Keeping the flow going through partnerships
Water is a critical necessity and investors can help combat the slippage caused by poor governance
The government and the private sector urgently need to combine efforts to improve and transform social conditions in South Africa.
More public-private partnerships (PPPs) are required. In his budget speech in February, finance minister Enoch Godongwana said the government is looking at initiatives to leverage private sector resources in public infrastructure delivery. This would strengthen the state’s capacity to expand infrastructure and catalyse private finance. The government intends to fast-track the implementation of the PPP regulatory review framework recommendations.
In this context, institutional asset managers have the power to direct investments to the “S” (social element) of ESG investing, especially following changed limits to alternatives in regulation 28 of the Pension Funds Act.
Funds can now allocate up to 15% of their fund exposure to unlisted infrastructure investments through infrastructure-focused private equity funds. They can allocate up to the same percentage to unlisted infrastructure debt through direct exposure or private infrastructure debt funds. And they can allocate an additional 15% exposure to listed infrastructure assets (debt or equity).
PPPs in the water sector
Mergence Investment Managers is invested in the only two long-term water concessions governed by PPPs in South Africa, between the two local municipalities and the concessionaires. The latter two are responsible for the operation, repairs and management of the water and sewage infrastructure, and they either buy the water supply from the local water board or obtain it through the production and recycling of wastewater into potable water.
The two concessions — in Ballito, KwaZulu-Natal, and Mbombela, Mpumalanga — have existed since 1999 and are valid for 30 years.
Key features that attracted us to these water concessions include:
- Long tenures to allow investors to recover the upfront capital outlay and, during the lives of the concessions, improve and maintain the water and sewage networks;
- Clear roles, responsibilities and risk allocation between the municipalities and the concessionaires;
- Specific termination and compensation mechanisms should the municipality wish to terminate the concessions early; and
- Explicit protocols for returning the infrastructure to the municipality at the end of the concession term.
These and a few other features created sufficient contractual certainty for Mergence as financial investors and our strategic co-investors, the management team with the requisite technical skills and one of South Africa’s leading commercial banks to invest in these concessions for the long term.
Management of the PPPs
Mergence actively manages the concessions via a special purpose vehicle called South African Water Works (SAWW).
Both concessions have explicit review mechanisms which allow the municipality and operator to assess performance regularly. Some operational aspects are reviewed quarterly, with the remainder measured annually.
Both concessions have a minimum target return on investment for the operator. One of the concessions also has a profit-sharing model in terms of which we share profits with the municipality once we achieve an agreed target return.
As with all agreements, there is always room for improvement after the fact. Some lessons learnt include the necessity to introduce explicit mechanisms to deal with illegal, unmetered connections.
The “S” impact
Through SAWW, we continue to deliver potable water to an estimated 500,000 people, including about 50,000 in disadvantaged communities. These households earn less than R4,000 a month and receive their basic water requirements for free.
Outside the disadvantaged communities, technical water losses at the SAWW concessions average 20%, compared with the national average of 37%.
In one of the concessions, we produce 3-million litres of potable water a day from recycling. This results in the concession drawing 30% less water from the bulk water supplier.
We firmly believe that combining the best features of these water concession agreements with those of South Africa’s renewable energy independent power producer procurement programme could fast-track another globally recognised PPP framework focused on water and sanitation services. The state should continue to regulate water to improve service delivery by leveraging private sector expertise and capital to invest, operate and maintain the reticulation systems.
The time to act, however, has already slipped by, and we are now playing catch up. As in the case of electricity, refurbishing or replacing ageing water infrastructure requires billions of rand in capital, and long lead times. We encourage all stakeholders to apply their minds and take urgent action.
Finally, it is incumbent on all these PPP arrangements to devise a viable framework for quantifying the collective effect on the “S” in ESG. Only then will they communicate the effective risk-return-impact statements to investors. We are now working with external advisers on this very question to measure tangibly what the collective effect of some of their portfolio companies is and put forward a badly needed good news story for citizens suffering at multiple social levels.
* Isaacs is the head of private markets at Mergence Investment Managers
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