OECD GLOBAL FORUM ON SUSTAINABLE DEVELOPMENT FINANCING WATER INFRASTRUCTURE FOR ALL

Financing water and environmental infrastructure for all 2 Critical issues when financing water projects with private funding The limits experienced by traditional project finance schemes: BOT / Concession… Recent innovative schemes that may illustrate the way forward December 18 th 2003, GSFD Conference

Financing water and environmental infrastructure for all 3 Some emerging countries lack long-term stability, a fundamental requirement for private investors and creditors. Water projects are constrained not only by economic & financial feasibility parameters, but also by political and social provisions: tariff as a key electoral argument, affordability by end-users, long term political support. Projects are often promoted by local authorities, with long term-undertakings and creditworthiness sometimes difficult to assess by private funders. Experience has shown that macro-economic risks ( foreign exchange in particular) cannot be mitigated by contracts, when host countries face major economic crises. Critical issues for financing water projects with private funding

Financing water and environmental infrastructure for all 4 The story so far: water project financing in emerging countries essentially based on BOT and concession schemes BOT : –The private sector is in charge of the construction and the operation of a single asset (water or wastewater treatment plants). A long term Take or Pay contract with a public off-taker mitigates volume and tariff risks; –Political and tariff risks are born by the public sector, retaining interface with end- users; –Major constraints: long term creditworthiness of public off-taker, potential mismatch between gross and retail tariffs, limited availability of political risk coverage for sub-sovereign off-takers… Concession : –From treatment to distribution, through billing and investment : the whole water services chain is contracted out to the private sector; –More built-in flexibility, allowing adjustment of investment roll-out to actual cash- flow generation; –High exposure to regulatory and political risks, insufficiently mitigated by contractual arrangements such as tariff revision formula. From classical project financing schemes…

Financing water and environmental infrastructure for all 5 Traditional BOT and concession financing have shown its limits in emerging markets (especially in Latin America and South East Asia). Despite huge and urgent needs, only very little could be delivered by the private sector (water represented less than 1% of the global project financing market in 2002) Private sector operators are more prudent and selective especially when projects involve carrying substantial investment costs. A clear need to help the local public sector finance and implement its own share of the infrastructure investment burden, alongside private sector participation. Alternative schemes are being tested to establish new ways of public-private financings. … to new alternative public-private solutions

Financing water and environmental infrastructure for all 6 Merits: –Suitable for municipalities facing budgetary constraints –Funding can be combined with public subsidies –May pave the way for private sector participation. Constraints : –Minimum creditworthiness of the municipality –A clear regulatory and tariff setting framework is essential. Financing a municipal water company with a limited recourse to the municipality Municipal water company raises long term financing on its own covenant The ability of the company to cover its operating and financing needs by tariffs is secured through a municipal support mechanism The municipality undertakes to compensate the company if tariffs cannot be raised to cover additional costs. Water Company Banks/ Mulilaterals Infrastructure upgrade Operation Municipality Public funds/ subsidies 100% Loan Support Agreement

Financing water and environmental infrastructure for all 7 Merits : –Gain operational efficiency through private operators –May attract more appetite from private sector, and be a first step for its further involvement in the asset upgrade/maintenance. Constraints : –Establish rules allocating clear responsibilities between asset maintenance (public) and O&M (private) –For the public sector, access to long term financing to upgrade the assets. Splitting the assets and the operations Water Co O&M Water Fees Water Co Assets Private Company Municipality End Users Ownership Lease, Rental Fees Ownership Assets remain under public control. Operation and management are rented out to an O&M company to be sold to private sector O&M Co pays rental fees for the use of the assets, allowing public sector to maintain the assets.

Financing water and environmental infrastructure for all 8 The first municipal bond issue with no federal government guarantee. The transaction has been rated AAA by S&P (local Mexican rating). A long-term (11 years) local currency financing, leaving the project unexposed to foreign exchange risks. It is the first time that IFC takes direct municipal risk. Mexico, Tlalnepantla Project : opening access to local municipal bond financing Dexia guarantees a 8M$ local currency bond issue, with a partial guarantee from IFC. The Trust uses bond proceeds to finance the water infrastructure. Interests on bonds are financed by end-users fees, flowing directly to the Trust. Excess cash is transferred to the Municipality. Part. Guar. TRUSTDexiaIFC Municipality of Tlalnepantla Water CoPlant Water Fees Bond Holders Guar. FinanceExcess cash

Financing water and environmental infrastructure for all 9 Whatever scheme is opted for, private sector participation can only be effective when public sector is able to sustain and manage its own obligations in the public/private partnership. Financing/guaranteeing sub-sovereign entities is crucial in a market where demand is local. Blending public and private finance techniques proved to be instrumental in delivering bankable projects. A few comments to conclude