International Business
Disputes Resolution

Assignment Submission

EPGP 2009-10 - Term V- Individual Submission
1   The Case background

1.1 Aguas Argentinas

A country-wide privatization program was carried out, and in the city of Bu...
on concession. Although Aguas Argentinas only served the city of Buenos Aires, ETOSS’s six
members’ directory represented ...
committee (which has been mandatory since 2001 for all public companies), and the administrative
control committee (which ...
of the board of directors, however the national securities commission (CNV) requires that it should be
formed by executive...
between the Argentine Peso and the US$ and aimed to revise the regulatory and contractual
framework applying to the privat...
2. Company has better international regulatory body support ( French Government and World
       Bank ) who also have inte...
Profitability rates for Aguas Argentinas S.A. 1994-2000 (post tax profits as percentage of net

    “Privatisation of the water and sanitation systems in the Buenos Aires Metropolitan Area: regulatory
discontinuity, ...
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Epgp027 ibdr assignment_rajendra inani

  1. 1. International Business Disputes Resolution Assignment Submission EPGP 2009-10 - Term V- Individual Submission 31-March-2010 Instructor: Prof. Anuj Puri Submitted by: Rajendra Inani - #27 Table of Contents 1 The Case background...................................................2 1.1 Aguas Argentinas..................................................2 1.2 Aguas Argentinas: Governance Mechanisms .......3 1.3 Ownership............................................................4 1.4 Monitoring Structure............................................4 1.5 Compliance with the Commercial Law..................4 2 The End of the Concession ..........................................5 3 After the crisis: the multinational tears up its obligations..............................................................5 4 Evaluation of options with Aguas Argentina................6 4.1 Company Perspective...........................................6 4.1.1 Case for Arbitration .......................................6 4.1.2 Case For Negotiation .....................................7 4.2 Government Perspective......................................7 4.2.1 Case For Arbitration ......................................7
  2. 2. 1 The Case background 1.1 Aguas Argentinas A country-wide privatization program was carried out, and in the city of Buenos Aires the privatization was done with the signing of a concession contract with Aguas Argentinas in 1992 before setting up a national regulation, or oversight body. Water privatization and regulation was decentralized so each local government, whether provincial or municipal, could pursue their own experience. Sanitation services in Argentina were provided by a national state-owned utility until 1982 when the national government transferred the responsibility to local governments except for the city of Buenos Aires and a few adjacent districts which remained under the control of Obras Sanitarias de la Nacion (OSN). General discontent with the system’s performance and ever-increasing pressures to enhance service provision and to ease the burden for financing underperforming assets led the way to private sector participation in the industry during the early 1990s. In Buenos Aires, water was free for many users before privatization, there were few meters; a third of all connections were unregistered, and many of those customers that were registered did not receive their bills or did not pay their bills when they received them. Around 68 per cent of total collections came from large industrial or commercial users that only represented approximately two per cent of the client base. Aguas Argentinas was created on May 1, 1993 as a result of the alliance of seven European and Argentinean partners. This was formed by two major partners: Compagnie Generale des Eaux (then Vivendi and now Veolia) and Lyonnaise des Eaux (now Suez) who won based on their proposed rate reduction of 26.9 per cent, the largest of all the bidders. The national government granted free of charge, no obligation to pay a royalty, a 30-year concession to supply drinking water and sewage disposal to the area covered by the city of Buenos Aires and 17 surrounding districts serving 10 million people. To avoid placing the user in a defenseless position a regulatory authority, Ente Tripartito de Obras y Servicios Sanitarios (ETOSS), was established by decree 23.696 in February 1992. The main duty of ETOSS consisted in controlling the quality of the service and the application of the rates system and its amendments, the expansion of services and investment programs, the attention rendered to users in accordance to their rights and the protection of the public asset given IBDR –Individual Assignment Page |2
  3. 3. on concession. Although Aguas Argentinas only served the city of Buenos Aires, ETOSS’s six members’ directory represented three governmental actors: the national government, the provincial government and the municipal government. The Ministry of Economics and Public Works of Argentina appointed two members, the Ministry of Public Works of the Province of Buenos Aires appointed two members, and the executive branch of the Municipality of the City of Buenos Aires appointed the last two. The only requirement for these six directors was that they should be government officials although having relevant experience was desirable but not required. The directors were appointed by April 1st 1992, but the body did not start operations until September 1992. The adjudication of the contract to Aguas Argentinas was signed on December 4th 1992 and operations started in April 1993. ETOSS was designed to operate as an independent unit financed by the three government levels plus the 2.67 per cent of bill collection income. Directors’ salaries were to be determined by the directors themselves in a collective manner. A few months after ETOSS started functioning as an independent body, the president of Argentina undercut ETOSS’ autonomy by signing a decree that placed it under the control of the Secretary of the Environment. The disempowered head of ETOSS appeared before Congress warning about the implications of this move, but this did not overturn the presidential decree. The dearth of the regulator’s power and authority became evident to all when it was left out and ignored during the renegotiation of the contract in 1997, which occurred because the consortium had failed to make infrastructure investments as required by its contract. For instance, the company had only invested US$9.4 million of a promised US$48.9 million in sewage works and had built merely a third of the new pumping stations and underground mains that it had promised to complete by 1997. This concession seems to be a very unusual case where a single watchdog regulates a single firm. There are several arguments that challenge the regulatory efficacy of ETOSS and its staff. For instance most of ETOSS staff belongs to the old national company OSN who were poorly qualified for the responsibility of regulating (Water and Sanitation Program, 2001) what was evident in the lack of enforcement of the licensee’s capital structure that by 1998 had a debt to equity ratio of 2.67 while the predetermined one was 0.73; also it was suggested that the staff could be tempted to adopt a pro-concession attitude as Aguas Argentinas was the most likely employer (Artana et al, 1999) which was reflected in some rulings that allowed to set unusually high meter installation tariffs, granted unexplained tariff adjustments with little economic analysis, transfer business risks to consumers through adjustments in access charges and gave consent to delays in the installation of meters. The weak position of ETOSS was evident since the beginning because within a year of signing the concession contract, Aguas Argentinas petitioned for a rate increase, even though the company had previously agreed not to impose any real rate increases for 10 years. ETOSS, agreed, increasing rates by 13.5 per cent in exchange for a promise of expediting contractual investments. ETOSS’s lack of autonomy and power continued regardless changes in the political sign of national government. It started to apply sanctions to the privatized company in the years 2000 and 2001 when a new national government critical of privatization agreements came to power. In October 2006 the ETOSS ceased to operate and was dissolved following the Argentinean government’s cancellation of the concession to Aguas Argentinas enacted in National Decree 303 the previous March. A new regulatory body but staffed with the same ETOSS employees was subsequently created with the mandate to only monitor water quality. 1.2 Aguas Argentinas: Governance Mechanisms It cannot be clearly determined, if the privatized company implemented the corporate governance mechanisms recommended by the literature or by normal practice in Argentina. In Argentina it is typical for a public company to disclose the composition of its board of directors, organizational structure, remuneration of directors and managers, and internal control mechanisms such as the committee for the integrity of information (following the Sarbanes-Oxley act guidelines), the audit IBDR –Individual Assignment Page |3
  4. 4. committee (which has been mandatory since 2001 for all public companies), and the administrative control committee (which is regulated in the commercial law and composed of certified accountants called syndics). Aguas Argentinas has several partners, included among them is one of the largest local banks, Banco de Galicia, with a stake of more than 8 per cent. It is likely that such partnerships do have robust internal controls. Under normal circumstances, governance mechanisms would be in place to monitor Aguas Argentinas, but may not be publicly disclosed, due to their proprietary and commercially sensitive nature. The lack of transparency might be due to the firm’s interest in keeping certain information private in order to increase their bargaining power in re-negotiating contracts with the government. Clearly the lack of transparency backfired, causing a feeling of suspicion within the civil society, which in the end comprises the ultimate stakeholders. 1.3 Ownership The ownership and control structure of Argentinean listed companies is characterized by a high level of concentration, and by the presence of a limited number of shareholders linked either by family ties or agreements of a contractual nature that effectively control de companies. Aguas Argentinas was a consortium of seven international and local firms that acted as investors but the operator was Ondeo from the Suez Group. As of 2003 the Suez Group had 40 per cent of the shares, Aguas de Barcelona 25 per cent, employees 10 per cent; Banco de Galicia 8.3 per cent; Vivendi 7.5 per cent; International Finance Corporation 5 per cent and Anglian Water 4.3 per cent. 1.4 Monitoring Structure The monitoring structure in Aguas Argentinas had two principal players: the audit committee and the external auditor. The audit committee is responsible to check the compliance of acts and decisions of the board of directors with the law and corporate bylaws, to review the adequacy of the corporate structure for issues such as internal controls, administrative, financial and accounting systems, and to ensure that the provision of all the information necessary to comply with the information requirements established by the law are adequate. Normally the inefficiency of the audit committee as a monitor is attributed to a lack of access to information related to shareholders’ activities and lack of independence from the controlling shareholders. The second structure, external auditor or auditing firm, is appointed by the shareholders’ meeting, although the audit committee has a voice on the choice of the firm. Normally the inefficiency of the external auditor as a monitor is attributed to being not competent or to being not independent. 1.5 Compliance with the Commercial Law In Roman-law based countries like Argentina, the effectiveness of codes of best practice is limited because of the lower enforceability of their recommendations in comparison with Anglo-Saxon common law based countries, therefore those best practices are normally included in the commercial code that is a compendium of all rights and obligations of persons and institutions practicing a commercial activity. A review of Aguas Argentinas compliance with the commercial law is useful to understand to what extent Aguas Argentinas compiled, at least formally, with the minimum standards of corporate governance in Argentina. The highest standards of corporate governance are regulated by the national securities commission (CNV) but are only applicable to public companies, which is not the case of Aguas Argentinas. According to a report on corporate governance of Aguas de Barcelona, one of Aguas Argentinas investors, the company had complied with all the requirements of the commercial law. The commercial law establishes that the Board of Directors is responsible for all of the major decisions and should meet regularly. The commercial law says little about the composition IBDR –Individual Assignment Page |4
  5. 5. of the board of directors, however the national securities commission (CNV) requires that it should be formed by executive and non-executive directors. The same regulation recommends that some of the non-executive directors should be independent in order to ensure protection. Although there is not a regulation that requires the separation between the chairperson and the CEO position, it is recommended that when both positions are held by the same person, the board of directors has to provide adequate information in its annual report about the duties and responsibilities of the chairperson and executive directors. 2 The End of the Concession (Information taken from Industry sources) The case study regards Aguas Argentinas SA as a concessionary company of water and sewage services that operated in communities around Buenos Aires, some of them quite poor, from 1993 to 2006. In 2006 Aguas Argentinas lost it concession and a state owned company was created to continue with the water and sewage services. The reasons for the loss of the concession have been linked to political reasons or to technical motives. On March 21, 2006 the Argentinean president signed a decree cancelling the concession contract to Aguas Argentinas. The decree mentions issues of poor water quality, specifically high levels of nitrates in some places, and lack of compliance in the expansion forecast plan in the concession contract as reported by ETOSS. The evidence shows that, despite a noteworthy increase, coverage rates remained significantly behind goals and that several contract renegotiations came along with significant tariff changes, but a good number of those failures seems to be related with the presence of a weak regulator with inexpert staff. Although this was expected, the problems of information asymmetry implied that the contract had to be renegotiated later. This arrangement was further challenged by a weak regulatory body that was operating within an ill defined regulatory framework and a company without any mandatory governance mechanism, not even by what is required by law for Argentinean public companies. The water concession in Buenos Aires was not as effective as it could have been. One of its main failures, as argued, was the absence of a truly independent and powerful regulator with budgetary autonomy. The Buenos Aires water concession, the world’s largest, appears to be a paradigmatic case of concession failure. Interesting to notice is that the revocation of the concession done in March 2006 occurred exactly six months after that a shareholder meeting on September 22, 2005 agreed to request the termination of the concession due to lack of fulfillment of concedent’s duties. According to statements made to the media, Aguas Argentina had contacted several potential investors, but none was interested in entering into an unbalanced concession in both economic and financial terms where the risks and responsibilities related with the service out weighted the potential benefits in the short and long term. The need to withdraw from water privatization in developing countries is a view shared by transnational companies. However, none of the big players in the water industry called for a set of governance mechanisms to be employed in emerging economies in order to increase the transparency of their operations as a way to gain trust and support from their stakeholders when pressured by the local governments. We see here a pervasive tendency to ignore corporate governance mechanisms, which cause serious difficulties for both privatized water companies and governments in emerging economies. 3 After the crisis: the multinational tears up its obligations The water concessions were based on protecting the multinationals, so that prices were indexed to the US dollar. With the collapse of the Argentinean economy at the end of 2001, however, that indexation is no longer sustainable. In 2002, following Argentina's default on the external debt, a new law on "Public Emergency and Reform of the Exchange Regime" (Law Nº 25,561) abolished the parity IBDR –Individual Assignment Page |5
  6. 6. between the Argentine Peso and the US$ and aimed to revise the regulatory and contractual framework applying to the privatized utilities. It specifically abolished the "dollarization" of prices and the periodic adjustment of tariffs to foreign inflation and currencies. The law also provided for the renegotiation of the contracts with the privatized companies operating the utilities according to a number of criteria, to take into account "the impact of prices on the competitiveness of the economy and the distribution of income; the quality of the services and the investing plans, when they were considered in the leasing contracts; the consumers’ interests and the accessibility to the system; the security of the systems; and the profits of the firms".i This has created a continuing conflict between the Argentinean consumers of water, and the multinationals like Suez and Aguas de Barcelona, represented by the French and Spanish governments. Aguas Argentinas (led by Suez), the largest and most prominent of the privatized water companies in Argentina, started an intensive lobbying campaign aiming to protect its shareholders' interests. In February 2002, the management of Aguas Argentinas and the French ambassador in Argentina, Paul Dijou, had a private meeting with the vice Minister of Economy and a senior ministerial official. The management of Aguas Argentinas sent a note to the Sub-secretary of Hydric Resources, informing him of Suez’ unilateral suspension of a number of obligations of Aguas Argentinas, including the investment objectives in the contract renegotiated as recently as January 2001. These unilaterally suspended obligations included the investment plans which the company had signed up to in 2001 with the regulator, and the regulator’s rulings that Suez had to repay customers whom they had overcharged. Suez also insisted that: “... the Central Bank of the Argentine Republic will sell dollars to Aguas Argentinas S.A. at the parity one peso = one dollar to guarantee the payment in time of short and long term debt services that were taken with National and International Banks, as well as with Multilateral Organisms” Aguas Argentinas’ external debt was $672 million dollars at the last count, and the Peso had already fallen to 2 = 1 dollar by Easter 2002, so this demand was in effect that the Argentine government and people should shoulder half of Aguas Argentinas’ debt. ii According to a note in June 2002, Suez states that it will continue to pursue the Argentineans for money to pay the loans of Aguas Argentinas – it implies that some of these are guaranteed by Suez – and also that it may sue the government of Argentina because the contract had a clause “guaranteeing a fair remuneration on capital employed (U.S. Dollar equivalent)”. 4 Evaluation of options with Aguas Argentina 4.1 Company Perspective 4.1.1 Case for Arbitration Aguas Argentinas can go for arbitration on the following grounds against Argentinean Government: 1. Unequal dealing by Argentinean Government with company’s investor and shareholders. 2. Without compensation expropriation of companies property 3. Violation of its obligations under international treaties for the protection for investments by Argentinean Government. Following points favors the company’s position: 1. Company has better economic strengths to handle legal battle IBDR –Individual Assignment Page |6
  7. 7. 2. Company has better international regulatory body support ( French Government and World Bank ) who also have interest in this company. 3. Influence in Argentinean Government officials. 4. Technical calculations show company’s loss amounting to US$3 billion. 4.1.2 Case For Negotiation 1. ICSID has no competence to analyze the economic policy of the country thus, even a favorable outcome of arbitration would not be enforceable. 2. The Convertibility Law was also abandoned which conferred that the Company did not suffer any discriminatory treatment, but it was exposed to the same governmental measures as the rest of Argentines 4.2 Government Perspective 4.2.1 Case For Arbitration Under-achievement on extensions, over-achievement on profits This interpretation appears to be supported by other data on extensions and profits. According to estimations by the Users’ Committee at ETOSS,1 the company only reached 63% of the population in the original bid (1,078,000 inhabitants) for the potable water service, and 88% for the sewerage service (812,000 inhabitants) during the first five years,2 only considering the investments made by the licensee. Aguas Argentinas: extensions of service as % of targets (excluding regularization of illegal users) during the first five-year period Water Sewerage With respect to the original bid 53.7% 43.2% With respect to Resolution Etoss Nº 81/94 52.0% 43.1% With respect to Decree Nº 1.167/97 61.0% 40.3% Source: Economy and Technology Department, FLACSO-Argentina on the basis of the History and Balances of Aguas Argentinas S.A. and information from the Users’ Committee of ETOSSS. The achievement on profits however was considerable, according to an analysis of the company’s reports between 1994 and 2000, when Aguas Argentinas S.A. recorded, on average, a 19% rate of return on net worth. This compared with an average rate of return of 4.5% over net worth of the two hundred biggest corporations in the argentine economy.iii 1 See Users’ Committee at ETOSS, “Propuesta de la Comisión de Usuarios frente a la revisión quinquenal del contrato de Aguas Argentinas”, August 2000, mimeo. 2 This period was further extended by eight months (till December 1998) through Decree Nº 1,167/97, granting a longer period for the company to alleviate its high degrees of non-performance. IBDR –Individual Assignment Page |7
  8. 8. Profitability rates for Aguas Argentinas S.A. 1994-2000 (post tax profits as percentage of net worth) Years % 1994 20.0 1995 14.4 1996 25.4 1997 21.1 1998 12.5 1999 18.6 2000 21.4 1994-2000 19.1 Source: Economy and Technology Department, FLACSO-Argentina, on the basis of the History and Balances of Aguas Argentinas S.A. Following points favor the Argentinean Government: 1. Less investment against the promised amount (US$2202 promised, but actual US$1266) resulting shortfall of water for 800 thousand people. 2. Company could not serve better to unconnected neighborhoods, specially poor population. 3. It charged excessive rates in line with US inflation, where as the country had deflation or near zero inflation. (against local laws) 4. Excessive charges for connection and cutoff services. 5. Despite its social importance, there is no information or data publicly available about its corporate governance structure and mechanisms. This perceived lack of transparency allowed the national government to claim breaches in the contract and renationalize the company regardless Aguas Argentinas and its major stockholders efforts to transmit a good image to the public based on ideas of corporate social responsibility. IBDR –Individual Assignment Page |8
  9. 9. i “Privatisation of the water and sanitation systems in the Buenos Aires Metropolitan Area: regulatory discontinuity, corporate non-performance, extraordinary profits and distributional inequality” by Daniel Azpiazu and Karina Forcinito(FLACSO). Presented to Prinwass meeting Oxford April 2002. ii Ibid iii FLACSO p29