OECD GLOBAL FORUM ON SUSTAINABLE DEVELOPMENT FINANCING WATER INFRASTRUCTURE FOR ALL

1. OECD GLOBAL FORUM ON SUSTAINABLE DEVELOPMENT FINANCING WATER 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 18th 2003, GSFD Conference

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

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…

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

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. Banks/ Mulilaterals Loan Public funds/ subsidies Water Company Infrastructure upgrade Operation Support Agreement 100% Municipality 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.

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. Municipality Private Company Ownership Ownership Water Co Assets Water Co O&M Lease, Rental Fees Water Fees End Users Splitting the assets and the operations • 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.

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. Bond Holders Part. Guar. Water Fees TRUST Guar. Dexia IFC Excess cash Finance Municipality of Tlalnepantla Water Co Plant 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.

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