In the previous issue of Water New Zealand‘s Water Journal, Senior Water Resources Consultant Brad Tiller explored alternative funding sources that could be used to help bridge the water infrastructure funding gap. Examples included our sovereign wealth funds, such as our NZ Super Fund, ACC, and KiwiSaver, which collectively represent $200 billion. In this second issue, Brad discusses market-based mechanisms such as incentives and disincentives, innovative impact finance and delivery models that could improve our infrastructure efficiency based on success abroad.
Home truths
The idea of exploring alternative funding sources to invest in water infrastructure was always going to cause a stir, but this is the type of conversation a critically underfunded industry should be having.
Since the release of part one in the previous edition of Water, several groups across the infrastructure sector such as councils, water service providers, iwi and consultancies, have reached out with overwhelming support. Many had little awareness of the magnitude of our KiwiSaver, or that most of it is invested overseas, or that our other two sovereign wealth funds, the Super Fund and ACC, invest so little into our domestic infrastructure.
Several from within the finance sector have also shown support, albeit wondering why this conversation hadn’t come from within their own silo… Perhaps it takes someone not in the industry to challenge the status quo by asking the question.
Aside from the discussion on where the money could come from, the infrastructure and finance sectors have acknowledged the rhetorical questions presented in part one as being on point. Although it made for confronting reading, these home truths extend well beyond the water sector – but regardless, they need to be our focus as a nation to move forward.
In case you missed part one, let’s recap:
- Are we still a nation of thinkers courageous enough to try something different, or are we resting on our laurels and getting a bit soft?
- Are we becoming a nation that is good at talking about issues but not solving them?
- Has our reputation for bold problem-solving, fueled by our isolation and innovative spirit, faded?
- Why is our financial innovation (which enables water infrastructure delivery and the development of the economy) less progressive than that of other forward-thinking nations?
- We are an affluent country with ample sovereign wealth, so why aren’t we drawing on our funding sources instead of burdening ourselves with more international debt?
Worlds collide
Powerful things can happen when you bring together different perspectives. I was fortunate enough to chair a keynote panel discussion at the Water New Zealand Stormwater Conference in May on how we can enable investment through sustainable finance. It was the first time such a discussion had taken place at a water conference, but I think it’s safe to say the audience learnt a lot. The profound moment for me was when Sam Stubbs of Simplicity asked the 300-plus audience to raise their hand if they supported the idea of our KiwiSaver owning a water network. Virtually everyone put their hand up. However, sustainable finance (directing capital and promoting environmental and social initiatives) goes beyond supplying capital. It includes how market-based mechanisms and innovative finance and delivery models can be used. This article will focus on describing these concepts.
Let’s use the carrot, and the stick
Market-based mechanisms come in several forms but essentially involve influencing human behaviour through economics. Incentives promote favourable outcomes through financial benefits to users such as subsidies, grants, cost shares and rates credits. Disincentives, on the other hand, are designed to reduce undesirable behaviours by making them more costly or less attractive, generally through taxes or levies. These concepts may not be new to you, but my research reveals that our sector is decades behind other countries. Aside from broad property rates, which indirectly pay for water services utilities, the only targeted user pays model we have (in some regions) is for potable water use and commercial wastewater discharge – both through metering. There are, however, very few financial incentives to promote good outcomes – much of it relies on goodwill, and hope. Sure, some council design manuals promote low-impact design for greenfield developments, but it doesn’t go far enough to minimise the ‘tragedy of the commons’ effect on existing properties.
Stormwater – the problem child with unrecognised potential
Stormwater runoff is directly linked to human behaviour through land use decisions – however, no financial incentives or disincentives exist. Once impervious surfaces are established, managing the effects is very difficult and costly. An impervious surfaces levy (or a stormwater utility charge) would change that. This is an equitable assignment of cost to a property owner proportionate to the demand placed on the stormwater network from each property. The more you pave, the more you pay. Local jurisdictions in over 40 states in America have adopted a stormwater utility charge that not only generates revenue but also influences land development choices and the subsequent load on the stormwater network.
Levy payers should, however, be equally provided the opportunity to lower the cost of the levy through favourable outcomes. Currently, 14 states in the US have implemented green infrastructure credit programmes. These programmes are designed to manage and reduce stormwater runoff by providing financial incentives or credits to property owners to implement green infrastructure practices such as rain gardens, permeable pavements, green roofs, reuse tanks, or using less fertiliser.
The programmes help municipalities meet water quality standards and manage stormwater more effectively by encouraging private landowners to contribute to these efforts. Given the pluvial flooding our urban centres frequently experience, isn’t it time for our councils to consider this tool? Aside from market-based mechanisms, what other initiatives should we consider? Below are a few examples of concepts that could be used to solve our water woes. These are, by and large, existing concepts – we just need to be innovative to try something different.
Let’s utilise innovative impact finance and delivery models
The public may be hesitant about the notion of private investment, which is understandable. From an economic standpoint, however, water infrastructure is the all-pervading and enabling asset class holding our nation back. Enabling investment into water services enhances quality of life and improves public health; increases property values and unlocks economic growth; protects the environment and provides resilience to climate change for future generations.
It is widely agreed that infrastructure delivery through private finance desperately needs a rebrand. Unfortunately, this stems mainly from our limited experience with public-private partnerships (PPPs). Funding the water infrastructure deficit with ratepayers’ money through publicly delivered projects alone won’t achieve the required step change in service levels. There is broad consensus that business as usual, can no longer be. We need to expand the pool of available capital, so how can we achieve it?
Let’s generate revenue by measuring use better
As outlined in part one, it’s hard to generate revenue from an asset (or service) if we don’t measure its use.
International and domestic investors (such as our KiwiSaver) would only provide finance if returns could be realised through targeted levies over a long term (commonly referred to as revenue bonds). This model would go a long way to achieving much-needed balance sheet separation (BSS) for council-controlled organisations (CCOs). But chasing BSS is like solving one face of a Rubik’s Cube – necessary but insufficient. Yes, BSS is the largest lever to influence a future council-controlled organisation’s credit rating – but to achieve that, we first need to show that we can generate revenue from what we build. With the right structures in place, the private sector can share risk with the public sector and contribute expertise, innovation, rigour, and high-quality management of infrastructure assets. The problem, however, is the perception of the private sector generating a return from delivering (traditionally) public infrastructure projects through PPP models. We certainly have a checkered history delivering infrastructure to time and cost as a nation, and worse – our largest construction firms often struggle to make a profit.
Three Waters Infrastructure is a gold-plated infrastructure class to finance on a hire-purchase type basis because it complements design, construction, and maintenance contracts over a long duration, as common with PPPs. Revenues from water use, for instance, can more easily be delineated to certain projects, and compliance performance can more easily be measured by leakage rates. So, what must the private sector do to earn the public’s trust?
Let’s improve accountability by measuring impact better
Once something is built, we often don’t measure whether it achieved what was agreed upon. If the payer of outcomes is the asset beneficiary, then evidence, not advocacy, surely generates trust and accountability. This is the purpose of impact investment, and it involves three core characteristics:
- Intentionality – an investor’s intention to have a positive social or environmental impact through investments, collectively defining and agreeing to what good looks like.
- Expectation of return – the investment is expected to generate a financial return on capital or, at minimum, a return of capital.
- Impact measurement – a commitment by the investee to measure and report on the social or environmental performance and the progress of underlying investments, ensuring transparency and accountability.
An Environmental Impact Bond (EIB) is a perfect example of impact finance that works well for water infrastructure. It is an outcomes-based contract between a public entity and the private sector where payment is based on measured impact. Think of it like a PPP but with more focus on measurable environmental impact.
Financing green infrastructure is the ideal candidate for EIBs because the impacts transcend water quality and quantity, which can be easily modelled and measured. A reduction in runoff, achieved by increased absorption or infiltration, or a reduction in contaminants, achieved by source control and treatment, are both considered a beneficial outcome or environmental impact. EIBs are essentially ‘results-based finance’ where the results are defined in advance, and outcome funders pay only once their achievement is independently verified. The world’s first EIB (for USD $25m) was issued in 2016 by the Washington DC Water and Sewer Authority to fund the retrofit of bioretention gardens, urban swales, permeable pavements, and infiltration basins across 200 hectares of impervious urban land. Following 12 months of baseline measuring, a 30 per cent reduction in runoff was modelled post-installation, and the investors received a return on their investment. Better yet, a bonus performance coupon for USD $3.3m was agreed if targets were exceeded.
Let’s have an intergenerational investment focus on water. The government is looking for (and suggesting) novel private finance and delivery models for transport projects – so why not water? Our sector has vast potential to upgrade leaky water mains and undersized stormwater networks, construct new wastewater and potable treatment plants, and build flood protection schemes through PPPs. We can learn from the experiences of PPPs and reinvigorate the public’s trust in such models. KiwiSaver and iwi are natural investors in infrastructure, but international investors are also willing to invest in low-risk, long-term, and stable infrastructure projects. The political will and mechanisms to encourage it, however, are lacking. We need to look further into the future to have a chance of leaving a high quality of life for future generations. Increasing the time horizon from the less than five-year Long-Term Plan or current election cycle would also give international suppliers the confidence to commit equipment and staff on a larger scale. This is the first step required to achieve scale in our infrastructure delivery. We need a pipeline of work to assist in resource planning.
Let’s improve transparency about risk and returns
Partnerships are led from the front, not driven from the back, and our industry could do with fewer lawyers. Litigation and trust often have an inverse relationship; the more contractual complexity and closed-book accounting, the less trust there is. The physical work that must be done at the front is relatively straightforward. However, lawyers generally overcomplicate and take an absurdist approach to risk from the back.
The cost and complexity of this and regulatory compliance associated with delivering projects are wasteful from an NZ industry productivity perspective. Improved safety in design and environmental compliance, as well as greater value for money and overall performance, can be achieved if contractors, designers, and planners are involved earlier at the feasibility stage. We must be willing to take calculated risks, but it shouldn’t all be lumped into the design and delivery consortia. This is the case, especially for the smaller suppliers that need more resources or insurance policies. I’m sure all parties would prefer a cooperative or alliance model where there is provision for risk to be shared, margins are respected, and mutual success is the focus rather than an adversarial and litigious commercial environment. For this to happen, however, it relies on transparency and sharing ideas and lessons learnt to improve and innovate. Our infrastructure sector is dominated by small to medium subcontractors and suppliers that can’t afford the risks and potential losses from a single project. These operators are often established on family values, proudly focused on doing their work well and delivering excellent results for communities and clients.
We should focus on these positives as a collective, not try to trip up one another for short-term gain. If you meet the project’s scope, we should all be eligible for a profit – so why does it need to be awkward? We all can win if we work together. The foundation of any robust partnership includes mutual respect, transparency, and a common purpose. An example of a successful project delivered under these principles was the design and construction of the new Taparahi bridge on State Highway 25A in the Coromandel. Under this joint-venture alliance, constructors (Fulton Hogan and McConnell Dowell) and consultants (Beca and Tonkin + Taylor) put aside their respective competitive rivalry to complete the project under budget three months earlier than anticipated.
The alliance took a mature approach to consenting and contractual negotiations to prioritise NZTA Waka Kotahi and, ultimately, the community’s needs instead of themselves as individual entities. Transparency and a common purpose drove efficiency through pragmatic supply chain management using standard designs and pre-fabrication. We should rely on something other than emergencies to drive delivery efficiency for our critical infrastructure. We need to adopt innovative consenting, financing and delivery models centred around measurable impact and human values to achieve a step change in the quality of life for all Kiwis.
The question is – are we innovative enough to try something different?
