Innovating the Cooperation in Industry and Financing between China and Latin America
By Edwin Zhiguo Li
Dacheng Law Offices, LLP
May 2016
In recent years, economic cooperation and exchanges between China and Latin America have become increasingly close, and the Latin American market has attracted much attention from Chinese investors. China is implementing policies to cut overcapacity, adjust structure and promote economic transformation and upgrading. How to use the capacity complementarity between China and Latin America to promote investment has become an issue of great concern. According to the 2015 annual analysis report, China and Latin American financial database is Latin America’s largest investor in China. Against this background, how Chinese investors seize the new opportunities of China-Latin America production capacity cooperation has become a new problem faced by Chinese enterprises that have invested or intend to invest in Latin America.
Opportunities and challenges
- Opportunities
At present, the Latin American market as a whole still needs a large amount of foreign investment to boost the domestic economy and employment. In the area of infrastructure, according to the report of the United Nations Economic Commission for Latin America and the Caribbean (ECLAC), investment in infrastructure will increase from 3% to 6.2% of GDP across the region. In order to achieve economic development goals in 2020, Latin America needed money will reach $320 billion a year. Latin America itself can’t provide such a huge sums of money, how to get the external financing became the various countries’ concerns.
In addition, the region’s industrial base is relatively weak, in Argentina, for example, its basic national economy dependent on agriculture, it is moving production to China provides a direction for export. Combined with the development of agriculture, energy and mineral industries in Latin America, China should focus on promoting industrial chain and bundled investment in Latin America, which will be a major opportunity for Chinese enterprises in Latin America in the future.
2. Challenges
We need to note that among these opportunities, Chinese investors will also face some challenges in the near and medium term. At a time when economic growth is slowing across the Latin American region and negative growth is widely predicted for 2016, Chinese investors and engineering companies will mainly face the following challenges.
First, the slowdown of global economic growth and the new normal of China’s domestic economic growth will directly affect the export trade of Latin American countries.
Second, constitute a Latin American economic mainstay fall in commodity prices of raw materials, make the resource dependence strong countries, such as Chile, Peru, Brazil, Argentina, etc., exports have been a strong shock. Since 2014, the international commodity prices are weakening, while trying to improve, but there are still hovering at the bottom of the uncertainties, affected by the economic and employment of Latin American countries should continue in 2016.
Third, as a result of Latin America’s financial system are greatly influenced by global volatility, a substantial decline in the currencies of Latin American countries now. With the arrival of the US dollar interest rate hike channel, the trend of capital flow back to the US will be more obvious, and the Latin American market economies will still be affected by the “return to the US” capital and political uncertainty in 2016.
Fourth, political turmoil. The current government in many countries of Latin America is facing increasingly serious political instability, the public dissatisfaction with corruption, unemployment and other issues and complaints are gathered. The recent demonstrations in Brazil, for example, are a manifestation of the discontent with the current and former presidents that has plagued Venezuela and Argentina, among others. Although usually not happen similar to some African countries of Latin America that social unrest, but still can cause the concerns of the foreign investors.
In the face of these challenges, Chinese investors should make full use of the advantages of abundant domestic capital and the policy of transferring superior production capacity to speed up the pace of layout in Latin America. What is currently lacking in Latin America is the initial/equity investment funds needed to launch relevant projects. Chinese enterprises can fully solve this critical funding gap by using their own funds or with the help of the China-CELAC Fund and the China-CELAC Cooperation Fund. On this basis, the reuse of regional financial institutions outside the territory of the people’s money, realization of project financing arrangements. On the other hand, Chinese enterprises have rich experience and strong strength in infrastructure planning, design, project management and operation, which will greatly enhance the credit of the whole project financing.
The transformation of cooperation mode
At present, China has set up two funds for Latin America — the China-Latin America Production Capacity Cooperation Investment Fund and the China-Latin America Cooperation Fund. The former is led by China Development Bank and incorporated in accordance with relevant Chinese laws and regulations. The latter is led by the Export-Import Bank of China and incorporated overseas. The China-Latin America Capacity Cooperation Fund has already stepped in and played a pivotal role in the 2015 deal for China Three Gorges Corporation to acquire concessions for two hydroelectric plants in Brazil. This is a merger and acquisition transaction, although there is no project financing component, but as the first large transaction in Latin America involved by the China-CELAC Capacity Cooperation Investment Fund, it has fully demonstrated the effect brought by the combination of Chinese capital and professional companies. Therefore, Chinese enterprises in Latin America should enter the local market from two dimensions. The first is acquisition, which means acquiring target companies or assets through the leverage of domestic financial institutions; The second is greenfield investment, which uses funds from domestic financial institutions or special funds to provide funds needed for project equity investment and project financing.
Of the melting production cooperation between still have huge space. With years of experience in overseas market development, Chinese project contracting enterprises should focus on exploring the infrastructure market in Latin America in two directions.
The first is to expand upstream into the raw materials sector. From the perspective of industry, Chinese EPC engineering enterprises should make full use of China’s capital, supporting capacity, engineering experience and technology and other advantages, and cooperate with relevant domestic entities to invest in Latin America. For example, China’s two new railway projects, the proposed construction will Brazil and Peru across Latin America and other countries and regions. Under the leadership of the China Railway Corporation or relevant leading parties, it is perfectly possible to cooperate with the governments or enterprises of the participating countries to transfer China’s superior production capacity, such as steel, manufacturing and cement, to the corresponding countries in Latin America. In addition to laying a material foundation for the implementation and operation of engineering projects, it will open important markets for the internationalization of Chinese enterprises.
Second, it extends to the downstream of the industrial chain. The participation of engineering enterprises in the operation of infrastructure themselves or in cooperation with other entities will be the key to future investment in the Latin American market. The benefits of such long-term operations are the ability to obtain long-term stable returns, improve profitability and enhance the ability to resist risks. Can also through the operation in the local establish a good reputation, lay the foundation for other projects in the future acquisition, business development model transformation engineering enterprise guerilla.
In the process of these two kinds of industrial chain expansion, engineering companies is not needed to control, but the cooperation of open mode, with the upstream and downstream of the Chinese enterprises to form a consortium of some kind or a consortium, strengthen cooperation with the local government for negotiations, and achieve the goal of disperse investment risks and increase profitability.
Risk averse
The risks faced by Chinese companies investing in Latin America cannot be ignored. In order to improve the success rate of investment in Latin America, it is necessary to control risks from the following aspects.
First, whether buying or greenfield investment, be sure to hire a professional third party consultants, such as lawyers, accountants, environment and human resources consultancy, etc., on target and invest in local market access in the host country to fully analysis and due diligence. Consultants should be involved in the whole project process, including tender preparation, agreement drafting, negotiation, delivery and daily operation, and listen to their advice carefully.
Second, currency devaluation is the current and future quite a period of time to invest in Latin America and key risks involved in the project construction. Enterprises should actively seek insurance coverage, especially for nationalization, foreign exchange restrictions, war and riot, government default and other risks, must take insurance as an important way of risk diversification. The risk of depreciation of the local currency still needs to be diversified through the corresponding clauses in the contract, foreign exchange forward transactions and payment schedule.
Third, local subcontractors should be reasonably used to carry out engineering projects to reduce risks in terms of project delay and foreign exchange.
Fourth, in addition to the cooperation between Chinese enterprises to actively with the international or local businesses and other organizations to carry out cooperation, each subject of interests bind together, reduce the resistance from all sides, greatly improving the success of the specific project opportunities, so as to realize the real win-win situation, to win more.
Suggestions on the development of project financing
In the current under the background of Latin American countries in recession, China’s enterprises to invest in Latin America and engineering contracting business, financial advantage to become a key element, which has no recourse or limited recourse project finance will become the core. There are only a few government-to-government projects or double-prime loan projects between China and Latin American countries, which cannot meet the needs of Latin American countries in infrastructure, electricity, mining and agriculture. While Chinese financial institutions, we lack experience in the region to carry out the project financing, Chinese enterprises should be more through the use of international or Latin American regional multilateral financial institutions on specific projects to carry out the project financing.
First of all, should understand these regional multilateral financial institutions to their respective functions, covering area and industry and project financing conditions. Multilateral financial institutions in the region, mainly including Latin American development bank (CAF), the inter-american development bank (IDB), the Caribbean development bank (CDB), the central economic cooperative Banks (CABEI) and IDB’s pan American investment company (ICC). Chinese enterprises should strengthen their research and liaison with these regional multilateral financial institutions.
Second, a comprehensive, serious and detailed possibility study should be conducted on specific projects, and on this basis, a bank feasibility study should be completed. This requires the participation of third-party consultants and other international or local partners in the feasibility study phase of the project to enhance the local character of the bank feasibility study report submitted to the relevant financial institutions and improve the chances of obtaining financing.
Thirdly, China’s development financial institutions, such as China Development Bank, China-Latin America Fund and China-Latin America Capacity Fund, as well as the Asian Infrastructure Investment Bank initiated by China, should also actively explore the project financing business in Latin America, strengthen the cooperation with the above-mentioned multilateral financial institutions in Latin America and development financial institutions in various countries, and jointly participate in the project financing business. In this way, we can not only learn the experience of project financing business in Latin America, but also give full play to the advantages of Chinese capital at the present stage.
Finally, investment in Latin America should be promoted through commercial operation mode as much as possible, and should not rely too much on “double excellent loans” from the government. Although in some cases, Chinese money can keep small profit, but that doesn’t mean we should give up the normal business operation mode and regulation of risk control. On the contrary, China’s enterprises and financial institutions should strengthen construction on its own market, to meet the challenges of the market economy.
Creating a flexible mechanism
The Chinese government and financial institutions should innovate in mechanism and evaluation method, change the past guarantee evaluation method, and no longer use the guarantee method of domestic financing to require foreign infrastructure projects. In overseas project financing transactions, it is necessary to fully evaluate the future cash flow of the project and the assets of the project itself, and fully analyze the feasibility study of the project at bank financing level, so as to determine the risk and interest rate of the loan. Have a clear and thorough analysis of the credit and experience of the owners, contractors, suppliers, off-takers and other participants, so as to judge the feasibility of the project as a whole.
In addition, it is necessary to strengthen the contact with international and regional multilateral financial institutions, and participate in the formulation, implementation and supervision of their specific project plans for specific countries, specific regions and specific industries. In this way, there will be more opportunities to use the funds of overseas multilateral financial institutions and open the channels for Chinese enterprises to finance overseas projects.
The Chinese government should appropriately change the risk supervision mode of state-owned enterprises. The appreciation and impairment of state-owned assets should not be based on a single project, but should be based on the whole enterprise. Enterprises should be allowed to bear reasonable and normal market risks in overseas investment, which is the operating cost of enterprises as a market subject.
Financial institutions should also adhere to certain standards when providing financing for overseas investment projects to Chinese enterprises, such as the Green Credit Guidelines issued by the China Banking Regulatory Commission in 2012. They should not fail to apply the rules and regulations formulated by these Chinese government agencies just because they are overseas projects. At the same time, they should also abide by the international banking practices and practices, such as the Equator Principle.
In addition, the Chinese government should step back to the background as much as possible, let Chinese financial institutions stand at the forefront of project financing, formulate financing policies by country, region and industry, and guide Chinese enterprises to invest overseas. This is the endogenous force of capital and the direction of marketization.
(The Chinees version of this article was originally published in the May 2016 issue of the International Journal of Engineering and Contracting, thanks to the editor)