According to a World Bank report, a quarter of Latin America's population is not connected to drinking water and about half is not linked to a wastewater treatment system. Over the next 10 years, investments needs for drinking water in the region will reach $5 billion and requirements for wastewater treatment will be $7 billion. This creates a wealth of opportunities for water companies through full or partial privatizations of state water boards, operating concessions and build-operate-transfer concessions.

French company Suez Lyonnaise des Eaux has led the way in successfully tapping these opportunities. The company acted as sponsor on the $130 million Salitre deal which signed in 1997. The project was, despite the painful pun, something of a watershed. It was the first wastewater plant in the world to be financed on the international capital markets and the first project financing to incorporate a partial risk guarantee from a multilateral development bank ? the Inter-American Development Bank ? without a sovereign counter-guarantee.

The project showed that institutional investors are interested in financing water projects. But this appetite has inevitably reduced in the face of recent events such as the Brazil currency devaluation. Didier Rétali, vice-president of project finance at the company's Paris office, says: ?We will continue to tap the capital markets when we feel it is appropriate. But there is no set rule. We raise financing for our projects on a case-by-case basis.?

Suez Lyonnaise has established a $300 million investment fund with GE Capital, Edison Capital, Banco de Galicia and Dexia. The fund, called the Lyonnaise Latin America Water Corporation (LYLAW), will support the expansion of Suez Lyonnaise in Latin America. The company has experience of a similar investment fund created in 1995 to support Lyonnaise Asia Water's activities in countries such as China, the Philippines and Malaysia.

Rétali considers Argentina the most dynamic Latin American market and Suez Lyonnaise manages municipal water systems in Buenos Aires, Santa Fé and Córdoba. But the company is also present in Mexico, Colombia and Brazil and provides drinking water for 19 million people throughout Latin America and water treatment facilities for 14 million. Rétali says his company is more interested in concession-based projects than in BOT deals.

Rival French company Vivendi is equally active, focussing on operating concessions in Brazil, Argentina, Colombia, Bolivia, Uruguay and Venezuela. The group is sponsoring the Aguas Argentinas 1993-1998 investment programme, which signed on February 12 1999 along with Suez Lyonnaise, Aguas de Barcelona, International Finance Corporation, Banco de Galicia y Buenos Aires, Meeler and Anglian water. The cost of the project is $90 million and proceeds are to finance a capital investment programme aimed at improving wastewater treatment for the city of Buenos Aires. Financing for the deal consists of a $90 million loan-style floating rate note arranged by Chase Securities.

But if the French water companies have dominated the Latin American market since the early 1990s, other companies are starting to challenge this monopoly, providing some healthy competition. Enron's water division, Azurix, is at the forefront of this challenge. The company is in advanced negotiations for 22 projects across Argentina, Brazil, Chile, Colombia, Panama, Peru, Bolivia and Venezuela. Most recently, Azurix acquired a joint interest in the Cancún water and wastewater concession in south west Mexico. Cancún is a resort area and 70% of the project's revenues will derive from hotels in dollar-denominated income streams. Amanda Martin, Azurix's president for the Americas in Houston, Texas, says: ?Strategically the project is important because of the visibility it will provide for us.? Azurix's commitments for the Cancún project comprise $13.5 million in equity and the assumption of $25 million in financing and operational costs related to improvements in the wastewater treatment system.

The company is pursuing a further five projects in the country and plans to raise funds for these deals from both bank debt and the capital markets. Martin says Azurix will consider concessions, acquisitions and pure project financings: ?If you cut one of these out, you limit your options,? she says.

Another new entrant to the Latin American water market is the UK's Thames Water. Jim McGivern, the company's business development director in Reading, says two things attract Thames to the market. First, from a macro perspective, it is looking to diversify its project portfolio and balance its Asian and Middle East deals with Latin American projects. Second, the region's large population and large metropolitan areas are comparable to the UK environment. Thames is focusing its interests in Brazil, Chile and Peru but intends to expand its operations. ?You will see Thames' name wherever there are big projects,? says McGivern. ?Suez Lyonnaise was very successful in the early stages of financing water projects but other companies are catching them up.?

Thames' fellow UK company, Anglian Water has teamed up with Chilean group Enersis to run the first water and wastewater company in Chile to be privatized. Esval is the second largest water and wastewater supplier in Chile and serves Vina del Mar and Concon, important tourist destinations along the Pacific coast, as well as the Valparaíso region.

There are another 12 water and wastewater companies to be privatized in Chile over the next three years. Bids will be sought for Emos, Santiago's main water company and for Essac, which supplies water to Lagos in the south. Essel, in the central south of ranguna will be auctioned off in the third quarter of 1999 and Essbio, in the southern city of Concepción, will be auctioned off in the fourth quarter of 1999. So far, no privatitizations in Latin America have been financed on a non-recourse basis, but this could change with the innovative financing models being developed by market players.

One effect of the surge in water projects offered on a private basis in Latin America is the need to hire consultants to help assess opportunities and structure project concessions. ?Water is a political issue because it is fundamentally seen as a social good,? says David Lynn, a manager at water consultancy Chemonics in Washington, US. This makes it necessary for an outsider to get involved to act as an independent adviser to local authorities and project developers. His company is working with the municipality of Montoría, Colombia to help structure a water concession. The number of municipal projects increasing, but investors fear that some municipalities are not sufficiently credit-worthy offtakers and that financial guarantees may not be honoured. ?Since water projects are usually completed on a national level, help is needed to bring this down to the level of a municipality,? says Lynn. He hopes this pilot project will be used as a model for future concessions and to fill in the holes that investors have identified in other municipal projects.

Another consultancy, Capital Advisers, which is a subsidiary of MBIA, is conducting a survey of Mexican water authorities to determine which are most worthy of private investment. James Hass, managing principle at the company in Washington, says that since the existing systems were not designed for private sector participation, many of the necessary frameworks do not exist. ?The government is trying hard, but it is hard to know what to tackle first,? he says. In Mexico tariffs need to be doubled or tripled to create self-sustaining water systems and this creates a political problem: ?Mayors got worried after 40 days of strikes last time rates were put up,? says Hass.

Suez Lyonnaise's Rétali says that approaching the problem of tariffs demands both a contractual and a political response: ?We try to structure our contracts to achieve economic equilibrium, taking into account exchange rate fluctuations and possible legal changes.? From a political perspective, Rétali says: ?We know it is difficult to increase water tariffs in a short period without showing service improvements. So in our risk assessment of a project, we check that the tariff we want will be acceptable to the population in terms of their revenue ratios.? Suez Lyonnaise does not take part in a projects unless it happy with the tariff arrangements.

Regulating the system

Another important challenge for sponsors is that Latin American countries have widely divergent regulatory regimes. ?Certain authorities develop their regulatory regimes at the same time as their concessions,? says Azurix's Martin. Thames' McGivern agrees that there is a disparity between the countries. He considers that Chile's system is the most advanced and comparable to the UK model with countries like Brazil offering a slightly less developed structure. McGivern says Peru is some way behind but the conditions are right for future improvements. But Peru can offer BOT schemes with opportunities for greenfield projects so weaknesses in some areas can be offset by strengths in others.

Colombia has also legalized BOT concessions and has a good record of protecting the concessions it issues. In contrast, Mexico awarded about 50 BOTs in the early 1990s without providing adequate regulatory frameworks for the concessions. As a result, only five of these projects have successfully reached financial close.

Robert Lawrence, a partner at law firm Milbank, Tweed, Hadley & McCloy in Washington. The firm worked on the landmark Salitre transaction, and Lawrence says there are less regulatory problems for non-recourse projects than for concession-based projects. This is because service contracts are competitively bid and because cost and pricing is based on this bidding process.

Lawrence believes that Brazil and Mexico have the most potential for project financing of water projects because in these countries increasing concerns about pollution and water pollution are combined with an increase in income. Milbank Tweed has adopted a ?wait and see? attitude to Latin America until the economic situation improves. Lawrence predicts that this will be in the next six to 18 months.

As in all emerging markets, the role of multilaterals in providing financing for projects is important.

The Inter-American Development Bank (IADB) has taken a lead in structuring innovative ways of providing funds and encouraging private financial institutions to invest in Latin America.

In October 1998 the bank approved a $250 million investment to support a trust fund arrangement designed to draw new private money into Argentina's water and sanitation sector. The IADB will provide $100 million in start-up capital for two trust funds. Banco de la Nación, Argentina's state-owned commercial bank, will administer the funds and will try to raise additional investments from private banks. The Argentine government will provide counterpart funding worth $320.6 million.

A spokesman at the IADB says: ?This is a novel mechanism never tried by the IADB before.? Counterpart funding would normally be extended on a 1:1 basis in large Latin American countries such as Argentina and Brazil.

The IADB investment includes $50 million for institutional restructuring and for strengthening the regulatory capacity of Argentina's provincial agencies. The trust will also pay for consultants to help make the country's water companies commercially viable through concessions and privatizations. And the overall programme will provide 280,000 new water supply or sewerage connections to more than one million inhabitants.

Activity in Latin America's water sector has reached a frenetic pace. But new markets are still opening up. As Project Finance goes to press, the International Finance Corporation has announced that it will invest up to $16 million in the Aguas de Illimani concession, the first privately financed water project in Bolivia. The Inter-American Development Bank and Corporación Andina de Fomento will provide parallel financing of up to $25 million. The investment in Aguas del Illimani, a consortium led by Suex Lyonnaise which operates the water and sanitation services in La Paz and El Alto under a 30-year concession, will support a project to improve the region's water and sewerage services and could provide a template for future projects in the country.

Ed Sandey, head of the US developer Poseidon which has operatedd projects such as the $35 million Madero wastewater treatment plant in Mexico's La Paz, sums up the mood of investors in Latin America: ?Water projects in the region have been progressing in fits and starts, but we believe that things are starting to get on a roll.?