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 translates into financial costs. Thus, at the project identification stage, in addition to assessing the sources of revenue linked with the affordability of the project, the public contracting authority and its advisers need to establish 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: <3>, <4>

□  Risk identification. The process of identifying all the risks relevant to the project.

□  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 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.

□  Monitoring and review. Monitoring and reviewing identified risks and new risks as the PPP project develops and its environment changes, with new risks to be assessed, allocated, mitigated and monitored. This process continues during the life of the PPP contract.

Broadly speaking, PPP project risks can be divided into commercial risk and legal and political risks: <5>.

□  Commercial risk can be divided into supply and demand risks. Supply risk concerns mainly the ability of the PPP company to deliver. Supply risk can be sub-divided 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 traffic volumes or a traffic composition not in line with base case assumptions.

□  Legal and political risks relate to, among other factors, the legal framework, dispute resolution, the regulatory framework, government policy, taxation, expropriation and nationalisation.

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

If government guarantees are envisaged, the public contracting authority and its advisers need to assess the impact of the risk allocation on the cost of the guarantee and its future implications on public finances before granting the guarantee. <6>