Proposed Clean Water Act Financial Capability Assessment guidance contains key changes

A recently released proposed guidance document from the U.S. Environmental Protection Agency (EPA) would modify key elements of the financial capability assessment (FCA) process used to help set compliance schedules for certain large-scale infrastructure projects required by the Clean Water Act. 

Striking a balance

Released by the EPA on February 16 and published in the Federal Register on February 23, the Proposed 2022 Clean Water Act Financial Capability Assessment represents the agency’s latest thinking on how to balance the financial realities of communities required to implement expensive clean water programs with the need to ensure that low-income customers are not hurt by resulting rate increases. At the same time, the proposed guidance also aims to ensure that environmental protections required by the law are implemented as expeditiously as possible.

“EPA is committed to ensuring that all Americans have access to essential water services and clean water,” said Radhika Fox, the EPA’s assistant administrator for water, in a February 16 news release. “This guidance provides needed tools that can help achieve that goal for rural, suburban, and urban communities across the country,” Fox said. “The guidance supports water affordability while ensuring that wastewater utilities can take vital steps to improve wastewater management.”

For entities facing the prospect of having to spend large sums of money on combined sewer overflow (CSO) control programs, the FCA process plays a “central” role in determining how much time a municipality or utility has to comply with the terms of a federal consent decree, says Chris Hornback, the deputy chief executive officer of the National Association of Clean Water Agencies (NACWA). 

In turn, the resulting compliance schedule can have a major effect on rates paid by customers, Hornback says. “If you’re a community that’s looking at a couple of billion dollars worth of CSO investments, how quickly you spend or borrow that money and then pay it back impacts how much your rates go up and what individual homeowners are paying,” he says. As a result, the FCA process is “pretty important.”

Existing approach

The new proposed guidance is intended to replace EPA’s 1997 document, titled Combined Sewer Overflows—Guidance for Financial Capability Assessment and Schedule Development. Commonly known as the 1997 FCA Guidance, the document, in short, established a two-phased process for assessing the financial capability of a municipality or utility to implement CSO controls. 

In the first phase, a metric known as the “residential indicator” is determined by evaluating the cost per household as a percentage of the median household income (MHI) of the given service area. In the second phase, a metric known as the “financial capability indicator” is determined by evaluating the fiscal health of the municipality or utility and local demographics relative to national norms. 

The two indicators then are incorporated within a matrix included as part of the 1997 guidance to determine whether a planned CSO control program is expected to have “low,” “medium,” or “high” financial impacts on the municipality or utility. The EPA then uses this finding as part of its determination of the timeframe for a compliance schedule associated with the given CSO control program. Generally, a higher financial impact leads to a longer compliance schedule, in the hopes of minimizing rate increases associated with the CSO control program.

The problem with MHI

For some time, many observers have criticized the use of MHI as part of the FCA process, noting that it can underestimate the financial effects of a CSO control program on a community’s poorest residents. Under the 1997 FCA Guidance, if an individual household is expected to pay more than 2 percent of the MHI of the given community on bills associated with the CSO program, the program typically is found to have a high impact.

The problem with this approach is that it “doesn’t really give you a good indication of what the individual burden is going to be on a low-income household,” Hornback says. In an area in which household incomes vary significantly, an anticipated fiscal burden of 2 percent of the area’s MHI could result in lower-income residents paying a much higher percentage of their income. In some cases, a low-income family “could be paying 7 to 8 percent of household income,” Hornback says. “That’s how dull of an instrument a median is.”

The 2020 version

In September 2020, EPA issued a proposed update of the 1997 FCA Guidance. In its proposal, EPA put forth two alternative approaches for assessing a community’s financial capability. The first alternative maintained aspects of the 1997 FCA Guidance’s methodology, but included additional considerations regarding cost, poverty, and the financial effects on the population within a given service area having incomes in the lowest quintile. The second alternative involved the development of a financial and rate model that examines the effects of rate increases over time on utility customers, including those with incomes in the lowest quintile.

During the waning days of the Trump administration in January 2021, EPA released an intended final version of the document that was largely similar to the September 2020 version. However, the Biden administration subsequently declined to publish the document in the Federal Register, rendering it moot.

Major changes

In its Federal Register notice related to its Proposed 2022 FCA Guidance, EPA highlights “three major changes” from its 2020 predecessor: consideration of lowest quintile households and poverty indicators, the addition of a financial alternatives analysis, and modification of scheduling benchmarks.

In its discussion of the use of lowest quintile households and poverty indicators, EPA acknowledges that MHI “does not account for the variability of income distribution from community to community,” according to its notice. 

Therefore, the agency offers two options “to assess the severity and prevalence of poverty in a community’s service area,” the notice states. Both options “consider the community’s lowest quintile income as benchmarked against the national lowest quintile income,” as well as the following five poverty indicators:

• Percentage of population with income below 200 percent of the federal poverty level,

• Percentage of population receiving food stamps or supplemental nutrition assistance program benefits,

• Percentage of vacant households,

• Trend in household growth, and

• Percentage of the unemployed population 16 and over in the civilian labor force.

In essence, both approaches would determine a final FCA result by employing different combinations of lowest quintile income and the five poverty indicators with a community’s residential indicator and financial capability indicator. 

Financial alternatives analysis

In certain cases, the proposed FCA process would entail the use of a financial alternatives analysis to assess whether a municipality or utility has taken adequate steps to ensure the shortest possible compliance schedule without burdening low-income residents. 

“Use of variable rate structures, customer assistance programs, and applications for grants or subsidies from the Clean Water State Revolving Fund are all potential tools to enable shorter compliance schedules by allowing increased total spending on compliance without burdening low-income customers,” EPA states in its notice. 

For its part, EPA “does not intend to provide extended CWA compliance schedules or greater consideration for water quality standards decisions unless the community demonstrates that it has taken all feasible steps to reduce or mitigate the financial impact of water service costs on the lowest quintile households and to achieve compliance as expeditiously as possible,” according to the notice.

To this end, EPA “expects to look comprehensively at the community’s financial strategy, including, but not limited to, an analysis of the community’s approach to covering costs through rate structure and design as well as its other initiatives to assist low-income customers while assuring necessary and timely compliance with environmental requirements,” according to the notice.

Modifying scheduling benchmarks

In its Proposed 2020 FCA Guidance, EPA stated that communities found to have “medium” FCA impacts could qualify for compliance schedules of up to 15 years, while communities having  “high” FCA impacts could receive compliance schedules up to 25 years. In the case of communities found to have what EPA called “unusually high impacts,” the compliance schedule  could last as long as the useful life of the planned CSO controls.

However, in its Proposed 2022 FCA Guidance, EPA proposes to modify these scheduling benchmarks, essentially decreasing their duration in an effort to ensure that communities enjoy environmental protection as quickly as practicable. To this end, the agency proposes to keep 15 years as the “outer recommended boundary for ‘medium’ impact communities and change the benchmark for ‘high’ impact communities to 20 years, or up to 25 years for unusually high impacts,” according to the notice.

“It is important to consider human health and environmental impacts as well as cost when considering extended schedules,” EPA says in its notice. “EPA is also mindful that prolonging water quality impairments could exacerbate environmental justice concerns. EPA believes that, for unusually high impacts, 25 years is a reasonable recommended scheduling benchmark that is more consistent with environmental protection and the [agency’s] past FCA practice.”

Questions and concerns

For NACWA, which supported the 2020 FCA Guidance, each of the three major changes between that and the 2022 version of the guidance that EPA highlighted raises certain questions and concerns, Hornback says. 

For example, Hornback points to the agency’s proposal to evaluate affordability, in part, on the basis of a community’s lowest quintile income as compared to the national lowest quintile income. This approach entails “looking at this community-level number compared to a national benchmark,” he says. “It’s a totally different way of evaluating financial capability.”

The EPA’s call for municipalities and utilities to conduct financial alternatives analyses as part of the process of negotiating compliance schedules also piqued NACWA’s interest as an item requiring further study. “That’s never been part of the financial capability assessment process before,” Hornback says. “That’s a paradigm shift in terms of what this document has done in the past.”

Another “significant change from current practice,” Hornback says, entails EPA’s proposal to prescribe set compliance benchmarks for communities found to have medium, high, or unusually high financial impacts. “There’s never been a hard cap on how long the schedule could be in the past,” he notes. “It’s been based on the individual community’s needs.”

‘Most important change’

The Natural Resources Defense Council (NRDC), which opposed the previous iteration of the guidance developed under the Trump administration, is much more receptive to the new version, says Lawrence Levine, the environmental organization’s director of urban water infrastructure. 

“The most important change is the requirement for a financial alternatives analysis that was added,” Levine says. “That really was in direct response to the feedback from us and others in the environmental community and the environmental justice community.”

The new guidance “gives a pretty good menu of options that [EPA is] expecting utilities to assess” as part of a financial alternatives analysis, Levine says. Such options include reconsidering rate designs to make service as affordable as possible for low-income customers, examining the potential for creating means-tested assistance programs, and ensuring that utilities are taking full advantage of opportunities for grants and subsidized loans from state revolving funds. 

“These things have all got to be examined as alternatives to help make compliance more affordable,” Levine says, “just as much as all the different engineering alternatives for how to reduce sewage overflows need to be considered.” 

‘Very flawed Band-Aid’

If municipalities and utilities are going to cite the burden on their low-income customers as justification for delaying compliance with the Clean Water Act’s provisions regarding CSOs, those entities should be required to do more to help those very customers, says Luke Wilson, the deputy director of the Center for Water Security and Cooperation (CWSC). The nonprofit organization works to ensure that law and the practice of law guarantee water security and universal access to water and sanitation.

“If you’re going to get this forbearance from the government, then are you providing that forbearance to your customers?” Wilson asks. “What are you giving in return for getting this forbearance?”

More broadly, some of the underlying assumptions of the FCA process need to be called into question, says Alexandra Campbell-Ferrari, the executive director of the CWSC. “The basic premise is flawed,” Campbell-Ferrari says. “We’re looking at poorer communities and saying, ‘You don’t get clean water. We’re not going to enforce the Clean Water Act as stringently in your community. We’re going to put in place an escape valve for your community.’ That just seems like the absolute wrong message.”

For their part, states need to do more to ensure that local communities have the funding they need to ensure that their residents enjoy access to clean water, Campbell-Ferrari says. “There’s a larger question of why the state is not redistributing resources or prioritizing sending grant money or other financial resources to those communities that are not able to afford some of these infrastructure fixes.”

Ultimately, “there are bigger questions that need to be asked and answered” as to why municipalities and utilities find themselves on the hook for having to finance the costs of large-scale CSO compliance programs, Campbell-Ferrari says. Against this backdrop, she says, the FCA process is a “very flawed Band-Aid” for addressing such questions.

Comments on the Proposed 2022 FCA Guidance are due to EPA by April 25, 2022.