Three waters reforms, complex, with conflicting incentives - advice

The Government was warned in April that it was progressing too quickly with its water reforms, with both Treasury and Te Waihanga - the Infrastructure Commission - saying the speed of the changes "means there will be a high level of uncertainty around the implementation of the reforms".

The Government will today unveil its decisions on how to fix New Zealand's broken water services. It proposes amalgamating freshwater, stormwater, and wastewater services, which are currently owned and largely run by councils - into four enormous water entities.

These ideas were put to Treasury and Te Waihanga earlier in the year. Sections of the advice to ministers have been released under the Official Information Act.

Te Waihanga was concerned that the ownership and governance of the new entities was so complex it could put local councils offside with the reforms.

Councils will still own their water assets, but they will own them by having an ownership stake in one of the four large water entities. That stake will not be a shareholding in the new entity - but a form of collective ownership.

Te Waihanga said the governance of the new entities could frustrate councils, because they would have little or no control over how the new entities were run.

Under the current proposals, a "Regional Representative Group", made up of local authority members and mana whenua, will vote on appointing an independent panel, and that panel will itself appoint board members to govern the local three waters entity.

"This may mean local elected members are unsatisfied with their lack of influence over the new entities, and could be a key point of contention when the final proposals are released," said a Treasury digest of Te Waihanga's advice.

Te Waihanga did note the reason for this complexity: balance sheet separation.

Modelling commissioned for the Government estimates that between $120 billion to $185b of investment will need to be made in water services over the next 30 years.

A significant amount of that money will be funded by debt. The Government has designed the new water entities so that it is clear that while they are owned by councils, they are independent enough that they have separate balance sheets, meaning the water entities and the councils that own them can borrow and spend without one affecting the other.

Te Waihanga notes this complexity is a design feature of the system, not a bug.

"The complexity of the proposed governance structure reflects the Government's objectives of retaining local authority ownership of water assets alongside financial independence of the water entities," the advice said.

To ensure that the debt of water entities is "off balance sheet", it is necessary to remove substantive control of the water entities from local authorities," the advice said.

Another concern is that the separation would "lead to friction between local authorities and the water entities once the entities are established".

Local Government Minister Nanaia Mahuta will shortly announce sweeping three waters reforms. Photo / Mark Mitchell.

One area where this friction could emerge is in planning. The Government's resource management reforms will give councils influence over infrastructure planning - although it is not clear whether they will have greater or less influence than they have today.

A digested version of this advice said the Government might want to think about managing councils' expectations about how much power they would have over the water entities

Another area of concern is around rules that will mean the new entities do not produce dividends for their owners. This rule is designed to make sure the new entities are not commercial enough to be targets for privatisation.

However, Te Waihanga said that this structure would come at the expense of incentivising efficiency in the water entity.

"We understand water entities will not be permitted to produce dividends but will instead need to reinvest surpluses back into their networks.

"The requirement of providing dividends can be effective at incentivising efficient operations in the absence of market competition. Te Waihanga is concerned the provision of surpluses may not have the same effect."

The new entities will not be allowed to be privatised, but advice warned that care should be taken when drafting a prohibition on asset sales.

The advice noted that while "Cabinet has committed to council ownership, some level of asset sales and the rationalisation of stock are a normal part of business".

It also said that some small water supplies might be "best operated by small communities as non-reticulated water supplies rather than stay within operation of larger water entities".