Risk Management Paper for Kuwaiti PPP Conference
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Transcript of Risk Management Paper for Kuwaiti PPP Conference
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 [email protected]
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