New Debt Instrument Helps Infrastructure Financings in Peru
By Carlos Albarracín and Augusto Cáceres
Public infrastructure projects are being financed in Peru by bringing in private parties to build, operate and eventually transfer them to the government, but with a special form of debt instrument backed by payment obligations from the Peruvian government that ensures the private party repayment of its construction costs.
The private party is also assured of receiving its operating and maintenance costs over time if revenue from the project falls short of the amount needed to cover costs.
The government experimented with the concessions it awards private developers of large-scale public infrastructure projects for more than a decade before it found a form of concession that works. All of the projects use a build-operate-transfer or BOT model under which the project is eventually transferred to the government after the private developer has been able to get his capital back plus a return.
Peru has been one of the most active and innovative countries in Latin America in terms of developing essential infrastructure through the use of public-private partnerships.
According to data published by Proinversion, a government agency, for the period 1995 through 2011, Peru awarded 73 concessions to private developers for infrastructure projects involving investment commitments of approximately US$14 billion. More than 60% of the projects have been completed and are currently operating. Peru’s success in attracting private sector investments to develop public infrastructure projects has been credited by many to the introduction in the early 1990s of pro-market economic policies and a well-designed privatization and deregulation program by former President Alberto Fujimori and the continuation of these policies by Fujimori’s successors, Alejandro Toledo and Alan Garcia.
As recently as the early 1990s, substantially all of Peruvian infrastructure and services were owned and operated by state-owned companies, which were poorly managed and lacked funding. These companies had no funding other than government grants and no access to local or international financing. In order to promote private sector investment in these companies and reduce government spending, in 1991, the Peruvian government launched a comprehensive privatization program to divest state-owned assets and companies through auctions and the granting of concessions. This privatization program included several investor-friendly features designed to promote foreign investor participation. They included equal treatment of domestic and foreign investors, tax stability agreements and protection under bilateral investment treaties. Peru is a party to 32 bilateral investment treaties that ensure legal protection for private investments in various sectors.
In the mid 1990s, the Peruvian government switched its focus from privatizing existing infrastructure to granting BOT concessions to projects ranging from ports and airports to toll roads, power plants and transmission assets. However, this initiative was unsuccessful because is coincided with a downturn in the local economy. It was also a period of local political unrest.
New BOT Concession Structure
In the early 2000s, the government overhauled its private investment promotion agency, Proinversion, to step up the effort to promote private sector involvement in public infrastructure.
The BOT concession structure designed for this purpose (known as concesión autosostenible) benefited from several innovative risk mitigation features such as providing “step-in” rights to the project lenders, naming the lenders as direct beneficiaries of a portion of any termination compensation payments, and providing for U.S. dollar-indexed or inflation-adjusted rates that allow concessionaires to repay the project lenders and earn an adequate return on their investments.
Examples of projects implemented under this BOT concession regime include the 30-year Lima international airport concession awarded to a consortium of local and European investors and the 25-year Red Vial 5 concession awarded to Graña & Montero to build Red Vial 5, the only highway linking metropolitan Lima to Peru’s productive regions in the north, Ecuador and Colombia.
However, the design of this initial BOT concession structure remained flawed. Some large-scale projects were completed using it, but financing sources (other than the multilateral lending agencies) remained scarce. They were deterred by the fact that the concession structure did not mitigate construction and performance risk (which was substantial due to the historically lower or uncertain demand for services from these projects due to low population density or low traffic projections, in the case of toll roads). These factors made commercial bank and capital markets financing on a limited-recourse basis virtually unavailable.
In 2005, the Peruvian government introduced an enhanced BOT concession structure (known as concesión co-financiada) in which the government provided financial support to mitigate the construction and performance risks associated with these projects. This new concession structure provides the concessionaire with a guaranteed stream of payments to cover construction costs. To make this new structure financeable on a limited recourse basis, the new concession allows concessionaires to grant a lien on or securitize these payment rights, thereby enhancing the risk profile of the projects and allowing for access to a variety of financing sources (for example, international and domestic capital markets, pension funds, commercial banks) that would otherwise not be available under the traditional concession model.
The success of the new Peruvian BOT concession structure is attributable to a number of factors.
It has an investor-friendly legal framework that includes beneficial features such as equal treatment of national and foreign investors, no restrictions on capital remittance, virtually no
foreign ownership limitations, tax stability agreements and investor protection under bilateral investment treaties.
The concession agreement includes “step-in” and other rights for lenders, such as the right to be secured by a mortgage in the concession agreement, receive termination compensation payments, request certain amendments to the concession agreement necessary to make it bankable and, upon default by the concessionaire under the financing arrangement, appoint a new concessionaire based on a pre-agreed objective qualification procedure.
The new BOT structure incorporates something called Remuneración por Inversiones según Certificado de Avance de Obra, or RPICAO, a payment mechanism under which, by submitting a construction progress report (certificado de avance de obra, or CAO) to a government agency or state-owned company, a concessionaire earns the right to receive compensation for construction costs incurred in connection with a project. RPICAOs are denominated in either US dollars or local currency (adjusted for inflation), and represent an irrevocable and unconditional payment obligation of the relevant government agency or state-owned company. RPICAOs are not direct obligations of the Peruvian government; however, the Peruvian government is obligated to honor their payment if the relevant government agency or state-owned company fails to make the payment. RPICAOs are not treated as Peruvian sovereign debt like their predecessors called CRPAOs. The Peruvian government had originally declared CRPAOs not to be sovereign debt obligations, but in 2010 the International Monetary Fund determined that CRPAOs were to be treated as sovereign debt of Peru. This discouraged the Peruvian government from continuing to use CRPAOs for these projects.
The new BOT structure also incorporates something called PAMO (Pagos por Operacion y Mantenimiento). These are payments to cover operation and maintenance costs of the concession. These payments are made to the concessionaire in the event that it does not receive enough toll or fee revenue from the project.
The credit enhancement features provided by RPICAOs and CRPAOs made the projects more financeable. Certain financing sources, such as local pension funds and domestic and international capital markets, were not available to these projects prior to these enhancements.
The real innovation has been the use of RPICAO-backed bonds that are issued in the domestic or international markets.
The first project financed using RPICAOs was the Huascacocha-Rimac water derivation 30-year BOT concession (US$215 million in total project costs) whose aim was to increase the supply of potable water in the highly-populated districts of Lima and Callao. This project was financed through a local currency denominated international note offering backed by RPICAOs.
The second transaction that used the RPICAO payment structure was the Taboada waste water treatment plant concession (US$330 million in total project costs), which was also financed by a local currency-denominated international note offering.
The following diagram shows the RPICAO structure used to finance the Taboada project:
While not used in recent transactions, CRPAOs may be a feasible option for certain projects that cannot be structured using RPICAOs.
CRPAOs are certificates issued by the government of Peru through the relevant ministry or government agency. Each certificate evidences an unconditional and irrevocable obligation of the government to make a payment denominated in US dollars to compensate the concessionaire for its construction costs to date. CRPAOs are freely transferable and, once issued, the government is unconditionally obligated to pay them. The main differences with RPICAOs are that CRPAOs are a direct obligation of the Peruvian government and are represented by negotiable certificates.
CRPAOs were first used in the 30-year BOT concession for the IIRSA toll road projects as part of the IIRSA initiative (Iniciativa para la Integración de la Infraestructura Regional Suramericana), adopted by a number of South American countries in 2000. The IIRSA toll roads link northern and southern Peru with Brazil, and provide Brazil with access to several ports located on Peru’s Pacific coast. The total cost of these projects was approximately US$1.9 billion, and the projects were financed by a combination of local bonds, international notes and bank loans, all secured by CRPAOs. The credit enhancement provided by CRPAOs was key to securing financing because, while strategic to Peru, the IIRSA toll roads were located in areas of low population density and, therefore, traffic projections were insufficient to cover debt service payments.
The boom in infrastructure projects experienced by Peru in recent years is unprecedented for the country, and for most other countries in Latin America. Two elements that contributed to this success are Peru’s consistently strong macroeconomic performance and a concession regime designed to promote investment in large infrastructure projects and to tap non-traditional financing sources, such as local pension funds and the domestic and international capital markets.
Peru has an ambitious strategy to upgrade its infrastructure. The Humala administration will probably face challenges as it will be required to provide substantial credit support for several large projects currently in the government’s pipeline while, at the same time, trying to maintain a sound sovereign credit profile. This promises to be a true balancing act, particularly in times of economic turbulence and political uncertainty.