BUDAPEST WASTE WATER SERVICES PRIVATISATION

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The project involves the partial privatisation of the Budapest Municipal Sewerage Company (FCSM) through the acquisition of a 25 per cent stake in FCSM (plus one share) by private sponsors from the municipality in order to bring in an experienced private sector operator to run the day-to-day operations of FCSM. The stake acquired by the sponsors in FCSM is to be sold to a special-purpose company, in which the EBRD would become a shareholder. The purpose of the project is to enhance the financial and operational performance of FCSM. The project will facilitate private sector involvement in sewerage services by Bank participation in an SPC. Through this, experienced private operators exercise operational and managerial control of Budapest's waste-water company so as to achieve improvements in operating efficiency and a reduction of operating costs. The project will expand private participation into another key sector of Hungary's economy, in the form of a public-private partnership arrangement. The municipality will retain majority ownership of FCSM. However, the devolution of management control to the private sponsors and linking their remuneration to efficiency gains will maximise the benefits of private sector involvement, leading to significant improvements to FCSM's capital and operating efficiency and a higher standard of service. This operation should be viewed as the first stage of a programme to meet Budapest's long-term capital improvement needs in this sector. Private management of FCSM will ensure that future investments to reduce pollution from waste-water effluents are selected, designed, procured and implemented in the most efficient way. The operation and its private-public partnership orientation is expected to have a demonstration effect for private sector involvement in the provision of municipal services. The sponsors will develop local skills in areas such as operations management, energy efficiency, revenue collection and administration, capital budgeting, procurement, leakage reduction, environmental management and financial management. The EBRD will become a shareholder of a special-purpose company (SPC), the purpose of which is to hold the equity stake (25 per cent plus one share) acquired by Vivendi (previously Compagnie Générale des Eaux) and Berliner Wasser Betriebe (together the "sponsors") in FCSM following its partial privatisation at the end of 1997. The Bank will invest ECU 22.7 million, representing at most 30 per cent of SPC’s equity. The sponsors will together hold 70 per cent of the SPC shares. The Bank's equity instrument is a hybrid of: (i) portage (predetermined Libor-based return, with a put to the sponsors); and (ii) real equity (possible upside depending on actual returns and market value of shareholding at exit), with a political and regulatory risk carve-out. ECU 75.6 million The project was screened as C/1, requiring an environmental audit of existing facilities. In April 1997 a consortium of independent consultants carried out environmental due diligence on FCSM prior to the partial privatisation. This due diligence audit revealed a series of non-compliance issues with regard to European Union and Hungarian environmental standards. FCSM has developed a draft Environmental Action Plan (EAP), which will bring the facilities over a period of around 16 years into compliance with applicable Hungarian environmental regulations and with EU requirements, which are currently being introduced in Hungary. Total investments required to comply with EU standards have been estimated at over ECU 1 billion. As part of the Bank’s covenants and requirements under the financing agreement, SPC will report to the Bank periodically on environmental and health and safety issues and improvements, in particular on the implementation of the EAP. None