Financing Water Supply, Sanitation and Flood Protection

5. Selected options to address financing challenges

Abstract

This chapter explores options EU member states may wish to consider to minimise financing needs related to water supply, sanitation and flood protection, make the best use of available assets and financing resources, and harness new sources of finance, if and when required.

The options were discussed in a series of country workshops co-convened by the OECD and the European Commission in countries, which face the most severe financing challenges. Some of the options reflect the work of the Roundtable on Financing Water, a joint initiative by the OECD, the Netherlands, the World Water Council and the World Bank (more information on the Roundtable is available here).

Part III of the report projected expenditure needs EU members face to comply with the Drinking Water, Urban Wastewater Treatment and Flood Directives. While all countries need to increase the current level of expenditure for water supply and sanitation by 20% or more (see Figure 3.6), some face more challenging needs, including Finland (+85%)1, Bulgaria (+100%) and Romania (+180%). It is likely that the investments remaining to be made for most countries to reach compliance are also among the most difficult: it is reasonable to assume that low hanging fruits have already been picked and future investments need to deal with the new connections with high marginal, or municipalities with low capacity.

The situation is compounded by projected needs to finance flood protection. With the exception of few arid Mediterranean countries (Cyprus, Greece, Malta, Portugal and Spain), other EU member states will need to increase flood protection expenditures if they want to keep pace with rising exposure to flood risks in the coming decades2 (see Figure 3.7). Austria, Luxembourg and the Netherlands are exposed to the highest increase in riverine flood risks. Compared to other countries, France, the Netherlands and the UK are projected to face the largest increases in exposure to risk of coastal floods, a driver to further increase investment in flood protection.

Based on analyses in Part IV, the degree to which EU member states are able to finance projected investment vary substantially. Some will face difficulties to raise tariffs for water supply and sanitation services without facing affordability issues for a significant part of the population (Bulgaria, Italy, Poland, Romania). Others are unlikely to find the fiscal space to increase public finance for water-related investment, as public budgets are constrained by public debt or high fiscal pressures (Belgium, France, Greece, Italy, Portugal or Spain). While few countries have experience with commercial debt to finance water-related expenditures, some of the countries facing the steepest increase in expenditure needs are, at the same time, the least likely to mobilise domestic commercial finance (Estonia, Latvia, Lithuania, Romania, Slovakia).

This final part of the report explores policy recommendations that can help meet financing needs. The recommendations are clustered around three sets of mutually reinforcing categories (see the table below):

• Make the best use of existing assets and financial resources

• Minimise future financing needs, and

• Harness additional sources of finance, where appropriate.

Table 5.1. Policy Recommendations to meet water-related financing needs in Europe

Make the best use of existing assets and financial resources	Minimise future financing needs	Harness additional sources of finance
Enhance the operational efficiency of water and sanitation service providers	Manage water demand	Ensure tariffs for water services reflect the costs of service provision
Encourage connections, where central assets are available	Strengthen water resource allocation	Consider new sources of finance
Develop plans that drive decisions	Encourage policy coherence across water policies and other policy domains (including nature-based solutions)	Leverage public and cohesion funds to crowd-in domestic commercial finance
Support plans with realistic financing strategies	Exploit innovation in line with adaptive capacities
Strengthen capacity to use available funds
Build capacity for economic regulation

The recommendations are illustrated by good international practices. While tailored to countries facing most severe financing challenges, the recommendations are likely to be relevant for all EU member states and beyond. Preliminary discussions highlighted the potential benefit of peer-to-peer learning, possibly supported by technical support.

The chapter was informed by discussions on financing challenges and policy options during country workshops convened by the OECD and the European Commission in 9 EU member states facing most severe financing challenges: Bulgaria, Croatia, Cyprus, Lithuania, Poland, Romania, Slovakia, Slovenia, Spain. The discussion also builds on on-going analyses of similar issues at the Roundtable on Financing Water, an initiative by the OECD, the Netherlands, the World Water Council and the World Bank to accelerate water-related finance.

5.1. Options to make the best use of existing assets and financial resources

Improving the operational efficiency and effectiveness of existing infrastructure and service providers can postpone investment needs and is a prerequisite to further investment in water security. This can be enhanced through better operation and maintenance of existing infrastructure, demand management, and engagement with stakeholders (to set acceptable levels of service, enhance willingness to pay, or drive water-wise behaviour). Such a line of action resonates with discussions at country workshops convened in the context of this project in countries facing the most severe financing challenges to comply with the three technical directives discussed in this report.

The ensuing sections present policy insights and guidance for the following recommendations to make the best use of existing assets and financial resources:

• Enhance the operational efficiency of water and sanitation service providers

• Encourage connections, where central assets are available

• Develop plans that drive decisions

• Support plans with realistic financing strategies

• Strengthen capacity to use available funds

• Build capacity for economic regulation.

5.1.1. Enhance the operational efficiency of water and sanitation service providers

Operational efficiency of water service providers is a condition to make the best use of existing assets and financial resources. It is also a requisite to attract other sources of finance, be they public or private. It is essential to maintain or increase water users’ willingness to pay for tariffs that reflect the cost of service provision.

Enhancing operational efficiency of service providers can take different forms depending on the national context. Building on international good practices (see OECD, 2018, for a discussion), performance indicators for water supply and sanitation services can focus on the following items. The relevance and relative weight of indicators would reflect local conditions:

• Technical performance indicators

  • Leakage performance and targets for reducing leakage and other unbilled losses, such as illegal connections

  • Mains bursts (as a proxy for distribution network condition)

  • Sewer collapses (as a proxy for sewer asset condition)

  • Number of wastewater pollution incidents, such as from too frequent operation of combined sewer overflows, or major failures at wastewater treatment works

  • Unplanned outages (loss of supply because of bursts, contamination, etc.)

• Compliance with existing regulation

  • Drinking water quality compliance (integrating with and reinforcing the role of the drinking water regulator, where this is separate)

  • Level of compliance with environmental permits and standards (integrating with and reinforcing the role of the environmental regulator, where this is separate). This can also be an indicator of the quality and state of drinking water and wastewater treatment infrastructure assets

• Customers’ experience

  • Reducing per capita consumption for households and demand in other sectors on mains supplies

  • Risk of demand restrictions in a drought

  • Customer experience: how well billing queries are dealt with, information about planned outages and supply interruptions.

Analyses in this report and discussions at the country workshop indicate that Bulgaria would benefit from a proactive approach to maintain and renew existing networks (instead of reacting to incidents such as bursts) to improve operational efficiency of water and sanitation operators, reduce non-revenue water and address the backlog of under-investment in maintenance of WSS infrastructure over the past decades. This includes improving the operation of the existing assets to reduce operational costs and avoid additional capital investments. It also includes active leakage control in the water supply system and regular maintenance of pipes of the collection systems. Performance based contracts may be considered to strengthen incentives for investing in efficiency improvements. Technical assistance for service operators could include capacity building for financial and technical dimensions of operations3.

In Poland, there has been rapid investment in infrastructure over the past years, but at the same time, a considerable part of the network is aging, which needs renewal and modernisation. Targeted maintenance, on a risk-based approach can help optimise spending, if data on the state of infrastructure is available.

In water-scarce countries like Cyprus, reduction of non-revenue water can minimise pressure on the resource and avoid (or postpone) investments in costly alternative water sources such as desalination. In Cyprus, this requires reducing leakage and increasing collection of water bills, especially under the jurisdiction of municipal water departments and community boards.

In Romania, reducing non-revenue water due to illegal connections (often associated with irrigation water use) and under-metering should be prioritized in the short term. In addition to generating more revenue for operators, addressing commercial losses should improve the official figure for the national piped water access rate, as currently un-registered connections would be taken into account. This process would be less time and cost intensive than addressing leakages in the distribution network.

Operational efficiency can benefit from benchmarking and public reporting of operators of water supply and sanitation services to increase accountability, transparency and incentives for efficiency and financial sustainability. In Lithuania, benchmarking has helped identify issues related to fragmentation and lack of efficiency of service provision for water supply and sanitation and could pave the way to reforming the sector. In Romania, benchmarking the performance of regional service providers on such indicators as leakage, reduction in illegal connections to networks, or number of staff per volume of water sold or treated could drive support for the needed efficiency gains.

Several countries (e.g. Cyprus, Lithuania, Slovakia) would benefit from exploring mechanisms to enable further consolidation of municipal and local services to improve operational efficiency and financial sustainability by reaching economies of scale. On-going reform in Croatia still needs to come to fruition, as progress has been slow. Experience from Hungary (where a staged approach has allowed a consolidation of utilities) or Ireland (where Irish Water was set up as a national service provider) can inspire other countries. Experience in Croatia and Romania shows that such institutional reforms can capture the attention of authorities and stakeholders, and delay other needed reforms. Planning, stakeholder engagement and sequencing reforms are essential to avoid capacity bottlenecks and overcome resistance to consolidation of utilities.

5.1.2. Encourage connections, where central assets are available

In countries such as Croatia, Lithuania, Romania and Slovakia, water users’ reluctance to connect to existing central water supply and sanitation infrastructure delays progress towards compliance with the DWD and the UWWTD. In such contexts, connection to central supply and water treatment systems can be encouraged, possibly through regulation, with a direct subsidy to households to cover (parts of) connection fees or by allowing one-time connection fees to be paid in smaller increments over time.

Similarly, in Slovakia, connection to central sewer systems could be incentivised, to reduce costs of water pollution and drinking water treatment, and to provide a new source of revenue for water supply and sanitation utilities. Options may include:

• increased monitoring, enforcement and issuance of financial penalties for mismanagement of individual and other appropriate systems

• direct government subsidies building on the success of the “let’s connect” programme (connection for EUR 1);

• incorporating the cost of connection into the overall capital cost; and

• public education and awareness on the environmental impacts of IAS and the consequences of inaction.

5.1.3. Develop plans that drive decisions

To make the best use of existing assets and financial resources, most countries would benefit from proper planning and priority setting. Investment planning should factor in demographic trends, including depopulation of rural areas and smaller towns to avoid over-investment in oversized infrastructure that will be costly to operate and maintain in the future. For example, the rural population is projected to contract by 40% in Romania in the coming decades, which has implications for current infrastructure development.

In non-viable areas, such as mountainous and isolated areas, cost-effective decentralised wastewater collection and treatment could 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).

In Cyprus, first order priorities include investments in sewerage networks, wastewater treatment and nature-based solutions that maximise benefits (to society and the environment) over the long-term and deliver the highest benefits in terms of compliance with the EU Urban Wastewater Treatment Directive and the Water Framework Directive. As compliance with the UWWTD increases, wastewater reuse could be expanded, where appropriate, to reduce pressure on groundwater resources.

Setting priorities can also contribute to cost-effective flood protection. In Slovakia, the 588 flood hazard areas should be reviewed to narrow the number of areas at highest risk and prioritise investment.

Effective plans must be consistent with initiatives in other sectors. For instance, in Cyprus, water management plans should be accompanied by a viable strategy for irrigated agriculture in line with sustainable aquifer management and the requirements of the EU Water Framework Directive.

Going beyond the compilation of individual projects, plans should consider how investments can be sequenced over time to improve resilience. This requires a shift from cost benefit analysis at project level to an assessment of the value created by investment pathways that combine and sequence a series of investments.

5.1.4. Support plans with realistic financing strategies

Plans and priorities should be accompanied with robust and realistic financing strategies. Such strategies are often lacking (e.g. in Cyprus, Romania or Slovenia) or pending (e.g. in Bulgaria). Strategies should clearly set priorities and drive investment decisions, and be developed in cooperation with national and local authorities. They should include provisions for improved operation and maintenance of water infrastructure, accounting for the backlog of under-investment in maintenance over the past decades. Strategies should also include targeted social measures to address affordability constraints and solidarity mechanisms to help cover investment costs in communities where financing capacities are especially limited.

The European Commission recently proposed an enabling condition to access further finding that goes into that direction. It remains to be seen how specific and comprehensive that condition will be.

The lack of a realistic financing strategy is especially acute for small municipalities (and rural areas). In Poland, for example, there is a mismatch between high investment needs, and technical and financial capacity of small municipalities (mainly rural). Affordability issues arise in smaller towns. Slovenia faces as similar situation.

In Bulgaria, due to the limited financing available and severe financing challenges in the future, there is a need to develop a consolidated vision of financing needs for compliance with the EU water acquis. This could ensure stronger policy coherence and alignment of priorities, as well as optimisation of limited resources use. The prioritisation of investments should systematically explore opportunities to combine funding to serve multiple objectives (water supply, flood risk management, pollution abatement, improving ecological status, etc.) to improve cost-effectiveness. Prioritisation should be considered in terms of policy objectives as well as geographies. Investment planning should factor in demographic trends, including depopulation of rural areas and smaller towns and economic trends (e.g. declining industrial use) to avoid over-investment in oversized infrastructure that will be costly to operate and maintain in the future. Priorities should reflect cost-benefit analyses made for RBMPs’ programmes of measures, or explain why they do not.

In Cyprus, a sustainable financing strategy for operation and maintenance of water infrastructure is needed, accounting for the backlog of under-investment in maintenance over the past decades, in cooperation with national and local authorities. This should include ensuring that revenues collected from water and sanitation tariffs are sufficient to cover, and are earmarked for, operation of utilities (which does not seem to be the case in rural areas). Without such a strategy, delays in implementation of the EU water acquis and dependence on EU funding may continue.

5.1.5. Strengthen capacity to use funds effectively and financial disbursement at national level

Capacity to use funds effectively and financial disbursement play a critical role in allocating funding when and where it creates most value. Several countries face difficulties to invest available funds in an effective and efficient way. For instance, disbursement of cohesion policy funds has been delayed in Croatia and Romania. Delays can affect the robustness of project selection and implementation, or generate tensions with the Treasury who may be tempted to redirect available finance to sectors where it can be used effectively.

In such contexts, the capacity to use funds effectively should be strengthened. Along with general capacity building, this could be done through developing a strong project pipeline, and measures to ensure the sustainability of investments. Other issues will need to be addressed, which go beyond the water sector and the ambition of this report; for instance, cumbersome public procurement procedures in Slovakia, or labour shortage in civil works and construction industry, have delayed realisation of investments in Croatia.

In Slovakia, the efficiency of expenditure programmes could be enhanced. The Environmental Fund has a pivotal role to play. Currently, it only supports small projects, below EUR 200k. Revenue from new economic instruments (e.g. environmental fines or pollution charges) could be earmarked for the Fund to better support larger projects.

5.1.6. Build capacities for economic regulation

Independent economic regulation can support the transition towards sustainable financing strategies. 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 could provide technical support to local authorities, strengthen the transition to full cost recovery tariffs, and ensure consistency of tariffs across regions and communities (OECD, 2018; 2015d). Experience in the UK, and more recently in Lithuania, can inspire other countries where independent regulation is missing (e.g. Cyprus).

Poland has made important strides in the evolution of the legal and institutional framework for the sector, including tariff regulation. In December 2017 amendments in legislation governing water use (Acts on Collective Water Supply and Collective Sewage Disposal) established a new regulatory office to oversee water tariffs. The main aim of this amendment is to ensure tariffs are affordable, while also taking into account the financial stability of service providers.

Where national regulators do exist, they may need to be strengthened. This is the case for ANRSC in Romania. Regional utilities will progressively need to finance larger portions of their investment through revenue collection. ANRSC will need to enhance monitoring of operational efficiency, strengthen revenue-raising capacities and introduce proper incentives. An important consideration will be how to include depreciation of existing assets in the calculation of allowable tariff levels. This is an issue for a number of EU member states and there may be scope of joint action and peer learning on that front.

Further, barriers to the effective execution of economic regulation should be removed. For example, in Bulgaria, although the recent sector reforms sought to provide greater clarity on the allocation of roles and responsibilities between owners (Water Associations) and operators (Water and Sanitation Operators), overlaps and inconsistencies among territories remain. This has stalled the approval of operators’ business plans by the regulator – the Energy and Water Regulatory Commission of Bulgaria (EWRC).

International good practices for water regulation

There are three core elements of water regulation:

• Protecting the environment: ensuring that standards are set and met in order to achieve policy objectives, and that abstractions and discharges operate within safe limits.

• Protecting customers’ interests (economic regulation): ensuring that the delivery of water supply and sanitation is efficient, the level of charges fairly reflect and fund the quality of service delivered, and that there are equitable, transparent grievance and remedy mechanisms that allow individuals to complain.

• Protecting drinking water quality: providing confidence to customers that water treatment processes are effectively managed and monitored, and that tap water is safe to drink.

Independent regulation can be achieved by any one, or a combination of, the following four models (OECD, 2015a):

1. Regulation by government. The public sector is responsible for the management of the water services and owns the assets. Service provision is delegated to public water operators while regulatory functions are carried out directly by the State at different levels: central, regional or municipal. This is the model adopted in the Netherlands, and to a lesser extent, in Germany. The challenge for this regulatory model is that one public body is regulating another.

2. Regulation by contract. The regulatory regimes are specified in legal instruments, and although public authorities are responsible for regulation, water service delivery can be delegated to private operators through contract agreements. These set the rights and obligations for each contracting entity, and service provision is awarded to private companies following public tender. This model is used in France.

3. Regulation by one or multiple independent regulators, where independence has three dimensions: independence of decision making, of management and of financing. This is the model used in the United Kingdom, where the regulatory framework is organised around three dedicated agencies with statutory functions relating to pricing and customer service (Ofwat), drinking water quality (Department for Environment, Food and Rural Affairs), and environmental regulation and security of water supply planning (UK Environment Agency).

4. Outsourcing regulatory functions to third parties. This model makes use of external contractors to perform activities such as tariff reviews or benchmarking.

Regulators sit between government and its policy making, the bodies responsible for the delivery of water supply and wastewater services, and their customers. This means that they must translate government policy aims into operational standards for those whom they regulate.

How a regulator acquires performance information and sets performance targets is important in bridging any gap between government and customer expectations. An outcome-based approach helps to ensure that the focus is not simply on easily measured outputs, but also considers the longer-term aims for water and sanitation, and the environment. It should expect the delivery body to monitor its service to customers, the operational performance of its assets, and how it is planning for resilient systems operation in the face of shocks, such as drought, process failures or cyber-attacks. The targets, and performance against them, should be published and made available to customers.

Customers should expect to be able to express their views on levels of service, priorities for investment and options for major infrastructure where this is proposed. The extent to which customers participate in the development of business plans can influence both their behaviour – and how much they value water and the service they receive – and that of the delivery body.

The regulator needs to ensure that the delivery body is funded to deliver efficiently the breadth of its services to the required standard. For household water and sanitation bills, affordability issues are best dealt with through the use of social tariffs or income support measures (outside of the water bill), rather than keeping water bills low and failing to raise adequate revenue and an understanding of the value of water and sanitation services. The United Nations has stated (UNESCO, 2017) that regulatory frameworks must not interfere directly or indirectly with people’s existing access to water and sanitation. States must ensure that disconnections due to inability to pay are prohibited. The regulator should seek to moderate bill increases so that it can satisfy itself, and others, that they are necessary and appropriate.

5.2. Options to minimise future financing needs

Options discussed in the previous section contribute to making the best use of existing assets and financial resources. They also minimise investment needs in the future, for instance by postponing the need to renew existing infrastructures. The ensuing sections present policy insights and guidance on the following additional measures to minimise future financing needs:

• Manage water demand, and strengthen water resource allocation

• Encourage policy coherence across water policies and other policy domains

• Exploit innovation in line with adaptive capacities.

5.2.1. Manage water demand

Water demand management can go a long way to minimising future needs to invest in supply augmentation. In Cyprus, demand management efforts (illustrated by the recent tariff reform, abstraction charges, awareness raising campaigns) can be scaled-up to reduce the need for costly supply augmentation. A revision of the WSS tariff structure and level can contribute to drive water use efficiency, with a higher proportion of – or rate for - volumetric charges (and a lower proportion of fixed charges), especially in small communities.

Abstraction charges in most countries are typically low or non-existent. However, freshwater abstraction charges to all users can signal the value of water and limit the pressure on water resources, particularly groundwater. Groundwater and surface water abstraction charges should be set in a manner coherent with each other, to account for potential substitution effects. When water abstraction is metered, a volumetric charge should be applied. If abstraction is unmetered, a flat abstraction charge or one based on a proxy, such as area of irrigated land (preferably in conjunction with the type of crop), can be used as a more rudimentary alternative in the interim (Ambec et al., 2016). The price should reflect the trade-off between abstracting water now or in the future, particularly for non-renewable groundwater resources (OECD, 2017). The revenue raised could be earmarked to fund water restoration activities. In addition, collection of water bills, particularly for unregistered abstractions and dealing with illegal abstractions should be a priority in some countries, such as Cyprus, to manage demand and ensure sustainable water abstractions.

5.2.2. Strengthen water resources allocation regimes

Several countries which face severe financing challenges could benefit from well designed water allocation regimes. For instance, in Cyprus, much water is allocated to low value agriculture uses, driving costly investments in supply augmentation and depleting the resource, thus weakening compliance with good ecological status. A reform of water allocation regimes would contribute to water use efficiency, discourage wastage and low value uses and secure water for valuable ecosystems. It should account for the fact that, while the share of agriculture in GDP declines, agriculture still is important for the national economy in terms of social cohesion, countryside and local tradition, and employment.

In Spain, water allocation regimes have led to costly reforms to buy back entitlements to contribute to environmental flows and to allocate water towards higher value uses. Current practices also led to costly investments in supply augmentation via desalination, a direction criticised by the Court of Auditors.

OECD (2015) suggests that an allocation regime needs to have two key characteristics: it should be robust by performing well under both average and extreme conditions and demonstrate adaptive efficiency in order to adjust to changing conditions at least cost over time. More specifically, a well-designed allocation regime has multiple elements (discussed in detail in OECD, 2015b). A clear legal status should be in place for all types of water resources (surface and ground water, as well as alternative sources of supply) with competing claims clarified. A clear and enforceable abstraction limit (“cap”) should be in place that accounts for in situ requirements and sustainable use, including environmental needs. Clearly defined, legal, volumetric water entitlements are needed. Water pricing, typically in the form of abstraction charges, is a key element of a well-designed regime. Pricing can contribute to cost recovery, internalise negative externalities associated with water abstractions, and send a price signal to users to discourage inefficient and low-value water uses. Scarcity pricing could help to signal the scarcity value of the resource, but has proven difficult to implement to date.

Groundwater allocation faces distinctive challenges, for instance as regards abstraction monitoring. However, a similar reasoning applies (see OECD, 2017 for a more detailed discussion).

Recognising the potential for improving current allocation arrangements, 75% of countries covered in the OECD survey have recently reformed their allocation regimes and 62% have reforms ongoing. However, managing the transition from existing arrangements to an improved regime is often very contentious and can be costly. Evidence from case studies of allocation reform in 9 OECD countries and BRIICS (Australia, Canada, Chile, China, France, Israel, South Africa, the UK, the US) provides insight into the reform process and lessons on how some of the obstacles of reform can be overcome.

Concerns about water scarcity and insufficient water for ecosystems are often cited drivers of allocation reform. Broader political or structural reforms have provided imperatives to improve the efficiency of resource use and equity in allocation of water resources. Droughts can provide a salient, visible event to trigger action. The case studies on reform highlight the importance of determining a sustainable baseline (how much water is available for allocation) before making significant changes, like introducing trading. Failure to do so can result in costly efforts to claw back entitlements already granted. Willingness to engage stakeholders in the reform process and appropriately compensate potential “losers” (with financial transfers, permits to build storage structures) facilitates the process.

A periodic “health check” of current allocation arrangements can help to assess the achievement of reforms and areas for further improvement. The OECD “Health Check” for Water Resources Allocation can provide useful guidance for such a review (see OECD 2015b, 2017). It is a tool designed to review current allocation arrangements to check whether the elements of a well-designed allocation regime are in place and to identify areas for potential improvement. In general, as the risk of shortage increases, the benefits of a more elaborate allocation regime increases.

5.2.3. Encourage policy coherence, across water policies and other policy domains

Policy coherence can contribute to minimising future financing needs. Coherence between water supply, sanitation and flood protection with agriculture policy is a case in point, as it could deliver a number of significant co-benefits. While the regulatory framework is largely set at European level, implementation varies across countries. In addition, countries would benefit from exploring flood management options that exploit synergies with the Water Framework Directive, such as flood protection measures that minimise alteration of the natural hydromorphology. From that perspective, nature-based solutions can reinforce and support existing flood defence investments (see further developments below on nature-based solutions for flood protection) while preserving the good ecological status of water bodies.

In Cyprus, improved coordination between land use planning and flood management could manage urban sprawl and flood hazards, and minimise investment needs for flood protection. In Slovakia, it is advisable to review and adjust the ten sub-basin water management plans so as to increase synergies between policies (including those for agriculture, water supply and sanitation, water quality, flood prevention, land use planning, nature conservation and climate change adaptation) and the objectives of the EU water acquis. Also, flood management could be decentralised to the local level to better reflect local priorities. In addition, greater emphasis could be placed on integrating flood prevention into river basin management plans, on better use of nature-based solutions, and improved coordination between land use planning and management and flood prevention.

Nature-based solutions in urban environments

Nature-based solutions (NBS) involve the use of natural or semi-natural systems that utilise nature’s ecosystem services in the management of water resources and risks. Examples include restoration or construction of wetlands, sustainable urban drainage design and green roofs. NBS can contribute to addressing water-related challenges in urban environments, often supporting multiple policy objectives (see Table below). In the European context, NBS are particularly relevant for catchment protection and protection against flood risks.

Table 5.2. Benefits of nature-based solutions versus traditional engineered ‘grey’ infrastructure for urban water management

Green infrastructure solution	Urban water management issue
	WSS (including drought)	Water quality regulation			Moderation of the extreme events (floods)			Protection of ecosystems
		Water purification	Biological control	Water temperature control	Reverine flood control	Urban stormwater runoff	Coastal flood (storm) control
Demand management	×							×
Local processing of black or grey water	×	×	×
Wetlands restoration/conversation	×	×	×	×	×			×
Constructing wetlands	×	×	×	×	×			×
Water harvesting	×					×
Green spaces	×	×		×		×		×
Permeable pavements	×	×				×		×
Green roofs						×		×
Protecting/restoring mangroves, coastal							×	×
Corresponding grey infrastructure (primary service level)
Dams, groundwater pumping	×			×
Dams, levees				×	×
Water distribution systems	×
Water treatment plant		×	×
Urban stormwater infrastructure						×
Sea walls							×

Source: adapted from UNEP (2014), OECD (2013a).

Traditional approaches to urban drainage have historically focussed on fast, proven and safe water removal using engineered grey infrastructure. They provide various benefits, including flood control and the treatment of contaminated urban runoff. However, nature-based solutions for stormwater management provide many other additional benefits, beyond what equivalent traditional grey infrastructure provides. These benefits include, inter alia, adding to the stock of green infrastructure and natural capital and hence providing opportunities for improved ecosystem services and biodiversity; reducing ambient air pollution (Pugh et al, 2012); and mitigation of urban heat island effects.

Investment in NBS is also generally less capital intensive; has lower operation, maintenance and replacement costs; avoids lock-in associated with capital intensive grey infrastructure; and appreciates in value over time with the regeneration of nature and its associated ecosystem services (as opposed to the high depreciation associated with grey infrastructure). In the context of a changing climate, where rainfall patterns, water availability and demand are becoming more uncertain, nature-based solutions can provide a flexible, scalable option to adapt. Nature-based solutions can also avoid or postpone the costs of building new, or extending existing, grey infrastructure. This resonates with the guidance of the European Commission on the topic, which claims that a network of healthy ecosystems often provides cost-effective alternatives to traditional infrastructure, offering benefits for EU citizens and biodiversity. This is why the EU Strategy on Green Infrastructure promotes the use of nature-based green and blue infrastructure solutions.

Many countries have shifted their perspective to better reflect the net value of a policy or project to society as a whole, and also to promote the use of natural systems, such as nature-based solutions (e.g. Xing et al., 2017). Cities are gaining experience with these approaches (see the case of Philadelphia in Box 5.1).

Box 5.1. Nature-based solutions to manage stormwater in Philadelphia, USA

Philadelphia, USA is considering a range of nature-based solutions to adapt to a changing climate and mitigate urban floods from heavy rains. Ongoing stormwater enhancements in Philadelphia are bringing some USD 2.6 billion (approximately EUR 2.35 billion) of added benefits by managing combined sewer overflows using nature-based solutions that deliver multiple functions.

The proposed eco-friendly “sponge-like” water system in Philadelphia involves new forms of drainage: green roofs, wetlands and repaving with porous materials. It is estimated to be less than half the cost of a conventional upgrade of the current system of pipes and basins. Achieving a similar level of service through an additional wastewater treatment plant would be 4- or 5-fold more expensive.

Sources: Various; adapted from OECD (2015c), Water and Cities, OECD Publishing, Paris.

Although the benefits of green infrastructure for water security and sustainable growth are known, significant barriers hinder investments in green infrastructure:

• Due to limited data on river flows, as well as of evidence on the value of freshwater and terrestrial ecosystems, it can be difficult to design and assess the costs and benefits of NBS. The estimation of benefits is especially complex as these may be hard to quantify and monetise. Much of the current efforts are directed towards developing the means of financial valuation of aspects of improvement in urban areas that are not readily captured in terms of market value4. As a consequence, there is a lack of track-record for costs and benefits, technologies, markets and financial products associated with NBS. The absence of available best practices and expertise for investors creates uncertainty related to bidding processes, timing for investments, transactions and underlying risks.

• NBS use vast areas of land, which can be expensive especially in urban contexts. However, once benefits are taken into account, the overall net present value of using NBS can be better than the traditional approaches. The major challenge is that many of the benefits do not accrue to water services or water service providers, instead going to elevated property values, health benefits and other non-water related societal benefits (e.g. Zhou et al., 2013; Ashley et al., 2018).

• NBS are multipurpose by nature, thus contract structures may be highly complex and vulnerable, exposing investors to risks and insecure returns.

• The innovative practices associated with NBS often combine different scales in urban water management, from individual buildings, to municipal and larger levels. Such combinations can be hampered by institutional arrangements, which split incentives and responsibilities along the water cycle.

• There are certain liability issues that cannot be addressed in the case of NBS, due to the intrinsic characteristics of its components, which rely on natural ecosystems. There is great ambiguity related to the determination of who to hold accountable in case of failure, for example, when a floodplain ceases to deliver the services it is expected to provide.

• Many investors have yet to conclude that green infrastructure investments offer a sufficiently attractive risk-return profile. A number of environmental, energy and climate policies and regulations still favour investments in grey infrastructure over green infrastructure. The competitiveness of innovative solutions is often hampered by lack of policy coherence; for instance, water prices that fail to reflect the opportunity costs of resource use; or land use and urban development that do not reflect the risks of building in flood plains. There is a need for support policies and funding mechanisms that price nature-based and ecosystem services in ways that encourage investments in green infrastructure.

The abundant literature and documentation of successful case studies (e.g. OECD, 2015) can inspire policies in EU member states. Issues remain regarding replicating or scaling-up experience with financing for NBS that contributes to water security and sustainable growth.

Nature-based solutions for flood protection

In the past, efforts have been made in Europe to control flooding. Traditional flood defence measures, also referred to as grey infrastructure measures, have been implemented on a large scale. They are defined as: “Grey infrastructure refers to man-made infrastructure. In the context of floods, it refers to dams, dikes, channels, storm surge defences and barriers in general. It is called 'grey' because it is usually made of concrete” (EEA, 2017).

Even though traditional flood defence measures have proved to be effective, it has become increasingly recognised that they actually work against nature and negatively affect the provisioning of ecosystem services. The financial and ecological challenges have pushed forward the search for more sustainable flood protection solutions that work with nature and contribute to the strengthening of the resilience of nature and society to flooding. The European Commission defines green infrastructure as a particular nature-based solution that can be applied to flood risk management and is defined as: “A strategically planned network of high quality natural and semi-natural areas with other environmental features, which is designed and managed to deliver a wide range of ecosystem services and protect biodiversity in both rural and urban settings.” (EC, 2013).

In the context of flooding, green infrastructure contributes to minimising flood risk, by using ecosystem-based approaches for flood protection, for example through flood plain restoration rather than constructing dikes only. Thereby, green infrastructure does not only provide benefits to society in the form of avoided flood damage like grey infrastructure. Nature-based flood protection measures provide additional benefits, such as biodiversity improvements, water quality improvements, or opportunities for recreation.

NBS to protect against river flooding can be classified into agricultural, urban, hydromorphological and forest categories (NWRM, 2016). Agricultural measures are mainly aiming to manage run-off and thereby reduce flood risk, for example through soil and land management measures (conservation tillage, early sowing, hedges, buffer strips), drainage measures (flow-paths in fields, controlled traffic farming, reduced stocking densities) and run-off pathway measures (farm ponds, swales, mulching). Forest measures aim to manage woodlands in such a way that they reduce flood risk by intercepting land overflow, or by encouraging infiltration and soil water storage. Hydromorphological infrastructures include wetland restoration and management, floodplain restoration and management, re-meandering, and stream bed re-naturalisation.

NBS that can be considered to protect against coastal flood risk include saltmarsh and mudflat management restoration, sand dune management, and beach nourishment. Advancing nature-based solutions for flood management often boils down to a discussion on the costs of NBS and whether or not these measures provide sufficient benefits in comparison with traditional grey alternatives.

The discussion of the comparative advantages and disadvantages of NBS and grey infrastructure measures focuses on the following criteria (EEA, 2017):5

• Costs of land acquisition and compensation: The financial expenditures incurred from buying land needed for the construction of the measure or compensation of landowners for externalities associated with the construction of the measures.

• Construction and rehabilitation costs: All costs incurred during the construction phase of the measure including the investments in equipment, infrastructures and other assets required as well as the associated labour and management costs.

• Operation and maintenance costs: Financial costs such as depreciation allowances, maintenance expenditures and operational expenditures.

• Effectiveness on flood protection through:

  • Capturing the features of water retention relating to storing surface run-off and slowing run-off through slowing movement of surface water without storage.

  • Capturing the features of water retention relating to storing or slowing river water through e.g. open or controlled connectivity of plains or increasing bed roughness.

  • Reducing runoff through increasing evapotranspiration, increase infiltration and/or groundwater recharge and increasing soil water retention.

• Side effects: All benefits or costs related to flood protection measures in addition to the initial flood protection objective itself.

In the evaluation of NBS and grey infrastructure measures, comparing costs and effectiveness (in a cost-effectiveness analysis) is not a fully informative exercise. The key advantage of nature-based solutions is that they deliver multiple benefits: in addition to flood protection they often provide a wide range of other ecosystem services (i.e. on water quality and recreation). In other words, NBS might be less cost-effective, but more cost-efficient, once all different types of benefits are taken into consideration. In general, the cost-efficiency hinges on land acquisition costs and additional benefits from ecosystem services.

It is difficult to generalise and to draw conclusions about the return on investments of NBS for flood risk management in comparison to traditional grey alternatives as the magnitude of costs and benefits highly depend on location specific characteristics. Either set of measures can have a relative advantage depending on the situation (geographical context, population density, economic activity, local price levels, and size of the project) to which it is applied. So, it is misleading to compare green versus grey infrastructure measures on a one-to-one basis (EEA, 2017). Table 5.7 summarises the overall advantages and disadvantages of NBS and grey infrastructure for flood protection, based on several criteria.

Table 5.3. Overall comparison of NBS and grey infrastructure for flood protection

	Grey infrastructure	Nature-based solutions
Effect on flood risk	Protective: they protect an area against damages from flooding by blocking water from passing into a specific area.	Preventive: they reduce the probability of a flood occurring.
Potential to withstand extreme flood events	Yes, measures are designed according to a certain protection standard with established monitoring techniques.	Uncertain, effectiveness to withstand extreme flood events not demonstrated. NBS is often implemented together with grey infrastructure to guarantee protection for extreme events (also called hybrid infrastructure).
Timing of functionality	Immediate, grey infrastructures provide service as soon as operational.	Delayed, NBS typically needs time to provide the service as rivers/coasts adjust their morphology in response to the measures. This process depends on physical processes that take time, causing a delay in reaching flood protection standards.
Land acquisition and compensation costs	Land acquisition and compensation costs are low due to a small physical footprint.	High physical footprint, consequently land acquisition and compensation costs are high (except for re-naturalization). Costs depend on actual land-use (agriculture, residential) and the market value of land in the area.
Construction and rehabilitation costs	Need for recapitalization: depreciating assets that need regular upgrading or replacement.	Recapitalization is not significant, these measures are often self-sustaining and do not depreciate.
Operation and maintenance	High	Low operation and maintenance costs. NBS are often to a large extent self-sustaining and reduces the need for maintenance compared to channelized rivers.
Ecological footprint	Increased ecological footprint due to the use of unsustainable materials and energy intensive processes.	Low ecological footprint due to the use of natural materials and processes.
Side-effects	Limited positive side-effects on the provisioning of ecosystem services The protective nature of grey infrastructure has a potential perverse incentive on location behaviour by attracting residents and economic activity to flood-prone areas (thereby increasing flood risk).	Provisioning of a large range of ecosystem services

Source: EA, 2017.

5.2.4. Exploit innovation in line with adaptive capacities

Innovative technologies and management systems are being developed, which provide opportunities to reduce investment needs in water supply and sanitation, and in flood protection, now and in the future, in particular in the context of a changing climate. EU Member states already equipped with infrastructures may face distinctive challenges to transition towards alternative systems: technical path-dependency and risks of stranded assets can limit the appetite for and the feasibility of alternative systems, at least in the short term. Member states where additional infrastructure is required may find it easier to adopt alternative systems and techniques and ultimately perform better with less capital costs.

This section focuses on technical innovation, with a zoom on distributed systems for water supply and sanitation. Innovation does not come in isolation; innovation delivers best when combined with financial and governance measures, and when the interface between urban and rural environments is properly addressed. For example, sustainable urban planning, water-sensitive urban design, innovative business models and dedicated policies to drive innovation can all minimise future financing needs.

Innovation and compliance with the EU acquis on water

Innovation can minimise the costs of water management. Water-related innovation is multifaceted:

• In agriculture, innovation is associated with the development of water-efficient irrigation, planting of less water-intensive crops, and the adoption of practices that reduce nutrient flows back to water bodies.

• In manufacturing, it deals with more water-efficient and cleaner production practices, appliances, and more effective treatment techniques. Similar opportunities are associated with water supply and sanitation.

• Innovation applies to storage techniques, monitoring of river flows and pollution loads, and the operation of infrastructure as well. Smart water technologies cut across these boundaries: they allow the users to monitor, manage and act on data relating to the part of the water cycle that is pertinent to their interests.

• Data management advances, associated with optimisation of monitoring systems, will lower costs of both demonstrating compliance and operating water service systems. Online and dynamic real time data will become more readily available for flows, pollutants and quality of water at taps.

Table 5.7 presents a summary of technologies and innovations for water systems, and social costs in comparison to traditional water systems.

Water-related innovation is not limited to new technologies: non-technical innovations can also contribute to water security and sustainable growth. Sustainable urban planning is a good illustration. The way in which towns and cities are planned and laid out in terms of building form, density and surface transport networks, has for a long time controlled the form and layout of water services. The buildings and roads are planned and designed, with the assumption that the water services will be added appropriately, usually using below-ground pipes laid beneath roads, conveying water into the area from upland treatment works and wastewater away to downstream and remote wastewater treatment plants. The surface water flows into highway and building drains, to join with the sanitary wastewater and thence to the treatment plant, unless the pipe capacity is exceeded and overflows occur.

Water-sensitive urban design takes an opposite perspective: it factors water-related risks into the design and planning of urban developments. As synthesised by van der Brugge and de Graaf (2010), water-sensitive urban design encompasses all aspects of urban water management, with additional urban design principles; it affects the volume and form of water-related investments: store or use water on site, rather than rapid conveyance of storm water; capture and use storm water as an alternative source of water, thus demanding less potable water supplied by a utility; use vegetation for filtering purposes; use landscapes to protect water-related environmental, recreational and cultural values; harvest water in decentralised systems for various uses; and treat wastewater in decentralised systems. Water sensitive urban design is most appropriate in expending cities, relatively low density urban environments, or in countries or cities projected to be affected by heavier rains, due to climate change.

Innovative business models for water utilities are other good examples of non-technical innovation. The revenues of most water utilities depend on the volume of water sold and of wastewater collected and treated. There are benefits in (at least partially) decoupling revenue from the volumes of water sold. This can be done through the development of well-designed water tariff structures, and opening up opportunities to derive additional revenue by enhancing environmental performance through performance-based contracts (where the utility receives a premium when it reaches certain level of performance regarding, for instance, leak detection, or the quality of effluents). Such options could be considered, in particular in countries and cities where water use per household is projected to decline.

Water-related innovation may derive from dedicated policies. For instance, several countries and states (Arizona, Australia, California, France, Israel, Korea, Malta, the Netherlands, and Ontario) have explicitly encouraged the development and deployment of smart water systems, either to address local issues, or to support a growing global business (OECD, 2015c). The challenge is to foster country collaboration and transfer innovations to less-developed economies.

Innovation in urban water management: the case of distributed systems for water supply

Biggs et al. (2009) define distributed systems as a model where infrastructure and critical services are positioned close to points of demand and resource availability, and linked within networks of exchange. Services traditionally provided by a single, linear system are instead delivered via a diverse set of smaller systems - tailored to location but able to transfer resources across wider areas. According to the authors, distributed systems represent a localised and highly networked approach to production and consumption, and blur the line between centralised and decentralised water models: the central infrastructure plays an arterial role at a regional level, while smaller, tailored systems operate and interact with users at the local level.

Distributed water supply systems have been advocated as part of the ‘soft path’ for water, characterised by Peter Gleick as an attempt to “improve the overall productivity of water use and deliver water services matched to the needs of end users, rather than seeking sources of new supply” (Gleick, 2002). In a systematic review of cases from Australia, Europe and the US, Biggs et al. (2009) show how distributed water systems can generate positive outcomes that enhance and supplement those provided by existing infrastructure models. Distributed systems can:

• Reduce costs and resource use, by adapting water management to context and making the most of available resources.

• Improve service security and reduce risk of failure, by building redundancies in the system.

• Adapt to shifting conditions and demands and respond to risk and uncertainty, by increasing the diversity and flexibility of water systems without locking utilities, customers and future governments into rigid pathways for delivering critical services.

Distributed systems can be well-adapted for the transition from oversized to more adequate infrastructure (see OECD, 2013b). In some German areas, demographic decline combines with the decrease of per capita consumption to induce such collapse in water demand that public systems end up being largely oversized. Some public operators admit that it will not be possible to sustain the present infrastructure; since it would need rebuilding anyway, one option is to redesign them with room for distributed technologies at single family, block or community level, in particular at the urban fringe.

Table 5.4. Technologies and innovations for water systems

Technology/ innovation	Applicability	Examples	Implications for societal costs compared with baseline traditional systems
			Existing assets (short to medium term)	New assets (medium to longer term)
Data, automation and control – real time monitoring, information and control (ICT)	Across the entire range of water systems, services and associated systems interacted with. There is a significant opportunity to maximise the potential of existing assets by getting the full use from them, by e.g. utilising the entire storage available by monitoring the volume and controlling flows, volumes and quality in real time.	Zimmer et al (2018) consider the use of predictive model based controls to manage combined sewer overfows spills for the Chicago deep tunnel sewer system. The added costs for the control options are compared with the avoided penalty costs for pollution incidents. Data analytics are now emerging as a concept for intelligent water systems control, enhancing efficiency and saving costs (e.g. Beach et al, 2018).	Overall costs to society should fall, although costs to service providers will increase in the short to medium term.	As for existing assets, but longer term system provision costs will fall for both society and operators.
Novel treatment processes	Especially relevant for wastewater systems in order to recover resource from waste and for different quality water supplies.	van Leeuwen et al. (2018) illustrate considerable opportunities to recover resources from waste that are now being exploited using novel technologies.	As most new processes will need to be retrofitted to existing treatment plants there will be added costs in the short to medium term.	There will still be added costs compared with the baseline in future, however, the benefits of e.g. resource recovery will far outweigh these.
Decentralised water systems	The emerging model of decentralised water service provision, using contemporary technologies.	The relative costs of centralised and decentralised systems depend on a number of factors (e.g. OECD, 2015). Institutional and operational arrangements are crucial to the optimisation of costs.	Where existing system provision is being expanded, decentralised systems may provide costs savings, but this will depend on context.	Decentralised systems can be installed at lower costs, depending on context, however, economies of scale will no longer be available.
Dynamic/intelligent asset management	This overlaps with the ICT category above and applies especially to (primarily capital) asset management	The extensive amounts of data now being collected routinely will mean that existing systems can be operated more effectively and even to extend the functionality beyond the original purposes.	There are significant ongoing added costs of installing monitoring and control systems into existing assets.	It may be that the clever data acquisition systems will be less costly in the future and a by-process of other data management systems, not water.
Multi-functional storm water/water systems	Systems that do more than simply provide safe water and safe wastewater disposal. Surface water in particular will provide opportunities for urban form and interact with lifestyles and willingness to accept more local systems	Water Sensitive Urban Design is an integrative approach to managing surface water more effectively in urban areas. Specific technologies will be required to do this using blue and green infrastructure and new modelling tools (e.g. Kuller et al., 2017). Lifestyle implications will need to be managed to ensure acceptability and uptake.	Taking advantage of the multi-functional opportunities that managing water differently can provide is going to cost more in the short to medium term as it requires retrofitting.	In the medium to longer term, multifunctional systems will become the norm, providing a wide range of added societal benefits. Although some costs will increase, these are likely to accrue to other societal service providers and individual property owners.
Mainstreaming opportunities	Mainly applies to piggy-backing on the provision of others systems or services	Rijke et al., (2016) illustrate how mainstreaming can save costs when responding to the threats from climate change. Although so far focused on flood risk management and potentially drought management, mainstreaming could provide many opportunities for co-provision of water and other services.	The provision of water related benefits will cost less when added on to other services.	As multifunctional systems become more widespread, needs to mainstream will be less required.
Behavioural changes, and lifestyle opportunities	Interactions with the ways in which people live in urban areas can provide novel uses and options for water management, especially uses of different grades of water. This requires influencing behaviours to e.g. use less water, use different types of water.	Demand management has been effective in many parts of Europe, although the lack of application of full cost recovery continues to hamper individual restraint in the domestic sector.	Demand management has had mixed success. Full cost recovery may make the business case for different water uses and sources more compelling to domestic consumers. Overall societal costs may fall, although costs to service providers may increase.	There may be more opportunities to influence behaviour longer term, although to ensure this will require compelling regulation.

Note: green: lower social costs; red: higher social costs; yellow: no change or not applicable

Source: Various. Compiled and synthesised by Richard Ashley for this report (Ashley et al. 2018).Options to harness additional sources of finance

Most EU countries would benefit from exploring options discussed in previous sections, to make the best use of existing assets and financial resources, and to minimise future financing needs. These options can contribute significantly to closing the financing gap, in particular in countries where this gap is widest. Still, additional finance will be required to close the gap. This section explores options that can mobilise new sources of finance available in all EU member states. Success in mobilising these sources depends on progress made in the other two sets of options discussed above, which can be seen as requisites to harness additional sources of finance.

Policy options discussed in this section are particularly relevant in countries that depend the most on EU funding (see Chapter 2.1 above). Such dependence is detrimental to sustainable financing strategies at country level, as these funds are programmed to decline and be gradually phased out. The ensuing sections present policy insights and guidance on the following options to harness additional sources of finance:

• Ensure tariffs for water services reflect the costs of service provision

• Consider new sources of finance

• Leverage public and cohesion funds to crowd-in domestic commercial finance.

5.2.5. Ensure tariffs for water services reflect the costs of service provision

In most EU countries – and in particular in those facing the most severe financing challenges - there is room to ensure that tariffs for water supply and sanitation services reflect the costs of service provision. Further increases of WSS tariffs can ensure adequate funding for WSS service providers and control water consumption. For instance, Bulgaria is committed to move towards full implementation and enforcement of recovery of costs of water services, including environmental and resource costs. Room of manoeuvre is significant in Cyprus, where urban water supply and sanitation tariffs (both from water boards and municipal departments) are lower than in most other European countries (Marin et al., 2018). In Croatia, affordability concerns create very little room to manoeuvre in terms of tariff increases. One option would be seasonal tariffs in touristic areas, matching peak demand.

A usual barrier to tariff increases, affordability concerns are best addressed outside of the water bill, through targeted social measures. This is supported by a vast and convergent literature. The forthcoming OECD report Addressing the Social Consequences of Water Tariffs (OECD, 2020) explains how sophisticated tariff structures – including increasing block tariffs, which are increasing widespread across Europe - require a lot of information, which may not be available, and end up being regressive: they benefit households who could afford to pay more for water services, while depriving service providers from needed revenues. In so doing they hinder the extension of water services to deprived areas, hurting the poor or vulnerable groups.

In countries where a significant share of the population faces (or is projected to face) affordability issues, accompanying social measures may need to be supplemented by well-designed solidarity mechanisms at a larger scale. These may take the form of cross-subsidies across water users or territories (from urban to rural areas). Aggregation of services providers or organising authorities can facilitate such transfers. This is the case in Romania and Bulgaria, and to a lesser extent in Lithuania, Latvia and Poland. Croatia is considering moving into that direction.

5.2.6. Consider new sources of finance

Most countries would benefit from considering new economic instruments to raise additional revenue for water management and internalise pressures on water bodies (that result from abstraction or pollution). This may include the introduction of fertiliser and pesticide taxes to reflect the costs of water pollution, storm water taxes on property developers for impermeable surfaces that increase the risk of urban flooding, and payment for ecosystem services from utilities to farmers in exchange for the protection of catchments and the quality drinking water sources. Storm water taxes on property developers can raise revenue for flood protection measures and incentivise nature-based solutions, such as sustainable urban drainage systems. They may be relevant in Cyprus, for example, where the construction sector is dynamic.

Countries could also exploit synergies and combined investment opportunities with other sectors (e.g. urban development, food security, energy security, tourism) that reduce water-related risks. Options to align incentives through insurance schemes and land value capture mechanisms (such as local taxes on property value) should be explored on a case-by-case basis.

Box 5.2. Land value capture – a suite of tools to finance water-related investments

According to the “beneficiary pays” principle, expressed in the Vancouver Declaration during Habitat I (UN, 1976), the beneficiaries of public investments that valorise their land should partly cover such costs or return their benefit to the public. The means by which beneficiaries can pay back include taxes, such as land taxes and betterment charges; development charges or permit fees; pricing and compensation policies; adequate assessment of land values; and leasing publicly owned land (UN, 1976).

Land value capture techniques can foster local urban development. Because public investments and planning decisions on urban development concern land in a very specific, localised manner, land value capture tools are a matter for local governments. Local governments may influence the direction of these projects to ensure the alignment with urban development and spatial planning goals.

Land value capture tools can fund a wide range of urban development projects. Even though they are not associated with any particular type of investment, some projects could particularly benefit from the adoption of such tools, such as urban renewal projects and Transit Oriented Development (TOD) projects, given the great potential to trigger land valorisation.

Experience in water-related projects is limited so far. Casablanca, Morocco, paved the way. Casablanca is characterised by rapid urbanisation; its population is expected to grow from 3.5 million to 5 million inhabitants by 2030. Extending the water network, securing access to the resource and protecting it against frequent floods are serious concerns for the local authority, which needs to finance these projects.

The city defined a new investment programme in 2007. Revenues from user tariffs cover operational and maintenance costs and the renewal of existing assets (accounting for 70% of total cost over the last decade). A dedicated account (fonds de travaux) covers the remaining costs (essentially land acquisition, network extension and social connections). Financed mainly by contributions from property developers, it has financed a growing share of total investment, from 7% in 2004 to 54% in 2014. Property developers also cover the costs of connecting to the network and in-house equipment. Their contribution varies depending on the type of housing (social housing, villas, hotels and industrial zones), and they pay additional costs for developments that do not feature in the master plan. Contributions are waived when the developments take place in underprivileged neighbourhoods and slums.

Source: OECD (2019), Land Value Capture: Framework and Instruments, unpublished paper; OECD (2015c), Water and Cities, OECD Publishing, Paris.

5.2.7. Leverage public funds (incl. EU) to crowd in domestic commercial finance

Domestic commercial finance is available across EU member states. As documented above, few countries have gained experience mobilising it for water-related expenditures. There is room of manoeuvre to attract commercial capital for creditworthy borrowers to finance water-related investments. This may require exploring how public budgets, incl. 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.

In Bulgaria, for examples, domestic financing (from public budgets, service providers revenues and potentially commercial finance) needs to be mobilised to reach the level of investment required to achieve compliance. This includes continuation of the water pricing reform, combined with targeted social measures to address affordability constraints and solidarity mechanisms to help cover investment costs in communities where financing capacities are especially limited. Authorities should review existing provisions that allow for service operators profits to accrue to government budgets rather than Water Associations, which could use such resources to strengthen the financial sustainability of the sector and provide a basis for accessing commercial finance. Building on recent set up of a Fund of Funds, in co-operation with European Bank for Reconstruction and Development (EBRD), options to attract commercial capital for creditworthy borrowers to finance water-related investments should be further explored.

Similar developments would benefit other countries. In Lithuania, existing financing structures such as the VIPA (Lithuanian Public Investment Development Agency) public fund managed by the Central Bank of Lithuania have a role to play. VIPA developed a dedicated financing instruments (the Water supply and wastewater fund and repayable assistance for the development of new wastewater networks). The fund could seek to attract private investment and facilitate the matching between the interests and needs of providers of private financing and project promoters. At a country workshop in October 2018, there were strong signals from International Financial Institutions that Romania could attract different kinds of support and funding as long as it is clearer in its strategy. This would also incentivise the private sector to invest in the Romanian water sector.

Tapping the potential of blended finance for water-related investments

The OECD defines blended finance as the strategic use of development finance (such as development assistance from donor governments and funds provided by philanthropic foundations), to mobilise additional commercial finance – (from public or private sources) –for investments that address the SDGs in developing countries.

The logic behind the approach is simple. Commercial investors, whether banks, investors, businesses or project developers respond to and are constrained by risks and returns associated with investments. As a result, investments with important public good dimensions may be backed by a sound business case but cannot necessarily be financed by commercial investors due to high risks associated with projects or uncertainty related to returns. In these cases, public support can be used strategically through blended finance to improve the ‘risk-return’ profile of investments, effectively de-risking investments to borrowers to access commercial finance. Blended approaches have a dual aim: i) mobilise additional capital for investments, and ii) serve a market building role, to help strengthen the financing systems upon which investment rely through greater accountability.

While the concept was developed with a focus on developing countries, the logic applies in European countries as well, in particular for water-related investments, where the public good dimension and political interference make financial returns uncertain.

The OECD has explored how blended finance could be accelerated for water-related investments, with a specific focus on water supply and sanitation utilities, off-grid sanitation and multi-purpose water infrastructure (see OECD, 2019b). Main lessons from this research are highlighted below and adjusted to the European context. Lessons from innovative arrangements in Europe could inspire further developments (see the Box 5.3 below).

Box 5.3. European experience with bending sources of finance for water-related investment

Although they do not all fit “neatly” into a blended finance definition, three recent developments in Europe can provide examples of mechanisms to leverage public/ development funds to access commercial capital.

NWB Bank in the Netherlands. Originally capitalised by public funds (Water boards [Regional water authorities] and government), the Bank now raises funds on capital markets to lend specifically for water-related projects (to the public sector – e.g. RWAs and other government authorities implementing projects). This is a fairly unique institution in the European context, but a good example other countries can learn from. For a concise summary, consult OECD (2014).

EIB’s Sustainability Awareness Bond (SAB). The Bond was recently launched to raise debt financing focused in particular on water and wastewater projects. In a recent report, the OECD notes that “the new bond product aims at supporting the global goals by contributing to the development of a sustainable financial system through the financing of water and wastewater projects. In September 2018, the EIB issued its first EUR 500 million SAB. SAB eligibility is open to projects that contribute to the implementation of the SDGs without any geographical restriction. By December 2018, EUR 128 million has been allocated across 15 projects in 12 countries, including Senegal (28%), Italy (22%), Egypt (16%), and Panama (10%). Of these, 52% went to wastewater collection and treatment projects (EUR 65.6 million), 45% to water supply (EUR 55.8 million) and the remaining 3% to flood protection (EUR 3.6 million). SABs are a “use of proceeds” type of bond, meaning that disbursements for an SAB-eligible project will be funded from a dedicated account, where all funds raised through the issuance of SABs are managed by the EIB to finance solely water-related projects that meet the bond criteria.” (OECD, 2019b).

As noted above, Bulgaria set up a Fund of Funds using a blended finance rationale and approach. The Fund of Funds will aim to use guarantees to help mobilise additional sources of capital. Further efforts could be developed to explore how public and development finance and risk-mitigation instruments (e.g. guarantees, credit enhancement instruments) can be used strategically to improve the risk-return profile of investments to attract commercial finance.

Source: OECD (2014), Water Governance in the Netherlands, OECD Publishing, Paris; OECD (2019b), Making Blended Finance work for water, OECD Publishing, Paris

A range of instruments are being used for blending, going beyond the more traditional loans and grants to the use of guarantees, securitisation, currency hedging, political risk insurance, etc. In this context, greater diversification of instruments could support better targeting of different risks and result in more commercial resources being targeted towards sustainable development outcomes. Amongst the different models, collective vehicles, such as funds, bring investors together to pool financing and offer opportunities for scaling up blended finance. In particular, structured funds allow donor governments to use concessional finance in a first loss position to provide a risk cushion for commercial investors. Blending can also occur through equity or debt investments in projects and companies in developing countries.

Beyond guarantees, technical assistance at the transaction level plays a major role in water and sanitation. Technical assistance can have different entry points in blended finance transactions, including for project development, investees such as utilities, or financiers such as banks to set up new lending programmes for the water and sanitation sector. Technical assistance has a particularly crucial role to play in tailoring existing blended finance structures to local contexts.

The success of blended finance is dependent on the ability to mobilise local commercial investment. Blended finance for water-related investments reinforces the need for, and benefits from, tailoring blended finance to the local context. Water and sanitation services are, by definition, locally sourced and provided and flood risks are best managed at the basin scale. At the same time, the sector requires strong public regulation due to the public good dimension of water and sanitation services and the common pool nature of water resources. These characteristics emphasise the need to work closely with local actors and align with local development needs.

There is a need to link blended finance approaches to the underlying value chain. To effectively tailor blended finance models for water-related investments, an understanding of the underlying business models and value chains is needed. Blended finance models can enter the sector at different points, for example at the water provision or treatment level, downstream at the end-user level or at the investor level. Effective blended finance approaches take into account the business models and respective revenue streams, and incorporate different stakeholder perspectives.

Pooling projects could be an effective way forward to address selected unfavourable project attributes. Providing commercial investors access to a variety of different transactions in the water and sanitation sector can mitigate concerns around small ticket size, risk exposure, limited sector or regional knowledge as well as high transaction costs. Pooling mechanisms such as blended finance funds tailor different risk and return profiles for individual investors, with development financiers often taking first loss and junior traches buffering the risk for commercial investors in the senior tranches. Guarantees, moreover, can strategically mitigate portfolio risk.

Beyond transaction-related insights into potential pathways to scale blended finance for water and sanitation, policy level implications can facilitate an uptake of blended solutions for sustainable development in the sector.

• Design blended finance in conjunction with efforts to improve the enabling environment. Blended finance cannot compensate for an unfavourable enabling environment, but rather needs to be accompanied by efforts to promote a stable and conducive policy environment. A weak enabling environment characterised by poorly designed or absent regulation, policies settings (e.g. water prices and tariffs), or institutional arrangements, compounded by political interference in the management of (often public) utilities, constrains commercial investment.

• Increase transparency to make a valid business case for commercial investment. Commercial investors are cautious about uncertainty regarding any of the risks related to an investment opportunity. With adequate contractual arrangement or blended instruments and mechanisms, it is possible to mitigate a variety of risks, share the remainder with the public sector or commercial co-investors, or take a certain level of risk on the financier’s own book. However, in order to make such an assessment, risks associated with an investment should be transparent and hence quantifiable.

• Establish policy-level co-ordination and co-operation processes for blended finance. Coordination and co-operation among development finance actors on their blended finance engagements is a key for the market building aspect of blended finance, particularly when a concessional element is involved. Development financiers should co-ordinate more structurally beyond single transactions. Notably, an excessive reliance on concessional finance can inadvertently crowd out commercial finance, creating market distortions that impede greater accountability and financial sustainability of the sector. While there is general agreement about the need for improved co-operation, actions on the ground may remain fragmented.

In a longer term and dynamic perspective, blended finance is a transitory market building tool that is designed to enable stand-alone commercial investment in the long-run, by providing confidence, capacities and track record in markets where commercial investors are not yet present. Blended finance, starting with concessional elements, should phase out over time and ultimately exit in order to prevent market distortion. An analysis of the exit strategy should be integrated in any programme design.

5.3. Financing as part of flood risk mitigation strategies

Today, financing for flood risk management is employed in two directions (OECD, 2016):

• Investments in lowering flood risk – and thus investments in flood protection infrastructures, be it traditional “grey” infrastructures or nature-based solution (also known as pre-disaster options); and

• Provision of financial protection in case of flood events, thus refunding flood losses and damages (this financial protection is provided post-disaster, but it is arranged in a pre-disaster phase).

To date, flood protection in Europe is largely financed through public grants (Colgan et al, 2017). This can create significant costs for governments in terms of both investments in risk reduction and emergency responses and reconstruction (OECD, 2016). This can be especially burdensome in these times of growing public budget constraints.

Nevertheless, alternative instruments are available to finance both investments in flood protection and the provision of financial protection in case of flood events – and two categories of instruments can be identified, respectively: (Koehler et al, 2014):

• Economic Instruments (EIs), to provide a monetary/economic incentive promoting efficient flood risk management and risk reduction; they can be administered either by the government or by private entities. This category includes natural resource pricing, taxes, subsidies, marketable permits, payments for ecosystem services, licenses, property rights, habitat banking and trust funds;

• Risk Financing Instruments (RFI), comprising all instruments that promote the sharing and transfer of risks and losses. These are pre-disaster arrangements coming into play in a post-disaster phase. They include insurance, weather derivatives and catastrophe bonds.

These economic instruments, if properly designed, can contribute to achieve two key objectives of risk mitigation strategies (Koehler et al, 2014): raise revenues to finance flood protection (some instruments are not designed to raise revenues, but their application might result in resource saving); and indirectly incentivise behaviour and increase the uptake and efficiency of risk-reduction measures.

This suggests that such instruments should not only be looked at as financing sources/ mechanisms, but they should rather be intended as actual policy instruments to manage risk mitigation, together with other risk mitigation measures such as regulatory and research and development measures. They could be part of an integrated approach to risk mitigation strategies.

In the context of an integrated flood risk mitigation strategy, both EIs and RFIs can further contribute to reducing exposure, and in particular:

• EIs: as mentioned above, most of these mechanisms can raise new revenues to be invested in flood protection; often, this releases some of the existing pressure on public budgets. In addition, some EIs can influence behaviour, further reducing exposure levels – for example, by providing incentives for building and buying properties outside of at-risk areas;

• RFIs: insurance scheme, if properly designed, could steer behaviour towards reduced exposure levels. For example, a mandatory insurance can be required for buildings in at-risk areas, making it less convenient to live and install businesses in such areas.

5.3.1. Investments in lowering flood risk in Europe

Grants

Financial arrangements for investing in flood protection infrastructures vary from country to country, but usually there are under the responsibility of national governments and the EU.

European funds employed so far to finance flood protection (incl. infrastructure, nature-based solutions and other measures) include cohesion policy funds and European Investment Bank (EIB) funding. Nature-based solutions can also be funded through the LIFE programme – in addition, under this programme, the EIB administers the Natural Capital Financing Facility, which is designed to provide a “pipeline of bankable projects” involving natural capital, including natural infrastructure as adaptation to climate change.

In contrast, private conservations investments so far have not been so much directed at nature-based flood protection infrastructures, but rather at preserving and/or restoring natural systems – with flood reduction as a co-benefit only (Colgan et al, 2017).

Disaster relief is also provided by the EU Solidarity Fund, which was created as a reaction to the severe floods in Central Europe in the summer of 2002 and has been used for a range of catastrophic events6.

Economic Instruments

EIs currently in place in Europe mainly belong to three categories:

• Land use taxes and fees: The flood-related land tax (or a flood-related component) can be applied to coastal or river flood risk management, to internalize the adverse effects of developments within high-risk areas. Land use taxes can represent a payment either for the land ownership itself or for its kind of use. Taxes and fees are also an important revenue-raising instrument, to raise funding for investments in flood protection infrastructures.

• Subsidies: Many forms of subsidies can intervene in managing flood risk. Subsidies can be on land prices in safe areas: while the demand for land increases in the subsidized safe areas, the demand for risky locations goes down decreasing land prices and pressure to develop there, and consequently decreasing costs for flood protection in the long term. Subsidies can also come along in the form of tax reduction – thus not necessarily as money transfers. Furthermore, some subsidies can have an adverse effect on flood risk levels.

• Payment for Ecosystem Services (PES) and Payments for Watershed Services (PWS): PES are voluntary mechanisms where suppliers of ecosystem goods and services (EGS) are paid by the beneficiaries to manage the ecosystems so that the provision of EGS is maintained and/or enhanced. PWS, in particular, are focused on the EGS provided by sound watershed management, linking upstream land and water management and downstream benefits. PWS are particularly relevant for financing natural water retention measures (NWRMs), as these measures are applied (or should be applied, to maximize their effectiveness) at the watershed level, and their impacts and related benefits also concern the watershed and, in particular, downstream areas.

Some of the existing EIs in Europe are presented in the Table 5.5 below7.

Table 5.5. Selected existing economic instruments in Europe

Taxes for dykes maintenance (The Netherlands)	Historically, Dutch Water Boards (regional government bodies) have collected taxes to cover the costs for the maintenance of dykes. At present, Water Boards finance their water quality and flood protection activities (up to 95% of total costs) through local taxes. These taxes are charged according to the `beneficiary-pays’ principle: the beneficiaries pay a water board tax proportionally to their interests. Thus different stakeholders (farmers, residents, industries) may be charged different taxes by the same water board. (Source: Filatova, 2014)
Taxes for landowners protected by a dyke (Germany)	Wadden Sea States are responsible for the organisation and administration of (public) coastal defence in Germany. However, as coastal defence has national consequences, capital measures are co-financed by the federal government with 70% of total eligible costs (the other 30% are matched by the states). The maintenance of existing state coastal defence structures is financed 100% by the state. Municipalities and/or local water boards that are responsible for coastal defence measures in their area normally have to contribute between 5 and 20%. A small but increasing contribution to coastal defence comes from the European Union. The overall principle is that all persons who profit from protection are in charge of maintaining the dikes. Beneficiaries are organised in water boards which have to do the maintenance and construction works on the mainland dikes, except for some which are under State responsibility. (Sources: Trilateral Working Group on Coastal Protection and Sea Level Rise - CPSL, 2010; CPSL, 2001)
Drinking water forests – Offset scheme1 (Germany)	Bionade Corporation, a beverage manufacturer, in partnership with Trinkwasserwald e.V. (Drinking Water Forest Association), is creating '"drinking water forests" all over Germany. The project involves afforestation of privately and publicly owned land with deciduous broadleaved trees, with the aim of enhancing groundwater regeneration. Bionade aims to offset its own water use in doing so, with a target of about 100 million liters each year or 130 hectares of reforested lands. Forest land holders sign contracts with Trinkwasserwald e.V. agreeing to reforest monoculture coniferous plots with deciduous trees.
Bosco Limite project – PES scheme2 (Italy)	The project aims at creating a forested area that will catch precipitation and increase groundwater recharge and other EGS. The project was implemented in an area previously used for intensive agriculture, and activities with high economic returns. In turn, it provides in fact a wide range of goods and services, such as groundwater recharge, runoff reduction (and thus flood mitigation), CO2 fixation, biodiversity safeguard, production of high quality wood and biomass for energy production, and recreational-touristic services. Such services have then become alternative, competitive sources of income for landowners who made their land available for reforestation, through the establishment of a PES scheme.

Notes:

1. NWRM project - http://nwrm.eu/sites/default/files/sd11_final_version.pdf

2. NWRM project - http://nwrm.eu/sites/default/files/sd11_final_version.pdf

Other instruments

A particular financing instrument, which cannot be defined as a EI, is the Barnier Fund in France. In essence, the Fund is mostly financed by a 12% levy on the compulsory insurance against natural disasters for residential and commercial/industrial buildings. The State’s contribution to the Fund is around 7% of total revenues, whereas revenues from the levy cover up to 97% of the total expenditures of the Fund. The Fund was set up to finance some flood protection actions and it is almost self- sustainable. A detailed analysis of Barnier Fund is appended.

Green bonds can also be used to fund flood protection infrastructures. “Green bonds” is the term that is often applied to environmentally related impact investing. The largest type of green bonds is funding related to climate change, predominantly for projects designed to reduce greenhouse gas emissions. To access the green bond market, nature-based infrastructure projects need to meet two conditions: i) a revenue source to repay the bond buyers; and ii) a set of performance standards to demonstrate attainment of flood risk reduction goals. Repayment of the bonds can come either from public funding or from private funding, in the form of private organisation created to share benefits among members/funders. Green bonds can be financed both by public or private investors. In the US (and, to a lesser extent, in Europe), the revenue flow stream for private investment in green bonds is often provided through “special purpose districts”. These districts manage “semi-public” infrastructure, and there is a variety of options for the structure, financing, and governance of such districts. Revenues are generated as these districts directly link the beneficiaries of infrastructures to the financing of infrastructures, so they can back green bonds (Colgan et al, 2017).

In the UK, the National Infrastructure Commission reported that many UK pension funds and other institutional investors have developed investment funds or investment platforms for infrastructures.

5.3.2. Provision of financial protection – Risk Financing Instruments in Europe

In some countries Risk-Financing Instruments (RFIs) are in place: this category comprises all instruments that promote the sharing and transfer of risks and losses. These are pre-disaster arrangements coming into play in a post-disaster phase. They include insurance, green bonds, weather derivatives and catastrophe bonds.

In Europe and elsewhere, the most common RFI is insurance, an instrument providing financial protection against flood damages. It aims at eliminating economically-unwarranted use of flood-prone area, while not prohibiting land use. Insurance serves as a risk-sharing and risk-communication device to help individuals rationalise their land use choices in at-risk areas. If risks are correctly priced in premiums, insurance allows location in hazard-prone areas for those who are ready to bear the risk, without increasing a burden on taxpayers (Filatova, 2014). In fact, the level of insurance penetration has been shown to be negatively correlated with the level of impact of disasters on economic output – in other words, countries with higher levels of insurance penetration face more limited negative impacts on economic output (OECD, 2016).

Nevertheless, the way insurance is designed and premiums are priced is key to the good functioning of insurances as a risk-communication instrument. In particular (Filatova, 2014), insurance premiums that are uniform or do not differentiate for actual flood risk may bias economic location decisions; non-compulsory flood insurance leads to information asymmetry among residential buyers and sellers.

Table 5.6 below provides an overview of existing flood insurance schemes in the EU.

Table 5.6. Selected existing insurance schemes in the EU

Mandatory multi-risk home insurance (Romania)	In Romania, homeowners are required to purchase home insurance covering damages from floods, landslides and earthquakes –they can be fined if not insured. Nevertheless, many homeowners do not purchase any insurance, because some legal clauses allow them to remain uninsured if some socio-economic thresholds are not met. As a result, only 38% of dwellings are currently covered by insurance. Overall, it was observed that the Romanian disaster risk financing framework, in its current form, is rather ex-post, and the link between risk reduction and risk financing is weak (Surminski and Hudson, 2017).
Flood insurance in the Po RBD (Italy)	In the Po RBD, flood risk management involves the controlled flooding of agricultural land (low-value use) in order to avoid larger losses in urban areas (high-value use). However, in agricultural areas, only some 5% of private properties at-risk are covered by flood insurance. In other words, flood insurance here is specifically designed to cover the deliberate costs arising from a risk reduction scheme (i.e. the temporary flooding of agricultural land to preserve urban areas) (Surminski and Hudson, 2017).
Flood Re scheme (the UK)	Flood Re scheme is a re-insurance scheme negotiated through a series of voluntary agreements between the Government and members of the Association of British Insurers (ABI). It has been set up to help those households who live in a flood risk area find affordable home insurance1. The aim is to ensure the availability and affordability of flood insurance, without placing unsustainable costs on wider policyholders and taxpayers. The scheme does not contain any risk-reduction element, although the Government is showing some commitment to improve flood risk management (Surminski and Hudson, 2017).
CatNat - Natural disaster insurance system (France)	CatNat is a public-private compensation system that covers losses that cannot be insured in private markets, such as flooding. Under CatNat, it is mandatory for insurers to extend property and vehicle insurance contracts to cover damage caused by natural disasters. These additional premiums are not differentiated according to the actual natural disaster risk, but are fixed by the Government following a principle of national solidarity. One of the main reinsurers providing coverage for CatNat is the Central Fund for Reinsurance2 (CCR), an international reinsurance company owned by the French government. The government will compensate damage above a certain amount stipulated in the law by providing an unlimited guarantee of compensation exclusively to the CCR, and not to other reinsurers in the market. The scheme is linked to Natural Risk Prevention Plans, which regulate land use to reduce exposure of property and people to natural hazards – mostly by limiting new construction and enforcing implementation of prevention measures by local communities in flood-prone areas (Poussin et al, 2013).

Note: 1. https://www.floodre.co.uk/

5.3.3. Innovative financing mechanisms from outside the EU

Innovative financing mechanisms have the potential to expand available funding options for flood protection. Some of these instruments are already used outside of Europe. Innovative mechanisms all belong the EIs category. See below for illustrations.

Table 5.7. Innovative financing mechanisms for flood protection

Instrument	Description	Examples from outside the EU
Marketable permits	A scheme was proposed in which government issues the socially-optimal amount of marketable permits for developing risk zones. The amount of marketable permits should differ per zone depending on the probability of hazard occurrence or other criteria. The market further allocates available land to the highest opportunity cost.	No examples available: instrument proposed at the research/ policy level, and never implemented.
Advanced market commitment	The government guarantees a certain income to the entity providing a desired activity, making this instrument comparable to a subsidy.	This instrument has not been applied to managing flood risk yet –although there is a potential for its application.
Transferable development rights (TDR)	A cap is set on the quantity of development and the area is split into the receiving zone (with lower or no flood risk) and sending zone (with higher risk). Landowners in the sending zone cannot use their development rights, but can sell them to someone in the receiving zone. Thus, TDR discourage development in at-risk areas and move it to low-risk areas, or areas which are easier to protect against floods. Thus, TDR are not a direct financing scheme for flood protection, but save public resource in many ways: i) it moves development in areas with lower flood protection costs; ii) it reduces transaction and administrative costs, as compared to the management of a traditional permit system; and iii) it reduces the costs of damages in case of flood events.	TDRs are common in the US for nature conservation projects – in fact, TDR schemes to manage retreat from flood-prone areas can go hand in hand with nature conservation initiatives (e.g. nature based solutions for flood risk management).
Water Funds (and Trust Funds in general)	Water funds finance watershed management, paying for the services that ecosystems provide to humans. Water funds pool together capital contributions from different stakeholders involved in watershed management such as water supply companies, hydropower plants, irrigation districts and agricultural associations. Capital contributions are invested in the financial market through trust funds, and the financial returns are invested in watershed management activities, such as conservation measures, protected areas, promotion of eco-friendly agriculture and so on. Trust funds have been used widely to finance nature conservation worldwide and in particular in Latin America and Asia.	Their implementation has been spreading in recent years and in Latin America in particular. The FONAG (Fondo para la Protección del Agua) is an example of this.
Habitat banking	Habitat banking aims at conserving the ecosystem services of land, including biodiversity. Credits are given for the creation, restoration and enhancement of habitats, while debits occur when ecosystems are unavoidably degraded or destroyed.	No examples available to the authors’ knowledge

Source: Koehler et al, 2014; Filatova, 2014, and NWRM Project.8

The following criteria were used to assess the potential of existing instruments as part of risk mitigation strategies:

• What is the revenue-raising capacity of the instrument?

• What is the capacity of the instrument to steer behaviour and minimize flood risk?

• Is the financing source adaptable? In other words: is the instrument apt to finance large, on-time investments (e.g. in large infrastructures), or rather modular, smaller investments over a period of time?

• Does the instrument decrease reliance on public budgets? Or, in other words: how does it allocate the costs to investors other than public actors?

• What is the geographical scale of the instrument? And what is its potential to be scaled up? Is it replicable in other countries? Which requisites must be met?

Table 5.8 below summarises the assessment of the relevance of innovative instruments as part of integrated flood protection strategies in Europe. A more detailed analysis of EIs and RFIs is appended.

Table 5.8. The performance of economic policy instruments as part of risk mitigation strategies

Performance criteria Economic instrument	1. Revenue-raising capacity	2. Capacity to steer behaviour	3. Adaptability of the source	4. Allocation of costs across actors	5. Geographical scale	6. Replicability
Land taxes	Can be significant	Yes, if proper rates	Yes (possible to plan)	Individuals in at risk-areas pay, but still some burden	All scales	Yes
Earmarking water charges	Not possible to estimate	No	Yes (possible to plan)	Water users pay, but still some burden	All scales	Yes
Offset schemes	Yes, but only as in integration to other sources	Not applicable	Low - focus on specific protection or restoration actions	Yes, private actors pays, but usually for specific measures	Localized measures and interventions	Yes, in principle
PES schemes	Yes, but only as in integration to other sources	Yes, but the scale depend on the scale of the scheme	Low - focus on specific measures or practices	Yes, private actors pays, but usually for specific measures or services	Often local or watershed scale	Yes, but there might be constraints
Green bonds	Significant capacity	It depends on the way revenues are raised	Mostly used for infrastructure development	Opportunity to boost private investment	All scales	To be investigated (for the EU)
Flood insurance schemes	Not applicable	Depending on how they are designed – Not at the moment	Not applicable	If properly designed, they can reduce burden on the long run	National level	Yes
Fonds Barnier	Yes – main source of disaster prevention	Not really, although it could	Wide range of expenditures	All building owners are charges, releasing burden	National scale	Countries where flood insurance is mandatory

Note: Colours reflect a traffic light approach. Grey stands for “not applicable”

In summary:

• Land taxes have a good revenue-raising potential, as well as a good potential to steer behaviour, they can be applied at all scales and in all countries;

• Earmarking water charges have a good revenue-raising potential and can be applied everywhere at all scales; nevertheless, they charge water user for flood protection, thus providing no incentive at all for risk-reduction behaviour (basically, the wrong people are charged!);

• Offset schemes offer the possibility to introduce private capital into nature protection and restoration, but they normally focus on specific measures and/or actions;

• PES schemes introduce some private financing for environmentally-sound management and nature protection, but usually for specific measures or services;

• Green bonds have a significant revenue-raising capacity, and offer the opportunity to inject substantial private investment into flood protection actions. However, their uptake is low in Europe, and further investigation is needed to understand why;

• Flood insurance schemes, if properly designed, could provide a strong incentive for risk-reduction behaviour – thus also reducing the need for public investment on the long run. However, existing schemes do not provide such incentives;

• The Fonds Barnier is a mechanism able at financing most of flood prevention actions in France. However, it does not really provide an incentive for risk-reduction behaviour, and a similar mechanism could only be implemented in countries with compulsory flood insurance for buildings.

Different instruments can be combined in risk mitigation strategies, to get the most out of each of them, and the best mix of instruments will need to be assessed on a case-by-case basis.

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Notes

← 1.  As noted in previous sections, the position of Finland may result from an underestimate of current levels of expenditures.

← 2.  Note that even relatively arid countries can face increasing flood risks. The Northern and Southern regions of Span are good examples. And Portugal is projected to face heavier rain.

← 3.  EU funding offers that kind of support.

← 4.  There have been a number of initiatives to try to account for the wider social benefits of NBS, which draw on the development of economic valuation techniques for ecosystem services concepts; social value; and natural capital accounting.

← 5.  The costs and benefits of both grey and GI measures presented in this study are not directly comparable as they are highly dependent on the geographical location of the measure.

← 6.  http://ec.europa.eu/regional_policy/en/funding/solidarity-fund/

← 7.  The literature on economic instruments for flood protection often quotes other instruments, such as for example catastrophe taxes, lower land taxes in areas with lower risk, water markets for indirect risk reduction. However, no more detailed information was found, so the table only includes those instruments for which a good level of information could be found.

← 8.  NWRM Project - Synthesis document No. 11: Financing of Natural Water Retention Measures. http://nwrm.eu/sites/default/files/sd11_final_version.pdf