Peru has trail-blazed the use of project bonds to finance infrastructure projects and their application is now spreading to other Latin American countries that want to close their infrastructure deficits.
For decades, Peru has striven to improve private investment in large infrastructure projects, and today – along with Chile and Mexico – it enjoys one of the most active public-private partnership markets in Latin America, underpinned by a strong PPP regulatory framework.
Until now, the use of PPPs in Peru has largely been limited to highways, airports, railways, electricity projects, telecommunications projects, ports, and natural gas and oil projects.
Of the 62 private concessions granted between 2005 and 2013, US$5.2bn was committed to electricity projects, followed by transport (including roads, airports and railways) with US$3.55bn, telecommunications with US$2.3bn, ports with US$1.6bn and natural gas and oil with US$1bn.
The country suffers from a huge infrastructure gap of US$142bn (estimated for the years 2012–2021), according to the National Association for Infrastructure Development (AFIN by its initials in Spanish), a trade association made up of Peru’s biggest construction companies. This estimate includes US$33bn in energy projects, US$36bn in transportation, US$19bn in telecommunications and US$8.6bn in irrigation projects.
PPPs will have a crucial role to play in helping to fill the gap, especially as the new government of president Pedro Pablo Kuczynski (PPK), who assumed office in July and represents the centre-right political party Peruvians for Change, is committed to extending their use to social infrastructure, including new hospitals, schools and prisons.
Peru’s infrastructure deficit is so big that the state cannot plug it on its own – and private sector involvement is key.
However, other Latin American countries – including Mexico, Colombia and Brazil – are also increasingly turning to project bonds and PPP programmes to reduce their infrastructure deficits.
Latin America faces an annual infrastructure gap of 6.2% of GDP and the International Monetary Fund says that infrastructure investment has the highest multiplier impact on the rest of the economy. In the long term, Latin America’s infrastructure spending is expected to reach US$557bn a year by 2025, with Brazil, Chile and Colombia likely accounting for the lion’s share of regional spending.
“Latin America has a huge infrastructure deficit,” said Gema Sacristan, chief investment officer at the Inter-American Investment Corporation, part of the multilateral lender, the Inter-American Development Bank. “One of the reasons is that international commercial banks are subject to higher capital requirements since the global financial crisis of 2007–2009.
“This means they are now more reluctant to provide sufficient loans to reduce the infrastructure deficit. In turn, that is creating a huge opportunity for project bonds and other innovative financial structures for private projects and PPPs.”
Mexico, for example, is leveraging future flows of the state-owned Mexico City International Airport to finance and support the construction of a new airport. The financing structure to build the new US$9.4bn airport uses the existing airport’s operating cash flow as a source of debt payment. This reduces the credit impact stemming from potential cost overruns and delays from the construction risk of the large project.
“It was thought that new laws in Mexico in 2012 would lead to a boom in PPPs in that country,” said Adrian Garza, a senior analyst in the global project finance and infrastructure group at Moody’s. “In the end, that never happened because the local markets had a long track record of financing toll roads and assuming demand risk.”
Colombia has advanced its own public-private partnership model – known as P3 or PPP – which it is applying mostly to develop a network of toll roads.
Under Colombia’s 4G toll road concession programme – which entails a total estimated investment of US$16bn – the concessionaires and the government share construction, operating and demand risks.
The country’s P3s also have unique risk-sharing elements such as cost overrun-sharing and availability and traffic compensation payments that reduce the sponsors’ construction, operating and demand risks.
Furthermore, Brazil needs to significantly encourage PPPs to improve infrastructure and generate employment, interim president Michel Temer, who represents the centrist Brazilian Democratic Movement Party, said during his swearing-in ceremony in May.
“While key services such as security, health and education will remain under public control, all others will need the private sector,” he added.
Infrastructure projects currently planned by the federal government include those under the R$198bn (US$61.4bn) logistics investment programme (known as PIL) announced last year. Some R$59bn in highway, railway, port and airport concession tenders are expected this year.
“International banks have become much less involved with Brazilian construction companies for compliance reasons,” said Jonatan Plavnick, head of asset finance and securitisations in Latin America at BNP Paribas.
“But the Brazilian state is trying to court investors in the US and Europe for new infrastructure projects, through 144A/Reg S bonds and other instruments.”
Argentina’s new president Mauricio Macri – who represent the right-wing Cambiemos political coalition – is pushing a PPP agenda as well. However, the government will have to remove a great many regulatory hurdles before this can work and clean up the country’s poor reputation for corruption.
“The markets must feel comfortable with the sovereign first before they back project bonds in the country,” said Felipe Garcia Ascencio, head of fixed income origination for Latin America at Credit Suisse. “In the case of Peru, Colombia, Mexico, and Panama the markets already have that comfort factor.”
Solid legal framework
Peru now enjoys a solid legal framework for the application of the PPP model. Its model is worth exploring in more depth as it is becoming the ‘go-to’ template for other PPP programmes in Latin America.
The main law – Decreto Legislativo 1012 – was passed in May 2008, and this provides a definition of a PPP contract and sets out the basis upon which concessions are awarded.
The strong legal framework and accompanying transaction structure includes two key aspects that strengthen the credit ratings of PPPs in Peru, making them close to or in line with the sovereign’s ratings: first, the use of government-issued payment rights (GIPRs) and, secondly, a make-whole enhancement.
Two types of PPP projects exist in the country: the self-sustainable projects and the co-financed projects. The latter require financing from the government to be of interest to private firms. As well as the traditional availability payments disbursed during the operational phase, the government developed a mechanism to ensure the sponsors receive compensation for the construction costs.
As specific construction milestones are met, the concessionaire obtains the right to receive compensation for the construction costs incurred (in other words, GIPRs). These are unconditional and transferable rights to receive a stream of future payments and can be denominated in US dollars or inflation-adjusted Nuevos Soles.
Several types of GIPRs have been used. For example, Certificados de Retribucion por Avance de Obras (CRPAOs) are very similar to sovereign debt obligations. On the other hand, more recently adopted Retribucion Por Inversion (RPIs) are not sovereign debt obligations and instead are budgetary obligations for the government (under Article 75 of the Constitution and Law No. 28,563).
While RPIs are not debt, their main credit strength is the fact that they are ultimately irrevocable, unconditional and transferable obligations of the government.
These instruments allow concessionaires to issue debt backed by GIPRs in local and international markets. Once all GIPRs are received, demand risk is reduced as future payments only depend on the government’s ability and willingness to pay.
“The transaction structure for GIPRs improves the sponsors’ liquidity during the construction phase and raises infrastructure activity without increasing public debt,” said Moody’s Garza.
The make-whole enhancement for bondholders also offsets the construction phase risk. During this period, bondholders would be exposed to the risk that the concessionaire does not reach milestones and so does not obtain GIPRs to sell onto the trust. However, the transactions are structured so that they compensate for construction phase risk at issuance.
The Peruvian PPP transaction structure and concession framework reduces construction and performance risks. However, risks after the construction period still exist, including the potential for payment delays stemming from the complex administrative processes required to calculate, schedule and transfer money to bondholders.
“The key for project bonds to succeed is which party assumes the construction risk,” said Sacristan. “In Peru, the government is largely responsible for that, and that is one of the main reasons why markets have been prepared to back the country’s project bonds.
“In Colombia, the government does not take on a guarantor role. The risk matrix is very different in Colombia from Peru. In the former, investors are exposed to competition, operating and liquidity risks which do not exist in the latter.”
Peruvian pension funds have also been important supporters of projects bonds coming out of the country. This is likely to continue in the future, though some role for international investors in mega-PPP projects will always exist.
Colombia has deep financial markets with well-capitalised banks and deep-pocketed pension funds. This is one of the reasons why the Peruvian-style model has not had to be adopted in the country.
Moreover, Chile has the most sophisticated financial system in the region, with a high savings rate. Infrastructure projects have largely been financed locally, without the need to tap international markets.
Project bond financing has already taken off in Peru. Its use is likely to expand as the new market-friendly president there applies it to social infrastructure projects. Latin America’s infrastructure deficit is vast and project bond and PPPs are the surest way to close the gap in the fastest time.