5.1  Overview

To achieve value for money, risks are allocated to the party best able to manage them. This ensures that the cost of managing risk is minimised on a whole-of-life and whole-of-project basis.

A full risk analysis should be undertaken for all PPPs. This involves comprehensive risk identification, assessment, allocation and mitigation strategies. This process generates information which is used, among other things, in the construction of the PSC, evaluation of value for money, determination of the payment mechanism, the development of risk management plans and in determining the contractual terms and conditions.

While it is desirable for government to adopt a standardised risk approach to minimise transaction costs, risks should ultimately be considered on a case-by-case basis, taking into account the unique characteristics of each project and the current state of markets.

The risk allocation and commercial principles for a social and an economic infrastructure project may differ markedly particularly in market risk allocation, treatment of force majeure events, default and termination events and compensation events. Optimal risk allocation

By adopting a service focus and paying only for services received, PPPs presuppose that the private party bears the risks associated with designing, building and operating the infrastructure, including the risk of obsolescence and/or residual value. From this starting point, to achieve value for money, government takes back those risks that it can manage for less than it would have to pay the private party to bear.

Optimal risk allocation seeks to assign project risks to the party in the best position to control them and therefore minimise both project costs and risks. The party with greatest control of a particular risk has the best opportunity to reduce the likelihood of the risk eventuating and to control the consequences if it does.

Thus, for both pricing and management reasons, optimal risk allocation dictates that particular risks are allocated in line with capacity to control and manage risk at least cost. The risk allocation process results in various risks being:

•  retained by a government;

•  transferred to the private sector; or

•  shared by the parties.

Although many risks are in the control of each party, to some degree certain risks are outside the control of both parties. If neither party is in a position of full control, the risk allocation should reflect how the private party prices the risk and whether it is reasonable for government to pay that price, taking into account the likelihood of the risk eventuating, the cost to government if it retained that risk and the ability of government to mitigate any consequences if the risk materialises.

In relation to shared risks, it is important to note that the sharing may not be on a 50:50 basis, but split in some other way. For example, government and the private party may adopt the use of caps on risk exposure, time thresholds, defining specific events and using a schedule of rates.  Risk sharing can also use a predetermined mechanism where the parties can act together to mitigate and share the consequences of the specified materialised risk.

Allocating risks in this context generally refers principally to transferring the financial consequences of risk events, rather than the risks themselves. Ultimately the risk and responsibility for the delivery of public services stays with government.

Where payment for the service is not made by government but by the end-consumer, the private party may be able to mitigate a materialised risk by passing through any additional costs to the end-users. Any passing through should be subject to appropriate contractual restrictions and may be subject to a regulatory regime which ensures that the level of pass-through is justified.