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9. Other Financial Support

9.1 Financial guarantees

In the context of water enhancement schemes, a financial guarantee refers to an undertaking from a financially secure party (typically local government) to meet the scheme debt servicing and repayment commitments in the event that these cannot be met through scheme operating cash flows.

9.1.1 Local Government

Local government provision of financial guarantees is common practice. The majority of these are for small amounts relating to sporting and community clubs. There are precedents for local government providing guarantees to water enhancement developments:

• Debt financiers of the Waimakariri scheme received a guarantee from the Waimakariri District Council for a 5-year term.
• Debt financiers of the Opuha scheme received a financial guarantee from the Timaru District Council for the initial 3 years of operation.

Justification for and risks relating to the provision of local government guarantees has been discussed in the study on the Role of Local Government.

From a funding prospective Local government need to consider the following key points in relation to providing financial guarantees.

• In many cases, funding (with appropriate terms) is not likely to be provided without a creditable financial guarantor.
• The key period of risk for a water enhancement scheme is the initial three to five year operating period, where the scheme has to manage water user take-up and wait for on-farm development and conversion. To minimise risk, local government should be able to limit the term of the financial guarantee to a five-year period.
• To manage risk, local government should complete rigorous due diligence on the scheme to confirm the financial viability prior to committing a financial guarantee.
• Local government need to ensure that there is provision for the scheme to pass into public ownership in the event of a call on the guarantee.

9.1.2 Central Government

Although the Public Finance Act 1991 allows for Central Government to provide financial guarantees to private organisations, a study on the Role of Central Government has not identified this as an option for Central Government to explore.

9.2 Government (Central or local) underwriting

The role of Central and local Government in relation to underwriting water rights has been addressed in other studies. The analysis below relates to underwriting as it impacts on funding options.

Revenue Underwriting

If a scheme wishes to access project financing or BOOT funding then certainty of revenue is critical. Given past experience with water enhancement schemes, achieving certainty over revenue is very difficult through the initial operating period.

Where a scheme is having difficulty getting commitment from water users there are three possible scenarios.

• The scheme is not financially robust enough for the range of water users and therefore no funding will be provided and the scheme will not proceed.
• The scheme is financially robust, and can be staged to meet user demand and be extended at a later date to cater for increases in volume. Under this scenario funding is likely to be available for stage one of the project.
• Government (Central or local) agrees to purchase all of the unsold shares in the scheme and hold these for future resale when demand for water increases (underwriting). Under this scenario funding is likely to be available for the entire scheme.

It is important that Government only consider underwriting a scheme after the first two scenarios above have been deemed inappropriate.

Providing underwriting support carries a high risk for the provider and if this is to be a viable option, the following conditions must be addressed:

• Set minimum levels of commitment for water users prior to scheme construction i.e. 70 percent committed.
• Ensure that there is a mechanism and a market available to lease water for recovery of take-or-pay costs.
• Ensure that the demand potential is high given that the scheme caters for significantly less that the total command area.
• Restrictions are to be put in place preventing general water trading until all Government shares have been re-sold.
• Include a sunset clause in the agreement enforcing a repurchase of outstanding water rights (including a financial return) after a defined period of time (i.e. 5 years). This provides an incentive for those in the scheme to market it to new users, or they will be paying the difference.

Cost Underwriting

Water enhancement financiers are less concerned about having scheme costs underwritten given that the majority of these costs are fixed or risks can be effectively managed through allocation to other parties (i.e. construction companies, DBO providers).

There is therefore limited value in a scheme having Government underwriting costs. It is also more difficult for Government to exit the investment if funding has been provided in this manner.

Exit Strategies

Formal exit strategies need to be agreed with funding providers and water users prior to entering into the underwriting agreement so all parties are aware of the risks prior to committing to the development.

The exit strategy should reflect the short-term nature of Governments underwriting offer ensuring exit is available as soon as possible, provided it is commercially prudent.

The viable exit strategies include:

Tradability of shares provides an easy exit route for Government to extract its investment. Provided the scheme is delivering water to the farm gate economically and the demand is sufficient shares may be sold to any of the following parties:

• New or existing water users;
• Other private investors;
• The scheme itself.

Government should expect to achieve a reasonable financial return for the sale of these shares given the level of risk undertaken. There has been clear evidence of share appreciation with both the Waimakariri and the Opuha schemes.

Other exit strategies include:

• Where a scheme is not performing as expected and the market for water shares is not active (unlikely, based on recent experience) Government may have to enforce a sale of shares back to the scheme based on the terms of the underwriting agreement (sunset clause), provided the scheme is able to financially support this transaction.
• Where a scheme does not have the ability to repay an underwriter based on the agreed terms, Government should cease the take-or-pay commitment (this will need to absorbed by the scheme) and consider converting the outstanding balance to a loan with commercial lending terms and exit over a longer period.

Contact for Enquiries

MAF Information Services
Pastoral House
25 The Terrace
PO Box 2526
Wellington, NEW ZEALAND

Fax: +64 4 894 0721
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