Mexico provides extensive trade and investment ties with global partners and benefits from a broadly diversified domestic market, making long-term arrangements such as infrastructure concessions, multi-year supply contracts, project finance loans, and energy offtake agreements commercially appealing. Yet these types of agreements also remain vulnerable to two interconnected macroeconomic risks:
- Currency risk: fluctuations in the Mexican peso (MXN) versus major invoicing currencies (most commonly the US dollar) change the real value of payments and returns.
- Inflation risk: persistent changes in the general price level erode fixed-price revenue streams and increase local costs for labor, materials, utilities and taxes.
The Bank of Mexico targets low and stable inflation (a 3% goal with a typical tolerance band around that target). Nevertheless, episodes of elevated inflation and peso volatility — for example the broad inflation shock and exchange market moves during and after the global pandemic period — illustrate why firms must build mitigation into long-term contracts.
Forms of exposure within long-term contracts
- Transaction exposure: anticipated inflows or outflows in MXN or other currencies whose amounts shift as exchange rates fluctuate.
- Translation exposure: accounting effects that arise when subsidiaries prepare statements in pesos while parent firms compile them in another currency.
- Economic exposure: long-run changes in profit potential and competitive position driven by differential inflation and enduring currency movements.
- Indexation and passthrough risk: the risk that expenses tied to local inflation outpace unindexed revenue (or the reverse), compressing margins.
Contractual design strategies
Well-drafted contracts are the first line of defense because they allocate risk, set adjustment mechanisms and define dispute processes.
- Invoicing currency clauses — clarify if payments will be settled in MXN or in a foreign currency (commonly USD). Buyers and sellers focused on exports frequently opt for USD billing to reduce MXN exposure during settlement.
- Indexation provisions — link pricing to an objective inflation gauge, such as the official CPI or another inflation-adjusted unit. In Mexico, long-term toll arrangements under public-private partnerships, rental agreements, and regulated tariffs often adopt inflation indexation to maintain real economic value.
- Escalation and price-review clauses — authorize periodic or event-driven pricing updates when cumulative inflation or cost metrics surpass agreed limits.
- Currency band or shared-risk mechanisms — allocate FX fluctuations within a defined corridor between the parties; once movements exceed that corridor, renegotiation occurs or the buyer provides additional compensation to the seller.
- Dual-currency or basket clauses — permit settlement in either currency or through a weighted basket to mitigate concentration risk.
- Force majeure and macroeconomic change provisions — outline conditions under which severe macroeconomic disruptions justify suspending, terminating, or urgently adjusting prices, while also detailing dispute‑resolution procedures.
Markets and tools for financial hedging
When contractual clauses do not fully remove exposure, firms use financial hedges available in Mexico’s markets and global markets.
- Forwards and futures — forward FX contracts lock an exchange rate for a future date. Futures on USD/MXN trade on Mexican and international exchanges (MexDer and major global venues), providing price transparency and standard maturities.
- Options and collars — currency options create asymmetric protection: a put option on MXN protects against depreciation while allowing upside. Collars limit both downside and upside within predefined bands and can reduce hedging cost.
- Cross-currency swaps — exchange principal and interest in one currency for another to match cash flows of long-term debt with revenue currency.
- Inflation swaps and CPI-linked derivatives — allow parties to swap fixed payments for inflation-indexed payments, protecting against local inflation when local revenues or costs are exposed.
- Local instruments linked to inflation — Mexico issues inflation-indexed debt and units that preserve purchasing power; contracting against such units is a common practice for long-term domestic obligations.
Practical note: liquidity varies across tenors and instruments. Short- and medium-term forwards are liquid; long-dated hedges are available but often pricier. Many large projects combine layered hedges (rolling forwards, options and swaps) to balance cost and protection.
Operational and natural hedges
Financial hedges can be complemented by operational measures that reduce net exposure.
- Currency matching on the balance sheet — borrow in the currency of revenues or hold cash buffers in foreign currency so that liabilities and assets align.
- Local sourcing and cost alignment — increase procurement in the invoicing currency or index local supplier contracts to the same reference as revenues.
- Diversified revenue streams — serve multiple markets or customers invoicing in different currencies to reduce concentration risk.
- Manufacturing footprint allocation — locate production where input costs naturally offset currency exposures (near-shoring to Mexico for USD revenue-generating exports creates natural currency alignment).
Sector-specific case studies
- Export manufacturing: A North American company holding a decade-long supply deal with a Mexican contract producer may stipulate that invoicing be carried out in USD. Although the purchaser continues to face currency translation risk in Mexico, the seller secures income in a more stable denomination. The manufacturer can manage remaining MXN working capital exposure through short-term forward contracts and align local labor cost increases by tying domestic subcontracts to CPI.
- Infrastructure concessions: Toll road operators frequently generate revenue in local currency while carrying debt in USD or instruments linked to USD. Standard practice involves adjusting tolls using CPI or Mexico’s inflation-indexed unit and incorporating revenue-sharing provisions when inflation rises beyond preset thresholds. Lenders often insist on cross-currency swaps or dedicated revenue accounts to protect USD debt service.
- Energy and gas supply: Long-horizon gas offtake or power purchase agreements are often priced in USD to shield investors from peso depreciation. When local laws or regulators mandate invoices in domestic currency, contracts embed pass-through mechanisms allowing fuel and transport cost components to move in line with transparent indices.
- Project finance and public-private partnerships: Lenders expect strong safeguards such as indexed revenue structures, FX hedging strategies, escrow arrangements, and step-in rights. Financial models run stress scenarios involving peso weakening and sharp inflation surges to determine appropriate reserve levels and contingency buffers.
Legal, tax and accounting factors
- Governing law and enforceability: The designated law and forum play a crucial role. International lenders often opt for neutral arbitration provisions and external governing law to limit risks tied to sovereign factors or domestic court systems.
- Tax treatment: Fluctuations in currency values may trigger tax effects. Agreements that adjust prices based on exchange rates should be designed to meet tax requirements on corporate income and invoicing. Coordinating with local tax advisers helps prevent unexpected timing or valuation complications.
- Accounting and hedge accounting: Under international accounting frameworks, companies are required to substantiate hedge relationships and demonstrate effectiveness to qualify FX and inflation hedges for hedge accounting. This approach mitigates earnings volatility but demands strong controls and thorough documentation.
Implementation playbook: spanning the path from negotiation to ongoing oversight
- Risk identification and quantification: assess cash-flow sensitivities to MXN fluctuations and varied inflation paths over different timelines, applying stress scenarios (for instance, a 20% peso drop or 5–10 percentage point inflation jumps) along with Monte Carlo simulations to obtain a probabilistic perspective.
- Contract drafting: specify clear indices, rounding conventions, adjustment intervals, caps and floors, dispute-handling mechanisms, and data-sharing duties tied to index sources, while eliminating ambiguous or subjective trigger wording.
- Hedge selection: pair contractual protections with market hedging tools, weighing expense against performance; for example, a collar might reduce cost relative to multiple forwards but limits potential gains.
- Operational alignment: align procurement, payroll, and debt currency with revenue currency whenever possible, and adopt local CPI-linked agreements to harmonize cost streams.
- Ongoing governance: establish thresholds, reporting channels, and a regular review rhythm for macroeconomic developments, updating model assumptions as monetary or fiscal conditions evolve.
Illustrative Examples
A foreign company signs a 12-year supply contract with a Mexican buyer for fixed MXN payments equivalent to MXN 100 million annually. The supplier expects cumulative inflation of 40% over 12 years and forecasts MXN depreciation near 25% against USD across the tenor.
- If payments remain fixed in MXN, local inflation steadily weakens purchasing power, causing real revenues to shrink and reducing the foreign investor’s USD-equivalent income as the currency depreciates.
- Mitigation package: apply annual CPI-based adjustments reflecting actual inflation, issue invoices in USD while allowing MXN payments indexed to CPI, and hedge projected USD/MXN cash flows by layering five-year forward contracts that are periodically rolled, complemented by a long-dated FX option collar to curb extreme downside risk.
- Trade-off: attempting to fully hedge the entire 12-year position with forwards may prove too costly or hard to source, whereas a staggered mix of hedges and options retains potential gains if the peso strengthens unexpectedly while concentrating protection on unfavorable movements.
