Creating More Sustainable Deal-Flow in LAC Transport
This is an Insight article, written by a selected partner as part of Latin Lawyer's co-published content. Read more on Insight
Transport infrastructure, including roads, railways, ports and airports are critical to economic growth and social development in connecting people to jobs, education and services and by linking national economies to the global marketplace. Transport is an essential component of national economic backbones that make everything else happen. Not surprisingly, the modernisation of transport and logistics networks has risen to the top of political agendas in both developed and developing countries as policymakers have realised that national growth rates and job creation are at stake.
While it is difficult to generalise across the countries of Latin America and the Caribbean (LAC), the World Bank reports in a recent study that the LAC region invests the least across all infrastructure sectors among most emerging markets and developing economy (EMDE) peers, with investment (including public and private) as a percentage of gross domestic product (GDP) under 3 per cent while East Asia and the Pacific, South Asia, the Middle East and North Africa are all investing at rates of at least 5 per cent of GDP. According to the study, the region suffers from "mediocre transport services due to low-quality infrastructure, and an uncompetitive transport industry, resulting in costly freight transport, congested cities, and deep pockets of rural isolation". In quantifying the transport infrastructure gap, the Global Infrastructure Hub of the G20 reviewed a subset of nine LAC countries and estimated investment needs for roads, airports, ports and railways alone at US$3.6 trillion prior to 2040 to accommodate future growth projections. If one were to consider the entire LAC region, the level of investment needed in the transport sector is an order of magnitude higher.
Given ever more constrained government budgets, the necessity to attract private sector capital to the transport sector is profound. Attracting private investment has become even more challenging of late due to a host of other issues, including the end of the commodities super-cycle, political forces rallying against open trade and a host of regional corruption scandals that have created paralysis in many government corridors, as well as with private investors. Major projects have been delayed and cancelled, which has postponed much-needed investment and economic stimulus, while discouraging investors. Not surprisingly, 2016 was marked by a substantial slowdown in new transport investment commitments region-wide, while the pipeline for new investment is hardly encouraging.
In spite of these challenges, the past few years have demonstrated that the LAC transport market is also a laboratory for innovative deal structures in certain countries. Following in the footsteps of Chilean and Mexican concession models that were consolidated a decade earlier and given the political consensus around the need for private participation in infrastructure, the last decade has seen a regional embrace of public–private partnership (PPP) models and intense waves of transport investment in countries such as Brazil, Peru and Colombia. During 2007–2016, over 200 roads, metros, ports and airports came to market in LAC under private sector modalities mobilising over US$150 billion in private investment in the sector. During this same period, LAC produced a series of highly innovative transport deals, including a few groundbreaking transactions in the debt capital markets for projects in Brazil, Mexico, Peru and, most recently, Colombia. While investment totals are not enough to close the gap of trillions of dollars in transportation described above, there are positive lessons to be drawn from this period to increase private investment in the sector.
Looking forward, there is an opportunity for LAC governments to learn from the successes of the past decade and to create a deeper and more sustained wave of private sector investment in the transport sector. First, it is important to strengthen institutional capacity of governments to produce greater volumes of well-conceived, well-designed projects. Second, to draw in greater volumes of private debt financing, governments should adopt a more demand-driven approach to bankability that is attractive to debt capital markets. Third, as climate-change-related impacts are being experienced across the transport sector (and beyond), climate considerations should be integrated into the concept of bankability and such considerations mainstreamed in transport planning, design and implementation processes.
Producing greater volumes of well-conceived, well-designed projects
Similar to other basic infrastructure services, the transport sector relies heavily on governments to originate pipelines of attractive investments. Unlike the energy sector where self-generation and bilateral contracting are part of the landscape, the transport sector largely relies on governments to plan capacity additions and originate projects. Although there has been an upswing in unsolicited proposals and private initiatives in recent years, the responsibility for creating fundamentally sound deal flow in the transport sector will continue to fall predominantly on the shoulders of governments.
Many LAC governments have already laid the groundwork for concession and PPP programmes with legal and regulatory frameworks designed to channel more private investment into the transport sector. However, now that these foundations are in place, governments are faced with the longer-term task of producing continuous pipelines of bankable projects year after year in order to address the mediocre performance of the transport sector and the daunting gap in investment. Progress on these fronts hinges first on the critical matter of institutional capacity and the ability of transport and PPP authorities to perform better at prioritising, planning, appraising, vetting and, ultimately, structuring projects that are attractive to private sector investors.
First, there is no substitute for strong in-house capacity including well-qualified staff in critical ministries with experience in both the public and private transportation markets. As PPPs become more prevalent and require a greater level of interaction between private investors and public authorities, having deep technical capacities on both sides of the table is becoming increasingly significant. It would be difficult to overestimate the importance of internal capacity-building within governments as fundamental to successfully addressing the transportation infrastructure gap.
Along with a deeper bench of in-house government capacity, investment in well-qualified advisory to produce solid commercial, technical, legal and environmental and social inputs is also critical. Further, it is imperative that government advisory teams have reasonable implementation timelines so that these key inputs can be appropriately investigated, designed, digested, discussed (including with the private sector) and completed. An unfortunate phenomenon of velocity versus quality has arisen, particularly in more recent years, whereby projects are often rushed through early development stages in order to achieve political ribbon-cutting. Unfortunately, this pressure weakens the vetting process on project fundamentals and can produce unintended consequences in the form of early cancellations, disputes, renegotiations and, in some cases, terminated projects.
The Peruvian government’s recent cancellation of the Chinchero Airport in Cuzco demonstrates some of the practical challenges related to institutional capacity. Uncertainty related to contractual fundamentals, which created a substantial proposed increase in government financing for the project led to contract disputes, and, ultimately, cancellation of the project in May 2017. While the airport will be re-auctioned, execution will be delayed and there is potential for ongoing litigation. Instances such as this create a chilling effect, particularly on private investors.
Finally, it is difficult to address institutional capacity in the transport sector without mention of transparency and corruption. Transport has not been spared from the recent corruption scandals in LAC, which have frozen transport pipelines in many countries. Public authorities are hesitant to take the personal and professional risks necessary to carry out the normal business of authorising and managing project execution, while many private sector investors have also adopted a much more cautious approach as well. The result is less project volume, and it is not yet clear whether governments will have the institutional wherewithal to address corruption problems without handicapping the sector with new layers of bureaucracy.
In addressing the need for institutional capacity and solid project fundamentals on a reasonable timeline under transparent conditions, development finance institutions, including multilateral and regional development banks, and bilateral agencies (together, DFIs), as well as the international donor community have an increasingly important role to play. Governments in LAC are chronically budget- and time-constrained, so advisory support and technical assistance from these entities can make a critical difference to both the quality and integrity of early development phases.
The DFI universe has come forth with a series of initiatives designed to enhance ‘upstream’ efficiency and effectiveness. The World Bank Group, Inter-American Development Bank and CAF Development Bank of Latin America have all created strategies and products for early-stage advisory, including technical, legal and environmental and social aspects. The long-term availability of this support cannot be underestimated, as the needs are recurring and this support at upstream stages helps governments create robust transport pipelines.
As an example of success in planning, appraising, selecting and structuring bankable transportation investments, the Chilean government has achieved high-quality and well-maintained systems of ports, airports, urban infrastructure and highways using a private sector concessions model for transport infrastructure. Supported by DFIs at various stages of development and implementation, success can be attributed to the strength of Chile’s institutions and the capacity of its public administration. The experience and capabilities of the Ministry of Public Works, in particular, in prioritising, preparing and executing projects has led to significant private investment in the transport sector that has delivered good-quality assets and strong value-for-money.
Taking a demand-driven approach to attracting funding from debt capital markets
A second area where LAC governments can take practical steps to closing the transport infrastructure gap is to adopt a more demand-driven approach to bankability that responds to the risk appetite of debt capital markets. According to the World Bank, assets under management by OECD institutional investors are on the order of US$80 trillion with an additional US$5 trillion under management in EMDEs. For governments that are able to structure transport projects to this audience, the rewards could be huge.
Over the past decades, the project finance market in LAC has been driven by international commercial banks and DFIs that have provided long-dated, limited-recourse project financing. Concessions have been structured by governments according to their own risk preferences – often with limited feedback from the private sector – which has left sponsors and lenders to deal with risk allocation that has proven challenging and expensive.
However, debt markets are changing. As commercial lending terms and conditions have become more conservative (including drastically reduced tenors) due to expensive capital requirements under Basel III and Basel IV, it is becoming harder to ignore domestic and international capital markets as complementary sources for project debt. Commercial banks simply do not want – or cannot afford – to hold long-term project exposure on their balance sheets, while yield-hungry institutional investors are willing to support the sector if risk allocation can be structured to meet creditworthiness criteria and credit rating thresholds.