An important aspect of a PPP project is an explicit arrangement for allocation of risks between the parties involved. A good feasibility study provides the background that is needed for an allocation exercise. The following general principles may be considered to manage and allocate risks:
• Eliminate or reduce to the extent possible the chances of a risk to occur. For example, when possible, borrow in local currency to avoid exchange rate risk.
• Allocate risks to the party that is best equipped to manage them most cost effectively. For example, political and regulatory risks are more appropriate for the public sector, while construction and operating risks are more suited to the private sector.17 The commercial risks are generally allocated to the private sector. But deviations can be considered on the basis of valid reasons - for example, sharing of commercial risks may be considered to attract private investors in an untested PPP market.18
• Consider an insurance (if available) to deal with risks which neither party is able to manage but still can maintain value for money in the project.
• When neither party is in a position to effectively mange a risk, it may be kept unallocated with an indication in the contract how the risk may be shared between the parties or assumed by a party in the event of its occurrence. In case of a concession contract, it may also be transferred to the end-users by way of charging higher tariffs.
It is not advisable to transfer all risks to the private party. There should be a good balance in risk allocation between parties. If a good balance is not achieved, it will result in increased costs and one or both parties may not be able to fully realize their potential.
The magnitude of project risks is also assessed as a part of the due diligence process undertaken by the lenders. The greater the assessed/perceived risk of a project, the higher is the risk premium charged by lenders. Consequently, the financing cost of project becomes higher.
Government means government in general or the concerned ministry, department or an organ of government as the case may be.
The table merely shows some examples of the common risks and their typical mitigation measures that may be considered. It does not provide any exhaustive list of risks, their nature or mitigation measures. Many mitigation measures shown in the third column may also apply to other risks identified in the second column.
Although the general principle of allocating risk that the party who is in the best position to manage should assume the risk applies to all situations, the party in the best position to manage a particular risk may vary from one situation to another. Many risks are project and situation specific.
A relief event is an incident that temporarily prevents the private company/SPV from completion or operation of the project. The private company is not penalized but also does not receive any compensation.
Some risks may remain unallocated to any specific party. These residual risks would have to be implicitly assumed by the SPV and the lenders.
Multi-lateral agencies such as Multilateral Investment Guarantee Agency or MIGA of the World Bank Group provide loan guarantee for developing country private sector projects. MIGA provides guarantee against foreign currency transfer restrictions, expropriation, breach of contract, war and civil disturbance. Many other development banks such as the Asian Development Bank, and ECAs have also similar mechanisms for providing loan guarantee to private projects.
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17. The project company, in turn, may transfer some of these risks to third parties namely by passing on to sub-contractors, covering them by insurance, having them guaranteed by the project sponsors.
18. However, in such a situation there is a danger that needs to be carefully examined before agreeing to any such risk sharing arrangement. It is convenient to structure the project debt around the government support, which basically turns the project risks into government risks.