PBA clarifies restructuring of water services

Received the following from PBA yesterday, clarifying some of the concerns raised in this blog and elsewhere over the federal-level involvement in Penang’s water sector.

For future upgrading – apart from the Mengkuang Dam expansion – I understand PBA has the option to source its own financing or arrange a similar funding arrangement with PAAB or obtain a federal grant.

Under the present legal framework, which centralises powers in federal hands, and knowing a couple of the people in Penang who worked on this deal – people who wouldn’t sell out the interests of the state – I think the deal is the best we can expect, short of a constitutional challenge in the courts. Perhaps consultation with the public could have been better and there could have been more debate in the state assembly.

Hopefully, the laws will be amended before long to ensure that overall control of the water sector in all matters, including infrastructure upgrading, is decentralised to the various states, with the federal agencies’ role reduced to providing coordination, resolving disputes and providing low-interest financing (out of tax revenue). When a new government takes over Putrajaya, one of the first things it needs to do is to reverse the trend of increasing centralisation of powers (including over water) at the federal level.

The latest sector to fall under this current trend of centralisation is solid waste management and public cleansing, which could be taken away from local authorities under a new Act. Three states have expressed dissatisfaction: Penang has correctly rejected the proposed takeover; Selangor has not yet stated its stand; while discussions with Perak have been postponed.

This is the letter from PBA:

Restructuring of Water Services Industry

In response to the recent concerns raised over the signing of the agreements on 2nd June 2011 which involved the transfer of water-related assets from the Penang State Government to Pengurusan Asset Air Berhad, the public need to understand the rationale and reason behind it.

The negotiations prior to the signing of the agreement was not publicized because of confidentiality undertaken by the negotiating parties and the fact that the water operator, Perbadanan Bekalan Air Pulau Pinang Sdn Bhd (“PBAPP”) is wholly owned by PBA Holdings Bhd (“PBAHB”), which is a public listed company. Matters of a fair return to shareholders have to be balanced against the ultimate objective of a constant supply of affordable potable water to consumers.

No less important is the need of timely mandatory disclosure of announceable events. The company needs to be mindful that undue publicity at any stage of negotiation may cause unwarranted share price fluctuation.

Furthermore, the issues that need to be resolved are complex and have to be carefully considered.

Change in the law

In 2005, following an amendment to the Federal Constitution, the power of the State Government to legislate on matters relating to water supply and services was removed and given to the Federal Government.

Through the constitutional amendment, the Federal Government enacted 2 new Acts in 2006 to control the water industry, namely:-

i) Water Services Industry Act 2006 which came into force on 1/1/2008;
ii) Suruhanjaya Perkhidmatan Air Negara Act 2006 which came into force on 1/2/2007.

With the enactment of the aforesaid Acts, the Federal Government assumed control over water supply and services which were originally under the purview of the States.

Previous funding from Federal loans

In the past, water operators including Pihak Berkuasa Air (“PBA”) were statutory bodies/ government agencies. They were given loans from the Federal Government through their State Governments to finance their development projects and infrastructure.

The various dams, reservoirs, treatment plants and other water infrastructures constructed by PBA were also financed by Federal loans through the State Government. The outstanding Federal loans repayable by the Penang State Government accrued to approx. RM 655.2 million.

Over the years, many of these water operators were corporatised. PBA was also corporatised and was subsequently listed on the main board. In view of this, the Federal Government was no longer keen to provide loans to these corporate bodies for the development of their water supply infrastructure.

Restructuring of water services industry

Under the Water Services Industry Act 2006 and the Suruhanjaya Perkhidmatan Air Negara Act 2006, the National Water Services Commission (“SPAN”) was established as a regulatory body to facilitate the financial self-sustainability of the water operators in the water services industry and Pengurusan Asset Air Berhad (“PAAB”) which is wholly owned by the Ministry of Finance Incorporated, was given the responsibility to finance construction, upgrading and refurbishment of new water infrastructure.

PAAB will source for and obtain competitive financing for the development of water infrastructure for the water operators. In return, PAAB will take ownership of the water-related assets and lease these assets back to the water operators for a lease rental.

The water operators are required to apply for license from the Minister for Energy, Green Technology & Water through SPAN and one of the conditions for the license application is that the water operators must propose a settlement scheme for the outstanding Federal loans.

Rationale for accepting PAAB’s financial arrangement

In light of the changes in the law, the restructuring of the water services industry and the outstanding Federal loans, the Board of Directors of PBAHB formed a Working Committee, comprising the Independent Directors and the Management, headed by a Director who is also a State Executive Councillor, to explore the options for settlement of the Federal loans and to make recommendations to PBAHB.

The Working Committee met with the representatives of SPAN and PAAB (including the Director and Executive Director of SPAN and the Chief Executive Officer/Director and Head of Finance of PAAB) to negotiate the terms of settlement of the Federal loans amongst other matters. The meeting took place after several protracted exploratory sessions between PBAHB Senior Management Executives with their counter parts from PAAB and SPAN.

The State had the option to repay the Federal loans either from its internally generated funds or from commercial loans.

However, after due deliberation the Working Committee took the view that given the legal constraints and the limited financial options, the scheme which it had negotiated with SPAN and PAAB was a more favourable option.

Upon the recommendation of the Working Committee, the State Government (who is the majority shareholder of PBAHB) agreed:-

(a) to the novation of the Federal loans from the State to PAAB (wherein PAAB will pay & discharge the liabilities of the State in respect of the Federal loans); and

(b) to transfer its water-related assets to PAAB (to the value of its outstanding Federal loans) on a leasehold tenure of 45 years wherein PAAB will then simultaneously lease the water-related assets back to PBAPP for the same period of 45 years for a lease rental (equivalent to the cost of assets transferred to PAAB) repayable over the period of the 45 year lease.

The main features of the settlement scheme are as follows:-

• the Federal loans will be repaid interest free over a period of 45 years in the form of lease rental instead of over 20 years under the previous arrangement
• upon the expiry of the 45 year leasehold tenure, the ownership of the assets will be reverted back to the State;
• the State retains effective control of the leased assets during the tenure of the leasehold, as PAAB cannot deal with or encumber these assets without the State’s consent;
• PBAPP will have access to low cost of funds offered by PAAB based on the arrangement;
• the Federal loan of RM1.2 billion for the expansion of Mengkuang Dam will be converted to a grant.

It has to be clarified that the agreement to accept PABB’s financial scheme was not to secure the RM1.2 billion Federal loan for the expansion of Mengkuang Dam. The expansion project was committed some 10 years ago .However, the allocation of the RM1.2 billion interest-free refundable loan to the State was converted to a grant during the negotiation for the migration of assets to PAAB.

PBAHB, like any other publicly quoted corporation, has to operate within the rules and regulations governing its activities. These include compliance with the provisions of the Water Services Industry Act 2006, Suruhanjaya Perkhidmatan Air Negara Act and the listing requirements of the Securities Commission and Bursa Malaysia. Given the circumstances, the Directors of the company are of the opinion that the right steps have been taken to ensure continuity of its business operations and to ensure the interests of stakeholders are balanced.

Y.B. Lim Hock Seng
Chairman of the Working Committee
PBA Holdings Bhd

23 June 2011