copy the linklink copied!2. Evidence on blended finance in water and sanitation utilities

This chapter presents the results of the in-depth review of the water and sanitation utilities subsector, including (i) an introduction to the subsector, (ii) a commercial investor perspective, (iii) an overview of blended finance transactions, (iv) a typology of commercial investment ready to be mobilised, (v) an assessment of the impact on the poor, and (vi) subsector-specific lessons learned. Blended models to finance utilities are emerging as they are an appropriate tool for creditworthy or near creditworthy utilities to move away from purely concessional donor finance to more sustainable market financing.

    

copy the linklink copied!2.1. An introduction to water and sanitation utilities

The water and sanitation sector encompasses water collection, treatment, and supply for domestic and industrial needs, and the operation of sewer systems and sewage treatment facilities that collect, treat, and dispose of wastewater. Water and sanitation utilities are entities that operate and maintain water supply and wastewater treatment facilities and infrastructure, thereby providing a service. These entities can be referred to as water and wastewater service providers.

Water and sanitation utilities are relatively heterogeneous depending on the specific context of service provision. Many developing countries present significant differences in the characteristics of utilities, particularly between urban and rural areas. Large-scale, centralised water and sanitation utilities tend to serve large urban areas, while small-scale, decentralised operators tend to be major service providers to low income households in urban and suburban areas, as well as to rural communities. Low-income households often make up the majority of under-served communities across both urban and rural areas. While utilities tend to be regulated, decentralised providers are largely informal and unregulated, and very often are the only available option to low-income households, for whom the connection cost of piped water and sewer can be prohibitive.

High rates of non-revenue water (NRW) are a notable problem in many developing (and developed) countries. NRW corresponds to the difference between the amount of water produced and supplied through the transmission and distribution network, and the actual amount of water billed to and paid for by customers. The two main sources of NRW are physical losses (real losses), due to leakage, and commercial losses (apparent losses), due to unauthorised consumption, faulty metering, or uncollected bills (Figure 2.1). As such, NRW is a major source of variable costs of a utility and an indication of the operational efficiency of the utility, the quality of the distribution network and commercial management practices.

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Figure 2.1. Non-Revenue Water
Figure 2.1. Non-Revenue Water

Source: Authors, based on (World Bank, 2006[1])

To limit NRW, utilities often resort to intermittent water supply and rationing. Providing uninterrupted water supply services prevents external infiltrations and the contamination of supplied water resources. However, the large leakages and deteriorating distribution networks can push utility operators to ration water supply to a few hours a day, which paradoxically contributes to a faster deterioration of the network infrastructure because of repeated water surges. This can lead to ruptured pipes and failing seals, ultimately increasing the operation and maintenance costs of the utility.

copy the linklink copied!2.2. Investment profile: an assessment of the risks, returns and project attributes

Water and sanitation utilities are perceived by commercial investors as high risk investments due to inefficient operations, weak financial and management practices and limited cost recovery. As such they tend not to be financially sustainable enough to attract commercial financing. A summary of investment attributes is presented in Table 2.1 below.

Water and sanitation utilities’ low creditworthiness undermines their ability to obtain commercial financing to maintain, expand and upgrade their infrastructure. Commercial financiers tend to be unwilling to lend to the water and sanitation sector because they may not be financially viable, although they are economically necessary, which is often the case with long-term, development-oriented infrastructure. As such, water and sanitation utilities are often seen as inefficient and unprofitable, thus high-risk investments. To palliate for that risk, banks often offer short tenors (5 to 7 years) than the sector needs (minimum of 15 to 25 years), together with high interest rates and collateral requirements. Additionally, water service providers also often lack the skills necessary to support their financing applications with adequate documentation, including cost-benefit analyses and financial statements to demonstrate the level of profitability of the project. All of these elements limit utilities’ ability to access commercial finance.

Utilities in developing countries often operate in challenging environments. Water and sanitation operators not only face financial constraints, they also face weak enabling environments characterised by weak or absent policies, regulations and standards. Additionally, utilities often do not have sufficient technical expertise to best manage their operations and finances, and thus lack the capacity to comply with regulations and standards, when they exist. Utilities also often face political pressure to keep tariffs low, with detrimental effects on their cash flow generation. Fostering an enabling environment to support utilities’ operations and improve the quality of service provided can be instrumental in the success of blended financing arrangements.

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Table 2.1. Summary of investment attributes

Feature

Description

Risk

Macroeconomic and business risks

Currency risk (due to mismatch revenue and debt servicing currency),

operating risk (weak performance of utilities), credit risk (inability of counterparty to honour contractual arrangements)

Regulatory and political risks

Regulatory and political risk (sensitivities around water and sanitation tariffs and potential for political interference in the tariff setting process); economic regulation may be weak or absent (further, regulatory regimes may preclude the possibility of including debt service in the costs that can be covered by the tariff, thereby limiting the feasibility of access to commercial finance)

Technical risks

Due to the long-lived and capital-intensive nature of water and sanitation infrastructure as well as under-investment in maintenance, performance risks may arise due to aging infrastructures, leakage and obsolesce of technologies. As water distribution infrastructure is underground and services can continue despite high levels of leakage, such degradation can go undetected for years, as rehabilitation and maintenance needs climb significantly.

Environmental/ social risk

Environmental risk (e.g. increasing water scarcity can lead to increase of cost of bulk water supply as a result from variability of rainfall and increasing uncertainty about future conditions).

Social risks (e.g. particularly for low-income households, relative to tariff increases as a result of major new capital investments)

Return

Cash-flow generation

Utilities collect tariffs and other payments (e.g. connection fees) from customers. Tariffs may not fully cover operational and maintenance costs and rarely cover capital expenditure. Improvements in operational efficiency can create more cash flow to invest in service expansion and increase the customer base and revenues.

Developmental return

Improved access to water and sanitation services produce a range of valuable benefits for individuals, communities and the environment, including a reduction in adverse health outcomes, increased educational attainment (especially for girls) and enhanced labour productivity.

Project attributes

Greenfield vs. brownfield

Greenfield projects face additional business or technical risk due to the construction.

Scalability

Some projects and financing structures could be scaled and replicated, with adaptation to local contexts and institutional structures. Other models present limitations to replication due to specific contextual circumstances.

Size

Depends on whether the water provider serves an urban or rural area. The population density of service area is a critical factor.

Transaction costs

High, given weak capacity of service providers to maintain an asset registry and sufficient financial and accounting record keeping.

Tenor/ Longevity

Minimum average of 15 years of debt financing for a sustainable debt service.

Source: Authors.

copy the linklink copied!2.3. Blended finance instruments and mechanisms for financing water and sanitation utilities

Despite challenges to engage commercial finance noted above, the blended financing of water and sanitation utilities can take multiple forms in an array of contexts. The case studies, interviews and research conducted for this report revealed varied blending experiences with different instruments (credit lines, credit enhancements, grants, etc.) and contexts (urban and rural; large and smaller operators). The research also revealed that blending can happen at multiple entry points along the financing chain, such as upstream, at the level of the lender or utility (technical assistance, loans, credit lines, risk-reducing guarantees), or downstream to customers (utility-based pro-poor financing schemes, access to microfinance loans), and is often accompanied by technical assistance at all stages of the project.

Guarantees are the most commonly used credit enhancing tool in the blended financing of water and sanitation utilities. Guarantees can lower both the political and commercial risk of lending to utilities (OECD, 2018[2]). In a guaranteed arrangement, the guarantor agrees to their obligation to service the loan in the event that the borrower cannot repay. This obligation limits incurring losses for the commercial lenders, thereby increasing their willingness to finance a project. The Philippine Water Revolving Fund (PWRF) had primary and secondary guarantees in place: a credit risk guarantee provided participating banks with a partial guarantee from the Local Government Unit Guarantee Corporation (LGUGC) - a private entity - that covered a maximum of 85% of the bank’s exposure against a 1% guarantee fee. This primary guarantee was backed (up to 50% of the LGUGC’s exposure) by a co-guarantee from the USAID Development Credit Authority.

Credit enhancement can be a powerful tool to allow existing revenue streams to be used as collateral. In 2008, the Office of Utilities Regulation of Jamaica allowed for the tariffs of the National Water Commission (NWC, the water and sanitation utility of Jamaica) to include a “K-Factor”, a pre-determined surcharge collected monthly from customers. The K-Factor revenues capitalise a special account earmarked for priority water and wastewater investment projects. Rather than using the K-factor revenue directly for capital investment, the accrued funds aim at servicing large commercial loans to finance investments in non-revenue water reductions, sewerage, and other operational efficiency processes. In the 2009-15 and 2016-18 periods, the K-Factor amounted to a 14% and 16% surcharge of the household bill.

Despite these efforts, the NWC continued to face difficulty in accessing the capital needed to expand and upgrade its water and wastewater services. The Global Environment Facility-funded Caribbean Regional Fund for Wastewater Management project (CReW), which aims at reducing the negative impacts of untreated wastewater on the environment and human health in the Wider Caribbean Region, selected Jamaica to pilot a credit enhancement facility. Credit enhancement improves the credit profile of structured financial products or transactions. The Jamaica Credit Enhancement Facility (JCEF) (Figure 2.2) placed a USD 3 million grant from the CReW in a reserve account as a guaranteed fund. With a 4:1 leverage of financial resources, the JCEF allowed for the fund capitalised by the CReW grant to provide secondary collateral against the USD 12 million loans disbursed by the National Commercial Bank (NCB) to the NWC. The debt servicing for the loan stems from annual K-Factor revenue. This instrument reduced the financial risk of the lender (NCB) and allowed greater access to commercial capital through the provision of a steady revenue stream earmarked for investments in priority wastewater and water supply projects.

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Figure 2.2. The Jamaica Credit Enhancement Facility
Figure 2.2. The Jamaica Credit Enhancement Facility

Source: Authors.

Another effective pooling mechanism in mobilising commercial finance is through investment funds or collective investment vehicles (CIVs). Funds pool resources to invest in specific sectors (or regions) using different type of instruments, including equity, debt or guarantees (OECD, 2018[2]). For instance, the USD 234 million Philippine Water Revolving fund (PWRF) (Figure 2.3) blends domestic public funds of the Development Bank of the Philippines (DBP) -which received a concessional loan from JICA-, with commercial financing from finance institutions at a 75%-25% ratio from each source respectively. This set up aims at sharing risk-return profiles, lower borrowing costs, and to market water and sanitation projects to private finance institutions. The PWRF revolves principal repayments on the loans while interest rates payments service blended contributions from the DBP and local banks. In order to mitigate the liquidity risks of the banks involved, the DBP uses the loan from JICA to create a credit line that the bank can rely on to disburse its share of the blended loans.

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Figure 2.3. The Philippine Water Revolving Fund financing structure
Figure 2.3. The Philippine Water Revolving Fund financing structure

Source: Authors.

Credit lines are a conditional avenue to provide private financial institutions with capital to on-lend to water and sanitation projects. Furthermore, by providing utilities with access to dedicated commercial financing, the long-term aim is to enable them to build the capacity and creditworthiness they need to attract market-based financing. In Morocco, BMCE partnered with the French development bank (AFD) and European Investment Bank (EIB) to set up the Blue Credit Line, a facility to encourage investments in the water and sanitation sector and increase the climate resilience of the country (Box 2.1). This credit line provides earmarked funds for BMCE to offer below market rate loans to water and sanitation utilities, along with technical assistance to both the bank and the borrower. Similarly, a credit line accompanied by technical assistance was established on concessional terms in Cambodia between the AFD and the Foreign Trade Bank (FTB), with funds earmarked for loans in the water and electricity sectors. The concessional nature of that credit line ensures lower interest rates so that loans are affordable to small- and medium- sized utilities, and that tenors are long enough with a sufficient grace period. To securitise this credit line, AFD also set up a partial guarantee through its ARIZ scheme, which enabled FTB to share the portfolio credit risk with the AFD. The guarantee was instrumental in giving the FTB the confidence to lower collateral requirements by half compared to the initial obligation.

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Box 2.1. AFD-EIB-BMCE Blue Credit Line

Protecting water resources for greater resilience to climate change

The preservation and protection of water resources is a key issue for Morocco. The country’s high reliance on the agricultural sector and low economic diversification are strong elements of its vulnerability to climate change, with significant changes in precipitation and temperature projected for the region. Morocco has made notable progress in providing access to safely managed water supply, with an increase from 55% in 2000 to 69% in 2015 (WHO/UNICEF, 2019[3]). Nevertheless, Morocco is still facing drawbacks in the management of water resources, and because of population growth and economic development, water needs are increasing. The total volume of wastewater discharged by the industrial sector is estimated at 80 Mm3 per annum (the equivalent of 32 000 Olympic swimming pools). This is projected to increase as the country is pursuing an industrialisation strategy focusing on urban jobs creation, along with a focus on minimising environmental damage. Additionally, there remains around 8 000 polluting industrial sites in Morocco, and about 85% of these sites are located in urban areas served by a collective sewerage system. The overexploitation and inefficient use of the country’s water resources, as well as lagging domestic and industrial wastewater treatment and, finally, ongoing climate change, are putting pressure on water resources. Some of these challenges can be attributed to a lack of investment in efficiency measures for water use and the treatment of polluted water. Obstacles to investment include limited financial access for project promoters; the fragmentation of small-scale investment opportunities; low cost of water resources for consumers; a lack of capacity to perform a cost-benefit analysis to evaluate an investment’s profitability.

In this context, BMCE Bank of Africa partnered with AFD and the EIB to create the Blue Credit Line “CAP BLEU”, a EUR 20 million financing facility dedicated to the implementation of projects in the water and sanitation sector in Morocco. This facility aims to respond directly to the sector’s investments constraints through the provision of a dedicated credit line, with a reduced interest rate for project promoters, and concessional technical assistance to support both the bank in the assessment of the technical, financial and environmental feasibility of the projects and the structuration of such projects by the promoters. AFD and EIB, together with BMCE, developed the eligibility criteria for the Blue Line, which enabled the development of the offer. AFD finances the technical assistance "CEP - Marketing and Project Evaluation", aimed at accompanying and reinforcing BMCE capacities in the water sector, while the EIB finances the technical assistance "PP - Preparation of Projects" which aims at support companies (end customers) in the technical and financial preparation of credit applications to the Blue Facility. For sanitation and wastewater treatment projects, the technical assistance will certify that the investments financed will at least ensure compliance with the discharge standards in the environment or with the specifications for connection to the sewerage network, as well as ensuring water savings and reduced leaks. Targeted projects include treatment plants, desalination, water savings in irrigation, industrial depollution and reuse of treated water and recycling.

Source: Inputs shared by BMCE.

In the majority of cases, technical assistance, provided in kind or through grants, is an integral part of blended finance arrangements. Technical assistance can play a key role in boosting investor confidence at multiple levels (Figure 2.4).

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Figure 2.4. Technical assistance models for water and sanitation
Figure 2.4. Technical assistance models for water and sanitation

Source: Authors.

In the project preparation phase, technical assistance can support government institutions with policy advice. In Rwanda, technical assistance was instrumental in helping structure WASAC, the newly established national water and sanitation utility, to ensure it has the capacity needed to off-take the wastewater treatment plant from the Kigali Water Limited company when the Build-Operate-Transfer agreement expires. In Jamaica, the GEF’s environmental focus contributed to ensuring that the credit enhancement facility fully integrated the reduction of pollution in water bodies in its strategy. The support of the government was a driver of the success in achieving high standards, as it not only ratified important treaties, but also passed key legislation and strengthened the capabilities of its institutions to enforce its water quality standards as a result.

Technical assistance can also support commercial financiers through capacity building, for instance in assessing the profitability of a project. As part of the BMCE Blue Credit Line, and AFD Facilitated Access to Finance for Domestic Private Water Operators in Cambodia, technical assistance provided to local banks increased their capacity to perform a cost-benefit analysis to evaluate an investment’s profitability. The concessional nature of the technical assistance grant is critical in addressing the capacity gap of financial institutions in better assessing project proposals, and its cost will need to be shared between the borrower and lenders in the context of phasing out of the blended finance arrangement over time.

Technical assistance is often deployed to enhance utilities’ creditworthiness through capacity building. Such assistance can be effective at reducing water losses, improving billing and collection rates, and improving the management of the utility. To address the issue of low operational efficiency, amongst others, Dutch utilities provide peer support to developing country utilities, an example of win-win cross-border co-operation detailed in Box 2.2 below. Strengthening the technical capacities of the operator contributes to improving the utilities technical performance, thereby enhancing their creditworthiness. Water service providers also often lack the skills necessary to support their funding applications with adequate documentation, including cost-benefit analyses and financial statements to demonstrate the level of profitability of the project. In Cambodia, development providers set up a technical assistance program to ensure that loans were disbursed to well-operated water service providers (WSPs). In doing so, the program provides WSPs with direct technical assistance in the management of their operations, from financial management to the control of the quality of the water supplied.

Technical assistance can also contribute to generating demand and increasing number of paying customers. In the Philippines, the Narra Water utility had received a concessionary loan to expand its infrastructure, for which it required revenue from a larger customer base to repay. Water.org provided them with concessional assistance in identifying those potential clients and marketing to them. Additionally, Water.org, through its WaterCredit initiative, encouraged local microfinance institutions (MFIs) to develop water and sanitation microloan products. These MFIs could then disburse WaterCredit loans to the new Narra Water clients who desired to connect (see section Chapter 3 for more information on WaterCredit and microfinance sanitation loans). Water.org also accompanies local utilities in improving their operational efficiency, and extending their infrastructure to poor communities to maximise their outreach and increase their paying customer base.

Beyond improvements in the operational and financial management of utilities, technical assistance and grants can support utilities in developing pro-poor pricing schemes. As part of the Facilitated Access to Finance project in Cambodia, development finance providers offered subsidies to reduce the cost of the connection for low-income households. In order to incentivise WSPs and ensure that low-income households had access to a continuous water supply with functioning metering, the WSPs received a pro-poor subsidy on an output-based basis, whereby they had to charge the lower fee to the household, and could only claim the subsidy once the connection had been established, and the metered connection verified. The implementation of financing schemes adapted to the needs of the poor can further enlarge the utility’s customer base, in turn increasing its financial sustainability.

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Box 2.2. Water Operators Partnerships

Implementing improved processes and pro-poor strategies through peer-support

Water Operators Partnerships (WOPs) are peer-support mechanisms designed to improve the operational efficiency and cost-recovery of water utilities in developing countries. Through the pairing of two or more ‘mentor’ utility companies in support of ‘mentee’ utility companies, hands on operator expertise and solutions are exchanged. WOPs aim at increasing the creditworthiness of the mentee on a not-for-profit basis. The objectives of these WOPs differ between projects, from the provision of technical assistance and training to the improvement of operations and maintenance for the reduction of non-revenue water, and developing infrastructure investment projects. According to the UN-Habitat’s Global Water Operator Partnerships Alliance, the organisation leading behind WOPs, over 300 WOPs have been established globally since 2010.

WOPs have the potential to rapidly achieve capacity building and improved performance in developing countries. The VEI-Dawaco WOP (between the Da Nang Water Supply Joint Stock Company (Dawaco) in Da Nang, Vietnam, and Vitens Evides International (VEI), an organisation that manage the Water Operator Partnerships of five Dutch water utilities), aimed to enhance Dawaco’s capacity and performance, and increase its creditworthiness through 3 objectives: i) the extension and improvement of water services in the city of Da Nang, Vietnam; ii) strengthening managerial and financial capabilities; and iii) extending services to the urban poor. The WOP also contributed to increasing VEI’s experience in Corporate Social Responsibility projects.

The VEI-Dawaco WOP made significant progress on its objectives in less than 3 years. By 2010, the project had achieved non-revenue water reductions to 26% from 39% in 2007 (and further down to 15% by 2017) and an estimated 49 000 new water services connections, including 7 800 poor households. In terms of financial and operational management, the project contributed to the installation of water management systems to track water quality and quantity at water treatment plants as well as water resources; a new tariff structure was implemented in 2011 and incorporates a pro-poor strategy to make low-cost consumption accessible to households in need; and steps were taken to equitize Dawaco, which became a limited liability company in June 2010 (it previously was a state-owned enterprise), and a joint stock company in 2016. Overall, the total cost of the WOP was USD 2.7 million was financed by the Directorate-General for International Cooperation (DGIS) of the Netherland’s Ministry of Foreign Affairs (USD 1.9 million), in-kind contributions from Dawaco (USD 282 500), and VEI (USD 550 000).

WaterWorx, a new partnership between Dutch Government and 10 Dutch Water Utilities, was launched in March 2017 with an aim to provide access to safe drinking-quality water to 10 million people worldwide by 2030. Through this programme, Dutch water supply companies will mentor 24 utilities across Africa, Asia, and Latin America in achieving infrastructure expansion and rehabilitation, and operational efficiency. The programme is supported by the Dutch government, with 55% of the first stage’s EUR 54 million budget financed by the Dutch Ministry of Foreign Affairs, and the remaining 45% by participating Dutch and local water utilities. The Ministry also supports the initiative with technical assistance in policy, law and regulatory environments, in order to increase the credit-worthiness of participating utilities and foster long-term private investments in the sector. To meet the 2030 objective, it is estimated that EUR 1.5 billion of infrastructure investments are needed. Through WaterWorX, the Dutch water supply companies support their colleagues in identifying and prioritising investment projects, acquiring the needed investment finance to implement the infrastructure development projects and provide the needed capacity building for investment implementation.

Source: Authors, based on inputs from WOP.

copy the linklink copied!2.4. A typology of investors in water and sanitation utilities

Development and commercial actors have different interests when financing projects. Commercial entities will evaluate an investment’s profitability, while development institutions will take development outcomes into account in their decisions.

Commercial finance from local financial institutions is a primary source of the commercial financing raised through blended structures for water and sanitation utilities. Blended finance can target local banks in order to boost their confidence in lending to water and sanitation utilities. As explained above, finance institutions tend to be unwilling to lend to the water and sanitation sector because utilities may not be financially viable, although they are economically necessary, which is often the case with long-term, development-oriented infrastructure. Blended finance thus acts as a risk-reducing mechanism to increase banks’ confidence and offer more suitable lending products, with reduced interest rates, longer tenors, and suitable grace periods and collateral requirements. At the same time, technical assistance as part of a blended finance package can support increased operational efficiency and financial sustainability in utilities. In Jamaica, the NWC had a ring-fenced fund in place, however given the very high rates of NRW, that fund by itself was not sufficient to unlock debt financing. In this context, Jamaica’s JCEF provided a second guarantee to the fund that, together with the development of an ambitious infrastructure upgrading project, was eligible to serve as the main collateral for the loan.

Development actors as Development Finance Institutions (DFIs) and Multilateral Development Banks (MDBs) also play a major role in utility financing. This was the case in the Kigali Bulk Water Supply project. As part of the structuring of the financing, the Government of Rwanda agreed with development finance stakeholders - the IFC, three PIDG facilities, and AfDB - that the project would be a Public-Private Partnership (PPP) arranged on a Build – Operate – Transfer basis, the first of its kind in Sub-Saharan Africa (excluding South Africa). As the national water and sanitation utility (WASAC) had recently been established, it was not financially viable at that stage, thus a private utility was established as the Kigali Water Limited and handed over to Metito, who was awarded the bid order to implement the PPP and to build, operate, and maintain the treatment plant for 27 years before handing it over to WASAC. DFIs provided a majority of the financing through loans, grants and technical assistance, and the private utility provided the balance (18%) as equity financing.

Bi-lateral development banks and agencies, such as AFD, JICA, and USAID, contribute to mobilising private finance through a variety of instruments at different levels. Their participation can focus on building the capacity of banks and utilities through technical assistance and concessional debt, and on boosting investors’ confidence with credit lines and guarantees. As part of the Facilitating Access to Finance project in Cambodia, AFD set-up a concessional credit line to cover the financial institution’s liquidity risk, along with a partial guarantee to reduce its credit risk. AFD also co-ordinated an EU grant for technical assistance to build the capacity of the bank and of water operators to assess the feasibility and profitability of a project and ensure its quality. Development agencies may also contribute with concessional loans, and acting as co-guarantors, which were the respective roles of JICA and USAID’s Development Credit Authority in the PWRF.

There is potential to mobilise commercial investors at scale. The EIB recently launched its Sustainability Awareness Bond (SAB), which it announced in April 2018. The new bond product aims at supporting the global goals by contributing to the development of a sustainable financial system through the financing of water and wastewater projects. In September 2018, the EIB issued its first EUR 500 million SAB. SAB eligibility is open to projects that contribute to the implementation of the SDGs without any geographical restriction. By December 2018, EUR 128 million has been allocated across 15 projects in 12 countries, including Senegal (28%), Italy (22%), Egypt (16%), and Panama (10%). Of these, 52% went to wastewater collection and treatment projects (EUR 65.6 million), 45% to water supply (EUR 55.8 million) and the remaining 3% to flood protection (EUR 3.6 million). SABs are a “use of proceeds” type of bond, meaning that disbursements for an SAB-eligible project will be funded from a dedicated account, where all funds raised through the issuance of SABs are managed by the EIB to finance solely water-related projects that meet the bond criteria. An example of an SAB-eligible project is outlined in Box 2.3 below.

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Box 2.3. The EIB Sustainability Awareness Bond

Example of an eligible project

In Benin, the city of Cotonou, located below sea level on a coastal plain between the Atlantic Ocean and the Nokoué Lake, experiences cyclical floods during rainy seasons. Cotonou is the main economic centre of the country and hosts most of the economic and industrial infrastructure of the country. The floods cause large-scale damage to public and private assets and undermine economic activities. Additionally, Cotonou’s rapid urbanisation rate is stressing the city’s insufficient and poorly managed water and sanitation infrastructure. As a result, flooding frequently exposes the city’s 1.5 million inhabitants to stagnant rainwater, resulting in adverse health outcomes, including typhoid fever and diarrheal diseases.

In December 2018, the government of Benin signed a EUR 50 million (USD 59 million) loan agreement with EIB for the financing of Cotonou’s Storm-water Management and Urban Resilience Project. EIB’s financing is part of a total cost estimated at EUR 128 million (USD 151 million), with additional financial support expected from the World Bank, AFD, the Islamic Development Bank, and the West African Development Bank. The programme consists in the construction of a storm-water retention pond, wastewater disposal infrastructures, and 47 roads to protect over 1.2 million people vulnerable to displacement, diseases, and material losses caused by the cyclical floods experienced every rainy season. The project aims at supporting sustainable growth and improving wellbeing, health and environmental outcomes by i) preventing flooding and the stagnation of rain water in the city, damage to urban dwellings and drainage infrastructure; ii) ensuring effective storm-water and wastewater drainage to improve sanitary conditions; iii) raising public awareness on hygiene, waste management, and sanitation; and iv) improving the quality of life of the inhabitants of several disadvantaged neighbourhoods through the provision of additional urban amenities (Republic of Benin, 2019[4]).

Although not explicitly stated in the loan agreement, the Cotonou project is 100% SAB eligible, providing an illustration of the types of projects that could qualify. The loan, which has been signed between the Finance ministry of Benin and the Bank is in line with EU legislation on water projects. 

Source: Authors, based on inputs provided by EIB.

Non-governmental organisations (NGOs) may use donations to blend technical assistance and grants with commercial financing to increase access to water and sanitation. Water.org, through the provision of technical assistance and small grants to microfinance institutions (MFIs) fosters the creation of new loan products suited to the needs of water and sanitation projects and low income households. Its WaterCredit initiative (Figure 3.2 in Chapter 3) encourages the disbursement of microloans earmarked for water and sanitation projects by covering the costs of the project preparation phase, and assisting the MFI with the development of an adequate loan product and its marketing. By extending MFIs’ portfolios with water and sanitation loans, Water.org also contributes to supporting SDG 8.10 “Strengthen the capacity of domestic financial institutions to encourage and expand access to banking, insurance and financial services for all”. NGOs can also act as a stepping stone to unlock additional financing for utilities. Water.org also assists utilities with technical assistance in order to strengthen their operations, improve financial management, and increase their paying customer base. In Indonesia, Water.org’s support to the PDAM utility was instrumental in unlocking over USD 51 000 in grant funding from the government to extend their pipeline to connect an additional 5 000 households.

copy the linklink copied!2.5. An assessment of sustainable development impact

Inadequate access to safely managed water and sanitation can have numerous escalating impacts -- from the proliferation of infectious diseases and premature deaths to the contamination of clean water sources and the environment and the destruction of biodiversity.

Blended finance can have demonstrated impacts on commercial financiers, from the testing of new financing vehicles and the creation of tailored financial products for water and sanitation utilities, to the improvement in lending practices. In the Philippines, the PWRF successfully encouraged banks to offer water operators longer tenors (increased from 7 to between 15 and 20 years) at lower, fixed interest rates. Notably, in the cases studied, the blended finance arrangements were conducive to the development and diversification of local banks’ portfolio of projects. The technical assistance they received enabled an increased understanding of the sector, and a better capacity to assess projects appraisals. In Cambodia, a technical assistance grant was disbursed to assist the FTB bank both in developing more adequate financial products for the sector, and in increasing its capacity to understand technicalities of water and sanitation to better assess project proposals.

Most cases studies examined in this report also demonstrated visible impacts on utilities through improvements in their operational efficiency and financial sustainability, which increased their creditworthiness. The resulting access to commercial finance also led to an increase in their paying customer base.

Overall, the blended financed projects studied have a considerable impact on development, not only by increasing access to water and sanitation in developing countries, as seen in Kigali, where the soon-to-be completed Bulk Water Supply project is expected to serve half a million people, but also to low income households, as in Cambodia, where 44% of the project’s beneficiaries were poor households. Some projects also served as a means to increase access to finance, whether when unlocking a loan earmarked for the construction, decommissioning or rehabilitation of wastewater treatment plants in Jamaica, or through the introduction of WaterCredit, microfinance loans to finance poor households’ water and sanitation projects.

copy the linklink copied!2.6. Subsector-specific insights

  • Water and sanitation utilities have distinct needs when it comes to accessing finance, in part because they require long tenors in order to service debt while maintaining affordability, and also because they often do not have sufficient levels of operational efficiency to guarantee attractive risk-adjusted returns on investment. Dedicated funds and facilities can tailor financing models to the specific needs of the sector. A recent development on this front is the Water Finance Facility, which seeks to mobilise large-scale private investment from domestic institutional investors (e.g. pension funds, insurance companies) by issuing local currency bonds in support of domestic priorities on water and sanitation. The first such facility is the Kenya Pooled Water Fund (KPWF), which has been initiated in Kenya with support of the Dutch government, Kenyan authorities and other development partners.

  • Water and sanitation utilities that are moving towards creditworthiness can benefit from the elaboration of well-targeted blended financing strategies, for instance in support of improving their operational efficiency and financial sustainability. In this context the use of blended finance can serve the market building purpose, because these utilities lack sufficient cost-recovery capacities to independently be financially sustainable, as well as the creditworthiness required to obtain commercial financing.

  • Capacity building as technical assistance is a common instrument in the blended financing of utilities. By improving the technical and financial performance of the utility, technical assistance contributes to enhancing the creditworthiness of utilities. Improvements in the quality of the service provided by the utility, such as achieving water supply continuity and improved water quality standards, can lead to demand generation, improved willingness to pay from customers, and a larger paying customer base. This, in turn, leads to increases in revenues that, if well managed, contribute to the financial sustainability of the utility.

  • Technical assistance can play a role in helping commercial financiers adjust their lending practices by creating financial products specifically targeting the needs of the sector, including longer tenors with a sufficient grace period, and reduced collateral requirements. In doing so, commercial financiers diversify their portfolios of projects, thus reducing the risk of their overall investment portfolio risk.

  • Water-related investments typically concern an investment in part of an overall system (e.g. rehabilitation of distribution infrastructure; expansion of water production or treatment facilities, etc.). How that investment is structured (e.g. what aspects of the overall system are included or not) can influence the appropriate financing structure. A common vision for impact across all stakeholders is thus key to the successful implementation of the blended finance arrangement.

  • Flexible and adaptive project management is key to the smooth implementation of blended finance arrangements. Cases studied highlighted the need to continually calibrate the programmes to manage the complexity of implementing novel financing approaches in developing country contexts. In particular, delays can result from a lack of co-ordination between the stakeholders, foreign exchange negotiations, procurement issues and exogenous factors, including the readiness of capital markets.

  • The effectiveness of blended finance arrangements also depends on the enabling environment in which they are implemented. Providing utilities with the financing needed to upgrade and expand their services is necessary, but it is not sufficient to make a blended finance arrangement work. Improving the enabling environment by strengthening the policy and regulatory framework as well as the institutional arrangements is equally important.

References

[2] OECD (2018), Making Blended Finance Work for the Sustainable Development Goals, OECD Publishing, Paris, https://dx.doi.org/10.1787/9789264288768-en.

[4] Republic of Benin (2019), PROJET D’ASSAINISSEMENT PLUVIAL DE LA VILLE DE COTONOU(PAPC), http://documents.worldbank.org/curated/en/529641552297946808/pdf/PAPC-RAPPORT-Cadre-de-Politique-de-R-installation-Vf.pdf (accessed on 14 June 2019).

[3] WHO/UNICEF (2019), Data | JMP, https://washdata.org/data (accessed on 8 July 2019).

[1] World Bank (2006), The Challenge of Reducing Non-Revenue Water (NRW) in Developing Countries How the Private Sector Can Help: A Look at Performance-Based Service Contracting, http://ppiaf.org (accessed on 29 July 2019).

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2. Evidence on blended finance in water and sanitation utilities