Mechanisms to protect foreign investors against local currency fluctuations

Rodovia dos Calçados

The São Paulo government sought to expand the a 720km NE-SW road across the state of São Paolo, which had one of the highest traffic volumes in the country
317 km was already managed by a concessionaire, while the remaining 403km were managed by the São Paulo government, who were seeking to award a combined concession to a single player to fund the required investment for the upgrade of the highway

The volatility of the local currency, presented a barrier to investment; in the past five years, the value of Brazil’s currency has fluctuated considerably
Currency hedging products offered by financial markets proved both too expensive and too short-term for the purposes of most infrastructure projects
Therefore, the government found it difficult to find willing investors for who would finance the highway upgrade

The State of São Paolo decided to include mechanisms in the offer it made to potential investors that provided some degree of protection against exchange-rate fluctuation at a lower cost than the protections traditionally offered by financial markets
These included reductions in the periodic concession fees if the value of the Brazilian real were to fall more than 5% against the U.S. dollar

Abertis — Project sponsor, worldwide leader in toll road management, and its Brazilian subsidiaries
Government of the State of São Paolo-Scheme regulator

Government of the State of São Paolo managed to secure a long-term concessionaire for the entire length of the route and to obtain a significant investment pledge thanks to innovative currency fluctuation protection mechanisms
In particular, part of the pledged USD 1.4B should finance the duplication of a 275 km-long stretch
The Brazilian Association of Highway Concessionaires maintains that following the introduction of such mechanisms, there has been “awakening interest” on behalf of foreign investors for concessions in the State of São Paolo

The use of innovation mechanisms to enable investors to hedge their currency risk, like the one used by the State of São Paolo, can attract capital to markets that have traditionally suffered from volatile currencies
However, the State of São Paolo does face the possibility of lower concession fees if the hedging mechanism is triggered, even though the value of Brazil’s currently is beyond its control; such mechanisms can sometimes shift the currency risk away from the concessionaire and to the government, rather than eliminating it entirely.
Despite the potential downside, São Paolo’s experience shows that hedging strategies can be critical in meeting infrastructure investment needs that the local capital markets cannot supply, and in encouraging other potential investors to the market.