Module 03: Planning & Organising

3.3 What are the risks?

Main Types of Risks:
1. political
2. those that relate to implementation
3. those that relate to construction
4. those that relate to operation revenue
5. financial
6. force majeure
7. environmental

All PPPs involve risks to stakeholders. For the partnership to be effective and sustainable, stakeholders must accept some risks. However, by careful planning and consultation, risks can be reduced to low levels that do not threaten the PPP and can be handled within the partnership arrangement.

The stages for addressing risks that can help in structuring a successful PPP include:

1. identifying types of risks;
2. evaluating risks;
3. seeking means to reduce or eliminate risks;
4. allocating risks to those stakeholders who have the capability to influence them; and
5. sharing any remaining risks.

These stages may be merged or overlap, especially in a small, short-term PPP. Risk handling can be crucial in large, long-term PPPs.

1. Political risks

The government and the public sector should state clearly its policy (which could change) on key risk-related issues, such as those listed below:

– The level of public support that will be in place for the private sector to use in its provision of public services.

– The support for independent regulation and/or review of the PPP to safeguard consumers and the private operator, especially in cases of monopolies where the government fixes tariffs. Governments often wish to retain the right to set tariffs, but these may be influenced by short-term political considerations. Such a situation can be perceived as a risk by the private sector, in which case the private operator is likely to seek a higher income to cover this risk.

– The ability of the public sector to take or share the commercial risks of the PPP.

Political risks include the consequences and likelihood of changes in government and the new government withdrawing support to a PPP. Support by all major parties reduces this risk.

2. Implementation risks

These can be reduced by consideration of the following issues:

– Have all stakeholders agreed to the PPP? Objectors can delay or even stop a PPP going ahead. From the creation stage, the PPP should be discussed with all stakeholders, but especially those who consider that they may be disadvantaged by the process.

– Is the implementation programme defined sufficiently to monitor progress? The programme should include milestones for starting activities and completion, plus any intermediate targets that can be defined clearly. Payment of fees could be related to achieving milestones.

–Are obligations and actions clearly identified, including a timetable for external review and approval? Approving agencies should agree time limits in which they will respond to applications (that are properly presented).

3. Construction risks

Where infrastructure is to be developed as part of the PPP, some construction will be necessary. Risks relating to this can be mitigated by consideration of the issues listed below:

– Can costs exceed the estimate? Under most construction contracts, the contractor (private operator) takes the risk for cost overrun if it is related to aspects under his/her control, such as inefficient working. However, costs can also increase because of changes in design, delays in approval/agreement by the public sector, changes in law, new taxes and so on. Competitive bidding also increases the risk of underestimating construction costs.

– Can completion be on time? Normally the contractor takes this risk as he/she has the responsibility for controlling the construction process. However, he/she could be denied access to land held by the public sector or may have been given misleading information on existing infrastructure. Over-optimistic programming increases this risk.

– Is construction to required standards? Normally this risk is reduced by independent site supervision on large constructions and routine inspections by the public sector.

– Does infrastructure meet performance criteria? Often final testing has to be undertaken at less than the extreme operating conditions on which the design has been based. Sound design reduces this risk.

4. Operating risks

These are particularly important for pure operating contracts. The municipality and the private operator should take account of the following issues.

– Are operating costs more or less than expected? Normally the private sector takes the risk of higher operating costs unless the increases are due to causes outside its control, such as new or increased taxes.

– Are operating costs likely to change during the PPP? For a long-term PPP, regular periodic reviews/renegotiations and adjustment of charges will improve sustainability.

– Could others also provide the services under the PPP and thereby reduce sales? This is more likely where the cost of starting up a PPP arrangement is low, for example, when there is no significant initial capital investment. Some exclusivity of service or area may be necessary for the initial PPP arrangement in order to protect the private operator, at least for a specified time.

5. Revenue risks

These involve risks that the private sector will not receive sufficient revenue to be commercial. In this respect, parties to the partnership (particularly the private contractor) should consider the following:

– Could there be fewer customers or lower demand? Predictions are made in the feasibility study on the amount of the service or product that people want.

– Are customers prepared to pay the commercial price? An evaluation of how much consumers or the public sector, if they take the output, will pay should be made at the feasibility stage of the PPP. Gradually increasing charges by a number of small increments reduces their impact compared with a single rise and reduces the risk of consumers not paying.

– Could customers refuse to pay? The public sector may be reluctant to withdraw a public service for non-payment, but it has the power of legislating for penalties and imposing them.

– Can the public sector default on payment if it is the sole purchaser? On large projects funded by donors, the donors may promise some support. Increasing the number of sources of revenue can reduce revenue risks. The private operator may then lose one source of income, but not others. The extreme case of many sources of revenue is where the private operator receives payment directly from consumers. It is most unlikely that all consumers will decide not to pay, hence this is a much lower income risk than if the total private operator fee is paid from one single source.

– Do published inflation indices reflect increases in operating costs? Except for short PPPs, adjustments to charges/prices should be made regularly in line with local and/or national inflation. Independent regulation with regular reviews reduces this risk.

– Can the public sector increase charges for critical cost components? For example, government may increase charges for services such as water, electricity and materials so increasing the private operator’s costs.

6. Financial risks

Funds will be raised for PPPs that include building infrastructure or where large working capital is required. In this respect, the parties to the agreement should consider the following:

– Will changes in exchange rates affect the PPP? This factor is important when there is international finance or when an international operator is involved.

– Can interest rates vary? This will depend on the finance package and whether loans have been made on the basis of fixed or variable interest rates. Fixed interest rates reduce this risk.

– Do loan periods match the length of PPP? Commercial loans are repaid out of income from the PPP; therefore the loan period cannot be longer than its duration.

7. Force majeure risks

Events may occur that are outside the control of stakeholders in PPP. Reducing such risks involves consideration of the following factors:

– Is there a flood or erosion risk? Protection works could be included within the PPP, but would increase costs. Locating on higher ground would reduce the risk.

– Is the PPP vulnerable to earthquakes? Infrastructure should be designed to withstand reasonable earthquakes. However, a PPP might suffer more from becoming unnecessary following an earthquake that leads to a loss of income -– for example, if a municipality suffers severe damage from an earthquake, collection of solid waste and street cleaning are no longer a priority. On the other hand, in such cases PPP resources could be diverted to general clean-up tasks; this would reduce the risk of total loss of income.

– Is the PPP at risk from riot or general strike? Could it be a target? Could it be protected? These risks reduce in a stable political environment.

8. Environment risks

Parties to the PPP should take account of the following:

– Does operation affect the environment? The PPP should comply with current environmental legislation. Planning should cover compliance with environmental standards to avoid the risk of penalties and other costs later on.

– Is there any pre-existing and continuing environmental liability? A thorough check during the planning stage reduces this risk.

Often PPP arrangements can cover the impact of risks by taking out insurance. Following an unexpected event, the PPP agreement should be reviewed and amended as necessary so that it can still meet the original, or revised, objectives.

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