Reforms are a major departure from accepted standards on asset ownership. Photo / 123RF
OPINION:
The Three Waters reforms — although recently revised due to their unpopularity — still represent a substantial departure from internationally accepted conventions around asset ownership, capital markets, infrastructure regulation and corporate governance regimes.
Corporate governance structures are broadly similar worldwide and date back to the inception of limited liability companies. There are three essential elements of this construct: the owners (investors); the board; and the management team.
The board is appointed by the owners to establish strategic direction, make key decisions including capital structure and distributions, and to appoint the management team to execute the plan. Importantly, they must act in good faith and in the best interests of the entity as a whole, and not favour the interests of a specific class of shareholders.
The concept of control generally refers to an owner or ownership bloc that can vote more than 50 per cent of the shares because the controlling shareholders can approve normal resolutions and appoint the board. Ownership and control are inextricably linked.
In effect, the delegation of authority runs from asset owners to the board and then from the board to the management team. In New Zealand, The Crown Entities Act requires that Crown entity boards understand their role as governor of the entity and primary monitor of entity performance. If delegated authority is the yin to this construct, then accountability is the yang.
Accountability flows in the opposite direction. Management is accountable to the board and the board is in turn accountable to the asset owners. The owners can appoint or remove directors via a democratic process.
The corporate objective is usually to create value over and above the original capital invested, by providing a product or service that is sufficiently valuable to its consumers that the entity is able to generate profits, pay dividends and increase the value of the capital invested.
In the case of regulated infrastructure, the regulator plays a key role in establishing an efficient cost base, the capital investment framework and ensuring fair tariffs for consumers. The regulator has substantial powers to determine allowable investment, asset values, cost of capital and tariffs.
There is a high level of confidence and reliance on this mechanism in capital markets globally, which has led to the aggregation of both equity and debt capital from disparate sources for large projects, undertakings or businesses and resulted in astounding achievements and wealth creation.
Business law and general property laws globally generally protect and promote confidence in this important arrangement. So much so, that investors and businesses tend to aggregate in jurisdictions with the most reliable legal environment. Countries looking to attract investment, the associated job creation and economic wellbeing essentially compete to establish capital markets with strong property rights and legal certainty, thus resulting in a low “cost of capital” which reflects the riskiness of the country and the specific investment.
It is this familiarity with such laws and conventions that has resulted in a thriving capital market for both equity and debt, at least in liberal Western democracies.
Boards themselves generally seek to achieve consensus among board members, particularly in respect to key decisions. It is desirable to have a range of skill sets and capabilities at the board level.
The key to establishing the framework for decision-making is identifying and agreeing on the entity’s purpose, objectives and mission. The board charter explicitly details the role and responsibilities of the board. The asset owners then entrust the board to make these decisions and to act in the best interests of the entity.
Three Waters represents a departure from these key capital market principles.
Three Waters establishes a governance regime that is essentially appropriated from the current owners and creates a framework of control by iwi.
The objectives of iwi on the one hand and ratepayers on the other may differ substantially.
The legislation establishes Māori as a priority interest group. Māori are entitled not only to appoint half the board, but also to issue Te Mana o te Wai statements to the boards of the water entities. Whereas utility regulation globally tends to be highly prescriptive, the scope and status of these statements lack definition, but they appear to be similar to directives to the board, thus undermining the role of the board to act in the best interests of the entities, diminishing its decision-making authority and its accountability while substantially eroding the rights and interests of the councils which have equivalent director appointment rights. The boards therefore appear to be effectively primarily accountable to iwi and it is questionable whether they have any independent functional value.
Despite the claim that the reforms are primarily about delivering affordable water services, the concept of asset ownership and associated rights, authority and accountability has been compromised. The ownership rights of the current owners will be significantly reduced and a powerful new ethnicity-based body introduced with very substantial ownership rights and powers.
Minister Kieran McAnulty claims all this is necessary to achieve “balance sheet separation”. Claiming this is a necessity is a dubious claim. What is required are water entities with strong capital bases, access to capital for future investment, and a strong regulatory regime that establishes a “regulatory ring-fence”, efficient cost bases and ensures “bankruptcy-remoteness” from their owners.
The core issue is that water assets, like most infrastructure in this country, have suffered from both under-investment and heightened expectations for quality and reliability. Rightly, there is an expectation of improvement. Happily, we don’t have to reinvent the wheel: regulatory regimes for monopoly infrastructure providers are common internationally.
The establishment of a regulated capital base, capital investment plans and water tariffs required to support and service the existing assets and future investment of the current asset-owning entities should be implemented. The concept of a “building blocks” approach to capital planning and an allowance for an efficient cost base are well-established concepts internationally. All of which would be overseen by the economic regulator anticipated in the reforms. The regulator should be the party that consults with iwi and requires, for example, that Māori principles including kaitiakitanga be observed and implemented in operations and capital investment planning, with standardisation across the water entities.
The government’s balance sheet can certainly play a role in these reforms and could provide preferred equity or debt guarantees to the asset owners or subsidise water tariffs for consumers who are struggling.
The greatest contribution the government could make is delivering up a low cost of capital and a robust and transparent regulatory regime, thus reducing equity and debt servicing costs and lowering tariffs. Ironically, by introducing a globally unique governance regime and exposing the fragility of property rights in New Zealand, the Three Waters reforms achieve the opposite.
These reforms raise numerous serious questions about the investability not only of water assets, but other key strategic assets that the government might unilaterally determine it wishes to own, control or to redistribute ownership rights.
There is a risk that, over time, confidence in New Zealand as a capital destination will be negatively impacted.
The ramifications of Three Waters reach far beyond water reforms.
- Simon Botherway is a company director and past member of the Securities Commission, Electricity Authority Establishment Board, the Guardians of the New Zealand Superannuation Fund and chair of the Financial Markets Authority Establishment Board.
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