Type of Risk

Definition

How can it be covered?

Debt service interruption risks

Lenders to PPP initiatives will insist on elaborate escrow arrangements to cover forward debt service and protect itself from sudden decreases in cash flow that may disrupt remittance of debt repayment.

Depending on the perceived extent of risk of the PPP project, escrow accounts may be established that can range from three months to a year of forward debt service.

Market or commercial risks

These relate to the possibility that the project cannot generate the expected revenue because of changes in market prices or in demand for the goods or services it generates. Both constituents of commercial risk may seriously impair the project company's capacity to service its debt and may compromise the financial viability of the project. Commercial risks vary greatly according to the sector and type of project. The risks may be regarded as minimal or moderate where the project company has a monopoly over the service concerned or when it supplies a single, or at best, a few clients through a standing off-take agreement. However, commercial risks may be considerable in projects that depend on market-based revenues, in particular where the existence of alternative facilities or supply sources makes it difficult to establish a reliable forecast of usage or demand. This may be a serious concern, for instance, in water supply projects, since the utility can face competition from private water vendors or even households digging their own shallow wells.

At the minimum, the government will have to set an environment in which the local PPP project will operate in. There are three general approaches of mitigating this type of risk.

First, the LGU or implementing agency undertakes a pledge of no competition, i.e., promises not to set up or allow an establishment of a competing facility during the cooperation period.

Second, there can be a 'take or pay' arrangement wherein the LGU will be commits to 'buy' a specific number of units of the service being provided by the PPP facility whether or not there is sufficient demand for such service. In this case, cash transfers from the LGU or implementing agency is set in place, and should be sufficient to either cover the private partner's debt payments or more substantially, cover both debt and a specified proportion of profit.

Third, and perhaps the heaviest allocation for the local government, is that it bears all risks. In this setup, the government will cover all market risks involved to attract private sector participation. This type of setup is usually done through build-transfer or build-transfer-operate arrangements.

The latter is however contrary to national policy that market risks should be borne by the private sector, and the most that the LGU should ensure is the agreed initial tariff and the rate adjustment formula.

Feedstock risks

This is a risk that a major material input to produce the PPP facility will not be available, such as when there is a sudden lack of water supply for a water project

The LGU may opt to supply the scarce material input (e.g. fuel, equipment, etc.) or the LGU may elect to have the proponent source the scarce material input. A new risk in the case of the second option would be a risk premium, which the private partner would have to recover from the service fees and charges.

Operating risks

During the operational phase the parties may face the risk that the completed project cannot be effectively operated or maintained to produce the expected capacity, output or efficiency (performance risk); or that the operating costs exceed the original estimates (operation cost overrun risk). The LGU and the users in the host community may be severely affected by an interruption in the provision of needed services. The LGU may have to deal with safety risks or environmental damages due to improper operation of the project.

This type of risk can be covered by performance guarantees in an operating and maintenance contract, which is assumed primarily by the private partner.