Privatization of Brazil's sanitation companies faces legal, political obstacles

Monday, November 20, 2017

Over the last two years, while Brazil was undergoing its worst economic recession on record, various state governments announced their intentions to privatize state-run water and sanitation utilities, but their plans are failing to gain traction.

A series of legal and political obstacles have emerged since these plans came to light, forcing states to abandon or at least delay their preparations and look into other mechanisms to raise cash for their water and sanitation works.

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In 2016, the federal government launched a program to privatize sanitation companies, with state development bank BNDES overseeing the processes. At that time, 18 states showed interest in privatizing their respective companies, but only seven went as far as to carry out in-depth evaluations of such projects.

Most of the companies that have been mooted for privatization are based in the country's poorest north and northeast regions, as well as those in states that have suffered drastic drops in tax revenues, such as Rio de Janeiro state.

"There is a mistake in the origin of these privatization processes. From the legal point of view, there is no possibility of selling these companies. Under the law, all pipelines [and] connections belong to the cities, not to the companies and there is nothing of value to be privatized," Roberval Tavares de Souza, president of the sanitation engineering association (ABES), told BNamericas. 

"If the government sells a company in this sector, investors will acquire just their real estate, as the change of company control leads to immediate termination of all contracts, according to the rules in force," he added.

Another barrier to privatization is the proximity of Brazil's next general election, which is due to take place in October 2018, with Brazilians electing a new president, state governors and senators. Since most Brazilians are opposed to privatizations, local governments will likely avoid any such unpopular moves. 

"What's happening with these processes [privatization plans] is that they're moving forward more slowly than previously expected due to a series of difficulties," said Rafael Vanzella, a lawyer specialized in regulated contracts and structured financing and employed by law firm Machado Meyer. Vanzella previously worked on a feasibility study for the sanitation company in Sergipe state.

"In some states, corporatism [political influence] within state-owned companies has proved stronger than expected due to workers unions, which curb the [advance] of privatization processes at the expense of [better] service quality," said Vanzella, in an exclusive interview with BNamericas, although he declined to comment on which states faced the biggest challenges to carry out privatizations.

Other alternatives to raise cash for sanitation projects

With the difficulties of privatizing the companies, state governments are opting for other alternatives to raise money to carry out works, such as the sale of small stakes in the firms, avoiding a change of control.

In September, the board of Goiás state water utility Saneamento de Goiás (Saneago), approved a plan for the firm to launch an initial public offering of shares.

Saneago said that the share sale will help the company expand its investments in water and sanitation projects, while the state government will retain control of the company.

Meanwhile, São Paulo state legislators approved the creation of a holding company to manage water and sanitation services. The holding company controls Sabesp, and by selling shares in the parent, the utility will have more funds to finance projects. Funding currently comes mainly from the fees paid by customers.

"There are other better and much simpler alternatives to raise cash for sanitation projects, such as those involving share offers and also PPP projects. We can't have a war between the private and public sectors; we need to have both sides united. The federal government's mistake was to think that the sector should be operated just by private parties," said Tavares de Souza.

Interest from global Investors

Despite all the challenges, experts see global investors having a great appetite for sanitation companies and projects in this area.

"The truth is that right now, basic sanitation has become a government target, while in the past few years the focus was on the construction of soccer and sports stadiums [in preparation for the 2014 Fifa World Cup and 2016 Olympic Games]," said Vanzella.

He added that with low interest rates across the globe, investors are on the hunt for investments with higher returns. "There are two profiles of investors looking for investments in this sector in Brazil: investors focused on financing, who seek short-term returns; and strategic investors, such as sovereign wealth funds, which are much more familiar with infrastructure projects."