In 1997, two concession contracts were awarded for water and sanitation services in Metropolitan Manila in what was then the world's largest water PPP project. At that time, Metropolitan Manila had a population of 11 million spread across 12 cities and five municipalities. With 16,000 people per square kilometer, this was a very densely populated conurbation.
The service area of the Metropolitan Waterworks and Sewerage System (MWSS) was divided into two zones-west and east-which were bid out separately in an international tender. The same company could not win both zones. The contract for the west zone was awarded to Maynilad Water Services Inc., a joint venture between Philippine conglomerate Benpres Holdings Corporation and French multinational Suez SA. The east zone was awarded to Manila Water Company, a joint venture of Ayala Corporation, one of the Philippines' largest companies, United Kingdom-listed water company United Utilities Group PLC, and United States construction and engineering group Bechtel Corporation. The 25-year contracts specified targets for the concessionaires to increase the coverage and improve the continuity of water supply. They were also required to pay concession fees to cover the costs of servicing MWSS debt. In return, the concessionaires received a revenue from tariffs.
From the outset, a hybrid regulatory system was adopted within a complex organizational structure of public and private entities (Jensen and Wu 2017). Contracts were signed between the MWSS and the concessionaires, and a new public agency, the MWSS Regulatory Office, was established under the MWSS as a contract monitoring body, with its legal basis set out in the contract document. The regulatory office's discretionary power was deliberately restricted to reduce perceptions of regulatory risk in the private sector. The office was not granted decision-making powers; instead, it makes recommendations to the MWSS board of trustees, and its decisions must be approved by the board before they are implemented. The board, however, has some financial autonomy since it is funded by a levy on the concessionaires rather than the public budget.
The water concession contracts provide for minor disputes to be heard by an ad hoc appeals panel, and for international arbitration for major disputes between the parties. The panel can overrule the regulatory decisions of the MWSS board, and the contract specifies that the panel's decisions are final. Therefore, the panel therefore has regulatory functions of an appellate character.
Between the government and the concessionaires, regulatory risk under the hybrid model was reduced by detailed contract provisions on tariffs, targets, and grounds for adjustment, which constrained discretion, and by using international arbitration to settle major disputes. Setting up the regulatory office and periodic rate rebasing were intended to deal with contractual incompleteness by allowing tariffs and targets to be reviewed and adjusted to take account of changes in the operating conditions in a planned way.
The first major regulatory challenge came in 1998, less than a year into the contract term. Manila Water petitioned the regulatory office for a tariff increase to take into account the rapid increase in the cost of capital caused by the Asian financial crisis, and to front load compensation for insufficient raw water supply caused by the El Niño weather phenomenon. The regulatory office rejected the petition. It argued that the contract implied that the tariff should not be adjusted to reflect changes in the appropriate discount rate until the first rate rebasing, and that front loading tariff adjustments under the extraordinary price adjustment was disallowed. Manila Water took the dispute to the appeals panel, which ruled in its favor. Some members of the regulatory office felt this early tariff adjustment undermined the validity of the bidding process. But most felt the office should respect the finality of the panel's decision.
The second major regulatory challenge was the first rate rebasing in 2002, which revealed gaps and ambiguities in the regulatory structure of the water concessions. To take just one example, the requirements for information disclosure by the concessionaires were not clearly specified in their contracts. Consequently, the technical and financial information that the regulatory office received was incomplete and not standardized.
For Manila Water, the first rate rebasing went smoothly in 2002. The regulatory office recommended a tariff slightly lower than that requested, reflecting certain expenditure disallowances, and Manila Water agreed to the adjustment. By contrast, Maynilad's rate rebasing not only turned out to be much more complicated than Manila Water's but also exposed considerable operational inefficiencies at Maynilad. The regulatory office's final determination included a large cost disallowance, and a much lower tariff than proposed by Maynilad. Maynilad rejected the determination, claiming its financial position was untenable, and gave notice that it was terminating its contract. The dispute was referred to the appeals panel, which found that neither side had breached the contract seriously enough to warrant termination. On the announcement of the panel's decision, Maynilad filed for bankruptcy in a local court, effectively preventing the government from recovering unpaid fees from the company. The government had no choice but to start negotiations on the terms of Maynilad's exit despite its weak bargaining position.
In 2006, the west concession was rebid and awarded to a consortium of two Philippine companies: D. M. Consunji Inc. and Metro Pacific Investments Corporation. The implied asset valuation of their bid was well above the government's reservation price, suggesting the bidders perceived the regulatory risk to be low. This can be interpreted as an endorsement of the regulatory system for Manila's water sector, and the regulatory office improving its ability to manage the water concessions.
Although the regulatory office has become more assertive, it has faced challenges to its authority. A decision by former President Gloria Macapagal Arroyo in 2008 to block Manila Water's petition for a tariff increase over concerns on the impact of the global financial crisis led to Maynilad-the name was retained by the new owners of the west concession-asking for its contract to be extended so that the increase could be spread over a longer period. The regulatory office opposed the extension, arguing that losing the opportunity to rebid the contract might lead to significantly higher costs for consumers in the long term. But the MWSS board was under heavy pressure from the executive branch of the government to grant the extension. Manila Water got its 15-year extension in 2009, and Maynilad's water concession was extended for 15 years in 2010.
The contract extensions were a blow to developing the regulatory office's role beyond the one provided for it in the water concession contracts. A more powerful agency with an explicit responsibility to represent the public interest might have been able to veto the contract extension. Under Manila's hybrid regulatory system, however, the primacy of contract over agency allowed the concessionaires to renegotiate opportunistically to suit their short-term financial interests.