Foreigners Funding the Future: Investment Opportunities in Mexico's Privatized Pension System (1999)

I. INTRODUCTION When we are young, we are supported by our parents; when we are old, we support ourselves-at least this is the way the world is supposed to function. Many people fail to plan for their retirement, so governments step in to provide a fallback through state-run social security systems. Several of the social security systems around the world, including those in the United States and Mexico, were established in response to the hardships of the Great Depression. These systems were intended as safeguards for those who could not, or would not, save for their own retirement. Unfortunately, these systems were not designed to compensate for a rapidly growing population which lives longer. After fifty years in practice, social security systems in many countries are headed toward bankruptcy. They can no longer guarantee sufficient payments to an aging population based on a redistribution of funds from the younger workers to the older retirees.1 One proposed solution to this problem is to privatize the social security pension system.2 Instead of investing the collected funds in low-return government bonds or using them to pay benefits to present-day pensioners, the government could transfer the funds to individual private accounts in the hopes of generating greater returns for the individual pensioners. Privatization also encourages saving by making workers individually responsible for their retirement. The prevailing system of pensions guaranteed by the national government provides a disincentive for individuals to save. Additionally, due to the greater rate of return received when investing on the open market, private investment of pension funds gives individuals more money for their retirement, albeit at greater risk.3 Privatization of state-run pension systems is increasingly popular in Latin America. It is seen as a continuation of the industrial privatization policies which were pervasive throughout the region in the 1980s.4 Chile was the first Latin American country to privatize its social security pension system, and its successful transition to a privatized system did not go unnoticed.5 In the mid-1990s, President Ernesto Zedillo Ponce de Le6n of Mexico recognized the impending collapse of Mexico's state-run social security pension system, caused both by mismanagement of the antiquated system and a severely devalued currency.6 In response, he replaced Mexico's fifty-year old, state-run, pay-as-you-go pension system with a new plan which substantially privatized the industry.7 Based on the Chilean model, Mexico's new law allowed for the establishment of private pension fund managers called Administradoras de Fondos para el Retiro [Retirement Fund Administrators] or AFOREs.8 The creation of AFOREs presents a significant opportunity for foreign investors who are interested in entering into the financial services sector in Mexico. Throughout most of this century, Mexico has been extremely protective of many of its industries, including financial services.9 Over the last decade or so, however, Mexico has relaxed its protectionist policies and opened many of its key industries, including financial services, to foreign investment. These changes in attitude toward foreign investment are reflected in provisions on foreign investment in the North American Free Trade Agreement (NAFTA), Mexico's new 1993 Foreign Investment Law, and now in the 1997 pension reforms which allow foreign ownership of AFOREs. This article argues that, although the chance to invest in AFOREs presents an important opportunity for foreign investors (particularly U.S. investors) to enter into the potentially lucrative financial services sector in Mexico, there are numerous flaws in the regulations governing AFOREs which could, in the long term, affect the profitability of these investments. Most significantly, AFOREs are prohibited from investing the funds under their control in foreign securities-they can only invest in domestic financial instruments. …