Ricardo Coelho joined Pinheiro Neto Advogados in 1985 and has been a partner since 1996. He has significant experience in corporate law, project finance, asset financing, foreign trade financing, PPPs, capital markets (equity and debt securities), credit facilities, joint ventures, M&A, leasing, oil and gas, energy, maritime law, ethanol and biofuels, transportation, and the aviation and insurance industries.
Marcella Amarante joined Pinheiro Neto Advogados in 2013 and is a junior associate. She has experience in corporate law, project finance, PPPs, joint ventures, M&A, leasing, oil and gas, ethanol and biofuels, transportation and distribution.
GTDT: What have been the trends over the past year or so in terms of deal activity in the project finance sector in your jurisdiction?
Ricardo Coelho and Marcella Amarante: Our firm has multidisciplinary teams involving the best in each specialisation and working in our project finance practice. We have been involved in almost every major project finance transaction over the years, especially considering those transactions sponsored by government-controlled companies. Project finance transactions have been very attractive for the government because they can be structured in a manner that mitigates certain public budgetary constraints.
Besides most oil and gas projects (Espadarte/Voador/Marimbás, Barracuda, Cabiúnas and Malhas (Southeast/Northeast), to name a few), we have also been involved in airport infrastructure – concessions for the construction and operation of airports at the federal government level (for instance, Guarulhos), as well as in sewage projects at the municipal level. Depending on the nature of the project, different legislation may apply to the specific case, under municipal, state or federal levels.
There are also projects in the transportation sector (for instance, subway, municipal trams and toll roads) and maritime transportation (including construction and operation of several floating production storage and offloading vessels and other vessels), as well as major hydropower plants (such as Jirau, Santo Antonio and Belo Monte) and renewable energy projects (particularly wind projects).
More than a decade ago, we worked together with the government and other players in the market to assist in the preparation of a bill of federal law to regulate PPPs at the federal level. The federal law was issued but so far there have been very few transactions at the federal level, although state and municipal legislation using the federal law as a template has made the implementation of several local PPP transactions feasible.
GTDT: In terms of project finance transactions, which industry sectors have been the most active and what have been the most significant deals to close in your jurisdiction?
RC & MA: The federal government recently created the Investment Partnership Programme, which purports to increase and strengthen the participation of the private sector in infrastructure projects, by means of PPPs and privatisation. Infrastructure projects considered of national priority by public authorities include:
- oil and gas bidding rounds;
- divestments of mixed capital companies in the energy sector (generation, distribution and transmission of electric energy);
- mining assets;
- airports; and
Regarding the oil and gas industry in Brazil, the Brazilian Petroleum, Natural Gas and Biofuels Agency (ANP) has already scheduled several bids for the next few years in order to give more predictability in the bidding rounds (in 2019, the 16th Bidding Round (3rd Quarter), the 6th Production Sharing Bidding Round – Pre Salt (3rd Quarter). The Brazilian local contents requirement policy has been softened and the Brazilian federal tax authorities have issued new regulations for the tax treatment of exploration, development and production of oil and natural gas activities. The tax authorities have also established a calculation formula for the purpose of withholding income tax applicable to cross-border charter and lease contracts of vessels operating in Brazil, subject to contractual split (whenever there is charter with rendering of services). This new regulation is expected to enhance legal certainty for investors in the oil and gas industry.
In 2017, the Ministry of Mines and Energy (MME) launched a public consultation on changes to the electric power regulations, aimed at improving the legal framework and also to reduce litigations involving players in the electric power sector. The federal government also announced the privatisation of Centrais Elétricas Brasileiras SA – Eletrobras, a listed company controlled by the Brazilian government with a presence throughout the entire electric chain (generation, transmission and distribution) and the largest company in the electricity sector in Latin America.
There is an ongoing controversy with respect to the validity of a foreign vessel mortgage in Brazil. A recent decision rendered by a higher court acknowledging the validity of the foreign mortgage based on international treaties consolidated the validity of foreign mortgages in Brazil, enhancing a standard ship financing practice widely adopted in the international market and providing additional comfort to financiers and suppliers in Brazilian operations.
New rules have extended the duration of authorisations to operate port facilities in Brazil from 25 to 35 years, which may now be extended for successive periods for up to 70 years. The management of public ports may also negotiate the anticipation of tariff revenue with users, in order to invest in infrastructure.
The federal government that took office in January 2019 has also announced that the number of privatisations will increase substantially in 2019, including in the infrastructure sector and in the divestment and sale of public entities. Among the projects envisaged by the new federal government are:
- the privatisation of Eletrobras (as mentioned earlier) and Casa da Moeda do Brasil, a public entity subordinated to the Ministry of Finance and responsible for producing and circulating Brazilian legal tender coins and banknotes in Brazil;
- the sale of participation of Infraero, a public entity subordinated to the Ministry of Infrastructure and responsible for the management and monitoring of the main airports in Brazil; and
- 24 auctions regarding projects under the Investment Partnership Programme, including airports, port terminals and the Norte-Sul railroad.
GTDT: Which project sponsors have been most active in driving activity? Which banks have been most active in providing debt finance?
RC & MA: Project finance transactions generally involve several stakeholders, such as creditors, suppliers, financiers, liquidity providers, insurers, regulatory agencies or granting authorities, in the particular case of projects subject to the concession, authorisation or permission regime.
In the past, the Brazilian Development Bank (BNDES) has been the major provider of long-term finance in Brazil. Commercial banks of the private sector usually tag along with BNDES, especially on-lending funds from BNDES and by way of infrastructure debentures (a type of project bond with tax incentives), as well as other foreign export credit and multilateral agencies, in order to provide financing in the shorter term, so that they could be repaid first and exit from the deal. In specific regions, we have also verified the participation of regional development banks and governmental agencies, such as BNB (a northeast development bank) and SUDENE (a northeast development agency). Other than in such circumstances, it may be difficult to have long-term finance from private banks in Brazil. So far, BNDES has been the bank that has led this source of long-term financing for project finance in Brazil. The number of applications for BNDES financing, however, has reduced dramatically in recent years, driven by government deficits and corruption scandals involving government-controlled companies that have reduced, if not paralysed, the negotiation of many projects of such nature. The change in the methodology to calculate the interest rate charged by BNDES is expected to make the private sector more competitive as far as long-term financing in the local market is concerned.
Joint venture arrangements related also to project finance transactions shall be subject to antitrust clearance in Brazil, whenever the transaction may have a direct or indirect impact in Brazil based on the parameters set forth by applicable law, and must be previously submitted to the Administrative Council for Economic Defence (CADE) for approval. To this end, the concept of economic groups for the purposes of the Brazilian competition law is very broad.
GTDT: What are the biggest challenges that your clients face when implementing projects in your jurisdiction?
RC & MA: The basic element to be considered when implementing projects in Brazil derives from the fact that project finance transactions were conceived in jurisdictions governed by common law, rather than by civil law (like in Brazil). Under Brazilian law, contracts shall be subject to the existing legislation, that is they must comply with the legal provisions applicable to the transaction as well as be subject to the specific limitations or restrictions established by virtue of law.
In Brazil, it is not customary to have a true project finance ‘plain vanilla’ project, where the project cost is fully repaid by project revenues. For instance, depending on the nature and structure of the project, the creditors could generally resort to the debtor or the sponsor and project assets (including also receivables) could be affected by labour, social security or environmental liability. For these reasons, it is necessary to structure the project carefully, whereby the project assets are ring-fenced and protected from third parties as much as possible. In many project finance deals there is a flavour of corporate finance or asset-based finance, where a suitable security package would also play an important role to mitigate creditors’ exposure to risk, besides requiring appropriate insurance to cover customary project risks in connection with completion and operation of the project.
Corporate governance of local legal entities, including consortium arrangements and shareholders’ agreements, must be governed by Brazilian law.
It is essential, therefore, to understand the specific features of Brazilian law, in order to negotiate a local joint venture, to implement the mechanics for local tariff calculation and adjustment and to enforce the security package.
In the energy sector more specifically, there is typically a mismatch between the tariff that is linked to the Brazilian currency and adjusted for inflation, on the one hand, and the project cost variation when involving foreign financing, on the other. For power purchase agreements with independent power producers, the developers may sell to the sponsor and recover the investment through that type of sale. To deal with currency mismatch issues and to enjoy certain tax benefits, many transactions have resorted to the issuance of debentures (which is a type of debt security that may be adjusted according to foreign exchange variation) in the local market and that has been an interesting source of finance for this type of transaction.
The same situation may occur in the event of a project finance implemented with foreign funds and generating local revenues paid in Brazilian currency and adjusted for inflation (rather than by foreign currency variation). There are mechanisms, however, that have been successfully adopted to mitigate such type of risk.
There is no discussion about the appetite for sewage projects in Brazil, although there has been a debate as to who shall provide financing support to such projects. For projects sponsored by state governments, there is also a regulatory risk involving the possibility of municipal governments starting to provide such services in a portion of the same geographical area, affecting the generation of project revenues.
In the case of airport deals, for instance, the bids were made taking into account the project revenue forecast. The possibility that the government might authorise the construction and operation of new airports in the neighbourhood of the existing airport must be discouraged in order to avoid any adverse impact on the flow of passengers and cargo in the existing airport and, consequently, any reduction in the expected project revenues.
“Corporate governance of local legal entities, including consortium arrangements and shareholders’ agreements, must be governed by Brazilian law.”
GTDT: Are there any proposed legal or regulatory changes that may give rise to new opportunities in project development and finance? Do you believe these changes will open the market up to a broader range of participants?
RC & MA: There are several ongoing regulatory discussions purporting to address specific market concerns or promote broader reforms in many different sectors.
As a result of the opening of specific segments, which were being maintained as monopolies operated by government-controlled companies, discussions on the new regulatory regime are defining the legal framework for operation by private-sector entities. Certain dysfunctions in specific sectors (such as local content requirements in the oil and gas and the generating scale factor in the energy sector), which resulted in an increase of lawsuits in such sectors, may have also brought this discussion so as to adapt their rules to the current economic scenario.
In the case of PPPs, a private-sector company may carry out certain activities for the government and in turn be repaid through receivables from the project, which may be enhanced by government contributions as a shadow toll either partially or totally, depending on the nature of the project.
New projects are also expected to be developed as a result of a new regulatory model for natural gas under discussion, which may also give the opportunity for the acquisition, modernisation, construction, expansion, operation and financing of new plants and transportation pipelines.
Compliance and corporate ethics, as well as financial soundness in the medium and long term are key aspects to be considered in order to negotiate appropriate indemnification provisions and avoid liability disputes in the future.
GTDT: What trends have you been seeing in terms of range of project participants? What factors have influenced negotiations on commercial terms and risk allocation? Are there any particularly innovative features?
RC & MA: While corporate finance involves debt (credit analysis based on past performance), project finance transactions involve risks (both commercial and political). The sponsor may not have a good credit rating, but reliance on project feasibility may be an important factor to attract investors and for the successful implementation of the deal. Indebtedness requires guarantees, while risks require insurance. The increase of project finance transactions is expected to further develop the insurance market and the modalities of risk coverage in Brazil.
There are also cases in which the financiers require that shareholders or sponsors meet certain minimum investment level requirements, including by providing parent guarantees, in order to show their commitment to the project
“Even if the privatisation of Eletrobras itself takes time, the sale of specific companies in which Eletrobras holds corporate participation is expected to occur at a fast pace.”
GTDT: What are the major changes in activity levels or new trends you anticipate over the next year or so?
RC & MA: Brazil is the world’s fifth-largest country (and the largest in South America) by geographical area, divided into 26 states and one federal district (Brasília), with its territory spanning three time zones and a population of more than 200 million people. The country has also increasingly expanded its presence in the international financial markets, and is also part of BRICS. Brazil has by far the largest economy in Latin America.
Project finance transactions appear to have been affected by an ongoing economic, political and fiscal crisis after a long period of economic growth in Brazil. On the other hand, major key assets are being sold to generate additional income for the government at federal, state and municipal levels. There has been an increase in major M&A transactions as a result of divestment programmes carried out by government-controlled companies – including Petrobras, the major Brazilian oil company – and also result of financing and corporate restructuring of major Brazilian entities, as well as by companies involved in corruption scandals or otherwise in need of cash availability to settle debt obligations or targeting selected investments more focused on their core business.
The forecast for 2019 onwards is more optimistic, as the market is expecting a scenario of controlled inflation rate, social security reform and more control of public expenditures. A better defined political environment is also expected as a result of the election of a new president, members of the Congress, state governors and state representatives. The preparation and follow-up on the ongoing discussions about regulatory matters may give leverage to potential investors and financiers.
Infrastructure facilities, agribusiness, biofuels, mining, construction, transportation, roads and even railroads, sewage, port operations and especially energy-related projects, including renewables like solar power plants and wind farm projects, are expected to increase. Eletrobras is likely to be privatised, according to a bill of law proposed by the former president and currently under discussion by Congress. Even if the privatisation of Eletrobras itself takes time, the sale of specific companies in which Eletrobras holds corporate participation is expected to occur at a fast pace, as occurred with the privatisation of six power distribution concessionaires of Eletrobras in 2018.
An oil price rise in the international market and the new auctions that have been made to exploit oil fields in Brazil, including those in the pre-salt area, are likely to attract new projects for the shipbuilding industry and the supply chain related to the oil and gas sector.
PPPs in the health and education sectors would be welcome. Likewise, investment in the construction, expansion and modernisation of federal prisons may also come to the forefront.
The government has been facing budgetary deficits and, notwithstanding the continuous strengthening of the capital markets in Brazil, the funds available in the local market may not suffice to cover satisfactorily the needs of infrastructure in Brazil. The implementation of project finance deals would be a competitive way to finance transactions that may be posted off budget and make the expansion and enhancement of the infrastructure in Brazil feasible, particularly in view of the public budgetary constraints and the forthcoming recovery of the Brazilian economy. There is a solid regulatory framework that has given comfort to foreign players and needs to be well understood for the purposes of a better risk assessment.
The Inside Track
What three things should a client consider when choosing counsel for a complex project financing?
Reliance, expertise and dealmaker. The selected firm should also have experienced attorneys in sufficient number and be able to act in a harmonious and robust working team.
What are the most important factors for a client to consider and address to successfully implement a project in your country?
To better understand the peculiarities of each jurisdiction, in order to make a proper risk assessment for the project and accommodate different interests of multiple players.
What was the most noteworthy deal that you have worked on recently and what features were of key interest?
The Malhas project was an interesting experience, not only considering the challenges faced to negotiate and develop a leading project related to natural gas transportation pipelines in the absence of detailed regulations applicable to the case at that time, but also because later on we were able to assist the company during the operation phase and exit from the project. More recently, we also participated in the sale of the project company to a third-party buyer in different circumstances and where a regulatory framework was already in place and ongoing. Another interesting project was the financing of a municipal tram (light rail vehicle) with BNDES support in a PPP sponsored by the municipality of Rio de Janeiro and destined to enhance transportation in preparation for the 2016 Olympic Games in Rio.
Ricardo Coelho and Marcella Amarante
Pinheiro Neto Advogados
Rio de Janeiro