Latin America is hot (don’t worry, you are not reading an old issue of this magazine). It is the best potential market for infrastructure players. The growth, the population and the needs are all there. Governments throughout Latin America have been announcing, launching and promoting billions of dollars worth of projects (often public-private partnerships (PPPs)). And the countries actually need it, so the future pipeline is huge. We see new infrastructure funds being raised in Latin America at an exponential pace. So why does it look like it is not working out?
In all PPPs there are three main entities intervening: the sponsors that bring the knowledge, experience and equity; the grantor who develops the project, defines awarding criteria and allocates risks between private and public entities; and last but not least the financing entities that bring the financing and take part of the risk. The reasons for the failure of a PPP programme are often diverse. It may be that the local governments are not sufficiently experienced or poorly advised, that there is no real strategy or it is too politically driven. Processes tend to be cancelled or enter into a state of limbo due to constant postponements.
On the other side, there is huge question mark as to whether local markets are sufficiently robust to finance the huge project pipeline under development. These problems are compounded by the fact that financing in US dollars has become less and less feasible due to the projects no longer having currency hedging mechanisms.
Notwithstanding the above, there is a big challenge facing PPP projects at this moment, and that is the significant mismatch between capital and capabilities/expertise.
Recently, new international players have been entering or trying to enter Latin American countries, supposedly making competition fiercer
The traditional sponsors that have been participating in PPP projects in the developed countries and in the first rounds in developing countries are over leveraged. The international financial crisis closed off the liquidity tap, and so this huge pot of know-how, capabilities and experience is being underutilised.
The sponsors have been trying to reduce this limitation by selling portfolio assets individually, although due to the early maturing phase (increasing perceived uncertainty) or due to the financial crisis, the valuations are too low to provide a viable solution to the problem.
As alternatives, sponsors are developing partnerships, joint ventures and selling majority or minority stakes of their portfolios to institutional investors, but this will arguably narrow the type of projects on which they will focus. Once these agreements are closed, the new entities tend to concentrate their efforts on the secondary market and brownfield projects and limit their geographical attention. Additionally, when participating in greenfield projects, the expected project returns tend to increase, forcing the proposals to be less competitive, consequently excluding them from the front line.
Above, only three main entities were mentioned as being involved in PPPs, but in reality there is another equally important party, and that is the contractors.
Betting on new markets
The contractors are one of the main participants in PPP projects. They were and still remain one of the main sponsors and with the significant decrease of their backlogs in traditional markets they have been betting on new markets perceived as high potential growth areas. Recently, new international players have been entering or trying to enter Latin American countries, supposedly making competition fiercer.
Nevertheless, there is a risk that a market ruled by contractors who have a huge necessity to fill in their backlogs and justify their market value may be tempted to neglect the long-term (concession business) in favour of the short-term (construction business).
Governments may argue that this is excellent for them since they will get a better outcome, either because they will be able to minimise their commitment in terms of cash support or because they will get the best return and/or will be able to pass-through additional risks to the sponsors.
This approach is highly questionable. The construction phase typically lasts for two to four years; then you still have a concession period usually for over two decades. Governments, sponsors and even financing entities often tend not to incorporate this fully in their risk analysis. Of all the entities involved in PPP projects, the contractors are justifiably short-term oriented; once they complete the construction works they move to the next construction site.
When 30-year projects are structured with a short-term mentality, there is a bigger risk that things will go (significantly) wrong down the line; thus, the perceived upside that the governments thought they had achieved in the awarding phase will evaporate as time goes by. The problem is not only the way that PPP projects are structured, because as long the rules are clearly and transparently divulged and reach a large number of potential interested parties, they should yield the best results for the governments under the given framework.
The eternal discussions on risk allocation are worth the time spent, but that alone, it can be argued, does not alter the fact that if a given project is accessible to a large number of players the final result will be the one that optimises the results for the grantor taking into consideration the requirements, risk allocation and any other constraints of the actual tendered project. On the other hand if, in the structuring of PPP projects, governments do not aim at having the best possible risk allocation, not realising that there are some risks that will deter certain type of sponsors (namely: institutional investors) from participating, the results will be sub-optimal.
The main risk in Latin America at present is the lack of rationality of the entities involved. On the one hand, specific sponsors are focusing on a short-term view and results, and on the other hand grantors tend to tighten the biding conditions because they see an apparently huge demand for their projects.
To avoid this situation and prevent a potentially negative outcome down the line, much of what has to be done is on the side of the grantors. PPP projects should be launched when they are fully prepared and the concession title and bidding documentation should be clear and precise, eliminating as far as possible the scope for misinterpretations. The definition and stability of the legal concession framework is also an important factor.
Multilaterals could and should have an important role in helping grantors throughout the region to define a general framework that incorporates the best world practices and to provide advice on the preparation level of each project to be launched. The implementation of an independent grading system by the multilaterals for each individual PPP project to be tendered would motivate governments to aim to have the highest grade, and would give additional comfort to international players (newcomers) in each market.
The financing of PPP projects is much more complex and here the country specificities do play an important role. Depending on the country, solutions can and should be different.
Debunking a myth
Getting back to the current mismatch of knowhow and liquidity, there is one myth that has to be put aside, and that is the view that in PPP projects, the construction phase is necessarily the riskier phase.
The construction phase risk is overrated when we consider that very few projects worldwide have failed during the construction phase. Contractors have proven in different geographies that they are able to complete construction works on time, within budget and meeting the necessary technical requirements. Institutional investors (liquidity owners) have to overcome this misconception and invest in greenfield projects. At the end of the day, most of the projects in the pipeline are actually greenfield projects.
It is true that the construction phase has certain particularities, it is also true that it is easier to manage a project that is already set up and working than a start-up, but knowhow exists and it is readily available to be more widely utilised.
Bridging the gap between the entities with liquidity and the need to invest, and entities with the know-how and capabilities is a challenge, but structures can be put in place that will ultimately leverage on each entity’s participation, creating significant synergies for the benefit of all parties involved.
In conclusion, it is important that new PPP projects being launched throughout Latin America are able to attract investors with a long-term view for the final result to be positive for all entities involved. For this to occur, as argued, the risk allocation has to be sensible and the projects need to be well prepared within a stable framework that provides the necessary comfort for liquidity owners to invest.
Institutional investors have to overcome their fears of greenfield projects to broaden the scope of projects they analyse, have to better evaluate the relationship between risk and return to be more competitive in their bids, and have to implement partnerships to improve their knowhow, thus reducing the perceived uncertainties of the construction phase.
Independently of the above, Latin America is hot and will remain so; the main question is: what will be done to improve the final outcome of PPP projects?
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