Conclusions: Moving Project Finance in Latin America Forward, Issues and Prospects
The worldwide economic recovery that started in 2016–2017 has accelerated, buoying Latin American countries with firming commodity prices and exports. This progress has reversed the 2014–2016 decline, setting the stage for a revival in new infrastructure investments.
In comparison to other middle-income developing countries, Latin American countries generally possess greater legacy infrastructure than do their peers in Asia and Africa. This advantage is combined with generally higher overall standards of living relative to their peers.
However, much of Latin America's infrastructure was built during the 1950s–1970s using sovereign debt, and after successive crises in the 1980s–2000s the continent's infrastructure is showing its age. Asia's shiny new airport terminals and speedy railways are not for Latin America. Domestic financial resources have proven insufficient to meet the growing demands for electricity, natural gas, roads, railways, ports, water and other essential services.
The authors of this practice guide have looked at a wide range of countries and infrastructure issues, ranging from oil and gas in Mexico and Brazil to transportation in Peru and Argentina. Among the concerns addressed are: law and regulation, financial resources and deal structures, corruption and compliance, and dispute resolution.
What ends must infrastructure investments serve?
As the economic outlook continues to show strength, Latin American countries have broadened their infrastructure goals beyond the basics – electricity, water, roads – to a wider array of needs. These include clean and renewable energy, rails, both urban and intercity, and upgrading regional and hub airports. The papers in this volume reflect the improved economic outlook for most countries in the region, and the findings build on reforms already highlighted in previous work.
Meet growing energy and electricity demand, cleanly
Electricity grids in Latin America currently provide almost complete coverage to the population. However, much of the network infrastructure was built for a smaller population, a lower level of demand, and less sophisticated quality of service requirements from users. In much of the region, demand doubles every 15–16 years. This growth compares with little or no net growth in the United States and OECD Europe and Asia. Generation was historically based on local resources, either hydro or fuel oil, and must now serve more customers, at a higher level of quality, with lower emissions. Natural gas use is growing rapidly, and has overtaken oil and coal combined as the second leading electricity generation source after hydro, which still accounts for more than 50 per cent of total generation in the region.
One key aim of the new infrastructure push is to promote more economic activity away from the major cities, evening out some of the current regional service disparities. This network expansion requires significant additional resources. Replacing older oil-fired power plants with cleaner generation sources also calls for major expenditure by suppliers that state-owned utilities can no longer mobilise themselves.
A major push into renewable energy sources for power generation, chiefly wind and solar, is no longer debated, and both now show high rates of year-on-year growth. Renewable energy mandates have assumed increasing prominence in almost every major country in the region. Most in the region have adopted some form of renewable energy targets, and all of these countries have advanced incentives, including combinations of feed-in tariffs, net metering, tax concessions and outright grants.
Many of the chapters address the key issues for the consensus 'refresh' that is needed in the region's power sectors. Energy infrastructure projects must, in addition to meeting growing demand:
- improve service quality;
- build up service to lagging regions;
- mobilise foreign sources of debt and equity;
- maintain national sovereignty over mineral resources;
- bring more natural gas into the national energy mix;
- pay attention to new supply technologies such as hydraulic fracturing and environmentally friendly drilling;
- provide greater levels of service reliability and quality; and
- do it all more cleanly than in the past.
The strengthened push for renewable sources of electricity resonates throughout many chapters, including the discussions of energy in Brazil, Argentina and Mexico (Chapters 1, 8, 11, and 12). For Brazil and Mexico, many renewable generation projects are seen as competitive at today's oil prices; renewables are now commoditised and need no longer require significant government assumption of their financial liabilities or even equity financial support. For project developers, this represents a sea change – renewables are increasingly treated as just another technology. Most governments have left the generation business for new projects, leaving developers, EPC contractors and banks to face the price risk for renewable energy projects.
Mexico has committed to its NAFTA partners a more than doubling of its 'non-carbon' generation portfolio by the middle of the next decade – another 32GW of solar and wind, almost all from private developers and investors using cost-minimising auction techniques and competitive bidding.
Other Latin American countries with ambitious renewable energy plans include Brazil, Peru, Argentina and Costa Rica. Brazil currently obtains most of its electricity from renewable sources, primarily hydro, with solar PV and wind expected to reach 10GW by the end of 2018. Argentina has recently reiterated its support for a 20 per cent renewables share by 2025.
Natural gas benefits from commoditisation in most countries. Gas is seen as an increasingly vital and high priority element of the fuel mix, while its technology has made use and acquisition far simpler with greater transparency up and down the value chain. Technologies that were somewhat daring a year or two ago – floating liquefaction or regasification – are now considered commodities, with transparent prices and costs. This transparency has been assisted by the 'Cheniere formula', which prices each element in the LNG and gas to power value chain explicitly.
With little technology risk and growing price transparency, the rationale for government monopoly exits as well. Discussions of these elements of gas supply and infrastructure development in are found in Chapters 1, 8, 4, and 11. None of the countries surveyed in this volume are even considering further use of state resources to augment future supplies of natural gas or renewable electricity.
Private participation is well accepted and previous needs to develop a salable rationale for PPPs and other private instruments have been replaced by discussions detailing the uses for private funds and consequent savings to the national treasury.
The chapters dealing with Mexico's energy and power sectors, 11 and 12, show the greatest evolution in the role of government and acceptance of private participation. The discussion on Mexico has now moved from the rationale for the programme to a broader discussion of the particulars of private participation throughout the energy sector, down to distribution of natural gas and refined oil products. Key elements of the chapter address ancillary changes in labour laws, company laws, financial regulation, and other components that will make better use of new private investments in Mexico's energy sector. In just one example, a relaxation of local content rules for hydraulic fracturing equipment has meant that the US and Mexican markets can better integrate across adjacent areas in Mexico. Mexico's offshore appears to be similarly benefiting. The extent to which the economic nationalism of the new Mexican president will slow down these trends is discussed in Chapter 11. The reforms put into place by the Nieto administration should outlive his presidency, though perhaps with less enthusiasm from the new government.
A similar discussion can be found in the Brazil PPP chapter (Chapter 1). The authors there have identified further steps for reform and improved effectiveness of PPPs now that the major enabling legislation has been implemented. Key areas of interest are labour law, social security reform, tax simplification and general debureaucratisation. Brazil's privatisation efforts hinge on the current electoral battle, a stark choice between economic liberalisation and economic nationalism and statism.
Chapter 12 describes how Mexico's reformers have moved on to natural gas. Mexico hopes to see the construction of more than 5,100km of gas transmission, worth more than US$12 billion, none of it owned or operated by Pemex or CFE. This requires institutional restructuring, with a market operator (CENEGAS), access rules and tariffs. The rapid establishment of CENEGAS was accomplished using a streamlined multi-agency approach: energy identified the actors, locations and timetables; finance addressed the fiscal terms; economy addressed local content; and environment focused on industrial safety and emissions. The main thrust of private-sector participation was not refought during the implementation stage.
The shift in thinking in Mexico, Argentina and Brazil is striking, even with some backsliding possible in Mexico. A psychological threshold for the three governments has been crossed; the oil and gas sectors are no longer seen as cash cows to be milked endlessly for public (and individual) gain. Venezuela's experiences since 2014, and those of Ecuador to a lesser extent, have proved dispositive in that vein. With lower prices and higher domestic use government cash generation from exports must take a back seat to the technological and financial engineering of supply itself – meeting the countries' energy needs in the most cost-effective ways. The recent US–Mexico trade agreement boosts Mexico's use of the least cost supplier of natural gas in the near term is the United States, the gas now flared in Texas' Permian Basin shale oil production.
Chapter 11 focuses on the changing role of government and private investors and operators in the upstream oil and gas sector. The last time oil prices were high, resource nationalism was coupled in many Latin American countries with imposition of tough terms on the IOCs fiscally and operationally. There was also a widespread belief that the China market would grow perpetually, generating endless cash. This was, in effect, a shift from an equity model of development, prevalent in much of the rest of the world, where IOCs took most of the financial risk, to a debt-based model where the NOCs took most of the risk, an approach that proved disastrous for many regional NOCs.
Unfortunately, the harsh terms produced no unconventional oil or gas, the pathway used by IOCs to bring new resources to the market. Can Latin America's governments afford to believe that the recent rise in oil and gas prices represents a real trend rather than a minor blip? That is, will they use the recent turnaround in oil prices to make the same mistakes they made in the past, just when they have corrected many of these same errors from the last period of high oil prices?
The authors show in Chapter 11 how Brazil, Mexico and Argentina, in particular, have found the will to make substantial changes in their oil and gas sector governance. Brazil's oil regime features relaxed local content rules and liberalised operational allowances. Argentina, and to a lesser extent Mexico, have also relaxed these local content requirements. In addition, other operational regulations – deep water, onshore, unconventional – have conformed with the technological needs for exploiting such resources and fiscal regimes have been improved. In Argentina, this has led to a pickup in activity in the country's Vaca Muerte shale formation, one of the world's largest. Mexico is attracting a variety of refining, retail, service and upstream firms. At the same time, new terms in the US trade agreement with Mexico will allow the latter to import less expensive refined products from the US, reducing the formerly pressing need to build additional refining capacity. Private investors now appear to have sufficient faith in the permanence of Mexico's reforms and the implementing regulations to invest in all segments of the industry, including downstream and oilfield services.
Like others in the region, Argentina has made renewable energy a high priority. The country has made extensive use of IFC, IDB and CAF private lending facilities for new solar and wind projects of approximately 300MW and associated transmission infrastructure. Argentina has also serviced as a key IDB customer for its programme for promoting risk mitigation instruments for renewable energy and energy efficiency (Chapter 5).
Move people and goods more effectively
In the discussion of Peru's regulatory framework, in Chapter 3, the authors identified the country's vast investment needs for infrastructure. The evolving regulatory framework permits private companies to invest in PPPs and new regulations permit private investors to propose projects not now included in government planning studies.
The overall framework for PPPs in Peru has been expanded from a long-running road project to transport of many different kinds of goods – roads, natural gas, railroads, electricity transmission lines, health, sanitation and new broadband. The regulations and laws in Peru reflect recent experience there and elsewhere, and include various dispute resolution options, reducing litigation and transactional costs for the government wherever appropriate and feasible.
In Peru's case, the overall goal of the PPP programme, representing more than US$3.8 billion in near-term infrastructure investments is to support a more strongly competitive economy. The authors note that Peru is now considered below the median in infrastructure. New legislation passed in 2018 improves the promotion of infrastructure PPPs and clarifies the role of ProInversion, a specialised body attached to the Ministry of Economics and Finance, whose responsibilities are to maintain transparency, represent the public interest, and maintain the smooth flow of project progress throughout its complex phases. The new arrangements include provisions for maintaining competition in the bidding process.
Throughout the region variations on the PPP model have achieved a degree of maturity and breadth that bespeaks the very rapid progress in this area. Chapter 1 describes Brazil's current experiences with PPPs in the Temer era. The PPP framework described in the previous editions of this guide discussed Brazil's economic transition in the 1990s and 2000s and its accompanying legal framework. These changes have made possible the private participation in hundreds of critical infrastructure projects – roads, ports, power generation and gas distribution.
Recent legislation builds on the country's PPP framework with a new investment law that improves the bidding and risk allocation features of Brazil's PPP system. A new committee has been established to generate project guidelines.
Specific laws have been drafted or will be enacted soon to further flesh out the legal framework for PPPs in specific transport and infrastructure sectors. The law governing private participation in port terminals has been updated to give private investors a larger role in ownership and operation. Brazil is also updating some of its labour laws in order to facilitate further outsourcing and contracting. The country's national development bank, BNDES, has modified its lending policies to make more room for private investors and international co-financing for infrastructure.
The improvements in Brazil's bidding regulations discussed in Chapter 1 cover a broad range of transport infrastructure, including airports, toll roads and railways. Just since last year, Brazil has expanded the scope of permitted private participation in transport, with more airport expansions and modernisations, more railway projects, larger port concessions, capacity increases, and modernisations for the country's toll roads, where more than 11,000km of projects have been approved thus far.
The PPP-led rehabilitation and expansion of Rio de Janeiro's Galeão Airport provides a similar example of the alignment of a well-understood revenue model with a physical facility possessing tremendous expansion and operational potential. Toll roads and airports work for PPP-led modernisation, since there is a well-understood revenue model.
Other countries have made similar moves beyond the obvious toll road concessions. Mexico (see Chapter 12) plans to contract out US$750 million in inter-urban railway investment and more than US$1 billion for intra-urban rail transport. Mexico's ports will also be upgraded and modernised with the intervention of private investors.
Argentina (see Chapter 8) aims for an extensive expansion of private involvement in its transport infrastructure. Under the country's evolving PPP legal framework, authorities seek private investors for US$5 billion in roadways, 20,000km of expanded and upgraded inter-urban railways, US$8 billion for intra-urban railways, including US$1.4 billion for the Buenos Aires metro, and private investment and management of all major airports in the country.
Some forms of infrastructure have proven more resistant to the PPP model than have those in energy and transport. Reasons for this unevenness of results include: (1) high transaction costs; (2) informational asymmetries; and (3) misalignment of interests between the public and private parties. Governments need to devise mechanisms to reduce the incidence of these difficulties. Many regional governments have spent the past year in efforts to provide such remedies. Specific initiatives include the use of public funds to perform the technical and financial feasibility studies for proposed PPP facilities, updating sector-specific legal regimes to reduce the perceived risk on both the governmental and private investor and operation sides for entering into a transaction.
More generally, Latin American countries have turned to private investment as an alternative to constrained government budgets and 'getting by' with inadequate transport infrastructure. The emerging frameworks for concession and PPP programmes in many countries will require some further institutional and legal buildout from the host countries (see Chapter 15). Key initiatives include improved in-house planning and contracting and preselection of high-quality advisers in construction, design, legal and financial services. These reforms are intended to reduce problems that arise on account of insufficient design detail or quality.
The authors of Chapter 15 believe that demand-driven projects will improve the bankability of the PPP efforts, especially as government guarantees ebb in this sector. As with oil and gas projects, transport infrastructure is becoming increasingly transparent and subject to ordinary market forces and overseen by the government. In order to reduce investors' risks and allocate it properly in the absence of the government guarantee, the authors suggest project revenues should be paid in foreign currency, allocating that risk to the government. Construction risks can be reduced using cost limits by critical subunits. And perhaps most important, the demand risk needs to be mitigated through the use of 'de-risked' demand forecasts.
A final risk consideration is the potential role of climate change. For transport projects this can take two forms. The first is the possibility of a reduction in the operational tempo of certain transport infrastructure due to ceilings on fuel use (e.g., controls on diesel long-distance truck transport). The second is the resilience of the subject infrastructure in the face of potential climate-driven events – floods, rising sea levels, storm intensity – that may stress the infrastructure beyond its ordinary design limits. Insurers will likely look at such issues before underwriting major privately financed transport infrastructure.
Mobilise additional private and public investment with less risk to governments
Chapter 5 discusses the roles of development banks and MLAs in financing Latin America's infrastructure. There are three major elements: (1) the rise of new infrastructure financing banks, the BRICS' New Development Bank, NDB, and the Asian Infrastructure Investment Bank, AIIB; (2) changes in the traditional roles and operations of the World Bank, IFC, and IDB; and (3) national changes in PPP laws and regulations that have made many countries better able to use these new funds in conjunction with private investments.
The traditional MLAs, IBRD, IFC, IDB, have made changes in their operational procedures to better compete with both private funds and the new infrastructure banks. The World Bank has extended its partial risk guarantee programme to private investments, making the popular guarantees more useful for infrastructure. This instrument has allowed Argentina to issue a 1GW (eventually, 2.4GW) tender for renewable energy technologies, tapping sources of financing in dollar, yen and euro markets that were unavailable to the country just a few years ago.
IDB has put in place streamlined procedures to participate in bond issues for private parties in the region. This allows the bank to move aggressively into supporting various 'clean development' projects in energy, transport and water.
The World Bank's private-sector arm, the IFC, has expanded its Green Bond programme, now US$100 billion annually, to renewable energy programmes in Mexico and Colombia, as well as the primary user of the Green Bond programme, China. The IFC has also expanded its ongoing Distressed Asset Relief Program, which is aimed at restoring its existing borrowers to health through divestitures. Priority activities in this vein have included market support, capital funding, investor mobilisation and access to the IFC's structuring expertise.
Finally, the IFC has created a new programme, the Managed Co-Lending Portfolio Program (MCPP), which creates diversified loan portfolios for other financial institutions, and significantly pushes the capabilities of the co-financing instruments. Investors delegate project approval and origination to the IFC, thereby reducing their own transactional costs. The MCPP has recently created an infrastructure financing programme, MCPP Infra, that reduces risk exposure for institutional investors in developing country projects. The programme has raised US$1.6 billion so far, and approved more than US$300 million in lending, of which one-third has gone to Latin American projects.
In the past several years, Latin American countries had initiated significant legal and structural reforms to access these IFC and World Bank instruments.
The two new institutions, the NDB/Brics Bank and the AIIB, remain relatively modest in their regional operations. In 2017 NDB lending was just US$2.5 billion, US$4 billion in 2018, all of that on a sovereign basis. Recently, new NDB lending rules permitted it to make a US$200 million loan to Brazil's Petrobras for an environmental remediation programme.
The AIIB now has approved most South American countries as members, the major exceptions being Colombia, Uruguay and Paraguay. The Bank has yet to approve a project in the Latin American region. However, the AIIB has signed cooperation agreements with other MDBs that focus on private infrastructure investment. The AIIB hopes to make its first loans in the region in the coming year.
Finally, the bilateral Brazil-China Cooperation Committee (for the expansion of productive capacity) approved five infrastructure and industrial projects for support with a total of US$2.4 billion in financing from this committee in May 2018.
Several of the Andean countries continue to resist these trends toward greater private investment and operation of infrastructure assets. Bolivia, Ecuador and Venezuela remain exceptions to the building continental trend toward 'controlled liberalisation' and privatisation in infrastructure.
Chapter 4 comes at the question of financing infrastructure from a different perspective: how can local companies and banks change their ways of doing business to adapt to an evolving economic and political environment? Authors note that the ongoing economic and political problems in Brazil combined to weaken such Brazilian stalwarts as Odebrecht, reducing their (and Brazil's) ability to implement large new infrastructure projects.
Other collateral damage from the 2014–2016 downturn affected such major international players as Spanish companies Abengoa and Ferrovial, spreading to US, Mexican and Korean firms Sun Edison, Empresas ICA, and Hanjin, respectively. Re-emerging markets in Argentina, Brazil and Peru have proved largely successful in devising more flexible transaction structures. Local banks have taken a larger role in a number of industries. However, risk concentration in regions, sectors and industries may limit some local financing options.
Some governments have started to divest assets held by SOEs. Brazil, in particular, is now aggressively divesting non-core assets held by Petrobras. The authors noted the likelihood of a greater role for M&A transactions in the region this year, as well as an extension of oil and gas reforms to the midstream, with significant divestitures in Brazil and Mexico particularly. The midstream divestment issues are discussed in detail in Chapter 12.
How is the legal and institutional environment evolving?
A major emerging theme in the Latin American region is the desire by Brazil and other major countries to put the corruption scandals of the past five years behind them. This means re-establishing a firm legal basis for transactions between government and private entities, providing clear rules of conduct, determining appropriate sanctions and settling disputes efficiently and at minimal cost.
First, put out the fires
When the 'Car Wash' scandal at Brazil's Petrobras captured headlines, the interest in the scandal obscured the key role played by international laws and standards in discovering the illicit payments. The unwillingness of Petrobras' auditors to furnish a 'clean' opinion in 2013, as required for NYSE-listed companies, led to a series of investigations that unravelled the trail of corruption there. Chapter 9 points out the steps taken worldwide to place boundaries on the kinds of problems errant employees can cause through criminal or negligent behaviour. It also points out the safeguards in place and those that might be needed in the future to limit the damage from such scandals.
The authors state that the starting point of any successful approach to corrupt activities in corporations is the acceptance that some people will misbehave if given an opportunity. US and UK anti-corruption legislation plays a vital role in establishing procedures that serve as deterrents, and if that fails, a trail of evidence, to sanction corporate and individual misbehaviour. The US Foreign Corrupt Practices Act (FCPA) acts as a restraint on companies worldwide, but especially those listed on US exchanges or doing business in the United States. Similarly, the UK's Anti-Bribery Act deters and documents misbehaviour for firms doing business in the European Union. Brexit may complicate the EU angle, as similar laws in Germany and France are not considered as comprehensive, strong or internationally recognised.
Chapter 7 notes that Brazil's anti-corruption law focuses on individuals while the US and UK acts also make the company responsible for the errant actions of their employees, a necessary element to prevent companies from feigning 'shock and surprise' when their employees are found to commit acts contrary to the country's laws. While non-participation in corrupt contracting or purchasing schemes is often cited by firms as a challenge to their success abroad, the authors contend that more robust enforcement of these acts has also created opportunities for firms that are able to comply fully with the requirements of these laws.
The Sarbanes-Oxley legislation from the US, drafted in the wake of the Enron scandal, also acts as a deterrent to corporate and individual malfeasance. Companies must report payments, including questionable ones, and they must report risks to the company, including those from employee activities that may violate laws in both the home country (US) or in some other jurisdiction.
Compliance as a deterrent to corporate misbehaviour
Worldwide efforts to fight corruption and promote business transparency have led to the creation of a series of laws, agreements and practices under the heading of compliance (see Chapter 9). In addition to the laws of individual countries, multinational companies, the MLAs and even the Organization of American States (OAS) have devised codes of conduct and rules to combat bribery and to proscribe illicit payments and transactions.
For Brazil, the key components of the legal edifice combating corruption are the FCPA of the US, the UK Anti-Bribery Act and Brazil's Clean Companies Act. These three acts create an environment that requires senior management to commit to the following behaviours and actions:
- establish reporting and oversight rules and procedures;
- carry out risk assessments on suppliers and customers;
- nominate a responsible officer within the company's corporate structure to oversee these efforts;
- train and certify employees and executives in avoidance of corrupt practices;
- establish internal controls consistent with SEC or COSO standards so as to integrate financial controls into a company's enterprise risk management system.
- carry out due diligence on transactional partners, including suppliers and customers;
- file reports as required by law;
- establish investigative procedures in the event of suspicious behaviour; and
- monitor ongoing activities.
These actions, if undertaken in good faith, provide a powerful deterrent to corrupt practices and mitigate a company's liabilities in the event not all its employees are angels. In light of these laws, and in the wake of recent scandals, it has now become normal practice for inbound investors who are subject to the US or UK laws to carry out FCPA/Anti-Bribery Act due diligence on their prospective partners in Latin America.
And if prevention and compliance fail? Dispute resolution in Latin America
Chapters 6 and 7 concern dispute resolution between governments and private investors, operators, developers and suppliers. In Peru, the PPP framework permits whichever type of dispute resolution is the most efficient with regard to the government's resources and the overall transaction, including direct negotiation.
Chapter 6 enumerates the rationales for invoking arbitration rather than a country's court system or a third-country court system. These include perceived fairness, time required to resolve the dispute, and transactional costs to the parties. Despite this trend, some countries still require that their court systems be the final arbiters of a disputed transaction. This requirement raises difficulties, possibly significant ones, when a transaction involves entities from countries with different local legal systems.
Chapter 7 opens with a discussion of the improved business and legal environments in Latin America as countries generally move from closed, protectionist systems to more open ones. The authors repeatedly note the differential treatment of SOEs and private companies, and note Latin America's disproportionate role in disputes, while hosting few arbitration forums as a seat. For example, in a number of countries local courts may step in to 'protect public or governmental entities', especially with regard to contract termination (Mexico, Ecuador, Bolivia and Colombia) and can name the site of the resolution. Disputes with the 'Bolivarian' countries are more likely to end up in courts, both the host country's and the investing country's, than are disputes in countries that have 'constitutionalised' international arbitration.
Despite these difficulties there is a growing comfort in the Latin American region with international arbitration, and its outcomes are increasingly recognised as legal, binding and appropriate in the region. Miami remains the arbitration capital for Latin America. Participants believe that the local law regime still matters, and international arbitration 'needs to be protected against local legal quirks', its neutrality is essential, and arbitration agreements must be enforceable, attributes not characteristic of potential Latin American arbitration seats.
The authors note that an improving legal and investment climate in Latin America will lead to the region becoming more favoured as an arbitration seat. They see Peru and Colombia, and possibly Argentina, as the first Latin American countries to be awarded a location as an arbitration seat.
1 Claudette M Christian is a partner in the Washington, DC office of Hogan Lovells US LLP.