Using Private Sector Participation (PSP) as an Effective Means of Achieving Compliance with the European Water Framework Directive (WFD):

The Case of the Divestiture of the Water and Wastewater Services in Tallinn, Estonia

By Cledan Mandri-Perrott

About the Author...

Cledan Mandri-Perrott is an international PSP consultant who has been involved in the development of PSP structures and regulatory frameworks in the water sector in a number of countries throughout Eastern Europe, Africa, the Caribbean, and South America. He previously served as a Director of a local joint venture company for an international water operator for a three-year management contract in Trinidad and Tobago. Recently Mr. Mandri-Perrott served as the Project Manager for the privatization of Tallinn Water Company in Tallinn, Estonia, valued at over US$75 million, where he was responsible for the design of the privatization structure and implementing the transaction.

Abstract

Cledan Mandri-Perrott assesses how the introduction of private sector participation can be a catalyst for raising the standards of water resource management. He looks at the case of the divestiture of the water and wastewater utility in Tallinn, Estonia and how the European Water Framework Directive compliance requirements were successfully integrated into the PSP transaction.

The Challenge of Meeting EU Accession Criteria in the Water and Wastewater Sector: the Water Framework Directive (WFD)

Estonia has been an accession candidate for the EU since April 1997 and its target for membership is 2010. Accession means, among other things, compliance with economic, financial, social and environmental criteria. As far as the water and wastewater sector is concerned, the criteria is encapsulated within the Water Framework Directive (WFD).

Although accession countries are not strictly bound by all the terms of the WFD, the WFD does call for co-ordination through the concept of River Basin Management. For river basins existing within the EU boundaries, member states have an obligation to coordinate efforts to meet the objectives of the WFD. For river basins existing both within and outside the EU boundaries, the WFD merely recommends that EU member countries and non-EU member countries coordinate their efforts to achieve the objectives of the WFD. When the accession countries are full-members of the EU, the principles of the WFD will be transposed into their respective national laws.

The WFD focuses on establishing the right conditions to encourage efficient and effective water protection at the local level, by providing for a common approach and common objectives, principles, definitions and basic measures to achieve a sustainable water policy. Thus, sustainable use ensures adequate supplies of water of good quality are maintained for present and future generations.¹

It can be concluded that the WFD has two key objectives, firstly an environmental objective based on the premise of preventing further deterioration and achieving "good status" in all waters, and secondly a managerial objective aimed at creating integrated water management at the river basin level to ensure overall co-ordination of water policy in the EU.

Rationale for Introducing Private Sector Participation (PSP) in Tallinn, Estonia

Estonia has lived through the transition from command to market economy after the break-up of the Soviet Union. At the same time there was pressure from neighbouring countries in the European Union to develop a suitable internal capability to deal with growing standards for both water and wastewater.

In Tallinn, the capital of Estonia, the provision of water and wastewater services was in the hands of a government owned entity. The entity suffered from under-investment, subsidized tariffs, low levels of customer service, pressure to meet greater standards in water quality and effluent discharge, operating inefficiencies, and high levels of unaccounted-for water. The company's legal and financial standing did not allow it to raise finance independently from any Central Government guarantee.

Although Estonia overall was making solid progress towards meeting accession criteria, a 1999 EU evaluation concluded that there was more to be done in the water and wastewater sector in particular with regard to water quality. Faced with these challenges and the inability to raise the required investments necessary to meet standards, officials examined the possibility of introducing the private sector for the provision of water and wastewater in the City of Tallinn.

The Chosen PSP Form: a Divestiture

As with many cities worldwide undergoing transition, the City of Tallinn was under pressure to finance new social development programs and looked to release itself from the administrative and financial burden of providing water and wastewater services as one of the options available to them. Despite the challenges listed above, the Tallinn Water and Wastewater Company (AS Tallinna Vesi) was considered a well-run company and would likely be an attractive investment opportunity for the private sector.

Once the decision was made to explore PSP options, the principal objective of the City of Tallinn was to attract a strategic investor/private operator for the management and financing of the Company in order to achieve the quality and service standards set by national and European Union regulations.

The type of private sector participation structure selected was a partial divestiture through the sale of a majority stake in AS Tallinna Vesi. This granted the strategic investor management and operational control, while the City of Tallinn retained a veto over a limited number of matters through a golden share. The process was arranged as a one-stage tender with a detailed pre-qualification. As a result of the bidding process, the strategic investor held 50.4 per cent of the share capital of AS Tallinna Vesi. This gave the strategic investor management control of the company via majority in the Supervisory Board.

Achieving Compliance with the WFD

To ensure that the transaction met compliance objectives of the WFD, key provisions of the WFD were integrated into the contract, as highlighted below:

• From an environmental perspective, compliance was achieved through the Service Agreement between the City and the strategic investor/operator. This contract set out obligations in terms of service, quality and discharge standards based on the premise of preventing further deterioration and achieving "good status" in all waters.
• From a managerial perspective, through the contract, the strategic investor/operator was required to manage water resources at a river basin level. This of course relied on the relevant local and ministerial authorities being established and effective.
• Achieving water quality of 'good status' was achieved by setting national standards to the same level of the WFD (and in some instances higher than the WFD).
• Outputs required in the Service Agreement reflect and respect the WFD, e.g. pollution control measures, water abstraction control etc.
• Monitoring of standards was done through the Service Contract itself, which set out the terms of quality, quantity and levels of service. Monitoring was done through the contract itself and enforced by the relevant ministry.
• Reporting obligations: The Service Agreement includes major reporting obligations as well as specifying the government agencies to which these reports are given.
• The principle of cost recovery was at the heart of the PSP arrangement and Government had, prior to the introduction of the private sector, outlawed cross subsidies. The method for compliance with quality standards was again set out in the Service Agreement.
• Existing investment in water production and distribution allowed water quality standards in line with WFD to be imposed. However, with respect to wastewater standards there was a progressive plan to achieve full compliance with WFD.

Conclusions: Key Design Considerations

From the experience of AS Tallinna Vesi we are able to draw conclusions on the key issues to be accounted for in the design of similar projects. These include:

1. A clear mandate for the privatization transaction at the highest political and administrative levels.
2. The necessary legal, technical and environmental parameters must be clearly defined, and be mirrored in the contract structure.
3. The necessary legal and institutional changes must be established, and appropriate regulatory mechanisms put in place.
4. The balance of risk between the public and private contracting parties must be appropriate and equitable.
5. It is necessary to recognize that complete and immediate compliance with standards may not be possible for all WFD issues, and that the introduction of a temporary 'moratorium' on full imposition of the standards may be necessary. This should be linked with a suitable method and timeframe for improvement, and for the introduction of the full standards.

Finally, although it can be argued that the privatization was successful in developing a mechanism to deal with some of the accession criteria, in particular with respect to the WFD, an element of pragmatism is called for. It was very difficult to achieve full compliance with all aspects of the WFD immediately and a progressive approach was required. However, the real test for the success or otherwise of this transaction will be if Estonia meets its environmental accession criteria.

For further information on the transaction, you may contact Mr. Mandri-Perrott at:
cledan@cox.net

¹ The main purpose of the WFD as specified in Article 1 is to protect, enhance and prevent further deterioration of the aquatic ecosystems, promote sustainable water use based on long-term protection of available water resources, enhance protection and improvement of the environment, ensure the progressive reduction and prevention of pollution of groundwater, and to mitigate against the effects of floods and droughts.