Regulatory changes intended to facilitate private equity investment and the opening of Mexico’s energy sector present enormous opportunities for American business and investors.

Through a confluence of factors, investment in Mexico  has never looked better – and private equity has taken notice. Despite a deep global recession that has crippled many economies around the world, Mexico’s economy has proven relatively stable in recent years, and its private equity market has benefitted accordingly. As a result, according to a Bain & Company report, annual fund-raising in Mexico increased nearly six-fold from 2008 to 2013.1 Mexico’s new fund raising annual compound growth rate  of 56% from 2009 through 2012 compares remarkably  well to that of Asia (at only a 4% growth rate) and the rest  of the world (at only a 2% growth rate excluding Europe and North America).2  Further, the number of general partners active in the market more than doubled in 20123 – in no small part due to an active foreign private equity investment climate. This growth was fueled by a set of reforms enacted in Mexico from 2006 creating improved tax transparency for investment funds and legal validation of a variety of corporate governance and shareholder controls already recognized in other countries and desirable to active outside investors.

Foreign private equity funds investing in Mexico have typically been structured as Canadian limited partnerships because they have long been acknowledged as fiscally transparent for Mexican tax purposes. Domestic private equity funds may be structured as “Private Equity Trusts”  or “Transparent Trusts”, depending mostly on tax strategy. Private Equity Trusts are required to invest in unlisted equity issued by Mexican corporations, or to provide financing to these corporations, while Transparent Trusts are required to derive at least 90% of their income from passive investments such as interest, capital gains, debt financing, sale of shares and dividends. In terms of fiscal transparency, Canadian limited partnerships, Private Equity Trusts and Transparent Trusts are not subject to Mexican income tax. Improvements in Mexico’s laws in important areas that allow private equity funds more control over  their investments were also seen as being key drivers in the sector. For example, Mexico now recognizes by statute corporate governance and shareholder controls relating to drag along and tag along rights, validation of shareholders’ rights agreements, affirmative and veto rights and a reduced threshold for the appointment of directors, among other important changes.

This year, Mexico’s Congress enacted a number  of additional important legal reforms, ending years of legislative paralysis on key issues surrounding investments. One set of reforms receiving a lot of attention from foreign and domestic investors includes new laws  and pending regulations allowing private investment in the energy sector, particularly in the oil production and electricity generation and distribution industries. Reforms relevant to the oil industry include allowing private entities to undertake “upstream” activities (such as exploration and extraction of hydrocarbons), directly or in conjunction with Pemex, Mexico’s state owned petroleum company, through “Exploration and Extraction Agreements.” Exploration and Extraction Agreements may encompass service agreements, shared utility agreements, shared production agreements and licenses.

In addition, Pemex may now enter into partnerships and joint ventures with private entities to be selected through  a competitive bidding process. As a result of the new legislation, private parties that have previously entered  into agreements with Pemex for exploration, production or public works pursuant to regulatory action taken under the prior statutory regime can convert those arrangements into Exploration and Extraction Agreements. Such conversions would result in greater legal certainty with respect to the validity of such agreements. Finally, Pemex is allowed to purchase, lease and otherwise acquire goods and services related to upstream activities from private parties.

Additional reforms specify that private entities may now undertake “midstream” and “downstream” activities directly by obtaining permits from Mexico’s federal government. Such permits allow private parties to engage in the treatment and refining of petroleum, processing of natural gas, importing and exporting hydrocarbons and petroleum products, transporting, storing, distributing, compressing, liquefying, decompressing, re-gasifying, marketing and retail sales of hydrocarbons, petroleum products and petrochemicals.

In the electricity industry, the newly enacted reform allows private entities to participate in a wide range of activities related to the generation and commercialization of energy. The new law allows private entities to enter into partnerships and joint ventures with Mexico’s former electricity monopoly, CFE, for the financing, installation, maintenance, administration, operation and expansion of infrastructure necessary to transmit and distribute electricity. In addition, the reform classifies electricity consumers into “qualified” and “basic supply” consumers, and provides that qualified consumers may purchase electricity from private entity suppliers, while basic supply consumers, who generally must continue to purchase electricity from CFE, may now become “self-generating” by acquiring and installing electricity generation equipment on their own properties. This is a very exciting development for domestic and foreign solar developers eyeing the Mexican markets and for investors in and lenders to such developers. Under the newly-enacted laws CFE must acquire electricity from private entities on an independently run market, through an auction process and in competition with other market participants, in order to fulfill its obligation to sell electricity to basic supply consumers. Again, a promising development for domestic and foreign commercial scale power generation developers, and their investors and lenders.

In short, Mexico’s newly enacted energy reform dismantled state-owned monopolies in the oil and electricity industries. These recent reforms create enormous opportunities for private equity funds to finance companies to engage in upstream, midstream and downstream activities in the oil industry, to partner with Pemex or to engage in the generation and commercialization of energy. In addition, as a result of the private equity reforms enacted in Mexico over the last decade, private equity funds that enter Mexico’s energy sector will also enjoy fiscal transparency in a much more flexible corporate regime – all of which we expect to further accelerate the dramatic growth already enjoyed by Mexico’s private equity market.

Fernando Eraña and Fernando Ortiz of Solcargo