Mexico: The Investment Funds Market In Mexico

1. MARKET OVERVIEW

Before the financial reform of 2014, the investment funds market in Mexico was growing steadily. However, the reform, and the subsequent passing of the new Investment Funds Law(IF Law) in early 2015, resulted in a greater projected growth, in part due to Mexican investment funds being bound to comply with more obligations and subjected to further scrutiny from the National Banking and Securities Commission (CNBV). For many years, investment funds in Mexico were called "investment corporations" (mutual funds), however, as a result of the financial reform, in January 2014, the investment corporations were formally renamed "investment funds" (however, they are essentially the same).

Under the IF Law, investment funds lack a shareholders' meeting, board of directors and statutory officer. Instead, the managerial responsibilities are held by the investment manager company. Another key change brought by the IF Law is the flexibility for investment funds to sub-divide or spin-off, subject to special conditions, in the event that the financial markets exhibit disorganised or volatile traits, or when the characteristics of the investment assets have liquidity or valuation issues. Further, investment funds, as well as their representative shares, must be registered with the National Security Registry (the Securities Registry) in order to provide investor access to information about the funds in which they are investing. Notwithstanding the above, the primary purpose of the IF Law was to have investment funds (and their investment managing companies) become more transparent to the general public, in order to attract more potential investors.

In the Mexican investment funds market, there are four types of investment funds recognised by the IF Law:

  • Variable rent investment funds.
  • Debt instrument investment funds.
  • Private equity investment funds.
  • Limited purpose investment funds.

While not defined under applicable law, hedge funds are a sub-category of the variable rent investment funds.

By law, all investment funds must be incorporated as limited liability stock corporations with variable capital. The fixed portion of the capital stock of these entities can only be subscribed by the funding partner of the investment fund, which must always be the investment manager company of the fund. The variable portion of the capital stock of investment funds is free to subscribe, meaning any individual or entity may subscribe stock in the fund, subject to any specific limitations set out in the articles of incorporation. It should be noted that financial institutions can subscribe stock in investment funds, but always by acting as trustee on behalf of individuals or entities.

According to information compiled by the Mexican Association of Financial Intermediaries (AMIB), during the first semester of 2015, the total amount of cash managed by Mexican investment funds totalled MXP$1.9 trillion, which marked an annual increase of 8.7%. While these numbers did not reach the MXP$2 trillion mark expected by sector experts, it still marked an important growth. According to the AMIB, the collective estate of Mexican investment funds represents 11% of Mexico's internal gross product.

2. ALTERNATIVE INVESTMENT FUNDS

2.1 Common structures

Mexican law provides that all investment funds must be incorporated as limited liability stock corporations with variable capital. Limited liability stock corporations operate under a company name and are formed exclusively by stockholders whose liability is limited to paying for their shares as capital contributions. To the same extent, investment managing companies must also be forcibly incorporated as limited liability stock corporations. The fixed portion of the capital stock of the investment funds must be exclusively held by the investment managing companies, while the variable portion of the fixed capital can be held by any individual or entity. Moreover, the shares representative of the variable portion can be issued in as many different series as the investment management company considers necessary, which each series of shares giving different rights and obligations to their holders.

As limited liability stock corporations, investment funds and investment managing companies are bound by the terms of the General Law of Corporations (Corporations Law), as well as to certain specific requirements set out by both the IF Law and the CNBV. General requirements for limited liability stock corporations, applicable to investment funds and investment managing companies, as set out by the Corporations Law, include:

  • Legal name and corporate domicile of the company.
  • Corporate purpose of the entity.
  • Duration of the company.
  • Total amount of the capital stock.

In this regard, the above requirements will need to form part of the corporate byelaws of the investment funds and investment managing companies.

Additionally, the investment funds and investment managing companies, pursuant to the Corporations Law must keep a:

  • Shareholder registry book.
  • Capital variations book.
  • The shareholder registry book must contain:
  • The name, nationality, domicile and tax payer identification number of all shareholders.
  • The number of shares held by each shareholder, along with all other relevant information.
  • The amounts paid by each shareholder for his or her shares.
  • Any transfers or endorsements that have been made of the shares.

In turn, the capital variations book must keep a record of all capital increases and reductions.

Further, pursuant to the Corporations Law, each share must be documented by a share certificate which must include the following information:

  • The name, nationality and domicile of the shareholder.
  • The name, duration and domicile of the corporation.
  • The date of incorporation of the company, the amount of capital stock, the total number of shares.
  • The instalments upon which the value of the shares have been paid or a legend stating that they have been totally paid and released.
  • The series and number of the share certificates, stating the number of shares that correspond to that series.
  • The rights and obligations of the holder of the share certificate.

2.2 Regulatory framework

Since investment funds and investment managing companies participate in the Mexican securities market, the authorities in charge of regulating the market are the Ministry of Finance and Public Credit (the Ministry) and the CNBV. Further, both investment funds and investment managing companies require prior authorisation from the CNBV in order to be incorporated. Laws which are directly applicable to both investment funds and alternative investment funds are:

  • The IF Law.
  • The Corporations Law.
  • The Securities Market Law (Securities Law).
  • The General Provisions Applicable to Investment Funds and Persons who Contract Investment Funds (General Investment Fund Provisions).

To a lesser extent, the Federal Civil Code and the civil codes for the states where the investment funds are domiciled and the Code of Commerce are also applicable.

  • Interested parties that want to incorporate an investment fund must submit an application to the CNBV, along with the following information or documents:
  • A draft of the investment fund's corporate byelaws, which should include the requirements set out by the Corporations Law, as well as the type of investment fund it will be, and including as their exclusive corporate purpose the professional and habitual purchase and sale of investment assets (mainly securities, as provided below) by using proceeds obtained from the sale of its stock to determined persons, through financial intermediations services (as defined below).
  • Information on the investment fund's founding partner (the investment managing company), including the authorisation to act as an investment managing company granted by the CNBV.
  • A draft of the prospectus for potential investors, as well as any other documents with key information for investors. The prospectus must include the type of investment fund and the term.
  • The list of persons who will provide services to the investment fund, including valuation and promotion and marketing services (when applicable).
  • Any other information or documents requested by the CNBV at its own discretion.

Investment funds, contrary to regular limited liability stock corporations, are incorporated only by the founding partner and before the CNBV, without the formality required by the Corporations Law to formalise the articles of incorporation before a notary public. Once this process has concluded, the founding partner must register the investment fund before the registry. Any amendments to the corporate byelaws of investment funds must be approved by the CNBV.

Similarly, in order to incorporate an investment managing company, interested parties must submit an application, alongside the following information and documents to the CNBV for approval:

  • A draft of the corporate byelaws.
  • The general operational plan, which must contain the plan of activities to be undertaken by the investment managing company. This must include, among others, the primary activities the investment managing company will carry out, the personnel structure for the investment managing company, the geographic locations where it will operate, a financial viability study and the security measures necessary to maintain the integrity of its information.
  • The operational manual and the conduct manual. The latter must include the policies in order to resolve any potential conflict of interest before the funds it manages (where such company manages more than one fund).
  • A list of the individuals who will, directly or indirectly, participate in the capital stock of the investment managing company.
  • A list of the probable directors, chief executive officer, and primary officers of the investment managing company, alongside the information which credits that each individual has the necessary qualifications to serve in such positions.
  • The name of the individual who will serve as the compliance officer for the investment managing company as well as the process for removing them and appointing a new compliance officer.
  • A receipt for the deposit of 10% of the total capital stock of the investment managing company.
  • Any other documents or information that the CNBV may require at its discretion.

Pursuant to the Securities Law, the activities of the investment managing company are considered to be financial intermediation. Financial intermediation means, under the Securities Law, carrying out on a professional and customary basis, any of the following activities:

  • Any activities to bring together the offer and demand for securities.
  • Entering into any transaction with securities as broker, agent or otherwise, acting in its own name (dealer) or for the benefit of third parties.
  • Transacting business involving securities in its own name with the public or with other intermediaries acting in their own name or on behalf of third parties.

The Securities Law defines securities as the shares of stock, equity interests, debentures, bonds, warrants, certificates, notes, drafts or bills of exchange and other negotiable instruments, known or unknown, registered or not with the registry which are subject to being circulated in the securities exchanges referred to in the Securities Law. They can be issued in series or otherwise, represent the capital stock of an entity or a share in a good or participation in a collective credit or any right under an individual credit, under any applicable national or foreign laws.

2.3 Operational requirements

Depending on the type of fund, each fund will have certain restrictions. In the case of private equity funds, the investment will be limited to private equity. Similarly, hedge funds will be limited to investing in foreign currency, while real estate funds will be limited to investing in debt instruments connected to real estate projects. A growing trend has been for foreign equity funds to invest in Mexican enterprises, primarily Canadian Limited Partnerships since they are transparent for Mexican tax purposes and have enough flexibility from a corporate standpoint, to allow for different types of investments.

Two relatively new investment instruments, as provided by tax regulations, were created as alternative investment assets:

  • Equity development securities with the primary purpose of raising funds for Mexican infrastructure products.
  • Modelled after the real estate investment trusts used in the United States of America, the Fideicomisos de Inversion en Bienes Raices (FIBRAS), which were created to raise funds in order to finance large real estate and infrastructure projects.

Both of these instruments are considered to have favourable tax incentives for investors, and low risks.

The share certificates representative of the capital stock of the investment funds must be deposited before a depository company duly authorised by the Ministry and supervised by the CNBV. Since 1987, the only authorised depository company in Mexico is S.D. INDEVAL, Institución para el Depósito de Valores.

Investment managing companies must publish the financial statements of the investment funds they manage in the Federal Gazette. In addition, investment managing companies must publish, through means available to the general public, relevant events related to the investment funds they manage, including amendments to the investment prospectus, or to the byelaws of the investment fund. The financial statements must be audited by an external auditor, and approved by the CNBV prior to their publication.

While the above are the only reporting requirements set out in the IF Law and General Investment Fund Provisions, the CNBV can request from time to time, and at its own discretion, any information it might deem necessary in order to verify that the investment funds and the investment managing companies are not breaching any applicable laws.

2.4 Marketing the fund

As provided by the IF Law, the primary marketers and promoters for investment funds are the investment managing companies that manage the funds. In some cases, and provided that the CNBV approved it at the time, the initial incorporation application, third parties may be contracted to promote and market the investment funds.

Investment funds can be marketed to any individual, legal entity or financial institution acting as trustee on behalf of individuals or legal entities, with the only limitation being the terms of the investment fund. That is, if an investment fund is only available to individuals, then, logically, the marketing will be directed to individuals only, and conversely, investment funds created for legal entities will only be marketed to legal entities.

The primary marketing material is the prospectus of the investment fund, which must include the following information:

  • The general information of the investment fund, such as the name of the fund, the name of the investment managing company, the modality of the investment fund (open or closed and the duration of the investment fund.
  • A detailed policy of the process required to sell the shares of the fund, and the limits of ownership per investor, pursuant to applicable law.
  • The manner in which the negotiation and liquidation for the purchase and sale of the shares of the investment fund will take place, including the current valuation price of the shares, and the term in which payments must be made.
  • The investment policies, including selection of the investment portfolio, and the diversification or specialisation of the investment assets, the minimum and maximum amounts of investment per asset, among others.
  • A detailed explanation of the risks involved in investing.
  • The methodology followed for valuing the shares in the investment fund.
  • When dealing with open investment funds, the methodology for repurchasing shares.
  • The structure of the capital stock, including the different series of shares, and the rights and obligations conveyed by each series.
  • The amounts and procedure to calculate such amounts, that the investment funds and their shareholders will have to pay and their timings.
  • A statement by the individuals who prepared the prospectus, stating that no relevant information was withheld at the time the prospectus was prepared.
  • The process and steps to wind up and liquidate the investment fund.
  • Any other specific requirements requested by the CNBV at its own discretion.

2.5 Taxation

The Mexican Mutual Funds Law provides that all mutual funds must be incorporated as limited liability stock corporations with variable capital.

Under the Mexican Income Tax Law, mutual funds will not be considered as taxpayers in Mexico, except for venture capital securities mutual funds. However, the members or shareholders of mutual funds will be taxpayers..

For debt securities mutual funds, their members or shareholders (residents in Mexico for tax purposes) must include in their gross income, interest income accrued in their favour by such funds. Likewise, the members or shareholders (residents in Mexico for tax purposes) of capital markets securities mutual funds must apply to the yields earned by such funds the tax treatment relevant to interest, dividends, and gains on dispositions of shares of which the yields are composed.

The mutual funds must withhold and pay monthly tax corresponding to their members or shareholders in case of interests. In general, terms, the tax is calculated by multiplying the 0.6% rate by the amount of the capital from which the interest is paid. The withholding must be paid at the authorised offices no later than the 17th day of the month immediately following the month to which the payment corresponds and a tax invoice bearing the amount of interest and the tax withheld will be issued by the mutual funds to its members. Through a general tax rule issued by the Mexican tax authority, the tax rate applicable is 0.00139% and in some specific cases, the withholding tax above will not apply.

The members or shareholders of the mutual funds can credit the tax paid in connection with the interest by the mutual funds against their estimated or definitive tax payments, provided that they include the taxable interest accrued on their investments in said mutual funds in their gross income for the year.

Members or shareholders (individuals residents in Mexico for tax purposes) who earn profits from disposing of shares issued by capital markets securities mutual funds (whose purpose is the acquisition and sale of investment assets with resources obtained from placing shares of their capital stock among the investing public) must calculate the gain obtained or loss sustained in the year from the disposition of shares of each investment fund. These individuals apply the 10% rate to the gain earned in that year. The tax paid will be considered definitive. Members or shareholders must submit a tax return for the gains earned and must pay, if applicable, the tax for the year, along with the annual tax return.

On the other hand, foreign residents will be subject to tax in Mexico for the disposition of shares issued by capital markets securities mutual funds (when the person who issued the shares is a Mexican resident or when more than 50% of the accounting value of said shares or securities derives directly or indirectly from real properties located in Mexico).

In general, the tax must be paid through withholding by the distributor of the shares in the mutual funds, applying the 10% rate over the gain derived from the disposition. The calculation of the gain is in accordance to a special procedure set forth in the Income Tax Law. Withholding and payment of the tax will be considered definitive with regard to the gain derived from the disposition.

Likewise, foreign residents will be subject to tax in Mexico for interest income, when interest is paid by a Mexican resident, on mutual funds. The Income Tax Law considers as interest the gain made from disposing of shares in the debt securities mutual funds (the law sets out a special procedure to calculate the gain).

The tax will be calculated by applying the following rates: 4.9%, 10%, 15%, 21%, 25% and 35% to the gross interest obtained by the foreign resident, without any deduction depending on the beneficiary owner of the income. The tax will be calculated by applying the 40% rate withholding to the gross income earned by the foreign resident, without any deduction if is a resident for tax purposes in a place considered to be a preferential tax regime for Mexican tax purposes.

It is important to point out that members or shareholders (individuals or foreign resident) are subject to additional tax on the distribution of dividends. The mutual funds that distribute dividends or profits must withhold tax at 10%, to be applied to the dividends. This tax will be considered definitive.

Mexico has in force several tax treaties, which may soften the tax burden.

Finally, if a higher degree of legal certainty is desired about the applicable tax regime, it is possible to request from the Mexican tax authority a written ruling with regard to the tax treatment applicable to mutual funds.

2.6 Customary or common terms

As mentioned above, there are no legal requirements with respect to the terms for investment funds, instead, the terms of each fund vary from fund to fund.

3. RETAIL FUNDS

3.1 Common structures

See section 2.1 above.

3.2 Regulatory framework

See section 2.2 above.

3.3 Operational requirements

As with alternative investment funds, depending on the type of fund, the restrictions will vary. Generally, variable rent investment funds, debt instrument investment funds and limited purpose investment funds are retail or mutual funds. Variable rent investment funds are limited to investing in securities, and fixed and variable rent instruments, these include private equity as well. Debt instrument investment funds can only invest in securities, specifically debt instruments such as promissory notes, bonds, and other variable yielding instruments. Finally, limited purpose investment funds can only invest in investment assets identified in its corporate byelaws.

As to the operation of investment funds, please see section 2.3 above.

3.4 Marketing the fund

See section 2.4 above

3.5 Taxation

See section 2.5 above

3.6 Customary or common terms

See section 2.6 above.

4. PROPOSED CHANGES AND DEVELOPMENTS

This is a market that has been rapidly growing, and periodically, new investment products and instruments are created. At the end of 2015, and as a result of the massive energy reform passed in 2014, a new type of investment trust was created, in the same vein as the FIBRAs, and for the purpose of investing in energy infrastructure projects, the FIBRA E. There is an immense potential for growth in the investment fund market, however, there are certain areas which could improve.

Firstly, and as evidenced above, Mexican investment funds are not at a point where regular individuals can understand the purpose or mechanism of these vehicles. This greatly limits the number of participants that the investment fund market in Mexico has, particularly individuals. Since this is a relatively new market in Mexico, the general population does not understand private equity funds or equity development securities. The primary change that needs to occur is that investment managing companies must provide a wider array of information when it comes to investment funds, and the assets in which they will invest. Even though the market has gradually increased over the past few years, more legal entities are investing in investment funds, and in order for the general population to participate in this market, more information and easier access to it is necessary.

As for necessary changes to the law, the most pressing need is to provide greater differences among the type of investment funds. As it currently stands, the only real difference between one type of fund and another is the underlying assets in which they will invest. Some types of funds, such as hedge funds, are not even referenced in applicable laws, and this leaves a grey area for the investing public, which may scare off potential investors, particularly after the recent economic global depression.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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