SGs involve the Government bearing some or all of the risks associated with a PPP project. Although potentially attractive for bringing the private sector in on PPPs, this redistribution of risks and rewards can jeopardise the private sector's incentives to perform. Maintaining these incentives is arguably the key to a well structured PPP. For instance, the lenders to a PPP project, when guaranteed, may not be sufficiently incentivised to perform a detailed appraisal of the project, to structure their financing in a way which adequately manages risks and rewards and to monitor the project performance throughout the life of their loan. At the wider programme level, SGs can create moral hazard as the market may get used to SGs and expect them regardless of individual project circumstances. Additionally, SGs can create two tiers of projects, those that benefit and those that do not. The latter may find it more difficult to attract private sector interest and/or financing.
Guidance: To avoid moral hazard, it is fundamental that the design of SGs should leave the private sector with sufficient risk at the margin. Partial guarantees can limit moral hazard. This can be achieved in many ways, such as (i) setting ceilings on Government exposure, (ii) restricting the SG coverage to specific events or specific project phases, (iii) limiting the guarantee coverage to a sub-group of lenders, (iv) requiring the Government claims to rank above those of the lenders or the investors in the event of a default and (v) once an SG is called, requiring Government payments to become loans rather than grants.