The high speed train (made in China) rolled out of the Brazilian capital, Rio de Janeiro, as Chinese vice president Xi Jinping toured Cuba, Uruguay and Chile to ink commodity deals in June. The strategic relationship between many South American nations and China have improved resulting in torrid trade growth totaling US$180 billion in 2010, up 50 percent from the previous year.
During Xi’s visit, Chile and China agreed to heighten cooperation in mining, banking and telecommunications. One example is China’s Minmetals Corporation’s large order of copper from Chile’s state-owned metal giant Codelco with funding from both nations’ state banks–Banco Estado and China Development Bank.
China-friendly environ
Investments in oil and gas, mining, infrastructure, agriculture and banking have emerged as the hottest sectors for Chinese companies.
For instance, Foxconn Technology Group announced plans to invest US$12 billion to build a plant in Brazil’s Sao Paulo to produce iPhones and iPads—a bid to defray China’s increased labour costs and the opportunity to sell directly to the South American consumers. In the financial sector, China’s Guosen Securities Asset Management plans to operate in Rio.
“The overall investment environment— from political stability, economic growth, market size and growth potential to natural resources is investor friendly particularly toward PRC,” noted Yu Lemin, general manager of Sinochem Corporation’s legal department.
“It appears that Latin America truly welcomes the outbound investment from PRC and does not share the apprehension normally seen in most of the Western nations.”
Under such auspices, Yu’s state-owned company bought 40 percent stakes from Norway’s Statoil ASA for its Peregrino offshore oil fields in Brazil for US$3.1 billion in April. Sinochem’s U.K. arm also bought British oil and gas explorer Emerald Energy Plc in 2009 for US$878 million to tap into wells in Columbia and Syria.
Steven Otillar, Dewey & LeBoeuf’s Houstonbased partner, believes more joint ventures similar to Sinopec’s US$7 billion capital injection into Repsol Brazil in fall 2010 will be realized and increased activities in places like Venezuela, Bolivia and Ecuador, where some U.S. or European companies are unable to get comfortable with these country’s higher risk profiles.
“We anticipate Chinese national oil companies to have the upper hand when negotiating with such countries over many international oil companies. In addition, (Chinese) involvement should increase in various bid rounds including Brazil, Peru and Colombia,” he added.
PRC firms playing lead counsels for SOEs
As China expands its area of influence across Latin America, PRC firms are along for the ride. Leveraging on its strong global infrastructure and construction practices, Beijingheadquartered Dacheng Law Offices has played lead counsel to many of its SOE clients venturing into South America. Samuel Jiang Rongqing, senior partner of Dacheng, said his firm’s advisory work for FDI to Latin America has been “growing rapidly” and they recently added a new hire—a Chinese- Venezuelan lawyer to the team.
More often, the PRC firms are using their local knowledge, connections and lower fees to beat out larger multination firms. Dacheng managed to win mandates against the likes of Baker & McKenzie and Skadden. Jiang attributed his firm’s success to the fact that many of these large-scale infrastructure and energy projects in South America are critical to China’s national interests and resources security. “PRC firms are often the preferred choice when it comes to these key cross-border transactions. In addition, we have built a strong client relationship with these SOEs over the years—our trust level is pretty high,” he explained. “We are also more reasonably priced and can better fulfill the demands of the Chinese clients.”
One high-profile deal that Dacheng handled was serving as PRC legal advisor for CRCC-Tonggguang Investment, a joint venture set up by Tongling Nonferrours Metal Group Holding and state-owned China Railway and Construction Corporation to acquire Vancouver-based Corriente Resources’ copper mine in Ecuador for US$686 million in May 2010.
Building alliances
When it comes to picking the right local partners, Jiang identified Latino firms through the World Services Group it joined in 2009. Dacheng engaged WSG member, Ecuador’s Bustamante & Bustamante Law Firm for local due diligence work when the need arises. To capture deals flowing to Portuguese-speaking Latino countries such as Brazil and Chile, and African nations Angola and Mozambique, Dacheng sealed an alliance this year with PLMJ, the largest firm in Portugal. PLMJ has sent three lawyers to Dacheng’s office in Beijing, and Dacheng has dispatched an attorney to the Portugal-based firm as well. In addition, Norwegian big four firm Wikborg Rein struck an exclusive alliance with Brazilian firm Viera, Rezende, Barbosa e Guerreiro Advogados recently to capture oil and gas transactions funded with PRC investment in Latin America that can benefit from Norway’s top-notched gas and oil drilling and production technology.
Leveraging U.S.-Latino expertise
Building on its long history of U.S.- Latin American advisory work, Milbank, Tweed, Hadley & McCloy opened its Sao Paulo office in Brazil last year, and draws on its 60-plus attorneys from the firm’s Latin American Practice Group based across New York, Los Angeles, and Washington D.C. for multijurisdictional support. Chinese clients can also seek advice from the firm’s Beijing office, where Milbank recently hired Li Chen as of counsel to bolster the branch’s corporate practice and cross-border M&A transactions.
One of Milbank’s blockbuster deals was its advisory work for State Grid International Development’s US$1.8 billion acquisition of eight Brazilian transmission projects from four Spanish EPC companies in December 2010, which was then China’s largest investment in Brazil and its first success at owning a foreign power grid system.
Anthony Root, the head of Milbank’s Asia practice, led the legal advisory work for State Grid. He noted that negotiations were greatly complicated by cultural differences among the parties, but praised the ability of the Chinese buyer to adapt quickly to the challenges of cross border M&A.
“After months of protracted negotiations across three continents, we were able to achieve exceptionally robust buyside M&A documentation,” recalled Root. He explained that the financial strength and technological sophistication of State Grid and its role as a potential future customer for the sellers was a key negotiating advantage.
One of the major surprises in the transaction was the need to refinance the existing debt after the national bank of Brazil, BNDES, chose to exercise change of control rights and require repayment of nearly US$1 billion inexpensive debt used to develop the transmission lines.
To ensure smooth transition, Milbank also provided ongoing support for SGID’s management team who has limited experience operating in Brazil.
Guarding against legal risks
Legal advisors are playing increasingly critical roles in these massive Chinese outbound projects, noted Jiang. “In the past, Chinese companies would dispatch their engineers and infrastructure teams to conduct feasibility studies to figure out if, say a hydro power plant could be built in the target Latin American country. But soon they realized that the technical hurdles were lot less costly than the legal challenges and damages they were confronted with, say if legal due diligence was not properly done and the deal fell apart in the end. Therefore, lawyers are now the first ones to be sent out to conduct feasibility assessments.”
Corruption is also a risk factor that many investors are trying to address in their outbound investments in South America, but Dewey’s Beijing-based partner Dirk Walker warned against the political risk of host governments being increasingly nationalistic in the oil and gas sector.
“The problem of resource nationalism that has plagued Latin America in the past several years has begun to shift,” said Walker. “Bolivia learned rather quickly that international oil companies’ (IOCs) expertise is required to effectively operate and maintain production, much less to increase reserves and output. We may well find that pre-salt reforms in Brazil set to exclude IOCs from operating such assets are also destined to be changed in the next year or two,” said Otillar.
To minimize these risks, Walker recommended investors to conduct due diligence not only on local companies but also key employees and agents and to take advantage of all available bilateral and international treaties. “It’s important to have a clear understanding of the eventual exit strategy,” said Walker, who noted ExxonMobil’s entry tin Venezuela went through the Netherlands expressly for this purpose to ensure their ICSID claim could be honoured.
For Brazil, tax is also an important consideration. “Countries can be put on and off of the so-called ‘black lists’ from time to time, so the structure should anticipate potential movements and allow for transfers or assignments in the least disruptive manner as possible,” he explained. According to Walker, five years ago, almost all foreign investments in the Brazilian oil and gas sector went through Cayman Island companies, but with the change in tax regime it was necessary to shift operations quickly and most went to the Netherlands, to avoid creating a taxable event.
“Similarly in Mexico, companies have learned that investments structured as SrLs are easier to liquidate and change control than with S.A.s.” Dacheng’s Jiang also cautioned that Brazil is yet to sign a bilateral investment protection agreement with China—Chinese investors need to tread carefully if any disputes arise. Other Latin American countries may heighten nationalization of private assets (evident in Venezuela) without much public notice and they may impose extra burden of corporate social responsibility on Chinese investors— demanding them to create more jobs, uphold better labour standards, provide education and public health and utility facilities as a pre-requisite for the entry of Chinese investments.
Sinochem’s Yu also reminded his peers that besides the rosy dealmaking, Chinese investors and their internal counsels also need to prepare for arbitration and have other dispute resolution mechanism in place when things turn sour.
Yu’s company purchased a minority interest in Ecuador’s oil asset Block 16 in 2003 and subsequently suffered from Ecuador’s 99 percent windfall tax which came into effect in 2006 when oil prices skyrocketed. Sinochem took the windfall tax dispute to the International Centre for Settlement of Investment Disputes for arbitration where, he said, it was “amicably settled.”
South-south trade beneficial
Despite the complementary nature of Sino-Latino trade and the synergies between their strong political relationships, Yu noted “competing factors” exist. “Both China and Latin America are ‘developing countries’— even though people may laugh at that moniker to which China firmly clings to— and both endeavor to upgrade their economies from the lower echelon of the division of labour.”
Nonetheless, he believes the benefits of the bilateral trade will prevail. “There is no doubt that the robust ‘China demand’ over raw materials or natural resources has significantly improved the ‘terms of trade’—the comparative price ration between export and import of one nation—for those Latin American countries to the extent that those countries benefit more from its relationship with China,” said Yu.
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