United States: Funding Of Privatization Projects In Brazil – Mitigating Currency Risk

Last Updated: July 12 2019
Article by David C. Tyler and Arthur Rodrigues do Amaral

In January 2019, Jair Bolsonaro took office as the new president of Brazil. The new administration has indicated that privatizations will be a strategic priority in the rebuilding of Brazil's economy in the wake of the system-wide corruption investigations which resulted in the bankruptcy or near-insolvency of several key Brazilian companies, particularly in the construction and oil & gas services sectors. To achieve its desired goals, the Brazilian federal government is revamping its Investment Partnership Program (IPP), an initiative created for purposes of coordinating and supervising concessions and privatizations of infrastructure projects in Brazil, to foster competitiveness and facilitate the participation of foreign investors.

The Investment Partnership Program was created in 2016 to expand and strengthen the interaction between the Brazilian federal government and the private sector through partnership contracts for the execution of public infrastructure projects and other privatization measures. Since its inception, the IPP has resulted in the privatization of over 120 infrastructure projects encompassing the energy, highway, airport, port, telecommunications and oil & gas sectors, totaling an amount greater than US$65 billion in investments from non-governmental sources. Of these projects, over one-third of them were awarded to non-Brazilian companies (either alone or in consortium with Brazilian companies). An additional 69 projects (with an estimated capex of over US$30 billion) have already been approved by the Brazilian federal government and are expected to be concluded in the next few years, covering, but not limited to, railways, ports, energy, oil & gas, mining, airports, highways and telecommunications. A further 94 potential projects have been identified and are in the process of being analyzed by the Brazilian government.

Big infrastructure projects require substantial financing (often in the hundreds of millions or even billions of dollars) and many times local financing options are limited or expensive, prompting investors to consider foreign financing (either in the international capital markets or through syndicated loans with global banks). Such projects, however, tend to generate revenue in local currency (e.g., Brazilian reais), thus creating a mismatch between liabilities in foreign currencies and project revenue in local currency. When this mismatch occurs, foreign investors may be unwilling to take the associated currency risk. This article contains a brief discussion of certain structural solutions1 that can be put in place to shift the risk away from the investors. Using a combination of some of the technologies listed below can be effective to mitigate currency risk.

Tariff and Foreign Exchange Adjustment

When a project calls for the payment of tariffs (such as toll roads, power plants and other regulated projects), the government may include a periodic tariff adjustment formula that takes into consideration foreign exchange variations or it may index the tariff directly to another currency and adjust it periodically.

The advantages of using tariff adjustments include not having additional upfront costs to investors and the possibility of protecting project sponsors from currency fluctuations. Some of the issues include the frequency and benchmark for the adjustments (e.g., spot price or a periodic average – spot prices are generally more volatile, but an average index may result in periodic basis risk for the sponsors). One of the ways of addressing these risks, however, is the use of a range whereby if FX trades within the range, the project takes the risk, but if it crosses a threshold, the excess is passed on to consumers.

Foreign Currency-denominated Cash Flows and Structuring the Debt Profile

Another option to mitigate currency risk is to match the currency of cash flows with the currency of the payment obligations. While this is not feasible for every project, certain commodities (e.g., oil and gas) and airport projects may allow separate streams of revenue in different currencies. Having a source of payments denominated in the same currency as the debt issued to investors (most likely US dollars) creates a natural hedge in which payment obligations are matched with the source of payments. However, the hedge may not be perfect on account of a timing mismatch where there is a lag between the timing of the source of payment and the payment of the debt obligation.

Overcollateralization

Overcollateralization refers to the process of posting more collateral than is necessary to secure payment of a debt obligation. In the context of financing through a credit facility or a project bond, the collateral is generally the cash flows from the project available to pay debt service.

Cash flows available for payment of debt should exceed the debt obligations – generally, the higher the ratio of cash flows to debt service (debt service coverage ratio), the better it is from the perspective of deal execution, which can lead to better pricing for the issuer and more investor demand. The excess of collateral is an important component of a transaction when it comes to rating agencies rating a transaction as well as investors evaluating the merits of a particular transaction – favorable ratings by rating agencies and high levels of demand by potential investors generally translate into more favorable pricing for the issuer. Projects that are currently generating cash flows are more prime for this sort of structural feature than greenfield projects where determining future cash flows and collateral levels may be more difficult.

Escrow Accounts

Similar to overcollateralization, if the currency is stable enough, it might be possible to mitigate currency risk by establishing escrow accounts to be funded from the proceeds of the relevant financing or project revenue on an ongoing basis. Funding escrow accounts periodically with a project's cash flows (after payment of operating expenses) provides project sponsors with further flexibility in terms of cash flow allocations. Escrow accounts could also be funded by use of an instrument such as a letter of credit that is drawn upon when necessary (rather than having cash on hand in the account).

Advantages of this option include having flexibility to fund the escrow accounts out of financing proceeds or project revenue and the possibility of being better received by rating agencies. Disadvantages include reducing the cash flow available to the project or sponsor and it exposes the sponsor to project risk in case of shortfalls.

Final thoughts

Addressing currency risk is not an easy task and Brazil has yet to propose a viable solution vis-à-vis the country's particularities. However, with over 500 finance lawyers around the globe and over 1,000 years of combined experience working on infrastructure deals, we are sure to help you find the best solutions to invest in Brazil and in Latin America. Hogan Lovells has been actively engaged in discussions with members of the Brazilian government responsible for the IPP to share our experience with privatizations around the globe and propose solutions to common international investors' concerns. On the ground in São Paulo and working alongside our broader finance team in New York, London and in several of our other offices around the world, we have the expertise necessary to guide investors and sponsors through successful investments in Brazil.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions