P3 101: International mixing

Already a common means of delivering infrastructure in many countries, the public-private partnership is growing in importance in the United States. Generally referred to as a P3 or PPP, this procurement model allows governments to use private-sector expertise and financing to deliver infrastructure ranging from bridges to water systems to public buildings.

Outside of specialist circles, however, most people know little about P3s. This month, Doggerel features a series of conversations with members of our advisory team exploring the basic concepts behind P3s. In this second installment, Arup transaction advice specialists Alfonso Mendez, Roberto Sierra, and Jorge Valenzuela discuss the role of international knowledge transfer in P3s.

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The three of you are based in San Francisco, but your team seems to be very international, is this a common arrangement? Do most infrastructure PPPs have international teams, or are most of the players local?

Sierra: It’s a mix. You must have a local component, but when you start delivering projects with a PPP scheme it’s often an advantage to bring in expertise from places with a successful track record in PPPs.

I remember when I came to San Francisco about seven years ago from Spain, Arup’s team was about 70% European and a lot of the senior people were British, because that’s where modern PPPs started.

Foreign expertise can be very valuable, even indispensable in some ways. You need knowledge transfer to get the basic frameworks right. Multilateral organizations, at least in Latin America, are key to bringing in that kind of knowledge transfer. Multilateral banks can (a) leverage funding for consultants and (b) provide frameworks that help emerging PPP markets develop.

Valenzuela: Infrastructure investment is a big global industry that is growing quickly. Many of our team’s key clients are large international banks based in the US that finance projects throughout the Americas. We even have projects in Colombia and Peru that have been financed through bond offerings placed in the US. The teams at these lenders are also very international. Local banks outside the US are also financing these deals, and they’re important clients for us too. We need to speak their language and build relationships with them.

Infrastructure investment funds from Europe and Asia are also calling us now because they are considering investing in the Americas. They normally partner with local developers, and they hire us to review the business plans of those local developers.

Our clients are coming to us because we offer global expertise with local knowledge. That’s the reason why we have designed a team that’s very international and speaks different languages. Currently, Arup’s transaction advice team in the US has around 35 people from 12 different nations that speak more than five languages.

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Mendez: We have reliable local advisors in Lima, Buenos Aires, São Paulo, and Panama, and we have people on the ground in our Bogotá office, in addition to staff in San Francisco, Los Angeles, and New York.

To do this kind of work today, you really need this kind of geographical presence.

It sounds like, while the work is very international, there is a really strong presence in Latin America. How would you characterize the difference between PPPs in the US and Canada versus Latin America, broadly speaking?

Sierra: In the US and Canada, PPP projects tend to be better structured. The public sector often has a more detailed approach to preparing the technical studies, procurement documentation, and information that the private sector will use when putting together bids for major infrastructure projects. All this results in more process certainty and a lower risk of contract renegotiation post award.

Valenzuela: Also, Latin America, with the exception of some countries, is basically a developing infrastructure market. The US invested in infrastructure decades ago, in some cases ahead of the need or demand for it, to catalyze development. Some Latin American countries are now developing quickly, but they have a big problem, because they lack the infrastructure that they need to make their economies more productive. Often infrastructure remains insufficient even when new projects are built — there is so much pent-up demand in many cases that new projects reach or exceed capacity within a few years of completion.

Mendez: To really understand the differences between the two regions, you need to think about the factors that shape P3s within those regions: the legal, funding, and procurement context.

For the legal context, you have a tradition of civil law in Latin America, as opposed to common law in the US. Common law is more flexible; every time a state or public entity closes a transaction it sets a precedent. This framework allows each one of the states to decide how it wants to pursue P3s. In civil law, on the other hand, you have a web of laws and legal frameworks that regulate P3 procurement throughout each Latin American country. Precedents don’t mean as much.

Another big difference is funding. The US market is characterized by a long-term yield curve and very deep banking and capital markets, meaning basically that lenders are confident that the economy and the currency will remain stable over long periods of time. On top of that, you have a well-developed market of institutional investors in the country, like insurance companies and pension funds.

In Latin America you don’t have these advantages. The volatility associated with Latin American economies, fiscal policies, and currencies doesn’t allow those countries to have a long-term yield curve.

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So most of the time when you want to fund long-term infrastructure in Latin America you have to come to the US and try to attract dollar-denominated funding, e.g., US investors. But you have to pay these investors more because they’ll incur cross-border risk.

And then in the best of cases, the project generates revenues in local currency, but has to pay its lenders in dollars. That also raises costs for the government agency procuring the project.

Valenzuela: Obviously in Latin America you have different markets, different economies, and different currencies. But most of those economies, for better or worse, are heavily exposed to changes in commodity prices: oil, gas, copper, gold, etc. They have a track record of being unpredictable in terms of GDP growth and inflation, and for investors inflation is key. If you can’t predict long-term inflation you’re not going to get investors to commit to long-term yields because they don’t want to take that risk.

Having said that, though, there is huge interest from companies in the US to do these deals in some countries in Latin America, because they might offer higher yields.

Mendez: The historical context around developers is also very important. In the early ’90s, Latin American countries were forced to sign the Washington Consensus and go on a forced economic regime because of existing sovereign and private debt. That’s when some of them assumed this type of delivery model, P3s, which had been developed in the UK previously. Before that they mostly used traditional delivery, design-build, and design-bid-build, for all public infrastructure.

In that period the major players in infrastructure projects were mostly large construction companies. Those companies essentially morphed over time into PPP developers. So what you still see in Latin American P3s is that the biggest chunk of returns for investors is concentrated in the construction phase of the project.

In the US, on the other hand, you have long-term developers and investors, and they’re usually different entities than the construction companies. You have P3 developers coming from the UK, Canada, and Australia, as well as some locals. They enter into arms-length agreements with construction companies and expect to make their profit over the course of the entire concession, not up front as Latin American developers tend to do.

 

Questions or comments for Alfonso Mendez, Roberto Sierra, or Jorge Valenzuela? Contact Alfonso.Mendez@arup.com, Roberto.Sierra@arup.com, or Jorge.Valenzuela@arup.com. Want to learn more about Arup’s transaction advice services? Contact ignacio.barandiaran@arup.com.

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