In January 2018, 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 from prior policy, two regulatory requirements made it all but impossible for pension funds to invest in them. These requirements were the daily disclosure of the assets in the mutual fund and the prohibition of certain investments 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.
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.
While the new regulation opens the prospect of AFOREs in Mexico, there are two components of the existing regulation that remain unchanged, creating challenges for AFORE investment teams to take full advantage of the 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 equity. Pension funds will primarily look to use the foreign investment limit in equities, while also satisfying their fixed income exposure in the local market.
1. Basica 1 - 10% (most conservative)
2. Basica 2 - 30%
3. Basica 3 - 35%
4. Basica 4 - 45% (most aggressive)
As global asset managers jockey to position to tap into these new potential flows from Mexico’s pension fund system, one important consideration will be tax. As a result of the US-Mexico income tax treaty, AFORE’s have 0% income tax withholding when investing in US vehicles. This is not the case in Chile, Peru, or Colombia, who currently have a 30% income tax withholding. This is an important development as it puts 40 Act funds on the same level as offshore funds in Mexico.
The delegation of final fund requirements to the Comite de Analisis de Riesgos (CAR), or Risk Analysis Committee comprised of various government bodies, is another key aspect of the regulation. Until the CAR releases their prescriptions, the industry can only speculate on the full scope of the new requirements. However, it’s likely they will treat the new funds similarly to ETFs and SMAs.
The approval of mutual funds is a significant development for the pension system in Mexico, but little action can be taken until regulators announce details such as minimum fund and fund manager size, maximum total expense ratio, and use of specific derivative strategies. The regulator is expected to meet again before the end of Q1 to finalize the requirements, which will be critical to understanding the real opportunity for global asset managers looking to distribute their products in Mexico.
SMAs will likely remain a viable investment for AFOREs, but mutual funds could slowly take over the allocation into active strategies, while ETFs will continue to cover passive strategies.
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