1.2.2 Risk allocation

Achieving the value for money that justifies the PPP option also depends on the ability to identify, analyse and allocate project risks adequately. Failure to do so will have financial implications. Thus, at the project identification stage, in addition to assessing the sources of revenue linked with the affordability of the project, the Authority and its advisers need to undertake a broad assessment of the risks that arise from the project requirements in order to manage them. Risk management is an ongoing process which continues throughout the life of a PPP project. It takes place in five stages:  Guidance 4, 5

•  risk identification: the process of identifying all the risks relevant to the project, whether during its construction phase or its operational phase;

•  risk assessment: determining the likelihood of identified risks materialising and the magnitude of their consequences if they do materialise;

•  risk allocation: allocating responsibility for dealing with the consequences of each risk to one of the parties to the PPP contract, or agreeing to deal with the risk through a specified mechanism which may involve sharing the risk;

•  risk mitigation: attempting to reduce the likelihood of the risk occurring and the degree of its consequences for the risk-taker; and

•  risk monitoring and review: monitoring and reviewing identified risks and new risks as the PPP project develops and its environment changes This process continues during the life of the PPP contract.

PPP project risks can be divided broadly into commercial risks and legal and political risks:  Guidance 6

•  Commercial risks can be divided into supply and demand risks Supply risk concerns mainly the ability of the PPP Company to deliver. Supply risk can be subdivided into construction risk and supply-side operation risk (where construction and operation constitute the two phases of the project). Construction and supply-side operation risks include financial market risk due to, for example, changes in the cost of capital or changes in exchange rates and inflation Demand risk relates to insufficient user volumes compared to base case assumptions.

•  Legal and political risks relate to, among other factors, the legal framework, dispute resolution, the regulatory frame-work, government policy, taxation, expropriation and nationalisation

In general, the private sector is better placed to assume commercial risks while the public sector is better placed to assume legal and political risks.

If a public guarantee is envisaged for the PPP project, the Authority and its advisers need to assess the guarantee's impact on the risk allocation and its future implications for public finances before granting it.  Guidance 7, 8