Opportunities open up

Author: | Published: 6 Jul 2012
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The legal framework for structured finance transactions in Mexico is gradually being modernised, and these types of transactions are on the increase. A number of Mexican statutes have been amended in recent years, making securitisations and other structured finance transactions easier to implement, and therefore more attractive and efficient both for issuers and investors. In addition, a series of legal provisions have been amended to allow Mexican pension funds to invest in public structured finance vehicles. The huge portfolios handled by such pension funds offer big incentives. Two new kinds of structures that are attracting interest in the Mexican market are fibras (the Mexican equivalent of the US real estate investment trusts (REITs)) and CKDs (public structured notes).

Fibras

Fibras – or Fideicomisos de Inversión en Bienes Raíces – represent a vehicle for the public issuance of real estate trust certificates (certificados bursátiles fiduciarios inmobiliarios or Certificates) that grant their holders a pro rata right in the assets and revenue of the Fibra. Fibras are the Mexican version of REITs which have been operating in the United States for many years. The Fibra allows investors to participate in commercial real estate development with a favorable tax regime, along with the transparency and access to information enjoyed by investors in the Mexican Stock Exchange (Bolsa Mexicana de Valores).

Fibras were introduced following an amendment to the Mexican Income Tax Law that was passed in 2004. This amendment triggered a series of additional tax reforms, making the investment in Certificates issued by fibras feasible, attractive to the market, and tax efficient.

Fibra Uno was the first fibra to successfully issue Certificates in the Bolsa Mexicana de Valores in March 2011. This transaction was approximately $250 million – a significant transaction by Mexican standards. During March 2012, Fibra Uno made an additional issuance of Certificates for approximately $700 million which included two components: a public placement in the Bolsa Mexicana de Valores and a private issuance in the international markets under rule 144A and regulation S.

In order to obtain the tax benefits of being a real estate investment trust, fibras must comply with five basic requirements set forth in the Income Tax Law. Firstly, the fibra must be established in accordance with Mexican law and the trustee of the fibra must be a credit institution resident in Mexico and authorised to act as such.

Secondly, the purpose of the fibra must be the acquisition or construction of real estate destined for leasing, acquisition of the right to receive income deriving from the leasing of real estate, or to grant loans for either of these purposes which are secured by means of a mortgage on the leased real estate.

Thirdly, at least 70% of the fibra's assets must be invested in either leased real estate, the rights to receive income from the leasing of real estate, or the loans mentioned in the paragraph above. The remainder must be invested in securities issued by the Mexican Federal Government and registered in the National Registry of Securities or in stock issued by debt investment companies (sociedades de inversion en instrumentos de deuda).

Fourthly, the real estate acquired or built by the fibras must be destined for leasing and may not be sold before the end of a term of four years as of its construction or acquisition. The real estate sold before the expiration of such term shall lose the benefit of considering the transfer of such real estate as a tax free transaction.

Finally, the fibra's trustees must issue Certificates and offer same by means of a public offering, and the fibras must distribute to the holders of the Certificates (Certificate-holders), at least once a year, a minimum of 95% of the net profit of the fibra for the preceding fiscal year.

If the fibra complies with the above requirements, the fibra and its Certificate-holders are eligible, among others, for certain tax benefits. The entity would be transparent for tax purposes. Certificate-holders who are not tax residents of Mexico are not subject to the 17.5% Mexican flat tax (IETU), and the 16% Value-Added Tax (VAT) for their investments in fibras.

Mexican securities firms or Casas de Bolsa acting as custodians of the Certificates on behalf of the Certificate-holders (under Mexican law, the Certificates are held on behalf of the Certificate-holders by these securities firms) are required to withhold a portion of the net profits distributed to the Certificate-holders at a rate of 28%, on an annual basis, unless the relevant Certificate-holder is not subject to income tax (e.g. Mexican and registered foreign pension funds and retirement funds).

Also, foreign tax residents are not subject to income tax, IETU or VAT with respect to the sale of their Certificates. This is provided such certificates are traded to third parties through the Bolsa Mexicana de Valores or recognised foreign markets.

As explained above, fibras are structured as Mexican trusts to which eligible real estate assets are conveyed by the original owners (and in some instances also sponsors of the fibra) who in exchange receive Certificates as consideration for such conveyance. Following this initial step, the fibra may go public through an initial primary (and possibly secondary) issuance. The proceeds deriving from the primary placement will be used to acquire or develop additional eligible real estate assets in accordance with the purposes and business plan of the fibra. To administer and manage its assets, the fibra will enter into administration and servicing agreements with one or more service providers so that such real estate administrator/s (most likely the sponsors of the fibra) manage the fibra's real estate assets and collect the leasing proceeds on behalf of the fibra and the Certificate-holders. For example, Fibra Uno has entered into an advisory agreement, a management agreement and a collection agreement with its sponsors, each of which contains different fee structures and services.

Although there are no specific corporate governance regulations for fibras, provisions can be incorporated into the structure to make them more attractive to prospective investors. This could include allowing Certificate-holders to appoint members of the technical committee of the fibra (a corporate body equivalent to a board of directors), integrating independent members into such a technical committee, creating audit or acquisition committees controlled by independent members, and granting certain special voting majorities to the members of the technical committee or the Certificate-holders, for matters such as real estate acquisitions over certain thresholds.

Due to the attractive tax benefits and leeway regarding the structuring of the transactions, we see an increase in the market's interest for the structuring and formation of new fibras that will follow the lead of Fibra Uno.

CKDs

Since 2009, Mexico has had a legal and regulatory framework that is geared towards allowing the creation and structuring of private equity funds through the issuance of public structured notes known as certificados de capital de desarrollo (CKDs). The majority of CKD issuances that have come to market in Mexico during the last few years have been aimed towards the infrastructure and real estate industries. However the law allows for the funds raised through CKDs to be invested in other areas, as long as they are invested in Mexican projects. Currently 19 CKD issuances have taken place in the Mexican market, eight of them in the real estate sector, four as infrastructure funds and the remainder as private equity funds. According to information from the Bolsa Mexicana de Valores, more than $4 billion has been raised through CKD issuances since 2009.

CKDs were for the most part designed with institutional investors in mind, primarily investment companies of Mexican pension funds or afores. As a result, most of the legal framework regarding CKDs deal with securities and afores regulations. The investment criteria outlined in afores regulations for these types of investors has become more flexible in recent years.

The issuance of these relatively new instruments is accomplished through Mexican trusts or fideicomisos, the purposes of which include, inter alia, investing the issuance proceeds into specified projects, subject to the guidelines and schedules set forth in the transaction documents. Although CKDs may be used to invest in single projects (ie type B CKDs), in practice, the majority of CKDs that have been issued have been structured as true funds, which allow the realisation of multiple investments throughout the life of the fund (ie type A CKDs).

Despite the fact that CKDs are issued as debt instruments, they contain characteristics of equity instruments. For example, they do not pay investors interest or principal, but rather share with them the profits (or losses) stemming from the investments carried out by the fund. Also, CKDs do not require a credit rating for their issuance.

CKD regulations in general offer flexibility to structure each particular fund (including cash flow distributions) in the manner most convenient to sponsors and investors. The structures of many of the CKD issuances that exist in the Mexican market also allow for the co-investment of sponsors, which is often used to make the fund more attractive and signify its solidity.

The structure of the fund's governance holds great appeal in CKD transactions. Governance provisions are significantly similar to the provisions required for Mexican public companies (sociedades anónimas bursátiles). Some of the key requirements are:

  • Any transaction in excess of 20% of the value of the issuing trust's assets must be approved by a majority of the holders of the outstanding CKDs (asamblea de tenedores)
  • The fund must have a technical committee composed of no more than 21 members, which will include representatives of the investors in accordance to their holdings and representatives of the manager and independent members (at least 25% of the committee must be independent)
  • The technical committee's purpose will include the duty to: approve or reject any transaction in excess of 5% (but less than 20%) of the value of the issuing trust's assets; approve or reject any transactions to be entered into with related parties of the sponsor or manager or that otherwise may involve a conflict of interest; and set forth the terms under which the manager of the fund shall carry out its duties; and
  • Investors that individually or in the aggregate hold 10% of the outstanding CKDs have the right to appoint a member of the technical committee and to call noteholder meetings.

Fund management

Another important aspect of CKD issuances is the management of the fund. The fund's sponsor (or an affiliate) will typically act as manager and will be responsible for the ordinary course of business of the fund, and its projects, as well as for instructing the trustee to carry out the investments in the relevant projects. Any investments to be made by the fund are subject to the guidelines and policies set forth in the transaction documents or as otherwise dictated by the technical committee. In most cases the manager will also be responsible for determining the manner in which distributions to investors will be made during the life of the fund, as well as the calculations related to such distributions.

CKD issuers have the same reporting and disclosure obligations as any other debt issuer in Mexico. Such obligations include the filing of annual reports to the Bolsa Mexicana de Valores updating the information originally provided in the offering documents, together with annual audited financial statements, as well as a standing duty to provide the market with any information that may be considered material or necessary for investors to reach an investment decision. As is the case with other public offerings, CKD issuances require regulatory filings with and approvals from the Securities and Banking Commission (CNBV or Comisión Nacional Bancaria y de Valores).

The original CKD regulations did not allow capital calls to, or commitments from, afores and therefore at closing investors were required to fund the full amount of their investment. Realising that this was not consistent with what occurs in private equity funds, and that it precluded a number of deals from actually coming to market, in July 2011 Mexican regulators enacted certain amendments to the CKD regulations to allow for capital calls and commitments. This new modality of CKDs has been embraced by both sponsors and investors and currently many of the CKD issuances that are being structured contemplate having investors commit to a certain amount of the issuance at closing, which amount will later be funded through capital calls required by the manager of the fund in accordance with the relevant transaction documents. We anticipate that the quality and number of CKD transactions will increase by virtue of these amendments.

Going forward

Fibras and CKDs are interesting and appealing Mexican structured finance alternatives for both retail and institutional investors. Due to the tax benefits derived from fibras and the flexibility granted by CKDs to structure a broad array of investment funds, we expect both instruments to be very active in the following years. This is especially true considering Mexican pension funds have been authorised to invest in Certificates issued by fibras and in CKDs, thus channeling the workers' retirement savings to the commercial real estate and the investment fund markets. Even though fibras and CKDs are now completely functional schemes in Mexico, as the market develops in the coming years we expect to see refinements to the regulatory framework to keep up with the pace and reality of the market for these and other structured finance instruments.

Héctor Arangua Lecea

Héctor is a partner with Nader Hayaux & Goebel and specialises in capital markets, cross-border lending, structured finance and M&A. He is an expert in securities and regularly advises both private and public companies on issuances in the local market. He has also developed niche expertise in CKDs. Héctor's structured finance practice is focused on providing advice to lenders on structuring complex bankruptcy-remote payment structures.

Recent work highlights include advising Axis on the creation of $250 million joint venture vehicle denominated Integradora de Servicios Petroleros Oro Negro, whose purpose will be to integrate diversified oil and gas service companies and assets. He has strong international experience and is licensed to practice in New York. He regularly advises US and other international clients on transactions in Mexico.

Héctor obtained his LL.M from the University of Michigan Law School, having graduated as a lawyer from the Instituto Tecnológico Autónomo de México.

Nader Hayaux & Goebel
Paseo do los Tamarindos
No. 400-B, Piso 7
Bosques de las Lomas
05120 Mexico

T: +52 55 4170 3022
F: +52 55 2167 3099
E: harangua@nhg.com.mx
W: www.nhg.mx


Gunter A Schwandt García

Gunter is a partner with Nader Hayaux & Goebel and specialises in structured finance, secured transactions, cross-border lending, real estate finance and acquisition finance. He is an expert in highly complex securitisations, and recently advised the State of Mexico on the groundbreaking securitisation of future flows stemming from the payment of fees to its Public Registry of Property. He has also developed niche expertise in CKDs (development capital certificates), a new type of security instrument recently introduced in Mexico. Another recent work highlight is representing Grupo Salinas in its negotiations with Grupo Televisa to form a joint venture in Iusacell.

Gunter has strong international experience and speaks fluent English. He is regularly involved in cross-border transactions, particularly on the side of foreign lenders in real estate and acquisition financings.

Gunter represents international banks and financial institutions, global real estate investors and insurance companies.

Nader Hayaux & Goebel
Paseo do los Tamarindos
No. 400-B, Piso 7
Bosques de las Lomas
05120 Mexico

T: +52 55 4170 3052
F: +52 55 2167 3099
E: gschwandt@nhg.com.mx
W: www.nhg.mx


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