ΛTKINSAbu Dhabi Bahrain Dubai Kuwait Oman Qatar Saudi Arabia India

ΛTKINS

Management

Consultants

ΛTKINS

Designing and EvaluatingRisk Management Strategies for PPP

Dr Rupert Booth+973 399 81410Rupert.Booth@atkinsglobal.com

ΛTKINSAgenda

• Overview: a Process not a Spreadsheet• Setting the Context• Risk Types and Identification• Risk Allocation and Potential Mitigation• Modelling across the Lifecycle• Risk Treatment & Transfer• ISO31000 Risk Framework• Summary

ΛTKINSRisk Management – a Process not a Spreadsheet

CONTEXT

• Identify motives for PPP• Perceptions become reality

IDENITF

Y

• Identify types of risk• List risks by type

ANALYSE

• Allocate risks to project stages• Examine source and potential mitigations

EVALUATE

• Life-cycle modelling• Cost of capital & Real Options

TREAT

• Public ↔ Private Transfer• Performance Management

Survey

Case I

Case II

Case III

ΛTKINSSetting the Risk Management Context

Multiple PPP Objectives• Risk transfer• Process excellence• Transparency• Private sector skills• Public debt ratios• Boost to economy

Perceptions become Reality• Perceived risk (including risk

of unknown) sets cost of capital

• Valuations based on expected cash flows

• Public (mis)perception becomes actual political risk

• Perceptions can affect deal structure, e.g. p-word FT 19Mar12

e.g. Kuwaitpriorities

ΛTKINSSurvey of Financiers Perceptions of Risks

Top Risks for Equity Providers(% state very important/important)

Risk transfer to subcontractors, 97%Return on subord.debt/quasi equity, 91%Target return on equity, 91%Availability of insurance, 86%Inflation on opex, 77%Available insurance for construction, 74%(9 risks cited in all)

Top Risks for Senior Debt Providers(% state very important/important)

Availability of interest rate swaps, 100%Risk transfer to subcontractors, 97%Availability of insurance, 91%Interest margin on cost of debt 91%Cover ratios, 91%Due diligence on financial model, 88%(13 risks cited in all)

Source: SATER (2010), Public Private Partnership financiers’ perceptions of risk

ΛTKINSSurvey of Financiers Perceptions of Risk Transfer

Pre-Operational Phases(% state very important/important)

Fitness for purpose of design, 100%Delivery of design, 100%Planning problems, 98%Construction cost over-run, 98%Planning approvals, 98%Late delivery of design, 98%(9 risks cited in all)

Operational Phases(% state very important/important)

Asset/service performance, 100%Asset/service reliability, 97%Employment laws, 93%Security, 91%Change in public partner requirements, 91%Costs of latent defects in assets, 85%(11 risks cited in all)

Source: SATER (2010), Public Private Partnership financiers’ perceptions of risk

ΛTKINSCase I: Power Due Diligence, Turkey

Pre-financial Close• Review of project agreements• Technology review • Risk assessments• Input to Information Memorandum• Review of technical input to financial model• Road show support

Implementation Phase• Regular site progress reporting• Payment validation• Advise on variations• Performance Test witnessing• Member of Acceptance Committee• Provisional Acceptance Certificate• Advise on Final Acceptance

Operational Phase• Review of operating and Maintenance reports• Annual report on O&M Contract• Availability and Reliability• Environmental performance

ΛTKINSIdentify Risks by Type

Develop Construct Operate Exit

Political Risks•Expropriation•Change of law•Judicial challenge•Regulation (Environmental, Economics)•Reputation

Commercial Risks•Completion: Cost, Time , Quality•Availability•Demand: Price, Volume)•Supply: Availability, Cost

Financial Risks•Funding (timing)•Creditors•Currency convertibility•Currency transfer•Redeposit risks

Economic Risks•Inflation•Interest rates•Exchange rates•Devaluation•Taxes•Technological change

ΛTKINSSample Political Risks

Phase Risk Source Mitigation/Allocation

Development Planning consent State Prior consent, or transfer to state

Construction Residents’ opposition Community Stakeholder building

Operation Tightening labour laws

State Develop subcontracting network

Exit Tighter environmental legislation

State Due diligence on future legislation

ΛTKINSSample Commercial Risks

Phase Risk Source Mitigation

Development Land acquisitionDesign faults

Prior acquisitionEPC contractors

Stakeholder buildingContract

Construction Cost over-runsTime over-runsLabour disputes

EPC ContractorsEPC ContractorsUnions

ContractContractTerms & Conditions

Operation Asset performance Asset availabilityLow demandSupply costs

EPC ContractorsEPC ContractorsTarget marketSuppliers

ContractContractNew buyersNew suppliers

Exit Asset damageAsset wear

VariousUsage

InsuranceAsset Management

ΛTKINSSample Financial Risks

Phase Risk Source Mitigation/Allocation

Development Open-ended, cash drain

Project management Project monitoring

Construction Liquidity (for overruns)

Project management Contingency funding arrangements

Operation Credit risk Creditors Guarantee

Exit Currency transfer/ convertibility

Change of law Contingency arrangements

ΛTKINSSample Economic Risks

Phase Risk Source Mitigation/Allocation

Development Key skill shortage Local labour Global recruitment

Construction Commodity supply Global markets Forward contracts

Operation InflationLow/negative growth

Economic cycleEconomic cycle

Forward contractsOffset with cost reduction

Exit Asset valuation Economic cycle Examine timing options

ΛTKINS Case II: Dublin Metro, Lifecycle Cost Analysis

Model Specification • Analysis covered duration of the

PPP contract• Forecast maintenance,

operational and renewal costs, across specific asset groups

• Included onerous hand back requirements contract-end

• Robust track model included so that the varying levels of usage over the contract life were modelled

Business Requirement• Shortfall in performance or quality

measures led to penalty payment.• No ‘free’ railway possessions to the

maintainer, so loss of service due to planned possession or maintenance works was treated unplanned loss

• Need to model different maintenance and renewal strategies to choose optimal

ΛTKINSLifecycle Modelling

Operations• Input Capex profile• Relate to Volume

& Revenue• Model Opex via

cost drivers and unit costs

• Include staff and key supplies

• Examine scenarios & bottlenecks

Project Finance• Equity

commitment• Debt drawdown• Interest • Tax• Cash waterfall• Ratios:

o Equity returnso Debt cover

Asset Financial Model• Capital, fixed &

working• Income &

Expenditure (to Earnings before Income & Tax)

• Statements:o Incomeo Balance sheeto Cash-flow

Common assumptions: Inflation, exchange rates, tax rates etc

ΛTKINSRisk & Financial Modelling

Treatment of Risk• Only ‘Systemic Risk’ reflected in

discount rate• Project- and company-specific

risk in cash flows:o Diversifiable for international

investoro Captures asymmetric effectso Link to risk management

• Discount rate is Weighted Average Cost of Capital for project company

Treatment of Options• Options occur when there is:

o Uncertainty abut futureo Future informationo Management ability to act

• Common uncertainties:o Market demando Environmental standards

• Options have a value, e.g. Option to widen road if demand increases

ΛTKINSCase III: M25 Scorecard and Paymech

Safety• Improve road user safety• Improve road worker safety

Operations• Maintain network• Improve incident management• User satisfaction• Journey improvement• Congestion reduction• Network Availability

Management• Continuous Improvement• Management of Agreement

External• Enhance the environment• Technology adoption

ΛTKINSTransfer: Role of the Private Partner

Equity Loan

Source: PWC (2008) The value of PFI; hanging in the balance (sheet)?

ΛTKINSTransfer: Role of the Public Partner

Project Risk• Protect lenders from SPV

default• Demand/usage risk• Construction Risk• Technology Risk• Sub-sovereign risk• Policy risk• Macroeconomic• Residual value

Guarantees Offered• Loan/refinancing• Revenue/usage• Service charge to cover debt• Change of law/regulation• Debt assumption on

termination• Sub-sovereign

creditworthiness

Source: EPEC (2011), State Guarantees in PPPs

ΛTKINSWhen Transfer Breaks Down

Source: Service Works Intl. (2011), The Importance of Transparency & Auditability in PPPs

Cited reasons for contract dispute:

ΛTKINSISO31000 Risk Integration Framework

Establishing the Context

Risk Assessment• Identification• Analysis• Evaluation

Risk Treatment

Communication and Consultation

Monitoring and Review

ΛTKINSSummary

• Clarify context of region/country• Identify risks by type and source• Allocate and mitigate• Risk analysis rooted in ongoing due diligence• Model scenarios, operationally and financially• Relate risk transfer/treatment to model findings• Base performance management on key parameters