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Currency risk in infrastructure financing and foreign exchange hedge mechanism


Ricardo Simões Russo; Rodolfo Figliolini Schreuders

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​It is unquestionable that the infrastructure sector in Brazil calls for heavy investments for the country to become competitive in the global economy. Economic indicators show that around 1.7% of Brazil's Gross Domestic Product (GDP), on average, has been recently invested in infrastructure projects. According to experts, however, to foster the competitiveness of the Brazilian economy, annual investments equivalent at least to 5% of the GDP would be necessary. In this context, studies indicate that R$ 8.7 trillion should be invested in Brazilian infrastructure between 2018 and 2038 to plug the current investment gap. So it is clear that foreign private capital may play an important role in achieving this goal.

Long-term infrastructure projects in Brazil are traditionally financed by the National Bank for Economic and Social Development (BNDES), either directly or through other lending financial institutions. An alternative financing source – which has been gaining more and more traction – is the Brazilian capital market, more specifically the so-called incentivized debentures (or infrastructure debentures). Infrastructure debentures have been an important alternative in infrastructure project financing, in particular in the energy, transportation, telecommunications and sanitation sectors (the aggregate capital raised up to July 2019 reached around R$ 65 billion).

To attract both domestic and foreign capital for infrastructure financing, incentivized debentures offer investors (non-resident and resident individual investors) full exemption from income tax otherwise payable on interest due by securities issuers.

In addition, other mechanisms have been created over recent years as a means of attracting more foreign capital to finance infrastructure projects, such as depositary receipts (DRs) backed by debt securities (infrastructure debentures, for instance).

Such mechanisms, however, have not attracted sufficient foreign capital, mostly due to the currency risk involved (specifically for foreign investors as infrastructure debentures must be denominated in Brazilian currency).

Given the need to attract foreign capital to boost infrastructure financing, the Federal Government, the private sector, lenders and diverse sector concessionaires have been talking to identify better foreign currency-denominated financing alternatives for infrastructure projects, among which are those targeted at mitigation of currency risk.

In this regard, below are some of the alternatives currently being discussed:

(i) foreign exchange hedge for long-term financing projects. The challenge in this alternative is the cost involved once infrastructure financing transactions are long term;

(ii) the inclusion of a fee component in US dollar (or another foreign currency) in the revenues of concessionaires, similarly to what was done in other Latin America countries;

(iii) the currency risk insurance, which could be provided by governmental bodies (for instance, by the Brazilian agency known as Agência Brasileira Gestora de Fundos Garantidores e Garantias – ABGF) to cover some of the currency risks related to funding in foreign currency; and

(iv) the creation of a fund, composed of a portion of the fee payable to the concessionaire and/or of a portion of the grant fee payable to the government, such funds to be used in case of foreign exchange fluctuations beyond a given range.

Recently, in line with its efforts to improve and boost funding in foreign currency by infrastructure project operators, the Federal Government has proposed, through Public Hearing No. 10/2019 of the National Land Transportation Agency - ANTT) dealing with concession of the Highway System BR-381/262/MG/ES, a "foreign exchange hedge mechanism" that may be adopted in highway and other sector concessions.

Under that mechanism, concessions would contemplate a variable grant fee (outorga variável), equal to 6% of the gross revenue, to be paid quarterly by the concessionaire to the granting authority. In brief, if the concessionaire at its sole discretion elects to adopt the foreign exchange hedge mechanism against the negative impact of foreign exchange fluctuations on long-term financing in foreign currency, the concessionaire will qualify for monthly offsetting of the variable grant fee payable to the granting authority.

Another important aspect concerning infrastructure financing in foreign currency is the possibility of creating rules that offer tax-advantaged treatment for lenders. For instance, as it happens with foreign investors acquiring infrastructure debentures, such transactions could be exempt from income tax due on the interest paid by long-term borrowers.

Considering the different alternatives to mitigate currency risk in infrastructure projects, and regardless of the means such risk is actually hedged under any hedging mechanism, it is essential to define an alternative that channels a significant volume of foreign investments into infrastructure financing in Brazil.

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