Foreign Investment Regulation

CHAPTER II Foreign Investment Regulation Foreign investment is essential for Mexican development. It makes possible the use of foreign currency in domestic economic activity, thereby contributing to the creation of sources of employment and the adoption and dissemination of new technologies. Mexico has succeeded in recent years in becoming one of the principal countries receiving foreign investment, particularly in the manufacturing, transportation, and communication sectors, as well as in the financial services sector. In addition, Mexican international trade has increased significantly in conjunction with the economic growth of the country. Among the factors most influential to this growth are the opening of the Mexican economy, deregulation and administrative simplification, and the new legal framework created over the last 20 years with the goal of strengthening and facilitating foreign investment in domestic economic activity and liberalizing Mexican international trade. This new legal framework consists primarily of the following laws and regulations: a) The Foreign Investment Law (Ley de Inversión Extranjera, LIE), issued in 1993 for the purpose of opening several economic sectors to foreign investment and establishing clear and permanent rules that provide a framework of legal certainty, thereby making investment in Mexico attractive for foreign investors and ensuring the retention of foreign investment in the economy; b) The Regulation of the Foreign Investment Law and of the National Registry of Foreign Investors (Reglamento de la Ley de Inversión Extranjera y del Registro Nacional de Inversiones Extranjeras), issued in 1998 in order to spell out the administrative details of the rules set forth in the LIE, clarifying the scope of the sectorial opening established therein and the administrative simplifications. 35

36 C H A P T E R I I Furthermore, in 1993, with the adoption of the North American Free Trade Agreement (Tratado de Libre Comercio de América del Norte, NAFTA), Mexico entered a new stage with regard to the regulation of foreign investment. In this new stage, in order to attract foreign investment, Mexico executed numerous international treaties that grant certain rights to foreign investors, such as national treatment, most-favorednation treatment, fair and equitable treatment, full protection and safety standards, freedom to transfer, right to prompt, adequate, and effective compensation in the case of expropriation, and access to international arbitration as a mechanism to guarantee compliance with the above-mentioned rights. As of this date, Mexico has executed 25 Bilateral Investment Treaties (BITs) and 11 Free Trade Agreements containing a chapter guaranteeing the reciprocal protection of investments. In this respect, our country has executed BITs with Germany, 1 Argentina, 2 Australia, 3 Austria, 4 South Korea, 5 Cuba, 6 Denmark, 7 Spain, 8 Slovakia, 9 Finland, 10 France, 11 Greece, 12 India, 13 Iceland, 14 Italy, 15 The Netherlands, 16 Panama, 17 Portugal, 18 United Kingdom, 19 Czech Republic, 20 Sweden, 21 Switzerland, 22 Trinidad and Tobago, 23 Uruguay, 24 and the Economic Union of Belgium and Luxembourg. 25 Of these, all are in force except those executed with Slovakia and India, which have not yet been approved by the Senate. 1 Published in the Official Federal Gazette (Diario Oficial de la Federación), March 20, 2001. 2 Official Federal Gazette, August 28, 1998. 3 Idem, June 12, 2007. 4 Idem, March 23, 2001. 5 Idem, August 9, 2004. 6 Idem, May 3, 2002. 7 Idem, November 30, 2000. 8 Idem, March 19, 1997. 9 Entered into on October 22, 1999. 10 Official Federal Gazette, November 30, 2000. 11 Idem, November 30, 2000. 12 Idem, October 11, 2002. 13 Entered into on May 21, 2007. 14 Official Federal Gazette, June 6, 2006. 15 Idem, January 17, 2003. 16 Idem, June 10, 2000. 17 Entered into on October 11, 2005. 18 Official Federal Gazette, January 8, 2001. 19 Idem, July 25, 2007. 20 Idem, March 25, 2004. 21 Idem, July 27, 2001. 22 Idem, August 20, 1998. 23 Idem, September 12, 2007. 24 Idem, August 9, 2002. 25 Idem, March 19, 2003.

Investment protection chapters contained in Free Trade Agreements signed by Mexico include the following: Chapter XI of NAFTA; 26 Chapter XVII of the Free Trade Agreement between the United Mexican States and the Republic of Colombia and the Republic of Venezuela (TLC G3); 27 Chapter XIII of the Free Trade Agreement between the United Mexican States and the Republic of Costa Rica; 28 Chapter XV of the Free Trade Agreement between the United Mexican States and the Republic of Bolivia; 29 Chapter XVI of the Free Trade Agreement between the Government of the United Mexican States and the Government of the Republic of Nicaragua; 30 Chapter IX of the Free Trade Agreement between the Republic of Chile and the United Mexican States; 31 As part of decision 2/2000 of the EU-Mexico Joint Council of the Free Trade Agreement between the United Mexican States and the European Union; 32 Chapter XVII of the Free Trade Agreement between the United Mexican States and Guatemala, El Salvador, and Honduras (Northern Triangle-CA3); 33 Chapter III of the Free Trade Agreement between the United Mexican States and Iceland, Norway, Liechtenstein, and Switzerland; 34 Chapter XIII of the Free Trade Agreement between the United Mexican States and Uruguay; 35 Chapter VII of the Agreement to Strengthen the Economic Association between the United Mexican States and Japan. 36 Although these investment protection chapters cannot be equated with the BITs, due to the legal context in which they have been executed, when compared it can be seen that both their content and particularly their purpose are very similar, since they confer virtually the same protection rights, differing only in superficial aspects. 37 Foreign Investment Regulation 26 Idem, December 20, 1993. 27 Idem, January 9, 1995. 28 Idem, January 10, 1995. 29 Idem, January 11, 1995. 30 Idem, July 1, 1998. 31 Idem, July 8, 1999. 32 Idem, June 26, 2000. 33 Idem, March 14, 2001. 34 Idem, June 29, 2001. 35 Idem, July 14, 2004. 36 Idem, March 31, 2005.

1. The Foreign Investment Law 38 C H A P T E R I I In order to present a basic panorama of the rules applicable to all foreigners who wish to invest in Mexico, in this chapter we will first discuss the rules set forth in the LIE in regard to the acquisition of real estate in Mexico and the trusts through which foreign individuals and entities can acquire the use and benefits of real estate located in the restricted zone alluded to in section I of Article 27 of the Mexican Constitution. We will also examine the rules applicable to both foreign investment in Mexican companies and the investment of foreign entities, alluding expressly to the requirements with which they must comply in order to engage routinely in business in Mexico. Finally, reference is made to the National Foreign Investment Registry (Registro Nacional de Inversiones Extranjeras, RNIE), particularly the obligations applicable to Mexican companies having foreign or neutral investments, foreign individuals or entities that routinely do business in the Mexican Republic, and the trusts by virtue of which rights are granted to foreign investment. The economic activities that are subject to restriction pursuant to the rules set forth in the LIE will be analyzed in a special section because of the relevance of this topic for foreign investors. 1.1. Acquisition of Real Estate 1.1.1. Acquisition of real estate by foreign individuals or entities The right of foreigners, whether individuals or entities, to acquire real estate in Mexican territory depends on the location of such real estate: a) Restricted zone. Real estate located within the so-called restricted zone, which is a 62-mile strip along the borders and a 31-mile strip along the beaches of Mexico, cannot be directly owned by foreigners under any circumstances. However, foreigners can acquire rights to the use and benefits of real estate located within the restricted zone through a trust with the permission of the Foreign Relations Ministry (Secretaría de Relaciones Exteriores, SRE). In this case, it is the credit institution that, as fiduciary, acquires rights over the real estate; the foreigner, as beneficiary, has the right of use and enjoyment thereof, including any fruits or products obtained and, in general, any proceeds resulting from any profit-yielding operation or exploitation, through third parties or the fiduciary institution. The duration of these types of trusts is 50 years, which may be extended with the authorization of the SRE; b) Unrestricted zone. Real estate located outside of the restricted zone can be directly acquired by foreigners, whether individuals or entities, provided that (1) prior to the acquisition a writ is presented to the SRE in which the foreigner agrees to be considered a Mexican national with respect to such property and not to invoke the

protection of its/his/her government ( Calvo Clause ), and (2) the SRE grants the corresponding permission. 1.1.2. Acquisition of real estate by Mexican companies with foreign investment For Mexican companies with foreign investment, to be able to acquire rights over real estate located in Mexican territory, they must have a Calvo Clause in their company by-laws. Furthermore, the type of rights that these companies can acquire either direct ownership or rights of use or enjoyment of the real estate depends on where the real estate is located. a) Restricted zone. In the case of real estate located in the restricted zone, the purpose for which such property will be used must be taken into account: Residential purposes. Mexican companies with foreign investment cannot acquire direct ownership of real estate located in the restricted zone when it will be used for residential purposes, that is, for housing for the use of the owner or third parties. In this case, such companies may only acquire the rights of use or enjoyment of the real estate through a trust with the prior permission of the SRE; Non-residential purposes. Mexican companies with foreign investment can acquire direct ownership of real estate located within the restricted zone provided such property will be used for non-residential activities. In this case, a notice must be filed with the SRE after the acquisition; b) Unrestricted zone. There is no restriction on Mexican companies with foreign investment acquiring ownership of real estate located outside of the restricted zone, provided their by-laws contain the Calvo Clause. The above-described rules applicable to the acquisition of real estate by foreigners or Mexican companies with foreign investment can be summarized as follows: 39 Foreign Investment Regulation Foreign individuals or entities Mexican companies with clause admitting foreigners: a) Residential purposes b) Non-residential purposes Restricted zone Acquisition of rights of use and enjoyment through a trust; permission required Acquisition of direct ownership; permission required Acquisition of direct ownership; notice to SRE Unrestricted zone Acquisition of direct ownership; permission required Acquisition of direct ownership; Permission not required Acquisition of direct ownership; permission not required

1.2. Forms of Investing in Mexico Foreigners who wish to engage in economic and commercial activities in Mexico can do so through the incorporation of a Mexican company or by investing as partners or shareholders in existing Mexican companies. Foreign entities can also become established in Mexico through branches or representative offices. 40 C H A P T E R I I 1.2.1. Investment in Mexican companies Any foreign individual or company can become a partner or shareholder of a Mexican company without needing any permission, provided such company does not engage in activities in which foreign investment is restricted or excluded. In the case of newly created Mexican companies, it is sufficient to include the Calvo Clause in their bylaws. When foreigners wish to invest in companies already incorporated whose bylaws contain a clause excluding foreigners, such clause must be substituted for by a Calvo Clause and the SRE notified of such a change. 1.2.2. Direct investment by foreign entities Entities legally incorporated abroad can become established in Mexico through different forms, depending on the activities in which they will engage in the country: a) Commercial operations. Foreign entities intending to engage routinely in commercial activities in Mexico can become established in national territory as a branch or an income-earning representative office. In both cases they must obtain authorization from the Secretary of Economy (Secretaría de Economía, SE) and register with the Public Registry of Commerce (Registro Público del Comercio). These foreign entities legally established in the country may engage in all types of business activity and commercial operations, except with regard to those activities in which foreign investment is restricted or excluded under the LIE; b) Intermediary operations. Foreign entities may also establish a non income earning representative office when their only purpose is to have an entity in Mexico that provides informational services and promotes the activities, products, or services that the foreign company provides abroad. For foreign entities to establish a non income earning representative office, an authorization from the SE is also required, but it is not necessary to register it in the Public Registry of Commerce. A non income earning representative office does not engage in commercial operations and its only purpose is to put the foreign company in contact with clients in Mexico. Any contracts resulting from such contact must be executed directly by the foreign company with the Mexican clients. Furthermore, it is the

foreign company that must issue invoices and carry out the other acts resulting from its commercial relationship with clients in Mexico. The non income earning representative office is not authorized to represent the foreign company legally in commercial acts or to assume legal obligations in its name. The non income earning representative office is only an intermediary between the foreigner and the Mexican client, and its activities may not earn any income. The foreign company must provide its non income earning representative office with the necessary resources to carry out its purpose, including the payment of the rent for the office and administrative and personnel expenses. 1.3. National Foreign Investment Registry The National Foreign Investment Registry (Registro Nacional de Inversiones Extranjeras, RNIE) is an agency of the SE and a source of statistics and figures on the flows of foreign investment in Mexico and the economic sectors and regions in which it is located. By law, the following persons and entities are required to be registered in the RNIE: a) Mexican companies having foreign investments (including Mexicans having another nationality and residing outside of Mexico), neutral investments, or both, either directly or through a trust; b) Foreign individuals or entities (including Mexicans having another nationality and residing outside of Mexico) that routinely engage in business activities in Mexico; c) Trusts over stock or ownership interests, real estate, or neutral investments, granting rights in favor of foreign investment (including Mexicans having another nationality and residing outside of Mexico). 41 Foreign Investment Regulation Mexican companies and foreign individuals or entities registered in the RNIE must comply with the following obligations in relation to such Registry: 1.3.1. Annual renewal. Economic-financial report Mexican companies and foreign individuals or entities registered in the RNIE must renew their registration annually by filing an annual economic-financial report. The time limit for filing the annual economic-financial report depends on the letter with which the name of the person or entity filing the report begins: From A to D: during April of each year; From E to J: during May of each year; From K to P: during June of each year; From Q to Z: during July of each year.

42 C H A P T E R I I 1.3.2. Information on income and expenditures. Quarterly report Mexican companies and foreign individuals and entities registered in the RNIE must file a quarterly report on the value of their income and expenditures, provided that the result of the total income or expenditures in the respective quarter has changed, negatively or positively, by more than three thousand times the general minimum wage in force in the Federal District. Otherwise there is no obligation to file the quarterly report. The following periods are understood as quarterly: from January to March, from April to June, from July to September, and from October to December. The information that should be taken into account for determining the value of the income and expenditures of the respective quarter are the following: a) New contributions or withdrawals therefrom that do not affect the capital stock, specifying the account in which the accounting entry is registered; b) The withholding of profits of the last fiscal year and the use of accumulated withheld profits; c) Loans to pay to or to collect from: Subsidiaries residing abroad; A parent company abroad; Foreign investors residing abroad who are partners or shareholders; Foreign investors residing abroad who are part of the corporate group to which the company belongs. In the case of foreign individuals and entities, only information referring to their operations in Mexican territory should be considered in quarterly reports. 1.3.3. Notice of changes to information previously provided Notice must be given when information previously provided to the RNIE is changed. Among the changes that must be reported to the RNIE are the following: a) Any change of name; b) Change of tax domicile or change of domicile of the principal offices or establishment of the person or company registered; c) Any change to the corporate bylaws of the companies registered; d) Any increase or reduction of capital stock of registered companies; e) A change of the legal representative of the person or company registered, authorized before the RNIE; f) Any change of the shareholding structure of the registered companies; g) Any change in the name of the partners or shareholders of the registered companies. 1.3.4. Cancellation Mexican companies registered with the RNIE must request the cancellation of their

registration in the event that the foreign investment, neutral investment, or both are withdrawn. Foreign individuals and entities must request the cancellation of their registration in the event they cease to engage routinely in business in Mexico. Finally, the importance of presenting the above-indicated reports and notices to RNIE within the time periods established for each case in the LIE and in its regulation must be emphasized, given that fines can be imposed on the registered persons or companies who fail to file in a timely fashion. 1.4. Economic Activities Subject to Restriction As a general rule, there are no legal restrictions on foreign individuals and entities engaging in economic activities in Mexico, either directly or as partners or shareholders in Mexican companies. However, the LIE specifies certain activities in which foreign investment is not allowed and others in which it is limited. In this section we will discuss the activities that are reserved or subject to a specific regulation. We will also refer to the concept, regulation, and scope of neutral investment, a mechanism through which foreign investment can participate in certain reserved or specially regulated activities. 1.4.1. Reserved activities Foreign individuals and entities and Mexican companies having foreign investment cannot participate in activities related to the strategic areas that by law are reserved to the Mexican State, or in activities that are reserved exclusively for Mexicans and Mexican companies with a clause in their bylaws excluding foreigners. a) Activities reserved to the Mexican State. The activities set forth in the laws governing the following strategic areas are reserved exclusively to the State: Petroleum and other hydrocarbons. Activities relative to transportation, storage, and distribution of gas other than liquid petroleum; Basic petrochemicals. The following are considered basic petrochemicals: ethanol, propane, butane, pentane, hexane, heptane, raw material for lampblack, gasoline, and methane, when the latter comes from hydrogen carbides obtained from deposits located in national territory and is used as raw material in petrochemical industrial processes; Electricity. This does not include the generation of electricity for self-supply, cogeneration, or small production; generation by independent producers for sale to the Federal Electricity Commission (Comisión Federal de Electricidad, CFE); generation of electricity for export, derived from co-generation, independent 43 Foreign Investment Regulation

44 C H A P T E R I I production, or small production; nor energy for use in emergencies resulting from interruptions in the public power grid service. Also not included is the import of power by individuals or entities exclusively for self-supply; Generation of nuclear power; Radioactive minerals; Telegraphs and radiotelegraphy; Mail service; Issuance of banknotes and minting; Control, supervision, and oversight of ports, airports, and heliports; b) Activities reserved for Mexicans. The economic activities and companies mentioned below are reserved exclusively for Mexicans or Mexican companies having a clause in their bylaws excluding foreigners: National land transport of passengers, tourists, and cargo, not including messenger and parcel services; Retail sale of gasoline and distribution of liquid petroleum gas; Provision of radio broadcasting and other radio and television services, other than cable television; Credit unions; Development bank institutions, in accordance with the applicable law; The provision of professional and technical services expressly indicated in the applicable laws. Foreign investment is not allowed in the above-mentioned activities and companies, directly or through trusts, agreements, partnership agreements or bylaws, pyramid schemes, or any other mechanism that grants them any control or share. Notwithstanding the above, there is a mechanism through which foreign investment can participate in certain activities reserved for Mexicans: neutral investment, which is analyzed in Point 1.5 of this chapter. 1.4.2. Activities and acquisitions subject to a specific regulation There are certain economic activities and companies in which foreign investment is not excluded but is limited to a certain proportion, ranging from 10 to 49 percent. There are also certain sectors in which even when the foreign investment is limited to 49 percent, it is possible to surpass such percentage with an authorization of the National Foreign Investment Commission (Comisión Nacional de Inversiones Extranjeras, CNIE). In order to determine the percentage of foreign investment in the economic activities subject to maximum limits of investment, the foreign investment made in such activities indirectly through Mexican companies with a majority of Mexican capital is not counted, provided the latter are not controlled by the foreign investment.

a) Limited activities. In the economic activities and companies mentioned below, foreign investment is limited to the indicated percentages, which cannot be surpassed under any circumstances, except through the mechanism of neutral investment, which is discussed in Point 1.5 of this chapter: Up to 10 percent: producers cooperatives; Up to 25 percent: National air transport; Air taxi transport; Specialized air transport; Up to 49 percent: Insurance companies; Bonding companies; Money exchange firms; Public bonded warehouses; Financial leasing companies; Factoring companies; Special-purpose financial institutions; The companies referred to in Article 12 bis of the Securities Market Law (Ley del Mercado de Valores); Pension fund management companies; Companies manufacturing and selling explosives, firearms, cartridges, munitions, or fireworks, not including the acquisition and utilization of explosives for industrial and extractive activities or the preparation of explosive mixtures for the carrying out of such activities; Printing and publishing of newspapers for circulation exclusively in national territory; Series T shares of companies owning agricultural, livestock, and forestry lands (series T shares only represent capital contributed in agricultural, livestock, or forestry lands, or capital to be used for the acquisition of such lands); Fishing operations in fresh and coastal waters and in the exclusive economic zone, not including aquaculture; Comprehensive port administration; Port pilotage services to ships for interior navigation operations, according to the applicable law; Shipping companies engaged in the commercial exploitation of ships for interior navigation and cabotage, except for tourist cruise ships and the exploitation of dredgers and naval artefacts for port construction, conservation and operation; 45 Foreign Investment Regulation

46 C H A P T E R I I Suppliers of fuel and lubricants for ships and aircraft and rail equipment; Concession holding companies pursuant to the terms of Articles 11 and 12 of the Federal Telecommunications Law (Ley Federal de Telecomunicaciones); b) Limited activities in which 49 percent can be surpassed with an authorization from the CNIE. Foreign investment can hold a percentage greater than 49 percent in the economic activities and companies mentioned below if they obtain a favorable decisions of the CNIE: Port services for ships carrying out interior navigation operations, such as towing, tying up, and launching; Shipping companies engaged in the exploitation of ships exclusively in high traffic; Concession or permit holding companies of airfields for service to the public; Private services of preschool, elementary, junior high, high school, or college education or combinations thereof; Legal services; Credit information companies; Securities ranking institutions; Insurance agents; Cellular telephony; Construction of pipelines for the transportation of oil and its derivatives (not including construction, operation, and ownership of pipelines, installations, and equipment, regarding the transportation and distribution of natural gas); Perforation of oil and gas wells; Construction, operation, and exploitation of railways that are a general means of communication and provision of rail transport services to the public. It should be emphasized that the favorable decision of the CNIE is only required for foreign investment to be greater than 49 percent in the economic activities and companies listed above when the total value of the assets of the companies involved at the time of submitting the acquisition request surpasses the amount that the Commission determines annually. 1.5. Neutral Investment Neutral investment is a mechanism through which foreign investment can participate in certain reserved or specially regulated activities. The LIE defines neutral investment as investment in Mexican companies or in authorized trusts that will not be taken into consideration for determining the percentage of foreign investment in the capital stock of Mexican companies.

1.5.1. Neutral investment represented by instruments issued by trust institutions The SE has the power to authorize trust institutions to issue neutral investment instruments, which will only grant, with respect to companies, pecuniary rights to their holders and, if applicable, limited corporate rights, without granting to their holders the right to vote in their general ordinary meetings. Furthermore, the SE can authorize the creation or modification of all types of neutral investment trusts, as well as the transfer of stock thereto, regardless of the activity that the company conveying its shares in trust engages in. 1.5.2. Neutral investment represented by special series of shares The investment in non-voting stock or stock with limited corporate rights is considered neutral, provided advance authorization is obtained from the SE and, when applicable, from the National Banking and Securities Commission. Companies already incorporated or to be incorporated, regardless of the activity they engage in, must obtain the advance authorization of the SE to issue special series of stock as neutral investment. 1.5.3. Neutral investment made by international development financing institutions International development financing institutions are considered to be those foreign entities whose principal purpose is to promote economic and social development of developing countries by the contribution of temporary venture capital, granting of preferential financing, or technical assistance of different types. These institutions can invest through neutral investment in the capital stock of Mexican companies, provided they are recognized in advance by the CNIE. Furthermore, these institutions can invest in the capital of Mexican companies that engage in reserved or specially regulated activities, provided they obtain a favorable decision of the CNIE. 47 Foreign Investment Regulation