Successfully closing a cross-border acquisition in an emerging market requires creativity, local knowledge and strong risk management expertise. The right partner will bring all three elements to the table, and more.
Risk.net discusses the challenges of building and executing a hedging solution across currencies and territories in a complex political landscape – with Djamel Bruimaud and Stephane Benhamou, interest rates and foreign exchange specialists at BNP Paribas Global Markets.
Early in 2018, BNP Paribas supported a consortium led by French energy company Engie with the purchase of 90% of the Brazilian natural gas transmission network owner Transportadora de Gas (TAG) for $8.6 billion. Working closely with Engie over the following year, the bank delivered a hedging solution designed to match the consortium's complex risk management needs. In-depth local knowledge and emerging markets experience, as well as the ability to innovate and adapt, helped BNP Paribas create a tailored solution to support this acquisition.
The challenge was twofold – as well as managing the uncertainty around winning the auction to purchase TAG, the consortium needed to maximise its bid and minimise market risk relating to the project. The mismatch between the debt and equity currency, which were to be raised mainly in US dollars, and the actual purchase price, which was in Brazilian real, created a foreign exchange risk. Moreover, the financing models assumed a long-term fixed cost of debt while the facilities themselves were priced on a floating basis.
The result was a series of carefully structured FX hedges for the various capital injections, coupled with an interest rate swap contingent on the successful completion of the acquisition.
What role did BNP Paribas play in this transaction?Stephane Benhamou: Using our strong derivatives expertise and deep experience of emerging markets, including local knowledge of Brazil, we developed an innovative solution to support the consortium's bid. The bank's integrated merger and acquisition (M&A) risk management offering draws from multiple areas of the business to help clients navigate such complex situations.
For this specific transaction, BNP Paribas also played the role of hedging counterparty and legal documentation co‑ordinator, liaising with the local custodian in Brazil, Central de Custódia e Liquidação Financeira de Títulos Privados (Cetip). This meant these structures could be clearly outlined in advance to reduce any accounting friction. Our close collaboration with Cetip ensured we could provide expert analysis of accounting impacts, as well as a smooth approval process.
What were the main challenges encountered during the Engie consortium's acquisition of TAG?Djamel Bruimaud: There was a great deal of political uncertainty at the time, which contributed to a long and eventful timeline to completion.
The Engie consortium won the first round of bids to acquire TAG in May 2018, but local unions blocked the deal before it was due to close that July. Only the Brazilian Supreme Court could unlock the situation, delaying the approval to October 2018, after the Brazilian general election. A second round of bidding followed in March 2019. While the consortium was once again successful, the transaction returned to the Supreme Court. Authorities granted final approval in May 2019 and the deal completed the following month.
It is hard to plan for such delays when you submit a bid, but we were prepared and ready to help the client navigate the unexpected complexity. We have extensive resources on the ground in Latin America and our internal analysis suggested a high probability of completion, albeit with some delays due to the election.
Stephane Benhamou: These deals do not simply involve pricing the transaction and managing market risk. We have extensive knowledge of the local market, the political environment and the regulatory regime, which was key to providing the most competitive pricing and satisfying the client's needs. BNP Paribas' local presence in Brazil enabled us to play a major role in supporting the consortium, while the co-ordination between our teams on the ground there and the hubs in Europe and the US was key to connecting with the client locally and globally.
What factors influenced your thinking in developing the final structure?Djamel Bruimaud: We discussed many different solutions during this process – mostly because of the legal delays. Hedging a transaction that is supposed to close in two months is very different to hedging one that will close in six to nine months.
In addition, BNP Paribas was able to source opposite interest for the FX element of the transaction from investors in other regions. This was essential for optimising pricing and managing the bank's own risk. We restructured the consortium's full position and minimised the market impact of such a large transaction.
Also, the local currency devalued by more than 20% during the deal timeline. The consortium was mainly funding in US dollars so it was essential the client could monetise the upside from the FX element – a 20% difference when funding a $8.6 billion transaction can dramatically affect the final bid.
Stephane Benhamou: On the rates side, it was important for the client to manage any potential increase in costs at the end of the transaction. We created a deal-contingent onshore US dollar interest rate swap settled in local currency, which transformed into a vanilla swap when the M&A deal closed.
This enabled the consortium to neutralise its market risk exposure. The terms of the hedges are agreed, but only become effective once the deal has closed. With the uncertainty around closing the transaction and the relative expense of using an option in this situation, this structure offered an extremely cost-effective solution.
What made this transaction stand out?Djamel Bruimaud: For the FX part of the transaction, BNP Paribas recycled all the associated risk in less than a week. This reduced the hedging cost for the clients when the deal became more certain and when they transformed the options into forwards.
Stephane Benhamou: We were also able to develop a solution that suited the longer timeline. The structure was adjusted until we had covered all the potential risks in a way that was acceptable to Cetip.
How did you manage client expectations during the process?Stephane Benhamou: We were in constant discussion with the consortium members. I think Engie really appreciated BNP Paribas' global reach and the service we provided, both in Europe and in Brazil. In particular, our onshore presence limited risks and costs for the consortium.
Djamel Bruimaud: Having a regional presence in Brazil meant we could speak knowledgeably and confidently about local processes and procedures. This was particularly useful, for example, when getting the client comfortable with the physical delivery of Brazilian real, as the amounts were large.
|A solid partnership|
Vincent Sanchez, head of financial risk management at Engie, discusses the key elements in its successful collaboration with BNP Paribas
What factors influenced your selection of BNP Paribas as a partner in this process? Vincent Sanchez: We needed a bank that could be flexible in terms of financing and risk management, with the appetite to provide the necessary hedging solutions. BNP Paribas proved it had that flexibility and could understand the key transactional issues rapidly. It had the necessary onshore and offshore appetite for the hedging element and took a leading role in the complex documentation discussions with the local custodian. In a nutshell, BNP Paribas was quick to adapt to the specific needs of the transaction, while offering innovative solutions.
What advice would you give to others embarking on similar acquisitions?
Vincent Sanchez: The best partner will perform in three key areas: market capabilities, real onshore presence, and an understanding of the environment and risk management landscape. With these areas covered, the process should be relatively smooth.
What were the key outcomes for the consortium?Djamel Bruimaud: The client reduced hedging costs considerably for the FX conversion, to the extent that it lowered the amount of equity injected from Europe.
Stephane Benhamou: The consortium was also pleased with the deal contingent structure used to manage interest rate risk. Our ability to execute onshore under local documentation was also helpful.
What are BNP Paribas' lessons for developing best practice risk management in emerging markets M&A?Djamel Bruimaud: Consider a wide range of solutions, especially in an emerging market where you can play with different parameters such as the emerging market carry or the option market term structure.
Also, the extraordinary level of co‑ordination between our team in Brazil, Europe and the US was key to successful execution, as was our ability to co‑ordinate locally and globally with the client.
Stephane Benhamou: There were a lot of legal constraints on this transaction, so local knowledge was crucial.
BNP Paribas had the onshore capabilities, the expertise to structure the contingent hedge and the risk appetite. Many banks only have one or two of these elements. As a result, we were able to deliver for the consortium from start to finish.