Today Colombia is one of the stablest and best-performing emerging market economies, with the second-largest population in South America (after Brazil) and the 23rd-largest in the world. Its GDP has been growing at an average rate of 4.8% over the past 10 years, and in per capita terms it has doubled over the past dozen years, from $5826 in 2000 to $12,424 in 2014. Colombia’s credit rating has been labelled investment grade since 2011, with current ratings of “Baa2” by Moody’s and “BBB” by Fitch and Standard & Poor’s. For its regulations to protect foreign investors, Colombia ranks third-best in Latin America, according to the World Bank’s “Doing Business 2014” report. The country is also characterised by low inflation and a strong currency. Its more than 9700 active export companies sell to 181 nations, and it has 13 free trade agreements in force – five signed and three under negotiation. Colombia is also in the process of becoming a member of the OECD, showing the government is committed to demonstrating the country’s stability as a regional economy.
Yet Colombia still has challenges ahead. The biggest bottleneck to development is lack of infrastructure. Out of 140 countries measured in the World Economic Forum’s business environment and infrastructure index, the country places 103rd overall and 130th for its ground transport infrastructure. Throughout its history, Colombia has had low rates of public investment in roads, since public spending has been focused primarily on developing the energy sector. However, in the “Doing Business 2014” report’s Cross Border Commerce category – which evaluates the time, costs and requirements for import/export – the country ranks 93rd out of 185. High costs and excessive delays for cross-border transactions greatly affect its performance in the index.
Colombia must bring its infrastructure up to date, develop its ground transport systems and become a more competitive regional player. Its industry needs roads and railways in order to deliver products efficiently from the centre, south and west of the country to its ports on the Atlantic, Caribbean and Pacific coasts. With this in mind, and knowing the importance of ground transport as a means of moving cargo (at 71% of the total), the current government has made development of this type of infrastructure a priority. Without a doubt, this will have a positive impact on Colombia’s competitiveness and will provide its economy with one of the most important requirements for development.
As part of the long-term measures adopted by the government to develop Colombia’s infrastructure, the country has undertaken certain material legal reforms which aim to promote public-private partnerships (PPPs), increase and diversify financing sources for infrastructure projects, and create a more attractive framework for foreign investors and lenders who take an interest in Colombia’s key assets.
As a first measure, the government promoted the country’s first PPP law. Second, Congress enacted a new infrastructure law, which created new and important tools to shorten the processes and time related to land expropriations, among other things. Third, the government amended the pension funds’ investment regime, increasing the size of the bucket related to investments in private equity funds devoted to infrastructure. A fourth important step was a modification to the private equity funds’ investment regime to increase the amount of assets under management (AUM) that may be invested in debt securities issued by PPP concessionaires. The government also reduced the withholding tax rate that is applicable to any foreign financings granted to infrastructure projects. Finally, Congress enacted a new international arbitration law which modernised regulations governing the dispute resolution mechanism in Colombia in line with guidelines issued by the UN Commission on International Trade Law (UNCITRAL). All of this is great news for a country that needs to streamline its transport network.
First PPP Law
Historically, Colombia’s infrastructure projects have been developed and constructed through traditional public concession schemes established by the government. In 2012, however, the government passed Law 1508, Colombia’s first PPP law (the “PPP Law”). The PPP Law created a new regulatory framework to structure important PPPs for infrastructure projects that are deemed capable of attracting and retaining private investment.
The robustness of the current project pipeline shows that the PPP Law effectively created an appropriate and attractive framework. Nine new toll road concessions were awarded in 2014 and, as of March 2015, 10 other toll road projects were being tendered. As of May 2015, five unsolicited PPPs have been awarded, and another 206 have been filed by private partners and are under consideration by state authorities. PPPs in Colombia are currently thriving.
The PPP Law regulates both public and unsolicited PPP projects. Public PPPs originate from a state entity; unsolicited PPPs, from a private partner. Except for infrastructure projects related to public utilities such as water and energy, the PPP Law applies to all types of public infrastructure, including airports, ports, toll roads, railways and social infrastructure such as schools, hospitals and prisons.
By law, the concessionaire’s remuneration must always be structured as an availability payment and may be deducted if the concessionaire does not comply with required levels of service. Depending on the type of PPP, said remuneration will comprise income derived from the commercial exploitation of projects (e.g., tolls, tariffs) and, in some cases, from government payments. The PPP Law requires that the private partner be in charge of the project’s construction, refurbishment and improvement as well as operation and maintenance.
PPPs must have a minimum estimated investment of $1.5m. Even when this amount seems small for an infrastructure project, applicable law states that, unless the PPP is structured and divided into functional construction milestones, 100% of the concessionaire’s remuneration will be retained until the end of the construction period. However, if the project is divided into construction milestones, each of which must have a minimum investment of $28m, a partial remuneration will be available to the concessionaire upon completion of the corresponding milestone.
The maximum term of a PPP project in Colombia is 30 years including extensions, unless the financial structure of the PPP requires a longer term and the National Council for Economic and Social Policy authorises the extended term. It is required by law that PPP contracts include a liquidation formula to calculate the termination payment, which represents an important bankability achievement.
In addition to the common features described above, public PPPs have certain particularities vis-a-vis unsolicited PPPs. They require government payments which are not capped by law and, therefore, in terms of the concessionaire’s remuneration, commercial exploitation income will be supplemented by public contributions. Depending on the type of payment obligation held by the government entity, it will have different budgetary mechanisms for payment, including vigencias futuras (future budgetary allocations), which assure that in the future the state entity will include in its annual budget the corresponding owed amount.
Certain contingent liabilities assumed by the state entity under the PPP contract trigger its obligation to make cash contributions to the National Contingencies Fund (NCF) in order to cover risks allocated to the government. Furthermore, public PPPs must be awarded through public bidding processes. In terms of modifications to the PPP contract, it may be amended after the contract has been signed, but the amendment may not exceed 20% of the initial contract value. The government is also entitled to make in-kind contributions to the project, which may consist of pieces of land to be used in the PPP.
Unsolicited PPPs may also require government payments or contributions in cash. Unlike public PPPs, government payments for unsolicited PPPs are capped and may not be higher than 20% of the project’s estimated investment budget. By law, the estimated investment of the project comprises both its capital expenditure (capex) and its operational expenditure (opex). It is important note that, according to a recent interpretation by the Ministry of Finance and Public Debt, project risks that are allocated to the government and have a medium-high probability of occurrence must be provided for in the NCF. Every provision is deemed a cash contribution and counts towards the 20% limit stated above.
Furthermore, the general rule is that unsolicited PPPs are awarded by the government to the originator of the project through a short awarding process that, even when published and accessible to the general public, does not require a public bid. However, if government payments are required by the private partner, the unsolicited PPP will not be awarded through said simple proceeding but through a traditional public bid. It is important to note that, according to the PPP Law, the originator of the project will get extra points in the bid. In cases of unsolicited PPPs that do not require government payments but which get a letter of intent filed by a third party during the period in which the PPP is published and accessible to the general public, these have to go through a brief competitive process in which the interested third party will have the right to present a bid for the unsolicited PPP. Originators of the PPP will have a right of first refusal, however. In any case, if the third party is awarded the project, it will reimburse the PPP structuring costs and expenses to the originator.
Finally, in terms of project risks, it is worth mentioning that the materialised risks allocated to state entities under unsolicited PPPs without government payments or contributions will be compensated by an extension of the term of the PPP contract, an increase in the tariffs associated with the infrastructure (e.g., tolls, airport tariffs), an amendment to the scope of the project to reduce estimated capex and/ or opex, or through similar mechanisms that do not require payments in cash by the government entity.
Toll Road Concessions
Based on the PPP law, Colombia created the Fourth Generation Toll Road Concessions Programme (the “4G Programme”) in an effort to modernise its highways through the concession of an additional 6000 km of roads, bringing the total length of roads under concession to 11,000 km. The 4G Programme created a $25bn public PPP toll road pipeline, with 17 launched projects since 2014. Nine of these have already been awarded, while the remaining eight were being tendered as of March 2015. The government aims to invest 2-3% of GDP in the 4G Programme. This, the National Planning Agency estimates, will have a marginal 1.5% impact on the country’s GDP from 2015 to 2019 and create up to 450,000 jobs during the construction period. Once the 4G Programme has been fully completed, it is expected that cost overruns for transport and logistics in Colombia, which currently range from 10% to 15%, will be reduced along with road travel times.
Below are some general comments on a number of the most important aspects of the 4G Programme which, in our opinion, are innovative for the local market and which are based on the PPP Law (and its regulatory decrees):
Due to their size, projects will be divided into functional units. These are types of construction milestones but comprise a road tranche (tunnel or bridge) that is functional or serves a purpose on its own. The division of projects into functional units has an important impact on concessionaire’s remuneration, as described below.
This comprises three things; government payments aimed at remunerating construction of the infrastructure; tolls; and commercial exploitation income of certain surrounding road areas (e.g., petrol stations, restaurants, hotels). On average, government payments will represent 40-70% of the total remuneration, and the remaining 60-30% will come from tolls and commercial income. Upon a concessionaire’s request, government payments may be denominated in US dollars, in which case the concessionaire’s remuneration will be a combination of income denominated in dollars and income denominated in Colombian pesos.
Each project will have a cap for the US dollar amount, which typically represents 25-50% of the total government payments for each project. Tolls and commercial exploitation income will be 100% denominated in Colombian pesos. Concessionaire remuneration is structured as an availability payment. During the construction phase, the concessionaire will not be entitled to receive its remuneration. This will be paid only once a functional unit has been finalised and delivered to the National Infrastructure Agency (Agencia Nacional de Infraestructura, ANI). The purpose of dividing the projects into functional units is to allow contractors to start receiving part of their remuneration without having to wait until construction of the whole project is over. Each functional unit has a specific weight which determines the multiplying factor to calculate the percentage of the remuneration to be paid to contractor once that functional unit has been delivered and is available.
Concessionaire compensation may be subject to deductions upon breach or partial compliance with certain required levels of operational service. The deductions are capped at 10% of the monthly remuneration so that lenders may easily estimate income haircuts associated therewith for their base cases.
Even though no minimum revenue is guaranteed to concessionaires, traffic risk is undertaken by the government. On years eight, 12, 15 and 29 of the concessions, the ANI will perform partial traffic monitoring studies to determine if there is a difference between expected and actual traffic. A net shortfall will be covered in cash by that government entity. It is worth noting that, due to the low frequency of the studies, any liquidity risk arising from such shortfalls is assumed by the concessionaire.
Upon early termination of the concession contract, a liquidation formula will apply to calculate the termination payment for the relevant project. That payment is aimed at remunerating, in general terms, the invested capex (less fines and unpaid deductions). The government has insisted that termination payments for the projects will be sufficient to cover any outstanding debt of the concessionaire at any time during the life of the projects, even if the contracts are terminated beforehand due to an event attributable to those contractors. Obviously, each lending institution involved in a project will have to make its own financial analysis to check if, based on the debt-to-equity ratios of the relevant base case, the formula is sufficiently robust.
Some of the projects in the 4G Programme, as well as other infrastructure projects that will be developed in Colombia within the next decade, are “greenfield”, requiring an extension of land to be purchased or expropriated. Others are “brownfield” projects, which require new pieces of land for second or third lanes to be constructed and existing infrastructure expanded.
Historically, land acquisition processes in Colombia have been challenging and inefficient. When voluntary negotiations have failed, concessionaires have faced long judicial proceedings to get the expropriation order, causing delays and cost overruns. These judicial proceedings affect construction schedules, as the pieces of land may be retained by their owners until plaintiffs have won their claims.
New Infrastructure Law
As part of the government’s effort to address Colombia’s infrastructure shortage, Congress passed Law 1682 in 2013 (the “Infrastructure Law”). The Infrastructure Law provides additional tools to help concessionaries comply with their land acquisition obligations under the PPP contracts, among other duties. These tools include more efficient proceedings for determining the boundaries of real estate assets, setting their valuations and consequent prices, and gaining access to required lands in order to begin construction on time.
Under the 4G Programme and most likely all other infrastructure PPPs, acquisition or expropriation costs, and management of the processes involved will be the concessionaire’s responsibility. Prior to the enactment of the Infrastructure Law, local and international construction companies, sponsors, lenders, and advisors raised concerns about potential delays and cost overruns caused by judicial expropriation.
The Infrastructure Law strongly promotes administrative expropriation as opposed to judicial expropriation. It also took the important step of declaring 100% of the land required for PPP infrastructure projects as “lands of public and social interest”. This constitutes an important milestone as the real estate assets required for PPP projects may be subject, by law, to administrative expropriation without the need for a future ad hoc analysis of the relevance of the project and the importance of the asset involved.
In addition, the administrative proceedings for expropriation are carried out before the PPP public partner – the ANI, which awards the PPP – and not before a judge. This is simpler and much more efficient than the judicial type of process. The Infrastructure Law even allows the use of police force by concessionaires to get access to the real estate assets that have been expropriated if the owners do not deliver the relevant piece of land within 15 business days following the date on which the PPP public partner ordered the expropriation. Disputes in connection with the price will not stop expropriations as, even when they are part of the expropriation process, under the Infrastructure Law they will be solved in a short period of time so that no delays are caused by price-related disputes. Provisions of the Infrastructure Law will shorten the average duration of the expropriation process for real estate assets required for PPPs to approximately three months.
Capital Needs & Financing Sources
Estimated investments for each of the 15 initial projects of the 4G Programme will range between $0.5bn and $2bn per project. The unsolicited PPPs will also be intense in capex and opex and, as the majority of them are not expected to have government payments or contributions, sponsors will need to rely even more on lenders and investors to finance their projects.
Diverse and multiple financing sources will therefore be required in order to supply sizeable capital requirements. Structured financing schemes will be necessary. Some of the projects may need a mixture of a capital markets tranche and a traditional lending ticket, which could open the possibility of longer tenures or maturity dates and will allow more efficient debt-to-equity ratios. Due to the size of the projects and the applicable limitations on credit risk exposure, Colombia needs to rely on the banking sector and on the capital markets, as well as on institutional investors. Both foreign and local players are expected to be active and to take an important financing role even during the projects’ construction phases.
Conscious of these capital needs, the government and Congress have adopted the following reforms, in order to allow a more active participation in PPP financing by institutional investors and private equity funds, and to reduce certain financing costs that were being triggered by the tax treatment applicable to foreign loans as well as to securities issued on international capital markets
Pension Funds Reform
Colombia’s regulated investment regime for pension funds does not provide a specific asset class for infrastructure projects. Pension funds may invest in infrastructure assets by investing in private equity funds and in debt securities issued by the PPP private partner. Investing directly in said debt securities is an option that probably triggers the necessity of having an internal and well-developed due diligence team that specialises in infrastructure assets (e.g., construction risk, sponsor analysis, project finance). The advantage is that if a certain pension fund is ready to commit to an investment, it will be allowed to invest up to 60% of its AUM (subject to certain credit limitations per issuer).
Another option is to gain exposure to infrastructure assets through an investment fund which will be in charge of performing the initial due diligence and monitoring the investment throughout the life of the infrastructure project. Before the second quarter of 2014, the investment bucket for private equity funds was limited to 5% of the AUM regardless of the nature of the underlying investments. As part of the measures adopted by the government to diversify and increase the financing sources for the upcoming PPPs, Decree 814 of 2014 was enacted in order to create an additional bucket for private equity funds that invest at least two-thirds of their portfolio in PPP projects. Pension funds may invest up to 5% of their AUM in this bucket, which will not count towards the 5% of the general private equity funds bucket. Therefore, a pension fund today may invest up to 10% of its AUM in private equity funds, 5% of which must be targeted to private equity funds which invest up to two-thirds of their AUM in PPPs.
Private Equity Reform
According to applicable laws, private equity funds may only invest one-third of their AUM in securities; the other two-thirds may be invested in any other type of assets. By the second quarter of 2014, through Decree 814 the government added to private equity funds’ investment regime by stating that investments in assets aimed at financing PPPs will count towards the two-thirds bucket even when the assets in which the investment is made classify as securities. Investments in PPP projects may be made with 100% of AUM even if the private equity fund invests more than one-third of its AUM in securities. The new regulation also clarified that private equity funds are allowed to grant loans and purchase existing loans with their AUM, provided that the proceeds are used to finance a PPP project. The government has diversified PPP financing sources with this reform. Today, between three and four private equity funds focused on infrastructure PPPs have been incorporated in Colombia. It is expected that these funds will be active lenders and investors in the 4G Programme as well as in other infrastructure PPPs.
Withholding Tax Reduction
In line with the financing needs of the 4G Programme, the government is committed, for the first time, to make part of its payments/contributions under said projects in US dollars. Therefore, part of the government payments under each 4G project will be denominated in said currency. This has opened the door for a naturally hedged financing in US dollars to be granted by foreign lenders to local concessionaires. Moreover, even when the financing might not be naturally hedged, foreign financing facilities are robust and diversify the financing sources that may be used to fund PPPs.
Up until December 2014, as a general rule, the withholding tax rate applicable to interest payments under foreign loans and debt securities issued abroad was 14% (when the loan’s tenor was greater than one year). In contrast, the withholding tax rate for local loans and local securities ranged between 2.5% and 7%. With the tax reform passed by Congress at the end of 2014 (Law 1739 of 2014), the withholding tax rate applicable to foreign loans and foreign securities was reduced to 5% as of January 1, 2015, provided that (a) the tenure of the loan or the notes is more than eight years, and (b) the proceeds of the credit facility are used to finance a PPP project.
The history of arbitration in Colombia has much evolved over the past few decades. Even though the country’s new arbitration statute, Law 1563, was enacted in 2012, arbitration has gained new importance in the PPP world since 2014. One element of this is the Infrastructure Law of 2013, which specifically promoted arbitration as a dispute-resolution mechanism for OBG would like to thank Philippi, Prietocarrizosa & Uría for its contribution to THE REPORT Colombia 2016. the PPP infrastructure contracts described earlier in this article. The Infrastructure Law explicitly states that the parties to a PPP contract are free to choose between alternative dispute-resolution mechanisms, which include both national and international arbitration. This option brings multiple benefits for both the PPP public partner and the PPP private partner, and has explicitly opened the door for international arbitration in the context of PPP projects. The move has been applauded by many foreign private partners who prefer and feel more comfortable with having an international arbitration clause in their contracts.
Before this new arbitration statute was passed by Congress, international arbitration was insufficiently regulated in Colombia, and thus its applicability was weak. The new arbitration law is based on the Arbitration Law Model issued by UNCITRAL, which is widely known around the globe and is considered to contain some of the best practices of international arbitration currently in use. This law model helped to modernise Colombian regulations on this matter, making the applicability of international arbitration clearer and stronger. As a result, business parties will be fully entitled to select international arbitration as their dispute-resolution mechanism – provided, of course, that the parties/contract meet with the legal requirements to dispense with local arbitration.
In regards to the benefits that this new statute brings in terms of international arbitration, it is important to mention four specific aspects that emphasise its advantages. First, the law enables the parties to freely designate the arbitrators for the arbitration panel, who may be foreign lawyers not admitted to the Colombian bar, Colombian lawyers and/or professionals from disciplines different from the Law. Second, in terms of the international arbitration award, it is not necessary to carry out an official government recognition process in Colombia (known as exequatur) to be able to enforce it before Colombian courts, provided that the seat of the arbitration panel was in Colombia. Third, the parties to a contract that has an international arbitration clause are free to choose the substantial applicable law for the dispute resolution mechanism, as well as the procedural law that will be applied by the arbitrators to the dispute. Finally, because the arbitration law is based on the UNCITRAL model, it will sound familiar to foreign sponsors and investors doing business in Colombia.
The positive impact that this new arbitration law has had in Colombia is evidenced by the nine awarded 4G concession contracts described earlier, all of which give the alternative of choosing between international and national arbitration. If the parties to the relevant PPP contract meet the criteria to dispense with local arbitration, they will be allowed to solve their disputes before an international arbitration panel. This has been an appealing aspect of the PPP contracts for a number of foreign investors.
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