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Brazilian Senate Approves New Sanitation Bill


Ricardo Pagliari Levy; Roberto Zilsch Lambauer

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The Brazilian Senate has recently passed a new sanitation bill (PL No. 4,162/2019 – "Bill"), fully ratifying the content approved by the House of Representatives in December 2019. The President has until July 15, 2020 to decide which provisions of the Bill, if any, he will veto, and sign the Bill into law.

Basic sanitation encompasses three types of services: (i) water supply; (ii) collection and treatment of sewage; and (iii) waste management. Brazil has long faced alarming figures in all three areas, falling significantly behind other South American countries such as Chile and Argentina.

Only a half of Brazil's population has access to collection of sewage and only a third has its sewage treated. Thirty-five million do not have access to water supply. Besides, the average water loss rate is at forty percent (in some regions, it exceeds fifty percent), which leaves significant room for efficiency improvements. The waste management industry is in an early stage, with landfills still being a frequent landscape item.

All of these create a pressing need for fostering investments to ensure universal access, which the Bill does by tackling key legal hurdles that have historically prevented the opening of the sanitation sector to the private market. Below we comment on each relevant aspect of the Bill.

National Water Agency's Powers to Enact Benchmark Regulation

In the absence of a clear provision in the Constitution, the Supreme Court held that municipalities have authority over sanitation services based on the prevailing local interests involved. As an exception, a state may enact a law to gain authority over sanitation services regarding a metropolitan region where municipalities have a shared interest in those services. Federal and state governments may nonetheless promote measures alongside municipalities to enhance sanitation, as provided for in article 23, IX of the Constitution.

The Federal Government's role will likely shift amid the current crisis from sponsor to central planner. Once signed into law, the Bill will add powers for the National Water Agency ("ANA") to enact benchmark regulation on sanitation. ANA's jurisdiction is currently limited to management of water resources. The benchmark regulation will cover items that are appealing to investors such as (a) water quality targets; (b) financial balance of contracts; (c) tariff revisions; and (d) amortization of investments. ANA is expected to enact such benchmark regulation by the end of 2020. Timing for its actual implementation at state and municipal levels looks a bit uncertain at this point.

Even though ANA's benchmark regulation would not be binding on states and municipalities, the Federal Government would only make discretionary transfers of resources to states and municipalities that adopt such benchmark regulation and advance universal access goals. The state and municipal agencies would supplement ANA's benchmark by carrying out end-to-end regulation based on local needs.

The Federal Government would further advance the Bill's goals by continuing to structure projects by means of the Brazilian Development Bank (BNDES), which has considerable expertise in infrastructure projects.

Scaling Projects Through Clusters of Municipalities
The Bill incentivizes the formation of clusters of municipalities to allow joint operation of sanitation services. That mechanism is intended to (a) increase scale gains and thus attract large ticket investments; (b) achieve universal access in both profitable and non-profitable regions; and (c) transfer end-to-end regulation to state level, which would to a certain extent mitigate risks regarding regulation at municipal level.
A cluster may be implemented in various formats, the most relevant being: (a) a metropolitan region created by state law; or (b) a group of municipalities. In either format, municipalities would transfer to the underlying state the necessary powers for carrying out a public tender and ultimately enter into a concession agreement with the winning bidder.
Regarding the latter format, each municipality would have to adhere to a certain group of municipalities by passing a specific law or a mayor decree depending on each local law. The underlying state would lead efforts alongside the Federal Government and BNDES to convince municipalities to form such groups before launching a public tender.
The group format may be considered less stable than a metropolitan region, whose creation and governance structure would be set in a state law, making it significantly more difficult for a municipality to exit a metropolitan region. Conversely, a municipality could in theory cease being a member of a group of municipalities by revoking its previous law or mayor decree, as the case may be. Even though that format has not yet been tested, sector specialists generally agree that such an event would likely trigger financial rebalance of the underlying concession agreement.

Requiring Government-owned Companies' Commitment to Universal Access and Quality Goals

Government-owned companies are major providers of sanitation services. The aforementioned figures are telling about their inability to reach universal coverage of water supply and sewage treatment. They have nonetheless not been subject to hard enforcement. Those companies usually operate under the so-called program contract (contrato de programa), which is usually bare bones with no clear contractual targets. Private companies currently have a market share of only six percent, but have been able to significantly enhance coverage and service levels within their areas of operation.

The Bill conditions the renewal of program contracts with government-owned companies on the setting of universal access efficiency targets, which most of the existing contracts currently lack. Such goals include gradually expanding coverage of water supply to 99 percent and treatment of sewage to 90 percent by the end of 2033. Universal access goals may be extended to 2040 contingent upon a showing of economic unfeasibility of reaching those milestones by the end of 2033. There are also qualitative goals that include ensuring steady supply of drinking water and reduction of water losses.

Inefficient operators would be at risk of facing forfeiture proceedings – i.e. termination for non-performance – in case they fail to meet those binding goals.

The Bill prohibits signing of new program contracts with government-owned companies by means of waiver of tender. That means government-owned companies would necessarily take part in public bids to compete with private players for new contracts.

Removing a Main Hurdle for Privatization

According to the current framework, transfer of ownership of a government-owned company to a private player would trigger termination of the company's program contracts with municipalities, undercutting its main assets. The Bill would revoke such provision and thus make privatization of large state conglomerates, such as the Sanitation Companies of São Paulo (SABESP) and Paraná (SANEPAR), a real possibility.

Sector Outlook

The BNDES has structured three sanitation projects which will be tendered September this year and is currently modeling several other projects, including the concession for sixty municipalities in the state of Rio de Janeiro and concessions for the states of Acre and Amapá.

Most projects consist of traditional concession agreements whereby new operators would take over (a) distribution of water; (b) collection and treatment of sewage; and (c) commercial services, e.g. collection of tariffs, customer relationship, etc. A new operator will often be required to construct and expand sewage and water treatment infrastructure as part of the concession package. Authorities expect private operators to amortize such investments by achieving efficiency gains.

In BNDES' benchmark project for the Metropolitan Region of Maceió, state-owned company CASAL would be downsized and remain responsible for collection and treatment of water. The new operator would provide water and sewage services to thirteen municipalities.

In the second most frequent format, a government-owned company would enter into a public-private partnership (PPP) with an operator for collection and treatment of sewage. CESAN – a company controlled by the state of Espírito Santo – is currently auctioning a PPP in that format for the city of Cariacica.

The new sanitation framework that will result from the Bill's passage into law – expected for next week – has gained momentum, with market analysts considering the sanitation sector next in line for infrastructure development in Brazil. On the other hand, some sector specialists are skeptical about authorities' ability to enhance regulations and structure more solid projects in the short term.

The success of the new sanitation framework will depend to a large extent on the continuous effort of the Federal Government to implement ANA's benchmark regulation and structure further concession and PPP projects at state level.
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