After having reached economic stability with the Plano Real in the 1990s, Brazil fast became one of the most consistently growing economies in the world, with increasing internal demand stimulated by factors such as controlled inflation, an expanding middle class and the increase in value of the Brazilian real against foreign currencies.
Being perhaps the Bric with the most Western culture, Brazil continues to attract solid foreign investment and promises to have such flow increased significantly in the coming years, to a large extent owing to investments related to the upcoming World Cup in 2014 and the 2016 Olympic Games.
Investments for the World Cup are estimated at $29 billion throughout the 12 cities expected to host the games (Belo Horizonte, Brasília, Cuiabá, Curitiba, Fortaleza, Manaus, Natal, Porto Alegre, Recife, Rio de Janeiro, Salvador and São Paulo), and an additional $10 billion is estimated for the Olympic Games in Rio de Janeiro.
Despite the considerable growth Brazil has experienced and the range of great prospects for the future, the country is lagging behind when it comes to preparing the necessary infrastructure for the upcoming sports events.
The country's big challenge has been to provide a stable legal framework that enhances investor confidence and reduces the so-called Brazil risk, whilst ensuring that the necessary infrastructure is ready in time.
Since the moment it was confirmed that Brazil would host the games, several incentive programmes and proposals to change the legal framework in order to simplify the government's public procurement rules have been announced. A Sports Incentive Law and other initiatives targeting specific benefits for the sports industry were among the first to be issued. State and municipal governments were also quite efficient in providing prompt tax incentives for specific investments. However, the heavy infrastructure investments that are essential at this stage are concentrated at the federal level, where the current public procurement regime is based on long and burdensome bidding procedures.
The Federal administration public procurement regime
Brazil's Federal Constitution reserved for the federal government the exclusive title to certain assets and the exclusive right to render certain services, which are considered strategic or of great public interest. Examples of such public goods and public services are those relating, among others, to power, telecommunications, air, waterway and road transportation, and associated infrastructure.
Public services may, at the discretion of the federal government, be rendered directly by the public administration or may be delegated to private parties by means of a concession, permission or authorisation, according to Law 8,987/95 (Public Concession Law).
As for the procurement of goods and services, including the construction and maintenance of public infrastructure, it is mandatory for the public administration to observe the rules for public procurement set forth by Law 8,666/93 (Bidding Procedure Law).
As its name suggests, the Bidding Procedure Law requires that the public administration promote public bidding in order to procure any services and goods.
The bidding procedure starts with studies carried out by the public administration that must justify the need for each contract, prepare and identify the corresponding budget to cover the contract and issue a formal authorisation for the bid. This phase is already burdensome for the administration and the studies usually have to be outsourced as well (through a separate bidding procedure), meaning that there is a long process to go through before the bidding procedure is even announced to the public. After this internal stage, three other main phases follow:
(i) publication of an Edital, an official document stating the subject of the bidding procedure and its rules, in a manner that allows all interested parties to participate in the bidding process;
(ii) a qualification phase, in which participants present their credentials, basically to demonstrate that they are eligible to enter into a contract with the public administration and meet the legal, technical and financial requirements to render the specific service or supply the specific goods; and
(iii) an offer phase, where the participants present their price and/or technical solution, according to the selection criteria for the specific bid (which may be determined in terms of lowest price, best technique or a combination of both factors).
The procedure described above can be exceedingly long and bureaucratic and is heavily criticised by both administrators and scholars, especially due to the number of appeals allowed in each phase – not always used for legitimate purposes – which suspend the procedure and may help explain why it is that a number of planned contracts never get to the execution phase.
Although simplified rules are available for smaller public contracts, the typical bidding procedure described above is still mandatory for major public investments, such as infrastructure construction.
In addition to the mandatory bidding procedure, activities such as the preparation of the project and environmental studies are also required by law to be contracted separately from the construction itself, disregarding the efficiency gains that could arise, for instance, from turnkey agreements.
Finally, the winning bid sets a fixed price for the service, without any room for incentives that could reduce the construction time or permit technology improvements after the bid (although penalties for delay or underperformance are allowed by law).
These are examples of some of the barriers that the Brazilian government is facing to implement the planned infrastructure for the World Cup and the Olympic Games. The hope that an existing proposal to streamline such procedures will be approved in time is possibly what is delaying the publication of the Editals for some of the public procurement projects that have been announced.
Alternative contractual regime
Aware that burdensome bidding procedures may prevent some of the main infrastructure projects required for the games from being ready in time, representatives of the legislative power at the federal level have presented a proposal to change the Bidding Procedure Law by creating an alternative procedure that would be available for infrastructure projects relating specifically to the Games. This proposal has been named Alternative Contractual Regime (Regime Diferenciado de Contratações) and is based on three main propositions.
Firstly, the inversion of the qualification phase and the offer phase, whereby the analysis of the offers would be made before any qualification documents are presented and, therefore, only the participant with the wining offer would have its credentials analysed after the bid (but before the execution of the agreement, and still in time to call the participant with the second best offer).
Secondly, the possibility to contract turnkey agreements, where both the engineering projects and the construction would be performed by the same party. And finally, the possibility to have bid offers with variable compensation, where the contractor would receive a bonus for improved time or technology in the agreement performance.
Such proposals are expected not only to reduce considerably the time involved in the bidding procedures, but also to attract more investors interested in a contractual framework that is more similar to the type generally used in the private sector.
Notwithstanding its clear benefits, the proposal has been brought to vote at the House of Representatives more than once, and so far the Brazilian Congress has failed to pass the proposal. The reasons for this are the alleged difficulties that the public administration would face to control the new form of bidding procedures and contracts.
In summary, the proposal's opponents believe that turnkey agreements and an incentive regime leave too much room for overpricing and that the inversion of phases would make it difficult to reverse a procedure after the price is known to other participants.
Nonetheless, the proposal has again been included in the Congressional agenda to be voted on shortly and its supporters are confident that the Alternative Contractual Regime will be approved in time to allow the bid and execution of the necessary infrastructure for the upcoming sporting events under this Alternative Contractual Regime.
The parallel solution: privatisation
While the proposal to simplify the public procurement contractual regime for major infrastructure construction is not voted into Law, alternative structures are beginning to be created and announced to address the pressing concerns about timeliness in implementing the required infrastructure for the Olympics and World Cup.
The construction and expansion of airports is one of the main areas of concern regarding infrastructure in Brazil and is a good example of how the current federal administration has been showing signs that it is putting aside ideological influences to favour pragmatism in solving some of the bottlenecks that could significantly affect Brazil's ability to host the forthcoming events successfully.
With airports in many important cities operating at the limit of their capacity, while demand for flights continues to grow rapidly, in March 2011 President Dilma Rousseff created a Civil Aviation Secretariat to study and propose solutions for the problems faced by Brazilian airports with regard to new airport construction, airport expansions and an overhaul of airport administration, which is generally perceived as very inefficient.
Airports in Brazil have typically been operated by the public administration, which contracts their construction and modernisation by means of the bidding procedure detailed above. However, instead of following this path to expand the existing airports to match the demand expected in the near future, the government has opted for a faster solution, namely privatising some of the airports.
Privatisation in this context refers to the government entering into concession agreements with private parties that would, on the one hand, be responsible for the construction and expansion of the airports and, on the other hand, obtain the right to exploit the airport commercially. Thus, these airports would be subject to a PPP-like regime the features of which are still being designed by the Brazilian authorities in charge of these plans.
The Brazilian government has recently announced that airport terminals in Brasilia, Guarulhos (São Paulo) and Campinas (São Paulo) will be handed over to private investors by means of concession agreements. Rio's international airport is another candidate for the new administration regime.
The structure envisioned by the government involves the formation of a special purpose vehicle incorporated to administrate the airport, of which 51% would belong to private investors and the remaining 49% would be held by Infraero, the state-owned company currently in charge of airport operation in Brazil. To boost investor interest, BNDES (the Brazilian Development Bank) has already announced that it is willing to finance the airport concessions under this new regime.
The bidding procedure has already opened for the first concession of this kind, for the construction and operation of the São Gonçalo do Amarante International Airport in Natal, which is being tendered under a PPP model. The winning concessionaire is expected to be announced in July 2011.
Other legislative and executive initiatives
Whereas the infrastructure for which the federal government would be primarily responsible is definitely the area where major investments are expected in connection with the World Cup and the Olympic Games, there are other areas that are also crucial for these events.
State and municipal infrastructure is the main example, including urban transportation and modernisation of the stadia where the World Cup matches are expected to be held.
In addition, private investments in accommodation, catering and the tourism industry in general will also play an important role, as many cities lack sufficient infrastructure to welcome the expected number of tourists visiting Brazil during the events.
Federal incentives
Among the legislative initiatives that were issued very early on is Law 11,438/06, the Sports Incentive Law. Its aim is to provide incentives for companies and individuals to invest in and sponsor sports projects approved by the Ministry of Sports.
Companies that invest in such projects are allowed to deduct up to 1% of their income tax, whereas individuals may deduct up to 6%. The project was considered a success in terms of project approval requests, but the amounts actually invested so far have turned out to be modest. In 2010, a total of approximately $118 million was invested under the Sports Incentive Law, as opposed to approved projects totalling more than $345 million.
Law 7,319/10 also created a special tax regime for the construction, expansion and modernisation of stadia expected to host World Cup matches. The special regime, named RECOM, suspends some of the taxes that would otherwise be levied on the acquisition of equipment and services related to such construction, expansion and modernisation.
More recently, Law 12,350/10 offered exemption from federal tax for imported equipment and goods to be used or consumed in the events, ranging from trophies to food, acquired by FIFA, its subsidiaries and its contractors.
State and municipal tax incentives
Tax incentives have also been announced at the state and municipal levels throughout the country, mostly to mirror the incentives already in place at the federal level.
There are, for instance, several state treaties (Convênios de ICMS) granting exemption from state tax on equipment and material to be used in the construction, expansion and modernisation of stadia or to be used or consumed in the events.
At the municipal level, most of the existing incentives are related to local taxation (ISS) on services to be provided by FIFA.
Federal incentives for municipalities
A large infrastructure investment programme was launched in 2007: the Growth Acceleration Programme (Programa de Aceleração do Crescimento, or PAC), which initially announced public investments of over $312 billion and a planned second phase for an additional $560 billion.
In February 2011 a specific PAC for investments in urban mobility, including the improvement of traffic infrastructure and public transportation – the Urban Mobility PAC – was announced for the majority of the state capitals. One of its objectives is to help meet the FIFA requirements for urban transportation in the cities expected to host games.
The federal government will invest approximately $4 billion from its own budget in the Urban Mobility PAC, and another $7.5 billion will be made available through financing. The rules for Urban Mobility PAC are quite strict in terms of expenditure control and threaten to exclude from the program any city that has not begun construction of new infrastructure by December 2011.
Among other changes in the federal legislation in order to allow further investments by the municipalities aiming to meet the World Cup needs is Law 12,348/10. This Law authorised an increase in the limit of indebtedness that municipalities are allowed to incur in order for them to be able to obtain further financing for infrastructure investments in connection with the games and FIFA related requirements. Any other indebtedness (indebtedness not relating to investments needed in connection with the games) can only be incurred up to the limit of the municipality's real net income.
Alternative financing for infrastructure projects
As discussed above, the Brazilian government has presented initiatives in all three of its spheres – federal, state and local – towards a more stable legal framework to foster investment in the infrastructure required for the World Cup and the Olympic Games.
All governmental incentives are, of course, most welcome and necessary. However, the pressing need for financing infrastructure projects has made sponsors and investors in general develop an interest in alternative forms of financing.
The financial crisis of 2008/2009 has dampened the international banking community's appetite for loans in the infrastructure area. Funding greenfield projects and assuming high construction risks in developing countries has certainly become a scarcer and more expensive business. Even the Brazilian Development Bank, BNDES, which has enormously increased its participation in funding infrastructure projects on a project finance basis in the last decade, experienced a reduction in its own sources of funds following the financial crisis and is visibly short on capacity to fund all the necessary construction on the scale expected of large international sporting events.
Sponsors of infrastructure projects in this economic environment have begun to look to the capital markets in search for an alternative to bank loans, and project bonds have emerged as a feasible source of funds for such projects.
While bonds have been used in the past mostly to refinance bank loans after the completion of a project, today it is becoming increasingly popular among Brazilian companies to issue bonds to finance the construction phase as well. These bonds have also borrowed features from project finance structures and they can be tailored to finance specific projects on a limited-recourse basis. In summary, project bonds in their pure form would look solely at the assets and future stream of revenues of a special purpose vehicle associated with the specific project.
With investors still resistant to construction risk, a simpler way to mitigate those risks would be for the sponsor to provide completion guarantees for the project bonds, which would be released upon completion when the project starts to generate revenue. This solution is also applicable to commercial bank loans, but in either case it is never the sponsors' preferred choice.
Another alternative to mitigate construction risk would be to have construction contracted throughout an engineering, procurement and construction agreement on a turnkey basis, subject to the construction company providing a robust guarantee. Brazil's host of large construction companies would be especially well placed to provide such guarantees. Insurance-based completion bonds would be another alternative to replace direct sponsor guarantees.
With regard to their other characteristics, project bonds can differ quite significantly from commercial bank loans. First, project bonds are more likely to have longer-term maturity dates than bank loans. Second, project bonds normally have fixed interest rates, and thus they are not subject to the same volatility as interest on bank loans. Finally, covenants on project bonds are usually incurrence covenants, whereas bank loan covenants are structured as maintenance covenants.
This last feature has to do with the differences in the process of obtaining waivers and amendments for bonds as compared to bank loans. The latter is a more expeditious process, as the borrower can negotiate directly with the bank or its agents. In a bond financing, however, the task of obtaining approvals from the required threshold of bondholders can be a difficult and time-consuming process, especially as bondholders tend to be more passive players than commercial banks. For that reason, covenants in project bonds are designed to cover mostly intentional breaches by the issuer, such as debt incurrence, avoiding maintenance covenants that could be breached without actual actions from the borrower.
With that in mind, and aware of the qualified investor market in Brazil formed by important players such as pension funds, insurance companies and investment funds, sponsors are starting to shift their funding plans from bank loans to project bonds.
A recent case, perhaps the first large project bond issue in reais, was the R$1.1 billion (approximately $687 million) issuance of 12-year project bonds by Concessionária Rota das Bandeiras, an Odebrecht group company, in connection with the Rota das Bandeiras project for the operation of the Dom Pedro highway in 2010. This was a successful and in a sense groundbreaking case that has already inspired other project bonds in Brazil and, one hopes, can be mirrored in connection with other investments in the pipeline for the World Cup and Olympic Games.
Game on
The panorama laid out here illustrates the efforts being made by the Brazilian government to ensure that the infrastructure required for the World Cup and Olympic Games is ready in time. Initiatives undertaken by private sponsors to seek financing by way of alternative sources, namely the use of project bonds, are also presented. Whether the current initiatives will achieve their goal is something we cannot know until closer to the event; there is still a great deal of the race to run and despite the home team having a lot of catching up to do, all bets are definitely still on.
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About the author
Ana Carolina Barretto is a partner of Veirano Advogados based in Rio de Janeiro, Brazil. She has been a member of the firm since 1997, and coordinates the energy and infrastructure practice group. Barretto specialises in project development and finance, focusing mainly on the energy and infrastructure sector. She has represented sponsors, lenders, EPC contractors and equipment suppliers in connection with the acquisition, development, financing, construction and operation of a number of energy and infrastructure projects in Brazil, including wind, ethanol and hydropower in the renewables sector, heavy oil, gas and coal power plants, shipyard and vessel construction, mining and logistics projects. She holds a law degree from the Pontifícia Universidade Católica do Rio de Janeiro, and Magister Juris and Master of Studies in Legal Research degrees from the University of Oxford. While at Oxford, Barretto was a Chevening/FCO scholar. |
Contact information
Ana Carolina Barretto
Veirano Advogados
Av. das Nações Unidas, 12.995 / 18º andar
São Paulo - SP - Brasil
CEP: 04578-000
t: 55 11 5505-4001
f: 55 11 5505-3990
w: www.veirano.com.br |
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About the author
Roberta is a senior associate with the infrastructure and natural resources department at Veirano Advogados, which she joined in 1998. Her practice is focused on project development, project finance and construction agreements, mainly in the power, mining and oil and gas sectors. Bassegio holds a degree from Pontifícia Universidade Católica do Rio Grande do Sul, a post-graduate degree from Universidade Federal do Rio Grande do Sul and a LLM from Columbia University School of Law, where she was awarded honours as a Harlan Fiske Stone Scholar. She also worked as an international associate with Allen & Overy in New York.. |
Contact information
Roberta Bagatini Bassegio
Veirano Advogados
Av. das Nações Unidas, 12.995 / 18º andar
São Paulo - SP - Brasil
CEP: 04578-000
t: 55 11 5505-4001
f: 55 11 5505-3990
w: www.veirano.com.br |