Monday, 10 December 2018

Latin pioneers

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In a bid to increase investment in new infrastructure projects and boost its economy without burdening taxpayers, Mexico has pioneered an innovative new security, allowing pension funds to make essentially private-equity investments while accounting for them as debt. Unlike anything seen elsewhere, it has similarities – but also significant differences – to the Canadian income trust. But where bankers dare to tread, will investors follow? Christopher Langner reports.

Certificados de capital en desarrollo, or developing capital certificates, could channel up to Ps80bn (US$6bn) into new projects, according to some observers. Local bankers report a pipeline of more than 10 deals worth over Ps10bn, with more in the works. Regulators are hoping this will provide a much-needed boost to infrastructure and housing projects, though the structure can be applied to pretty much any kind of business.

There is a caveat: investors, the cornerstone of the initiative, remain unconvinced.

Not the time for complexity

Being officially a debt security, CCD will have to be rated. But rating agencies still have not determined how they will evaluate the securities, and local bankers are not yet in a position to offer much help. Naturally, credit analysts at the pension funds themselves will have even less idea how to evaluate them. Mexican pension funds often rely particularly heavily on rating agencies for their investment decisions. In preliminary discussion with investors about potential deals, the reception was very cold, according to one banker.

The securities are certainly an attempt by the government to nudge investors to put money into new projects, for example in offering additional yield, based on the added risk of the investment.

Liquidity is not at issue. Local pension funds are allowed to invest up to 20% of their assets in the new security, which would amount to around Ps80bn. But Mexican investors are conservative. Evaluating the new security alone promises to be a significant challenge.

No deals have been done yet. Consar, the Mexican pension fund regulator, only changed the rules to permit investment in CCD in August. It remains unclear how deals that fit into the new rules will work in practical terms. According to the guidelines set by the regulator, the new securities will be issued as debt. However, they are more akin to equities.

Looking under the bonnet

In CCD deals, a company creates a project, or even a plan to buy assets – effectively a special-purpose acquisition company – and sells an equity stake in it, as if it were an independent enterprise, to a trust. The trust is then sold to investors through certificates.

There is no guarantee of principal, so while investors will buy securities categorised as fixed income notes, they have equity risks. Returns are not fixed either, though some of the upcoming deals will predict returns in their prospectuses.

According to one banker in Mexico, of the four deals he is working on, two will have returns similar to those of preferred shares, with a fixed dividend, while two will pay investors similarly to common stock, according to generated income. In fact, the only difference from a straightforward equity security is that these certificates are expected to pay back principal to investors at a certain maturity, when the stock in the project will also be returned to the company that created it.

Mexican bankers came up with the idea for the new security after a successful deal last year led by Credit Suisse. At the time, forestry company Santa Genoveva sold a Ps2.2bn 20-year bond, with returns tied to revenues of new forestry areas to be developed with the deal’s proceeds. That deal included a minimum return clause, via sovereign notes held in the trust, with principal repayment at maturity guaranteed.

The deal was well received and Consar saw a chance to boost lending for infrastructure and housing – two sectors seen as vital to the recovery of the Mexican economy. The result was the creation of specific rules allowing pension funds to invest in debt securities backed by equity stakes in projects, as long as principal was guaranteed. A few deals emerged, none of them related to infrastructure, but the reception failed to meet lofty expectations.

Consar responded by scrapping the guarantee of principal, making the securities even riskier but boosting potential returns. "I think it is a super asset-class, but I am not sure it will catch on any time soon," confessed a DCM banker in Mexico City.

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