Local Government (Building Upgrade Agreements) Amendment Bill

Second Reading

Adjourned debate on second reading.

(Continued from 7 May 2015.)

The Hon. I.K. HUNTER (Minister for Sustainability, Environment and Conservation, Minister for Water and the River Murray, Minister for Climate Change) (16:21): I rise to conclude the debate on this bill and will be seeking the support of the council to have the committee stage adjourned to another day. I would like to thank honourable members for their time and consideration on this bill.

I will briefly remind honourable members that the bill before the chamber today enables the introduction of a voluntary building upgrade finance mechanism in South Australia which is designed to help owners of existing commercial buildings access finance to fund the environmental upgrades of their properties. It is also designed to help to address the split incentive between landlords and tenants in lease buildings, where the building owner incurs the costs of the upgrade but the tenant receives the benefits through reduced utility bills and improved accommodation.

Equivalent schemes have already been established in the City of Melbourne in Victoria and in New South Wales. In developing this bill, we have sought to harmonise with these as much as possible. I will briefly recap the key parameters of the building upgrade finance. Under the mechanism, a local council can voluntarily enter into a building upgrade agreement with a building owner and a financier.

The building owner agrees to undertake upgrade works in respect of their building. The financier agrees to advance money to the building owner for the purpose of funding the upgrade works, and the council agrees to levy a building upgrade charge against the land on which the building is situated. This charge is paid by the building owner to the council. The council then passes the received repayment to the financier to recoup the loan.

As a result of the arrangement, the loan is effectively tied to the property rather than the property owner, with loan repayments collected via the building upgrade charge. In the event of the transfer of ownership of the property, the charge can remain with the property if the purchaser agrees. The strength of the mechanism lies within this statutory charge. The charge effectively secures the loan, being ranked senior to mortgages, taxes and other charges in the event of default.

This is a key feature of the mechanism which provides heightened security to the financier, allowing them to offer finance to the building owner at more attractive terms, including longer terms at a fixed interest rate. This is the key to what makes the mechanism work. The bill is clear that local councils are not exposed to any financial liability relating to the payment of the building upgrade charge if repayments from a building owner have not been received or recovered by the council.

This is a long-awaited piece of legislation. The South Australian government commenced its investigations on this legislation in 2012, and the bill we consider is a result of a collaborative partnership between state and local government based on the business case investigations, public consultations and input from stakeholders.

The bill has the in principle support of the Local Government Association of South Australia and the Adelaide City Council. The South Australian division of the Property Council of Australia is supportive of the introduction of the mechanism, and Business SA gave its in principle support via its 2014 Charter for a More Prosperous South Australia.

However, as an honourable member mentioned in her speech, Business SA takes a view that the consent approach should be the only pathway to the recovery of a tenant contribution to a building upgrade charge. I need to remind honourable members that we are considering enabling legislation to establish a voluntary mechanism designed to unlock retrofitting activity in our existing commercial buildings, to realise the associated environmental and economic benefits, including savings for businesses, be they the owner-occupiers, landlords or tenants.

As I have mentioned, the mechanism is specifically targeted at overcoming two entrenched market failures that prevent building owners from undertaking upgrades that give rise to these savings and to environmental performance. These are the access to finance and split incentive barriers I mentioned earlier.

I will address the issue of access to finance a little further. As I mentioned earlier, the super secured status of the building upgrade charge is what makes the mechanism work. Without this level of security there will not be a building upgrade finance mechanism; it really is quite that simple. With regard to the second issue, by entitling a building owner to recover a tenant contribution to a building upgrade charge, the mechanism helps to address the split incentive issue. It also allows for the upgrade to occur mid-lease, therefore, bringing forward investments that could only otherwise occur at lease renewal.

If we remove provisions that enable the full potential to tackle the split incentive barrier in leased buildings, the ability to facilitate upgrades will be compromised. To ensure that costs and benefits arising from the upgrade are shared in a fair and transparent way without adding administrative complexity, building on the interstate experience the bill specifies two pathways under which the tenant's contribution can be recovered by a building owner: one, a consent approach where the tenant consents to the payment of a contribution towards the building upgrade charge, or, two, a 'no worse off' approach, where the tenant's consent is not required, provided the amount recoverable does not exceed a reasonable estimate of the cost savings to the tenant resulting from the upgrade.

Under this pathway the cost savings must be estimated in accordance with an approved methodology, which will be developed by the state government and published in the Government Gazette. This is the approach that is operating in New South Wales. We recognise the importance of tenant protection provisions. The feedback received during the consultation process, including that from Business SA, has informed the overall design of the legislative framework for introduction of building upgrade finance.

We should be mindful that we are considering legislation designed to apply to different types of commercial buildings, individual landlord/tenant relationships, tenant profiles and types of tenants. Some tenants are small businesses and some are large corporations. With that in mind, I reiterate that the bill outlines two pathways for fairly sharing the benefits and costs of a building upgrade.

The first allows an administratively easy approach, where the building owner and the tenant agree on cost-sharing arrangements through commercial negotiations, without prescribing how this should occur. That is probably going to be easiest for smaller buildings that have very few tenants. The second allows a building owner to recover a contribution via notification but is highly prescriptive in terms of how this occurs, where the tenant is afforded legislative protection to ensure the tenant is not financially disadvantaged and is afforded a means of redress.

Through consultations we received views on and support for both of these options. As an honourable member acknowledges, the Property Council is comfortable with the provisions as they are. Further, the Shopping Centre Council of Australia, in both its 2012 and 2014 submissions, indicated the importance of the 'no worse off' approach. Also, in their 2012 submissions to the consultation paper, both Low Carbon Australia Limited (which is now part of the Clean Energy Finance Corporation, I am advised) and the National Australia Bank expressed views indicating that the 'no worse off' approach is essential. I quote from the National Australia Bank's 2012 submission that:

Another feature of the New South Wales scheme worthy of mention is the ability of the EUF obligations—

it is called EUF (Environmental Upgrade Financing) in New South Wales—

to be passed through to tenants of the building without the explicit consent required of each tenant under certain and strictly monitored circumstances. The tenant is afforded legislative protection to ensure that he or she is not adversely impacted. This approach allows for the sharing of the capital burden and also the benefits associated with the upgrade in an equitable manner, without the requirement for the building owner to chase multiple tenant consent forms attached to a single building upgrade. This increases the attractiveness of the EUF as a mechanism for sustainable investment.

Can honourable members just imagine a large shopping centre owner wanting to invest in, for example, a large solar photovoltaic system and having to secure over 100, 200 or 300 individual consents? It is just not likely to ever happen. Also, I can continue by quoting NAB:

…by sharing the capital cost between the mutual beneficiaries (building owners and tenants) of the retrofit, capital investment can be realised earlier. Bringing forward capital investment has noticeable positive impacts in that it brings forward environmental targets and goals for both building owners and tenants whilst continually stimulating the economy.

I would like to reiterate, therefore, the point that the bill is drafted to balance views of various stakeholders; provide for pathways to suit individual circumstances, landlord-tenant relationships, tenancy profiles and types of tenants; and ensure that the split incentive barrier can be addressed without causing a financial detriment to tenants whilst not affecting the mechanism's potential for uptake.

I note that some honourable members have expressed concern about the methodology for calculating the reasonable estimate of tenant cost savings. Members would probably understand that, before proceeding to the development of the methodology, we need to have legislation in place. However, I can advise that the methodology will seek to align with existing methodologies, for example, the methodologies used in New South Wales as part of their environmental upgrade finance mechanism.

Honourable members have observed that the bill is silent on dispute resolution mechanisms, and there is a good reason for this. The bill is fundamentally about introducing a new way of securing and repaying finance, and we have deliberately not confused this with other separate issues pertaining to commercial leases. We are not seeking to duplicate existing mechanisms for resolving commercial disputes. We do not seek to introduce red tape measures.

Instead, the bill relies on existing arrangements when it comes to dispute resolutions between tenants and landlords. This means that, for tenancies under the Retail and Commercial Leases Act 1995, dispute resolution provisions under this act apply. I am advised that a tenant may apply to the Small Business Commissioner for mediation. If not happy with the outcome of the mediation, the tenant may take the matter to the Magistrates Court. For tenancies not covered by the Retail and Commercial Leases Act 1995 the tenants are expected to follow dispute resolution processes specified in their lease agreement.

I would like to thank honourable members for their concern about how these mechanisms will be administered, and I will briefly outline now how this mechanism is administered by councils interstate. In Victoria, the Sustainable Melbourne Fund, which is fully owned by the City of Melbourne, administers the mechanism on behalf of the City of Melbourne. In New South Wales, each participating council administers the scheme individually.

In our state, feedback received through consultation indicated a universal preference for a central administration model for the delivery of the mechanism. The state government committed $1.9 million for the establishment of the Building Upgrade Finance mechanism in South Australia. The majority of this funding is envisaged to go towards the establishment and operation over four years of a central administrator.

The central administrator's key role is to support South Australian councils to offer and administer building upgrade agreements within their municipalities. This is intended to avoid administrative duplication between councils, centralise expertise, reduce barriers to council participation, as well as provide a one-stop-shop for building owners and financiers.

This administrator is expected to support participating councils by undertaking most of the functions associated with the administration of building upgrade agreements, for example, educating councils about the mechanism, assisting councils to establish relevant internal procedures, undertaking assessment of applications and providing advice to councils, preparing agreements, and undertaking general education and awareness-raising activities.

The operation of a central administrator will reduce associated costs to participating councils and make it easier for them to offer the mechanism within their municipal areas. The administrator is not expected to get involved in tenant dispute resolution processes; as I mentioned earlier, these will be addressed through existing processes. It is important to note that the decision to participate in the scheme is the prerogative of a local council.

Also, following the administrator's assessment of an application for building upgrade finance, to ensure that it complies with the requirements of the legislation, the decision as to whether to sign an agreement will remain with the local council and it will be council's role to collect and distribute building upgrade charges. Local government is central to the functioning of the mechanism.

The majority of the administration of Building Upgrade Finance will be the responsibility, as I said, of local councils. Given that the central administrator will be providing services to these councils, it will need to be able to understand council's business and procedures.

The Local Government Association of South Australia has been identified as a potential candidate for the role of the central administrator. I am advised that officer level discussions have occurred in relation to this model. Subject to the passage of the bill, the state government will continue to work with local government to establish a robust delivery model.

There is no potential conflict of interest associated with this model as building upgrade finance is a financial mechanism that involves an agreement between a council, a property owner and a financial institution. This model has a number of benefits. The LGA is constituted to provide services, support and leadership for the local government sector and is established under the Local Government Act 1999. As the professional body, the LGA is best positioned to support councils in offering and administering the program.

The LGA has a long history of service delivery in partnership with both the state and commonwealth governments. These include community wastewater treatment programs, for example, electricity procurement processes, commonwealth reform projects—and the list goes on. The LGA also administers financial programs, such as the Local Government Research and Development Scheme which distributes funding to local government entities annually to advance the sector. The LGA has the capacity and expertise in establishing prudent governance and financial mechanisms to deliver and maintain a high level of public integrity. This includes independent auditing processes. This model would not preclude the LGA from engaging external specialists to provide advice or undertake certain aspects of scheme administration, of course.

As to the issue of the imposition of a cost of the administration on to the tenant, the legislation is clear that the tenant either consents to the payment of the building upgrade charge or contributes an amount which is up to the tenant's savings resulting from the upgrade. In the absence of a central administration body, individual councils will be expected to administer the mechanism. This would be, I would suggest, a very inefficient model and is contrary to feedback received during consultation phases.

One of the honourable members has mentioned the risk associated with subordination of the first mortgagee. The overleverage test and the requirement to notify the mortgagee are the primary means of mitigating this risk. These are modelled on a scheme in place in Victoria, I am advised. Upon receiving notification the existing mortgagee would be able to assess any risks, raise any concerns with a prospective building upgrade finance provider (assuming they are not one and the same organisation) and consider the building upgrade charge in future dealings with the property owner.

With regard to the Hon. Mr Darley's question about the capital value being used for the purpose of administering the overleverage test, I can advise that the bill defines 'capital value' as to have the same meaning as in the Valuation of Land Act 1971. As such the capital value of the land is inclusive of the value of improvements on it—that is the buildings. The Valuer-General value estimates will be suitable for the purposes of the overleverage test. However, this does not preclude the central administrator, on behalf of the council, from accepting value estimates undertaken by financiers. Therefore, councils will not be precluded from using a more conservative value estimate if that is their determination.

This will be clarified in the guide to building upgrade agreements to be developed in conjunction with the central administrator. The test relies on the capital value of land prior to the upgrade—that is, there is already a buffer as it does not take into account value improvements resulting from the upgrade. Furthermore, the total value of the building upgrade charge includes both principal and interest, creating a further buffer.

Also, financiers generally do not lend to the full amount of the market value, and generally request some form of mortgage insurance or security against other assets with equity, where the amount being borrowed exceeds their loan to value ratio. The lending practices of financial institutions already ensure a buffer between the market value of the property and the debt secured against it without the need for it to be regulated. Prescribing a specific threshold in legislation could potentially stop certain types of upgrades from going ahead, thereby not delivering a full range of environmental and economic benefits.

The honourable member further asked about finance sector engagement in our consultation process. I can advise that the National Australia Bank and the Clean Energy Finance Corporation have been engaged throughout the process; both are involved in offering environmental upgrade finance interstate. Other financial institutions were also invited to provide feedback on the draft bill. These included the ANZ Bank, Commonwealth Bank, Westpac, bankmecu. However, these organisations did not provide feedback, I am advised.

Whilst ANZ Bank and bankmecu have not engaged directly in the development of the legislation in our state they have loaned to environmental upgrade agreement projects interstate and are familiar with the mechanism. I am advised that officer level discussions have been held with representatives from other financiers in our local market, including Bank SA and Beyond Bank.

I think the Hon. Michelle Lensink has raised concerns regarding regulations. As I indicated during the second reading of this bill, it is my intention that regulations will be developed following the passage of the bill as is normal practice and that key stakeholders will be consulted regarding these before they are finalised.

The provisions of the subsequent regulations will be influenced by the parliamentary debate on the bill. In other words, let's not put the cart before the horse. It is our intention to prescribe the following items via regulation:

restricting the mechanism to non residential buildings defined as buildings used wholly or predominantly for commercial, industrial or other non residential purposes;

extending the mechanism to heritage upgrades as eligible upgrade work and we will consult broadly on this with stakeholders when working on regulations; and

requiring the Building Upgrade Agreement template, which will be developed by the state government, to specify a building owner's reporting requirements to a financier and a local council, as well as any information disclosure provisions.

Depending on stakeholder feedback, the subsequent regulations may also define:

the method of calculating the penalty interest rate on money advanced by the financier;

potential additional requirements regarding the contents of a building upgrade agreement;

any additional requirements regarding the notice that building owners must provide to an existing mortgagee;

any additional requirements that must be met before a council may enter into a building upgrade agreement; and

any additional requirements regarding the notice of the building upgrade charge issued by the council.

As I said, these will be informed by consultation. An honourable member made a comment regarding interstate uptake, which I understand has been low. It would be unfair to single out a single reason for this but contributing factors, I am advised, are understood to include the general global economic downturn, perceived complexity of the building upgrade agreement template, the limits of the tenant consent pathway in Victoria, the relative newness of the mechanism, and in Victoria the current restriction on the limitation to just the city of Melbourne.

However, upward pressure on electricity, water and gas prices in these states continues and the cost of clean energy technologies, such as solar, energy storage and trigeneration, is coming down. There is still a strong sense of optimism about the scale of upgrades that this mechanism could unlock.

To respond to the Hon. Mr Darley's question about the number of eligible buildings in South Australia, I am advised that a study by Arup in 2012 entitled 'Quantifying the environment and economic opportunities from retrofitting commercial buildings across SA' identified over 3,000 separate titles associated with commercial and industrial buildings just in the city of Adelaide. Over half of these were associated with commercial office buildings, around one-third were commercial shops, and the remainder was a mixture of accommodation, warehousing and industry. I am also advised that the Property Council of Australia's data covers some 1.4 million square metres of office building stock alone in the Adelaide CBD across some 400 buildings.

In developing this bill we kept a number of key considerations in mind that members should be aware of.

1. We recognise the importance of harmonising with other state schemes, given that financiers and many property owners operate across different jurisdictions and that South Australia is a relatively small market.

2. We recognise that the broader the coverage of the scheme, both geographically and in terms of eligible buildings, the greater the potential economic and environmental benefits to South Australia.

3. We recognise the need to ensure that tenants are protected, but without creating additional red tape for building owners that prevents projects which would provide benefits to tenants from going ahead.

4. We also recognise that this bill is fundamentally about securing and repaying finance and the mechanism should rely on existing processes wherever possible, including processes relating to development approvals for certain types of upgrades and existing dispute resolution mechanisms regarding commercial leases.

5. By being the third state to develop such legislation, we have had the benefit of examining both the Victorian and the New South Wales' schemes and being able to adopt the best elements of both based on their experience implementing the schemes.

Building Upgrade Finance mechanisms continue to gain momentum in our country. I understand Victoria is moving to expand the coverage of its scheme to all Victorian councils. Tasmania's recent energy strategy includes an action to investigate the case for Environmental Upgrade Agreements.

In conclusion, the bill as it stands takes into consideration all interests and has adopted the best elements of interstate schemes and therefore sets the new benchmark for other states considering adopting this model. I commend the bill to the house.

Bill read a second time.