It is important to define the concept of risk and which elements of a project the tests are applied to.
For the purposes of the MGDD guidance and this paper, the concept of risk refers to the potential deviation from expectations in an assumed plan. Therefore, when considering the allocation of risks and rewards associated with the assets that underlie PFI and similar transactions, the question of whether a party should record the underlying asset is determined by looking at the extent to which each party would bear any variations in asset (the underlying property) related profits (or losses).
It is important to note that, in common with the UK GAAP assessment previously applied, the MGDD guidance is clear that any risks associated with services that are ancillary to the asset should not be considered. This means that services that can commercially be separated from the provision of the underlying asset should be excluded from the analysis. For example, service provision that is separately negotiable or which is market tested or benchmarked at regular intervals within the contract (see Box 1).
Statistical approaches can be used to model a range of expected values for the asset related profit and losses associated with the project, in order to determine which party bears the majority of the risks and rewards associated with the assets, having reference to the MGDD primary risk factors.
Box 1. Indicators that a contract is separable (source FREM 6.2.41) A contract may be separable in a variety of circumstances, including but not limited to the following: a) the contract identifies an element of a payment stream that varies according to the availability of the property itself and another element that varies according to usage or performance of certain services; b) different parts of the contract run for different periods or can be terminated separately. For example, an individual service element can be terminated without affecting the continuation of the rest of the contract; or c) different parts of the contract can be renegotiated separately. For example, a service element is market tested and some or all of the cost increases or reductions are passed on to the grantor in such a way that the part of the payment by the grantor that relates specifically to that service can be identified. |