Australia: Is the Commonwealth Government waterproofing our future? The new National Water Infrastructure Loan Facility

The promise of increased Commonwealth funding for water infrastructure can only be a good thing, but as always the devil is in the detail, with key structural questions that are yet to be answered.

Water infrastructure is high on the Commonwealth Government's agenda. Proof of that is the recent launch of the $2 billion National Water Infrastructure Loan Facility designed to accelerate the construction of major water infrastructure projects: dams, weirs, pipelines, water treatment or reuse facilities.

The plumbing: how does it fit with existing water funding?

Traditionally, States and Territories have funded water infrastructure. But the Water Loan Facility, originally announced as part of last year's Federal Budget, is the latest newcomer to a changing landscape.

The Water Loan Facility augments the Commonwealth's existing $440 million National Water Infrastructure Development Fund ($170 million of which has been earmarked for water infrastructure in northern Australia). The Water Development Fund established a grant scheme to provide feasibility capital to the States and Territories to start the detailed planning required to build or supplement existing water infrastructure.

The Water Loan Facility reinforces the Commonwealth Government's growing desire to contribute funds to projects via concessional loans, rather than grants. It is therefore consistent in approach with other Commonwealth initiatives such as the Clean Energy Finance Corporation and the Northern Australia Infrastructure Facility (NAIF).

The Water Loan Facility will initially be administered by the Commonwealth's Department of Agriculture and Water Resources. However, responsibility for the scheme is expected to be transferred to the Regional Investment Corporation, once established.

Above the watermark: meeting the eligibility criteria

The Water Loan Facility is aimed at new major regional water infrastructure works. Retrospective activities, feasibility studies and water infrastructure for urban and potable use are ineligible. Only States and Territories can apply for financing from the Water Loan Facility, but that does not preclude them from using funds received in partnership with other public and private sector organisations. Proposed projects must be shovel-ready and consistent with the National Water Initiatives.

In addition to meeting the eligibility criteria, proposed projects also need to satisfy the mandatory assessment criteria, each of which have different weightings. These include providing:

  • a robust business case, including comprehensive financial modelling to demonstrate ability to repay Water Loan Facility debt;
  • proof that the finance from all Commonwealth sources (including the NAIF and the Water Development Fund) will not exceed 49% of total project costs; and
  • a credible stakeholder and indigenous Australian engagement strategy.

If the eligibility and assessment criteria are strictly interpreted, it's possible that the potential pool of announced projects to benefit from the Water Loan Facility may be quite limited because each project would need to cost greater than $100 million. Potential candidates include the Tasmanian Scottsdale Irrigation Scheme (the construction of a dam and irrigation network) and the Tottenham Water Supply scheme in NSW (the construction of a dam, pump station, power supply augmentation and transfer pipeline).

Flow of funds: meeting the loan conditions

Loans provided under the Water Loan Facility have a number of additional requirements including:

  • a $50 million minimum loan amount, with loans greater than $100 million requiring approval from Infrastructure Australia;
  • maximum tenor of 15 years comprising a maximum five year construction period in which only interest payments are made, and a further principal amortisation period; and
  • unlike many other Commonwealth concessional loan facilities, the interest rate will be variable based on an average of the 10 year Commonwealth bond rate.

Plugging the leaks

The promise of increased Commonwealth funding for water infrastructure can only be a good thing. But as always, the devil is in the detail. There are a number of key structural questions that are yet to be answered. For example:

  • how will the recipient State or Territory engage in partnership with the private sector to develop projects while utilising the facility? For example, will a traditional PPP or BOOT structure that brings its own private sector debt be eligible?
  • how will the various project risks be allocated between the potentially four different types of participants in the project: the Commonwealth, the State/Territory, the private sector sponsors and the project financiers?
  • how will the relevant State/Territory Government mitigate its exposure to construction phase interest rate risk when the project is not producing revenue?
  • how will the State/Territory Government manage its long-term floating interest rate exposure?
  • will alternative products (eg. guarantees or credit wraps) be available from the Water Loan Facility instead of loans?
  • will the Water Loan Facility loans be secured: if so, how will the intercreditor issues with the project financiers be managed?

Pipedream?

In addition to following the now well-trodden path of concessional loan arrangements, the launch of the Water Loan Facility presents an opportunity for the Commonwealth to re-write the infrastructure funding manual. For example, structural products could be developed to turn unbankable water projects into robust, risk-mitigated investments capable of delivering the stable, long-term yields needed to unlock private sector capital.

International products such as the:

  • European Investment Bank's (EIB) credit enhancement facility, under which the EIB provides a limited subordinated cost overrun facility designed to insulate senior debt from cost overruns and delays; or
  • United Kingdom's government guarantee, which provides an irrevocable financial guarantee of scheduled senior principal and interest (in return for a guarantee fee and a lower overall project cost),

have each been successfully deployed by foreign governments (including on water projects) as a means to leverage increased private sector financing for key infrastructure assets. While both of these products have traditionally been used in conjunction with debt capital markets financings, they could be adapted to work in Australia with other sources of funds. These structures have at their heart the same objective as the Water Loan Facility: efficient use of government funds to kick-start the development of much-needed infrastructure. If adapted properly to suit the Australian market, these products could enable the Commonwealth to leverage further its funds - allowing it to provide assistance to more projects while maintaining a reasonable return on the taxpayers' investment.

The first drop: utilising the Water Loan Facility

The first application window is now open. Proposals must be received by 16 March 2017.

RELATED KNOWLEDGE

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

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