Financing Water Supply, Sanitation and Flood Protection

Projections of future investment needs derive from a baseline of current expenditures (based on best-available and comparable data) and the influence of several drivers of investment needs. Three scenarios are considered:

• Business as usual for water supply and sanitation services. This scenario projects the same level of effort, with no new policies. Projections are driven by urban population growth (see below the discussion on drivers). The projections reflect the current level of effort: they do not consider the potential delay or backlog of investment and the state of existing infrastructures. Potential under-spending in the operation, maintenance and renewal of existing assets will continue under this scenario, potentially leading to significant additional investment needs in the longer term.

• For water supply: projections to achieve compliance, efficiency and access. Most EU member states already comply with, or are close to complying with, the Drinking Water Directive (DWD). It is anticipated that, even when member states comply with the revised DWD, countries will need to invest in water efficiency and minimise non-revenue water (including leakage). In addition, countries will have to ensure that vulnerable groups have access to safe water.

• For sanitation: projections to achieve compliance. Several EU member states do not fully comply with the Urban Wastewater Treatment Directive (UWWTD). The extent of compliance varies across EU member states and has been considered the main driver for additional investment in this domain.

The current level of efforts in flood protection was not monetised. Only a few countries monitor financial flows for flood protection, usually the ones who can be expected to spend the most (Austria, the Netherlands). It was not possible to extrapolate based on available data. Therefore, projections on investment needs for flood protection are based on changes in the exposure to flood risks.

Emerging challenges, which could not be monetised, are discussed qualitatively. These include climate change and contaminants of emerging concern (e.g. focused primarily on pharmaceuticals for the purpose of this analysis). A rough estimate of investment needs to address contaminants of emerging concern is presented at an aggregate level, using costs measured in Switzerland.

Obviously, options to minimise financing needs exist and will be considered by most countries. This is the case, notably, of distributed systems or nature-based solutions for sanitation and for flood protection. How these options will materialise and affect investment needs in each member state remains highly uncertain. Therefore, such options are discussed in the report, but not reflected in the monetised projections.

The method and data used to support the baseline and the projections are synthesised in Annex B of the report. They are described in more detail in a separate methodological note.

Baseline estimates point out to an annual average expenditure of EUR 100 billion across the 28 EU member states, with the lion’s share attributable to EU15 (Germany, France, United Kingdom and Italy in particular). The aggregate figure masks huge variations. Eight EU member states spend less than EUR 100 per capita per year on water supply and sanitation services. At the other end of the spectrum, six countries spend more than EUR 250.

Countries vary according to the level of efforts allocated to water supply and sanitation. Slovenia, the Czech Republic or Cyprus allocate a larger share of their GDP to water supply and sanitation than Estonia, Denmark, Sweden or Finland. This reflects the costs of the service and local conditions, and level of effort in the investment and operation of the service. This may also reflect the level of efficiency of expenditure programmes, where comparatively high levels of investment do not narrow the distance to compliance.

Looking ahead, expenditures for water supply and sanitation need to increase significantly, if countries want to comply with the DW and UWWT directives and to enhance the efficiency of water supply systems. Total cumulative additional expenditures by 2030 for water supply and sanitation amounts to EUR 289 billion for the 28 member states. Sanitation represents the lion's share of the total additional expenditures, particularly in Italy, Romania and Spain and - at lower levels – in Bulgaria, Croatia, Portugal and Slovakia. In these countries, urban population growth plays a minor part (sometimes nil) in projected future expenditures for water supply and sanitation, which are mainly driven by the need to enhance efficiency in water supply and/or compliance with the UWWTD.

A telling indicator is to compare the additional expenditures for water supply and sanitation with the current level of expenditures as captured by the baseline, on a country basis. According to the projections, all countries but Germany will need to increase annual expenditures for water supply and sanitation by more than 25% in order to comply with the directives. At the higher end, Romania and Bulgaria need to double (or more) the current level of expenditures. At the lower end of the spectrum, Cyprus, the Czech Republic, France, Germany, the Netherlands and Slovenia are projected to face comparatively minor needs for increase (by less than 1/3). This is likely to reflect different situations, including high levels of expenditures and good anticipation of future needs, significant catch-up in recent decades (Czech Republic), or underestimates of future needs, possibly driven by overreliance on IAS (Slovenia).

One pervasive challenge across member states remains financing to operate, maintain and renew existing assets. The rate of asset renewal is not known with accuracy. When it is documented, it is usually below a rate that would reflect the life expectancy of assets, suggesting that renewal efforts need to step up urgently, to avoid rapid decay of built infrastructures and degradation of service quality.

The OECD has identified three “ultimate” sources of finance for water supply and sanitation expenditures: revenues from water tariffs, taxes, and transfers from the international community (in Europe, essentially EU funds or to a lesser extent, concessional finance): the 3Ts. Other sources of finance (debt or equity) can be mobilised to cover the upfront costs of investments, but will need to be repaid, through a combination of the 3Ts. This rationale can be refined and characterised further, but it provides a robust heuristic to characterise financing options.

Financing capacities reflect the room for manoeuvre available to countries have with 3Ts. EU member states vary according to the ultimate source of finance mobilised for water supply and sanitation. Some rely essentially on water tariffs (Denmark, England and Wales) while others shift the burden to taxpayers (Ireland is the best example).

In some countries, public budgets allocated to water supply and sanitation heavily rely on EU funding. This is not sustainable as EU funds available for water supply and sanitation will decline over time. Therefore, EU member states need to consider more systematic reliance on domestic sources of finance to cover projected financing needs to comply with the DWD and UWWTD now and in the future.

It is difficult to assess the capacity to increase levels of public budgets allocated to water supply and sanitation, per country. Ultimately, this remains a political decision, and involves arbitrage between policy priorities. Still, macro-economic conditions and constraints can indicate room for manoeuvre to increase public spending at an aggregate level (both national and local, acknowledging that, in several countries a large share of public spending for water supply and sanitation originates in local budgets). For several countries, the current level of public debt and/or the sovereign credit rating raise concern about the capacity to allocate more public funding to expenditures related to water supply and sanitation.

With the exception of Ireland, revenues from tariffs are considered a reliable source of finance to cover at least some of the costs of water supply and sanitation services. The points above suggest that this may be even more so in the coming decades. The question then is about the room for manoeuvre to increase tariffs for water supply and sanitation services.

While affordability constraints are mentioned to justify tariffs below cost recovery levels, robust data shows that in 24 EU member states, more than 95% of the population could pay more for water supply and sanitation without facing an affordability issue (considered as a situation when households spend more than 3-5% of their disposable income on water supply and sanitation). In those countries, targeted social measures are more effective than cheap water to enhance the financial sustainability of water services while addressing the social consequences of higher tariffs.

These considerations provide a rationale to rank EU member states according to the severity of the financing challenge they face to comply with the DWD and UWWTD, now and in the future, considering both the additional level of effort required and financing capacities. Selected clusters include:

• Romania and Bulgaria face severe financing challenges as the projected additional level of effort is very high and room for manoeuvre for financing appears limited.

• Slovakia and Estonia may face similar levels of effort in the future but Estonia is better placed to cover them, as public finance looks less strained, should it need to be mobilised.

• Latvia, Poland and Portugal face similar levels of efforts in the future, but have distinct capacities in place to cover them. Affordability issues are relatively less severe in Portugal.

• The ranking of Greece and Slovenia begs questions. The additional level of effort reported by countries is probably underestimated, reflecting excessive reliance on IAS. A reassessment of additional financing needs would translate into severe challenges, as financing capacities are limited for both countries.

• The Netherlands and Germany are in privileged situations, as the additional level of efforts required is comparatively limited and financing capacities are strong.

It was not possible to establish a robust baseline of current expenditures, as flood protection does not correspond to a sector or subsector in any international statistical standards/ international classifications. Further, survey data reported by member states are very patchy. The FD mandates the development of Flood Risk Management Plans. However, countries vary in their capacity to draft relevant planning documents and implement (and finance) them. Reported cost data for the FD in the Member State compliance assessment reports shows high variability: as an illustration, the Fitness Check calculated average capital costs per inhabitant, and those vary from EUR 0.2 in Estonia, to EUR 261 in Slovenia.

In that context, it was only possible to project additional exposure and vulnerability of countries to flood risks, taking into account annual expected affected population, urban damage, and GDP (defined as total growth factors). This was quantified for riverine floods (using WRI data) and qualitatively discussed for coastal floods. Urban floods were considered as an emerging challenge, essentially because they are not properly documented or monitored in existing data sets.

Countries can be clustered into four different categories, reflecting different perspectives on future exposure to riverine floods:

• Countries affected by the highest total growth factors (Austria, Luxembourg, the Netherlands). The increase in total growth factors is driven by climate change, indicating that urban assets, GDP and population will be increasingly exposed to flooding in the future compared to the current situation.

• Countries affected by moderate growth factors (Belgium, Czech Republic, Denmark, France, Germany, Hungary, Ireland, Poland, Romania, Slovakia, Sweden, the UK). In some of these countries, the impact of climate change is relatively low and more or less equal to the contribution of socio-economic developments in the explanation of future increases in flood risk.

• Countries benefitting from lower exposure of population (Bulgaria, Croatia, Estonia, Latvia, and Lithuania). In contrast with other member states, socio-economic developments – not changes in the climate - have a relatively large contribution to a future increase in flood risk in these countries.

• Countries benefitting from low or negative growth factors (Cyprus, Greece, Malta, Portugal, Spain). In general, these countries have limited exposure to river flood risk due to their arid or semi-arid climate (even though some catchments can be exposed to flooding during winter).

To date, flood protection in Europe has been largely financed through public grants. Alternative instruments are available to finance both investments in flood protection and the provision of financial protection in case of flood events. First, economic instruments provide a monetary/economic incentive promoting efficient flood risk management and risk reduction; they can either be administered by the government or by private entities. Second, risk financing instruments (RFIs) are pre-disaster arrangements coming into play in a post-disaster phase. They include insurance, weather derivatives and catastrophe bonds. Because they indirectly incentivise behaviour and increase the uptake and efficiency of risk-reduction measures, such instruments should be used as actual policy instruments to manage risk mitigation, together with other risk mitigation measures such as regulatory, research, and development measures. Different instruments can be combined in risk mitigation strategies to get the most out of each of them; the best mix of instruments will need to be assessed on a case-by-case basis.

The assessment of financing challenges provides a robust basis to explore policy recommendations that can help meet financing needs. Policy recommendations that cut across the areas covered in the three directives are clustered around three sets of mutually reinforcing categories.

Recommendations need to be tailored to national and local contexts. They can be informed by good international practices. Some crosscutting messages deserve particular attention.

Planning has an essential role to play to ensure efficient allocation of finance. While plans are abundant in EU member states, they vary in their capacity to drive investment decisions. Investment planning should factor in demographic trends, including depopulation of rural areas and smaller towns. They need to reflect robust projections on climate change. Effective plans must be consistent with initiatives in other sectors (e.g. urban planning and land use; environment, agriculture, energy and transport). Plans are best accompanied by realistic financing strategies, which specify where finance will come from.

In selected areas, such as mountainous and isolated territories, cost-effective decentralised wastewater collection and treatment can be considered. Compliance monitoring and enforcement will be crucial to ensure environmental protection (i.e. to prevent groundwater contamination from leaking septic tanks, and inappropriate wastewater disposal without treatment to rivers). IAS should be considered in the context of national strategies, with mechanisms to ensure reliable performance of services. This is likely to increase the costs of IAS, in places making the connection to existing pipes competitive.

Independent economic regulation (usually at national level) can support the transition towards sustainable financing strategies for water supply and wastewater collection and treatment. Key features of well-defined independent regulation are to separate functions and powers of policy from operations, and to incentivise greater performance and accountability from local authorities, operators of water services and water users. Such oversight can strengthen the transition to cost recovery through tariffs, and stimulate improved performance of service providers (be they public or private).

Most countries will need to consider new sources of finance. Private finance (commercial debt or equity) is available in all EU member states. So far, it has only marginally been mobilised to finance investments in water supply and sanitation. There is room for manoeuvre to attract commercial capital for creditworthy borrowers to finance water-related investments. This may require exploring how public budgets, including cohesion policy funds and risk-mitigation instruments (e.g. guarantees, credit enhancement instruments) can be used strategically to improve the risk-return profile of investments that can attract commercial finance. Lessons from innovative arrangements in Europe to combine or blend public and private sources of finance could inspire further developments.

On of all these and related issues, the European Commission has a role to play to foster and accelerate the transition towards robust strategies to ensure compliance with the DWD, UWWTD and FD, now and in the future. While Cohesion Policy has been a major driver for compliance across member states, other tools and mechanisms need to be considered and developed to adjust support to the distinctive needs and capacities of heterogeneous member states, particularly in the context of the decline of Cohesion Funding for water-related expenditures.

Most importantly, the European Commission needs to continue efforts to enforce compliance monitoring and reporting. This creates a momentum for data collection, strategic planning, and enhanced accountability of member states (to the European Commission and citizens).

Considering its importance for the cost-effectiveness of policy responses, the performance and efficiency of water supply and sanitation services deserve particular attention. This line of work potentially combines guidance on independent economic regulation (for tariff setting, benchmarking the performance of water utilities), agglomeration of small entities and support to define and implement robust national strategies for IAS. This can be achieved through a combination of peer learning and some form of conditionality of support.

Similarly, national and local authorities across Europe would gain from enhanced capacity to design and implement investment plans and expenditure programmes that contribute to compliance with the EU acquis at least cost for the community. As stressed above, such plans and programmes must consider long-term issues (including climate change) and coherence across policy areas. The new enabling conditions to access EU funds go in this direction, when they encourage robust investment plans combined with financial strategies. More guidance may be required to characterise appropriate plans and strategies.

In addition, member states would continue benefitting from practical policy guidance on pending and emerging issues, where member states are still looking for appropriate policy, technical and financial responses (e.g. CECs, combined sewer overflows, sludge). Any sort of guidance on these topics should cover issues related to costs and financing.

Other parts of the European Commission can also contribute. For instance, the development of domestic financial institutions can crowd-in private finance for water-related investments. Such institutions could usefully be encouraged as financial partners in the disbursement of EU Funds, whenever feasible. Support can be initiated by the European Commission, for instance in the context of the action plan on sustainable finance.

These options need to be refined and adjusted to reflect the priorities and means of action of the new European Commission. They provide a fertile ground to rejuvenate constructive and fruitful policy guidance and peer learning with and across member states, on water and related issues.