Credit agencies are watching like hawks as the Government introduces its two most important Three Waters bills to Parliament this month – the final structures will determine whether NZ can pay the price to fix its run-down water infrastructure

Soaring inflation and interest rates are putting new pressure on plans to fix New Zealand’s leaking pipes and unconsented wastewater plants. The wrong model could cost the country billions of dollars in debt servicing.

This month, ratings agencies plan to closely scrutinise the water services implementation bill, and the bill establishing an economic regulator to oversee how the new Three Waters incorporations charge for their services.

Their assessment of the models will help answer the question of how New Zealand can afford to pay the projected $185b price to fix and maintain its run-down water infrastructure over the next 30 years.

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The cost of borrowing to pay for infrastructure is already putting council credit ratings under pressure: Wellington City Council has been placed on a negative outlook, and Marlborough District Council has been downgraded. When ratings go down, interest rates go up – which means increased liability for ratepayers. This will affect the four new water entities even more, because of their size.

The new bills will help answer the questions of how separate the new entities’ balance sheets are from councils, and from central government, which has agreed to a backstop liquidity facility.

That, in turn, will influence the credit ratings for the new entities, and for the 67 councils that nominally own them, and potentially even for the New Zealand Government’s sovereign rating.

“The question is, does the bill give us the information we needed?” asks Anthony Walker, director of sovereign and international public finance at S&P Global. “Or is there more financial and transition unit information coming next year, which may be the information we need to wait for?”

The experts’ verdicts

There has been political and social media debate over the merits of the existing and new financing models – so Newsroom has gone to the experts on the big questions about financing the reforms.

Ratings agencies S&P, Fitch and Moody’s discuss the impact on ratepayers, taxpayers, and on those consumers whose water charges will pay for the highly leveraged borrowing of the four new water corporations.

Even the passing of the legislation next year will not be enough to entirely assure those agencies of the risks to investing in water infrastructure – opposition parties are warning they will unstitch much of the reform programme if they are elected at the end of next year.

“The status of the Three Waters Reform and its final features, in terms of the timing of the execution of the reform, asset transfers, relative impact across local government bodies and funding responsibilities, remain unclear,” says John Manning, the Vice President and Senior Credit Officer for Moody’s Investors Service.

“This is particularly the case given the length of the reform process and the forthcoming national election. Moody’s will continue to monitor any relevant credit impacts as information on the reform evolves.”

We’ve also asked three top independent experts to assess the pros and cons of the Government’s financial model, and some of the alternative proposals. 

They are legal expert Josh Cairns, a partner at Simpson Grierson; finance advisor Bevan Wallace, executive director of Morgan Wallace; and former Three Waters transition programme leader Amelia East, Asia-Pacific head of advisory for HKA infrastructure consultancy.

There are big questions about plans to “aggressively” leverage water revenues (S&P’s characterisation) borrowing six to eight times the entities’ annual revenues – and whether councils or the Government will be expected to bail them out if things go wrong.

And there’s a new problem that’s fast emerging: inflation, and the high interest rates being imposed to try to rein it in. The scale of the planned infrastructure works will expose the four new entities, and those who pay their bills, to an extent greater than any infrastructure programme previously seen in New Zealand.

Credit agencies will consider whether the new water corporations will be sufficiently independent of local council politicians to borrow beyond councils’ debt caps – at most, 300 percent of their annual rates revenues. And whether they will be sufficiently independent of central government that investors won’t blithely lend them money in expectation of a government bail-out.

“It’s a lack of preparedness to charge sufficiently for the cost of delivering services, and a tendency to shift the cost of infrastructure upgrades onto future generations.”
– Hamiora Bowkett, Department of Internal Affairs

Amid the focus on the dollars and cents, it’s worth remembering that the promised cost savings of the reforms are secondary to the main event: improving the safety and quality of New Zealand’s drinking water, wastewater and stormwater.

Hamiora Bowkett, the executive director of the Three Waters reform programme at the Department of Internal Affairs, says reform is intended to address a range of issues including the large number of small water service providers, which limits opportunities for efficiencies of scale, and political incentives and governance structures that are not conducive to long-term decision-making.

“These issues won’t be solved only by improving access to finance,” he warns. “It’s a lack of preparedness to charge sufficiently for the cost of delivering services, and a tendency to shift the cost of infrastructure upgrades onto future generations.

“Addressing the financial issue alone would not improve the fragmented delivery structure, address the lack of management capability, or bring more certainty to investment pipelines thereby enabling more sophisticated procurement, supply chain management and other efficiencies.”

1. How does the anticipated level of borrowing against water revenues compare with debt on water infrastructure overseas?

Dŵr Cymru Cyfyngedig may be a challenge for many New Zealanders to get our tongues around, but the Welsh water company can help us get our heads around our own water reforms. 

For all the comparisons with utility providers in Scotland, or the Australian states of Victoria and Tasmania, it’s Dŵr Cymru that has most similarities to what the Government proposes for us.

It serves 3 million people – that’s a population just 40 percent bigger than the water entity that would serve Auckland and Northland. 

And it’s been held up as a model of economic, social and environmental sustainability, ever since 2001 when it was purchased from its private owners by a not-for-profit company, using bank and bond finance.

Dŵr Cymru’s scale is similar to the New Zealand entities, and so too would be its debt-to-revenue ratio. According to this year’s financial statements, it has borrowings of £4.2b, derivatives worth £224m, and £697m in deferred tax. That multiplies to 6.4 times its revenue this year, which was £807m.

The big council-owned water corporations proposed for New Zealand would also be not-for-profit, suggesting that official projections for how much they can borrow aren’t out of the ballpark.

As inflation soars and interest rates rise, Cymru’s experience is again educational: Its financing costs leapt from £134m to £277m in interest payments this year, because of its inflation index-linked debt. Its auditors say increasing costs and inflation are the risks most likely to adversely affect the company’s liquidity.

This just highlights the extraordinary cost of a nation’s public infrastructure.

New Zealand’s Government expects the new water incorporations will borrow a multiple of six to eight times their annual revenues, to catch up on decades of work left poorly attended by some councils. 

If capex of $120b to $185b over the next 30 years is required, as the Government has been advised by the Water Industry Commission for Scotland (which it contracted to analyse the infrastructure deficit), then that rate of borrowing will be needed. And that will be significantly higher than what you see in countries like Australia or Scotland.

But it’s not entirely unusual for such standalone water entities – those in some other parts of the world, mostly the US, are leveraged at eight times their revenues. In England, too, water entities tend to be more highly geared as they are owned by private equity operations. Using debt allows them to maximise their return on equity.

The Department of Internal Affairs modelling was based on leverage at six times the new water entities’ revenues, which is what was tested with S&P and approved ahead of the co-governance model being developed.

2. What about in comparison to existing council debt caps – how is it that the Government expects both the water entities and council to be able to magically borrow more once these reforms are implemented?

To be blunt, New Zealanders won’t get an accurate assessment of how much the water entities will need to borrow until they have been established, and draw up realistic plans of what infrastructure is required to meet the new water standards. Data needs to be collected not only from councils but from all the privately-run schemes that the new water entities may end up taking over. 

And for councils, it’s not strictly true that all of them will have increased debt headroom. A small handful have functioning water infrastructure with little or no debt against it; they will lose management of their water assets, as well as losing the revenues they charged on drinking water and wastewater services. These councils will receive one-off payments from the Government’s “no worse off” fund – most notably Whangārei, which will receive $90m – but they argue that this doesn’t come close to covering lost revenues for the next 30-plus years.

Most councils will shift their debt liabilities to a water entity for cash, improving their balance sheet position when the transition takes effect in July 2024. They will have more room to borrow for other community infrastructure, like parks and libraries.

Paul Norris, director of international public finance for Fitch Ratings, expects some councils may benefit and some may be more constrained under current plans. “This will depend on the impacts on council finances once water-related revenues, expenses, debt and assets are stripped out of councils and the proposed changes wash through, and on support provided by the sovereign,” he says.

“An important assumption is that there will be no liability to councils related to the water entities, which we understand would be the case via legislation.”

Initially in July 2024, the combined Three Waters debt (councils and new water authorities) will be only a little more than at present. The small increase is mainly because the new entities have to borrow $1.5 billion immediately, to finance the Government’s “better off” sweetener and “no worse off” compensation to councils, an attempt to solicit their support for the reforms.

But over time as the entities increase their Three Waters infrastructure spending, and councils use their increased headroom to finance more community assets and public transport projects, the combined level of debt will increase. 

Officials say more customers, a larger revenue catchment, balance sheet separation and economic regulation will provide the new water entities with stronger balance sheets and greater flexibility to direct significant investment to where it is needed. This would enable them to finance the required catch-up investment, and respond to short-term shocks like earthquakes, and long-term challenges like climate change.

There is doubt, though, about the official expectation that the new water entities will achieve similar issuer credit ratings to councils’ AA ratings. Yes, water entities will achieve higher leverage ratios, enabling them to borrow up to $8b more through to 2031.

But without a Crown guarantee of that debt, finance experts and rating agency S&P predict they would have credit ratings around BBB-, which is the lowest possible investment grade. S&P defines that as: “Adequate capacity to meet financial commitments, but more subject to adverse economic conditions.” And that means higher interest payments that will be passed on to customers. 

Forecast additional debt capacity for new water entities (nominal $b)

That's forced Finance Minister Grant Robertson to agree to a Crown liquidity facility – an emergency fund entities could borrow from when access to the usual financial markets is constrained. It would be similar to a $1.5b fund made available to the Local Government Funding Agency. Officials say that won't constitute an on-demand source of cash, and would only be available to bail out the entities if they are hit by "extraordinary events" that result in a lack of liquidity. That could be, for example, a temporary dislocation in capital markets.

Even with a proposed liquidity facility, the corporations will struggle to match the AA+ ratings of bigger councils.

Bevan Wallace says increased debt will come with a corresponding increase in interest rates paid, unless they have an implicit guarantee from the Crown. "Absent such a guarantee, the ability to borrow is either constrained or penalty interest rates are incurred, much as is the case with borrowings secured on a second mortgage.

"The ultimate borrowing costs will be anchored to the Crown’s cost of borrowing rather than the risk of the entity if such a guarantee is either implicit or explicit."

3. Who would actually manage the borrowing for water infrastructure? 

It really doesn’t much matter. Most likely, there will be transition arrangements where the new water entities use Treasury’s Debt Management Office team, or the Local Government Funding Agency – indeed, there may be advantages to doing that for the long term. 

In the long run, the water services entities should be big enough and ugly enough to run their own treasury operations at a similar capacity to any major corporate.

“This isn’t publicly known yet, but the Three Waters National Transition Unit will be working through it now," Josh Cairns says. "Given the scale of the water services entities, I’d expect them to each be able to establish and manage their own debt capital programmes."

At present, only councils like Auckland and Dunedin go directly to the debt markets – most find it more cost-effective to do all their borrowing through the Local Government Funding Agency. But Hamiora Bowkett reveals work is indeed underway to ensure the four water services entities have a range of debt options, including their own treasury functions. 

Internal Affairs says initial feedback from capital markets participants indicates the credit profile of the water services entities would make them an attractive proposition to capital markets investors.

The water authorities would join a suite of large, highly-rated New Zealand borrowers like the Debt Management Office, Kāinga Ora, Auckland Council and the Local Government Funding Agency, who access the capital markets in volume, the department says. The four new water entities would increase New Zealand’s presence in international capital markets, providing a wider benefit to New Zealand borrowers.

"The Local Government Funding Agency has been a hugely successful borrowing programme for local authorities. It has consistently delivered access to credit at favourable margins to the local authority sector, so I’m sure the possibility of the water services entities also joining in some way will be being looked at closely."
– Josh Cairns, Simpson Grierson

The Local Government Funding Agency is a key player, here. It is 20 percent owned by central government and 80 percent by councils. With Southland Regional Council joining up last month, it now has 77 out of 78 councils as members. The only exception is Chatham Islands Council, which is not a big player in international debt markets. 

The agency already has an interest in Three Waters financially through approximately $6 billion of water-related loans to councils, and is one of the options being considered for financing the water service entities.

Josh Cairns says the agency could have an ongoing role as a provider of debt capital. "The Local Government Funding Agency has been a hugely successful borrowing programme for local authorities. It has consistently delivered access to credit at favourable margins to the local authority sector, so I’m sure the possibility of the water services entities also joining in some way will be being looked at closely."

If the water corporations join, the key questions would be whether the Local Government Funding Agency can maintain its credit strength, to continue to deliver the same borrowing benefits to the local authority sector, and whether it be structured in a way that does not cause a foot fault on the required balance sheet separation between water entities and local authorities.

But the Kāinga Ora example is more vexed. Because not long after Internal Affairs lauded it as a member of that suite of large, highly rated NZ borrowers, the Government announced Treasury would take over the housing agency's borrowing.

Kāinga Ora is the country's largest residential landlord in New Zealand, housing more than 186,000 people in 69,000 properties. Under its funding and financing model, the full capital cost to build new social housing and retrofit existing homes is borrowed, against future rental revenue. Since 2018, Kāinga Ora had issued debt in private markets as the primary source of borrowing in the name of its subsidiary, Housing NZ Ltd. The maximum level of private borrowing, which had increased over time, was approved jointly by the ministers of finance and housing.

But Kāinga Ora was paying a premium for its borrowing, because of its smaller investor pool and lower liquidity. So the ministers decided that instead, the Debt Management Office would do the borrowing centrally, and "on-lend" to Kāinga Ora. At the same time, they agreed to increase the housing agency's borrowing capacity to $2.75 billion.

"In the Kāinga Ora case, the Crown, through the Treasury’s Debt Management Office, has recently assumed responsibility for meeting the organisation's debt obligations and provide ongoing financial support," Bevan Wallace says.

"As we have seen recently, when Kāinga Ora has failed to execute on its financial plan the risk ultimately resides with the Crown."

4. How are councils like Auckland going to achieve balance sheet separation, when their shareholding has to be less than 20 percent?

It's important to understand there are two types of balance sheet separation: the accounting rules, and the credit rating expectations. 

For this purpose, the more important issue will be ensuring no single council has too much governance and operation control, rather than dilution of equity ratios. You could theoretically have 100 percent ownership in an entity, but divest yourself of influence mechanisms to such a degree that the ratings agencies might not require you to carry a contingent liability on your books for that entity.

And again, let's be blunt. The reduced influence of local politicians and civic managers is not an unfortunate effect of balance sheet separation, as far as the capital markets are concerned. It the whole idea. Given local authorities track record in under-investing in water infrastructure, they won't trust any new utility that has too much council control.

"Too much of the focus is on funding assets in our opinion, and too little on what are the optimal arrangements to deliver new assets, maintain the assets we already have, and meet the diverse needs of consumers and communities.”
– Amelia East, HKA

To that extent, 50/50 iwi membership of the regional representative bodies is seen as commercially desirable, because it lessens the influence of councils, with the perverse, short-term political incentives described by Hamiora Bowkett.

It will be difficult to reassure investors and the ratings agencies, though, when the water entities are still wholly owned by councils, and when councils are expressing their intent to influence the new water entities as much as possible through representation on the regional bodies, appointing the directors and scrutinising the strategic plans.

That's why ultimately, the Government will ensure its bottom line of balance sheet separation is achieved through legislation. Councils will be prohibited from providing any financial support to the new three water entities and constrained from selling or transferring their shares. Three water entities will not be able to pay any dividends to shareholders. This makes the council ownership structure more nominal than real. In essence, councils' only input will be through the regional representative group.

5. The Mayors of Auckland, Christchurch and Waimakariri want to retain control of their Three Waters assets, and finance upgrades through Crown Infrastructure Partners instead?

Crown Infrastructure Partners is not set up to provide cost-effective lending, as it only allocates central government funding or arranges more expensive special purpose vehicle funding – most notably, for the groundbreaking Milldale development at Orewa, north of Auckland.

Potentially, it could work from a funding and financing point of view, provided the councils had the discretion to determine arm's-length fees and charges associated with the provision of associated services. "Crown Infrastructure Partners could be a source of asset finance for which it would levy a charge," says Bevan Wallace, "likely similar to a lease arrangement that covers both financing costs and a depreciation provision for any assets that it holds directly on behalf of councils."

But there are several complications.

First, says Amelia East, in setting up a special purpose vehicle, councils would theoretically have to vest ring-fenced water assets and revenues to that company – which means they effectively give up ownership.

Second, it creates few incentives to move to a utility model, which is where we desperately need operational change in New Zealand, she says. "Too much of the focus is on funding assets in our opinion, and too little on what are the optimal arrangements to deliver new assets, maintain the assets we already have, and meet the diverse needs of consumers and communities.

"For example, I can’t see how using the special purpose vehicle model is going to incentivise water procurement reform.”

"I suspect there will be an implicit assumption that in the event of failure the Crown will intervene as per Kāinga Ora and the Christchurch earthquakes."
– Bevan Wallace, Morgan Wallace Ltd

There's one other question. The Three Mayors have published only a skeletal description of their plan; they say they're just trying to "prompt constructive conversation". It's not clear, but it rather looks like what the mayors are seeking is not financing, but grants that they don't have to repay – similar to roading through Waka Kotahi or the Housing Acceleration Fund. Free money, in other words.

And that might suit the councils – but from the point of view of the public, it serves only to shift the debt liability from their rates bill to their tax bill.

If it's not a grant, then there's at least an expectation the Government would underwrite the council debt – and why would the Crown agree to underwrite a model over which it would have no control?

"I suspect there will be an implicit assumption that in the event of failure the Crown will intervene as per Kāinga Ora and the Christchurch earthquakes," Bevan Wallace says. "The Crown does however have control options through regulation and setting the terms of any intervention."

6. Could the Three Mayors regional water organisations credibly provide the balance sheet separation that avoids council borrowing caps?

Quite possibly, yes – except for Auckland Council. Which is a little ironic, given the new Auckland mayor Wayne Brown is the architect of this alternative model.

Implicit in the Three Mayors model are smaller regional water organisations – the "sensible" consolidation of local government entities, avoiding any overly ambitious attempt to defy New Zealand’s unique topography and population distribution. Already, councils in Hawke's Bay have proposed a regional grouping along these lines. And consultancy Castalia produced a report for the 30-strong Communities 4 Local Democracy council grouping, that suggested similar council-owned and operated regional groupings.

It can sometimes work at that scale. In Australia, water services are provided at state level, not local authority level. The state of Victoria has 15 water entities. This doesn't seem to impact the price consumers pay for water, compared to South Australia and Western Australia which have only one water entity apiece

However, regions with smaller populations may need some government support, as New Zealand already does with infrastructure like roading. For example, Southland District Council has the largest geographical land area of any territorial council but only 32,000 people – that's a lot of roads, and a lot of water pipes.

Again, it comes back to the point: different models can work, but someone, somewhere has to pay.

Bevan Wallace offers a reminder that balance sheet separation means financially viable water organisations, as well as protecting ratepayers from cost blow-outs. That often won't be possible within existing council borrowing caps, when they need to catch up on deferred maintenance, or provide capital investment to meet government standards.

To meet those costs, when council borrowing caps prevent them injecting more capital, the regional water organisations will need to raise service charges or external equity. 

That was an outcome of the electricity distribution reforms in the 1990s, where separation saw significant new investment – and customers found themselves charged accordingly.

"When I was advising on the valuation of council electricity entities there were instances where rate schedules did not generate an appropriate return on the assets," Wallace recalls. "The assets were therefore valued at a discount to replacement cost. The discount to replacement cost could be eliminated if the rate schedules were reviewed."

"Some councils chose to establish commercial schedules and accordingly the valuations more closely aligned with the replacement cost of assets – customers paid more for their electricity supply but the ratepayer asset value was correspondingly higher and the charges reflected the cost of service including provision for asset replacement.  

"Others chose to continue to levy non-commercial charges and would struggle to replace assets upon the end of their economic life. The tragedy of the reforms was that some councils sold their assets at a discount based on the non-commercial returns and the private sector buyers then proceeded to lift the rate schedule thereby accruing additional value. Customers and ratepayers suffered accordingly."

7. Could Three Waters infrastructure be routinely placed in new statutory regional special purpose vehicles?

Ahead of the weekend, the Government announced the creation of the first special purpose vehicle under the new Infrastructure Funding and Financing Act.

The new company will raise finance from private markets to build 13 transport projects around Tauranga, then repay the debt by charging a levy on those who benefit from the infrastructure. Tauranga City Council's balance sheet will never see a cent of the money – not the debt, and not the levies raised to repay it. 

There are sceptics who questioned whether the new act would ever result in any large-scale regional project, saying such funding had been slow, bureaucratic and expensive. So Friday's announcement was somewhat of a vindication for those involved.

"The Infrastructure Funding and Financing Act was not designed to be a business-as-usual financing source for councils so is not – by itself – a solution to financing Three Waters infrastructure across the whole country at scale."
– Josh Cairns

One of those was Josh Cairns at Simpson Grierson, which had been advising the Treasury on the Infrastructure Funding and Finance model since its inception in 2018. "It’s really rewarding to now see it in action as it starts to deliver important infrastructure projects to support growth across Aotearoa," he says.

“Without the model, otherwise viable and much-needed projects – like those in the Western Bay of Plenty Transport System Plan – would be much more difficult for the council to achieve within its debt limits,” he says.

But even Cairns, one of the biggest champions of the special purpose vehicle model, is a doubtful it could work at the scale of New Zealand's nationwide Three Waters scale.

Yes, he says, the Infrastructure Funding and Financing Act includes Three Waters infrastructure, as well as transport and environmental resilience infrastructure. And it’s possible for councils to retain ownership of infrastructure financed through the Act. 

"But it was not designed to be a business-as-usual financing source for councils so is not – by itself – a solution to financing Three Waters infrastructure across the whole country at scale," he says.

"In order to use the Infrastructure Funding and Financing Act, a council needs to prepare a levy proposal that must be approved through Cabinet. That’s a workable process for particular infrastructure projects or programmes in areas of high need, but not for day-to-day borrowing requirements for all councils."

Bevan Wallace comes back to his previous point – the similarity to the electricity reforms of the 1990s. "Such special purpose vehicles would mirror the electricity distribution sector reforms and as a consequence you would then likely see sector restructuring through mergers and acquisitions that would likely deliver a commercially aligned outcome rather than a politically orchestrated one."

Would the Government allow such mergers and acquisitions at the expense of local representation?

Wallace responds drily: "I can’t answer what restraints this or any future government might impose on fundamental property rights."

8. The Government has said balance sheet separation is a bottom line – but is it that important? 

Balance sheet separation, while a bottom line for the Government, is ultimately a policy position. It's a trade-off.

Tasmania Water, which is owned by 26 councils, is evidence that separation is not essential. The creation of council-owned regional water entities might reduce the impact on individual councils, by spreading capital expenditure obligations more evenly across a wider region, over time.

So it is not essential.

"Balance sheet separation is a means to an end, not an end in itself. It is not necessary nor in some instances would it be desirable."
– Bevan Wallace

But if councils were to keep their water assets on the balance sheets, they could incur credit rating downgrades over the next 10 years, to finance the large capital expenditure programmes they would have to take on.  

"Balance sheet separation is a means to an end, not an end in itself," Wallace says. "It is not necessary nor in some instances would it be desirable. Separation should be done when there are net benefits of doing so."

He argues those benefits accrue when separation informs decision making. Council balance sheets reflect the accumulated resources that have largely been funded through levies on ratepayers and government grants over many generations. So separation requires context, as do balance sheet valuations.  

In the case of the electricity reforms, continued ownership, the financing of the assets and whether or not they remained on council balance sheets were secondary considerations. "The returns generated from such assets generally supported creditworthiness and thereby the borrowing capacity of the councils. Separation of assets on terms that would ultimately undermine the creditworthiness of a council is not desirable."

9. If the Three Waters assets remain on council balance sheets, how dramatically would that constrain councils' ability to maintain existing assets? Would they have to raise rates more? 

Keeping water infrastructure on the balance sheet would mean some councils need to more carefully prioritise when specific infrastructure spending occurs. The key is to have good long term infrastructure strategies, so that capital expenditure is well planned over a long time period.

Currently there are some short term challenges as New Zealand has under-invested in infrastructure over the past 30 years. But with good planning this infrastructure deficit can probably be addressed over time – that comes back to the challenge of the right political incentives. If every council is trying to boost its re-election chances by diverting water network depreciation capital to new civic buildings and monuments, or by cutting rates, then the out-of-sight infrastructure underneath the ground will continue to suffer.

“Council indebtedness occurs on a spectrum, one that is heavily tilted towards balance sheet conservatism outside of the cities, so on paper, councils probably have a fair amount of financial headroom," Amelia East says. 

"The constraint is not how much could they borrow, but how much will ratepayers allow them to borrow, and that explains why there are local authorities out there with zero debt but crumbling pipes. New regulatory standards will bind councils’ (and ratepayers') hands to some degree, but we really are courting the same funding challenges if significant reform of some kind or other doesn’t alter the water status quo.”  

"This could become more of an issue for higher-growth councils over time, particularly if further development of water infrastructure is needed to meet water standards or likewise with other local infrastructure."
– Paul Norris, Fitch Ratings

Bevan Wallace agrees. Managing assets, he says, is not a constraint on councils – it is an obligation. What ratepayers demand they are managed efficiently, and that the costs are allocated fairly through direct fees for service, rates or taxes.

"Councils should rightly be constrained on new investment such that they do not embark upon vanity projects," he says. "Where maintenance is required to ensure minimum service delivery standards are met they should be able to recover such costs through appropriate levies either on users, ratepayers or even taxpayers depending upon who is making the demands."

While councils have financial headroom now, that may soon tighten. Paul Norris says Fitch doesn't expect the eight councils it rates to be "materially constrained" by debt ceilings or their current rate increase plans over the ratings agency's projections period, which are currently out to 2026.

"That said, this could become more of an issue for higher-growth councils over time, particularly if further development of water infrastructure is needed to meet water standards or likewise with other local infrastructure," he says. "We would expect rates would need to go up in such cases to keep in step with higher capital spending demands but we don’t see this as a significant issue for most councils for now."

In July, Fitch affirmed Queenstown Lakes District Council at its AA- rating, with a stable outlook. If anything, Three Waters might strengthen Queenstown's debt position, the agency said. "The reforms aim to transfer councils' water assets and associated debt, revenue and expenditure to newly created independent water entities from July 2024," it said. "We believe Queenstown Lakes District Council will maintain sufficient stability and flexibility in its revenue and expenditure, in line with its risk profile, and that the reforms may improve its debt sustainability."

It's also affirmed ratings for Waikato, Waipā, Rotorua, Ashburton, Timaru and Invercargill – though, always with the caveat: "There is insufficient clarity at this time to determine the precise impact on debt metrics."

10. The Opportunities Party argues water infrastructure should be managed by a Ministry of Water Works, and paid for through 30-year government bonds. Pros and cons?

The leader of The Opportunities Party, Raf Manji, has rejected balance-sheet separation as risky and unnecessary. He instead highlights the centralisation of Kāinga Ora borrowing under the Treasury's Debt Management Office as an example of what could and should be done for Three Waters. 

“Cabinet has finally realised that it’s cheaper to fund core public expenditure from the Crown balance sheet, and that doing so provides more certainty around what Kāinga Ora can deliver in the future," he says. "The Government should apply the same thinking to funding water infrastructure."

That's not the only thing counter-intuitive about his proposal: he is suggesting a new Ministry of Water Works to commission and oversee the infrastructure upgrades required. When much of the opposition is to regionalising Three Waters management, he wants to go even further and centralise it, holus bolus. And seemingly arbitrarily, it would all be funded through 30-year bonds.

There are pros and cons to Manji's proposal. A benefit is that debt costs would be lower by borrowing through central government's Debt Management Office, Josh Cairns says. "That’s likely to be cheaper than what local authorities or water services entities could access by themselves."

"Individual communities are better placed to specify and meet their own demands and where economies of scale exist collaborate with neighbouring regions to achieve these."
– Bevan Wallace

But it would add to the government own debt which may end up putting downward pressure on the government’s credit rating.  The disadvantage of just one water entity, though, is there is no benchmarking of performance.  Having at least four entities would enable metrics such as compliance with water standards and pricing to be compared.  And perhaps the biggest con: having one water entity would result in a loss of localism, entirely.

"It involves a shifting of the funding burden – from the ratepayers that benefit from the local infrastructure to the general taxpayer," Cairns says. "It would also add to the core Crown debt and therefore impact on how much the Government could borrow for other things.”

Bevan Wallace suggests this is precisely the wrong way to deescalate tensions around Three Waters. "As a general rule one size does not fit all and, as such, individual communities are better placed to specify and meet their own demands and where economies of scale exist collaborate with neighbouring regions to achieve these."

Amelia East cites Scotland as an example of a country that is happy for its government to do the borrowing on behalf of its water utilities, in a manner like that proposed by Manji. "However, there are always trade-offs," she says. "And there can be times when the need to increase water borrowing or capital to meet investment demand is not met because of other borrowing priorities or debt limits. We see this regularly with state-owned enterprises in New Zealand.”

11. Does it make financial sense, as the Greens and the Three Mayors suggest, for councils to retain control of stormwater assets, which are harder to carve off?

There is quite a lot of overlap between council assets and stormwater assets. The Government realised that quickly, upon including stormwater as the third of the Three Waters. The gutters running down roads are part of the stormwater assets – so ministers were forced to specifically exclude roads from the assets being handed over to the new water corporations. 

There's pressure for it to go further and exclude sports fields, culverts and public reserves, which play critical role in soaking up and carrying away water. That detail should be disclosed in this month's implementation bill, which lays out which assets will be transferred, and how. 

Councils have to compile a list of their Three Waters assets, and Local Government Minister Nanaia Mahuta has indicated councils will play a leading role in the decision on which stormwater assets to transfer over. The rule of thumb, some says, is that unless it's an old-fashioned pipe running through a metropolitan area, they plan to retain control of it.

Bevan Wallace says: "Councils generally have a holistic management systems and as such, carving out specific assets or classes of assets is problematic."

"Drinking and wastewater are fairly easy to generate revenues from, but the quasi-public good nature of stormwater makes this more challenging."
– Amelia East

The Greens and the Three Mayors argue stormwaters should be removed from the reforms entirely: they're not so easily commercialised as drinking water and wastewater, and their infrastructure is intrinsically linked to other other council infrastructure.

But the downside of that, for councils, is that some have massively under-invested in their stormwater by some councils.  Drinking water and wastewater are often the easier waters to fix; if councils keep stormwater, they will also be stuck with the costs.

“This is a challenging issue in New Zealand, because we are taking a novel approach by including stormwater in the reforms, and with that comes risk," says Amelia East. "That’s because drinking and wastewater are fairly easy to generate revenues from, but the quasi-public good nature of stormwater makes this more challenging.

"So, from that perspective, two waters is better than three.

"But at the same time, as a country on the edge of the global economy with thin labour markets, I have sympathy for the argument that leaving stormwater with councils will make it extremely challenging for councils operationally, as they will have to compete with four large utilities for engineering and construction talent. So avoiding the race to the bottom on stormwater really builds the case for Three Waters.”

12. Phil Goff and others asked for the Government to guarantee Three Waters debt. Realistically, is water infrastructure too big to be allowed to fail?

Tasmania Water has no government guarantee, and the New Zealand Government is similarly averse to providing guarantees. It has, however, agreed to provide a liquidity facility of at least $500m, that the water entities can call upon in extreme and strictly limited circumstances.

That's the official position. Unofficially, or course, as lifeline services water networks are too big and too critical to fail. This Government is considering bailing out a skifield operator; of course it's not going to allow a major utility providing the public with safe drinking water and wastewater services to go under.

Investors believe such government backing to be pretty much a certainty; ratings agencies certainly think it highly likely. 

Paul Norris: "Fitch does often look at the likelihood of government support for public sector entities and may create a credit-linkage between an entity and a government sponsor even in the case of no explicit guarantee, although this is dependent on a number of particular factors rather than just the type of asset or service."

"There will always be an unknowable line that the Crown is not willing to cross, so making assumptions as to the level of implicit support is ultimately a fool's game."
– Josh Cairns

And that likelihood is why the new water corporations can be leveraged to a larger extent – the security over something people depend on to live is adamantine. But it's also why the entities will be heavily regulated, both by Taumata Arowai for water quality, and by the Commerce Commission for how they operate as businesses and the charges they impose on consumers.

Josh Cairns has a warning: "In practice the Government might not allow the entities to fail – but that is a very dangerous assumption for rating agencies or financiers to make now, in the absence of an explicit guarantee or support.

"There have been situations in the past where financiers have lent on the basis of implicit Crown support which did not turn out as financiers had assumed, Solid Energy being a case in point. The situation might be different for water, but there will always be an unknowable line that the Crown is not willing to cross, so making assumptions as to the level of implicit support is ultimately a fool's game."

Bevan Wallace says the Crown intervention to support Kāinga Ora strengthens a "tacit assumption" that the Crown would underwrite the debt obligations.  "The provision of an explicit guarantee should result in a reduction of any premium to the government borrowing rate paid by the Three Waters Agency but due to the lower liquidity compared to Crown debt, the [entity] would likely incur debt costs that were above government rates despite any guarantee – be it implicit or explicit."

13. Is this just an argument about whether taxpayers or ratepayers are liable for Three Waters debt, and which generation picks up the tab?

In some ways yes – we need the infrastructure and it has to be built and financed by both current and future generations. Whoever pays for the water – taxpayers, ratepayers or consumers – they are largely the same people.

But how the costs are shared is important. For instance, there is an argument that residents in smaller regions should be subsidised because they do not have the population to manage water assets over large geographical areas

And to a degree, the distinction between taxpayers or ratepayers being responsible for Three Waters debt overlooks an important feature of the reforms: the defining shift to a commercial utility model.

"The utility model enables a range of operating and investment efficiencies, as well opportunities to spread the burden of debt among customers, that are not readily achievable under a council operated model. This is completely overlooked in our view when discussing who services the debt.”
– Amelia East

So there's something more – and this reinforces Hamiora Bowkett's point at the start of this article. These reforms are not just about who picks up the tab; fundamentally, they're about ensuring critical work is actually done. Because in many parts of the country, for many years, it hasn't been.

Amelia East says extensive overseas experience shows that the utility model enables operating and investment efficiencies, and opportunities to spread the burden of debt among customers, that are not readily achievable under a council-operated model.

So to reduce the Three Waters debate to a question of who services the debt would, she says, completely overlook the fundamental need to provide better, safer, more efficient water services.

Watching, not entirely disinterestedly, from over in Australia at S&P Global, Anthony Walker is forthright. "There's no magic pool of money. At the end of the day, ratepayers are paying through their taxes, through their council rates, or through water levies. Somebody's paying for it, and it's always gonna come back to you at the end of the day."

Newsroom Pro managing editor Jonathan Milne covers business, politics and the economy.

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