Module IV·Article III·~3 min read
Risk Allocation in PPP
Public–Private Partnerships (PPP)
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Principle of Optimal Risk Allocation
The fundamental principle of PPP: the party that can manage the risk most effectively should bear the risk.
If the government bears all risks, there is no sense in PPP (it is simply a public procurement with private construction). If the private party bears all the risks, the cost of capital is too high and the project is not viable.
Optimal allocation finds a balance between these two extremes.
Classification of Risks in PPP
Construction Phase Risks
| Risk | Typical Allocation | Rationale |
|---|---|---|
| Construction risk (cost overrun, delay) | Private | Contractor manages |
| Geological/subsurface | Shared | Difficult to control |
| Force majeure (natural disasters) | Insurance / government | Uncontrollable |
| Permitting | Government | Government issues permits |
| Design changes at government’s request | Government | Government is the initiator |
Operational Phase Risks
| Risk | Typical Allocation | Rationale |
|---|---|---|
| Demand (actual traffic vs. forecast) | Mixed | Depends on PPP model |
| Operational risk | Private | Concessionaire manages |
| Technical availability | Private | As per service level agreement |
| Expense inflation | Partially private, indexed | Negotiable position |
Financial Risks
| Risk | Typical Allocation |
|---|---|
| Interest rate risk | Private (hedged) |
| Currency risk | Shared or government |
| Refinancing | Private / shared |
Political and Regulatory Risks
| Risk | Typical Allocation |
|---|---|
| Change in law | Government (compensation events) |
| Political force majeure | Government |
| Expropriation | Government |
| Tariff changes at government’s initiative | Government |
Mechanisms for Protecting the Private Investor
Compensation Events
A set of events upon the occurrence of which the government is obliged to compensate the concessionaire for additional costs or losses:
- Changes in legislation affecting costs
- Specification changes at the government’s initiative
- Delays in permit issuance
Relief Events
Events giving the concessionaire the right to an extension of deadlines (but not compensation):
- Force majeure
- Actions of third parties
Force Majeure
Both partners are released from obligations (suspension). A complex issue regarding risk allocation: who bears the financial losses during force majeure?
Termination Provisions
In case of early termination:
- Termination for Government Default: The concessionaire receives compensation (typically, debt + fair return on equity)
- Termination for Contractor Default: The government receives the facility, pays less (or nothing)
- Optional termination by Government: The government pays full “buyout value”
Demand Risk: The Pivotal Dilemma
Does the concessionaire bear demand risk (actual traffic/users vs. forecast)?
Revenue concession (concessionaire assumes demand risk):
- The concessionaire earns directly from users
- Bears the risk: less traffic → less revenue → financial problems
- Example: Toll roads where actual traffic is reflected
Availability payment (no demand risk):
- The government pays the concessionaire a fixed amount for ensuring the facility’s availability
- The concessionaire bears operational risk (to maintain the facility in working condition), but not demand risk
- Example: Hospitals, schools, prisons, roads with “shadow tolls”
Minimum Revenue Guarantee (MRG):
- The government guarantees minimum revenue in case of low demand
- Balances incentives for the concessionaire with protection for the government
- Example: Rail projects in Korea (excessively generous MRGs resulted in government losses)
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