Perspectives On 'Water For Development': Keys To Project Development And Financing
An interview with Xavier Leflaive, Water Team Lead, Organisation for Economic Co-operation and Development (OECD) Environment Directorate
By Julie King
SIWI World Water Week in Stockholm, Sweden ended last Friday, Aug. 28. This year’s conference theme was Water for Development. The mission now is to carry forward the needs and trends identified during the week into the practical realms of policy, collaborations, and bankable projects.
Moving forward, it is vital to “align the agendas,” as Rasoul Dashtbani Mikkelsen of Grundfos Lifelink says, of all stakeholders — from beneficiaries to investors to civil society organizations. One of the starting points for this is to identify key concepts and determine what they mean to leaders within the different sectors involved in Water for Development.
High on the list of priorities during World Water Week was how to attract and optimize the financing required to deliver both water and sanitation requirements to the hundreds of millions — into the billions — of people worldwide without access to either. Impact investors play a role, as do governments and donor agencies. And importantly, so do communities.
But even before identifying the right financing structure for a project, there is a need to consider the range of options available to project developers and financiers that will most effectively address the project objective(s). What are the problems the asset is being designed to resolve? The fear of many is that large-scale infrastructure projects will be the default solution, without any regard to other viable options.
In the first of a series of interviews during World Water Week, I spoke with Xavier Leflaive of the Organisation for Economic Co-operation and Development (OECD).
How do you structure a project to attract more private investment — including Impact Investors — and to ensure a project’s stated social and environmental objectives are achieved?
“I have a slightly different perspective. For the most part, I am talking to governments. A well-designed project structure is not the only issue involved. One of the key issues is to look at what alternative projects exist before deciding on which structure is best suited to accomplish all of the objectives. For Impact Investors, this is particularly the case. They have to look for projects that are not only bankable, but that will deliver in terms of sustainable growth and equity.
“Project-level analysis is unable to provide this information. A project will only deliver in terms of sustainable development and equity if it is part of a well-designed and thoroughly implemented sequence of projects, or pathway. A project must be subject to analysis at both the strategy level and the project level.
“Investment decisions need to consider how investment in one project depends on those made in previous and future projects. This dimension is often missing. If Impact Investing really wants to have an impact, this is the approach that needs to be taken.”
How much, if any, of this is actually being done now?
“People understand why the pathway approach matters. In talking to investors, they understand the principles. But bankers ultimately make investment decisions and those decisions also impact their bonuses, which are based on the ROI [return on investment] at project level. But the need to demonstrate ROI at project level is actually better served by combining both levels of analysis — that is, ROI at project level and actual gain in terms of water security.
“How to combine the two — an analysis of the performance of different pathways and how a project fits within that — and there needs to be both — is a ‘work in progress.’ In fact, under some circumstances one project may not be ‘bankable,’ but it may contribute strongly to the overall pathway. The issue is how to reconcile this in the context of investment. What we know is that this combined analysis ‘should be done’. What we can do is explain this, especially to Impact Investors – and then they can also propose options on how to best reconcile this ‘disconnect’.”
How can infrastructure projects sustain performance so that the asset is fully operational, and social and environmental objectives continue to be met throughout the lifecycle of the asset?
“First of all, from our recent work, we see that initial financing for projects should include CAPEX [capital expenditures] and OPEX [operational expenditures] for the first few years of operations. We know how to finance CAPEX. But after the project is up-and-running, performance is usually below expectations. The business model may not be working or there is insufficient capacity.
“As such, we see that the initial financing should include the OPEX for 2 to 4 years, which would create less pressure on revenues and increase the opportunity to transfer knowledge and learning to maintain the equipment properly. This would better equip local service providers/operators to maintain operations.
“Secondly, performance-based financing should be increased so that part of the revenue would depend on specific
performance standards and indicators. So part of the performance targets could relate to social and environmental performance — i.e., service providers might be subject to annual reviews as part of their revenue-based performance requirements.
“[The performance-based financing] … avenue is getting traction and there is value in it. The issue is how to define and measure performance. It is also about CSR [corporate social responsibility] and how to define performance there.
A consistent theme in infrastructure project financing in emerging markets is the use of performance terms by bilateral and multilateral financial institutions in financing agreements. The use of such ‘conditional loans’ aims to ensure that minimum performance standards for social and environmental objectives are met before further tranches of funding are released.
Directly contrary to the use of conditional loans are ‘unconditional loans,’ which some governments and lending agencies make ‘with no strings attached.’ Do such contracts threaten the progress made to date in creating a culture of furthering social and environmental objectives in the execution of infrastructure projects?
"That’s an issue [re: unconditional loans]. And there is no easy answer. The answer lies with the government, really. If a government is attracted to unconditional loans and they can see value from their perspective, it is very difficult to stop.
“That being said, performance conditions can also come from the government. It can build strong relations with civil society organizations — to share info and possible consequences from projects. CSO can influence and educate governments.
"Performance standards," "pathways" … these terms go to the idea that projects must be ‘sustainable.’ What does the term “sustainability” means to you in terms of the role of water and the practical issue of financing and bringing access to sustainable water supplies to those without it?
“My definition for ‘sustainable’ is that something will not undermine its own continuation or preservation. This includes consideration of environmental performance [and] fair allocation of water and water risks. In addition, while financial sustainability is a condition of sustainable water services, it should not undermine the water conservation objectives and other policy objectives. Current business models are unsustainable in this regard. A business model for water must contribute to the financial performance of the utility, as well as other objectives.
“Prevailing models link revenue to the volume of water sold. But this contradicts water conservation. The model must contribute not only to the sustainability of the business and to more global sustainability; something which promotes conservation. This is a promising area: to reconnect business objectives with the underlying policy objectives.”
There was widespread consensus between conference speakers from all sectors, as well as international participants, that the private sector must play a central role if the transformational impact envisioned in the Post-2015 Sustainable Development Goals are to be achieved. To you, what does “engaging the private sector” mean?
“The first point is that the private sector is very diverse, and there is more than one way of thinking within this group. There are water users, utilities, [and] financiers who are not water service operators; there are small entrepreneurs. The ‘private sector’ includes everyone from large international banks and pension funds to utilities — and the farmers who have small businesses … also operate in water and may have investments in it — whether this is in the types of crops they grow, how they irrigate, etc.
“One must engage differently with the different actors within the private sector. The key is to give them the opportunity to contribute — in the widest sense of the meaning. Engagement means giving them the opportunity to share their perspectives, priorities, and their capacities, and know-how.
“[It] is also about giving them the opportunity to innovate and share how much risk they are willing to take. They are entrepreneurs. But within this area there is a wide range in their capacity and willingness to take risk. In parallel, government policies tend to assign a certain risk profile to entrepreneurs, which is not always correct. Sharing the different risk appetites of different entrepreneurs is important in order to drive investment.
“Most of the time, the government in its policies is pre-empting the discussion; it is not giving entrepreneurs the opportunity to define the risk profile for themselves. We see this, for example, in the definition of water rights. The government cannot anticipate the risk profile of different farmers in their access to water use. This depends on the types of crops they choose to grow, what access they have to technology in their farming operations, etc. What has happened in areas of drought is that governments issue a straightforward ban on low-value users of water. But this response to drought pre-empts the discussion of how certain water users can choose to adjust their usage and the level of risk-shortages they are willing to take. This action by the government of an outright ban is an inequitable response and is probably economically inefficient.”
Conclusions
Conferences in general can be a ‘mountaintop experience’ or a means of lulling people to sleep. Neither was the case for SIWI World Water Week. Instead, there was a palpable sense of urgency around responsibly managing water resources. But, hand-in-hand, there was a sense that ‘this is doable.’ If the private sector, civil society organizations, the public sector, and local stakeholders get — and stay — on the same page, then the global issue of water will indeed be properly stewarded on the local level, where every person is a stakeholder and has a role to play.