Making innovative finance work: Business models and approaches for water supply and sanitation

1. Making innovative finance work: Business models and approaches for water supply and sanitation Laila Kasuri Water Investments and Policy Solutions Specialist

2. Contents • Financial flows into the water sector and gaps • Is innovative finance the answer? • Current status of water supply financing • Business models for water supply and sanitation • Concluding remarks

3. Achievements made and ODA financial flows • Aid for water and sanitation has sharply risen since 2001, at an average annual rate of 5% in real terms, with bilateral aid rising at 7% p.a. and multilateral aid at 3% p.a. • In 2017, total ODA annual aid commitments to the water supply and sanitation sector rose to USD 5.2 billion. • The proportion of the population using a basic, unimproved drinking water service had increased to 89 % in 2015. • But we are far off our SDG targets which call for more investments!

4. Highlights of water and sanitation financing • To reach SDG targets, we need to extend services to 844 million people who still lack even a basic water service and improve the quality of services to 2.1 billion people who lack improved water sources (i.e it is accessible on premises, available when needed, free from contamination). • There are other sources of finance - ODA is not the main form of funding. In fact, a major proportion of financing comes from household contributions, predominantly tariffs. • A breakdown of WASH financing for 25 countries indicated that nearly 66% was derived from household sources based on the responses from 25 countries • This represents US$ 43 billion in annual expenditure for WASH. • But the gap for financing is growing and future ODA commitments are actually decreasing, so what do we do?

5. Contents • Financial flows into the water sector and gaps • Is innovative finance the answer? • Current status of water supply financing • Business models for water supply and sanitation • Concluding remarks

6. So is “innovative finance” the answer? • We keep throwing around Innovative finance regularly. These are instruments and tools that facilitate or “crowd-in” additional financing. • ODI think tank report shows that innovative finance, particularly blended finance not working and cannot bridge the SDG financing gap. • Aims are too unrealistic: ‘billions-to-billions’ is more plausible than ‘billions to trillions’. • Between 2000 and 2008 the World Bank issued US$7.7 billion in guarantees which leveraged total investments of US$20 billion—a leverage ratio of roughly 2.6. • Recent research shows that the leveraging ratio is even less and not even 1. • AND THE BIGGER PROBLEM- Too much focus on innovative finance can undermine poverty eradication agenda

7. Getting into the issue of “innovative finance” • Understanding aims - Leaving no country behind • Innovative finance presents an exciting opportunity but we need to be clear about the problem we are trying to solve.. • More ODA being spent on structuring “innovative finance” rather than directly into sectors in poor countries. There is a risk of diverting allocation away from LICs and direct investment in health, water, education and extreme poverty. • Changing institutional incentives to crowd private finance can drive aid away from poor countries. • Instead of spending money to get already viable projects financed, ODA might be better spent on reaching the very poor where private sector is unlikely going to ever finance. • Too much focus on innovative finance skews donors towards stable markets in MICs or sectors with secure streams of positive cash flows where obligation targets will be easier to achieve.

8. Getting into the issue of “innovative finance” • De-risk at the country and sector level • Each $1 of MDB and DFI invested mobilizes on average $0.75 of private finance for developing countries, but broken down, only $0.37 for LICs, $1.06 in MICs. • Innovative finance cannot work if the fundamental economics are not right and the project is not financially feasible. • Frequently the case for infrastructure projects in many of the poorest countries, which lack secure streams of positive cash flows. At best O&M can be viable but there’s not big money in social sectors. • As a result, public finance will still be required to fund infrastructure investment in LICs. • Currently, it is the public sector (the MDBs and DFIs) still that is taking of 73% of the cost of innovative (blended) investments to date in LICs. • To improve financial feasibility of sector investment, emphasis needs to shift from using aid to ‘de-risk’ single investment projects, but to using aid to de-risk the entire sector, through addressing core sectoral and legal issues, then working towards projects and investments.

9. Contents • Financial flows into the water sector and gaps • Is innovative finance the answer? • Current status of water supply financing • Business models for water supply and sanitation • Concluding remarks

10. What does this mean for water supply financing? • Innovative financing can transform marginal projects into financially viable transactions, but no amount of innovation can make non-viable projects bankable. • There is a business case for water. Most households are already paying and willing to pay for water. Thismeans it can be a commercial/business activity and financial recovery is possible. • But to meet social outcomes – as well as make water supply businesses financially viable, different business models needed. • For urban water supply, structuring of public finance and public institutions of service delivery, sector governance, utility performance, and revenue predictability. • However, innovative financing should not be seen as the panacea for water projects !

11. What does this mean for water supply financing? • Water projects are constrained by economic and financial feasibility, but also by political and social provisions- • Tariff as key electoral argument, affordability by end-users, long term political support. • Poorer residents are now paying the most (Tanker mafia in Karachi) while economic sectors are provided subsidized water. • Need to fix water pricing, address water theft and improve service delivery in parallel before moving into innovative finance. • What about microcredit and microfinance for the poor? • Mounting evidence that microloans for water and sanitation have proven to be somewhat exploitative. For water, appropriate models are needed for the appropriate income group – the very poor need to be targeted since they are suffering the most. But the market based model cannot work entirely for them.

12. The state of affairs in Pakistan… • Pakistan right now is a different story! • Other than a public-private desalination project in Karachi, the private sector has not financed ANY water supply and sanitation projects, not even through a PPP, even when it is viable!! • Viable projects should be taken up by private sector, so that public sector can focus on subsidizing the poor. • Worse: Piped water supply actually decreasing in urban areas with poor paying the most! • WHY? • Poorly structured sector for service delivery with no independent regulator • In Punjab, no delineation between the LGD, the Urban Unit, and PHED. • In Sindh, multiple policies produced by multiple departments without implementation. • Certain infrastructure sectors have never been suitable for private management or ownership owing to government policies. • Urban water distribution systems not particularly attractive for pure private sector due to poor structuring and inability to separate ownership and management. Also, obtaining licenses in Pakistan is complicated and expensive – one of the worst in South Asia. • PPPs can be undertaken where complementarities between private and public sectors are enhanced. • For example, bulk water supply by the private sector with public sector distribution and private sector collection could be a model in municipal water supply that creates complementarities.

13. Contents • Financial flows into the water sector and gaps • Is innovative finance the answer? • Current status of water supply financing • Business models for water supply and sanitation • Concluding remarks

14. Business Model 1: Restructuring Utilities from subsidized to market based model • Current water utilities in PK not financially independent - get direct subsidies from the provincial government as well as federal funds for payments to electric company, infrastructure expansion, and debt servicing. • But bulk water supply by private sector with public sector distribution and private sector collection could be a model in municipal water supply that creates complementarities. • PPP model is fairly successful with the right contractual arrangements. • To achieve this: Restructure utility structure, make it financially independent and do away with subsidies for them. Utility models are for city centers that tend to be wealthier. Once revenues are secured, cross-subsidize slums and poor areas. • Step 1: Ensure the urban water sector sustainability: • Begin in city center with high affordability • Ensure the payment of the administration bills and decrease debt burden on the state budget • Increase the private tariffs (eventually change the tariff structure) : need to depoliticize discussions around tariff • Step 2: – Achieve the SDG and social issue • Increase access in slums and small towns : though there s no incentive to expand beyond the original perimeter from financial standpoint.

15. Business Model 1: Restructuring Utilities from subsidized to market based model • Private sector can bring considerable benefits to the management of water: efficiency, management and finance can improve quality and distribution of water, even for the poor. • Benefits depend on improving the capability of governments to undertake PPPs • Not all types of PPPs are applicable for low income countries ( better start with the easier PPP models) • PPPs consist of two core elements: project finance ; long term contracts. • Probably better to start with‘management contracts’ than expensive concession/BOTs. (getting water from its source into the network/pipes requires large investments); • Private sector needs to recover the costs and investments through charges to users, this may not be sustainable for low income countries; • Common belief among human rights groups: • The companies charge higher prices for water which are ‘out of the reach’ for poor people who are forced to look for (less safe) alternatives, e.g. rivers • Water (that should be ‘free’) is turned into a commodity

16. Case Study: Successful PPPs in water Bucharest: Water and Sanitation Overview: Veolia of France won the bid to operate and maintain the water and sanitation system for 25 years. Outcome: • appr. €70 million investment into modernizing water and sanitation services between 2002 and 2006; • built a new water treatment plant; • reduced water losses by 44.4%; • introduced a new metering system and reduced leakages, leading to a drop in total demand from 497.8 cubic millimeters in 2002 to 304.1 cubic millimeters in 2006;  Manila Water Overview: Manila Water, a profitable listed company with 45% of its shares in public hands, has received numerous awards for operating efficiently and bringing water to the urban poor. Outcome: • non-revenue water reduced from 63% in 1997 to just 12.5% at present; • without taxpayer money being spent for new water sources, amount of delivered water to customers grew threefold from 440 million liters per day to 1,140 million; • served customers from 3 to 6 million, who get 24-hour service, from just 30% before privatization; • cost of piped water from P 150-200 per cubic meter to P75 per month.

17. Business Model 1: Restructuring Utilities from subsidized to market based model • But could these improvements have been achieved without the private operator ? • Yes - but evidence also shows that private sector operators out-perform public sector counterparts • However, PPPs dont work if the government: • Lacks the skills of making viable projects and of designing contracts • Private sector ‘takes over’ and the problems begin. ( many governments actually renege on contracts) • Answer is to create a strong capacity building programme to ensure that the public, municipal authorities protect their interests.

18. Case Study: Phnom Penh Water Supply (Public owned) • Story was similar to Karachi. • PPWSA like KWSB was corrupt (high level of corruption at lower cadres.) • Transformation of a public utility under difficult post- conflict (civil war) conditions • High levels of illegal connections and unaccounted for water, including bribery of utility officials • What changed?

19. Case Study: Phnom Penh Water Supply (Public owned) • Period of 15 years, political support for the reform process came with the Prime Minister giving full support. • Top management restructured (based on qualifications), dynamic younger personnel with more advanced qualifications promoted to senior posts with more responsibilities. • Granted autonomous status with independent management – This meant it needed to have a business case. • Began with city center focus, tariff pricing. Other improvements included establishing a complete consumer database, reducing NRW to less than 6%, improving collections, metering all of the utility’s water supply coverage, and introducing 24x7 water supply. • Operations were also made more efficient by overhauling old infrastructure, and streamlining the billing process. • PPWSA was able to widen its distribution network from serving 40% of Phnom Penh in 1993 to over 90% in 2009 with clean, affordable water.

20. Business Model 2: Decentralized solutions and local entrepreneurship • Bottom up – requiring non water professionals. • More entrepreneurs are looking at water and sanitation as a means to • explore innovative ideas. • Toilet Expo held in Beijing showcased new WASH approaches, including • a self-contained toilets requiring no water. • New business models where private sector is getting involved. • WateROAM (Singapore): Low-cost, easy-to-use, portable water filter for • disaster-affected areas and off-grid communities that requires no • maintenance and contains 0.02 NSF-certified membranes for 99.99% bacteria removal • Non-water professionals are entering this domain and using market-based approaches to make WASH not just a public health issue, but a means to showcase ingenuity. • This model is important for decentralized and onsite WASH since the utility model doesn’t work here. • Grants and foundations are the appropriate donors here who can finance smaller pilots and activities for villages/rural areas. Such projects would work in rural Sindh and Balochistan

22. Scaled up models: SANERGY • MIT students who returned to their country. • Began and enterprise in Kibera, Nairobi (Kenya). • Sanergy designs and manufactures low-cost sanitation facilities. • Originally put out toilets in public places at a fee. • Realized there was a lack of sites to reach scale. • Solution: Franchising • Private entrepreneurs buy a toilet ($USD 500). • Entrepreneurs provide services to public. • Toilets have cartridges that collect waste. • Waste is collected, treated and reused. • Fertilizer ready in about six months and comes pathogen-free - increases crop yields, often by as much as 30%. • Sanergy toilets come with “cartridges” that are emptied and the waste is transported to centralized facilities, whereSanergy adds agricultural waste like sugar cane husks and rice husks, as well as microorganisms that break down the matter. • Currently supported by social impact investors, USAID, the Gates Foundation, and several family foundations who provide complete grant for the initial stage.

23. Business Model 3: Reuse and valorization as a means to derive value from used water • Reuse and valorization and shift from linear to a circular economy • Such models are particularly helpful to cover the costs of wastewater services, and to reduce the cost of water supply. • Water supply and wastewater tariffs, often billed together. Where meters are installed, tariffs are typically volumetric (per usage), sometimes combined with a small monthly fixed charge. • In absence of meters, flat or fixed rates — which are independent of actual consumption — are being charged. • In developed countries, tariffs usually the same for different categories of users and for different levels of consumption. • Most people do not pay for wastewater treatment however. To cover these costs, additional revenue streams can be explored.

24. Business Model 3: Reuse and valorization as a means to derive value from used water • Focus on making wastewater the energy generator: neutral or net producer of energy, through biogas production. • The Omni-processor - Treatment technology to properly treat sewage while leading to net positive generation of energy and clean water. The term "omni" in its name refers to the fact that an Omni Processor machine can process a variety of waste streams or fuel sources. • Revenues include: wastewater treatment fee, wastewater reused in industries and agriculture means freshwater can be left for drinking, energy savings, water savings, CDM mechanism • Examples of technologies which Omni Processors may employ include combustion, water oxidation and pyrolysis. • Piloted in Florida (Janicki), Senegal and India.

26. Contents • Financial flows into the water sector and gaps • Is innovative finance the answer? • Current status of water supply financing • Business models for water supply and sanitation • Concluding remarks

27. Concluding remarks • Public money needs to be wisely spent – not always for attracting private sector and not always for mobilizing innovative finance. • Assess the problem first –then decide the appropriate financing mechanism: • Governments / donors for very poor areas (where business case is difficult to establish). ODA would be essential for war-torn countries and conflict areas. • Foundations for remote, off-grid areas where there is willingness to pay and business case can be developed at small scale. • Private sector for city center utilities where there is clear demonstrated case and where public sector could share some costs. Cross-subsidy models can support poorer, underdeveloped areas. • Social impact investors entering the market (Oikocredit International, Ceres Investor Water Hub ) – these can support areas where returns are marginal but nevertheless, financial viability needs to be demonstrated because at the end of the day - > investors want returns.

28. Concluding remarks • In mature markets, there are business models for which innovative finance will be useful. Recognize that many of these models that are touted in one country may not survive implementation in other countries. • In many cases, there will never be a viable market solution. Serving the very poorest, working in challenging geographies—or areas where a constellation of problems is particularly complex (and solutions hard to isolate)—might never be profitable, and will always require substantial philanthropic or government support or subsidy. • We still have a lot to learn - Only a few businesses supported by innovative finance may, in the end, merit full scaling up. Also, though a few may make noticeable contributions, none is likely to totally revolutionize the long, hard work of development; there is no silver bullet. • New financing approaches can be useful additions to the current array of instruments and activities for helping developing countries, BUT require certain conditions. • In order to achieve SDGs, focus on outcomes before running after innovative finance…

29. References • World Health Organization. "UN-water global analysis and assessment of sanitation and drinking-water (GLAAS) 2014 report: investing in water and sanitation: increasing access, reducing inequalities." (2014). • Samantha Attridge and Lars Engen. "Blended finance in the poorest countries: the need for a better approach." London: ODI (2011). • Leigland, James, Sophie Trémolet, and John Ikeda. Achieving Universal Access to Water and Sanitation by 2030: The Role of Blended Finance. World Bank, 2016. • Clark, Robyn, James Reed, and Terry Sunderland. "Bridging funding gaps for climate and sustainable development: Pitfalls, progress and potential of private finance." Land Use Policy 71 (2018): 335-346. • Auerbach, David. "Sustainable sanitation provision in urban slums–the Sanergy case study." Broken Pumps and Promises. Springer, Cham, 2016. 211-216. • Pooi, Ching Kwek, and How Yong Ng. "Review of low-cost point-of-use water treatment systems for developing communities." Npj Clean Water 1 (2018): 11. • Matthews, Sue. "Water reclamation." Water Wheel 14.3 (2015): 26-29.