Risk management is at the hart of the PPP Issue because it is closely linked to Value for Money (VfM). Maximizing VfM, the raison d'être for using PPPs, involves maximizing the allocation of risks, which in turn requires taking precise and detailed account of them – Thibaut Mourgues
PPP Project Risk is a Real Concern
De-risking projects requires that the public sector engage the private sector in consequential ways where the resources of both parties can improve the sustainability and resilience of current and future projects through the allocation of project risk to appropriate parties.
In a recent survey conducted with 164 PPP practitioners (in the public and private sector) from 60 countries that I launched in May of 2020, almost all respondents shared their concerns about project risks that the current and potential future pandemics can pose. Respondents repeatedly emphasized that the pandemic caught project proponents and concessionaires unprepared and left them rethinking project risk caused by force majeure events. Project lifecycle risk has become an all-consuming concern that has project proponents scrambling to explore de-risking of existing and future projects through future forward and failure-proofing strategies.
Infrastructure Sector Projects Most at Risk
Infrastructure PPP projects sectors identified by survey respondents as the most at risk, were the following, listed in descending order: transportation (toll roads, airports, and maritime ports); tourism-leisure; power-energy (due to declines in demand and ability to pay); healthcare (due to stress caused by demands in covid-19 mitigation and declining demand for cancer and cardiac services); and education (inability of schools to provide online education platforms). The two most common challenges cited by respondents with these sectors was the massive drop in usage – due to restricted access to these sectors - and the resulting decline in user /revenue fees.
It must be pointed out that not all risks are the same and are seldom equally important. Because of this there is a need to focus on project risks that can be materially handled and yet remain flexible enough to manage risks that are “unimaginable.” This includes comprehensive full life cycle risk management in the design, build, financing and operations and maintenance of infrastructure PPP projects.
Project Triage De-Risking
To ensure the survivability of infrastructure PPP projects, the public sector and their private sector partners will have to seriously look at de-risking. This means that serious decision will need to be taken regarding an existing project’s ability to survive pandemic induced stresses or adverse natural events. A pragmatic and subjective approach to de-risking projects will require a “triage” approach where projects that are meritorious (e.g. can contribute to economic growth or SDG goals) and which can survive pandemic type events become the focus of remedial actions. This will also include a similar strategy when deciding what to do with current national infrastructure PPP project pipelines in regards to their future viability. I would recommend that public sector project proponents seriously revise their infrastructure PPP project risk assessment criteria (and bankability) and retune their national infrastructure project pipelines accordingly. They will also have to revisit project risk matrices and clearly articulate which party is accountable for identified risks, whether they are legal (i.e. force majeure), design, construction, financing, operational or maintenance.
Project Bankability and Allocation of Risks
We must also remind ourselves that de-risking of projects enhances project bankability. This means that tangible project risks have to be identified and declared to potential investors and developers. The day of a “laisses faire” approach to infrastructure PPP risks are over. The new reality is that reputable investors and developers of future projects will have a laser focus on project risk profiles and will increase their levels of due diligence before considering projects “bankable”.
De-risking must be tied to appropriate project risk allocation - where risk is only allocated to public and private sector project partners who can best manage and mitigate identified risk. What to do in relationship to unidentified risk (unimaginable risk) will have to be explored. I believe that if the unimaginable is entertained and mitigation and de-risking strategies are devised, that projects will have a greater successful recovery potential when pandemic magnitude events occur.
However, the current pandemic and the specter of future pandemics has most certainly led to project implementers and investors asking whether risk allocation has been efficiently implemented in the past and whether it can be accurately implemented in the future. I have no doubt that PPP investors will be increasingly be asking whether risks are fairly allocated and whether governments will remain committed to the allocation? Once agreement is reached on accountability, this clearly needs to be articulated in a project matrix, or else the whole exercise will serve no purpose. Another question will be asked is who will be responsible for unimagined risks.
The Need for Objective Project Risk Assessments
It will also be important to question whether proponents of extremely large, costly, and “politically” ambitious (vanity projects) projects in the future will be able to allocate project risk objectively, thereby increasing their bankability potential. No risk responsibility should be inappropriately forced on a party that does not have the resources to manage it. Project proponents are increasingly finding themselves in a testing position. Paradoxically, if they objectively and exhaustively identify every possible risk, this exercise might frighten off investors and leave a project un-bankable. On the other hand, if they subjectively under-identify risks, then project developers and investors will be suspicious of a project’s bankability as well. What most certainly is needed is a balanced and pragmatic approach to de-risking projects where mitigations are identified well in advance, and risk accountability is emphasized.
There are contextual realities that will have to be accepted. Project types, project sectors, and locations (countries) will add risk layers to projects. Current projects will need re-assessments of project risk probability that factors in pandemic impacts, while planned projects will now need an additional review of potential future risks due to unimaginable challenges exposed by the pandemic.
Improved Enabling Environments and Risk Disclosure
Governments that commit to enabling environments (legal frame works) that unequivocally demand structured risk assessments and disclosure, to protect all parties - will most certainly be well positioned for promoting de-risking strategies. It is all about perceptions and governments will need to manage perceptions strategically. Governments cannot afford to be caught out camouflaging risk descriptions and probabilities. The market will not forget such mis-endeavors. New de-risking strategies will also require political fortitude as well. Some countries might feel that if they acknowledge too many risks that they will be unable to compete with less honest neighboring countries. However, I strongly feel that countries with track records that point to objective and concerted efforts to identify risks and attempt to de-risk country project programs will most certainly come out on the top. Remember, investors are not sentimental, especially in the post-pandemic world.
Government Support for De-Risking Projects
De-risking of projects must include unequivocal government support, that could include offering guarantees of financial support (i.e. subsidies) to cover lost user fees in the event of future events. However, this must be with the caveat that any government support must only be directed at projects that have undergone a pandemic “survivability triage.” In the short run, de-risking should focus on the ongoing operations and maintenance of existing infrastructure PPP projects so that they do not deteriorate under long periods of shut down and become un-bankable for restructuring and refinancing during and after recovery.
Furthermore, the provision of a continent liability fund will mitigate project risk. This should include a strategy where the public sector undertakes to support critical components of projects in structured contracts and offer bridging payments for delayed projects so that the risk of additional costs caused by delays can be avoided. Such support would in turn prevent escalations in long-term project financing costs. This approach would however be based on government willingness to accept certain risks and to retrofit accountability to projects that have been seriously impacted by the pandemic.
De-Risking Best Practices
De-risking strategies should include the following best practices –
§ Strengthening political will and transparency when acknowledging project risks
§ Optimizing value for money, value for people, and value for future considerations
§ Re-evaluating all projects against strong sustainability and resilience criteria
§ Improving stakeholder participation, especially regarding transparency in decision making
§ Considering project costs holistically
§ Improving project due diligence and enhanced feasibility studies
§ Hiring professional advisors to help with projects if internal capacity does not exist for de-risking actions
§ Searching for best practices - that have been adopted elsewhere - that enhance resilience and sustainability
§ Tying all future projects to sustainability development goals that allow infrastructure PPP projects to become tools for economic recovery and development
§ Leverage private sector experience (innovation) and resources in future projects
Risks as Opportunities
Enhanced risk management can be seen in terms of opportunities to design and implement better projects that are sustainable and resilient. We need to bridge the gap between common risk practice and best practice if we hope to be successful. We should be planning for future risks and being ready to mitigate them. Obligatory risk management plans that contextualize risk will lower project costs (i.e. insurance risks); reduce chaos; allow for informed justifications of projects commercial and economic viability and bankability; and help establish project management reserves for unforeseeable future events. However, this will only be possible if risk management biases are also addressed. For bias to be addressed and informed decision making to take place, governments will need to develop “peril” databases that capture what has gone wrong with projects and which offer a realist perspective of challenges that projects could face in the future.
Tom Kendrick’s Book – Essential Tools for Failure-Proofing Your Project – Identifying and Managing Project Risk – offers very useful advice in this regard. Risks should be identified early and systematically and be supported by plans (with accountable managers) that address them immediately.
A Seven-Step Approach to Risk Management
Thibaut Mourgues in his recently published book – Public-Private Partnerships: The Road to Sustainable Development Goals? - provides a de-risking seven-step approach to a risk analysis and mitigation methodology. These steps include:
§ Risk identification by a public (and private sector) working group that develops a risk matrix through a detailed analysis that allows the identification of risk categories and sub-categories relevant to the specificities of the project
§ Risk analysis according to three factors which include: defining the nature of the risk; its timing; and its severity
§ Assessing the likelihood of each risk based on evaluations of similar projects, estimation based on experience to team members, and consulting of experts in the field
§ Calculating the costs of each risk where cost = probability x monetary impact
§ Risk allocation to the most appropriate partner in a PPP. Maximization (or loading of) of risk transfer to one party needs to be avoided
§ Construction of a risk matrix that includes risk categories, sub categories, descriptions, consequences, probabilities, cost of risk, and allocation of risk
§ Risk mitigation strategies that includes the correct allocation to the party best able to handle them, insurance coverage, guarantees offered by international institutions, and financial risk hedging instruments. Risks that cannot be treated, reduced, or transferred must be subject to a contingency provision
Conclusion
I believe that the impact of the pandemic on infrastructure PPP projects will be a positive development regarding project viability in the long-term. For years there have been calls for PPP proponents and investors to take project risks more sincerely so that projects can be resilient and sustainable. The pandemic wake-up call should ensure that risks to current and future infrastructure PPP projects will be taken seriously and that new pragmatic and objective risk mitigation strategies will evolve that acknowledge potential future pandemics and exceptionally adverse events as “worthy of attention.” We need to set risk naivety aside. If not, risk insurance costs, for example, could result in projects becoming “un-bankable”. It is also certain that a reassessment of risks will result in force majeure events being redefined as well.
References:
Dale Cooper, Stephen Grey, Geoffrey Raymond, and Phil Walker (2005) – Project Risk Management Guidelines: Managing Risks on large Projects and Complex Procurements – Wiley
Thibaut Mourgues (2020) – Public-Private Partnerships: The Road to Sustainable Development Goals? Greenwhich Publishers
Tom Kendrick (2015) – Essential Tools for Failure-Proofing your Project: Identifying and Managing Project Risk - AMACOM
Author: David Baxter (https://www.linkedin.com/in/david-baxter-33531b15/)
The comments and ideas set out in this article are the comments and ideas of the author and not Nexsoma Legal.