How Mexico’s incoming Government (whichever) ought to increase the country’s attractiveness in the global capital market.

(And, no, it’s not all about security and rule of law for a change….)

Executive Summary

1.      Mexico should leverage the best practices imported by its foreign investors and generalize them to all its economic stakeholders.

2.      The Mexican Government should seize all the implications of a recent but overlooked regulation that may push Mexico’s capital-intensive projects further into the global competition to attract capital, and act accordingly.

3.      The incoming Government should intensify its efforts to improve Mexico’s business environment perception which is currently unfairly ill-conceived among many investors’ community outside the American region.

4.      A more pedagogical approach to explain its public policy would help the Mexican Government face less resistance and negative perception from its constituencies and would generate more confidence to investors.

  No matter who wins the July 1 Presidential election, the new administration will need to find answers to a critical question: how to attract more and more investment for its much-needed Infrastructure projects from an increasingly demanding and competitive global capital market? Every single country in the world (advanced or developing, large or small…) is now vying for global capital.

Beyond its infamous security and rule of law issues, and its much-commented presidential election (there is already tons of literature available on these 3 capital issues), there are some drivers that we think the incoming Governmental team should immediately consider to position itself in this long run race:

1.      Make the application of International Institutional Investors standards’ and the replication of other countries’ investment best practices the domestic rule, not the exception.

Mexico has long been known for the opacity of its public tenders and more broadly for the “specificity” of its business rules in both the public and private spheres.

 Under the hypothesis that the public opinion’s growing aversion for corruption now weighs more than the sum of the individual interests for a status quo and will be the guideline for the next six-year term, the next administration can carefully look at what is already being made by its neighbors or at the standards that prevail in some of the investment projects in its own territory.

Foreign investors that have decided to bet on Mexico generally carry with them business principles that, by convictions or legal obligations, they do not give up while settling in Mexico.

U.S. entities have lived with the rules and regulations of the Foreign Corrupt Practices Act rules since the end of the 70s. Consequently, most of the U.S. funds make of the inclusion of such principles in the governance rules of any M&A operation an essential condition. The British Bribery Act passed in 2010 has also extra-territorial reach for the companies incorporated in the United Kingdom with activities abroad and entities such as Oil & Gas majors BP and Shell have applied them in their daily operations in Mexico.

But the fight against corruption is not the only front foreign investors are attacking. In the last two decades, the environmental and social impact of the economic growth has also become a central point of focus and new standards to conduct business more respectfully of the local environment have arisen, like the Equator Principles.

Foreign stakeholders are not the only ones to set standards high. Tribute must also be paid to local players. Independently of any political consideration, some local NGOs have developed analytic tools or work frames that could be easily retaken by the Government. The Instituto Mexicano para la Competitivad (IMCO) has released a thoughtful methodology to analyze the risk of corruption in the purchasing process of dozens of public organizations and represents a valuable tool the next Government can use to design the policies aimed at tightening control on corruption.

It is worth adding here that in the past years, the Mexican Government has proven that it could learn fast and emulate international best practices. Derived from the best practices found in Norway, Brazil or Canada, the methodology designed to lead the successive bidding rounds of O&G exploration blocks since July 2015 has been acclaimed as an example of professionalism and transparency by both the contenders and the external observers. This can be considered as the right course to maintain in the near future. 

2.      Get ready for the era of “investment funds’ freer competition”.

 In April 2015, a significant paradigm of the Investment industry in Mexico was broken in a relative indifference. Under certain conditions, the AFOREs, the Mexican Pension Funds, have now been allowed to invest their clients’ money abroad, in a new financial vehicle recently created: the Certificados Bursátiles de Proyectos de Inversión, known as CERPIs, with rules similar to the ones prevailing in the Private Equity sector.

Decided by the financial authorities themselves, the measure aims -among other objectives- at allowing the AFORES to search abroad for the long-awaited extra return on investment (ROI) that they have not been able to capture in the Mexican environment over the last few years. Though the amount that the AFORES can invest in the CERPIS is limited (between 5 and 20% of the total AuM, depending on the type of SIEFORE inside the AFORE), and though this is not the first financial vehicle the Mexican pension funds have had to invest in foreign currency, it might be different this time.

Indeed, the AFORES have been historically far from filling up their investment quota of structured product investments -which the CKDs and now CERPIS belong to-, probably because of the poor ROI offered by these vehicles in the domestic market so far. And the profit perspective of the CERPIS is particularly promising as giants of the Private Equity industry like BlackRock have publicly announced their intention to set up a CERPI, thus opening the doors to the AFOREs to potentially juicy investments managed by experts with successful proven tracks all over the world. That way, AFORES may provide to their clients return rates more in line with what other pension funds and sovereign funds offer to their clients and their citizens elsewhere in the world.

  The benefits for the AFORES are clear: geographical and FX risk mitigation, ability to capture fruits from higher economic growth rates in other geographies. But beyond those benefits, the potential subsequent impact on the Mexico investment landscape is two-fold.

First, this means that the capital-intensive projects in Mexico (infrastructure, real estate, etc.), which have traditionally captured a large amount of the liquidity from the domestic pension funds with a large appetite for this class of assets, may soon find it harder to maintain this quasi-monopoly as the AFOREs will now have the option to try some new kinds of risks, with investment opportunities in other geographies, where some of the CERPIS will focus on. Therefore, Mexican players will in turn have to compensate the loss of their captive sources of financing with new sources to be found abroad.

The second effect is actually derived from the first one: as the AFOREs will get more and more familiar with the international leading-edge management and governance standards of the Private Equity industry, their expectation towards the way their investments in Mexico are carried and the expectations towards their IRR will raise higher and higher, putting the local players under pressure in a business environment that is not always favorable to optimize the projects’ rates of return.

** Weighted Average of SIEFORE SB3

It is unclear whether the Government has seized the full impact of the change in the rules of the domestic investment game it has designed itself. . What is clear is that the Mexican Government will have to generate the right conditions that will incentivize Mexican project sponsors to design and structure attractive projects where the expected IRR is aligned with the risk allocation. Elements like a stronger encouragement of non-requested PPP projects, an aggressive strategy of Government’s financial warranty for infrastructure projects, stronger legal certainty and fiscal law stability for corporations are some vectors that the authorities should particularly take care of in the coming years.

3.      Improve Mexico’s business environment perception across the world, and in particular outside the American continent.

Given the direction taken by the US-Mexican cooperation over the past six months, it may be the right time for Mexico to re-assess its strategy in term of foreign capital attraction. The Northern neighbor no longer refraining from using the tariffs and barriers as a strategy to have the US investments stay in their homeland, it becomes relevant for the country to diversify its investment sources outside of its historical comfort zone. 

However, this requires a significant effort from the Mexican Government.

First, if we look at the potential alternative origins for investment, the Gulf countries -quite logically– currently prefer to invest in their neighboring countries (plus India and Africa) whose economies they are familiar with. Likewise, for Asian nations such as China and Singapore. Cultural and geographical proximity weigh significantly in investors’ choices

Secondly, an additional difficulty for this diversification lies in the fact that to most investors around the globe, Mexico is an unknown animal at best, an extremely dangerous and unstable country in most cases. However, the 15th world economy (by GDP size) offers solid economic opportunities within a relatively stable macro-economic ecosystem and in recent years, it has - as far as possible- tried to develop strategic infrastructure that many others would envy. Yet, these assets are most often overshadowed by security issues or ignored by the investment community who probably rely too much on the generalist competitiveness global rankings issued by famous institutions and organizations like the World Bank or the World Economic Forum. Mexico too often appears in the second tier, deterring many of the best quality investors, those with the long-term vision and the actual will to accompany the organizations they invest in with their expertise and know-how.

Even though Mexico can be a hidden gem with its skilled labor, its relatively cheap and reliable energy sources, its countless free trade agreements and its unique geographical position in the middle of the 3 main markets of the planet, it fails at highlighting these assets.

We believe Mexico comes short when it comes to selling itself. Its promoting bodies and initiatives, like Pro Mexico, seem to lack the resources necessary to compete on the global market of national marketing. However, it is time to lure investors of other continents to look more closely into the Aztec land. For that, the momentum must be impelled by the Government and its strategists. Mexico could and should define a simple and clear message for its ambassadors of all kinds (academics attending conferences, scientists visiting fellow scholars, officials on visits abroad, business men and women on professional trips…): Mexico is open to investment, and a much better opportunity than most of those usually considered.

4.      Make its own constituency better aware of the challenges of the 21st-century economy and thus better understand the rationale behind the much-needed reforms.

Mexico is certainly not the only country facing this challenge, but the problem is particularly acute here as shows the presidential campaign: because they lack the tools to apprehend them, Mexicans struggle to process the tectonic changes that have affected the world in the past 20 years and equally struggle to understand why the Mexican Government needs to undertake extensive reforms that change the fundamentals of the social and economic fabric of the country. As an illustration, there has always been fondness for the state monopolies and conglomerates of all sorts that marked the economic growth of the 20th century, but little appetite for the new agile methods of management in the public sector or for the opening of some sectors to free competition. Modern challenges derived from the globalization, from the increase of trade of goods and knowledge to the new technologies and their impact on societies are often covered, explained, debated in a much too simplistic way that is distorted and fails to expose what is at stake.

For instance, a staggering 63% of Mexicans are not aware that the national oil production has collapsed in the past decade: it thus seems unlikely they can assess objectively the reach of the recently passed Energy Reform. It would be worth making sure that they become aware that with the contracts awarded to IOCs, up to 70% of the production from the oil fields awarded to the private sector will return to the Mexican state coffers. This lack of pedagogy probably explains part of the reluctance (from local and indigenous communities, from petroleum industry stakeholders and populations living in the oil-producing States…) the pioneers of the Reform have encountered while taking possession of their assets…

Although the problem is clear, the remedial action is admittedly a complex shot to take for the Government, mixing both short-term communicational and long-term educational initiatives. The long-term dimension goes beyond this article’s scope and deals with a specific effort to be made from the middle school level to provide the citizenry with a stronger layer of economic principles’ knowledge. On the short-term side, it is unquestionable that the authorities must act differently from what has been done recently: whatever reforms the incoming Government will undertake, this latter must put more emphasis in demonstrating the legitimacy of its decision and in detailing better the actual reach and timeline of the reforms’ impact. Better-informed discussions, deeper debates should be fostered by the non- and specialized press, professional social media and academics, to help Mexicans understand and in their majority support decisions that are key to their future. In contrast, the most debated topics of the ongoing presidential campaign, which centered around the possibility to literally unwind the iconic reforms passed by the former administration (Energy, Labor, Education, etc.), are a vivid illustration that a significant group of the population still questions reforms that have yet been praised by the international community. This has unfortunately spread a growing concern in all domestic and foreign private investment circles. 

To us, most of aforementioned actions could be implemented by any of the presidential hopefuls, regardless of their political platform, and many do not require massive financial investment but instead a more pragmatic approach of the exercise of power. They would help any incoming administration place Mexico on the radar of a broader pool of international investors that will otherwise keep their eyes on other geographies.

If you care for Mexico and its future like we do, don’t hesitate to join the discussion in the comments area below. We look forward to reading your own contributions.

 Authors:

Frederick Pierru is a former industry senior executive and professional management consultant with an extensive experience in Latin America, currently focusing on the infrastructure sector in Mexico.

Thibaud Cadieu is an Oil & Gas consultant specialized in the Mexico Energy Reform and its ramifications for the national upstream sector. 

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