The Public-Private Partnership Law Review: Mexico
Mexico is a federal republic composed of 32 states and several municipalities within each state. As such, federal and local statutes apply to public-private partnerships (PPPs).
The development of PPPs in Mexico began in 2004 under the scheme known as projects for the provision of services (PPS), although the enactment of the Law on Public-Private Partnerships (the PPP Law) and its Regulations occurred until 2012. In Mexico, however, different types of public-private investment schemes have been used since the early 1990s to implement infrastructure projects, such as concessions, financed public works and investment projects with deferred expenditure registration. These schemes served as direct precedents of PPPs as understood at the time of writing.
PPPs constitute a long-term contractual relationship between the public and private sectors for the provision of services to the public sector or the end user, in which the private developer provides, partially or totally, the infrastructure required for such services and, generally, the public entity pays a monetary consideration to the private developer. PPPs have been used for government policy reasons to increase social welfare, offer more and better infrastructure and foster investment in the country.
Since the enactment of the PPP Law in 2012, there have been more than a 100 public biddings for the implementation of projects through the PPP model focused on the following sectors: health, transportation, telecommunications, social and hydraulic infrastructure. Also, the energy and environmental sectors have shown an increasing participation in PPPs.
To ensure transparency and access to information, the federal government created two websites known as CompraNet and Mexico Projects Hub. CompraNet is a digital platform that provides public information on projects, bidding processes, procurements, leases, public works and other related services; while Mexico Projects Hub contains updated detailed information of the most relevant energy and infrastructure projects that require private investment. The Hub is part of the Mexican government's initiative to create an investor-relations office to link investment projects with domestic and foreign potential investors, encouraging long-term financing for infrastructure.
In the following years, the PPP agenda in Mexico may increase, particularly in the transportation and telecommunications sectors, since the new administration for 2018 to 2024 has shown particular interest in developing railways, highways, airports, as well as an extensive telecommunications network project to provide internet access and digital services across the country.2
The year in review
In 2019, the incoming administration, led by new president Mr Andres Manuel Lopez Obrador, established its government programme with new policies, directives and regulations. The new government continued to award projects from previous years but did not launch new projects since it focused on reshaping and restructuring greenfield projects such as a train over the south-east region of the country known as Tren Maya (Maya Train) and highways and roads PPP projects. For 2020, the federal government will spend approximately US$450 million from the federal budget for previously awarded and ongoing projects. Landmark projects announced during the campaign, such as a new refinery in the state of Tabasco, a new airport for Mexico City and Tren Maya are yet to be tendered. However, presumably such projects or parts of them will be structured as a PPP.
On a state level, PPP projects have increased since the PPP law came into force in 2012. A state agency from the government of Nuevo Leon is structuring the first waste to energy project under a PPP scheme to be tendered during the first semester of 2020. In addition, the state of Baja California Sur is planning to tender contracts for the construction and operation of a desalination plant and improve water state-owned operating agency, and it is expected that during the second semester of 2020 different states will tender highways and roads PPP projects such as the State of Mexico. Such states face important challenges such as compliance with the Financial Discipline Law for States and Municipalities, enacted in 2016, which provides for specific conditions for state PPP projects.
i Types of public-private partnership
There are different structures to develop PPP projects in general, including the following:
- concessions, in which the private sector – concessionaire – builds and operates the project owned by the public sector and the investment is recovered through the fees or tariffs paid by the project's end users;
- financed public works, in which the private developer invests in a project, and once it is constructed and operating, the public entity repays the total investment;
- joint ventures, involving particular risk-sharing models; and
- PPP contracts (stricto sensu), which regulatory framework consists of the PPP Law and its Regulations. For projects that are not regulated by the PPP Law, there is a specific legal framework for each infrastructure sector (i.e., oil and gas, power or special economic zones).
Regarding PPP contracts in particular, the PPP Law and its Regulations set forth a classification related to the funding used for the project:
- pure PPP projects – completely funded with public resources, either:
- provided in the annual federal budget; or
- resources different from budgetary funds, including those granted by Fonadin;
- combined PPP projects – using both public funds and any other source of funding; and
- self-financed PPP projects – funded exclusively with private funds, other non-financial resources or with the cash flow generated by the project itself.
In 2018, a couple of PPP projects were structured for the first time through the self-financed PPP model for the development and construction of water and energy facilities (i.e., Mazatlán Aquarium). Also, the waste to energy projects to be launched in 2020 will be a self-financed PPP. As previously explained, the private developers will not receive any payment from the public contracting parties; rather, they will repay the financing and recover their investment entirely through the cash flow obtained by operating the project.
ii The authorities
The process of structuring, bidding and entering into a PPP contract is subject to the control of the public entity acting as contracting party in the relevant jurisdiction. As mentioned before, PPP matters are subject to federal and local statutes; therefore, the contracting party could be any federal, state or municipal authority developing a PPP project, whether state-owned companies, agencies, public trusts or any other governmental entity.
At the federal level, the PPP Law applies to federal public agencies and entities, federal public entities regulated by federal laws with autonomy derived from the Constitution, federal public trusts not considered state-owned entities, and any other governmental entities (state or municipal) that allocate federal resources to PPP projects.
The Ministry of Finance and Public Credit is one of the principal authorities for PPPs in Mexico. It has jurisdiction to interpret the PPP Law for administrative purposes and to enact complex rules to prepare viability studies required to structure a PPP. Another relevant authority for PPPs is the Inter-Ministerial Commission on Public Expense, Financing and Disincorporation, which approves those projects previously analysed and authorised by the Ministry of Finance and Public Credit to be developed under the PPP scheme and that have complied with the regulatory requirements provided for in the PPP Law and its Regulations. Once the Inter-Ministerial Commission's authorisation has been granted, the projects are submitted to the budget and Public Account Commission of the House of Representatives (in Congress) for the authorisation of the allocation of budgetary federal funds.
The Ministry of Public Affairs also plays an important role in PPPs as it is in charge of state-owned property, valuations and investigation of public officials' responsibilities. The PPP Law also provides for the Ministry of Public Affairs' responsibility to provide information related to PPP projects and the bidding processes through CompraNet, including the supervision of the project and the enforcement of the PPP contract.
The Ministry of Environment and Natural Resources also participates by authorising the environmental impact assessments for PPP projects, intended to protect the environment, as well as to preserve and restore the ecosystems for the purpose of avoiding or minimising the adverse effects on the environment of works and activities caused by the development of the projects.
Other authorities at the federal, state and municipal levels may also be involved in the implementation of PPPs, for instance, to grant the specific permits, licences or authorisations required to develop the project (i.e., land-use licences, water supply and wastewater discharge permits, civil protection and municipal operating licences, among others).
iii General requirements for PPP contracts
A public entity interested in developing a PPP must first complete a structuring phase for the project according to the following considerations:
- if the PPP project involves budgetary funds provided in the annual federal budget, the public entity must prepare and obtain:
- the viability studies of the project;
- the registry in the Investment Portfolio of the Ministry of Finance and Public Credit;
- the authorisation of the Inter-Ministerial Commission on Public Expense, Financing and Disincorporation; and
- the authorisation of the budget and Public Account Commission of the House of Representatives;3
- if the PPP project involves federal resources different from budgetary funds, the public entity must prepare and obtain:
- the viability studies of the project; and
- the registry in the Investments Portfolio of the Ministry of Finance and Public Credit; and
- if the PPP project involves other non-budgetary funds or other non-financial resources (such as self-financed PPPs), the public entity must only prepare the viability studies for the project.
Moreover, the viability studies that the PPP Law provides for must include the:
- a general description of the project;
- necessary goods and assets (including real property) for developing the project;
- necessary permits, licences and authorisations for developing the project;
- social, legal, economic, financial and environmental feasibility; and
- a financial analysis on the convenience of developing the project through the PPP scheme compared to other models of project financing.4
Bidding and award procedure
i Expressions of interest
After the project is structured and approved by the corresponding authorities, the public entity publishes a tender notice or call inviting the private sector to participate in a bidding process. The tender notice shall be published in the contracting entity's website, in the Official Federal Gazette, in CompraNet and in a newspaper of major distribution. The PPP Law establishes that PPPs are subject to transparent and publicly available bidding processes.
Along with the tender notice, the contracting entity publishes bidding rules containing, among others, the:
- the identity of the contracting entity;
- requirements for the participants to prepare and submit their proposals;
- the term for the services to be provided;
- characteristics and technical aspects for the construction of infrastructure works and services to be provided;
- the PPP contract model containing the rights and obligations of the parties and the distribution of risks;
- guarantees that participants must deliver; and
- ancillary documents that participants must submit together with their proposals.
After the tender notice and bidding rules are published, the contracting entity grants a period for Q&A with the participants (the PPP procedure shall have at least one Q&A meeting to clarify doubts and concerns that participants may have). Once that period is concluded, participants prepare and submit their technical and economic proposals. At the end of the bidding process, the project is awarded to the bidder that offered the best terms in price, quality, financing, opportunity and other circumstances as determined by the contracting party in the bidding rules.
Any person is allowed to attend the events of the bidding process as a public observer. Likewise, the bidding process shall have a social witness to verify that the procedures follow the principles of legality, free participation and competition, objectivity, impartiality, transparency and publicity.
ii Requests for proposals and unsolicited proposals
Any individual or entity that fulfils the requirements established in the bidding rules is allowed to participate in the bidding process, whether individually or as a consortium. The term for the submission of proposals is at least 20 business days after the last Q&A meeting or event as provided for in the bidding process calendar. Bidders must submit a technical and an economic proposal for the project in separate and sealed envelopes, which are opened in a public session for evaluation.
The technical proposals shall contain, among others, technical aspects to carry out the project, including the development of the infrastructure and the provision of the services referred to in the bidding rules, as well as the commitment to create a special purpose vehicle (SPV) to develop the project. On the other hand, the economic proposals shall contain, among others, the minimum financial requirements, the project's financial model, investment amounts committed for the project and the price of the services to be provided.
Additionally, the PPP Law sets forth terms and conditions for the submission of unsolicited proposals by private sector entities interested in implementing a PPP project. An unsolicited proposal begins with the request for an expression of interest by the private sector to the public entity; the public entity shall respond within 30 business days whether it is interested or not in developing the project. Once the private sector obtains a favourable expression of interest from the public entity, it must prepare the unsolicited proposal with the following documentation: the viability studies including the description and characteristics of the project; legal, technical, economic and financial feasibility of the project as a PPP; essential elements of the PPP contract; and financial requirements and estimated investments.
Furthermore, public entities can ask for proposals of PPP projects they are willing to accept, specifying the sectors, subsectors, geographical matters, type of projects, estimated goals, relationship between the proposal and the purposes described in the National Development Plan, as well as the expected benefits. Interested parties take into consideration this information to prepare more accurate unsolicited proposals that could be admitted for public bidding.
The public entity receiving an unsolicited proposal has three months to conclude the analysis and evaluation of the proposal. This term may be extended for an additional three-month period if the complexity of the project requires so. In addition, the public entity may as well transfer the proposal to other authorities or invite federal, state or municipal entities to participate in the project, if applicable.
After the analysis and evaluation period, the public entity issues an opinion on the feasibility of the unsolicited proposal. If the proposal is considered feasible, the public entity has the right to call for a bidding process inviting private sector participants, which is conducted under the general rules of bidding procedure as provided for in the PPP Law. Still, if the promoting party that submitted the unsolicited proposal is the only participant in the bidding, the PPP contract may be directly awarded if it fulfils the corresponding requirements.
The promoting party of an unsolicited proposal is entitled to obtain an incentive in the evaluation of its offer during the bidding process, which shall be no greater than 10 per cent of the evaluation method over other bidders. It also has the obligation to convey the necessary information, documents and studies to the public entity to ensure fairness in the bidding. If the promoting party does not win the bidding, it has the right to receive the amounts expended to carry out the studies for the unsolicited proposal.
iii Evaluation and grant
When evaluating the technical and economic proposals submitted by the bidders, the public entity is required to verify their compliance with all the requirements set forth in the bidding rules and the integration of every element contained in each proposal.
The PPP Law emphasises the importance of the objectiveness in the evaluation of the proposals, so that no participant is favoured over the others. For such purposes, the public entity may use an evaluation matrix that could consist of percentage points, cost-benefit criteria, point-rated criteria or any other quantifiable method that allows an objective and impartial evaluation. This evaluation criteria shall be clearly determined in the bidding rules so that every participant knows the method that the public entity will use to award the contract.
The public entity must evaluate the technical proposals of each bidder and, only if these proposals fulfil the necessary requirements provided for in the bidding rules, it continues with the evaluation of the economic proposals. The bidding rules provide for cases in which a proposal is considered insolvent, being the most common in the following cases: if the proposal is incomplete or its evaluation is impossible; if the proposal fails to comply with legal, technical or economic provisions contained in the bidding rules; and if the provided information is misleading or false.
After the evaluation of proposals, the public entity awards the PPP contract to the bidder whose proposal is considered solvent for fulfilling all legal, technical and economic requirements, in accordance with the evaluation criteria detailed in the bidding rules. If two or more proposals are considered solvent, the contract is awarded to the proposal that provides the best economic conditions for Mexico; and if two or more proposals are still in equal conditions, then the contract is awarded to the proposal that considers the greater generation of national employment, as well as the use of national or regional goods and services.
To support the public entity's decision, it must issue a detailed opinion explaining the analysis of the proposals, the reasons for their admitting or discarding, a comparison between them, and the elements by which the winning proposal is considered to offer the best conditions for the project. The award is then notified to all participants in a public meeting and published in the entity's website and in CompraNet.
One of the main elements that the PPP contract model includes is the form of payment to the private party for the infrastructure and services provided during the project. Participants in the bidding process put special attention to the rules regarding consideration and payment procedure to prepare and submit their proposals.
The payment mechanism depends on the specific nature of every project and the allocation of risks established in the contract. A variety of payment models have been implemented in Mexico; however, the typical form of remuneration in projects awarded in the last couple of years consists of monthly payments that are subject to deductions or withholdings depending on performance indicators set forth in the contract, to ensure that the services are being rendered effectively according to the agreed upon technical specifications. Under the self-financed PPP scheme, the payment method includes solely the collection of fees by the private party from the end users of the infrastructure (e.g., highway tolls, waste to energy and water tariffs). For instance, in the aforementioned waste-to-energy project, one of the largest projects expected to be tendered in 2020, the PPP contract model should provide payments based on the trading and output of energy to final users.
ii State guarantees
In general, federal PPPs do not offer state guarantees to secure payment by the public entity to the private developer. Approval of the required funds for the project and their provision in the annual federal budget as multi-annual expenditure commitments may suffice to prove the government's solvency to comply with its payment obligations under the PPP contract.
Nonetheless, some guarantees to the private party could be contractually based, such as assuring a minimum level of revenue or usage of the project's infrastructure. For instance, if the revenues generated by the project fall below the amount set forth in the PPP contract, the public entity may be responsible for the difference and this type of contractual provision is frequently used to enhance the bankability of the project.
On the other hand, sub-national PPPs must include mechanisms to guarantee payment obligations undertaken by state and municipal public entities in PPP contracts to be successful. Financial institutions are reluctant to finance state or municipal PPPs if they fail to provide an alternative source of payment different from the state or municipality budget allocation authorised for the project. Usually these guarantees include the creation of special funds with federal contributions that states and municipalities are entitled to receive from the federal government or the pledge of revenues collected from local taxes. Thus, the type of guarantees will depend on the availability of funds by the relevant state or municipality. The desalination plant for the Municipality of Los Cabos is expected to structure and provide an alternate source of payment to achieve its success.
iii Distribution of risk
Risk evaluation and allocation represents a key factor for the project's success. Project risks analysis is based on a due diligence process intended to ensure that all necessary information about the project is available, the identification of project risks and the distribution of such risks to the appropriate parties that can bear them efficiently through provisions in the PPP contract.
The main risks to be considered and shared among the parties depend widely on the specific nature of each project, but the most common risks that are constantly considered in the structuring of a PPP project in Mexico are:
- commercial risks: those inherent in the project itself, on the industry or market in which it operates (e.g., commercial viability, construction, revenue, operating and environmental risks);
- macro-economic risks: not directly related to the project, but to external economic conditions of the country or region;
- regulatory and political risks: relating to the effects of government action or political events, such as changes in law, war or civil disturbance, etc;
- financial risks: attempting against the funding of the project (including capital and debt requirements); and
- force majeure: unpredictable events that do not allow the ordinary course and development of the project.
Considering the above, the usual measures adopted to prevent and mitigate project risks include the following:
- contract provisions: the PPP Law provides that the contract must contain among its provisions the efficient distribution of risks between the public and private parties, which must be properly balanced and, in any case, the contracting entities cannot guarantee any payment or indemnity for risks that are not established in the contract, the PPP Law or its Regulations;
- SPV: the SPV or project company is the entity responsible for hiring financing for the project, entering into the necessary agreements (i.e., EPC and O&M) and being held liable in the case of default;
- insurance: the PPP Law also provides that the private party must hire insurance to cover, at least, the risks that the infrastructure, end users, assets and goods are exposed to during the term of the contract;
- guarantees: the private party must grant guarantees for completion, operation and performance level of the services as established in the bidding rules; and guarantees in favour of third parties by the nature of the SPV itself and with respect to the project;
- financial terms: lenders are usually willing to bear limited risk provided that they are adequately compensated through interest rates or other financial terms and conditions on the project loan.
iv Adjustment and revision
Any adjustment to the PPP contract may be formalised in an amendment agreement and, when applicable, the necessary authorisations for the project shall be also modified. However, in emergency cases or when the security of the end users is at risk, the public entity may request the private developer to carry out the corresponding actions and changes in the operation of the project without entering into the relevant amendment agreement.
The adjustment of the PPP contract may only have the following objectives:
- to improve infrastructure features, which may include additional works;
- to increase the services or their performance level;
- to deal with aspects related to environmental protection, as well as to the preservation and conservation of natural resources;
- to adjust the project in case of unpredictable events during the structuring, award or development of the project; and
- to restore the economic balance of the project.
To restore the economic balance of the project, the private party has the right to request the amendment of the PPP contract if an act of authority caused a substantial increase in the developer's obligations or substantial reduction in the benefits. A substantial variation generally means any change that is long-lasting and puts the financial viability of the project at risk. However, specific requirements have to be met depending on the causes and effects of the adjustment to the parties' obligations.
v Ownership of underlying assets
The responsibility to acquire the necessary assets for the development of the project may rest with the public entity or with the private developer, as established in the bidding rules and agreed upon in the PPP contract. The acquisition may be achieved through conventional means (observing civil law property transfer rules) or through taking or expropriation proceedings. Nonetheless, in Mexico, the public entity generally has ownership and control of the underlying assets, since the projects are mostly implemented over state-owned real property. In such cases, a concession or permit is sufficient to authorise the developer to use, exploit and operate the assets provided that, upon termination of the contract, the underlying assets of the project's infrastructure and the ones that were essential to provide the services will remain under the public entity's ownership and control, subject to the state-owned property regime. The public entity is also entitled to acquire from the private developer the remaining assets that are not strictly necessary for the project.
vi Early termination
The public entity has the right to terminate the PPP contract before the specified term for reasons of public interest or if the need for the contracted services or infrastructure no longer exists, and if the performance of the contract would cause an injury or damage to the state. The early termination decision must be accompanied by an opinion issued by the public entity stating the reasons for the termination.
If the contract is terminated for causes that are proven different to the private party's fault, developers are entitled to receive a termination payment in the form of reimbursement of the expenses and investments that could not be recovered and have not been fully redeemed. The termination payment also covers the financial obligations assumed by the private developer in the project's financing.
The PPP Law provides that the contract shall address termination causes for the public entity default, for the private party default, for extended force majeure events and for convenience of the public entity as explained herein.
In Mexico, PPPs are financed through a combination of equity and project finance-based debt, either public or private. The PPP Law requires that an SPV is formed by the sponsor upon the award of a contract. This structure requires the private sector sponsor to fund the project (at least partially) with equity. Public funds are also usually allocated to PPP projects mainly from Fonadin, the government agency responsible for coordinating the financing and development of infrastructure. The debt-to-equity ratio depends on the particular circumstances of each project, such as the participants' desired leverage, borrowing costs and risks involved in the project.
Most common lenders include commercial banks, multilateral agencies and development banks. From the public sector, the main players in project finance transactions in Mexico are Fonadin and Banobras and, when publicly financed, the projects must meet additional legal requirements to ensure the proper repayment of debt in favour of lenders.
Whether by equity or debt (public or private), foreign entities are frequently involved in the financing of projects in cross-border transactions. Most of these transactions are funded in foreign currency and, in such cases, participants have to deal with exchange risks. Project sponsors engage in hedging or swap instruments to reduce the project's sensitivity to changes in the foreign exchange rate. On the other hand, project sponsors may recur to local currency loans in Mexico if the market can offer the amount and term of financing to eliminate any long-term currency risk.
Although there is no jurisprudence related to PPPs in Mexico yet, and there have not been relevant administrative or judicial procedures in the past years, in 2017, the Supreme Court upheld, in an amparo procedure, Article 130 of the PPP Law, providing for sanctions to individuals and entities that are in default of their obligations under PPP contracts for reasons attributable to the private party and that may, therefore, cause serious damage to the public entity. Other similar judicial decisions have been made regarding early termination rights and termination payments. These rulings strengthen the application of the PPP Law as they seek a balanced protection of the parties' interests and the principles of the bidding process to award PPP projects.
Mexico represents an opportunity for the promotion of PPP projects since they have been a fundamental mechanism in developing economies to increase the offer of infrastructure and public services, involving public and private funding with the participation of the private sector in the development of projects where the private sector has better knowledge and experience. As of 2016, 41 new federal PPP projects have been structured and developed in Mexico; of those 41 projects, 18 are in the structuring and pre-investment phase; six in the bidding phase; and 17 in the development and operation phase. These projects are focused on the transportation, health, telecommunications, social and hydraulic infrastructure.
When President Andres Manuel Lopez Obrador took office in 2018, he announced an ambitious agenda in infrastructure, mainly focused on the south and south-east regions of the country, which are the most marginalised in terms of public services. This agenda included the development of new railways, highways, ports and refineries. At first, Mr Lopez Obrador proved to be reluctant and sceptical about PPP projects, however, at the end of 2019 he announced the National Infrastructure Plan, whereby the federal government plans to invest approximately 43 billion pesos in over 1,700 infrastructure projects from 2020 to 2024, mainly in roads and transportation, energy, tourism, water and sanitation; many such projects are structured under a PPP scheme. Besides, to prevent a reduction in foreign investment, it is essential that the federal government turns to PPPs as a viable option for structuring and developing new infrastructure projects that are much-needed in the country, gaining investors' confidence and promoting the participation of the private sector in Mexico's economic growth. The signing of the new United States-Mexico-Canada Agreement certainly reflects the trust and confidence in the country for the upcoming future. Entering its second year, federal government may use this leverage created by the new T-MEC to boost the projects recently announced.
The development of PPP projects by states and municipalities has increased in recent years. In 2020, the State of Nuevo Leon intends to bid and award the first waste to energy project in Mexico. The estimated amount of investment will be US$500 million and it will be developed in the city of Monterrey, partly financed by the federal government through Banobras. Also, early in 2020, Fonadin will bid and award an MRO agreement under a PPP scheme for four federal roads and two international bridges on the states of Nuevo Leon and Tamaulipas, on a project known as the 'Northeast Package'. The fact that local PPP projects have increased over the years is certainly a good sign for the sector itself, since it helps ease the burden on the federal budget.
For the upcoming year of this new administration, PPPs will become fundamental for the accomplishment of the goals established in the federal budget for 2020. If a safe environment for national and foreign investment is assured, PPPs can expect to grow in the following years, with some expected changes to provide more transparent and objective mechanisms in public biddings, as well as to properly manage public funds in the implementation of PPPs.
1 Alejandro Rojas V is a partner and David Malagón L is an associate at Nader, Hayaux & Goebel, SC.
2 For more information on the projects agenda please refer to the following link: https://www.ppef.hacienda.gob.mx/work/models/PPEF2020/paquete/egresos/Proyecto_Decreto.pdf
3 See the previous section for information about the authorities involved in the structuring of PPPs.
4 Article 14 of the PPP Law and Articles 21 to 31 of its Regulations provide for the preparation and submission of the viability studies for a PPP project.