THOMAS CRANMER: Wayne Brown lays down the challenge to Ardern and Mahuta

The Mayors of Auckland, Christchurch and Waimakariri deftly proposed an alternative plan for Three Waters on Monday and despite the Government’s initial response, the ball remains in its court. THOMAS CRANMER writes –

The press conference was held in Auckland and although it was led by Brown he made only the briefest of opening remarks before handing over to Waimakariri Council Mayor Dan Gordon, who announced “the path forward” with what he described as the “new consensus plan”.

Christchurch Mayor Phil Mauger then spoke in support of the proposal.

A fourth Mayor, Helen Worboys of Manawatu, was also scheduled to attend but was unable to do so due to family circumstances. Thus, whilst the press conference had all the optics of an Auckland proposal, it was clear that the impetus was coming from further south.

Indeed, despite the claim from Dan Gordon that this was a “new” plan, it was also clear that this proposal was based on a significant amount of the C4LD analysis and was broadly in line with the opposition to Three Waters that had been voiced in the recent local government elections.

That in itself is not a bad thing. The fact that this proposal leverages off the C4LD and Castalia work gives it more weight and counters any arguments that this is a half-baked plan concocted by novice mayors.

The important opening remark to make is that the mayors are not opposed to water reform. They were at pains to stress that they supported safe and reliable drinking water and wastewater services for New Zealanders which they acknowledged would require long term investment. Their stated desire was to work with government to form a consensus on the best approach for delivery.

That, of course, is easier said than done.

From his very brief remarks, it is clear that Brown is focused on the practicalities of the structure. He stated that he “supports ideas that will work in practice” and remarked that no-one had been able to explain to him “how will it actually work”. In my opinion, that is the right approach to take given the numerous concerns about how the structure will operate.

In the government press conference that followed the mayors’ announcement, Prime Minister Ardern and Minister Mahuta ruled out any alternative that did not include ‘balance sheet separation’. In addition, Ardern confirmed that the mayors’ proposal to keep the assets and not make co-governance compulsory meant that it did not comply with the government’s bottom lines.

In his article this week, Bernard Hickey argued, rightly in my view, that

“… the Labour Government looked to have been given an off ramp to abandon Three Waters for a much less politically divisive alternative that would have allowed for more investment in and consolidation of water assets, but without the compulsory co-governance or councils losing control”.

Matthew Hooton, Brown’s head of policy and communications, was more generous to Ardern in his assessment of her response, commenting to Hickey,

“… I think you make many good points but have taken an overly negative view of the Prime Minister’s response to what you call the potential off-ramp”.

That may be the case, but it is difficult not to conclude that the government’s so-called bottom lines are going to act as significant road blocks to reaching consensus.

Take the government’s first bottom line – balance sheet separation. Hickey explains that this is a response to the longstanding policy position that “central government taxes should be limited to around 30% of GDP and debt should be limited to 20-30% of GDP over the long run.”

This is the whole point of Three Waters. It shifts the council-owned assets into new balance sheets that are also separate from the Crown’s, which would then be able to borrow against streams of water charge revenues unconstrained by politicians trying to avoid ratepayer revolts against water meters, water charges and higher council debt.

The problem is that the structure does not ring-fence this liability from the Crown’s balance sheet. The liability is ring-fenced (by statute) from local councils but not from the Crown. Rather, there is an implicit guarantee from the Crown to provide financial support if the structure becomes financially distressed or defaults.

This is very plainly set out in all of the publicly available papers related to the financing and is in line with what one would expect from a financing of this type. The Information Memorandum prepared by the Department of Internal Affairs notes the “high likelihood of support from the Crown should the WSEs face financial distress” and the Standard & Poor’s evaluation report dedicates a significant amount of its analysis to “the high likelihood of extraordinary support from the Crown during a distress scenario”.

In fact, so significant is the likelihood of Crown support that the S&P rating is given a three notch ‘up-lift’ to reflect that understanding. If you were to remove that ability, by ring-fencing the liability from the Crown’s balance sheet, the S&P rating drops to just above junk bond status.

The Castalia analysis prepared initially for the Department of Internal Affairs and then for C4LD, also notes the increased fiscal risk to the Crown as a result of the proposed structure.

Indeed, I put this very question to the government a few weeks ago, when I asked if it wished to make any comment on the fact that it is noted that Crown support in the event of financial distress is ‘highly likely’. A Department of Internal Affairs spokesperson responded:

WSE financial distress is a very unlikely outcome. Their failure is even more unlikely.

Thus, when questioned directly, the government does not deny the high likelihood of Crown support in the event of a restructuring. It just doesn’t think that it is very likely to occur.

The ‘balance sheet separation’ that Ardern talks about is simply separation from a legal and accounting perspective that allows us to comply with what Hickey describes as “our political economy’s dual 30/30 constraints on tax and debt”.

In other words, it looks good for the books. It emphatically does not separate the Crown from Three Waters liability in the event of financial distress or default. Quite the opposite, banks and bondholders will buy this debt on the basis of that Crown support.

In progressing the debate, it might help if the government, media and commentators would acknowledge this simple fact. Taxpayers remain on the hook for the Labour government’s Three Waters proposal.

Ardern also confirmed that co-governance was another bottom line for the government. Indeed, it was evident from the caution that the three mayors applied when approaching the topic on Monday that this is the third rail of these reforms.

In Hickey’s view, questions about co-governance are simply the gripes of “grumpy provincial and suburban voters” which revolve around “a plot to take our water and give it to the iwi”.

The debates around the actual merits of Three Waters as a vehicle for doing the necessary investment should be shorn of co-governance and judged on the cost, the logistical viability and the political sustainability of it.

With respect, I think there is more to it than that. This is where I come back to Brown’s dogged focus on understanding “how will it actually work”.

It is essential for these reforms that the co-governance mechanics work. Yes, there are examples of co-governance models working – with varying degrees of success – around the country. But none involve a nationwide infrastructure upgrade with debt projected to exceed $10 billion by 2048 with leverage coming close to an eye-watering 10:1 (debt to EBITDA).

When the government is proposing such a high-risk financing it is imperative to examine the governance structure. The number one reason why highly leveraged deals such as this become distressed or require restructuring is because of poor management and governance.

In fact, having management totally aligned with the financial success of the project is always a key issue when structuring these deals. All management will have a ‘management incentive plan’ which will set out their annual salary and significant bonuses based solely on financial success.

There will also be a very significant bonus upon reaching certain milestones. All this is done in order to align management with the success of the project.

The Water Industry Commission for Scotland (WICS) final report to the New Zealand government highlighted the key role that management plays in the success of these projects. They noted:

It is striking how much the performance of companies in England has ebbed and flowed under different management regimes.

WICS noted that “total senior management (top 50) bonuses could reach about NZ$3,000,000 in aggregate (about 0.15% of annual expenditure). This compares with CE packages in England of in excess of NZ$4m annually.”

I have a serious concern that the demands of co-governance (however well-intentioned), and the very significant social and cultural requirements placed on management, will pull them in different directions which will jeopardise the success of the project. I am not aware of any leveraged financings anywhere in the world that has attempted to incorporate such an ambitious array of competing priorities.

Again, this is an issue which is also highlighted in the Castalia report.

If the Three Waters financing requires restructuring the first thing that the lenders will do is appoint a chief restructuring office to the board who will oversee the restructuring on behalf of lenders. It is typical that as part of the restructuring members of the board are replaced at the request of lenders in an effort to improve performance.

In the case of Three Waters however, replacing the boards of the water services entities may have only a minimal effect on performance given the constraints that will be imposed on them by statute and by their constitutions.

This is why I have raised concerns about the scope and potential effect of the Te Mana o te Wai statements that can be issued by mana whenua (iwi and hapu) to the WSEs under section 140 of the Water Services Bill. To be clear, these statements are not the same as those included in the National Policy Statement for Freshwater Management.

There are no limits at all on what can be included in the section 140 Te Mana o te Wai statements. Indeed in her June 2021 Cabinet Paper, Minister Mahuta was very clear about that and described how they could include such issues as the social and economic aspirations of mana whenua.

When the Department of Internal Affairs was asked how many iwi and hapu could issue these statements, they referred to a register held by MBIE which has over 1200 iwi and hapu on it. Each Te Mana o te Wai statement will be completed at the cost of the relevant water services entity who is then obligated to put them into effect.

There is nothing in the Bill or in any commentary which describes how they are to be prioritised, how conflicting Te Mana o te Wai statements are to be reconciled, or how those statements which conflict with the infrastructure upgrade are to be dealt with. The Te Mana o te Wai mechanism seems to give an unbridled amount of power to iwi and threatens to overwhelm the water services entities.

I have been told by a mayor who was on the Three Waters Working Group on Representation, Governance and Accountability earlier this year that the Te Mana o te Wai statements were the subject of intense debate. Yet not a word has been mentioned of them in the media.

To date, Minister Mahuta has provided only the vaguest of descriptions which do not come close to covering the range of issues that she describes in her cabinet papers.

In the circumstances, it seems entirely reasonable to me that Mayor Brown should ask – how does all this work then?

As the mayors reiterated on Monday, they are open to mana whenua having a meaningful role in the reforms. The issue is when that becomes de facto control.

To those that think that I am over-playing the risks of the financing or am describing theoretical risks as if they are real, I say take a look at the English water companies. We are following the financial model adopted by them and they are in a complete mess. Anglian and Southern Water have both undergone debt restructurings.

Thames Waters has been battling its debt mountain for years in an effort to stave off a full default. The dire state of the industry has seen concerns about poor performance and has led many to question the high debt financing model.

These utilities are struggling under massive amounts of debt but have none of the complications that co-governance will bring to Three Waters.

There also seems to be an unduly high level of reliance placed on the Standard & Poor’s evaluation report by the New Zealand government and some commentators. Their report on the water services entities was completed last year on the basis of six hypothetical scenarios.

It is part of the normal pre-marketing phase of debt offerings but at this stage it is no more than a sense-check at the very start of the transaction. In the UK, many of the water utilities have suffered ratings downgrades by S&P as they encountered problems with performance and debt. In 2020, S&P issued a report in which it downgraded four UK water utilities, put four more on negative outlook and placed a further two on negative credit watch.

The announcement last week that S&P did not yet have enough information about the government’s Three Waters policy to change its credit ratings for New Zealand or local government bodies is also concerning. In their statement S&P raised concerns about how the reforms would be implemented as well as with the financial aspects of the proposal.

Thus it appears that, like Mayor Brown and the New Zealand public, S&P is also lacking in some important details.

The government has been far too ambitious with its financing and governance structures for Three Waters. If they had picked one and not the other then it might have had a chance of success. But the combination is fatal. There is no chance that it would work without issue for the next 30 years. And all the risk falls on the taxpayer.

The government would be wise to heed Hickey’s advice and take the off-ramp that Brown and his fellow mayors have offered.

  • THOMAS CRANMER is the pseudonym adopted by a legal analyst who has been carefully dissecting the Three Waters legislation.  This article was first posted on Cranmer’s Substack, public interest citizen journalism about politics, culture and law in New Zealand. You will find it at Wayne Brown lays down the challenge to Ardern and Mahuta (substack.com)

One thought on “THOMAS CRANMER: Wayne Brown lays down the challenge to Ardern and Mahuta

  1. Another excellent contribution form Thomas Cranmer. I want to raise the issue of the undefined expressions in Te Reo used to decribe apparently critical concepts in the 3 Waters legislation. First, Mana Whenua.

    The Waitangi Tribunal itself has strongly recommended against the use of the term Mana Whenua in legislation. So why does it appear in the 3 Waters legislation?

    The Tribunal’s reasoning, which covers a number of points of serious concern, is set out as follows (WAI64 Ministry of Justice 2001):

    “The term “Mana whenua”appears to have come from a nineteenth-century Māori endeavour to conceptualise Māori authority in terms of the English legal concepts of imperium and dominium. It links mana or authority with ownership of the whenua (soil). But the linking of mana with land does not fit comfortably with Māori concepts. Recent research tends to agree that the term “mana whenua” itself does not appear in the early records about customary rights to land. … These opinions confirm that the term “mana”was personal and was used in regard to the influence authority of chiefs. Other opinions .. consider that mana whenua was a nineteenth-century invention. Crown counsel likewise challenged –we think correctly –its use to describe the general authority of a particular group over any area of land. We are inclined to think that the term “mana whenua”is an unhelpful 19th century innovation that does violence to cultural integrity.

    However, subject to such arrangements as may have been settled by the people themselves, our main concern is with the use of the words “mana whenua”to imply that only one group can speak for all in a given area when in fact there are several distinct communities of interest, or to assume that one group has a priority of interest in all topics for consideration. Some matters may be rightly within the purview of one group but not another.This criticism of the use of the term “mana whenua”as part of the definition of the term “tangata whenua”has also been adopted by the Environment Court. The Court concluded that it was not appropriate to use the term Manawhenua Iwi in a District Plan.27 The Court adopted the criticisms made by the Waitangi Tribunal of the term mana whenua and considered that the use of the term as a proper noun, Manawhenua, did not resolve the concern over the exclusivity implied.”

    In view of these reservations, does the expression “Te Mana O Te Wai” have any established meaning or credibility. Or has it been invented on the fly? Given the meanings of these terms are not settled it appears that this draft legislation if adopted will likely prove highly problematic and occupy the courts for many years.

    Liked by 1 person

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