By Diana Capetillo, Associate Director.
(Octavio Frias de Oliveira Bridge, São Paulo Brazil)
Infrastructure development in the Latin America region often requires large amounts of investment. This is due to socio-economic and geographic factors such as the nature of emerging markets, a broad demographic base, highly populated cities and discontinuous orography, among others.
Hence, there is a need for project finance in Latin America.
This article examines some of the challenges of structuring Project Finance deals in Latin America. These include:
- Public and Private sectors’ collaboration
- Bankability
- Stable regulatory framework
- Long-term approach
- Out-of-the-box financing structures
- Others
A) Public and Private sectors’ collaboration
It is widely understood that collaboration between the Public and Private sectors is essential when structuring infrastructure projects. This is particularly true for grants, permits, and licenses.
However, in Latin America, project developers must manage additional challenges related to indigenous and protected areas, social impact, and stakeholder perceptions.
The public sector is the lead agent in protecting the rights of Indigenous people and developing social programmes for rural communities and communal lands (tierras ejidales). It also plays a crucial role in ESG compliance.
B) Bankability
Bankability is essential for any Project Finance transaction, and no less so in Latin America.
Achieving a bankable structure is easier when the project has a private off-taker than when the project involves a complex public tender process.
For private off-takers, the process will involve obtaining credit ratings and suitable guarantees and protections as part of the preliminary analysis. For tenders, the public documents must include early termination clauses to the satisfaction of the banks, reliable payment source(s), and a suitable credit rating of the entity, amongst other things.
C) Stable regulatory framework
Lenders and equity investors will both carefully assess regulatory risk before committing funding to a project. Neither banks nor investors wish their projects to be expropriated without fair compensation or to become unfeasible because of reductions in regulated tariffs.
D) Long-term approach
The higher risk associated with the Latam region means investors require higher returns than in more mature markets. This must be achieved while maintaining sensible tariffs. High returns combined with large typical project costs mean that grants or longer off-take agreements are more often required than in other geographies.
This might be challenging for fund-raising activities, particularly when raising financing from counterparties such as non-operating investors and banks used to shorter lending terms.
E) Out-of-the-box financing structures
Advisory firms must be creative in developing viable structures that all counterparties can accept. For instance, while some entities in Latin American countries can sign grants or off-taking agreements in a hard currency, mainly USD, many of them cannot or will not do so. This is often due to issues such as regulatory constraints and FX instability.
With EPC contractors’ pricing in USD, the question arises of how to make disbursements in hard currency and pay debt service in a soft currency. While cross-currency swaps can be an option, they are generally only available for shorter terms than the typical debt tenure for Latin American countries. A solution that can work here is the use of multi-currency debt tranches.
F) Others
The different ways that countries within the region are organised internally could lead to significant differences in the credit ratings of public entities of the same nature but corresponding to other geopolitical areas.
For instance, state or municipal entities, neighbouring states or even municipalities may have quite different credit ratings due to issues such as local public indebtedness, track record, reliability, stage of development, demographic profile, etc.
Over the next few weeks, we’ll expand into these topics for further reference and discussion. In the meantime, please don’t hesitate to contact us for more information on our services available in Latin America.
