Financing waste projects, a challenging opportunity

Developing countries face the challenge of rapidly increasing waste volumes beyond what their current infrastructural and organisational, institutional and financial arrangements can cope with. The investment requirements for the physical infrastructure and capacity building to properly collect, segregate and recycle waste materials are substantial. The cost of providing basic Municipal Solid Waste (MSW) services to all Indian cities, for example, is estimated at between USD 500 million and USD 5 billion annually (David Hanrahan et al., 2006). Another indicator is the size of the market for technologies that specifically deal with MSW management, and which is estimated to be in the range of USD 2 - 3.5 billion for India alone (Yes Bank, 2010). Not all of this investment can be publicly financed. In order to decrease the financial pressure and improve MSW service provision, governments increasingly seek to rely on the private sector's involvement and financing. While private companies express interest in investing in this sector, they often find it difficult to raise the required capital. The major barriers include the unavailability of long-term finance, high transaction costs, and the limited value of the assets as collateral, due to the specialised nature of the technical operations and assets. Development Finance Institutions (DFIs) therefore have a role to play, as they can provide maturity-matched financing for large-investment projects, and are geared towards cash flow–based lending. Further, with the involvement of DFIs, measures could be introduced that minimise the negative impacts of MSW and contribute to an improvement in environmental and social (E&S) conditions. Considering the multiple economic, environmental and social benefits, there are major reasons for DFIs engagement in the waste sector. However, experience shows that, even for this kind of institutions, investments in waste management projects are challenging. This article illustrates the sector-specific aspects that have proven critical to the successful engagement of DFIs.

Technologies matching local conditions

The waste sector is a specialised industry, with high technological standards. Thus, engagement with the sector requires in-depth experience, thorough research and engineering know-how. The proven track record of a promoter or team of specialists is therefore the basis for successful project development. Technological know-how alone, though, does not guarantee successful project implementation. Many of the technologies applied in reprocessing and recycling waste, extracting energy and producing other products from the waste and gas captured from landfills, may have been tested in commercial use in industrialised countries. But, the effort required to adapt these technologies to local conditions is usually underestimated. Even a dated technology like landfill gas extraction does not work in Tunisia in the same manner as it does in Germany. Knowledge of the local context and the appropriate adaption to local conditions are therefore just as important as technological know-how. The applied machinery must match with the composition, quantities and qualities of waste delivered to the facilities, the local climatic conditions and the potential demand for products derived from the waste. There have been projects where the entrepreneur concerned was not aware that basic recyclable wastes are removed at the point of collection. Although the applied technology was of the latest standards, the business model failed. Sales were meant to be generated from recycled plastic, but the waste that was delivered to the borrower's facilities was virtually plastic-free. Waste pickers typically take away about 10-15% of the waste (by weight), which consists of the basic recyclable waste such as glass, plastic and metals, reducing the nominal value of the waste (Hanrahan D. et al., 2006). A private company that processes such basic recyclables is most likely to face bottlenecks in the supply of raw materials in low-income countries if it does not know how to ensure a proper supply.

The need for existing markets

In line with the development of new technologies, the quality of products generated from waste has been improved. As a result, the sale of compost, refuse-derived fuel, sand, plastic and waste-to-energy has become the standard business model of the recycling industry, including in developing countries. However, many of the smaller recycling companies have a single product focus. While specialisation in a single product is viable in terms of economies of scale and process know-how, the focus also makes the company vulnerable to market or waste composition changes. The composition of MSW differs from one location to another, based on lifestyle, taste, economic status and the preferences of the people staying in an area, and it evolves over time. Consequently the output volume of the respective product generated from the waste will also vary. Hence, multi-product production lines are beneficial for mitigating the risk, as producing multiple products reduces dependency on the composition of MSW. Another important factor to be taken into consideration is whether a market already exists for the sale of the output products. Depending on the region and the product, potential customers may be sceptical about purchasing products generated from waste, due to cultural, ethical, and religious restraints; due to their lack of knowledge of the product; or due to an unsuitable regulatory or incentive environment. There have been cases where local farmers have accepted compost derived from waste as a substitute for chemical fertilizers only after substantial marketing efforts. By the time the market was finally created, the company suffered from liquidity shortages. The evaluation of existing marketing tie-ups should therefore also form an important element of the feasibility of the project.

Environmental and social requirements

Waste projects include significant environmental, health and safety risks that are linked to the collection, treatment and disposal of waste. Associated problems include the contamination of land and water resources, air emissions, and a negative impact on the health and safety of workers and residents. In order to overcome these challenges, E&S management systems requirements, based on international best practices, need to be implemented by private companies. These E&S requirements are incorporated into an action plan, which forms an important element of the DFIs financing documentation to be signed. In order to ensure the implementation of the envisaged standards, a stringent monitoring system lead by external consultants is required. DFIs should accept that the implementation of E&S standards often needs to be carried out in several steps over a long period of time. Investing in below-standard but still acceptable facilities and then contributing to important E&S improvements is preferable to rejecting a finance request due to reputational concerns. In a lot of cases, unfortunately, the revenues of the private companies are not sufficient to address all the E&S requirements of the DFIs. Technical assistance provided by the financial institutions can form a partial solution to implementing the required E&S actions, but it is not always sufficient when the financial requirement is too large. A particularly sensitive social issue in connection with financing waste projects is the role of the waste pickers. It is critical for the lending institution to determine the extent to which the envisaged financing affects the income generating capacity of the waste pickers, and which instruments are available to enhance their living and working conditions, and their income levels. One option is the establishment of a close operating relationship between the formal and informal sector. Eventually, such cooperation may contribute to a progressive formalisation of the waste sector so that the waste pickers receive training, health protection, benefits, and fair compensation for their labour.

A secure regulatory, financial and legal framework

Private sector involvement in Municipal Solid Waste Management (MSWM) implies a shift in the role of government institutions, from service provision to regulation, delegation to the private sector and monitoring of the service provided by private companies. Unfortunately, the public institutions in developing countries often fail to provide what is required to ensure a proper and sustainable transfer to the private sector. At best, the government promulgates a MSW law, but it is rarely properly enforced, as appropriate systems of monitoring and control, along with relevant skills at the respective government and municipal levels are mostly not established. The governments focus on delegating responsibilities to municipalities, but these are often too weak and do not have the financial means, the organisational structure, nor the professional capacity to cope with the challenges of MSWM, and they do not have any mandate to regulate the sector. Besides, the sector is evolving quickly, and this requires adapting the regulation, which public entities are enable to do rapidly. This uncertain regulatory framework and lack of structure makes it difficult for an investor to identify and mitigate its risks. Another consequence of capacity limitations at the institutional level is that the contracts executed between municipalities and private enterprises may be of poor quality. Some of the primary issues of concern are the unclear definition of roles and responsibilities and inadequate risk mitigation measures. Another issue is municipalities tending to contract for more services than for which they are able to pay. Once the services have been billed, the municipalities may delay payment or try to lower the billed amounts by querying the service provided. As it is difficult to amend the contractual documentation signed by the municipalities, because of lack of experience or for bureaucratic reasons, it is very important for DFIs to assess the risks associated with these uncertainties and to define the minimum requirements to be included in these agreements. These requirements should include, among others, that the period of the agreement matches the period of the DFIs' financial engagement in the project; that major regulatory approvals, such as land leases, are obtained directly by the municipality; and that a guaranteed quantity of waste is to be provided by the municipality to the private recycling operator. The above illustrates the wide variety of critical issues that need to be overcome in order to mitigate investment risk for DFIs. There are of course niches where private companies can already invest and develop profitable business models, particularly in recycling. Such projects are very important as showcases for the public and decision makers. It is the role of the DFIs to carefully select those projects with acceptable risk profiles and to provide adequate financing solutions. Gradually, this may lead to the increased confidence of both investors and other financiers, and could contribute to the development of a mature commercial MSWM sector in developing countries. However, project financing alone may not be sufficient to remedy the deficiencies of the sector in developing countries: satisfactory capacity building and appropriate budgets also need to be addressed by the municipalities, in order to regulate the sector in proper ways. The question is whether DFIs should confine themselves to risk mitigation at a project level or whether they should in parallel support sector development, for instance, by providing policy loans dedicated to the development of an ‘enabling environment' for more advanced MSW projects.

References

Hanrahan, D., Srivastava, S. Sita Ramakrishna, A. 2006. Improving Management of Municipal Solid Waste in India – Overview and Challenges. Environment and social Development Unit, South Asia Region. The World Bank. / Yes Bank ,2010. Project Appraisal Memorandum.