In establishing a project consortium, the sponsor typically establishes the private party in the form of a special purpose vehicle (SPV), which contracts with Government.
The SPV is simply an entity created to act as the legal entity of a project consortium. Because the arrangement is financed through non-recourse debt, creditors have access to the project’s cash flows but limited recourse to the sponsors’ balance sheets.
Sponsor risk is the risk taken by Government that the SPV, or its sub-contractors, will not fulfil their contractual obligations and that:
• Government will be unable to either enforce those obligations against the sponsors, or recover some form of compensation or remedy from the sponsors for any loss sustained by it as a result of the SPV’s breach, or
• the sponsor(s) will prove to be inappropriate or unsuitable for delivery of the project.
An agency’s exposure to sponsor risk can be mitigated both contractually and through the operation of the evaluation process.
The SPV will typically have no historical financial or operating records that Government can assess. During the evaluation processes agencies should assess the SPV’s ability to fulfil their project obligations, by evaluating individual consortium members’ historical performance. This will include their performance on projects where consortium members have previously worked together.
The project consortium must be carefully assessed for probity, financial viability and competence to deliver the infrastructure and services required. If there is a likelihood of the SPV not being significantly capitalised after financial close, Government should generally seek security before entering into the contract.
Security may be in the form of guarantees from the sponsors or parent companies (parent guarantees) or in the form of performance bonds that ensure that the private party is fully committed to delivering the required outputs.
When deciding whether to request this from the private party, agencies should refer to Chapter 15 (Protection against late or insufficient service delivery) of the Risk Allocation and Commercial Principles for PFPs.
Government can also lessen sponsor risk by retaining an appropriate level of control over changes to the ownership of the SPV. However, value for money can only be maintained if the benefits of imposing restrictions outweigh the costs (see further Chapter 22 (Change of Ownership) of the Risk Allocation and Commercial Principles for PFPs.)