Taking a Chance Abroad
Companies looking to bid on emerging market P3 projects must take care. But while the legal and regulatory risks are significant, the rewards may be even greater.
ONE OF THE PRIMARY OBSTACLES preventing developing countries from growing more quickly is the lack of Infrastructure. Some 2.5 billion people in emerging economies do not have access to basic sanitation, according to the United Nations. About 2.6 billion have only limited access to electricity. Roads and telecommunication networks are also sorely needed. It goes without saying that this pent-up demand represents a huge opportunity for construction companies, banks, engineering firms and others involved in the creation of Infrastructure.
But players are moving cautiously, especially in Canada. Part of the reason, says Erik Richer La Flèche, a partner at Stikeman Elliott LLP and co-head of the firm’s Infrastructure group, is that there’s plenty of work in North America and Europe. Canadian Infrastructure companies are well regarded around the world after a string of successful public-private partnerships in British Columbia and central Canada, and for the time being their order books are full.
Plus, companies recognize that getting established in emerging markets involves a steep learning curve, says Richer La Flèche. Firms hoping to move into emerging countries “are going to have to devote a lot of senior resources to this; people are going to have to learn on the job.” He adds, “You’re going to have to learn to do business in a different environment. It’s very demanding.”
Still, the reward is there for those willing to make the investment.
Richer La Flèche declines to go into detail about his work, but it is safe to say his services are in demand. He has worked on Infrastructure projects in dozens of developing countries, including Cuba, the Bahamas, Costa Rica, Cuba, South Africa, Sri Lanka, Guinea, Senegal, Bahrain and Armenia. He’s acted for governments, corporations and lenders, so he’s familiar with the territory.
Most of the major players in the field are international firms headquartered in Europe or the US, and he suggests that some Canadian firms may stay away from developing world projects because they feel they lack the pedigree or name recognition of some of the dominant companies. But that is a mistake. “Canadians can compete against anybody provided the rules are public, well known, and there is transparency and integrity [in the bidding process],” he says.
Indeed, being from the Great White North can be an advantage because this country doesn’t carry a lot of cultural baggage — we’re the only G7 country that was never a colonial power, he says. And when it comes to countries such as Cuba, Canada never had an embargo, says Richer La Flèche.
More importantly, this country has had significant experience with P3s. Due to the high cost of roads, railways and other kinds of Infrastructure, governments are increasingly turning to the private sector to share the load in exchange for a piece of the profits, and the P3 model has become the vehicle of choice.
Starting in the early 2000s, Ottawa and the provinces embarked on a series of ambitious P3s. BC was the first, launching more than $10 billion of mostly transportation projects in the early 2000s. Later, Alberta and central Canada took the ball with the construction of new hospitals and more roads. Today, those projects are heralded as examples of how P3s should be done.
“The Canadian P3 experience is a large one. Canada, the UK and Australia are really at the forefront of the world,” says Richer La Flèche.
A key challenge for any major Infrastructure project in the developing world is credit. Many governments struggle to pay for essential transportation and power supply. Since regions like Africa and Latin America are often dependent on natural resources, government revenue tends to rise and fall with commodity prices, which means the money may run out before the project is built.
That’s usually not a major concern in OECD countries, but in the developing world, it should be top of mind for Infrastructure suppliers, says Douglas Younger, a partner at Aird & Berlis LLP and chair of the firm’s national Infrastructure team. Otherwise, they risk being left high and dry when it comes time to get paid.
According to Younger, there is a way around the problem. P3 deals come in several versions. One involves what are known as “availability payments,” or revenue streams that flow directly from a government to a construction firm or other provider. This includes payment to the company. In Canada, such structures typically involve hospitals or other public service projects supported by income taxes. But deals around availability payments can be tough to implement in some countries because “whoever the payor is, i.e., the government entity, has to have a very good credit rating,” says Younger, who advises clients to avoid such deals.
The solution: look for deals where payment comes directly from revenue generated by the project itself, such as tolls collected from users of a bridge, fees from a power project and so on. These are known as revenue deals. As long as the project is operating there will be fee revenue generated.
“Those deals are doable because the private-sector concessionaire is going to rely for payment not on the government but on the toll revenue or the revenue from operating the facility,” says Younger.
Another way to reduce risk is to work on projects sponsored by international organizations such as the World Bank, the International Monetary Fund and the African Development Bank. Not only do these so-called multi-lateral development banks bring cash to the table, they bolster the process by ensuring participants keep to an approved rule-based structure aimed at eliminating corruption — often a key concern.
They may provide some of the financing and they typically guarantee financing put forward by the other lenders. “Say you have three banks who are all going to chip in $1 million and then the World Bank says, ok, we will backstop the money that’s there or we will guarantee a certain amount more,” says Danna Donald, a partner at Osler, Hoskin & Harcourt LLP. In many cases, that guarantee is the difference between a project that’s financeable and one that’s not.
Increasingly, Canadian pension funds are also joining the fray. OMERS, Teachers and CPPIB, which have multi-billion-dollar Infrastructure portfolios in OECD countries, are starting to kick the tires in the emerging markets, and they’ve already embarked on a handful of projects. CPPIB, with US$316.7 billion under management, has 25.2 per cent of its global Infrastructure portfolio in Latin American assets. It recently opened an office in São Paolo, Brazil, and another in Mumbai, India. Canadian firms looking to get involved in developing world Infrastructure may find it helpful to team up with one of them.
Some lawyers “will say, if you are doing a development project internationally you need to pick a large international firm, with a depth of experience in financing these sorts of projects,” says Donald. Others “will say you need a local firm who is on the ground and who understands the culture, the permitting, the politics and all those pieces.
“But the answer is, you need a team. It’s actually not one or the other. The people who are the most successful at getting these projects done will have a team of lawyers, and they will use their lawyers to open doors, all over the world — so in Washington at the World Bank but also on the ground, connecting them with local counsel. [That way they will know] this is what the permitting website says, how long will this actually take and what is the risk that my competitor who is also buying up land next door will get their permit ahead of mine?”
It’s this kind of granular information that Infrastructure firms need to know before they start signing contracts. Sharon Vogel, a partner at Borden Ladner Gervais LLP and national leader of the firm’s construction group, advises clients “to think very carefully about the relevant risks, the nature of the project and the regulatory capacity in that country.”
Additionally, she suggests that firms consider contracts requiring that disagreements be settled through international arbitration as opposed to local legal systems. That way, there’s more certainty that rulings can be enforced.
Given the risks, it’s perhaps not surprising that many Canadian Infrastructure firms conclude the grass is greener on their side of the fence. The need for Infrastructure in the domestic market is healthy and they know the landscape. So why take chances? Judy Wilson, a partner at Blake, Cassels & Graydon LLP, argues that’s not the way to look at it.
Wilson has been involved in projects across Canada and in much of the developing world. Mostly, she’s worked on the government side. But she’s had the opportunity to experience successful projects and she knows firsthand that it makes sense for firms to consider broadening their client base.
“It’s a very busy market in Canada, but as we all know, you have to be conscientious about your diversity and your capability to grow. Anybody in Infrastructure has to be concerned about down the road. The low-hanging fruit can’t last forever. We have got to have another market to serve other than the Canadian market if we are to continue to prosper.”