Effective risk transfer is essential to the success of PPPs. Over time, PPP practices across different jurisdictions have developed what might be termed a "standard risk allocation". Where for some reason this "standard" is not sufficient to satisfy the private sector, SGs can help to tackle specific project issues. In these cases, the aim of SGs is therefore to make PPP transactions bankable and attractive to financial investors. The principal risks that SGs commonly seek to address are reviewed below.
- PPP company default risks - Perhaps the most extreme forms of risk coverage are the SGs which protect lenders against the risk of a PPP company default / bankruptcy, irrespective of the reasons for such failure. Interestingly, although the PPP company creditors are most exposed to the insolvency risk of their borrower, the risk also matters to the Government and the taxpayers. The financial distress of a PPP company may indeed lead to an unscheduled increase in user charges / service charges, a taxpayer-funded bailout or a project collapse.
- Demand / usage risks - Whilst demand or usage risks are normally considered to be operating risks that should be borne by the private sector, the Government will often have to bear these, at least in part. This is more explicitly the case where forecasting future demand is prone to uncertainties (e.g. a competing road for a toll motorway) or where the Government is the sole or main user of the PPP company services (e.g. schools or hospital projects). The prime objective of such SGs is to make lenders more comfortable with the risks affecting the revenues of the PPP company.
- Construction risks - For particularly complex construction projects procured as PPPs, part or all of the construction risk can at times benefit from SGs. Although the private sector is normally prepared to bear the risks of completing an asset on time and on budget, it may be reluctant to accept exceptional risks (e.g. the geology of large tunnel projects, archaeological finds in a location well known for antiquities).
- Technology risks - Lenders are often reluctant to accept emerging technologies, high-risk technologies or technology obsolescence risks in PPP projects. They would either refuse to lend or do so only on onerous or inadequate terms. PPP project services may however require a degree of technology risk (e.g. electronic road charging schemes). SGs can facilitate the financing of this type of PPP.
- Sub-sovereign risks - Many PPPs are procured by public entities which are not part of central government, and do not have direct or explicit recourse to the relevant ministry of finance. Under these schemes, the private sector is asked to bear the risk of losses arising from a payment default or the non-performance of obligations of sub-sovereign entities. Sub-sovereign risk therefore refers to the credit or payment risk of local government entities (e.g. regions, provinces, cities, municipalities), government agencies (e.g. national road agencies) or public enterprises (e.g. rail infrastructure companies). SGs can be used to tackle sub-sovereign risks.
- Policy risks - The so-called policy risks normally fall into the category of risks that the Government should keep for itself. Policy risks arise from unpredictable changes in Government actions. They relate to matters such as: changes to the price the PPP company is allowed to charge for its services; changes to the service charge that the contracting authority is due to make to the PPP company; unexpected changes in laws and regulations; changes to service quality standards; and expropriations without compensation. SGs are sometimes used in jurisdictions where the private sector is particularly concerned about the extent of policy risks.
- Macroeconomic risks - Private operators are sometimes provided with SGs which protect them from adverse macroeconomic developments, such as devaluation or depreciation of currencies (e.g. for projects whose revenues are in local currencies whereas the costs and debt service obligations are denominated in a foreign currency) or interest rate fluctuations (typically where the swap markets are not deep/liquid enough to offer adequate hedging).
- Residual value risks - These risks relate to the value of the assets handed back to the Government when the PPP contract ends. As explained in section 2.2 below, a Government's undertaking to make payments on early termination or natural expiry of PPP contracts is sometimes akin to an SG.