Appropriate allocation of project risk between the government and private parties—and effective management of those risks in practice—is critical to achieving the potential benefits from successful PPP projects. Many elements of the PPP project structure—such as the allocation of responsibilities and the payment mechanism—stem from the risk allocation. The process of structuring a PPP is therefore primarily a process of risk allocation.
PPP risks vary depending on the country where the project is implemented, the nature of the project, and the assets and services involved. Nonetheless, certain risks are common to many types of PPP project. The first step toward structuring the PPP is to put together a comprehensive list of all the risks associated with the project—that is, factors that could cause unpredictable variation in the project's value.
The following categories of risk are common to many PPPs:
- Site: risks associated with the availability and quality of the project site
- Design, construction and commissioning: risk of construction delays construction, cost overruns, or poor design or construction quality
- Operation: the risk of interruption in service or asset availability, or that costs are higher than expected
- Demand, and other commercial risk: risk that demand for the service is not as predicted or revenue collection
- Legal, Regulatory or political: risk that laws or regulations or political winds will change that affect the project
- Default: risk that the private party is not financially or technically capable of implementing the project
- Economic or financial: risk of changes in interest rates, exchange rates, or inflation
- Force Majeure: risk from natural disasters, war or civil disturbance
- Asset value: risk that the value of the assets at the end of the contract is not as expected.
To focus effort when allocating risks, it is helpful to consider the importance of the different risks. Some risks will be much more significant than others: in terms of the likelihood of the risk occurring, the severity of its impact, or both. Risk can be assessed either quantitatively, or qualitatively.
In practice, many implementing agencies take a qualitative approach at this stage. Each risk is categorized as being low, medium, or high for both risk status (likelihood) and impact. Most effort should be directed to managing those risks identified as being both high likelihood, and high impact.
For some key risks—such as demand—quantitative assessment may be warranted.
Allocating project risks
A central principle of risk allocation is that each risk should be allocated to whoever can manage it best.
Risk allocation is achieved primarily through the PPP contractual agreements. The payment mechanism is the central tool for allocating risk—including construction and operational performance risk, through availability-based payments and bonus or penalty mechanisms; demand risk, if the private party will charge users; and macroeconomic and other risks, by defining payment or fee adjustment mechanisms. The government may then accept back or share certain project risks through guarantees or indemnity clauses, such as minimum revenue guarantees. Termination clauses and payment commitments are also crucial, in defining the cost to each party of walking away from the contract.