IWA Bucharest, June 17, 2014

1. A Discussion of Regulatory Issues in the Water and Sanitation SectorKatharina Gassner, PhDWorld Bank Group IWA Bucharest, June 17, 2014

2. Outline • Regulation in the International Context • Country Specific Options for Establishing a Regulatory Framework • The Role of the Private Sector • Regulating State-Owned Enterprises • Benchmarking

3. Economic Regulation in InfrastructureWhy is it Needed? Infrastructure markets are imperfect and long term contracts are incomplete. Regulation is different from Policies. It is a technical function that helps balance the interests of users and of operators. It is meant to issue/enforce decisions/recommendations using technical tools and consistent with boundaries set by pre-existing policies/laws/contracts. Regulation does not replace policies. Regulation provides a level playing field to all stakeholders in the sector. autonomous third party equal treatment of all operators, private and public effective regulation provides a transparent, predictable operating environment (important for investment!) Economic Regulation focus on Ex-ante Interventions, not on Ex-Post actions. This is the difference with Competition Laws. 3

4. The Rise of Regulatory Agencies outside the OECD (by sector) Sources: ITU (ICT); authors’ database (electricity and WSS) Note: WSS is incomplete.

5. Regulation as ONE of the tools for Government

6. Establishing a Regulatory Framework:No One-size-fits-all

7. Regulatory Functions Need to be Matched to Sector Objectives

8. Option 1: Standard Independent Regulatory Model

9. Option 2: Regulating Private Providers by Contract Example: Bucharest Water and Wastewater Concession

10. The Example of the Bucharest Water Concession 2008 1990 1995 1996 1997 1998 2000 2001 2002 2003 2006 2007 ICAB RGAB Apa Nova Full EU membership Associate EU membership Liberal-democratic Government elected March: Concess-ion signed End of Communist dictatorship May 2001 and Oct. 2002: Staff strikes Apa Nova sells 10% of shares to employees Comprehensive agreement and contract amendment November: Veolia takes over Customer satisfaction Typical Household Bill (real) Water quality Non-revenue water (l/km/d) Staff per 1,000 connections

11. The Results of the Apa Nova Water Concession • Was the Bucharest water and wastewater concession a success, as measured by: • Access? Increased from 90 to 92 percent and expanding in the unmapped areas • Quality of service? Improved and approaching Western European standard • Tariff? Remained below average and far below Western European level • Operating efficiency? Increased thanks to higher labor productivity and energy efficiency • Fiscal impact? Saved US$349 million • Private investment mobilized? EUR200 million (US$250) since the start of the concession • What are the lessons for future water PPPs? • A committed public authority • A committed and expert advisory team • A well-prepared, high quality, and transparent transaction process • An unusually thoughtful and innovative contract design • A well-negotiated plan for the staffing reduction • Well-designed and implemented contract monitoring and dispute resolution arrangements.

12. The Connection Between Utility Performance and Private Sector Participation • Global evidence on a sample of suggests private sector participation has a strong positive effect on performance: • number of residential water connections up by 12 % • electricity sold per worker up by 32% • residential coverage in sanitation services up by 19% • bill-collection rate in the electricity sector up by 45% • distribution losses in electricity down by 11% • hours of daily water service up by 41% • These effects—differences in averages between the pre-PSP and the post-PSP period—occur over five years or more and are over and above the change for similar SOEs. Source: Does Private SectorParticipation ImprovePerformance in Electricity and Water Distribution? Katharina Gassner. Alexander Popov. NataliyaPushak. PPIAF 2009

13. An Important Role for Private Investment Flows –but they are vulnerable to crises…. Private investment commitments to PPP projects in developing countries, by sector, 1990–2009 Asian Crisis ? Brazil Crisis Market Liquidity Mexico and Argentina Global Crisis TequilaCrisis Expansion Source: World Bank and PPIAF, PPI Project Database *Adjusted by the US Consumer Price Index

14. … and difficult in WSS Source: PPIAF PPI database

15. The Role of Regulation in the Case of State Owned Enterprises Objective: improve the accountability for water and sanitation sector performance The institutional framework needs to: • take into account conflicts between roles (ownership vs rule making) • impose on service operators a set of rules and contractual relationships that: • establishes accountability through absolute clarity of roles and objectives; • specifies rights and obligations consistent with those roles • provides necessary incentives and sanctions to encourage efficiency (hard budget constraint); • ensures that incentives are aligned with wider social interests; • sets out clear principles and processes to be applied when circumstances change or disputes arise.

16. Benefits of benchmarking in regulation Strong incentives are provided to operators to be efficient and innovative, mitigating the costs of operation and the capital expenses; Main advantages of benchmarking use An on-going pressure is put on the water utilities to improve the quality of service; A fairer recovery of costs and of the capital investments is assured; Anincrease of transparency and sharing of information,minimising its asymmetry between different stakeholders (specially between regulator and operators). Benchmarking

17. Case studies – Benchmarking to set prices (1/2) WSS regulation in England and Wales (E&W) is pointed out, in the literature, as one of the successful examples of YC application Office of Water Services (OFWAT) Regression DEA Determine the efficient costs that are the basis for the X factors calculation (in the price cap formula) YC (Sunshine regulation) Determination of the Overall Performance Assessment, measured through a compilation of several performance indicators Quality of service

18. Case studies – Benchmarking to set prices (2/2) Chile … efficient operator is imposed to enable the regulator to determine the base costs for the setting of tariffs and it can further include the expected productivity earnings (X factor) in the price cap formula Colombia Economic regulation of the water sector La Comisión de Regulación de Água Potable y SaneamientoBasico(CRA) Definition of methods and tariff formulas It uses benchmarking (DEA technique) to compute the efficient administrative costs and the efficient OPEX; Regulatory Process Based on a system of price cap defined for a period of five years which also includes a prices floor (minimum limit of 50 %).

19. Case studies – Benchmarking to improve quality (1/2) Victoria, Australia Responsible for… The regulator (now Essential Services Commission – ESC) applies sunshine regulation here since 1994. • the quality of service supervision the quality of the supplying (e.g. water quality and compliance with the norms); the service reliability (e.g. interruptions, non-revenue water and blockages); the services availability (e.g. prices, special customers and lack of payment); the customer service (e.g. call centres, claims and customers’ satisfaction). • the economic regulation … increases the transparency and accountability of the WWS. The WSS performance improvementcan be seen, i.e., in the evolution of the indicator water interruptions

20. Case studies Benchmarking to improve quality (2/2) Portugal

21. Conclusion (1/2) • Working towards more effective economic regulation in infrastructure is key, because regulation influences the performance of the sector, in the short (productive efficiency) and long term (investment and expansion of services). • Not everything is regulation: sector policy matters, and weaknesses there (in rules and institutions) have a major impact on results on the ground. • Improving internal governance is an equally important pillar of reform, i.e.: • for PPPs: Contracts design • for SOEs: internal systems of incentives and governance which affect their own drivers of performance and sensitivity to economic regulation.

22. Conclusion (2/2) • The benefits of using yardstick competition are well visible in the cases analyzed, including in the case of sunshine regulation (takes longer, but often best option). • Ultimately, what matters for successful regulation is • technical soundness of decisions, coupled with common sense that recognizes the political/social dimension of these services; • legitimacy, autonomy & accountability of the regulatory institutions; • transparency, predictability & credibility of the rules & processes in place. • A last word: good communication can strengthen a regulator, increase its effectiveness and improve its autonomy.

23. THANK YOU Dr. Katharina Gassner kgassner@worldbank.org 23