'Viva la infraestructura: Mexico – the Latin tiger'

The future for Mexican infrastructure has never seemed brighter with President-elect Enrique Peña Nieto set to take power. It has been a long march from the infamous days of the Tequila crisis in 1994 that brought with it a crushing end to Mexico’s initial efforts to foster private infrastructure investment. Today, the country presents a compelling set of conditions that should intrigue any party interested in developing and investing in its infrastructure.

The lessons learnt from the 1994 crisis were taken to heart by both government and private sector before the country, in 2004, recommenced the search for private investors for a new generation of infrastructure projects.

The Mexican government incorporated best practices and expertise by following closely the UK’s Private Finance Initiative (PFI) experience. The legal framework for concessions was strengthened, technical expertise was sourced from private parties to support government skills, and the government harnessed an improved role for its development banks while creating new agencies to support private participation.

Better understanding

On the private side, banks established proper project finance departments, construction companies became sophisticated and thorough in their analysis of risk and its allocation, investors gained a better understanding of the risks and returns inherent in the asset class, and international bidders, attracted by the incipient success of the programme, provided healthy competitive tension.

Harnessing the lessons from the failed experience of the past enabled the solid platform on which current optimism in Mexico’s infrastructure is grounded.

There is hope that Peña Nieto’s team will get things kick-started with an ambitious new version of the National Infrastructure Program (NIP) in early 2013. The new programme would likely include significant initiatives and investments including gas pipelines worth up to $12 billion to upgrade capacity for importing from the US; a necessary new airport for Mexico City ($5 billion to $12 billion) to replace the existing one which is bound to become saturated within the next four years; and the continued privatisation and upgrading of the FARAC  road network still managed by CAPUFE  (the government’s highway operator).

As many know, some of the above projects have been high on the list of priorities for quite some time. The difference now is that incoming president Peña Nieto, with a disciplined party behind him and a more supportive Congress, will be able to execute more efficiently than the outgoing administration. The President-elect was extremely successful in his previous posting as governor of the State of Mexico, completing numerous key infrastructure initiatives and should be able to continue this on the national stage. Peña Nieto’s plans will also benefit from a recently passed public-private partnership (PPP) law that clarifies the rules and strengthens the legal framework for all parties.

Challenges

Still, Peña Nieto will have his share of challenges to deal with. For instance, in spite of the massive investment required to take advantage of Mexico’s vast energy resources, private participation is limited solely to the provision of services to Pemex, the country’s oil monopoly. Energy reform intended to increase private participation is on the cards, but such reform requires complex constitutional changes and it is uncertain that it would be approved by Congress.

Security is another glaring issue lingering in the minds of investors when considering Mexico. Although isolated to certain areas, drug-related violence has become a national issue with repercussions for any future development. While no major project has been cancelled on the basis of security threats, Peña Nieto’s government needs to ensure that it remains this way.

Investment capital, long a scarce resource when developing infrastructure projects in Mexico, became widely available to help complete essential projects with both debt and equity sources keeping financing flowing during the recent global credit drought.

Banobras, the infrastructure state development bank, has been instrumental in ensuring that viable infrastructure projects of high social benefit are funded. It bridges the gap between the debt required to complete projects and that which is being provided by commercial banks. Mexican-based banks like Santander, Bajio, Banorte, Interacciones and BBVA have picked up the slack left by the retrenchment of the European banks and, in the process, established solid in-house project finance teams.

The National Infrastructure Fund (Fonadin), a trust managed by Banobras, has deployed a wide array of financial instruments designed to foster private participation in the delivery of projects along the spectrum. Since its inception in 2008, Fonadin has provided $8 billion-plus in the form of equity, subordinated debt, guarantees and seed investments for infrastructure funds. Under the helm of its managing director, Federico Patiño, Fonadin has done a superb job in promoting Mexican projects as an attractive alternative for global investors and it’s the first stop for anyone interested in entering the market.

Poor documentation

Local and international bidders constantly raise concerns about the lack of coordination and the poor quality of documentation provided by the various ministries and government agencies when tendering for projects. A logical proposal for the new administration, considering Fonadin’s highly technical and financial in-house expertise and its intimate knowledge of investors’ requirements, would be to provide it with an enlarged mandate in order to better coordinate government entities throughout the procurement process up to financial closing.

Furthermore, by possibly granting Fonadin independence from Banobras, it would help both entities in avoiding potential conflicts when projects become distressed since they both participate in their distinct roles: the former as an equity investor and the latter as a debtor. 

Perhaps the most exciting development – and the one with the biggest potential to provide long-term sustainability to the push in Mexico for better provision of public services and lasting competitiveness through infrastructure – has to do with the arrival on scene of the Mexican pension funds, the Afores . The Afores collectively manage $130 billion-plus in assets today and are expected to be managing up to $300 billion within the next five years. The Afores are likely to be the most reliable source of financing for infrastructure in Mexico in the foreseeable future.

Arrival of the CKD

In 2008, pension fund regulations were amended to allow for the creation of special investment vehicles through which the Afores could invest a percentage of their assets under management (AUM) in alternative assets including infrastructure . These investment vehicles are called CKDs and by law they are required to be listed on the Mexican Stock Exchange.

The listing requirement, in principle, might not make the CKDs appealing to some international investors focused on unlisted vehicles. However, plans are afoot to allow the CKDs to invest not only in Mexican infrastructure but also in international projects. This is likely to generate the interest of some international managers eyeing the possibility of tapping a bountiful new source of funds. It should also reduce the possibility for the Afores to participate in a race-to-the-bottom with their returns if at any point in the future the pipeline of local projects becomes constrained.

Boston Infrastructure Investments (B2i) has been at the core of CKDs’ development since their inception. B2i crafted the first approved structure by the regulator for an infrastructure fund and was placement agent for MMIF, the first infrastructure fund listed as a CKD.

B2i is currently in the process of developing two new investment vehicles that will combine the interest of Mexican pension funds with that of international investors.

On the construction side, the robust project pipeline has allowed Mexican construction firms to regain their footing and to participate vigorously in the competition for new projects. Their backlog is increasing and with it, their ability to raise funds in the market. Suffice to say that recently, the market cap of Ideal, an infrastructure concession company listed on the Mexican market and owned by Carlos Slim, topped the combined market value of three of the top five Spanish infrastructure companies.

The Mexican infrastructure opportunity looks significantly enhanced when you consider other favourable trends:

*The discovery of significant shale gas resources on both sides of the Mexico-US border is likely to provide an abundant source of cheap energy to Mexican industry for years to come;

*The convergence in the not-so-distant future of labour costs between China and Mexico; and,

*The recovery of the US economy.

These trends, when coupled with the stable and prudent management of Mexico’s public finances, its strategic location within the world’s second-largest trading block and the access provided by the largest number of free trade agreements in the world, make a compelling case for considering Mexico’s infrastructure an opportunity not to be missed.

B2i has been at the core of developing Mexico's CKD market since its inception in 2009. B2i crafted the first approved structure by the Mexican regulator for an infrastructure fund and was placement agent for MMIF, the first listed CKD infrastructure fund of its kind in 2009. B2i is currently in the process of developing two new investment vehicles that will combine the interest of Mexican pension funds with that of international investors.