Public-Private Partnerships in the Czech Republic The importance of risk management in PPP projects

1
Public-Private Partnerships in the Czech
RepublicThe importance of risk management in
PPP projects

• Twinning Project CZ/2005/IB/FI/04
• Training event on risk management in PPP projects
• Prague, Ministerstvo financí, 26 May 2008
• Rui Sousa Monteiro
• (Parpública SA, Portugal)

2
Contents

• Is risk really important in PPPs?
• What are the risk challenges?
• What are the goals of PPP contract management?
• What are its main components?
• How to deal with PPP risks?

3

• This presentation conveys some overall good
  practices regarding risk management in PPP
  projects, and particularly reflects the authors
  research and experience in Portugal and other
  countries

4

• The establishment of an effective and efficient
  risk management system depends on idiosyncratic
  characteristics of each public administration and
  government department
• The recommendations here included should be
  supplemented by rules tailored to local
  circumstances

5

• Risk is defined as the uncertainty of outcome,
  whether positive opportunity or negative threat,
  of actions and events

6

• Is risk really important in PPP procurement and
  PPP contracts?

7
PPPs

• Public-private partnerships (PPPs) are long-term
  contracts between a public entity and a private
  entity...
• ... for the provision of services usually they
  include the construction or acquisition of
  infrastructure or assets with a long economic life

8
Risk-transfer is critical

• The efficiency of a PPP contract depends on the
  effective transfer of some risks to the private
  partner
• Private entities are efficient in the management
  of a project if they have money at stake, and if
  they face risks that they can manage

9
Private management

• PPP efficiency implies committing private capital
  to the management of a public project
• But private-management efficiency will only arise
  if they face risks a private manager protected
  from risks will only manage rents

10
Risk is costly (1)

• The private partner in a PPP long-term contract
  will be forced to design an infrastructure and
  manage a project using a whole-life costing
  approach
• The efficient design of the infrastructure will
  depend on the credible expectation that the
  private partner will assume the long-term risks

11
Risk is costly (2)

• If risks are not clearly allocated to the private
  partner, it could realise that it is more
  profitable trying to shift risks to the public
  sector than managing those risks
• This way, the focus of the private partner could
  be risk-devolution, and not the provision of
  quality services to government/end-users

12
Risk is costly (3)

• During tender, as well as during the life of the
  contract, the profit-seeking nature of the
  private partner will induce him to transfer back
  some risks to the public partner
• formally, during procurement
• effectively, during contract life

13
Risk management

• So, both the project manager (during the
  pre-procurement and the procurement phases) and
  the contract manager (after contract close) are
  required to manage risks carefully
• Identifying and allocating risks
• Monitoring risks
• Mitigating risks

14

• What are the risk challenges for PPP projects and
  contracts?

15
Three phases

• We need to consider three phases
• Project selection phase
• Procurement phase
• Contract management phase

16
Project selection phase

• Project risks
• Project-design risks
• Project-scheme risks
• Budgetary/fiscal risks

17
Project selection risks

• PPPs may significantly reduce project risks for
  the public sector
• But, if the appraisal framework is not
  appropriate, PPPs may
• bias the selection of public projects, inducing
  the government to procure low value projects
• endanger overall fiscal discipline

18
PPP budgetary risks

• PPPs increase budgetary rigidity
• PPPs create political risks as they establish
  bounds and restraints on public policy changes
• Formal bounds
• Financial bounds
• Those bounds may be redeemed through financial
  compensation

19
Designs and schemes

• Some risks are not really accruing out of a
  project, but out of the PPP scheme designed for
  that project
• So, a specific project-design presents some risks
  that are related to that design ...
• ... and risks that vary, depending on the kind of
  PPP-scheme selected

20
Project-scheme risks (1)

• For instance, consider a free highway
• Construction risk is a project-design risk
  (whatever the PPP scheme, the project will face
  construction risk)
• Demand risk is a project-scheme risk (under a
  shadow-toll regime, there will be demand risk,
  but under an availability regime there will be no
  demand risk for the project)

21
Project-scheme risks (2)

• Consider now a toll-road PPP project
• Demand risk may affect the scheme significantly
  (if traffic risk is allocated to the private
  partner)
• Or just marginally (if payments are made
  according to a pure availability regime, there
  will be almost no demand risk affecting the
  private partner)

22
Project-scheme risks (3)

• Consider now an accommodation project
• If some non-infrastructural services (e.g.
  catering) are included in the scheme, services
  demand will affect the contract
• If those services are to be provided by a third
  party, there will be no demand risk, but the
  scheme will now be affected by interface risks

23

• During PPP procurement, beside all the usual
  negotiation risks, there is the possibility that
  bidders change contract provisions in a way that
  prevents effective risk transfer to the private
  partner

24
Risk and procurement

• If risks are not clearly allocated in the draft
  contract (included in the Invitation to Tender),
  bidders will do their best to reallocate risks in
  the final contract
• Unclear allocation of risks may also prevent
  effective competition and transparency during the
  tender

25

• After contract close, risk allocation is written
  down in the contract, so it is supposed to be
  established for the whole life of the contract

26

• However, risk devolution, from the private to
  public partner, is always possible if there is no
  proper contract management by the public
  authority ...

27

• ... namely if the contract manager is not
  permanently concerned with risk management and
  with the prevention of strategic moves by the
  private partner

28
Risk devolution (1)

• After signing a PPP contract, the private partner
  will have plenty of opportunities to transfer
  risks to the public sector, due to
• Technological, commercial, or demographic change
• Political change
• Force majeure events
• Some other unforeseen events
• (e.g. archeological discoveries)

29
Risk devolution (2)

• Improper contract management (by the public
  authority in charge of the contract) creates
  excellent opportunities for the private partner
  to transfer risks back to the public sector,
• shifting costs to the public sector
• or simply by not keeping up to the prescribed
  quality of service

30
Risk devolution (3)

• Government will always be politically responsible
  for public service
• So the private partner may behave in a strategic
  way, inducing the public authority to change
  service require-ments and pay compensation
• If change in not managed, authoritys room for
  maneuvre will shrink and it will lose bargaining
  power

31

• So, it is clear that significant risks will
  affect PPP contracts, and that they should be
  managed by the public partner

32

• How shall the public authority protect the public
  interest regarding risks accruing from PPP
  projects and contracts?

33

• Risk management shall be an integral component of
  an effective contract management

34

• What are the main goals of PPP contract
  management?

35

• Note that, beside the usual contract management
  goals, in the PPP case there is the long-term
  partnership characteristic that requires a mix of
  cooperation and skepticism

36
Three goals forcontract management

• Enforce the contract in order to achieve its
  objectives
• Facilitate cooperation between public and private
  partners
• Manage public sector risks, preventing strategic
  behaviour that may damage public interest

37
Goal (a)contract enforcement

• Manage information interchange
• Supervise asset and staff transfer
• Supervise construction phase
• Supervise operational phase
• Measure production performance
• Manage changes and conflicts
• Prepare/manage termination

38
Goal (b)cooperation/partnering

• Improve relations between private and public
  partners
• Improve interfaces with other public entities
  communication, licensing, regulation, feedback
• Improve interfaces with end-users, taxpayers, and
  media

39
Goal (c) strategic contract management

• Identify, monitor, and mitigate all risks
  potentialy affecting the contracting authority
  and the public sector, for the full life of the
  contract
• Be aware of possible strategic behaviour (by
  private partners or other stakeholders) that may
  affect the service or the public interest

40
A note on (a)(b)(c)

• Goal (a) requires careful planning and fast
  response, and it goes by the book i.e. the
  contract
• Goal (b) is based on a cooperative approach,
  while (c) requires a (game-theoretical)
  non-cooperative reasoning and a skeptical
  approach
• In a certain way, (b) activities aim also at
  balancing this skepticism with improved partnering

41
Mismanagement effects

• Underperformance (low production or
  overproduction, low quality, ...) if undetected,
  leading to payment of services not really
  provided
• Perverse behaviour by private partner e.g.
  cream-skimming, demand fostering, client
  rebuffing
• Effective change in risk sharing, with some risks
  devolved back

42

• What are the main components of contract
  management?

43
Contract management components

• Planned routine activities
• Information interchange
• Construction and transition monitoring
• Effective performance monitoring
• Communication strategy and plan
• Strategic reasoning
• Risk registering and monitoring
• Strategic awareness
• Risk prevention and contingency plans

44
Contract management internal requirements

• Governance structure
• Define structure of Contract Mgt team
• Clarify roles (accountability, decision making
  rules, clear responsibilities with no overlap)
• Reports, interfaces with other entities
• Capacity acquisition development
• Staff requirements consultancy use
• Hiring and retaining staff
• Training staff, interchanging knowledge

45
Routine and strategy

• Routine tends to be overwhelming, preventing the
  Contract Manager from strategic thinking and
  planning
• Routine contract enforcement activities
  typically involve a lot of paperwork and
  information interchange, marked by a sequence of
  deadlines for reports, invoicing, payments and
  licensing

46
Some routine activities

• Output measurement
• Performance measurement
• Invoice validation and auditing
• Checking contractual milestones
• Periodical review / benchmarking
• User and staff surveys

47
Planning

• The Contract Manager should plan all routine
  activities, in order to guarantee that there are
  enough resources free for
• Keeping a broad view on the contract, focussed on
  outcomes
• Managing risks and preventing damaging strategic
  moves

48

• How to deal with PPP risks?

49
Public sector risks

• PPP risk management involves a sequence of steps
  that need to be repeated over time
• Identifying risks, based on formal contract risk
  allocation, on past experience and on logical
  reasoning
• Assessing risks (impact and likelihood of
  occurrence) for all parties
• Monitoring and mitigating risks

50
Risk managementbefore contract close

• The identification, assessment, and allocation of
  risk must be done having in mind that, because
  the PPP contract is a long-term contract
• The private partner will be able to engage in
  strategic moves aiming at benefiting from changes
  and unforeseen events
• In preventing those moves, the public authority
  will be bounded by the need to provide
  high-quality public services

51
Risk managementafter contract close

• After contract close
• The contract manager should identify risks
  through a careful analysis of the contract and
  the fundamentals of the PPP scheme
• But be aware that exogenous change and strategic
  moves by the private partner (or mismanagement by
  the public partner) may create additional risks

52
Risk register (1)

• Each contract manager should have a risk
  register, listing all risks during the
  construction and operational phases
• It should be reviewed regularly, to include new
  risks and to reassess impacts and likelihood of
  occurrence
• The responsibility for managing each risk should
  be allocated to one specific institution or
  individual

53
Risk register (2)

• The listing of risks should be exaustive,
  considering all possible potential threats to the
  project, regardless of being addressed in the
  contract or not
• Change (political, commercial, technological,...)
  and innovation will create new risks, so the
  listing itself should be reviewed regularly

54
Risk identification

• Requires
• Analytical skills
• Good acquaintance with the contract
• Knowledge transfer between projects
• Intensive game-theoretic reasoning

55
Risk assessment

• Recourse to past evidence and to the advice of
  external technical experts
• Simplicity you are not pricing the risk, you are
  just assessing its significance.
• So, impact may be measured using a
• critical / high / medium / low
• scale and the likelihood of occurrence may be
  presented by probability intervals

56
Risk monitoring

• For many risks, the probability of having them
  affect the public sector will depend
• On preventive measures
• (that require strategic reasoning)
• On the reputation and perceived ability of the
  contract management
• (it will impact on the likelihood of private
  partners strategic moves)

57
Risk management

• Do not try to learn by doing
• Risk management theory and practice has a long
  track record, with many good practices and bad
  practices already established profit from them

58
Non-naive approach

• But do not forget that PPP contracts, being
  long-term contracts, need an adequate non-naive
  approach
• do not assume public administration is perfect
  and able to react quickly
• do not assume the private partner is a charitable
  institution working on behalf of the public

59
Final note

• PPPs present an opportunity for efficient
  provision of infrastructure
• Efficiency implies transferring risks to the
  private partner
• But, if risk is not properly managed, the
  public-service and long-term characteristics of
  PPPs allow the private partner to transfer back
  risks and so jeopardise efficiency

60
Thank you

• Rui Sousa Monteiro
• Parpública SA
• Rua Laura Alves, 4, 8º, 1050-138 Lisboa, Portugal
• tel [phone],  (351) 969 845 042
• fax [phone]
• e-mail rui.monteiro_at_parpublica.pt