State Law authorizes the sale of the CEDAE

Privatization of CEDAE

Law No. 7,529/2017 of the State of Rio de Janeiro authorized the sale of all the shares of CEDAE’s capital stock, including by transfer of control, in the manner established by the Brazilian Corporation Law. The privatization of CEDAE is one of the obligations assumed by the State of Rio de Janeiro in the Term of Commitment entered into with the Federal Government, on January 26, 2017, to implement the Tax Recovery Plan, which aims to restructure the state public accounts.

CEDAE – Companhia Estadual de Águas e Esgotos is a mixed-economy company that carries out the collection, treatment, supply and distribution of water, as well as the collection, transportation, treatment and final disposal of the sewage generated by the affiliated municipalities on the State of Rio de Janeiro. The shareholding structure of the company is divided as follows: State of Rio de Janeiro (99.9996%) and minority shareholders (0.0004%). CEDAE has 8.5 million consumers in 64 of the 92 municipalities in the state of Rio de Janeiro. The Municipality of Rio de Janeiro is responsible for 77% of the company’s gross revenue (http://www.cedae.com.br/Portals/0/Demonstracoes_Financeiras_2015.pdf).

According to Law No. 7,529/2017, the State Executive Branch is authorized to contract a credit facility in the amount of up to R$ 3.5 billion with national or international financial institutions. The funds arising from the sale of CEDAE’s shares will be used for the settlement of loans and debt relief with federal banks guaranteed by the Federal Government, as well as debts of the State of Rio de Janeiro.

To date, there is no defined model for the privatization of CEDAE. The Executive Branch has a term working for up to six months, extendable for the same period, to contract federal financial institutions for evaluation and structuring of the operation. Financial and legal analysis will be key if the CEDAE is to be transferred to the private sector.

At the beginning of the negotiations with the federal government and BNDES under the Investment Partnership Program (PPI), the State of Rio de Janeiro considered dividing CEDAE’s areas of operation into four. In each of the new areas, the retail operations of water distribution and collection and treatment of sewage would be privatized, but CEDAE would retain the wholesale business of water production.

However, the model considered was not that of privatization, but rather of subdelegation: the state sanitation company, contracted by the municipalities, would subcontract private companies to operate part of the services. A “contract of interdependence”, provided for in article 12 of the National Basic Sanitation Law, would be signed to regulate relations between CEDAE and private companies, since the water supply service would depend on the joint efforts of both.

Such format, however, was criticized, since it would require the granting of guarantees for the delivery of volumes of water by CEDAE to the private company, in addition to the fact that CEDAE would have the right to set tariffs and take (or resume) distribution to the final consumer.

Another important aspect is water loss, which would require investments in infrastructure and management, as well as the provision of services to low-income users.  (https://www.abdib.org.br/noticias-do-dia/noticias-do-dia-/esqueletos-da-cedae-podem-diminuir-preco-de-venda-da-empresa). Even if the privatization of CEDAE comes to fruition, there will be relevant aspects to be considered, such as financial liabilities of a social security nature estimated at R$ 166.8 million.

Increased private sector presence in the sanitation sector

Under the Investment Partnership Program (PPI), options are being discussed to expand the private sector’s presence in the sanitation sector, which has become timely due to a combination of several factors: a) the provision of these services in Brazil needs to change, as a result of the great majority of states and municipalities needing fiscal reform and their inability to make new investments; and b) the provision of sanitation services for all, with positive impacts on quality of life, health, school and work productivity, tourism, economic activity and job creation.

The program of concessions for the sanitation sector is therefore a priority for the Federal Government and targets state enterprises, which are responsible for a large portion of the sector’s service (about 70%). In order to do so, the Federal Government has the assistance of the National Bank for Economic and Social Development (“BNDES”) as the operator of the PPI.

The BNDES has been assisting state governments in contracting consultants for technical studies and in the analysis of the privatization process, whether by the sale of shares or through concession contracts. Once it has finished the analysis, BNDES will continue the process until the implementation of an auction or another form of partnership with the private sector.

The situation of the companies in the sanitation sector varies, some of which have serious financial issues and have poor service levels in the supply of water and sewage services. Currently, 18 state companies are working with the BNDES to evaluate new models of basic sanitation: concession, sub-concession, public-private partnership, asset disposal or other arrangements.

However, the restructuring process as a whole can be lengthy. The analysis of each project will, therefore, be key for attracting investments to the companies put in the first group for PPI business: Companhia Pernambucana de Saneamento (COMPESA), Companhia de Saneamento Ambiental do Maranhão (CAEMA), Companhia de Saneamento do Pará (COSAMPA), Sergipe Sanitation Company (DESO), Companhia de Saneamento de Alagoas (Casal) and Companhia de Água e Esgoto do Amapá (CAESA) (https://www.saneamentobasico.com.br/portal/index.php/category/concessoes/).

Water and Sewerage Services in numbers

According to the Sanitation Information System (SNIS), in 2015 (http://www.snis.gov.br/diagnostico-agua-e-esgotos/diagnostico-ae-2015), the principal statistics that show the size of the sector are as follows:

The above figures reflect the lack of service in the basic sanitation sector in the country, which will require large investments in order to reach the goal of provision of sanitation for all, especially with regard to sewage treatment and disposal. Of the total of municipalities, 4,421 are served by state companies and 1,039 by autarchies, secretariats or municipal entities. In most cases, service is limited to water supply. Private participation is restricted to approximately 5% of Brazilian cities (ABDIB, 2017).

Investments in the sector have three main sources of funds: financing with FGTS funds, financing with funds from the Worker Support Fund (FAT), and transfers from the General Budget of the Federal Government under the Growth Acceleration Program (PAC). In addition, there is the expectation of a contribution from the states, municipalities and service providers. The companies of the sector are also accessing the capital markets, through the issuance of debentures and quotas of the Credit Rights Investment Fund (FIDC), as well as the issuance of Bank Credit Notes to CAIXA.

Regulation of sanitation services

The success of the opening of the sanitation sector to the private sector will depend on the regulatory regime to be adopted.

The sanitation sector has a variety of contractual models, many of which have already been implemented, such as: a) contracts for the provision of peripheral services (e.g. hydrometer reading, equipment maintenance, collection, etc.); b) system management, operation and maintenance contracts, with the operator’s remuneration fixed in terms of performance metrics with defined indicators; c) operation and maintenance contracts, whereby the granting authority transfers to the private sector the management of public infrastructure for the provision of services to users; d) leasing contracts, whereby the state retains ownership of the assets, while the companies that operate the service are required to make investments in maintenance and renovation of the facilities; e) partial concession contracts, aimed at expanding the production of treated water or the installation of sewage treatment systems; f) full concession contracts, whereby the operation and maintenance of the system and the responsibility for the necessary investments for a certain period are transferred to the private sector, during which the concessionaire will be remunerated by the users’ tariffs; g) public-private partnership agreements, which presupposes the creation of a guarantee fund to minimize the risks to the private entities to which the service will be delegated; and h) disposal of shareholdings, partial or total.

However, the fact that the ownership of sanitation services is municipal generates a greater perception of risk to long-term investors, due to the weakness of local regulators and the influence on them by local political forces. Therefore, a federal solution is being looked at that would provide a federal regulation which would provide guidelines and rules for the functioning of entities on national, regional and local public spheres. Also under the PPI, the federal government is in charge of the linking of states and municipalities to provide political and regulatory alignment in order to implement solutions with improved performance by the companies.

Thus, increasing private sector involvement in the sanitation sector will require the issuance of a new regulatory regime in order to guarantee independent decision-making, administrative, budgetary and financial autonomy, transparency, technical innovation, speed and objectivity in decision making.

According to the National Basic Sanitation Law, contracts aimed at providing basic public sanitation services may only be executed if four separate requirements are met: (i) the existence of a basic sanitation plan; (ii) the designation of a regulatory entity; (iii) the presentation of an auction notice and draft agreement to a public hearing and consultation; and (iv) the preparation of a technical and economic-financial feasibility study (EVTE).

Based on this Law and its respective regulation established by Federal Decree No. 7,217/2010, the Ministry of Cities, through Ordinance No. 557/2016, established the standard for the preparation of technical and economic-financial feasibility studies (EVTE) for contracts aimed at providing public basic sanitation services.

Regarding water and sewage services, this standard establishes, among other rules, the use of budgetary resources for PPPs and sanitation concessions, allowing public and private investment to coexist. Ordinance No. 557/2016 is only an example of a federal policy that aims to promote regulatory improvement, establishing national standards for contracts (as in the case of EVTE), quality of services, tariff methodology, efficiency indicators, in order to provide a favorable context for private investment.

There is no doubt that there are still challenges to be overcome in order to achieve progress in the sector, such as, for example, conflicts over the ownership of sanitation services in metropolitan areas. Therefore, the new analysis should consider not only Law 11,445/2007 (National Policy for Basic Sanitation), but also the decision of the Federal Supreme Court (STF) in ADI 1842 and the provisions of Law 13,089/2015 (Metropolis Bylaws), which removed the predominance of the states over the municipalities, and establishes that they should form an  entity which can operate throughout the country.

Finally, Federal Law No. 13,329/2016, which established the Special Regime for Incentives for the Development of Basic Sanitation (REISB), provides for transforming the PIS/COFINS tax into additional investments, which could contribute to promising solutions for basic sanitation.

Water safety

The basic sanitation sector is one of the main users of water resources, either for the purpose of producing water (abstraction) for supply, or for the purpose of removal of sewage treated in watercourses, being subject to grant under the terms of the National Policy of Water Resources, approved by Law No. 9,433/1997.

This law provides for the priority usage of water for the purposes of public supply, favoring the sanitation sector in case of shortage. In recent years, the water crisis has demonstrated the lack of investment in sewage treatment, compromising the preservation of water sources and, consequently, water supply.

The lack of investment in infrastructure (such as improved flow regulation and multiple use reservoirs) has increased the risks to the security of water supply, affecting the production and supply of treated water. Another vital measure for the availability of water is the decontamination of rivers. As regards this, the sanitation sector has a large liability for the disposal of untreated sanitary sewage.

In conclusion, the regulation of water resources management is key for the attraction of private investment to the sanitation sector, since it should implement different solutions and new structures for water allocation (such as improved flow regulation and multiple use reservoirs) and conservation (such as pollution control and cleaning of water sources), thereby providing greater security of water supply for users.

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