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DERECHO & ECONOMÍA DERIVATIVES AND RISK MANAGEMENT IN MEXICO FINANCIAL INNOVATION: GROWTH AND NEW PRODUCTS Dr. HERNÁN SABAU MAY 2001 Innovations in different markets DERECHO & ECONOMÍA • Fixed income securities • Interest rate • Foreign exchange • Currencies • Equity • Indices and individual stocks • Credit • Default risk The Mexican Derivatives Market: past innovations in different markets DERECHO & ECONOMÍA • Fixed income • Petrobonos (1977) • OTC Senior / Junior structures (1993) • FX • Coberturas cambiarias (1987) • Equity • Warrants market (1992) • IPC, guaranteed returns, american call spreads • OTC issues • Nafta warrant (1993) • MexDer • Futures on individual stocks (1999) • Credit (?) DERECHO & ECONOMÍA The Mexican Derivatives Market has not grown to a mature market • Trading Volume has grown very slowly • Underlying markets: depth and liquidity • 1994 / 1995 crisis: effects on credit and the financial system • Regulatory issues • Excess controls through early and mid 90’s • Capital requirements after crisis • Risk management • Tax implications • Risk culture DERECHO & ECONOMÍA The Mexican Derivatives Market: recent developments favoring innovation in the Fixed income and FX markets • Up to 1999 longest rate was for 91 days • Development of a long term interest curve: • Decreasing inflation and stability • Bank disintermediation: increasing market share of Government debt • Introduction of M2 – M5 bonds: fixed income 2-5 year bonds with fixed rate • Institutional investors: Afores, Life Annuities, Insurance Companies DERECHO & ECONOMÍA Recent developments favoring derivatives innovation: bank disintermediation Market Share Annual Real Growth 50% 120% 45% 100% 40% 80% 35% 30% 60% 25% 40% 20% 20% 15% 0% 10% -20% 5% -40% 0% 98 A J O 99 A J O 00 A J O 98 A J O 99 A J O 00 A J O Checking accounts + current deposits Checking accounts + current deposits Rest of bank securities deposits Rest of bank securities deposits Government securities-held by residents Private securities- held by residents Government securities- held by residents Private securities- held by residents DERECHO & ECONOMÍA Recent developments favoring derivatives innovation: Government debt with fixed rates and 2 to 5 years maturity Government Securities Structure (Thousand dollars) DERECHO & ECONOMÍA Recent developments favoring derivatives innovation: Institutional Investors Siefores All figures in million dollars Mutual Funds Insurance Companies and Life Annuities (Reserves) DERECHO & ECONOMÍA Recent developments favoring derivatives innovation: 5 year interest rate curve DERECHO & ECONOMÍA Recent developments favoring derivatives innovation: 5 year interest rate curve DERECHO & ECONOMÍA The Mexican Derivatives Market: recent developments favoring innovation in the Fixed income and FX markets • Development of more depth and liquid markets • Deregulation: • easier access to markets • Capital requirements and risk control • Market makers • Since october 2000, 5 institutions • Only Fixed rate Government securities • More competitive picture in equity trading • Opening of listed futures market and clearing corporation DERECHO & ECONOMÍA Recent developments favoring derivatives innovation: more liquidity Liquidity (Daily turn over/outstanding) Fixed Rate Securities Floating Rate Securities Inflation Link Securities IPAB Securities Central Bank CETES 17.77% BONO M3 139.55% BONO M5 2.03% BONDE 28 0.42% BONDE 91 0.56% BONDES 182 0.95% BONDES T 0.000% UDIBONOS 3 0.002% UDIBONOS 5 0.003% UDIBONOS 10 0.000% IPAB 0.002% BREMS 0.002% DERECHO & ECONOMÍA Recent developments favoring derivatives innovation: more competitive equity market Accival Vafin 3% 10% Merril Lynch 9% Vector 9% Bancomer 4% Goldman Sachs 5% Santander 9% Inverlat 7% GBM 8% Probursa 7% Otras 16% Inbursa 6% Banorte 7% Scene for derivative innovations which are on the way in different markets DERECHO & ECONOMÍA • Fixed income securities • Interest rate swaps (28d vs up to 5 yrs) • Caps and floors • Foreign exchange • Currency swaps • Options, futures and forwards • Equity (?) • Credit (?) • Asigna: absortion of counterparty risk • Problem: • mostly interbank, lack of corporate risk policy