Much of the PPP literature focuses on risk allocation. Some of it can give the impression that, once a preferred risk allocation has been settled, this can somehow translate smoothly into a detailed contract. Such an impression may be misleading, since many experienced PPP practitioners will go through an intermediate step in which they define other elements of the contract structure such as: "who will do what?", and "how will the payments flow?" Unfortunately, relatively few resources describe how the risk allocation translates into an overall contract structure.
The World Bank's toolkit for PPP in water services [#273, pages 97-124] is an exception, and explicitly sets out a process of allocating responsibilities and risks together-since each responsibility is typically associated with a bundle of risks. For example, the private party may be responsible for revenue collection, which carries the risk that some customers will not pay. The private party may be responsible for construction, which entails a series of risks. Labor costs, the timing of equipment delivery, and the cost and time to obtain permits can affect total costs and construction times, positively or negatively.
The toolkit therefore sets out an approach to contract structuring, starting with identifying the major areas of responsibility, or functions: design and construction of new assets, finance, operations, and maintenance (for more on these functions see Section 1.1: What is a PPP: Defining 'Public-Private Partnership'). For each function, specific responsibilities can then be defined, and risks identified that are associated with each responsibility.
The toolkit also describes the close linkage between defining the details of the payment mechanism-in this case, tariff review mechanisms since the toolkit focuses on user pays project-and risk allocation. Section 3.4.2: Payment Mechanism goes into more detail.
Generalizing from this approach suggests that it may be helpful to think of arriving at a 'PPP type' (see Section 1.1: What is a PPP: Defining 'Public-Private Partnership') from considering whether the public or private party is better able to carry out each of the key 'functions' (Design, Build, Operate, Maintain, and Finance). This allocation of functions may be based on an analysis of which party is best able to bear the risks naturally associated with each function. Consideration of institutional linkages and political constraints will also factor into the decision on which party can perform which function.
Once a basic PPP type is chosen, the remainder of the risk allocation can be thought of as a gloss on the basic function allocation. For example, if the private party is to be responsible for the 'Build' function, but the public party is to retain geotechnical risk, this would be included in the contract design as an exception to the basic functional principle that all construction-related risks are for the private party to manage and absorb.
Beside allocation of functions, another key element in contract structure is how the payments flow. Payment mechanisms may follow from the allocation of functions and risks. For example, if the private party is better able to manage collection risks and demand risks, then the private party will likely be remunerated directly from user charges. However, if the private party is able to manage collection risk but is not asked to take demand risk, then the payment structure may involve the private party collecting user charges and remitting them to the public authority, while the public authority then pays the private party for asset availability, with a bonus for achieving high levels of collections.
Finally, a necessary complement to defining the payment mechanism is defining how performance will be measured, monitored, and enforced. For example, the government's payment may be conditional on the availability of the asset, with a view to transferring most operating risk to the private sector. This risk transfer can only be achieved in practice if the standards required as part of 'available' are clear and practicable. Section 3.4.1: Performance Requirements provides more details.
The following resources provide further guidance on the linkages between responsibilities, risks, rights, and payment mechanisms, which can inform development of the contract structure:
• Irwin [#161, page 61] briefly describes how responsibilities, rights, and risks should be allocated together. This follows from the principle of risk allocation that a risk is allocated to the party best able to manage it: the rationale only holds if the party is also given the right and responsibility to make decisions related to that risk
• Iossa et al [#159, pages 26-31] also describes how different PPP contract types-with different functions allocated to the private party and different payment mechanisms-typically correspond to different risk allocations. The authors also describe [pages 33-34] how output specifications, payment mechanisms, and risk allocations need to be closely aligned
• India's online PPP Toolkit [#143] Module 1: PPP Background has a section on 'PPP model variants', which describes typical risk allocations under different PPP Contract types, thus giving a guide to how risk allocation can translate into choice of basic contract structure.
| Key References: Structuring PPP Projects | |
| Reference | Description |
| Tim Irwin (2007) Government Guarantees: Allocating and Valuing Risk in Privately Financed Infrastructure Projects, World Bank | Chapter 4 defines risk, and explains the principles of allocating risk under PPP projects. Chapter 5 provides examples of putting those principles into practice for three risks: exchange-rate risk, insolvency risk, and policy risk |
| Yescombe, E. R. (2013) Public-Private Partnerships: Principles of Policy and Finance, 2nd edition, Elsevier Science, Oxford | Chapter 14 on risk evaluation and transfer describes types of risk that are common to PPP projects |
| Jeff Delmon (2009) Private Sector Investment in Infrastructure: Project Finance, PPP Projects and Risks (2nd ed) London: Kluwer Law International | Chapter 5 on risk allocation goes into more detail on PPP risk categories |
| Australia, Infrastructure Australia (2008) National Public-Private Partnership Guidelines: Public Sector Comparator Guidance (Vol. 4) Canberra | Section 16: Identifying, allocating, and evaluating risk describes in detail different methodologies for quantitatively valuing risk in PPPs |
| Asian Development Bank (2002) Handbook for Integrating Risk Analysis in the Economic Analysis of Projects, Manila, Philippines | Chapter 2 describes quantitative techniques for assessing risk |
| Australia, Victoria Managed Insurance Authority (2010) Risk Management: Developing and Implementing a Risk Management Framework, Melbourne | A general guide on risk management frameworks, developed for public sector managers in the State of Victoria, Australia. Includes examples of risk assessment, and risk management templates |
| Farquharson, Torres de Mästle, and Yescombe, with Encinas (2011) How to Engage with the Private Sector in Public-Private Partnerships in Emerging Markets, World Bank/PPIAF | Appendix B is "risk register" for a PPP project, providing an example of a risk allocation matrix, and of a qualitative approach to assessing and prioritizing risks |
| Iossa, E., Spagnolo, G., and Vellez, M. (2007) Contract Design in Public-Private Partnerships, World Bank | Section 3 on "risk allocation incentives, and types of PPP" describes typical types of risk in PPP contracts, the principles of effective risk allocation as well as its limitations, and typical risk allocations under different types of PPP contract |
| Organization for Economic Cooperation and Development (2008) Public-Private Partnerships: In Pursuit of Risk Sharing and Value for Money, Paris | Chapter 3 on "the economics of public-private partnership" includes a section on the role and nature of risk, which describes the concept of optimum risk transfer |
| Ng & Loosemore (2006) Risk allocation in the private provision of public infrastructure, International Journal of Project Management, 25(1) 66-77 | Describes classification and allocation of risk in PPP projects, and provides a case study of risk allocation for a railway PPP project in Australia |
| Bing, Akintoye, Edwards & Hardcastle (2005) The allocation of risk in PPP/PFI construction projects in the UK, International Journal of Project Management, 23(1) 25-35 | Assesses how risks have been allocated in practice in PPP projects in the United Kingdom |
| Banco Interamericano de Desarrollo (2009) Experiencia española en Concesiones y Asociaciones Público-Privadas para el desarrollo de infraestructuras, Washington, D.C. | Review of the Spanish PPP experience. Includes a description of typical project structure divided by sectors and includes multiple examples of successful PPP projects. |
| Ke, Y., Wang, S., & Chan, A. P (2010) Risk Allocation in PPP Infrastructure Projects: Comparative Study, Journal of Infrastructure Systems, 16(4) 343-351 | Compares risk allocation for PPP projects in China, Greece, and the United Kingdom, exploring how country characteristics affect the risk allocation that can be achieved in practice |
| Australia, Infrastructure Australia (2008) National Public Private Partnership Guidelines: Commercial Principles for Social Infrastructure (Vol. 3), and (2011) National Public Private Partnership Guidelines, Commercial Principles for Economic Infrastructure (Vol. 7), and (2011) National Public Private Partnership Guidelines: Roadmap for applying the Commercial Principles, Canberra | Describe in detail how risks and responsibilities will be allocated in social infrastructure projects (based on a government-pays model) and economic infrastructure projects (based on a user-pays model). The Roadmap describes how the principles should be used-as a starting point for developing contracts for particular projects |
| Hong Kong Efficiency Unit (2008) An Introductory Guide to Public Private Partnerships (2nd ed), Hong Kong, China | Section 6 provides guidance on managing risk. Annex E provides an example risk allocation matrix for a water treatment plant |
| Brasil, Governo do Rio de Janeiro (2008) Manual de Parcerias Público-Privadas, Rio de Janeiro | Annex 2 provides an example of a typical risk matrix |
| South Africa, National Treasury (2004) PPP Manual Module 4: PPP Feasibility Study, Johannesburg | Annex 3 provides guidance on how to calculate the value of risk. Annex 4 presents a standardized PPP risk matrix-listing risks, and describing for each risk a typical risk mitigation mechanism and allocation. |
| World Bank (2006) Approaches to Private Sector Participation in Water Services: A Toolkit | Section 6: Allocating Risks and Responsibilities describes a process and principles for allocating both risks and responsibilities, as well as how the allocation can be defined in the contract, including through tariff rules |
| India, Ministry of Finance (2011) PPP Toolkit for Improving PPP Decision-Making Processes, New Delhi | Module 1: PPP Background has a section on "PPP modal variants", which describes typical risk allocations under different PPP contract types. |
| España, Ministerio de Economía y Hacienda (2011) Texto Refundido de la Ley de Contratos del Sector Público, Boletín Oficial del Estado, 276, I, 117729-117914 | The Spanish Procurement law regulates the public procurement PPP contracts that can be used in Spain. Some of them are partially structured by the law and some of them have a flexible risk allocation. |
| Banco Interamericano de Desarrollo (2009) Experiencia Chilena en Concesiones y Asociaciones Público-Privadas para el desarrollo de Infraestructura y la Provisión de Servicios Públicos, Washington, D.C. | Review of the Chilean PPP experience. Includes a description of typical project structure divided by sectors and includes multiple examples of successful PPP projects. |