The Coalition Government's water reforms enable council-controlled entities to borrow through LGFA and grant Commerce Commission extensive regulatory powers

The latest rendition of water reform will allow council-controlled entities to be established and borrow through the Local Government Funding Agency (LGFA) at low interest rates.

Water entities will be strictly regulated by the Commerce Commission, which could be given the power to take control of water pricing and specific investment decisions if an entity fails to deliver.

Ministers Simeon Brown and Andrew Bayly announced the new policy alongside LGFA chair Craig Stobo during a press conference on Thursday morning.

Brown told reporters council-controlled entities will be able to borrow via the agency as soon as they are established, provided they meet prudent credit criteria.

“The LGFA provides the lowest-cost financing available to local government and, from today, will support leverage for water council controlled organisations (COOs) up to a level equivalent to 500% of revenue,” he said.

“A lower cost of borrowing means that councils and their water CCOs can invest for long-term growth while resulting in lower rate rises than would be the case under Three Waters.”

The LGFA was established in 2011 to raise debt on behalf of local authorities on terms more favourable to them than if they raised the debt directly. It has 31 shareholders, including the Government with 20% and 30 councils holding 80%.

It can borrow at lower interest rates than councils because it has a AAA credit rating, whereas many councils don’t even have a credit rating. Councils rated by S&P Global Ratings have an average rating of AA, two notches lower than the LGFA, meaning they would face higher interest rates if borrowing independently.

Auckland’s Watercare will not be eligible for this arrangement as it is financially separated from Auckland Council and will need to raise capital on its own, likely at higher interest rates.

Regulated to the hilt

Bayly said a new regulatory regime would be established to ensure these water entities built the right infrastructure, provided high-quality water, and charged consumers appropriately.

Importantly, water revenues will be ring-fenced to fund infrastructure upgrades.

The primary regulatory tool will be information disclosure, but a secondary list of reserve powers would allow the Commission to set prices and make infrastructure decisions if necessary.

MBIE said in a statement the regulation regime would be "risk-based and flexible" and was similar to those imposed on gas pipelines and electricity lines. 

The LGFA will make its own assessment of the credit worthiness of these entities and lend to them at an appropriate interest rate. The more secure the entity, the better the rate it will receive. 

Stobo said lending caps for CCOs were a commercial decision made by the LFGA board, whereas the rules for councils were written into foundation policies and shareholder agreements.

This is partly why the agency believes it can lend up to 500% of revenues for water entities, even though it only allows councils to borrow between 175% and 285%.

Entities will need to have a high-quality board, a strong balance sheet, and an appropriate business plan for the board to approve that level of funding — which isn’t guaranteed.

Although the LGFA has agreed to treat CCOs and councils as separate entities for lending purposes, international credit rating agencies are unlikely to do the same.

This means increased borrowing by water entities would appear on councils’ balance sheets, which could result in lower credit ratings for individual councils and possibly the LGFA.

Stobo said he was confident the extra borrowing wouldn’t result in a rating downgrade for the agency, which currently has near-perfect credit ratings, partly due to being 20% Crown-owned.

Credit risk

In February, S&P Global Ratings said it did not expect lending to council-controlled organisations to have a material impact on LGFA’s credit metrics, as that lending remained “very small”.

Weaker credit ratings for councils and increased debt levels would weigh on the LGFA’s credit worthiness, although this may be limited by the Crown guarantee backing the agency.

It’s likely that regional entities will be formed as envisioned in Labour’s proposal, albeit with more council control and less Māori involvement. Treaty obligations still apply at a council level and will mean mana whenua are involved in the decision-making process. 

Simeon Brown said councils were expected to work together and that a regulatory backstop could be used to force amalgamation if any were left stranded.

In a press release, Labour’s local government spokesperson Kieran McAnulty said the announcement “turned a blind eye” to credit ratings and would push property rates higher. 

Credit rating agencies told the previous government that anything other than balance sheet separation would be detrimental to councils’ credit worthiness.

“We know agencies stated that without balance sheet separation it would be difficult to maintain the required credit rating. It appears the Government is working on its own analysis, which conveniently disregards the feedback of their own credit agencies,” McAnulty said.