Martin Litwak of Litwak & Partners analyses the project finance and fund formation opportunities in Uruguay that are helping to attract foreign investors

While Uruguay has always been one of the most stable countries within the Latin American region, the last 12-13 years have witnessed an incredible consolidation of the growth of its economy.

Today, Uruguay has positioned itself as a trustworthy and attractive destination for foreign investors. In 2013, for example, the country was the largest FDI (foreign direct investment) recipient after Chile, receiving a total of almost $2.8 billion. When considering FDI stock in relation to GDP, Uruguay also ranks second after Chile.

The consolidation of the inflow of FDI cannot be explained purely by the fact that commodity prices have been rising year after year over the past decade.

In fact, there are various reasons that explain the consolidation of FDI in Uruguay. Uruguay has a very favourable legal framework that promotes investment. The county is, by far, the most politically and socially stable country within the Mercosur, as well as the least corrupt; Uruguay offers certain tax benefits and allows for free repatriation of capital and profits; it does not discriminate between domestic and foreign investors and/or between high or low tax jurisdictions (this allows for offshore structures to be used to invest in the country). There are more than 10 free trade zones, some of which are dedicated to services. And the jurisdiction has in force many bilateral investment treaties (BITs) as well as various agreements for avoiding double taxation and it is a member of the International Centre for the Settlement of Investment Disputes (ICSID).

Even though Uruguay has been governed by a left-of-centre political party, the economy has always been in the hands of the most market-oriented sector within that party; As a result, the economy grew robustly in the 2000s, registering annual average growth rates of over 5.5% from 2003 to 2013; and, with an estimated per capita income of $16,188 in 2014, Uruguay is one of the richer countries of Latin America.

If the government of Uruguay is successful in identifying and then eliminating the risk factors the economy of the country still has (such as the fiscal deficit, the huge influence of labour unions, the lack of a modern legal framework to regulate the financial sector and the dominance in certain key sectors of state-run companies), the future of the country should also be bright.

Project finance in Uruguay

Unlike FDI in general, project finance is not regularly used in Uruguay and it attracts a relatively small volume of resources. This has been the case mainly because of the small size, and the lack complexity of the projects Uruguay has historically seen, and the participation of the government in most of them.

Another problem this type of transaction has always had in Uruguay is that Uruguayan law provides a pari passu treatment of all creditors in a bankruptcy, with only a couple of exceptions that are included in the bankruptcy laws. Commonly used in structured and project finance deals, contractual subordination is not regulated in Uruguay and there are virtually no judicial precedents on this issue. Technically speaking, there is no impediment for a bankruptcy court to enforce a subordination agreement between creditors, provided that it does not adversely affect the mass of creditors. However, due to the lack of legal certainty, it is advisable to use foreign law to govern a subordination agreement (or the whole deal).

Having said that, with various investment opportunities and several projects that are underway or in the pipeline (especially in the areas of energy, oil and gas, railways, mining and deep-water ports) and the relatively recent enactment of a modern and comprehensive public-private partnership (PPP) regulatory framework, it is expected that this situation will change dramatically by the end of this decade.

To date, most of the project finance transactions that have taken place in the country have been structured as hybrid financings. The structure depends on the type of asset and the sector. Projects that require a concession from the government resemble a build-own-operate-transfer (BOOT) or a build-operate-transfer (BOT) structure, while projects that do not require a concession are usually structured as build-own-operate (BOO). As we have said before, the number of PPPs has increased in recent years and we do expect that PPP structures will be the norm in the medium term.

Investment funds

Investment fund is a broad generic term that encompasses all types of collective funds and schemes, including mutual funds, hedge funds, real estate funds and private equity/venture capital funds.

An investment fund is an arrangement whereby a group of investors pools the ownership of respective property into a collective scheme, losing day-to-day control and direct ownership of the assets concerned, and the property is then collectively managed by the operator of the scheme, generally the investment manager.

If the fund vehicle is open-ended the investors have a right to demand redemption of their shares at regular and specified intervals should they wish to exit the fund. Redemption proceeds are then calculated as a share of the fund's net asset value on the relevant redemption date. This means that increases and decreases in the value of the fund's assets are directly reflected in the amount an investor can withdraw.

Closed-ended funds, on the other hand, are those where investors do not have this right. They are generally used for real estate projects or for investment ventures that involve only a small number of partners and/or where the partners know each other.

The fund industry worldwide is a very important part of the financial system, with fund vehicles of various types, strategies and sizes, which held in excess of $58.3 trillion at the end of 2011, according to a report titled Capturing Growth in Adverse Times: Global Asset Management 2012, published by Boston Consulting Group.

A European merchant established the first ever mutual fund. This happened in the Netherlands in 1774. The first fund outside the Netherlands was the Foreign & Colonial Government Trust created in the UK in 1868. This fund still trades on the London stock exchange.

Mutual funds were introduced into the US at the end of the 19th century, with the first open-end mutual fund with redeemable shares being established in 1924.

After the crash of 1929, the investment fund industry did not grow substantially for decades. It was only when confidence in the stock markets finally returned, in the 1950s, that the mutual fund industry began to grow again. This growth pattern only stopped for a small period of time during the 2008/9 sub-prime crisis, but in 2010 the industry resumed its growth, both in terms of assets under management and number of active funds.

The investment fund regime in Uruguay

Uruguay has been an exception to the international trend set out above. In fact, even though investment funds were introduced by Law No. 16.774 of 1996 (the Funds Act), there are no active funds in the country.

Under the Funds Act, investment funds do not have legal personality. This notwithstanding, assets invested into the fund are segregated and independent from those of the investors. As such, an investor's creditor cannot seize the fund assets, and in the case of a legal action against an investor the creditor can only seize the shares that the investor holds in the fund.

Since a Uruguayan fund does not have a legal personality independent from that of its investors, a company whose exclusive purpose is to manage those assets and to generally represent the fund, manages the fund assets (sociedad administradora de fondos de inversion).

Investment funds in Uruguay are subject to the supervision and control of the Central Bank of Uruguay.

Financial trusts in Uruguay

Most of the major investments that are carried out in Uruguay these days are either channelled through an offshore fund or through a local/Uruguayan financial trust.

An offshore fund is of course a collective investment scheme established in an offshore financial centre, such as the British Virgin Islands (BVI), the Cayman Islands, the Bahamas, Luxembourg, and so on. Offshore funds offer eligible investors important tax benefits compared to many high tax jurisdictions such as the US or the UK.

Quite apart from these tax advantages, investment managers have found other advantages in choosing offshore over onshore domiciles for setting up their funds including:

  • flexibility to set out investment strategies and objectives without the restrictions generally imposed by onshore regulators in the name of consumer protection and the consequent absence of expensive reporting requirements;
  • if the investment management of a fund is conducted offshore, there may be regulatory advantages for the investment manager as well;
  • offshore centres tend to have governments that recognise the importance of working closely with the private sector to provide legislation which meets market needs;
  • offshore centres, in particular those we referred to above, are home to a concentrated level of fund expertise, including specialised law firms, experienced administrators, custodians and accounting/auditing firms; and,
  • many of these offshore jurisdictions are considered investor-friendly and are internationally regarded as financially secure.

The regulatory framework in force in most of the offshore jurisdictions typically takes a two-tier approach. A distinction is made between funds that are offered to members of the public, which require a high degree of regulation because of the nature of potential investors, and funds that are either offered to sophisticated investors (such as the 'professional funds' in the BVI) or only marketed among a small and select group of investors somehow connected with the investment manager (such as the 'private funds' in the BVI).

Financial trusts were introduced in Uruguay by Law No. 17.703 of 2004 (the Trust Act) as an alternative to the traditional bank credit. Back then there was in the country a strong need to enhance investments and credit for the country's productive sectors as a direct result of the restricted credit that followed the 2002 banking crisis.

Since then, financial trusts have been used in a variety of sectors of the Uruguayan economy, such agribusiness, real estate, services and infrastructure. Any type of asset, including assets that are not in existence, can be placed into a trust.
In a nutshell, investors in a financial trust receive, as consideration for their investment into the trust, a certificate of participation in the trust property and/or a debt certificate that is secured by the trust assets. Once the trust is established, the trustee has the obligation to manage these assets for the benefit of the investors, who are the beneficiaries of the trust.

Only approved financial institutions or investment funds can act as trustees in this type of trust. As we have seen in respect of investment funds, the Central Bank of Uruguay also supervises financial trusts.

As Uruguayan financial trusts are more flexible than corporations and investment funds, both foreign and local investors feel comfortable with them.

It seems that the Uruguayan administration (which took office less than two months ago) has understood that the country can play an important role as a regional financial centre. If this is going to be the case, it will be necessary for the legal framework applicable to financial entities and structures (not only those we have referred to in this article) to be enhanced and modernised. This will help to ensure that the country continues to receive a large portion of the FDI coming into Latin America during a decade that will be much more unstable for the emerging markets than the previous one.


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Martin Litwak
Litwak & Partners

About the author

Martin Litwak is an award-winning investment funds and private client lawyer with 15 years of international experience. His professional practice is focused on representing investment funds of different types and magnitudes. He represents fund managers based throughout Latin America in all aspects of their operations, from their launching to their liquidation. He also provides professional advice to high net worth individuals, families and family offices domiciled in Latin America in relation to the structuring of trusts, family funds, foundations and other instruments relative to estate planning.

Litwak has authored and co-authored several legal articles, published not only in Latin America but also the UK and the US, and is a frequent speaker at regional and international conferences and seminars. He has been quoted frequently by newspapers, legal publications and journals on a wide variety of issues in the investment funds and/or wealth management industries.

He obtained his law degree with honours from the University of Buenos Aires (Argentina) in 1998. A few years later he was admitted as a lawyer both in England and Wales and the British Virgin Islands. He also holds a Master's degree in Finance from UCEMA (Argentina).

Litwak is an active member of the American Bar Association (international section) and STEP Latin America. He is also a member of 'Team BVI', a board of advisors to the International Finance Centre of the BVI, where he heads up the Uruguayan chapter. He is also a member of the board of directors of the Hedge Fund Association (Latin American chapter).