XI Central Banking Operations Meeting CEMLA and Banco de México From the response to the COVID-19 crisis to the structural development of financial markets Gerardo García López, General Director of Central Banking Operations, Banco de México. * The views expressed in this presentation are the ones of the author and do not necessarily reflect those of the of . Introduction

• The COVID-19 pandemic inflicted an unprecedented shock to the global economy and worlds´ financial markets. Emerging market economies suffered historically large capital outflows, and abrupt movements in financial asset prices in early 2020.

• The policy response was forceful, including massive monetary stimulus and large packages of fiscal measures to stimulate the economy. Banco de México addressed the pandemic working on four different dimensions: , liquidity provision, credit channels and fostering an orderly behavior of financial markets.

• The extraordinary measures to address the crisis had a positive effect from the beginning, by providing liquidity and becoming an important backstop for financial markets. Up until the end of May, around 30 billion USD had been used to provide collateralized funding to financial institutions (that represents 2.4% of GDP). Around 18,000 SMEs and 215,000 households had also benefited from such measures.

• As the worst of the crisis was left behind, the focus shifted to an orderly winding-down of the extraordinary facilities, and staying the course towards the development of liquid and resilient financial markets.

2 Policy response • In response to financial markets’ volatility, weaker economic growth, and lower inflation and inflation expectations, Banco de México announced several policy measures, targeting four dimensions. If fully implemented, these measures would have represented about 5% of GDP. Monetary Policy Liquidity Provision

• Reduction of target from 7.00% to • Decrease of Monetary Regulation Deposit 4.00%. • Excess of intraday liquidity. • Last week, the Central Bank raised its interest rate • Expansion of eligible collateral for liquidity facilities. to 4.25% to strengthen the monetary policy stance • Medium term repo facility for government securities. in order to avoid rising inflation to materially • Medium term repo facility for corporate securities. affect inflation expectations. • Securities lending facility (swap collateral facility)

Credit Channel Fostering an orderly behavior of markets

• Provision of resources to banking institutions to • Foreign exchange hedges (2 billion USD) channel credit to micro, small-, and medium-size • USD credits using the Federal Reserve swap line. enterprises (SMEs) and individuals. • Government securities exchange operations. • Collateralized financing facility for commercial banks with corporate loans, to finance SMEs.

3 Policy response • As mentioned, these measures have helped Banco de México to successfully implement monetary policy and prevent an unwelcomed tightening of financial conditions.

Spread between target rate and interbank funding rate Money market stability Basis points, 5 day moving average 50 40 30 • Good liquidity conditions in payments and financial 20 system. 10 0 • Interbank funding rate has not shown major deviations -10 regarding the monetary policy target rate. -20 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Deviation from target Average 2019-2020 (4.6 bp)

Monthly corporate debt issuance Spread between AAA corporate emission and Billion pesos government bonds with similar duration Corporate debt market 40 Basis points, 10-day moving average Long Term Short Term 260 <- Spread 16% 30 220 Estimated yield for corporate bonds • Debt issuance resumed in the second half of 2020. rated AAA -> 12% Estimated yield for sovereign 180 nominal rate bonds -> 20 8% 140 • More dynamic operation in the secondary market. 10 100 4% 0 60 0% • Spreads in corporate debt have tightened. Jul-20 Jan-19 Jan-20 Jan-21 Jan-21 Jun-20 Oct-20 Sep-19 Sep-20 Apr-20 Apr-21 Feb-20 Sep-20 Feb-21 May-19 May-20 May-21 Dec-20 Aug-20 Nov-20 Mar-20 Mar-21 May-20 May-21

4 Policy response • As mentioned, these measures have helped Banco de México to successfully implement monetary policy and prevent an unwelcomed tightening of financial conditions. Source: Brokers with calculations byBancodeMéxico. MXN condition index Fixed Income condition index Deterioration Deterioration 100 100 Improvement of trading conditions in Foreign Exchange 80 80 and Fixed Income markets (not yet in pre-pandemic 60 60 levels) Improvement 40 Improvement 40 Index 20 Index 20 20 day moving average 20 days moving average • Conditions across markets showed improvement, but 0 0 were highly dependent to US financial conditions Jan-19 Jan-20 Jan-21 Jan-19 Jan-20 Jan-21 Sep-19 Sep-20 Sep-19 Sep-20 May-19 May-20 May-21 May-19 May-20 May-21

Spread of USD Forward Implied Yields in the USD/MXN Forward Curve againstPercentage OIS Curve USD funding has also remained stable through time, Percentage 2.0 1.6 despite concerns about COVID-19 and the expectation of 1.2 a bond tantrum 0.8 0.4 0.0 • USD funding rates have presented little deviation from -0.4 the FED’s funding range. Jul-20 Jan-20 Jan-21 Jun-20 Jun-21 Oct-20 Apr-20 Apr-21 Feb-20 Sep-20 Feb-21 Dec-20 Aug-20 Nov-20 Mar-20 Mar-21 May-20 May-21 3M 6M 12M

5 Policy response: Avoiding cliff scenarios • The gradual reduction of the extraordinary liquidity facilities that were used during the pandemic will contribute to avoid a cliff-effect in local financial markets.

Temporary security swap window for low Corporate Securities Repurchase Facility Government Securities Repurchase Facility liquidity instruments Million pesos Million pesos Million pesos 110,000 110,000 110,000

100,000 100,000 100,000 100,000 100,000

90,000 90,000 90,000

80,000 80,000 80,000

70,000 70,000 70,000 65,000 65,000

60,000 60,000 60,000

50,000 50,000 50,000 50,000

40,000 40,000 40,000 35,000 35,000

30,000 30,000 30,000 30,000

20,000 20,000 20,000 15,000

10,000 10,000 10,000

0 0 0 March April May June July August September March April May June July August September March April May June July August September Source: Bank of Mexico Source: Bank of Mexico Source: Bank of Mexico

6 From the juncture of COVID to the structural development of markets

• Looking past COVID-19, the focus will be the further development of our financial markets.

Working group on Working group on Repo Working group on Derivates Operations Securities Lending Specialized working groups formed by market participants, regulators and supervisors Working group on Working group on Working group on Market Inflation Linked Corporate Debt Infrastructure (CCP) Securities

Working group on Libor Transition

7 From the juncture of COVID to the structural development of markets

Working group on Derivatives

Main objective: Analyze and create initiatives to further develop Mexican derivatives markets (Exchange traded and OTC). Projects and proposals include:

• Credit derivatives as means to further develop corporate debt market.

• Analyze the feasibility of implementing a Market Makers program for the derivatives market.

8 From the juncture of COVID to the structural development of markets

Working group on Repo Operations Working group on Securities Lending

Main objective: Adopt international best Main objective: Adopt international best practices to further enhance the liquidity of practices to further enhance the liquidity of financial instruments through repo financial instruments through the securities operations. Projects and proposals include: lending market. Projects and proposals include: • GMRA • Tri-party schemes • MSLA • Open repo • Tri-party schemes • Collateral management • Open loans • Collateral management • Regulatory changes in fiscal matters • Enhancing market reference data

9 From the juncture of COVID to the structural development of markets

Working group on Inflation linked Working group on Corporate Debt securities Markets

Main objectives: Expand the investor base in Main objectives: Expand the investor base in inflation linked securities in order to enhance corporate debt securities in order to enhance its liquidity. Projects and proposals include: its liquidity. Projects and proposals include:

• Including Udibonos in widely used bond • Addressing taxation issues to promote Indexes. foreign investor participation. • Meeting with investors in order to increase • Developing a reference curve together awareness of the characteristics and with quasi-government issuers. benefits of these securities. • Analyzing the feasibility of implementing a Market Makers program for the corporate debt market. • Adjusting valuation methodologies and enhancing market reference data.

10 From the juncture of COVID to the structural development of markets

Working group on Market Working group on Libor transition Infrastructure – CCP Main objective: Adoption of the new Mexican Main objective: Analyze the feasibility of reference rate TIIE de Fondeo. Projects and implementing a central clearing counterparty proposals include: (CCP) in order to further develop debt market, repo market, and securities lending market. • Development of futures linked to TIIE de Projects and proposals include: Fondeo (CME and Mexder) • Development of fixed income securities • Analyzing the role of a CCP in enhancing linked to TIIE de Fondeo. transparency in the markets. • Adoption of TIIE de Fondeo in credit • Analyzing the role of a CCP in adopting products. electronic platforms. • Cost/benefit analysis given the different characteristics across markets.

11 Final Remarks • The COVID-19 pandemic has had a severe impact in the world economy and financial markets. It has also presented extraordinary challenges for central bank policy making.

• Banco de México, acted swiftly to promote an orderly adjustment of financial markets and to stimulate economic activity, providing ample liquidity, maintaining the flow of credit to the economy, and intervening to temper volatility and market dysfunction.

• The extraordinary facilities that were implemented during the crisis will be closed down gradually in the coming months but will remain as part of the toolkit of central banks to address financial stress going forward. This is a key legacy of CB's response to the pandemic.

• Looking past COVID-19, the long-term challenge for EMEs remains: building liquid and resilient financial markets that facilitate the price-discovery process, and work as shock-absorbers during financial turbulence. Doing so will aid EMEs in preventing and mitigating crisis, and in promoting long-term financial stability.

• In that regard, Banco de México has an ambitious agenda to further develop its financial markets in the coming year.

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