Who's Who Legal has brought together Phillip Fletcher and Alexander Borisoff of Milbank Tweed Hadley & McCloy, Caio Queiroz of Felsberg Pedretti e Mannrich Advogados e Consultores Legais, Rogelio López-Velarde of López Velarde Heftye y Soria and Filipe Lowndes Marques of Morais Leitão Galvão Teles Soares da Silva & Associados to discuss the key issues facing project finance lawyers today.
Milbank Tweed Hadley & McCloy LLP
Who’s Who Legal: Over the last few years we have seen a definite decrease in lending by European banks. Have you seen any new players emerge to fill this lending gap such as national banks or private equity investors?
Phillip Fletcher: Although there has been a reduction in the ability of European banks to lend, particularly in dollars, the resulting liquidity gap has been filled in large part by a combination of public sector, regional and non-bank lenders. From the public sector, the most notable are export credit agencies, multilateral and development finance institutions and domestic special purpose lenders, such as the Green Bank in the UK, BNDES in Brazil and the North American Development Bank in the US. Japanese and Chinese banks have not been balance sheet constrained and in various regions, such as the Middle East, local banks have had signficant capacity to lend. For well-structured projects, the capital markets (including the sukuk market) can be an attractive source of finance.
Caio Queiroz: Yes. The National Economic and Social Development Bank (BNDES) has been the main funding mechanism for long-term financing in relation to infrastructure projects. Its support takes place mainly in the form of loans: the institution’s disbursements reached 21.2 billion reais in the first two months of 2013, an increase of 39 per cent in comparison to the same period the previous year. Considering that infrastructure investments demands in Brazil are huge, it is expected that part of the funding will shift to the private sector in the next few years, through both debt and equity transactions. According to specialist reports, the private equity industry has experienced surprisingly high volumes in Latin America; the number of buyouts has been increasing significantly, including in Brazil, which leads the ranking of deals in the region. Several financial institutions have set up funds aimed only at acquisitions of infrastructure assets.
Alexander Borisoff: There is no doubt that the European banks continue to be less active than they were pre-financial crisis. Even now, with signs of life emerging from some of these institutions in certain sectors (not to mention growing activity levels from their US, Canadian and Australian counterparts), the activity levels across the commercial bank world remains severely depressed.
To put a “real-world” context on this, 10 years ago the vast majority of project deals were funded by a group of “traditional” commercial banks, and there were close to 30 to 40 of them that we regularly worked with in the projects market – today, it wouldn’t be a stretch to say that number has been reduced by almost two-thirds, if not more. That said, this contraction in the commercial bank sector has opened doors for other liquidity providers, with the result being that project sponsors can now look to a bigger number of funding options when putting together a financing package.
On the commercial bank side, we’ve seen the Japanese megabanks successfully fill a big piece of the funding gap left open by the Europeans, bringing both practical expertise and deep pockets to projects across every sector and every geographic region in the world. Similarly, official funding sources, such as export credit agencies and multilateral development banks, have stepped in and become indispensible participants in virtually every major project financing currently in the market. Other liquidity providers have also taken advantage of the door left open by the traditional commercial banks, including Islamic finance providers, private equity participants, fund managers and, of course, capital market investors (both on local and international levels), all of whom have increased their activity levels in the project space in recent years. These growing market participants represent a new feature of the projects landscape that will not go away, even when the traditional commercial banks return back to health – overall, a development that is very good for the projects market in the long run.
Rogelio López-Velarde: Multilateral agencies continue to be very active, but we have seen an increase in lending by Japanese and Korean export credit agencies and commercial banks (following the trend of Japanese and Korean investors increasing participation in many infrastructure projects), coupled with an increase in the lending activities of Mexican commercial and development banks. Likewise, a large number of European and US investment funds are now taking larger equity positions and continue exploring investment opportunities across a number of sectors, particularly energy, while a number of financing schemes involve the issuance of securities.
Filipe Lowndes Marques: There has definitely been an upsurge in private equity investors, who have a large amount of funds available. Discussion is progressing on whether the Portuguese state should set up a development bank to assist the funding shortfall, but no final decision is expected soon.
Who’s Who Legal: In recent years the market has seen a departure from traditional financing methods. PPP contracts, for example, are now commonplace in many jurisdictions around the world such as Australia, Canada, India and the UK. In 2012, the reduction in the availability of traditional sources of debt financing caused governments to look for new alternatives, such as project bonds, to bring new life to infrastructure development. Have you seen the development of any new financing methods in your jurisdiction? Are there any planned changes in the future?
Caio Queiroz: Yes. Recent years have shown that Brazil’s state and federal governments are incentivising infrastructure investments with a significant portion thereof currently expected to be sourced from the new state and federal public-private partnership (PPP) initiatives, as well as through the adoption of new financing methods, such as project bonds with tax incentives attached. The 2014 World Cup and the 2016 Olympic Games have placed additional challenges for infrastructure in stadiums and transportation, in addition to other well-known infrastructure bottlenecks, such as railroads and ports. Several of those projects are aimed to adopt PPP in order to attract investments focused on the modernisation and quality of the services. The federal government has also granted tax incentives for investments in project bonds (debentures) if the project qualifies within certain areas of interest (such as logistics, railroads and roads). Syndicated loans may also constitute an alternative in the near future.
Alexander Borisoff: Funding issues have absolutely had a creative influence on both borrowers and lenders, as both sides have searched for alternatives to the “traditional” debt funding model that had, until recently, been the principle feeding mechanism of liquidity into this market. PPP structures and project bonds represent just a few of the tools being employed by project participants to meet this demand for new methods of moving capital. By way of example, dedicated project debt funds for financing diversified portfolios of projects have become more commonplace, and are quickly becoming used by a wide spectrum of market participants, ranging from private equity to export credit and multilateral development agencies. We have also seen ECAs becoming more active with capital market issuances (including ECA-wrapped bonds) and direct equity investments, all of which are being used to grow the range of options available to these entities to deploy capital in new and innovative ways.
Rogelio López-Velarde: Structured finance deals using schemes that are less burdensome to developers are being implemented, along with a wide range of securities being placed by both local and municipal governments and private investors, including project bonds, participation certificates issued by real estate trusts (the Mexican version of REITs) and capital development certificates (known as CKDs) issued by trusts formed to finance one or more projects, or otherwise structured as private equity funds to hold participations in the companies developing projects. Amendments to the legal framework of Mexican pension funds allowing them to invest in these type of securities has boosted the use of these type of instruments to finance real estate and infrastructure projects.
Filipe Lowndes Marques: There has been a marked decline in project financing in Portugal over the last two to three years due to the funding shortfall and uncertainty about Portugal’s financial future, and the state is currently wary of assuming any new commitments (under whatever type of funding alternative).
Who’s Who Legal: Emerging markets remain a strong growth area for both energy and infrastructure projects. To what extent does your firm engage in international work? Are there any regions that have been particularly active?
Phillip Fletcher: All of the leading project finance firms are focused on the emerging markets. There are two reasons why project development is so active in the emerging markets: first, they hold many of the natural resources that are needed globally and, second, their growing populations and economies require huge amount of infrastructure investment, ranging from power to transport to telecommunications. For Milbank, we have long focused on the markets of Asia, the Middle East, Latin America and more recently Africa. We and the other leading international firms have learned, with the help of our colleagues at the leading local law firms, to harmonise international project finance “norms” with the practical limitations imposed by the legal environment in many host countries.
Caio Queiroz: We are involved in all aspects of the legal structuring of greenfield projects, from the legal due diligence phase to the drafting of corporate documents and negotiation of supply and operational contracts, guarantee models, and structured operations in the capital markets. The firm has been involved in several projects in the past few years, such as the concession of new energy plants and transmission lines, ports, tube lines, among others), advising both international lenders and sponsors. Our international capabilities are well known and we have been retained by multilateral agencies for several financing schemes that are mainly based in Brazil.
Alexander Borisoff: Cross-border work is at the core of our projects business, with the majority of our mandates involving emerging market host countries and investors and/or lenders from a large number of foreign jurisdictions. The projects sector – at least when it comes to the largest and most complicated deals – is inherently a “cross-border” business, and given the rapid escalation in project sizes and costs, the need for development in many of the fast-growing developing regions of the world, and the continuing resource race among Asian countries that is forcing sponsors to look at opportunities across the globe, there is no doubt that emerging markets will continue to present some of the biggest and most important opportunities in the sector in coming years.
That said, one of the most interesting trends in recent years has been the upswing in natural resource-related projects in the developed world. The shale gas revolution, for example, has transformed the United States into the target of a resource rush, with gas-hungry developers working hard to acquire assets that will give them direct access to immense reserves. Similarly, both Australia and Canada have embraced (to various degrees) their potential as huge feeders into the natural resources market – Australia, for example, is currently host to some of the world’s largest deals, and within five years expects to be the biggest exporter of natural gas on the planet. Similarly, both countries have experienced recent mining booms, which, although sensitive to constantly changing market pressures, looks set to provide a relatively stable source of growth for many years to come.
Rogelio López-Velarde: Our practice is primarily focused in Mexico, where the development of infrastructure and energy projects has been very intense over the last decade at all levels. Federal and state governments have enacted new statutes to permit PPPs and other similar schemes promoting private investment participation that are now used in a wide variety of sectors to cope with the country’s infrastructure needs, including water treatment, highways, transportation, hospitals, and education and correctional centres, among others. The demand for natural gas infrastructure (including pipelines and LNG regasification terminals) has also prompted a number of important financing deals in Mexico, and the trend is expected to continue. In the electricity sector, private investors now have an important participation, mainly as a result of the IPP programme of the Federal Electricity Commission (CFE) (Mexico’s national power utility company), where power plants are built and operated by private investors who sell all their capacity and energy to CFE. Likewise, private investment also holds an important stake in the renewable energy sector (apart from large hydros, which remain under the control of CFE).
Filipe Lowndes Marques: We have seen a marked growth in energy and infrastructure projects in both Angola and Mozambique, where we have local firms that are part of the MLGTS Legal Circle and that work in very close cooperation with us on these transactions.
Who’s Who Legal: This year has seen the financing of a large number of renewable energy projects. It appears that solar, wind, hydro and biomass projects are attractive to investors, especially given the subsidies that are offered by various governments. Do you have experience in this area? Do you expect this volume of projects to continue?
Phillip Fletcher: These sectors will prosper as long as technical advances continue to narrow the pricing gap between thermal power and renewable power and as long as governments find a way either to price carbon emissions or to subsidise renewable energy.
Caio Queiroz: Yes, our infrastructure practice has in-depth regulatory expertise regarding renewable power generation. We provide legal advice on matters from initial licensing procedures right up to the negotiation of EPC contracts and similar agreements. Significant growth has been felt on the small hydro and wind power plants, as a result of long-established regulatory laws and incentives that are aimed to foster green power generation. In addition, it is expected that solar and waste-to-energy projects will become the big hit in the next few years, as the country has favourable natural radiation conditions, especially in the north-east region, and adopted a very stringent legislation as regards the operation of landfills that have the potential to create a market for several new waste-to-energy power plants across the country.
Alexander Borisoff: What we are seeing in our practice is that the global renewables market continues to grow in leaps and bounds, and that this sector will continue to expand as technologies improve and demand for green energy becomes more widespread. In Japan, for example, we are seeing first-hand the impact of new government programmes on renewables, as investors from around the world continue to work hard to find opportunities in the domestic market, which is currently offering the world’s most generous subsidy regime through the new feed-in tariff that was enacted last year.
That said, although government subsidy programmes and policies promoting renewable energy “targets” have had a big impact globally as a catalyst for growth in this sector, there have been speed bumps along the way as many of these programmes in different regions have fallen victim to the lack of political will necessary to entrench them for enough time to give investors the predictability they need to make long-term investment decisions. Other variables, such as the discovery of shale gas, the accelerated demand for base load build-out in fast-growing parts of the developing world, and the slow but steady rekindling of the nuclear renaissance, will continue to create pressures for renewable developers. That said, as technologies and efficiencies in the sector continue to develop, and as sensitivity to sustainable energy practices becomes a permanent feature of the “energy debate”, it is inevitable that renewables will represent an ever-increasing share of the global power market.
Rogelio López-Velarde: No direct subsidies are available in Mexico for renewable energy projects; however, the availability of very attractive natural resources, combined with some limited tax benefits, a larger availability of financing resources and a number of specific schemes designed to offer wheeling services in the national electric grid to renewable energy at more favourable conditions have worked to permit the development of a large number of renewable energy projects. Hydro and wind projects continue to be the most frequent, but solar projects are also being developed. Many of these projects, which are not yet regulated as utilities, have been able to obtain competitive financing (including project finance schemes and project bonds), which has increased investors’ attention to this sector. Moreover, CFE has included wind projects in its IPP programme, which has also been to further develop this sector. Our firm has participated in many of these projects, representing both developers and lenders.
Filipe Lowndes Marques: Portugal was for many years one of the principal European countries to have engaged in renewable projects – during 2003 to 2010 we had a steady stream of five to 10 projects a year on which MLGTS assisted. Due to the current situation this number has now decreased to two or three a year.
Who’s Who Legal: Our research has shown project finance to be relatively active compared to other areas of commercial law. Have you seen an increase in the number of lawyers who are practising in this field? Would you encourage young lawyers to specialise in this area?
Phillip Fletcher: Although in recent years there have been fewer project financings that have reached financial close, the scale of the projects that have are growing exponentially. As a consequence, the project finance legal market has generally become more concentrated, with the number of firms with the skills and capacity to take on the largest deals being somewhat limited. For those who are fortunate enough to act on the “first of a kind” and “mega” deals that we now regularly see, nothing could be more challenging or fun than to be a lawyer helping to structure and close these massive undertakings. Those lawyers get to contribute to expanding the “real” economy in a very tangible manner, helping to improve job prospects and living standards for a broad range of people.
Caio Queiroz: Yes. We have seen a great number of lawyers acting in the project finance field in Brazil, especially within well-known law offices that have been organising and lifting their capacity to attend colossal infrastructure projects. Additionally, the corporations and contractors that are normally engaged in projects have also retained a number of in-house attorneys duly educated on project financing. This scenario is a result of the several governmental initiatives aimed at unlocking the infrastructure bottlenecks, and created a “new market” for lawyers that are equipped with the necessary expertise to convey intricate and multidisciplinary legal tasks.
Alexander Borisoff: The projects space has continued to remain active through the difficult markets of the recent past, and in fact the deals themselves (and the structures required to finance them) have become bigger and more complex than they were just a few years ago. One of the most significant impacts of this trend has been the increased levels of cooperation and collaboration between companies, banks and agencies from traditionally competing markets (take, for example, Japan and Korea), as many market participants have found that pushing forward with these massively capital-intensive undertakings on a “do-it-yourself” basis is no longer a practical approach. As the deals get bigger and more complicated, the need for more skilled legal advisers will continue to grow.
At the end of the day, the demand for new projects, particularly in the natural resources, power and infrastructure sectors (and even more particularly in the fast-growing developing world), will ensure that these deals will continue to get done, and that more and more specialists will be required to execute them. For those entering the practice, my message is twofold: there is absolutely room for more project specialists in this growing market, and if you have the patience to work in a sector that requires extended periods of time to get from start to finish and that constantly finds ways to take you out of your “comfort zone”, you won’t find a practice area that is more dynamic or that exposes you to more cross-border and cross-industry issues than project finance.
Rogelio López-Velarde: Yes. The continued need to develop more and more infrastructure as a way to promote economic growth in emerging markets has expanded the need to have sophisticated legal advisers capable of understanding and implementing projects in ways that makes them suitable to obtain the required financing, as well as lawyers capable of designing and bringing into life complex financing schemes. We believe this practice will have a strong market in the upcoming years and would definitely encourage young lawyers to specialise in this field.
Filipe Lowndes Marques: For all the above reasons the project finance market in Portugal is passing through a lean spell and this has reduced the number of lawyers active in the field, although we are hopeful that when Portugal has weathered the current storm this mode of finance may assume its historically important role.