 13
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Almost a quarter of a century has passed since the founding of the Mexican Securities Industry Association (Asociación Mexicana de Intermediarios Bursátiles, A.C., or AMIB). During that time, our institution has proven itself to be a valuable forum for the analysis, dissemination and exchange of experiences in the Mexican securities market. Our mission is increasingly interwoven with global priorities such as transparency, accessibility, and other concerns. During this past year, we kept abreast of events that might help us improve the regulation and performance of the financial markets, and to afford greater protection for investment and for investors. We maintained open channels of communication with market authorities through our committees, in order to be prepared for the many challenges of the market's constant development and the demands of global competition. The actions taken in 2004 are grouped into four sections of this report: I. COMPETITIVITY II. TRANSPARENCY III. CERTIFICATION IV. PROMOTION 15
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I. Competitivity Central Securities Counterparty (CSC). On February 9, 2004, the central securities counterparty formally began operations, guaranteeing settlement of all transactions on the Mexican Stock Exchange (BMV). In order to keep settlement guarantees, or margins, consistent at all times with trading levels on the Mexican stock market, and to encourage the development of the CSC, at AMIB's request, the CSC's Risk Committee authorized: The addition of various securities to the list of authorized margin securities, originally consisting only of 91-day Federal Treasury Certificates (CETES) to include all government securities, letters of credit, and even stocks (with the application of a "haircut" or discount); and Changes in the margin requests issued by the CSC at the close of trading hours, which starting in March must be covered up to 100% by government securities, a requirement that may on the following trading day be replaced by 30% cash. In addition, the national securities depository, S.D. Indeval, released a CSC account statement lookup function in its system, allowing users to consult information for three months (current month and two previous months) of historic information. Because the response times by the application introduced by the CSC were initially slow, AMIB was asked to help diagnose of the situation. The result was a set of measures that must be applied before installing any system that affects broker processes. Participants analyzed the causes of the processing delays, as well as the procedure for testing and releasing S.D. Indeval applications. The following agreements resulted from these discussions: Including the acceptance and/or authorization sheet from participating users in the tests. Eliminating weekday global testing. Continuing to conduct independent or specific tests on weekdays. Preparing, testing, authorizing and publishing contingency procedures. Creating policies for a system release checklist. 17
Additionally, participants agreed to review current contingency plans, concretely against the Business Continuity Plan. The purpose was to minimize the probable operating risk posed by the possible failure of an application. Changes to the Payment System Another important measure taken to reduce risk in securities settlement was the introduction of a new phase of the Payment System Reform. Starting in 2003, settlement hours were reduced, a process that was consolidated in 2004. Also in 2004, brokerage firms began using an intraday repo scheme and began scaling back credit lines. Another aspect of the reform was the introduction of Immediate and Deferred Settlement modules in the new payment system, called the Interbank Electronic Payment System (known as SPEI for its initials in Spanish), which allows for transfers between banks, and between banks and clients (brokerage firms and mutual fund managers, among others) or any other party.this means that when a payment order is requested by a client from their bank, it can be sent within ten minutes of the time that request is received, and the amount of the order credited in ten minutes more. Collateralized repurchase agreements Three trade organizations whose members are regularly involved in repurchase agreements, or repos, worked intensively to discuss and compile information on a project aimed at lowering counterparty risk in such transactions through the use of collateral guarantees and margin calls. The Mexican Bankers' Association (ABM), Association of International Financial Intermediaries (AIFI) and AMIB itself collected observations from the industry on the subject, and lobbied Banco de Mexico officials. The results were fruitful, and enriched this new scheme of security, to the benefit of the entire financial sector. In August and October 2003, Banco de Mexico issued Bulletins 1/2003 and 1/2003 Bis, respectively, establishing rules for banks, brokerage firms, mutual funds, and retirement funds, in their repo transactions. Having analyzed the proposals of intermediaries, and after an extensive phase of consultation, discussion and analysis, the group concluded that a 18
system of margin calls would be the most appropriate for mitigating the risk of these transactions between financial brokers. S.D. Indeval expressed an interest in providing the service of administering and valuing the margins, as well as handling the margin calls and maintaining custody of them. The basic features of the collateralized repo scheme are: 1. The repos are conceived of as one main contract (the repo) and one accessory contract (the guarantee).the rider to the contract includes the associated costs: notification, executors and administrators of the guarantees. 2. Requirements for additional guarantees (margin calls) can be fulfilled in cash or in securities of any kind, as determined bilaterally between the parties in the Contract Rider. The margin calls are intended to cover the risk create by a change in the price of the securities involved in the repo; they must be met in T+1. 3. They allow for a maximum trading limit and a haircut (discount) on the margin securities, also determined bilaterally by the parties, and stipulated in the contract rider.this reduces the counterparty risk. 4. The market value of the securities involved in the repurchase agreement is calculated according to prices supplied by a price vendor designated by common agreement between the parties, called the Calculation Agent. 5. The parties may bilaterally negotiate the minimum maintenance margin and the minimum transfer amount, based on credit lines also established in the contract rider. 6. Margins may be freed during the life of the repo agreement in the event of a positive change in the price of the securities involved. One of the conditions necessary for the application of this trading model was the creation of a standard contract, approved by the three trade associations (the ABM, the AIFI and AMIB). For this purpose, a work group was assembled with the support of the law firm Ritch, Heather and Müeller, S.C. and six versions of the contract were circulated and successively approved the legal and trading work groups. In addition, the three associations agreed on the terms of trading for repurchase agreements, which will serve as the basis for all the institutions to develop their own systems and determine the obligations that are negotiated bilaterally in the contracts. 19
Representatives from the risk areas of the trade associations, and members of the legal and trading work groups studied new proposals for creating margins on repo transactions, and established a table of components for estimating haircuts for margin securities; this table was released on July 5. On March 17, the final version of the standard repo contract was delivered so that intermediaries could negotiate their riders and sign the contracts with the parties with which they intended to trade. Because S.D.Indeval needed a longer period of time to develop and test the system for recording and administering margins for repo transactions-- called the System for Administration and Valuation of Repos (SAVAR, by its initials in Spanish), an extension was requested in order to standardize all the repo transactions carried out on the market. Through Bulletin 1/2003 Bis 1, dated April 30, 2004, Banco de Mexico agreed to extend the deadline for institutions to document their repo contracts with various institutions, to August 3, 2004. On June 7, Banco de Mexico issued Bulletin 1/2003 Bis 2, which specifies that repo transactions with foreign securities be governed by the provisions that apply to them. In the section entitled "Prohibitions", a point was added prohibiting the transaction of repurchase agreements under terms different from those contained in those provisions, and in the "information" section, a provision was added requiring participants to notify S.D. Indeval of the transactions performed with other parties and with the central bank that are settled through that securities depository, on the same day those transactions are negotiated.that Bulletin took effect on June 8. On July 30, Banco de Mexico issued Bulletin 1/2003 Bis 3, granting another extension so September 3, given the advisability of clarifying the scope of some provisions on the subject or repo transactions, and in response to various requests by the ABM, the AIFI and AMIB. With regard to the voluntary early termination of repo contracts, the participating institutions agreed that the standard Securities Brokerage Contract should include the same text as is found in the Standard Securities Trading and Repurchase Agreement Contract, establishing that the agreement may be concluded in advance upon written agreement by both parties. Following these last adjustments, along with a change in the signs of formulas mentioned in some provisions and further specification of some 20
definitions, on June 7 the official version of the Standard Repurchase Agreement Contract was distributed, replacing the version that was originally published on AMIB's web page. On July 1, the definitive models for contracts on securities collateral, collateral, and trusts, prepared by the legal group of the ABM, the AIKI and AMIB. Observations and instructions for improving the functionality of S.D. Indeval's scheme for recording and administering margins could not be included in the August 3 release of the system,but will be incorporated into a second version that will be released in 2005. The comprehensive testing necessary for this type of system were conducted, and on August 30 of 2004, SAVAR went into production. For the second version of S.D. Indeval's SAVAR system, an inventory of requirements and specifications for further development was taken, which will include: Adjustable-rate repos. Obligatory early expiration with Delivery Versus Payment (DVP) settlement, in which the counterparty that is in performance of its obligations may choose the transactions(s) it wishes to classify as past due. Valuation of margins using an average price vector, regardless of the book record. Separation of repos for early expiration. Distribution of margin transactions by counterparty, with or without transfer of domain. The introduction of haircuts other than the minimums established in the table of components approved by the three associations. Differentiation of marginable assets by counterparty. Securities Lending On June 7, 2004, Banco de Mexico issued Bulletin 1/2004 on Securities Lending. The Bulletin was originally to take effect on August 3, 2004, but in Bulletin 1/2004 Bis, published on July 30 of that year, the date was moved up to February 3, 2005. This Bulletin includes rules for banks, brokerage firms, mutual funds and retirement funds that engage in securities lending transactions. In addition, the National Banking and Securities Commission (CNBV) issued general provisions that apply to brokerage firms who engage in securities 21
loans, published on July 28, 2004, which took effect on the same day as the Banco de Mexico Bulletin. These provisions stipulate that securities loans between financial institutions and institutional investors must be transacted under a Standard Contract approved for this purpose by the ABM, the AIFI and AMIB, and the Mexican Association of Retirement Fund Managers (AMAFORE). A work group of the four associations was appointed to develop a procedure for proprietary securities lending, which would contain the trading criteria and rules for the trading and systems areas to develop their own systems. Another group was assembled to prepare the Standard contract. Under the new scheme, the margins for securities lending transactions are calculated using a dynamic haircut methodology for stocks, and the prices used to value the securities, both those involved in the loan and those submitted as margin, are the average prices supplied by the price vendors. On October 5, the securities lending procedure was finalized after various meetings of the trading work group of the four associations (ABM, AIFI, AMAFORE and AMIB). In those meetings, agreements were made on the development of a standard securities lending contract.with his procedure, the legal group was able to create a draft of the standard contract, which is expected to be released for use in trading by the institutions starting February 3, 2005. Representatives of AMAFORE are consulting with the National Retirement Savings System (CONSAR) to allow for the valuation of margins using average prices. The Risk Group analyzed proposals on the haircut table for debt securities and the calculation of Dynamic Value at Risk (VAR) for stocks. The table is expected to be ready for release in the first half of 2005. Because the contracts will be signed after the provisions take effect, Banco de Mexico issued Bulletin 1/2004 Bis, allowing securities lending transactions involving stock up until April 3, 2005, using the contract formerly in effect (a contract signed in S.D. Indeval for transactions through the Valpre system). International Quotations System (SIC). At the request of members of the securities industry, the Mexican Stock Exchange was asked to include SIC trades in the total trading volume 22