Co-authored by Hans P. Goebel C. and Héctor Arangua L. of Nader Hayaux & Goebel in México, D.F. and Philip T. von Mehren and Damien G. Scott of Venable LLP in New York, NY. This Overview does not constitute legal advice, and was prepared and updated as of February 8, 2016.
1. What are the Mexican regulations that affect international private equity firms investing in Mexico?
Mexican laws do not specifically regulate investments in Mexico by international private equity firms. The Mexican Foreign Investment Law, however, prohibits or limits foreign investment, whether directly by a foreign entity or indirectly through a controlled Mexican entity, only in a few strategic sectors of the Mexican economy.1 Nonetheless, foreign investment is permitted in those restricted industries through a special type of neutral investment authorized by the National Foreign Investment Commission (“NFIC”).
The prior approval of the National Foreign Investment Commission is required regardless of the industry in which a foreign investor intends to invest, if (i) the foreign investor will own more than 49% of the equity in a Mexican company and (ii) the outstanding value of the assets of such Mexican company exceeds MXP $3,601,905,682 (or approximately US$ 258,000,000). Although investments of international private equity firms are not regulated by specific legislation, the general limitations on foreign investments affect the landscape for international private equity firms investing in Mexico. 2
2. What are the Mexican regulations that affect international private equity firms raising funds in Mexico?
Although Mexico does not specifically regulate private equity fundraising in Mexico, all public fundraising transactions must comply with the general rules set forth in the Mexican Banking Law (Ley de Instituciones de Crédito) and in the Securities Market Law (Ley del Mercado de Valores). As in many countries, Mexico limits how private equity funds raising capital may do so in the Mexican market. Only registered banking entities may (i) solicit, offer or promote fundraising activities towards the general public, or (ii) obtain or solicit funds habitually or professionally. 3
In order to comply with these rules, international funds and local funds either (i) enter into referral agreements with registered intermediaries or (ii) privately target solicitations from Mexican investors, allowing the investors to request offers rather than accept offers presented by private equity funds. Likewise, private offers are regulated by the Securities Market Law as an acceptable form of fundraising, which must comply with certain specific requirements in order to be considered a private offer.
3. What Mexican regulation and rules affect international private equity firms seeking to raise capital from Mexico pension funds and insurance companies specifically?
Pension fund managers (Administradores de Fondos para el Retiro, or “Afores”) are not allowed to invest directly into private equity funds. Afores may, however, invest in capital development certificates (certificados de capital de desarrollo, or “CKDs”) that are structured as trusts. The securities issued by a CKD are publicly registered and traded (although the liquidity of the market is quite limited).
Several different types of CKDs have been raised.4 Some of them act as funds of funds in the sense that the CKD invests in funds managed by third parties. Others act as parallel investment vehicles for funds managed by the same private equity group, co-investing with the mother fund into Mexican transactions. Finally, some CKDs are, in substance, standalone funds focused on a specific investment strategy that is functionally equivalent to a fund.
In addition, CKDs cannot currently be used to invest in funds planning to invest outside of Mexico and present additional administrative burdens to fund sponsors due to the registration and public company compliance requirements.5 Therefore, international firms without a local CKD structure cannot raise funds from Mexican Afores, as permitted in countries such as Colombia or Peru. However, there is an expectation that the Afores will be able to diversify internationally in the coming years.
Mexican insurance companies can also invest in local or international funds either directly or through a CKD. In either case, the Mexican insurance company must obtain authorization from the National Insurance and Bonding Commission (Comisión Nacional de Seguros y Fianzas (“NIBC”). Several requirements must be met in the NIBC application including (i) documentation demonstrating the expertise of the fund manager, (ii) the fund must have an independent investment committee and (iii) the fund documentation must contain specific rules addressing conflicts of interest, reporting requirements, including, for example, calculations of expenses, carried interest, and gains and losses. In addition, the private equity fund may not invest more than 20% of its aggregate capital in any single company or affiliated group of companies unless authorized by a majority vote at the fund’s shareholders’ meeting. The fund must also ensure that Mexican insurance companies are provided with sufficient information to comply with the informational requirements of the NIBC regarding the operation of the fund.6
4. What are the Mexican Regulations that Affect the Formation of Local Private Equity Funds in Mexico?
Among the structures used for private equity investment into Mexico include those with Ontario and Quebec partnerships as well as Dutch B.V.s as the immediate owner of the equity of a Mexican portfolio company. Although Mexico does have a vehicle like a Delaware or Cayman Islands partnership, international funds still invest into Mexico through off-shore vehicles.
Local managers in Mexico generally use a private equity investment trust (Fideicomiso de Inversión de Capital Privado) (“FICAP”) when forming a local Mexican fund. This form of a Mexican vehicle is used because of certain tax benefits afforded to this type of vehicle aimed at incentivizing private equity investors. Investors in a FICAP purchase trust certificates issued by the FICAP, which are either publicly placed through the Mexican Stock Exchange (Bolsa Mexicana de Valores) or privately issued. The main feature of the FICAP is that the trust is subject to a transparent regime for tax purposes, which allows investors to (i) openly identify the income generated through the trust (dividends, capital gains, interest payments, etc.) as if they had obtained such income from investing directly in a Mexican target entity and (ii) delay taxation until the FICAP makes a distribution to its beneficiaries.7 FICAPs face two limitations that might inhibit their use as a private equity vehicle. The first is that the FICAP cannot transfer any shares acquired by the FICAP for two years following the acquisition thereof. The second is that the tax benefits associated with a FICAP must terminate (no extensions are permitted) after ten years – even if the trust agreement lasts longer. 8
In addition to the FICAP, private equity funds are also formed as ordinary Mexican trusts. If a fund is formed as a trust, the Mexican Fiscal Resolution (Resolución Miscelánea Fiscal) applies. This resolution requires that the fund have 90% of its income in the form of passive income, which is defined broadly in the Resolution to include capital gains and dividend income, in order to grant full tax transparency to the trust. In addition, these trusts do not have to comply with the FICAP regulations. The main feature of the trust is that it is transparent for tax purposes, therefore allowing investors to declare the income obtained through the trust (dividends, capital gains, interest payments, etc.) as if they had gained such income from investing directly in a Mexican entity; nonetheless, investors will need to recognize income when generated by the trust, irrespective of whether a distribution to the trust’s beneficiaries occurs or not.
The Comisión Nacional de (CNBV), in coordination with the Secretary of Finance, issued rules in December 2015 to regulate a new vehicle called the Certificado de Proyectos de Inversion (CERPI). The CERPI is an investment vehicle intended for sophisticated investors only, unlike CKDs. The Certificates would be issued through the BMV in the form of a restricted offering for investors (e.g. pension funds and insurance companies) and would focus on a specific project rather than a pool of assets or portfolio companies. As a result, this vehicle will be riskier than a pooled investment, and the role of the manager will be, consequently, more important.
Another vehicle used for private equity funds in Mexico (and in other contexts as well) is the investment promotion limited corporation (Sociedad Anónima Promotora de Inversión) (“SAPI”), which provides a great deal of flexibility to provide for an increased level of protection for minority stakeholders and exit strategies.9
Public fund solicitation in Mexico is expressly restricted to authorized entities (i.e. banks, brokerage houses, public debt issuers, etc.); nonetheless, private equity funds may raise capital by privately soliciting institutional and sophisticated investors in Mexico under the Mexican safe-harbor rules that allow the private placement of securities to such investors, as described above in response to question 2.
Finally, the Mexican authorities have recently published the rules setting out the requirements for the creation of a new Energy and Infrastructure Investment Trust (FIBRA-E), in addition to details on the tax regime that will be applicable to these types of vehicles. The new FIBRA-E will provide vehicles for investment in projects or assets of the energy and infrastructure sector, including activities such as generation, transmission and distribution of electricity, roads, highways and railways, among others.10
5. What Additional Mexican Regulations Affect the Management of the Private Equity Funds in Mexico
Although not governed by any specific statute or regulation, the obligations of managers, the scope of their liabilities, their remuneration and other related provisions are usually matters agreed upon by contract in a fund’s relevant management agreement.
Common provisions of the management agreements include, among others: term of the appointment, term of the investment, management fees, success or promotion fees, insurance, limitations of liability, fiduciary duty over the investments, powers of attorney granted to the manager, representations and warranties, events of default, etc. Although not found in every management agreement, confidentiality, non-compete and other similar provisions are also commonly negotiated terms.
1Foreign investment is prohibited in a few strategic areas such as the generation of nuclear energy, the control and administration of the electricity market, the control, supervision and surveillance of ports, airports and heliports, and land passenger transport, whether tourism or cargo (not including courier services). However, foreign investment in these restricted activities is permitted, subject to the approval of the NFIC, via a special type of neutral investment. Other strategic industries are capped at thresholds of up to 10%, 25% or 49%. Foreign investment in other sectors is permitted subject to the approval of the NFIC.
2See below for a link to the Spanish-language version of the Foreign Investment Law (Ley de Inversión Extranjera) currently in force in Mexico. Articles 5 to 9 set forth the limitations generally described in this paragraph and footnote 1. http://www.diputados.gob.mx/LeyesBiblio/pdf/44_110814.pdf
3Another mode of fundraising is for funds to raise capital, directly or indirectly, from pension funds through certificados de capital de desarrollo. This approach is discussed below in Section 3.
4This below link provides statistics on the growth of private equity in Mexico through CKDs. See page 2 of the document “Private Equity in Mexico: Primed for significant growth” prepared by Antonio Martínez Leal and Pino del Sesto. http://www.bain.com/Images/BAIN_REPORT_Private_equity_in_Mexico.pdf
5However, the National Banking and Securities Commission (“NBSC”) will shortly issue several regulatory reforms in order to decrease the administrative burdens associated with CKDs and to, probably, allow CKDs to invest abroad. Furthermore, the National Pension Funds Commission (“NPFC”) is also working on a regulatory reform in order to allow a more flexible investment regime for Afores, including the ability to invest outside of Mexico.
6A number of Mexican fund managers also use offshore vehicles, including Ontario Limited partnerships, to structure private equity funds focused on Mexican investments.
7See “The Private Equity Review 2015”, Part I Fundraising, Chapter 10 Mexico, prepared by Hans P. Goebel and Héctor Arangua L.; page 109.
8The Mexican authorities are presently contemplating changes to this rule that would do away with this ten-year limitation and allow FICAPs to enjoy these tax benefits indefinitely.
9See below, a link to the Spanish-language version of the Securities Market Law (Ley del Mercado de Valores) currently in force in Mexico. Articles 12 to 18 include the provisions governing the investment promotion limited corporation (Sociedad Anónima Promotora de Inversión). http://www.diputados.gob.mx/LeyesBiblio/pdf/LMV.pdf
10“New FIBRA-E investment structure for the Energy Industry in Mexico”, PWC October 2015. https://www.pwc.com/mx/es/impuestos/archivo/20151001-tls-boletin-nueva-fibra-e-en.pdf