Financing Mexico’s next infrastructure wave

Author: | Published: 27 Aug 2013
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Hans P Goebel and Gunter A Schwandt of Nader Hayaux & Goebel on Mexico’s latest development plans and how they may be financed

The day after Mexico's current government took office on December 1 2012, President Enrique Peña Nieto and the leaders of the three main political parties signed the Pacto por México, an unprecedented coalition that set the groundwork for reform of the social, economic and political agenda of the country. These long overdue and highly anticipated reforms, if passed, have been identified as the starting point for launching Mexico's new era of prosperity. The planned reforms include amendments in a broad variety of areas, including education, telecommunications, labour, social security, the financial system, energy and tax. As of the time of writing, education, competition, labour and telecommunications reforms have been passed. The financial reform bill is under review by Congress, and it is expected that the tax and energy reform bills will be presented in the autumn of 2013.


"More than half of the presidential commitments assumed in the plan are related to infrastructure"


In addition to the Pacto por México, on May 20 2013 the National Development Plan 2013-2018 (Plan Nacional de Desarrollo 2013-2018, or PND) was published. It sets out in detail the government's commitments, activities and goals for the duration of the administration and the years to come. It is very revealing that more than half of the presidential commitments assumed in the PND are related to infrastructure. Within the PND's infrastructure objectives and strategies are to promote the participation of the private sector in the development of infrastructure; to articulate the participation of state and municipal governments to boost high social impact projects; and to promote the development of capital markets for the financing of infrastructure. As a signal of the government's commitment to expanding and reinforcing the current spending in infrastructure, it was recently announced that infrastructure investment for 2013 will be around M$310 billion ($23.6 billion).

The fact that both the Pacto por México and the PND have such a strong focus on infrastructure is not a coincidence. It not only reveals the current administration's interest in laying the foundations for the country's future development, but is also a clear indicator of the very large needs and requirements that Mexico has in this respect.

According to the Global Competitiveness Report for 2012-2013 published by the World Economic Forum, Mexico is ranked 68 out of 144 world economies with respect to its basic requirements in infrastructure. According to the report, two of the top-ten most problematic factors for doing business in Mexico are access to financing, and an inadequate supply of infrastructure.

The main areas where infrastructure needs in Mexico are most evident are energy (oil and gas, power plants (renewable and non-renewable), natural gas, oil drilling and platforms), toll roads and highways, penitentiaries, maritime ports, airports, trains and public transportation, water facilities, hospitals and educational centres.

Funding alternatives

As can be seen, infrastructure needs in Mexico are large and many, and therefore the need for funding will be commensurable. From a legal perspective, financing in Mexico throughout the last few years has remained relatively strong and safe to foster infrastructure projects. In fact, new developments in the legal, banking and infrastructure sectors have made it easier to envision or reinforce financing opportunities through structured finance, securitisations, secured lending, capital markets and loan syndications. All of these financing alternatives are adequate for implementing, among other things, ad hoc security packages and cash-trapping structures, as well as bankruptcy remote vehicles, as may be necessary or convenient for each particular case.

As a general matter, in order for a project to be bankable it will require a legal structure that permits its financing by primary lenders by stipulating, among other matters: (i) adequate and sufficient collateral; (ii) clear and defined exit strategies (the possibility of undertaking bond take out financings, for example); (iii) early termination payments in favour of investors; (iv) payments of minimum guaranteed amounts and indemnities in favour of service providers; (v) clear compensation schemes and milestones; (vi) full insurance coverage; and (vii) reasonable termination events and step-in rights. Although many infrastructure projects now have an adequate structure that will allow it to be financed, the challenge always remains as to finding the most efficient structure for each particular project.

The role that corporate and commercial banks have assumed in financing infrastructure has been relatively limited in the past few years due principally to the structures that banks are required to implement as a result of banking regulations that are more focused on collateral in itself rather than on the feasibility of the projects. This makes commercial bank financing more appropriate for projects that are in an advanced or developed stage (brownfield projects) as opposed to projects that are in developing or initial stages (greenfield projects). The role that commercial banks traditionally should have in financing infrastructure has been occupied as of late by development banks and private equity.


"Private equity will continue to play an active role in infrastructure"


Mexico's Public Works and Services Bank (Banco Nacional de Obras y Servicios Públicos, or Banobras) is a development bank whose objectives include financing or refinancing public or private investment projects geared towards infrastructure and public services. It is anticipated that under the reforms to be implemented as a result of the Pacto por México and the PND, Banobras will assume a more proactive role in increasing the amount of credit allocation to generate a greater amount of public infrastructure and services, therefore contributing efficiently to increase productive activity. The credit allocation to be made by Banobras will include other financial intermediaries to increase the participation of commercial banks and other private financial institutions in financing infrastructure projects, with Banobras acting mainly as guarantor or facilitator. During 2013 alone, Banobras plans to provide loans of up to M$38 billion for infrastructure projects that are expected to in turn generate investments of up to M$42 billion.

The National Infrastructure Fund (Fondo Nacional de Infraestructura, or Fonadin) was created in early 2008 by presidential decree with the purpose of promoting the private sector's participation in the development of infrastructure, through the grant of recoverable and non-recoverable funding that may improve a project's ability to access other types of financing. One of the main objectives of Fonadin is to diversify the sources of public financing while, among other things: (i) maximising and facilitating private capital's access to infrastructure projects; (ii) undertaking risks that the market is unable or unwilling to assume; (iii) enhancing projects that due to their high-social and low-economic profitability may otherwise be considered non-bankable; and (iv) achieving long term financing under competitive conditions. Fonadin actively participates in the following sectors: roads, ports, airports, railroads, tourism, water, renewable energy, urban transportation, gas lines and waste management. Since its creation, Fonadin has supported projects for an aggregate amount of M$114.4 billion. It will undoubtedly have a main role in the implementation of the PND in the coming years, whether directly or through public-private partnership structures.

Export credit agencies (ECAs) also have a prominent role in infrastructure financing. First, because their participation works as a catalyst for other banks to participate in a particular financing and, second, because they may partially provide the guaranty that commercial banks need to finance infrastructure projects. In Mexico, ECAs have been involved in many of the most relevant energy and other infrastructure-related projects. In addition to providing a very important financing enhancement, interest payments made by Mexican borrowers to non-Mexican lenders are exempt from Mexican withholding tax to the extent the financing is guaranteed by ECAs and certain additional requirements are met.

Another route to financing is through capital markets and private equity. Unlike traditional bank financing, where the security package is very relevant to enable a project's bankability, funding infrastructure in this way allows for greater flexibility and shifts the focus to the stem of flows arising out of the actual project and regardless of the sponsor's identity. This is the case, for example, in securitisations of toll roads where the behaviour of the flow of funds is essential for investors.

For such purposes, the legal structure that is generally used consists of setting up a special purpose vehicle through a Mexican trust to which the receivables are conveyed in exchange for the issuance proceeds, therefore achieving a true sale while also creating a bankruptcy remote vehicle. This structure also creates tax efficiencies inasmuch as, if correctly implemented, the conveyance would not be considered as a taxable event and even, if properly structured, an off-balance sheet treatment may be achieved.

The trust structure is used also for the issuance of a recently created security known as certificado de capital de desarrollo (a capital development certificate, or CKD). This structure allows the parties great flexibility to agree on the rights and obligations of each party, including corporate governance provisions and management and distribution rights, irrespective of the amount of contributions made to the respective project. CKDs were created primarily to raise capital from the public to invest in one or more projects or sponsored companies and have been very successful due to the change in the investment regime of the Mexican pension funds, or afores, that enable them to invest in these types of securities without the need of rating them. CKDs are considered as debt/equity hybrid securities as there is no obligation to repay the placement proceeds but they are subject to a term (typically of between 10 and 15 years). The types of projects where CKDs have been recently investing are infrastructure, real estate and private equity. Close to 30 CKD issuances have come to the market for a total aggregate amount of approximately $5 billion and, given the government's focus on infrastructure projects, it is expected that many of the CKD issuances that are in the pipeline will be focused on energy, penitentiaries, toll roads and other infrastructure projects. Although the fact that Mexican pension funds are allowed to invest in CKDs has been an essential factor to develop the CKD market, it has become more and more common for other type of investors to invest in CKD projects (for example bank clients, including corporates and high net worth individuals), either by buying CKDs directly or by creating co-investment structures with them.

Another structure that has been recently introduced is the Fibra (fideicomiso de inversión en bienes raíces) which may be considered as a Mexican equivalent to the US real estate investment trust. Recent changes to the Mexican pension funds' investment regime also allow Mexican pensions funds to invest in Fibras, which has helped to boost the Fibra market. In a Fibra, existing real estate projects are transferred to a Mexican trust which issues real estate certificates to the investors. The funds raised through Fibras may also be destined to the acquisition of a portfolio of real estate properties or projects. Up to this date five Fibras have been placed in the Mexican market for a total aggregate amount (including follow-on issuances) of approximately $5.4 billion, and a number of additional Fibras are in the pipeline. Unlike CKDs, Fibras may be also subject to global offerings (such as Reg S / Rule 144A placements), which has been the case for all of the Fibras on the market.

Although the Fibras that exist in Mexico have been aimed only towards the real estate and hospitality markets, it is foreseen that in the near future new regulations may be adopted that could enable these types of structures to invest in infrastructure.

Private equity funds have also shown an appetite to invest in infrastructure in Mexico. In fact, aside from the sponsors of infrastructure projects, private equity funds are typically better positioned to invest in a project in the earlier or developing stages and, once the project has developed, private equity funds may use the capital markets or any other type of financing as their exit strategy. The structures used to channel private equity investment in infrastructure may vary from one project to another, although they will usually share a number of key features, including tax efficiency, efficient risk allocation and the use of either a trust or a sociedad anónima promotora de inversión (a fairly new form of Mexican corporation that enables great flexibility to structure joint ventures, shareholder agreements and affording different rights and obligations to various types of investors).

Public-private partnerships

After a long period of having to structure and implement public-private associations under regulations that were not entirely designed for these types of projects, a dedicated public-private partnership (PPP) law was finally enacted in 2012. This new PPP Law is aimed at increasing private investment in long-term projects of the Mexican Federal Government. The PPP Law and the services contracts associated with it allow the public sector to partner with private investors and contractors in the development of infrastructure while taking advantage of the private sector's expertise, flexibility and ability to access financing in a cost-efficient manner.

As the need for infrastructure continues to be great and as the public funds available to develop infrastructure in a traditional manner continue to be limited, it is likely that the PPP market will develop and more government-sponsored projects will be structured through these types of associations.

Recently, the first refinancing of a PPP hospital took place. The company charged with building Mexico's largest public hospital successfully placed notes worth $144 million in the Mexican Stock Exchange. The transaction, surely the first of many more to come, signals the confidence of the market in the PPP legal structure.

What lies ahead

As Mexico's infrastructure needs continue to grow, the funding required to satisfy them will require solutions that, among other things, protect the funding parties' interests, achieve tax efficiencies and correctly allocate risks among the contracting parties. The government, through actions such as the Pacto por México, the PND, the proposed reforms and the announced National Infrastructure Plan (Plan Nacional de Infraestructura), has clearly indicated its willingness to tackle this issue and promote a more active participation of the private sector.

The financial reform bill being discussed in Congress includes a number of improvements to existing regulations that will be aimed towards, among other things, increasing the participation of Mexico's development banks in the financing of infrastructure; encouraging a more prominent role of commercial banks through the strengthening of guarantee and security mechanisms offering expedited foreclosure procedures, and stimulating the capital markets, making it easier for small and medium-size companies to access this type of financing.

As the PPP, CKD and Fibra markets continue to develop and strengthen, it is likely that the government will make additional amendments to regulations that may improve the manner in which these structures are implemented. It is also foreseen that in the future new regulations may be adopted to allow for Fibra vehicles to invest in infrastructure. It is expected that private equity will continue to play an active role investing in infrastructure projects, whether at inception or as the projects reach a more stabilised condition. The use of alternative financing solutions, such as project bonds, will increase as investors and other project participants become more creative in the pursuit of efficient structures that may deal with the challenges of financing complex projects.

Author Biography
 

Hans P Goebel Caviedes
Nader Hayaux & Goebel

Hans Goebel specialises in banking and finance, capital markets, M&A and private equity. He is a name partner of NHG and has a strong background in banking law and regulations and handles a range of financial and capital market matters. He is an expert in complex structured finance deals and security issuances and has developed niche expertise in CKDs (development capital certificates), a new type of security instrument recently introduced in Mexico. He handles real-estate finance and advises clients on financial and corporate restructurings.

Goebel is recognised by all the main legal publications for his outstanding expertise. Chambers Latin America ranks him as a leading individual in Banking & Finance and Capital Markets, describing him as 'extraordinarily efficient and pragmatic'. Other recent editorial commentary highlights his 'rare combination of profound legal knowledge, acute business sense and dedication' and points out that he is 'at the cutting edge of new financial products and corporate law' and 'accessible, responsive and great to work with'. Goebel is also ranked as a leading lawyer by IFLR1000 (M&A), PLC Which Lawyer? (Capital Markets) and Best Lawyers (Banking & Finance, Corporate & M&A and Structured Finance).

Goebel has strong international experience. He speaks fluent English and regularly advises multinational clients on their local operations and transactions involving the Mexican market.

He spent a year working in the Chicago office of international law firm Mayer Brown, having received his LLM (with honours) from the Northwestern University School of Law of Chicago. He graduated as an attorney from the Instituto Tecnológico Autónomo de México and has lectured in Financial Contracts at the Universidad Iberoamericana. Goebel acts as independent director and board secretary of various financial institutions.


Author Biography
 

Gunter A Schwandt García
Nader Hayaux & Goebel

Gunter Schwandt specialises in structured finance, secured transactions, cross-border lending, real-estate and infrastructure finance and acquisition finance. He is an expert in highly-complex securitisations, recently advising 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 and Fibras.

Schwandt 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. His work highlights include: representing the State of Mexico in the structuring and issuance of long-term senior and subordinated amortising bonds totalling more than M$4 billion and M$3 billion, respectively, repayable from future revenues of the State's Public Registry of Properties (the first securitisation in Mexico of future revenues from a state government's public registry of property; the proceeds will be used for the modernisation of the state registry institute and other priority infrastructure projects); representing Grupo Salinas in its negotiations with Grupo Televisa to form a joint venture in Iusacell; and representing Prudential Real Estate Investors in the creation of its third industrial real estate fund in Mexico through the public issuance of more than M$3 billion of CKDs in the Mexican market.

Schwandt spent a year working at international law firm Mayer Brown in Chicago, having received his LLM (with honours) from the Northwestern University School of Law and a Certificate in Business Administration from the Kellogg School of Management. He graduated as an attorney (with honours) from the Universidad Iberoamericana.


 

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