Published on Tuesday 24th May 2016
What was the level of debt-financed M&A in your jurisdiction in 2016? Was there any industry or sector that saw any noteworthy uptick in M&A and related financing deal activity in 2016 in your jurisdiction?
According to Thomson Reuters there were 12 deals in Peru in 2014, of which only two have disclosed their funding. The most important infrastructures projects granted by the government to the private sector during 2015 were the Linea 2 del Metro de Lima, the Chinchero International Airport in Cuzco, the Vías Nuevas de Lima (Carreteras Panamericana Norte y Panamericana Sur) (road); Carretera Longitudinal de la Sierra Tramo II(road); Proyecto Majes Siguas II (irrigation); Ampliación de Puerto Matarani (port); Terminal Portuario General San Martín in Ica (port).
What types of investors are the most frequent sources of acquisition financing in your jurisdiction?
Two examples of acquisition financing deals are as follows:
The most frequent sources of acquisition financing in our jurisdiction remain domestic or foreign banks. The level of participation of investment funds and other institutional investors in financing mergers and acquisitions (M&A) transactions has increased during the last five years, however, these do not represent a source of a substantial level of financing for M&A transactions, as there are not many investment funds that finance such transactions. Most of the local investment funds invest in equity minority participations or in infrastructure projects, and although there are some investment funds that provide finance, these are mostly for new projects, venture purposes or for mezzanine credit purposes.
The local institutional investors, namely, managing companies for private pension funds, local insurance companies, mutual and investment funds, family offices, governmental and private health service companies; the ONP (public pension fund entity); and private banking and family offices, participate in these types of financing transactions through the acquisition of the bonds and other debt securities that are issued and placed in the Peruvian market by local companies and in those international issuances of debt instruments by local qualified companies.
In addition, foreign institutional investors (United States, European, Latin American and Asian funds) are a source of acquisition financing for large issuances and, they, basically, prefer Peruvian corporate debt of qualified local companies that have access and experience to the international capital markets, as well as Peruvian governmental sovereign debt.
Peruvian insurance companies are an example of the institutional investors that invest a substantial portion of their resources in local and international instruments. They are allowed to invest in certain eligible assets, such as instruments issued by the Peruvian central government, classified local and international corporate bonds and shares, among others. However, in order to balance levels of risk, applicable regulations have imposed a number of limitations on insurance companies with respect to their investments (limitations on the issuer, economic group, type of instrument and nationality, among others). In general terms, no more than 20 per cent of the total amount of an insurance company’s technical obligations may be invested in certain instruments (including, among others, stocks and bonds) issued by the same economic group. The investment regulations further specify that investment policies of Peruvian insurance companies shall consider maximum limits by issuer (calculated over the regulatory capital of each company) depending on the type of investment and the insurance industry in which the company operates. Insurance companies that operate within the life insurance industry cannot invest more than 55 per cent of their regulatory capital in non-liquid shares of the same issuer, or more than 20 per cent of their regulatory capital in debt instruments of the same issuer, among other limitations.
Investment in financial instruments by Peruvian banks and financial entities is restricted to those financial instruments listed in the Peruvian Banking and Insurance Law, such as equity instruments traded on a stock exchange, debt instruments (to the extent that certain requirements are satisfied), sovereign debt instruments and quotas in mutual and investment funds, among others.
The Peruvian Banking and Insurance Law (Law No. 26407), as amended, provides lending limit rules for local banks and financial entities. In that sense, under such provisions, the total amount of direct and indirect credit and financing granted in favour of a person shall not exceed 10 per cent of the bank’s regulatory capital. A person is defined for the purposes therein as a person or group of persons or entities representing a common or single risk.
The Superintendency of Banks and Insurance Companies (SBS) has issued special regulations establishing the guidelines that must be followed by banks when determining legal reserves for legal proceedings for past or due loans and foreclosures.
The 10 per cent limit indicated above may be raised to 15 per cent, 20 per cent or 30 per cent, depending on the type of collateral securing the excess over each limit. For instance, the limit can be extended to 15 per cent when the excess is secured by a mortgage, it may be raised to 20 per cent when the excess is collateralised with securities listed in the Selective Index of the Lima Stock Exchange and it may be raised to 30 per cent when the excess is secured with deposits that are maintained and pledged with the bank.
Other special lending limits must also be taken into account, such as lending to related parties or affiliates (30 per cent of regulatory capital), to local banks (30 per cent) and to foreign banks (from 5 per cent for non-regulated banks to 30 per cent for first category international banks, and may also be raised to 50 per cent when backed by letters of credit). There are other limits that require banks to diversify their portfolio through different types of assets, benefitting liquid and low risk assets.
With respect to lending to related parties, the Peruvian Banking and Insurance Law regulates and limits transactions with related parties and affiliates of banking and financial institutions on an unconsolidated basis. In 1997, the SBS and the SMV enacted regulations containing definitions of indirect ownership, related parties and economic groups, which serve as the basis for determining limits on transactions with related parties and affiliates. These regulations also provide the basis for the subsequent development of specific supervision standards of financial institutions and conglomerates formed by financial institutions.
Additionally, pursuant to article 202 of the Peruvian Banking and Insurance Law, the aggregate amount of loans to related party borrowers may not exceed 30 per cent of a bank’s regulatory capital (exceptionally, according to circular B-2148-2005, as amended, the amount of loans to related parties may not exceed 50 per cent of a bank’s regulatory capital if the excess of 30 per cent is secured by credit letters from foreign financial institutions). For purposes of this test, a related party borrower includes any person or an affiliate of that person, holding, directly or indirectly, 4 per cent or more of a bank’s capital stock, directors, certain of the bank’s principal executive officers or other persons in more junior positions affiliated with the bank’s management.
All loans to related parties must be made on an arm’s-length basis with terms no more favourable than the best terms that Interbank would offer to the public.
With respect to the country risk management, SBS Resolution No. 505-2002, enacted in June 2002, requires the funding of reserves to cover exposure to country risk, which is defined to include sovereign risk, transfer risk and expropriation or nationalisation risk, all of which may affect operations with companies or individuals in foreign countries. The SBS has also established guidelines indicating the procedures and responsibilities necessary for coping with country risk.
What types of debt instruments do you most frequently see for local acquisition financings?
Local acquisitions are financed through the following sources, in order of importance:
Foreign capital market transactions have been directed to replace medium-term local banking debt with long-term debt instruments at better financing terms, as well as to finance acquisitions. The Peruvian capital market is comprised mostly by the aforementioned local institutional investors.
Historically, foreign banking and capital market financing have been granted and issued in foreign currency (US denominated credits or bonds and commercial papers), because they have interests in consumer finance, mining, energy, oil and gas that are export-oriented and mainly deal with commodities-oriented business. The economic growth of the Peruvian economy and the low level of inflation have been promoted by soles-denominated credits, as well as the issuance in the local and international markets of soles debt instruments. During the last year, as a consequence of the decrease of economic growth of the Peruvian economy and the devaluation of the local currency, the level of soles-denominated credits and issuance of bonds has decreased substantially. We should point out that the sovereign debt has mostly been denominated in US dollars; however, there have been issuances of soles-denominated notes in the international markets. However, it would be difficult, in the current circumstances, for the market to be interested in soles Peruvian sovereign debt because of the devaluation that occurred during 2014 and the first quarter of 2015.
What are the usual maturities and amortisation profiles of acquisition-financing credit facilities?
Local banks usually provide a bridge loan, with a six to 12 months maturity, to be paid with a take-out issuance of debt instruments in the international markets, or with a syndicated banking loan. The term of the financing depends on the needs of the company. There are no standards of maturities and amortisation profiles of acquisition-financing credit facilities. This will depend on the size of the project. Local companies may obtain financing for three, five, seven or even 10 years, either in the local or in the international market. The amortisation profiles depend also on the structure of the project to be financed. Usually, there are semi-annual instalments, with an initial six-month grace period. The medium or long-term finance may also be structured with monthly or semi-annual instalments with a balloon payment at the end
Are there legal, banking, currency exchange, regulatory or other considerations that favour certain sources of funds over others? For instance, mandatory reserve or deposit requirements? Do the requirements vary by type and location of investor or lender? Were there any changes in the regulatory environment in 2016 that are likely to affect M&A and related financing deal activity?
Peruvian law provides reserve requirements for banks that assume foreign banking financing in those cases where the long-term or credit facility has more than two-year term.
There are no legal regulations in Peru that give more economic favourable treatment to a finance facility from a certain source or on the type of credit instruments or agreement. As is indicated in question 6, there is an income tax differential treatment for foreign banking credits with respect to issuances of debt instruments to the international capital markets.
There were changes in the regulatory environment in 2015 that are likely to affect M&A and related financing deal activity. The Peruvian market, entrepreneur community and the local investors are at the expectation of the results of the ballotage election, that will take place on 5 June 2016 to elect the new government that will enter in office on 28 July 2016.
What is the withholding tax treatment of acquisition finance loans made by, and bonds purchased by, foreign investors in your jurisdiction? Were there any changes in tax laws in 2016 that are likely to affect M&A and related financing deal activity?
Interest paid on foreign bank credit facilities, commercial loans or credit facilities, or bonds, notes or other debt instruments issued by Peruvian companies to non-Peruvian holders, will be treated as Peruvian-source income and will be subject to Peruvian withholding income tax at a rate of 4.99 per cent, provided that certain requirements (related to the entering of the proceeds of the credit or of the issuance into Peruvian territory through banking channels, as well as the destiny of such proceeds that should be used in relation to the corporate business and purpose of the borrower or the issuer) are complied with. However, if the non-Peruvian bank or commercial creditor, or the foreign holder of the bonds, notes or other debt instrument is considered to be related to the borrower or the issuer, under Peruvian tax laws (this includes cases where an indirect relation exists between the borrower or the issuer and the holder of a bond, note or other debt instrument), or if the foreign creditor or the non‑Peruvian holder is an individual and domiciled in a ‘tax haven’, as defined in the Peruvian Income Tax Law and its Regulations, the withholding income tax rate will be 30 per cent.
The borrower or the issuer is required to act as a withholding agent for income tax payable in connection with interest paid on the notes to the foreign creditor or the non-Peruvian holders of bonds, notes or other debt instruments. However, if the bonds, notes and other instruments are listed on the Lima Stock Exchange, the Peruvian clearing house (CAVALI) will act as the withholding agent instead. CAVALI will apply the rate of 4.99 per cent in all cases. If the applicable rate is 30 per cent, the non-Peruvian holder will be responsible for paying the excess.
Proceeds received by a non-Peruvian holder on a sale, exchange or disposition of a beneficial interest in the bonds, notes and other debt instruments held through a foreign clearing system will not be subject to any Peruvian withholding or capital gains tax. In the event that the bonds, notes and other debt instruments are listed at the Lima Stock Exchange, any capital gains accrued and received by a non-Peruvian holder from the sale, exchange or disposition of bonds, notes and other debt instruments will be subject to Peruvian income tax at a preferential rate of 5 per cent if the following requirements are satisfied:
A capital gain will be equal to the difference between the amount realised on the sale, exchange or disposition of the bonds, notes and other debt instruments, and the purchase price paid for the bonds, notes and other debt instruments, which must be certified by the Peruvian tax administration before any payment is made, pursuant to a form submitted by the seller along with back-up documentation evidencing, among other matters, that the purchase price has been paid into a Peruvian bank account, unless the sale, exchange or disposition is made through the Lima Stock Exchange. In the latter case, the non-Peruvian holder must register the cost of the notes and expenses related to the acquisition of the notes before CAVALI, otherwise the withholding would be upon the gross income.
Any premium received upon an early redemption of bonds, notes and other debt instruments will be subject to withholding Peruvian income tax at a rate of either 4.99 per cent or 30 per cent depending on whether the premium is characterised as interest or capital gain. However, a 30 per cent withholding tax rate will apply to any premium received if the non-Peruvian holder of the bonds, notes and other debt instruments is considered to be related to the issuer.
There are no Peruvian tax rules that favour or disfavour non-traditional debt investors, or, in general, to any type of investor.
There were no changes in tax laws in 2015 that are likely to affect M&A and related financing deal activity.
Are there limitations on the ability of the parties to choose a foreign law as the governing law of the financing or to select a foreign forum for dispute resolution?
There are no restrictions, prohibitions or limitations in the Peruvian laws on the ability of the parties to choose a foreign law as the governing law of the financing or to select a foreign forum for dispute resolution. Indeed, even the Peruvian sovereign debt, as well as foreign governmental, multilateral and banking finance to Peruvian governments, may be subject to foreign law, as well as a foreign forum for dispute resolutions.
Does the local insolvency regime treat lenders under an unsecured credit facility on a on a pari passu basis with all other unsecured obligations of the debtor?
Yes, Peruvian insolvency and bankruptcy legislation, provided under Law No. 27809, as amended (Insolvency Law), provides that unsecured credit facilities and, in general, unsecured debts will be paid on a pari passu basis with all other unsecured obligations of the debtor and with that portion of the balance of the indebtedness originating in secured credits that have not been paid with the proceeds of the execution and realisation of the respective security or with the adjudication of the assets matter of the guaranty.
Discuss the legal and practical limitations on obtaining a valid and perfected security interest. Are there any documentation formalities required by local law to make the security interest enforceable against the debtor and third parties? Is it possible to create a floating blanket lien on all of the debtor’s assets?
Peruvian law provides that to obtain a valid, perfected and enforceable interest against the debtor third party’s title of guaranty (secured creditor), security interest on assets that are affected or transferred in trust for purposes of the constitution of a trust in guaranty, or mortgages and pledges on fixed assets, shares and other movable goods, should comply with certain formalities, such as the instruments under which either guaranty is granted and constituted should adopt the form of a public deed granted before a Peruvian public notary that should be executed by the parties and recorded at the corresponding public registry in Peru.
Peruvian law does not contemplate the legal standing of a floating blanket lien on all of the debtor’s assets (including assets acquired after the closing date of the financing). Peruvian Banking and Insurance Law, contemplates that local banking entities may obtain from their respective borrowers the constitution of mortgages or pledges that may guarantee, in general, any and all current and future credit or finance obligation of such borrower without limitation, which means that it would provide a blanket lien on all the current and future obligations that the borrower has assumed or may assume with the respective banking entity.
Does the local insolvency regime enable complex capital structures, for instance, recognising the validity of subordination of payment, subordination of liens, and other inter-creditor agreements?
Yes, under the Insolvency Law the validity and enforceability of subordination of payment clauses, as well as the contractual provisions on subordination of liens and other inter-creditor agreements will be recognised and enforced within the insolvency, liquidation or bankruptcy procedure, which is filed with the National Institute for the Defence of Competition and Intellectual Property (INDECOPI).
If an equity investor provides some of the debt financing, do local insolvency rules afford those loans equal treatment as other (third-party) loans?
Yes, they will have equal treatment to other loans given by non-related entities.
Are there any other insolvency considerations that a foreign debt-investor or lender should be aware of?
It is advisable that in the foreign loan and other type of credit facility agreements to be entered into by foreign banking and financial entities with local borrowers, as well as in the instruments under which bonds, notes and other debt instruments are issued to be placed in the international markets, clauses should be included that provide the right of the foreign banking creditor or the representative of the bonds, notes and other debt instruments to accelerate the term for the payment and claim the total amount of the corresponding debt before the insolvency of the local debtor is declared or even before a petition for the declaration of insolvency of the debtor is filed with the INDECOPI by one or more creditors, or by the debtor itself. Therefore, the banking or financial creditor may execute the acceleration clause and claim the full amount of the credit in the event that, in the reasonable opinion of the foreign bank or financial entity or the representative of the bonds, notes and other debt instruments, the economic condition of the local debtor has been affected or has deteriorated in a way that, in the sole opinion and consideration of the creditor or the representative of the creditor the debtor, it may not be able to fulfil the payment of its debts and obligations. There are other provisions that should be included in the respective agreement, to provide a protective and pre-emptive contractual framework for the creditor against potential insolvency or similar situations of the debtor, before they occur.
What do you expect to see in terms of market developments for acquisition financings in 2017?
Peru, as with other Latin American countries, will be affected by a slowdown in M&A activities, as a consequence of the reduction in the level of economic growth. Our country will grow approximately 4 per cent during 2015 as compared with the Latin American region level average of 0.9 per cent of GDP, however, as Peru is entering into a pre-electoral year (there were national elections for the President and for Congress in April 2016, and there will be a ballotage election between the two candidates that obtained the major votes on 5 June 2016), we expect several investors to watch and see the outcome of the political and economic proposals of the different parties that will participate in the election. It is expected that the party that wins the election will continue to be market-friendly and maintain the fundamentals of the economic policy applied during the past 20 years, as there is a consensus in most of the Peruvian political spectre of the need to maintain the free market, equal rules for local and foreign investment and an open economy legal framework. Actually, the two candidates that will dispute the ballotage electiondo not have substantial differences in their policies to keep the fundamentals of the economic policy referred before. Consequently, no substantial changes are expected and both candidates have promised the implementation of policies to implement public investments in infrastructure and utilities, as well as to promote the local and foreign private investment in infrastructure and concession projects. Therefore, we expect a continuity in the promotion of foreign and local private investment in infrastructure projects, such as ports, airports, roads, irrigation, gas pipelines, water and sewage and hydroelectric projects, with new investors coming from Asia besides United States, Brazilian and European investors. We have identified a couple of M&A opportunities in the energy and mining sector that should come on to the market during the next two quarters.
In addition, local companies are still implementing projects and digesting M&A’s transactions that have been financed during the last five years, including cross-border M&A financing undertaken by foreign companies that have acquired local corporations. Also, we do not envisage that local companies that are currently in a delicate economic situation will need new local or foreign investment that would have a change of control effect.