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Risk Management Paper for Kuwaiti PPP Conference
1. Abu Dhabi Bahrain ΛTKINS
Dubai Kuwait Oman Qatar Saudi Arabia India
2. ΛTKINS
ΛTKINS
Management
Consultants
Designing and Evaluating
Risk Management Strategies for PPP
Dr Rupert Booth
+973 399 81410
Rupert.Booth@atkinsglobal.com
3. ΛTKINS
Agenda
• 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
4. ΛTKINS
Risk Management – a Process not a Spreadsheet
• Identify motives for PPP
• Perceptions become reality Survey
CONTEXT
• Identify types of risk
IDENITFY • List risks by type Case I
• Allocate risks to project stages
ANALYSE • Examine source and potential mitigations Case II
• Life-cycle modelling
EVALUATE • Cost of capital & Real Options Case III
• Public ↔ Private Transfer
TREAT • Performance Management
5. ΛTKINS
Setting the Risk Management Context
Perceptions become Reality Multiple PPP Objectives
• Perceived risk (including risk of • Risk transfer
unknown) sets cost of capital • Process excellence e.g.
• Valuations based on expected Kuwait
• Transparency priorities
cash flows • Private sector skills
• Public (mis)perception becomes • Public debt ratios
actual political risk
• Boost to economy
• Perceptions can affect deal
structure, e.g. p-word
FT 19Mar12
6. ΛTKINS
Survey of Financiers Perceptions of Risks
Top Risks for Equity Providers Top Risks for Senior Debt Providers
(% state very important/important) (% state very important/important)
Risk transfer to subcontractors, 97% Availability of interest rate swaps, 100%
Return on subord.debt/quasi equity, 91% Risk transfer to subcontractors, 97%
Target return on equity, 91% Availability of insurance, 91%
Availability of insurance, 86% Interest margin on cost of debt 91%
Inflation on opex, 77% Cover ratios, 91%
Available insurance for construction, 74% Due diligence on financial model, 88%
(9 risks cited in all) (13 risks cited in all)
Source: SATER (2010), Public Private Partnership financiers’ perceptions of risk
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Survey of Financiers Perceptions of Risk Transfer
Pre-Operational Phases Operational Phases
(% state very important/important) (% state very important/important)
Fitness for purpose of design, 100% Asset/service performance, 100%
Delivery of design, 100% Asset/service reliability, 97%
Planning problems, 98% Employment laws, 93%
Construction cost over-run, 98% Security, 91%
Planning approvals, 98% Change in public partner requirements, 91%
Late delivery of design, 98% Costs of latent defects in assets, 85%
(9 risks cited in all) (11 risks cited in all)
Source: SATER (2010), Public Private Partnership financiers’ perceptions of risk
8. ΛTKINS
Case I: Power Due Diligence, Turkey
Pre-financial Close Operational Phase
• Review of project agreements • Review of operating and Maintenance reports
• Technology review • Annual report on O&M Contract
• Risk assessments • Availability and Reliability
• Input to Information Memorandum
• Environmental performance
• 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
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Identify Risks by Type
Political Risks Commercial Risks Financial Risks Economic Risks
•Expropriation •Completion: Cost, •Funding (timing) •Inflation
•Change of law Time , Quality •Creditors •Interest rates
•Judicial challenge •Availability •Currency •Exchange rates
•Regulation •Demand: Price, convertibility •Devaluation
(Environmental, Volume) •Currency transfer •Taxes
Economics) •Supply: •Redeposit risks •Technological
•Reputation Availability, Cost change
Develop Construct Operate Exit
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Sample 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 State Develop
laws subcontracting
network
Exit Tighter State Due diligence on
environmental future legislation
legislation
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Sample Commercial Risks
Phase Risk Source Mitigation
Development Land acquisition Prior acquisition Stakeholder building
Design faults EPC contractors Contract
Construction Cost over-runs EPC Contractors Contract
Time over-runs EPC Contractors Contract
Labour disputes Unions Terms & Conditions
Operation Asset performance EPC Contractors Contract
Asset availability EPC Contractors Contract
Low demand Target market New buyers
Supply costs Suppliers New suppliers
Exit Asset damage Various Insurance
Asset wear Usage Asset Management
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Sample Financial Risks
Phase Risk Source Mitigation/Allocation
Development Open-ended, cash Project management Project monitoring
drain
Construction Liquidity (for Project management Contingency funding
overruns) arrangements
Operation Credit risk Creditors Guarantee
Exit Currency transfer/ Change of law Contingency
convertibility arrangements
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Sample Economic Risks
Phase Risk Source Mitigation/Allocation
Development Key skill shortage Local labour Global recruitment
Construction Commodity supply Global markets Forward contracts
Operation Inflation Economic cycle Forward contracts
Low/negative growth Economic cycle Offset with cost
reduction
Exit Asset valuation Economic cycle Examine timing
options
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Case II: Dublin Metro, Lifecycle Cost Analysis
Business Requirement Model Specification
• Shortfall in performance or quality • Analysis covered duration of the
measures led to penalty payment. PPP contract
• No ‘free’ railway possessions to the • Forecast maintenance,
maintainer, so loss of service due to operational and renewal costs,
planned possession or maintenance across specific asset groups
works was treated unplanned loss
• Need to model different • Included onerous hand back
maintenance and renewal strategies requirements contract-end
to choose optimal • Robust track model included so
that the varying levels of usage
over the contract life were
modelled
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Lifecycle Modelling
Operations Asset Financial Model Project Finance
• Input Capex profile • Capital, fixed & • Equity
• Relate to Volume working commitment
& Revenue • Income & • Debt drawdown
• Model Opex via Expenditure (to • Interest
cost drivers and Earnings before • Tax
unit costs Income & Tax)
• Cash waterfall
• Include staff and • Statements:
• Ratios:
key supplies o Income
o Equity returns
• Examine scenarios o Balance sheet
& bottlenecks o Debt cover
o Cash-flow
Common assumptions: Inflation, exchange rates, tax rates etc
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Risk & Financial Modelling
Treatment of Risk Treatment of Options
• Only ‘Systemic Risk’ reflected in • Options occur when there is:
discount rate o Uncertainty abut future
• Project- and company-specific o Future information
risk in cash flows: o Management ability to act
o Diversifiable for international • Common uncertainties:
investor
o Market demand
o Captures asymmetric effects
o Environmental standards
o Link to risk management
• Options have a value, e.g.
• Discount rate is Weighted Option to widen road if
Average Cost of Capital for demand increases
project company
17. ΛTKINS
Case 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
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Transfer: Role of the Private Partner
Equity Loan
Source: PWC (2008) The value of PFI; hanging in the balance (sheet)?
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Transfer: Role of the Public Partner
Project Risk Guarantees Offered
• Protect lenders from SPV • Loan/refinancing
default • Revenue/usage
• Demand/usage risk • Service charge to cover debt
• Construction Risk • Change of law/regulation
• Technology Risk • Debt assumption on termination
• Sub-sovereign risk • Sub-sovereign creditworthiness
• Policy risk
• Macroeconomic
• Residual value
Source: EPEC (2011), State Guarantees in PPPs
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When Transfer Breaks Down
Cited reasons for contract dispute:
Source: Service Works Intl. (2011), The Importance of Transparency & Auditability in PPPs
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ISO31000 Risk Integration Framework
Communication and Consultation
Risk
Assessment
Establishing Risk
• Identification
the Context Treatment
• Analysis
• Evaluation
Monitoring and Review
22. ΛTKINS
Summary
• 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