Contributed By Mattos Filho, Veiga Filho, Marrey Jr. e Quiroga Advogados
Project Finance in Brazil
The expansion of mass consumption requires a perpetual effort to maintain, modernise and increase the infrastructure of a nation. In Brazil, infrastructure bottlenecks are compounded by a decade of economic growth that has increased the demand for services in a country with a moving frontier and a new population entering into the middle class.
When compared to other BRICs, Brazil has a low investment rate in infrastructure, with an average of 2.25% of the GDP for the last two decades. This is usually explained by a low level of domestic savings, fiscal problems in the public sector and few long-term financing options ("Infrastructure for Growth – the dawn of a new multi-trillion dollar asset class"; Citi GPS: Global Perspectives & Solutions; October 2016).
The Brazilian Development Bank (BNDES) continues to play a major role in long-term financing in Brazil, although it has reduced disbursement estimates for the next few years. During 2017, only BRL70.75 billion was disbursed – a decrease of 19.8% from 2016. BNDES has been decreasing its disbursements since 2014, which might be explained by fiscal issues and recession in recent years in Brazil. Commercial banks have reduced their financings, but continue to provide bank guarantees (to BNDES and debentures) and BNDES on-lending facilities.
In an effort to foster different sources of long-term financing, BNDES has been requiring companies to come up with multiple sources of financing, including from commercial banks, export credit agencies and project bonds (debentures). The challenge has been to find commercial banks that are willing to provide such long-term loans, and investors with the appetite to buy project bonds (debentures). In addition to BNDES, other institutions that typically act as project finance lenders in Brazil include local and international development banks, such as the Brazilian Northeastern Bank (Banco do Nordeste do Brasil – BNB), the Brazilian South Regional Development Bank (Banco Regional de Desenvolvimento do Extremo Sul – BRDE), the Inter-American Development Bank, export credit agencies, receivable investment funds (FDIC) that invest in infrastructure receivables and credit instruments, and FI-FGTS (an investment fund by a public pension fund called FGTS).
Since the mid-1990s, private companies have been allowed to operate public services in Brazil by means of concession, permission or administrative authorisations, and BNDES has been the main source of capital to fund infrastructure projects in Brazil, mainly due to its policy of subsidised interest rates.
As part of its efforts to reduce Brazilian fiscal deficits and redirect government subsidies, on 21 September 2017 the Brazilian Congress enacted Law No. 13,483 to confirm the replacement of the traditional BNDES subsidised interest rate TJLP by the Taxa de Longo Prazo – TLP for loans granted by BNDES after 1 January 2018. In 2018, the TLP is fixed at the same level of the TJLP and will gradually increase, from 2023 onwards, until it is calculated based on the Brazilian inflation rate (Índice de Preços ao Consumidor Amplo – IPCA) plus the yield on government bonds (Notas do Tesouro Nacional Série B – NTN-B).
It is expected that the TLP will reach the interest rate on Brazilian government bonds in five years.
While the TLP may increase the cost of BNDES loans, it is expected that, broadly speaking, it will allow commercial banks and the capital markets to become more competitive and develop other sources of long-term financing.
In view of the recent economic downturn that affected the financing ability of national development banks, the Brazilian government's efforts to recover investments in national infrastructure projects are largely associated with the attraction of foreign capital.
One of the aspects that currently prevents foreign financing to Brazilian infrastructure projects is the foreign exchange risk to which infrastructure investors are exposed, considering that projects’ cash flows are denominated in BRL and adjusted by inflation.
Although long-term hedging could address the associated risk of currency mismatch, such alternative is not available in Brazil or, when it is available, comes at prohibitive costs.
Therefore, financing infrastructure projects in Brazil with foreign capital is very unusual. Nonetheless, the Brazilian government is focusing its efforts on replicating successful experiences in other Latin American countries, through adopting similar policies and developing an alternative funding source to infrastructure projects. One possible alternative is the indexation of part of the tariffs paid by users of public services to a foreign currency or a basket of foreign currencies. In this way, the risk of a major devaluation of BRL can be mitigated in the structuring of the financing conditions by means, for instance, of the stipulation of a grace period triggered by the currency devaluation event – considering that currency devaluation events are, as a rule, followed by macroeconomic adjustment policies.
Another possible measure is the adoption of a foreign currency indexation mechanism of part of the concessionaire’s revenues without transferring the risk to the users of the public service. In this case, the risk of foreign exchange variation (either positive or negative) is borne by the granting authority. Moreover, the Brazilian government can offer a long-term swap to investors, directly or by means of BNDES, in exchange for a percentage of remuneration. In this scenario, even if there is higher devaluation of BRL in relation to USD, the existence of exchange reserves and the increase of tax collection could operate as a natural protecting mechanism to the Brazilian government. There would not be such a severe impact on the treasury, since project finance debts in infrastructure projects are partially amortised over long periods.
In this regard, BNDES has evidenced efforts to design new products and policies to mitigate currency risks. It is expected that the BNDES Strategic Plan – to be released by mid-2018 and executed by 2035 – will announce new conditions to address this issue, along with the completion risks and the development of Brazilian capital markets. As part of the plan, BNDES has announced that it will release a new credit line to mitigate hedge transaction risks related to foreign loans executed by Brazilian companies, through which BNDES would guarantee a portion of the company’s obligations for the project under a hedge agreement as a means of reducing the hedging arrangement’s costs.
Non-Recourse Project Finance
As mentioned, Brazil is yet to achieve non-recourse project finance for local projects. Infrastructure finance is usually guaranteed by corporate guarantees from sponsors until financial completion. Therefore, a creditor’s review of construction agreements and pre-operational issues is usually not extensive, and credit analysis for these risks is mostly based on sponsors.
Equity support agreements are also commonly used to guarantee contributions from sponsors in order to achieve completion. Some equity support agreements go beyond typical international practice and provide that sponsors must cover the amount of the debt.
Due to the influence of international sponsors and private equity players, there has been some discussion in recent years regarding the reduction of the amount of recourse against sponsors during the construction phase, which has led to an interesting debate about the optimal risk allocation among the parties involved in a project.
Capital Markets – Green Bonds
Along with the efforts to boost the capital and financial markets to replace the traditional sources of financing, the Brazilian government is also motivated to allocate resources in low-carbon infrastructure projects in order to comply with the ambitious environmental commitments made under the Paris Agreements. Because of this strategy, BNDES issued a USD1 billion green bond to raise resources in the foreign market to fund eight wind power projects in Brazil.
Public authorities are concerned about the Brazilian potential to develop the green agenda. National and foreign institutional investors with a share of BRL1.8 trillion in assets in Brazil have signed the “Brazil Green Bonds Statement”, in which they commit to contribute to the development of the green bond market in Brazil (available at https://www.climatebonds.net/files/files/Brazil_Green_Bond_Statement_EN.pdf). On its first issuance in 2015, the Brazilian green bond market reached USD3.6 billion, ranking as one of the largest in the world (available at http://www.valor.com.br/financas/5143838/brasil-ja-emitiu-us-37-bi-em-bonus-verdes).
Bonds for infrastructure projects are also becoming more common, and may accrue tax benefits for investors when use of the proceeds involves the construction of new works (greenfield or brownfield projects) and the project is within the requirements set out by the government for “priority infrastructure projects” (as per Brazilian Law No. 12,431 of 27 June 2011).
In addition, BNDES and the Inter-American Development Bank have recently announced a partnership to set up a USD1.5 billion infrastructure credit fund to foster investments in debt instruments in the transportation, energy, sanitation and social infrastructure sectors.
Finally, these changes by Brazilian policymakers in response to the current macroeconomic scenario are expected to further increase the share of the capital markets and commercial banks in Brazilian project financing. Therefore, project finance in Brazil is expected to remain as one of the main sources of funds and there is no reason to believe that this will cease to be the case in the near future.