The Energy Reform recently approved by the Mexican Congress offers great opportunities to companies that want to expand into the energy sector in Mexico. But corruption levels in the energy sector remain pervasive, posing an ongoing risk to all participants. The reform legislation seeks to reduce corrupt behavior by officials via several provisions addressing corruption and transparency. Still, it is unlikely these measures alone will stop corruption in the energy sector. Companies need to understand the risks they face and take practical steps to mitigate their exposure. The energy sector has in the past faced an unfortunate association with corruption. Some observers have argued that the Energy Reform will fail if this trend continues. Thus, the Mexican authorities are interested in deterring acts of corruption by adopting preventative measures and pursuing those involved in improper activity. This interest is reflected in several provisions of the Energy Reform.

Energy Reform – Anticorruption Considerations

The debate on the implementing legislation of the Energy Reform included discussions about the fight against corruption, and the new legislation presents some new anticorruption measures.

Transparency

To promote transparency, the reform establishes that all bidding procedures awarding exploration and production contracts should be open to the public, including the creation of a public information portal with data on contracts from the past 5 years. PEMEX and CFE will host these information portals, on which they must share data on their contractors/vendors and the quality of their work under their respective contracts. PEMEX and CFE are also required to create an anonymous whistleblower system. Still, it is unclear whether these new transparency rules will prevent the abuses of the procurement procedures that have grown common. Under existing rules, the procuring agency must award a public contract to the company presenting the most competitive proposal in public, via an electronic and open bidding procedure. Even though open bidding procedures help provide transparency on public spending, the bidding rules consist of more than a thousand pages and hundreds of requirements. Such complicated procedures often serve as cover for officials and contractors to do something quite simple: rig the outcome of the bid. If a procuring agency and supplier collude, they can develop technical specifications that contain a sole technical requirement that has no practical importance but only the supplier’s equipment meets. The supplier’s competitors are excluded from the bid for not meeting the specifications and the procuring agency can purchase the supplier’s equipment via a sole-source, non-competitive procedure. It seems unlikely that the new transparency provisions will eliminate such practices.

Measures Aimed at Conduct of Officials

The new legislation establishes that all public servants of the Secretary of Energy (“SENER”) will be obligated to follow a Code of Conduct, in addition to existing provisions of the anticorruption regulation. The reform also explicitly states that employees of PEMEX and CFE are covered by Mexico’s 2012 Federal Law on Anticorruption in Public Procurement (“2012 Anticorruption Law”). The new legislation also imposes new measures seeking to inhibit conflicts of interest, such as prohibitions against public officials when the bidding procedure is in progress to meet with any contractors competing for the bid, or accepting any expenses or travel reimbursements from any other third party. Rules will be issued to regulate the attendance of public officials at meetings and events with stakeholders. Nevertheless, when it comes to punishing public officials the new laws also left a window that can lead to impunity. Specifically, the Mexican authorities can refuse to sanction a public official if the action investigated is related to a matter of judgment. With that criteria, the public servant can argue that a decision motivated by corrupt intent was made according to another, legitimate business rationale.

Risks to Private Companies

The Energy Reform does not impose any major new rules or penalties on private companies developing hydrocarbons or supplying PEMEX and CFE. Nonetheless, the heightened risk of scrutiny in Mexico surrounding the Energy Reform makes the existing measures much more noteworthy. The penalties for private companies failing to comply with the Hydrocarbons Law include fines and the administrative termination of contracts for exploration and extraction of hydrocarbons. The Mexican authorities also have some administrative debarment measures they can take, which could exclude offending companies for the duration of the Energy Reform implementation. The extensive public procurement that will go with the Energy Reform calls to mind the 2012 Anticorruption Law, which imposes administrative and civil liability on companies and individuals. The 2012 Anticorruption Law prohibits a number of actions, ranging from paying bribes to procurement officials to evading the rules of the tender process. Violations of the 2012 Anticorruption Law by legal entities are punishable by fines of up to $15 million or up to 35 percent of the value of the contract (whatever is larger), and up to 10 years debarment from public procurement.

Strategies to Mitigate Risk

It is challenging to identify the main corruption risk in the energy sector, as risks arise along the entire spectrum, from public bidding, to licensing and certification, delivery and evaluation of the services, and onwards. Compliance officers and counsel of energy companies operating in Mexico must adopt a comprehensive and robust compliance program and system of internal controls that are battle-tested and ready before doing business with PEMEX or CFE. A paper program introduced by a spare, check-the-box training is not enough.

Role-Based Training

Compliance departments should approach training in a much broader sense. Specifically, training should communicate to employees in every function what their role is as relates to compliance and how fulfilling that role is inherent to their performance. Such role-based training needs to be tailored to different audiences (e.g., sales personnel vs. accounting). The examples presented to each group should fit the real world situations they are most likely to encounter. Compliance departments could consider further reinforcing role-based training by making organizational changes that get personnel actively involved (e.g., local ethics committee comprised of management, HR, internal audit). Certain categories of personnel, such as accounting/audit, will in any case need training on the compliance-related aspects of their positions and should feel obligated to follow up on any concerns that emerge.

Third Party Risk Management

The other main risk that companies can mitigate is the role of third parties. It will not be uncommon or unreasonable for local partners and agents to play a role assisting foreign companies in navigating the newly-opened Mexican energy sector. Still, third parties usually are the weakest point in the compliance chain for companies operating in Mexico, where companies sometimes over trust and only discover an agent’s misconduct after the fact. The inverse problem is also a risk – that the company will trust none of its agents and thus close itself off from beneficial partnerships. Companies dealing with Mexican state-owned enterprises should have a comprehensive third party management system with a risk-based protocol for selecting/vetting, training, and monitoring third parties. Of these, the selection and vetting of third parties is the most important. Compliance departments should incorporate existing due diligence protocols for third parties into its local operations well before there is a need to partner with a local company. Existing protocols designed for lower-risk markets and transactions should be adjusted for the Mexican energy sector. For example, an energy company with operations mostly in the United States and Canada may not have due diligence protocols in place that are adequate for Mexico.

Conclusion

The Mexican energy sector poses many risks – corruption, environmental, labor, etc. But companies can take practical steps to limit their exposure. Most companies have already taken these steps, although some have not faced such risk levels in the past. Before taking advantage of the opportunities offered by Mexico’s Energy Reform, all companies would be wise to assess what they have in place and what more they need to do to mitigate the risks they will face.