How infra investors in Brazil can avoid risks and reap rewards

Brazil's infrastructure sector has attracted a host of different participants and is among the country's most diverse.

But regulatory issues are still putting off potential investors.

Ricardo Simões Russo, an infrastructure and project finance-focused lawyer at Pinheiro Neto Advogados law firm, talks with BNamericas about the good and the bad.

BNamericas: What areas are infrastructure investors most interested in?

Russo: The water sector has attracted a lot of interest, both from the point of view of companies that invest in the contracts being offered and from that of participants interested in credit operations related to the sector. This interest is explained by the regulatory change [in 2020] and the great need for investment.

Another segment with a lot of business potential is urban mobility, including metro, VLT and BRT projects, as we see governments focusing on those.

Streetlighting continues to offer great potential for expansion.

In the ports area, I also see operations taking place. There is a lot of discussion about the fact that the privatization of Santos port should not happen, but if we look at other smaller ports, such as those of São Sebastião or even Itajaí, this possibility may indeed exist, in addition to the various other types of contracts being offered in relation to the leasing of port terminals.

The rail sector also has business going on. The government has made regulatory adjustments with the authorization regime, which helps diversify the transport network in Brazil, increasing the participation of rail lines in logistics.

Many highway contracts are still being offered. Sometimes we look at São Paulo state and think that most highways are already managed by the private sector, but if we consider the scenario in Brazil as a whole, a large part of the highways are still managed by the government, so there is much space for new concession contracts.

In the airport sector, as the large facilities are already granted to and controlled by the private sector, we would see some processes more linked to possible re-offerings of facilities that were granted in the past, but are not performing well.

BNamericas: And what about other sectors?

Russo: The government is raising a big flag regarding the energy transition. At the moment, Brazil has a strong electrical matrix in hydroelectricity, complemented on some scale by thermoelectricity, which has a large environmental impact. 

To change this scenario, I see that the focus is now more on solar and wind energy, with offshore wind as a frontier being explored and a little more in the medium-term, although the country still lacks [related] regulation.

Many customers are also asking about Brazil’s green hydrogen potential.

But one aspect worth mentioning is that the federal government's recent announcement of [infrastructure program] PAC made it clear that 40% of investments projected in the program have to come from the private sector, so we see many opportunities.

Furthermore, the states’ infrastructure agenda is quite relevant. São Paulo has a huge project pipeline, with the privatization plan for water firm Sabesp, the construction of the tunnel connecting Santos and Guaruja, new metro lines being built along with train lines.

BNamericas: What is the profile of players entering the infrastructure sector?

Russo: We've seen a little bit of everything. We see large local financial groups, such as Itausa, buying shares in [water firm] Aegea, we see CCR, which is an important infrastructure operator, participating in auctions, as well as the Equipav group, among many others. I also see the entrance of French, Spanish and Chinese groups.

In fact, with Chinese investors, I see an interesting movement as they enter the country, but these companies have a very strong energy transition focus, even looking at mining assets to meet inputs related to electric vehicles and batteries.

Sovereign funds such as GIC and Mubadala are present in large infrastructure projects too, as are some international pension funds.

But I still see a gap in the participation of local pension funds in projects.

BNamericas: Have large local construction companies absorbed the financial impact of the Lava Jato anti-graft probe and are gaining traction?

Russo: Maybe these companies can make a comeback, but there are practical obstacles in relation to compliance because many of these companies still have lawsuits pending. However, due to the high demand for infrastructure, there is room for a return of these companies. Large players have changed their profile and pushed deep changes in the sector.

In the past, these companies won concessions for the operation but also took over the construction of projects. Today we don't see such broad participation.

BNamericas: What are the main regulatory risks in Brazil?

Russo: It depends a little on the sector, but sectors such as water and rail have interesting existing regulations, while others, like green hydrogen, lack any regulation.

In Brazil, we also have a continuous risk factor related to political cycles, when the government may change every four years.

A point that is not necessarily a risk but worth mentioning is the environmental licensing process. Currently, if a project is not well structured, with all environmental risks well explained to the competent authorities, the license will not be granted or it takes too long to happen because the studies go through many revisions.

BNamericas: How has the ESG focus changed risk assessment?

Russo: We are seeing a big change in mentality that was closely linked to issues arising from corruption. Now, if a project does not include details on measures to combat corruption, slave labor and on compliance with environmental rules, the project does not move forward because it cannot obtain financing.

Furthermore, these obligations with best ESG practices must be respected throughout the term of the contract. A simple report in the media about a project's environmental or labor problem can lead to the immediate suspension of financing.

BNamericas: Are climate risks bound to become more important?

Russo: Maybe specific risks will at some point be considered more, but what currently exists are more generic mentions, such as force majeure situations.

BNamericas: How do you see the infrastructure role of development bank BNDES?

Russo: Going back in time a little, the entire regulatory framework for infrastructure debentures [local bonds granting tax exemptions] was designed during the previous PT [Workers' Party] administration, more than 10 years ago. I say this to make clear that it is a government that does not exclude private sector participation in financing.

In recent years, we have seen BNDES reducing its participation in financing and focusing more on structuring projects. It is realistic to imagine that we will see a scenario in which BNDES will finance infrastructure a little more directly.

But I think that in addition to BNDES, the entrance of pension funds and foreign financiers will be important. Currently, foreign investors are not so comfortable taking on an infrastructure debenture because this is a local bond.

Regulation is being evaluated in congress that extends the benefits of infrastructure debentures to overseas bonds issued by Brazilian companies related to infrastructure projects. If this regulation is approved, it will be extremely important because international funds will become more comfortable buying these international securities.