If, after financial close, the private party is not expected to be significantly capitalised, government should generally seek security to ensure that the private party is fully committed to delivering the required outputs. This security can either be in the form of:
• guarantees from the sponsors or from the private party's parent companies where they differ from the sponsors (parent guarantees); or
• performance bonds,
These are particularly significant in the operational phase when guarantees under the construction sub-contracts are no longer in place. In this instance, the sponsor may seek to walk away from the contract rather than address operational difficulties - leaving the special purpose vehicle to be liquidated in circumstances where it lacks the resources to compensate government for the contract breach.
The need for sponsor guarantees or performance bonds depends in part on the nature of the project. Where the contract is for accommodation services from which government will deliver core services, there may be less need to secure operational performance. Where project assets will transfer back to government at some value at the end of the contract term, there may be less need for sponsor guarantees or performance bonds.
A requirement for parent guarantees may be an inefficient method of providing security to government. Depending on the nature of the guarantee and the accounting practices of the party providing it, a parent guarantee may have a balance sheet cost which will be passed through to government in the form of a premium (particularly where the guarantee is open ended). An unlimited parent guarantee is also inconsistent with the preference of many project sponsors for infrastructure projects to be of a non-recourse or limited recourse nature.
In many circumstances, it may be more efficient to use performance bonds. Performance bonds are transparent from a pricing perspective, and also may be preferred from a project management point of view because they are much easier to enforce than a parent guarantee.
Where government does require a parent guarantee or performance bond, it must ensure that it continues to receive value for money. One way of achieving this is to keep the cost of the guarantees/bonds down by ensuring the amount of the guarantees/bonds is at the minimum required to cover necessary costs (such as the cost of installing a new operator).