Rolf Lindsay and Nicholas Pattman examine how private equity is filling the gap left by diminishing state funding for investment in Latin America.
Private equity is filling the gap left by diminishing state funding for much-needed investment in infrastructure and energy projects in Latin America, and this has led to more firms looking to raise capital to invest in the region.
It is a lesson that Latin America could usefully learn from Asia: the economies that have done best have embraced the free flow of capital. Over the last 10 years, the economies of East Asia and the Pacific collectively have grown impressively, with a high of 12 per cent in 2007 and never less in any one year during that period than seven per cent. By contrast, the economies of Latin America and the Caribbean have never grown collectively by more than six per cent in any one year (also in 2007) and are predicted by the IMF to have grown by one per cent in 2014 and to grow by two per cent this year.
No country illustrates this wisdom of opening its economy to foreign capital better than China. Since 1979 China’s economy has grown, on average, by ten per cent a year. Between 1985 and 2013, the country attracted close to US$1.5 trillion in foreign direct investment, according to UN statistics, and is still bringing in some US$120 billion a year in FDI. If you compare China with Brazil, Latin America’s largest economy, Brazil’s more restrictive approach to the free flow of capital has coincided with growth of no more than three per cent, and from comparable invested capital (relative to the population). From comparatively similar starting points, the difference is so marked that China has pledged to invest US$250 billion in Latin America over the next decade.
Latin American Opportunities
That Latin America needs investment is in no doubt. There is a huge need to build infrastructure, transport and oil and gas projects. The burgeoning middle class has an insatiable need for power and services, while the extension of basic utilities to remote towns or developing urban areas presents its own challenges and opportunities. It is not surprising, then, that local government is a major investor.
However, government investment has been cramped by the dramatic slide in oil and commodity revenues, which in many cases is their most significant source of revenue. Adding to their plight is a shortage of traditional financing mechanisms.
Private equity investors are clamouring to fill the funding gap. In the last five years, private equity has raised some US$48 billion to invest on the Latin American continent. More than a dozen prominent global PE houses have invested in Brazil alone since 2007, in addition to local firms and funds. Fundraising by the industry’s leaders has returned to levels not seen since the global financial crisis, though with a greater focus on funds that are specialised in terms of geographic and industry sectors. Brazil and Mexico are the recipients of the lion’s share of PE funds investments. While this investment is significant, Latin America still only attracts a relatively small proportion of overall PE investment, including PE funds, which approached US$800 billion in 2013/2014. The potential to attract greater PE investment is clearly considerable.
There are many reasons why there has not been more PE investment in Latin America, ranging from government imposition of controls on export of capital to the outdated view, at least in some circles, that offshore jurisdictions such as the Cayman Islands are considered to be a ‘fiscal paradise’ rather than legitimate domiciles of funds that serve as the most efficient structures to pool PE investments. This has meant that the very direct wealth generation benefits afforded by the efficient deployment of international investment capital are lost at a time when they are most needed.
However, that position may be softening. A more enlightened approach by the government in Mexico has recognised both the need to attract private investment in the oil and gas industry and the advantages to be gained from raising capital in international financial centres such as Cayman. The sea change in Mexico’s attitude has not gone unnoticed by investors: in just the past few months we have received a number of enquiries from clients looking to establish Cayman Islands fund structures to invest into Mexico.
Cayman Island Benefits
The Cayman Islands has long been established as the jurisdiction of choice for private equity fundraising. The reasons for the preeminent position of the Cayman Islands as a jurisdiction used for PE structures are not hard to identify: the jurisdiction offers a well-developed legal structure under a flexible statutory regime and within a common law system renowned for its sensible approach to commercial disputes, which is particularly welcome when investing across borders. Regulatory transparency and a robust AML regime provide peace of mind to investors and regulators alike. All of which affords fund sponsors the ability to raise capital efficiently in a tax-neutral environment, and to structure complex acquisition vehicles with infinite flexibility.
The world’s most prominent financial institutions and international investors see the Cayman Exempted Limited Partnership (ELP) as the favoured vehicle for the efficient pooling of international capital. ELPs cater for the primary PE investor requirements, by facilitating fund sponsors to structure and manage entities with many investors and allowing for a variety of strategies and multiple layers of debt and equity that can be managed efficiently, effectively and productively in a multi-national environment. Recently updated legislation has ensured that the Cayman product remains at the cutting edge.
It is inevitable in the energy and infrastructure space that transactions tend to cross national borders, and this is particularly so in Latin America. Transactions can be complex and fraught with political risk, and the benefits of neutrality and sophistication offered by the Cayman Islands courts should not be underestimated.
Hope for the Future
The situation is certainly improving. Myths surrounding offshore jurisdictions are being debunked, and a greater appreciation of the very significant and direct benefits afforded by capital raised in the IFCs is gaining ground. Private equity holds the key to investment in major projects on the continent and to unlock a new phase of economic growth and prosperity for its citizens.
Nicholas is Senior Counsel in the Walkers’ Cayman Office and advises asset managers, sponsors and financial institutions in the United States, Latin America and internationally in relation to the structuring, formation and ongoing operation of hedge funds, private equity funds and other alternative investment vehicles employing a variety of investment strategies. As a member of the Global Latin America Group, a major part of his practice involves advising clients located in or connected to Latin America, in particular Brazil, on a broad range of transactions both into and out of the region.
Rolf Lindsay is a partner in Walkers’ Cayman Office and has extensive experience advising a broad range of clients in relation to the structuring, formation and management of general partners and the alternative investment funds controlled by them. A significant part of his practice involves advice in relation to mergers and acquisitions, initial public offerings of securities, secured financing facilities and derivative products, both within the private equity context and more broadly. Rolf also leads regular seminars in relation to the legal and practical issues affecting alternative investment fund formation and Cayman corporate and transactional matters.
Bermuda, British Virgin Islands, Cayman Islands, Dubai, Guernsey, Hong Kong, Ireland, Jersey, London and Singapore.