Growth Markets Special: Pricing the right risks in Latin America

The region has shown immense promise as a growth market in the past few years, but investors are still wary of political risk.

When it comes to narratives that simplify the economic development of regions, Asia-Pacific has earned the title of ‘success story’, while Africa raises constant alarm bells. Latin America, meanwhile, seems to be somewhere in the middle. While there is much to be said for recognising the complicated and often counterproductive steps a country or region must take to reach investment-grade status, there is also concern that that ambiguity causes the region to attract only those already familiar with it.

“LPs [investing in the region] are typically those that are composed of people that have studied or worked in Latin America or that have a connection with Latin America, as they more easily digest the risks associated with it”, says Juan Pablo Moreno, a partner in Mayer Brown’s banking and finance practice and its Latin American and Caribbean group.

Indeed, while a substantial amount of capital has flown into the region, especially in recent years, investment is coming from only a select few players. Infrastructure investing is no exception. As of H1 2022, infrastructure funds in market globally were seeking to raise $207.5 billion, only $3.9 billion of which were earmarked for Latin America, according to Infrastructure Investor’s most recent fundraising report.

There is, however, cause for optimism. The growth market has recently seen a lot of… well, growth, especially when it comes to attracting foreign investment. “We’ve come across a couple of investors that are not familiar with the region, that are doing it for the first time or the second time in the history of their company or the sponsor,” Moreno says. “It is difficult to see those investors, but they are coming, and coming more from different countries, not only the US, but Europe, Canada and Australia, too.”

While that may be true, risk and opportunity are not consistent throughout the region. As a result, only a few countries are attracting capital.

Countries that were once the darlings of the investor community now wouldn’t even be on investors’ radars. “Transactions that used to happen quite a bit in Argentina and Venezuela in the 90s are no longer happening, just because the risk is so uncertain that investors do not even consider investing, or banks do not even consider going to those markets,” explains Moreno.

Where then are investors looking to invest today? According to Nicolas Escallon, a partner at Actis, one of the leading infrastructure investors in the region, “in all major markets, renewables play a key role in terms of matrix additions, whether it’s Colombia, Chile, Brazil or Mexico”.

Each major market has its pitfalls. For Mexico, it is regulatory risk. Emilio Andrade, director of Latin American infrastructure investments at Ardian, explains: “[In Mexico,] there are sectors that are more linked to regulatory concerns, like the energy sector, which has big government companies that are the main players. But there are others, for example telecommunications, which I would say are less regulated or under the influence of governmental entities, so less affected by regulatory issues. So we’re selective in Mexico about the sectors we invest in.”

Moreno agrees: “[President Andrés Manuel] López Obrador is still in power for about two years, so I think we won’t see a lot of developments there. He recently limited the amount of energy that can be imported and the conditions under which Canadian or US investors can invest in energy-related assets, which will probably lead to an arbitration in terms of the trade agreement that the US, Canada and Mexico have.”

More complicated is Brazil. Unlike the other major markets listed above, it is not an OECD country – and it has a rocky political past.

“Due to Brazil’s political issues, there has been a steady and important increase in public debt. So I think that brings uncertainty for investors,” says Paulo de Bessa Antunes, a partner at CMA Law specialising in Brazilian environmental law.

“The infrastructure that a country like Brazil needs – ports, transmission lines and railways – all these things are most likely to cross indigenous territories. So many infrastructure initiatives from the government are being challenged in the Supreme Court, and the last rulings have all been against the government’s decisions, as the administration has not been complying with applicable laws. So that brings more uncertainty.”

Escallon recognises this key risk but sees positives, too: “The country has matured a lot over the last decades, especially in regards to its institutions, and it has gotten to the point where most investors here are, I wouldn’t say fully agnostic about political risk, but there’s an expectation of consistency regardless of what the outcome of an election is. What is key is that this whole trend around the energy transition is apolitical, and it continues to be a major driving force in whichever administration that takes power.”

Bessa agrees: “Brazilians are learning to live without government. We are going to reach a point that no matter what the government thinks, the economy will move on.”

Overlooking El Dorado

Outside of these larger markets, excellent investment opportunities still remain in the region – if you know where to look. “Big markets will continue to drive the lion’s share of the absolute dollars invested in Latin America because of their size,” says Escallon. “But if you think of investment opportunities by themselves, we do find and see very attractive ones in some of the smaller markets. Sometimes in Central America or the Caribbean, there can be very interesting jurisdictions to invest in. These are markets that have dollar-denominated, long-term contracts, relative macroeconomic stability and regulatory sophistication.”.

Moreno agrees: “Central America, compared to South America, is much more behind in terms of infrastructure. And that creates, obviously, a big set of opportunities for their governments to set up PPP programmes. We have seen an opening of the Central American countries, especially the Dominican Republic.”

But he adds a caveat: “When you do a transaction in Peru, Colombia, Mexico and previously in Venezuela, you would see that the legal infrastructure was very flexible in terms of investments, in terms of how you register security interests and the timing and procedures associated with that. When you deal with countries like Paraguay, Nicaragua, Honduras, the legal infrastructure is much less sophisticated. So everything and every process with the local authorities takes longer.”

Sectors to watch

Ardian’s Andrade sees transportation, telecommunication and the energy transition playing a large role in the investment landscape, especially with recent PPP concessions in transportation, airports and hospitals by the OECD’s LatAm countries.

For telecoms, Moreno has his eye on Colombia: “They developed a 4G programme, and last year they launched a 5G programme to develop infrastructure. The country was fairly active in receiving investment and was fairly open to providing a variety of flexible possibilities to investors in dollars to develop those projects.”

Meanwhile, Actis is focused on energy. “We built some of the first private independent power producers in the region, like Kallpa in Peru,” Escallon explains. “We’ve built and owned some of the first renewable assets in the region, including the first wind farm in Latin America located in Costa Rica. We have built six renewable energy platforms in the region, gas platforms, and utilities, collectively building and owning well over 10GW across our history. That’s where a lot of the opportunity we see in Latin America lies.

“The electric grid is going to become such an important priority, especially post-covid. We’ve seen what happened in Texas, in California and Germany, etc. You need a lot of redundancy and resilience in your power grid, and those investments take time, take political will, take capital.”

The risk that remains

Despite showing promise, Latin America is, at the end of the day, a growth market. Bessa perhaps puts it best: “Latin America is always risky. But investors put a price on it.”

This price will vary greatly by country and administration, as Moreno explains: “When there is a change of government, there’s a big risk or a big opportunity, dependent on the political party or the president. However, in some countries like Colombia, that political risk can be mitigated through the hiring of local law firms, which will give investors comfort in the fact that the courts will follow the rule of law.

“I do think that perhaps because of the election of [Donald] Trump, investors have seen that even developed countries are not isolated from political risk and uncertainties. Any leader can say things on Twitter or on other media platforms that gain widespread attention and then never happen. So when that happens in Latin America, and nothing happens, people trust the checks and balances of the system more than they fear volatile leadership. In that sense, you might see that people are more open to have uncertainty at the level of the executive, as long as the Congress and the courts and the rule of law [are] protected.”

Should one conclude that now is the time to move investments to Latin America? Escallon thinks so. “Latin America has access to global capital markets. It has been embraced by sophisticated, global capital providers, and the interest is growing. It also has a very highly qualified talent base – in Latin America, you can more easily attract the smartest people in the region to industries like the energy transition.

“Yes, there is a finite amount of opportunities out there, but [with more players entering the market] there are now more collaboration and partnership opportunities, and the exit environment is more robust.”

As developed countries flounder in a post-covid macroeconomic crisis, Latin America might provide a solution. Investors, however, should keep in mind that both risk and opportunity will vary from country to country.