Author: | Published: 10 Oct 2001
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Argentine provinces have been financing public infrastructure projects and fiscal deficit for the past decade by pledging co-participation funds or hydrocarbon royalties. Only a few provinces, including Buenos Aires and Mendoza, have being able to obtain clean financing in recent years.

Provincial financing represents a significant portion of the total financing to the Argentine public sector, and therefore investment bankers are permanently focused in developing innovative structures based on co-participation or hydrocarbon royalties to obtain financing for provinces at lower cost. This article provides a brief description of the co-participation and the hydrocarbon royalties from the perspective of their use as collateral in structured financing, as well as a description of a recent innovative structured transaction backed by royalties.


Description of the co-participation system

Under the Argentine Federal Constitution, both the federal and provincial governments are authorized to levy taxes. In order to avoid double taxation problems and take advantage of the potential savings to be generated by a centralized tax collection system, in 1935 the federal and provincial governments established a coordinated tax system, pursuant to which the Argentine federal government collects certain taxes on an exclusive basis and allocates a portion of those tax revenues to the provinces. At present, the government collects income taxes, value added taxes, personal assets taxes, excise taxes on various consumer goods and fuel taxes. Banco de la Nación Argentina, acting as paying agent of the government under the co-participation system, transfers funds on a daily basis to the provinces.

The co-participation system has been modified and extended on several occasions. In 1988, a new tax co-participation law No 23,548 was enacted, which has been amended by the 1992 and 1993 Fiscal Pacts and the 1999 and 2000 Federal Agreements. The amendments to the constitution adopted in 1994 provide for and establish criteria for a new federal tax co-participation law.

The Tax Co-Participation Law establishes a tax fund made up of all or a portion of the revenues derived from various taxes levied by the government. A portion of this fund is then allocated to the provinces. This portion of the funds is transferred to the provinces on a daily basis as taxes are collected.

On November 17 2000, the government and the provinces (with the exception of the Province of Santa Cruz) entered into the 2000 Federal Agreement, which supplements the 1999 Federal Agreement. Under the 2000 Federal Agreement, the government agreed to increase the fixed guaranteed amount to be distributed to the provinces to a monthly aggregate amount of $1.364 billion, independent of the effective tax collection. Payments to provinces for the 2003, 2004 and 2005 fiscal years will be the average of the effective collection of taxes subject to the co-participation system within the three prior fiscal years to each of the above mentioned fiscal years. Notwithstanding this, the government guarantees payment to the provinces of an aggregate minimum monthly global amount of: $1.4 billion for the 2003 fiscal year; $1.44 billion for the 2004 fiscal year and $1.48 billion for the 2005 fiscal year.

Assignment of co-participation

One of the most common ways of securing provincial indebtedness is through the assignment or pledge by the relevant province of all or part of its rights to receive tax co-participation payments. The assignment agreement may be structured either as a source of repayment or as a lien, in which case the tax co-participation revenues are diverted to the creditor only under certain conditions, such as the occurrence of an event of default or other specified events. An assignment of co-participation payments is perfected with respect to third parties upon delivery of a notice of assignment by a province to each of the Federal Ministry of Economy and Banco de la Nación Argentina (as paying agent of the tax co-participation revenues). Upon receipt of such notice of assignment, Banco de la Nación Argentina will make all payments of the assigned tax co-participation revenues directly to the assignee.

Priority of claims

Under Argentine law, the priority of claims regarding provincial tax co-participation revenues is determined according to: (i) in the case of private secured creditors, the date a notice of assignment is served on each of the Federal Ministry of Economy and Banco de la Nación Argentina in the manner provided for in the Argentine Civil Code and all other applicable regulations; or (ii) in the case of an on-lending granted to a province by the government with funding provided by a multilateral organization or other obligations with the government, if under the terms of the respective instruments the government authorized to deduct payments due from co-participation revenues, the date of execution of the relevant loan agreement (however, the status of those loans has not been judicially tested, and there are grounds to argue that they are junior to any other assignment of participation duly notified to Banco de la Nación Argentina).

Loans from the government generally do not specify the percentage of provincial tax co-participation revenues that may be allocated to repay the loan upon default by the relevant province. Therefore, although in theory, 100% of such tax co-participation revenues may be allocated to repay the loan, the actual limit will be the amount of the present instalment of principal and interest due and unpaid thereon. In general those agreements lack acceleration provisions.


Hydrocarbon royalties are payable to the provinces in whose territory hydrocarbons are extracted in accordance with the Argentine Hydrocarbons Law 17.319 and of the terms of the concessions. The percentage of the hydrocarbon production payable by each concessionaire to each province as royalties is set forth in each applicable concession. The amount of royalties payable under the concessions is fixed at 12% of commercialized oil and gas production, valued at the well-head price. Commercialized production excludes amounts consumed on the oil fields, amounts re-injected or flared and force majeure losses. Well-head price is defined as final sale price obtained by the concessionaire less certain expenses relating to transportation, treatment, compression (gas only) and shrinkage (oil only).

Royalties are required to be paid to the province no later than the 15th day (or the next succeeding business day in Argentina) of each month with respect to production during the preceding calendar month. Royalties are paid in pesos at the selling exchange rate quoted by the Banco de la Nación of Argentina on the business day immediately prior to the date payment is due. Hydrocarbon royalties are payable either in cash (in pesos) or, at the province's discretion, subject to the approval of the National Energy Secretary and with 90 days' prior notice to the concessionaires, in oil or gas. Under subsequent regulations, the federal government transferred its right to receive royalties to the provinces, but such regulations did not specifically refer to the assignment of the right to elect payment in kind except in the event of a payment dispute between a concessionaire and a province.

Assignment of royalties

The traditional way to secure financing to provinces with royalties is to assign a portion of the rights of the respective province to receive royalty payments, for the benefit of the lenders. The assignment is effective against third parties upon the service of a notice of assignment to the concessionaires and the National Secretariat of Energy. The notice to the Secretariat of Energy is required because, under the hydrocarbons law, the concessionaires are obliged to make the payments to the federal government and the government is, in turn, obliged to make such payments to the province. This method of payment has been simplified by regulations in order to allow direct payment from concessionaires to the provinces. However, the law is in effect and regulations may change in the future suspending direct payment provisions, and in such an event the government has to be formally notified of the assignment, in order to preserve lenders rights.


On February 15 2001, Lehman Brothers, Banco Macro and Santander Investment, structured and placed notes issued by the Salta Hydrocarbon Royalty Trust. The obligations of the trust are backed by an assignment by the Province of Salta of 80% of its rights to receive hydrocarbon royalty payments. The transaction received an investment grade rating by Fitch and Standard and Poor´s. The rating was obtained due to: (i) the innovative legal structure developed for the transaction, that dramatically reduces the risk of unilateral rescheduling by the provincial government; and (ii) a limited political risk insurance policy.


Under the transaction documents, the province assigned 80% of its rights to receive royalties payments from concessionaires to a Delaware business trust. At its turn, the trust issued the notes under a trust indenture, backed by the assignment of the royalties. The notes have a final maturity of 15 years. The trust has a limited recourse against the province in the event of default by the concessionaires of their payment obligations under the royalties. The assigned royalties were transferred by the province to the trust pursuant to a sale and assignment agreement. The transfer under the agreement, as of the receipt by each of the concessionaires and governmental authorities named in the sale and assignment agreement of notice of assignment of the assigned royalties, constitutes a transfer of the assigned royalties by the province to the trust, and after the transfer, the royalties are not considered any longer as property, assets or rights of the province, but will instead constitute property of the trust, free of any claims of third parties and the transfer may not be set aside or invalidated at the instigation of any creditor of the province. In other words the transfer constitutes a true sale of the royalties by the province to the trust. The province received, as consideration for the assignment of the royalties, a sum equal to the net proceeds from the placement of the notes plus a subordinated certificate of participation on the trust. The certificate entitles the province to receive excess cash, after payment of debt service on the notes by the trust.

The true sale status of the transaction was a determinant factor for the rating agencies to grant an investment grade rating. Although the limited recourse against the province raised some doubts about the true sale nature of the assignment, the conclusion was that a recourse limited to default by concessionaires (not covering sufficient of the amounts due under the royalties to make payments due under the notes), should not affect the true sale nature of the assignment. The reason why the true sale status reduces so dramatically the provincial risk is that, after the closing date, there are no pending obligations of the province. If the province has any potential unilateral rescheduling power, it can only exercise it if there are provincial obligations to be rescheduled. If all obligations of the province (transfer of the royalties) are complied with at closing, there is nothing to be rescheduled by the province in the future. In an emergency situation declared under federal law, the province may try to delay payment obligations under the guarantee (which constitute the only potential pending obligations of the province after closing). In no event will the province be in a position to revert the transfer of the royalties to the trust. That is the basic difference between a true sale transaction and any other structure in which indebtedness is incurred in the head of the Province, even if such indebtedness is secured by royalties or other collateral. Any collateral may be used to secure provincial indebtedness, but such indebtedness is subject, to some extent, to unilateral rescheduling risk. Under Argentine law, upon rescheduling, the collateral will continue securing the obligations incurred by the province, but in the new terms set by the rescheduling provisions.

The province acts as servicer under the terms of a servicing agreement, and will monitor and supervise the collection of, and enforce the right to collect, payments by the concessionaires in respect of the assigned royalties pursuant to the servicing agreement to the extent permitted under applicable law.

Insurance policy

The indenture trustee is the beneficiary of a Policy of Political Risk issued by Sovereign Risk Insurance, as agent (ACE Bermuda Insurance, an insurance company chartered in Bermuda). The policy will be in effect from the closing date to the earlier of the final maturity date and the date on which the notes have been paid in full or that of the defeasance.

The policy covers inconvertibility events during a waiting period. The ''waiting period'' will be a period of 90 days from the first quarterly payment date occurring after the indenture trustee has attempted, but due to an inconvertibility event, was unable to convert dollars to Argentine pesos or transfer dollars from the Argentine collection account to the US collection account. If an inconvertibility event occurs and continues for the duration of the waiting period, the insurer will pay compensation in dollars to the indenture trustee not later than the quarterly payment date following the commencement of the waiting period, up to a maximum amount described in the policy

''Inconvertibility event'' covers acts by the government that prevents the indenture trustee from: (i) converting pesos into dollars; or (ii) transferring in a timely manner dollars outside Argentina; or (iii) expropriation, confiscation, or discriminatory actions by the government or other measures, which have the effect of depriving the trust or the indenture trustee of the use or control of the funds deposited in their accounts.


One of the key elements to improve provincial risk seems to be the isolation of assets from any potential provincial rescheduling powers. The Salta Hydrocarbon Royalty Trust is the first step in this direction. Many others may follow, even using other assets and features, such as payment in kind agreements with concessionaires for the securitization of oil royalties.

This article is a general guide only. Those considering financing public sector in Argentina should obtain professional advice in advance.

Bruchou, Fernandez Madero, Lombardi & Mitrani
Ing. Enrique Butty 275, Piso 12
Buenos Aires
Tel: +54 11 5288 2300
Fax: +54 11 5288 2301