In the asset manager’s quest for new investors, Latin America represents a land of opportunity. Toshihisa Watabe, Vice President, Investor Services at BBH explains why regulatory changes could soon spur a global gold rush in Mexico.
For many years, Latin America has been fertile ground for regulated cross border fund vehicles, such as European UCITS funds, driven primarily by local pensions scheme investment. This growth comes from the high degree of comfort LatAm institutions and pensions schemes have investing in these highly regulated vehicles. Owing to a combination of ever increasing wealth accumulation and the culture of strong pension savings, Latin America remains a favorable fund distribution environment for global asset managers. Chile, Colombia, and Peru have years of experience of investing in regulated cross border funds. However, just last month, Mexico embarked on regulatory reform that may make it easier for capital to flow to and from international regulated investment vehicles. While new opportunity awaits, there are several wrinkles that still need to be ironed out.
In January, the regulator for the Mexican pension fund system (CONSAR) released new investment regulations, which appear to include the approval of mutual funds. Currently, Mexico’s Administradoras de Fondos para el Retiro (AFOREs) pension funds are only able to invest in exchange traded funds (ETFs) and separately managed accounts (SMAs), for non-Mexican investments. Although mutual funds were not explicitly prohibited within the prior policy, two regulatory requirements made it all but impossible for Mexican pension funds to invest in them. These requirements were the mandatory daily disclosure of the assets in the mutual fund portfolio and the prohibition of certain investments either held or potentially held by the fund not approved by the regulator. This means that certain securities not approved by the regulator, such as derivatives, could “contaminate” a fund and the pension fund would not be allowed to invest.
The AFORE system currently manages $160 bn and represents the largest and one of the fastest growing private pension system in the LatAm region with a 9.9% five-year CAGR, doubling in size in seven years.
The Devil is in the Detail
While CONSAR announced the new investment regulation to much fanfare, several questions remain and the devil is in the details. The industry is looking for the regulator to provide clear guidelines and reveal the full scope of their intentions. Here’s what we know and don’t know, so far:
Released on January 5, CONSAR’s initial rules are in line with those of a typical US 40 Act or UCITS fund. For example, funds must have a prospectus, issue periodic financial statements, strike a daily NAV, and maintain daily liquidity.
AFOREs will be responsible for ensuring the new funds comply with the regulation. Per the regulation, a third-party entity will be responsible for confirming the fund’s eligibility. In Chile, the Comisión Clasificadora de Riesgo (CCR) holds that responsibility. Now, it’s likely the Asociación Mexicana de Administradoras de Fondos para el Retiro (AMAFORE) will be the third-party entity for Mexican Administradora de Fondos de Pension (AFPs), as is already the case for ETFs.
The regulation named 51 approved domiciles for the new funds, including Ireland, Luxembourg, and Mexico itself. However, it’s unlikely there will be any significant flows into Mexican funds by the AFOREs for their global allocations. That’s mainly because the AFOREs will have direct access to global managers and their offshore structures without the need of a Mexican feeder that could potentially add cost.
The underlying securities of the fund must be publicly traded. In addition, the asset manager must also be regulated and domiciled within one of the 51 countries approved for the domiciles of the mutual funds.
Outbound Investment Challenges
While the new regulation opens the prospect to expand the AFOREs investment options with the addition of offshore funds, there are two components of the existing regulation that remain unchanged, creating challenges for AFORE investment teams to take full advantage of the new investment opportunity. The foreign investment limit remains at 20%, which can only be amended through a change in law. That is unlikely to happen due to the upcoming Mexican presidential elections.
The second challenge for AFOREs when allocating flow abroad is the current admissible limits on foreign equity investments. Pension funds will primarily look to use the foreign investment limit in equities, while also satisfying their fixed income exposure in the local market.
The approval of mutual funds is a significant development for the pension system in Mexico, but little action can be taken until regulators announce the details. We expect the regulator to release more information over the next few months. Meanwhile, the industry is pushing hard for these detailed requirements, which will be critical to understanding the real opportunity for global asset managers looking to distribute their offshore fund products in Mexico.
 Willis Towers Watson’s Global Pension Assets Study 2017