5. Criteria for Evaluation & Prioritisation of Investment Opportunities

5.1 Council criteria

Councils generally do not have formal investment criteria to apply to the evaluation and prioritisation of competing investments.

Councils evaluate all potential projects and investments on a case-by-case basis weighing up social and cultural benefits of a project with the requirement for financial return on investment.

There are however many similarities in the general criteria applied by Councils when evaluating investment options relating to new business initiatives. As expected the criteria for investment evaluation is linked strongly to Council objectives discussed in section 3.

Provided Council has the funding available, the general investment criteria used to determine the level of investment into a new project is based on a projects’ ability to:

create sustainable quality jobs for the region;
sustain or increase regional populations;
generate a financial return for Council investment;
provide wide community benefits and a stronger social structure for the region;
comply with environmental legislation.

The weighting applied to each of the criteria is different depending on the individual project (case-by-case assessment). For example a project that provides significant community and social benefits may have a lower financial return requirement.

Christchurch City Council (CCC) has developed a draft investment evaluation criterion, which has been included within appendix 1 as an example. This is still under debate and has not yet been used to formally assess a project.

Water enhancement schemes clearly meet the criteria in relation to employment, population, and community benefit and have the potential to generate a financial return. However, Council funds are limited and many other investment opportunities also meet the above criteria.

Council justification for providing additional investment into water enhancement, as apposed to other competing projects, must be based on:

Community Benefit

It must be demonstrated that the public benefits (Social, environmental and economic) provided by water enhancement schemes are greater than other projects and are provided at a lower cost to Council. Results of study 5 will be important here.

Positive Financial Return for Council

Schemes must be able to show financially stability to prove to Council that they can generate a return for any investment sort, but more importantly, that they will not require additional Council funds to prop them up in the future.

Lack of Private Sector Investment

Although not formally included within Council criteria, Council is more likely to support a project in a situation where the private sector will not/cannot fund the scheme without the requested Council intervention and therefore the significant community benefits will be lost from the region. By way of example, a scheme may not reach fruition (even though it is fundamentally viable) because of uncertainty surrounding the resource consent process. In this situation, the private sector would want to share some of this early "start up" risk with the Local Council.

One of the key issues/barriers for Council when determining/justifying their level of investment commitment to a water enhancement development is the lack of understanding of economic and social benefits provided to a community from this investment. It is therefore difficult to compare this investment with other competing projects. Study 5 will provide Councils with this evidence and a framework for quantifying this investment.

5.2 Council roles

By applying the above criteria Council has made investments into economic development projects in the past, including water enhancement. The types of assistance provided include:

Provision of financial guarantees – Waimakariri District Council
Equity investment (partial funding) – Timaru District Council
Provision of debt (partial funding) – Mackenzie District Council
Provision of hybrid equity (partial funding) – Waimate District Council
Underwriting revenue streams – Canterbury Regional Council
Provision of subsidy – Christchurch City Council

The following key points can be made:

Generally the roles undertaken by Council have been the result of negotiations related to the specific project and therefore may not be conventional assistance relevant to other projects with different circumstances. The role ultimately needs to satisfy the requirements of both Council and the private sector.
Each investment was justified on the basis that:

The project was perceived to provide significant economic and social benefits for the community (Although in most cases these benefits had not been quantified or evaluated after the project was complete).
The private sector would not fund the project without Council providing assistance.
There was adequate financial return for Council in supporting the project. "Adequate return" differed for each type of project, but needed to be a positive return.

Agreeing formal exit strategies (rather than intended exit strategies) is key to Council managing risk effectively.

5.3 Best Practice

In February 2001, the Office of the Auditor General (OAG) issued a report titled "Good Practice for Involvement in a Major Project, Lessons from the Opuha Dam Project". The report outlines "Key Messages" for a public authority (local and regional government) when considering making an equity investment or lending funds to a major project. An extract of the key messages from the OAG report is included at Appendix 2.

Essentially, the report identifies three areas of focus for a public authority to consider prior to making an equity or debt investment in a major project:

ensuring the investment is in line with policy objectives and long term strategy;
completing adequate risk assessments and risk management strategies;
ensuring the investment generates an adequate rate of return.

5.3.1 Policy Objectives and Long-Term Strategy

The OAG concluded that the equity investment by Timaru District Council (TDC) and the debt lending from McKenzie District Council (MDC) met expectations regarding Councils rational for investing in the project. The basis for this conclusion was that Council had made an investment decision based on:

the benefits accruing to the community in the form of securing a long term supply of drinking water for the community, providing development opportunities for the district and increased economic activity with the district estimated to be in the order of $80 million;
ensured that it was within its statutory powers to invest/lend the money;
disclosed the proposed financial involvement within the Council annual plan.

5.3.2 Risk Assessment

The OAG concluded that TDC and MDC met expectations in assessing the risks of investing equity capital and lending to the Opuha project. This conclusion was based on the following risk management arrangements:

A fixed price contract was negotiated for the design, building and maintenance of the scheme. The contractor was also required to put up a performance bond of $5 million to ensure completion.

Both project designer and contractor had experience with earth dams. A principle project manager was appointed to oversee the contract, along with three peer reviewers, and a supervisory mentor (principle peer reviewer).

Contractor had to indemnify the principal against all losses and claims for injuries or damage that might arise out of construction, and insured against any liability in respect of the construction.

5.3.3 Rate of Return

OAG expected that public authorities would have taken steps to satisfy themselves that they would receive an adequate rate of return on their investment.

What constitutes an adequate rate of return was not specified, however, the OAG concluded that TDC as equity provider and MDC as lender, met expectations in relation to rate of return as follows:

External advice indicated that TDC investment in Opuha would have after tax returns of 8% - 8.24% over a 50-year project life.
MDC negotiated commercial interest rates based on the 90-day Bank of New Zealand bank bills bid rate.

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