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ASSIGNMENT

NICMAR/ SODE OFFICE

BY

KAMALUDDIN BISWAS

REGISTRATION NO.: 217-07-41-50994-2181

Course No. - GPCD 21

Course Title - Risk Management and Insurance

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ASSIGNMENT

For the successful implementation of a project, it is essential that persons


involved in its implementation be sensitive to the risks involved in the project
and formulate the most suitable structure for the management of such risks.
There are certain variables and uncertainties are common to most of the
infrastructure projects. Many risk mitigation techniques are applied to
infrastructure projects. Discuss in details the risk management in construction
with special reference to any project currently in progress with your company.
INTODUCTION

Risk management is a project management technique, which intends to identify


and quantify risks so that decisions can be taken on how to respond to risks under
different scenarios. Although financial, political and technical risks are inherent in
construction projects, the impacts of risks on the project outcome are not assessed in
a systematic way and decisions are usually based on subjective judgments without any
consideration of identification and quantification of project risks. Risk management is a
systematic approach which comprises the stages of risk identification, classification, analysis
and response management.

At the risk identification stage, sources of risks, events that will be affected by exposure to
risks and consequences of risks are defined. Based on expert opinions, intuition, market
research, collected data and past records, a "checklist" of project risks is prepared. Risk
identification is the most important stage of a risk management system, as an identified risk
turns out to be a management problem and a poorly defined risk structure will breed more
risks. Then, risks on the checklist are classified according to their impacts, origins or
consequences, to facilitate risk analysis.

Risk analysis is the assessment of risk impacts on outcomes of projects by using


qualitative/quantitative techniques such as decision analysis, sensitivity testing, Monte Carlo
Simulation, etc. Analysis results reveal that the project outcome may change under different
scenarios, necessitating contingency planning.

Response management is the last step in a risk management framework at which risk
mitigation strategies are made clear upon discussion of analysis results. Depending on the
attitude of decision makers and nature of the risk structure, risks can be insured, reduced by
taking necessary precautions, transferred to other parties by contractual arrangements or
retained. The clue in a successful risk management system is that, every party being involved
in the project must be conscious about the amount of retained risks by specifying the proper
counteractions and risk should be shared among the parties that could manage them in the
best possible way.

Project selection; pre-tender feasibility, comparison of design and construction alternatives,


tender preparation and evaluation, and contract strategy development stages of construction
projects could be listed among the possible application areas of risk management techniques.

RISK MANAGEMENT IN CONSTRUCTION

Risk is nothing more than the variables or circumstances associated with the implementation
of a specific project that has the potential to adversely affect the development of a project or
the interests of a participant, as the case may be. Risks include circumstances or situations,
the existence or occurrence of which will in all reasonable foresight result in an adverse
impact on any aspect of the implementation of the project.
Sources of Risk

Government

Legal & Regulatory


Framework

Contracts
Developers

Risks in a typical
Construction PPP Project

O&M

Demand

Target Market

Specific Categories of Risk:

Although risk identification and management are specific to each project, it is possible to
identify certain variables and uncertainties that are common to most infrastructure projects.

i. Revenue Risk:

Revenue risk is the uncertainty in relation to the revenue that a project would actually
generate. The uncertainty of the ‘revenue’ of an infrastructure project is because of its
public nature, which carries with it, the uncertainty in the ability and willingness of
consumers to pay for the benefits arising from the project. This risk may be mitigated to
a great extent for construction industry by assuring quality at an adequate price of the
product. The manner of managing this risk is essentially to carefully undertake a
feasibility study of the project that evaluates not only the economic demand of the
project but also the willingness to pay and the ability or credit worthiness of the main
consumer.

Revenue risk generally comprise of:

i. Ability of consumer to pay the tariff,


ii. Determination of the tariff,

iii. Collection, appropriation and enforcement of the tariff, and

iv. Usage of the facility or demand for the services or commodity produced by the
facility.

ii. Design Risk

This risk relates to any defect in the design of the infrastructure facility or the design
requirements stipulated for the project. This is an inherent risk in the project as it is very
difficult to conclusively ascertain that damage to the facility is actually caused due to
the defect in the design parameters or the very design itself. Generally, it is the design
contractor who is responsible for the design aspects of the project. In the event of the
design parameters being stipulated by the grantor of the concession or license, this risk
would be within the control of the grantor.

iii. Construction Risk:

The construction risks are essentially a bundle of various individual risk factors that
adversely affect the construction of a project within the time frame and costs projected
and at the standards specified for the facility.

Construction risks generally relate to:

i. The risk related to availability of land for the project,

ii. Suitability of the land for the construction of the project facility,

iii. Delay in completion of construction,

iv. Cost overruns in supplies, transportation, machinery, raw materials, equipment


etc,

v. Availability of the basic infrastructure required for the construction of the facility
such as water, electricity etc.

vi. Availability of work force,

vii. Occurrence of force majeure events, and

viii. Failure of the facility to meet the performance criteria and the standards
stipulated.

The constructions risks are generally distributed and sought to mitigate by adequately
drafted construction risks are best handled by, and are generally within the control of
the construction contractor.
iv. Operating Risk:

These risks are similar to the construction risks. They are a bundle of risks associated
with the operation of the infrastructure facility.

Operating risks generally relate to:

i. Operating costs overrun,

ii. Risks relating to obsolescence,

iii. Risks associated with the compliance of specified performance criteria, quality
and quantity,

iv. Force majeure risks, and

v. Risks associated with the inability to comply with the maintenance standards and
availability of funds required for the operation and maintenance of the facility.

v. Financial Risk:

This risk is the totality of all risks to financial developments external to the project that
are not in the control of the project developers. These risks include:

i. Risks associated with the fluctuation in foreign exchange rates,

ii. Risks associated with the devaluation of the local currency,

iii. Risks associated with the non-convertibility or non-repatriation of foreign


exchange from India, and

iv. Risks associated with the fluctuations in interest rates.

The general mechanism for mitigating some of the risks constituting the overall
financial risk of the project is to include, in the security package for the lenders,
hedging facilities against exchange rate risks such as currency rate swaps, caps and
floors.

vi. Political Risk:

Political risks are a bundle of distinct risk that can include not only political factors but
also administrative, social and economic factors. Political risks associated with project
are closely evaluated as they are generally outside the control of the parties to the
project, other than the government to a certain extent. But even the government granting
the concerned concession rights does not have control over all the categories of political
risks. It should be kept in mind that many of the political risk arise from the possibility
of arbitrary action by the government and altering the framework on which the very
foundation of the project rests. Political risk can be:
i. Relating to the manner of investing and doing business in a particular country or

ii. They may be specially relating to the project or

iii. May arise from certain general events.

The main categories of political risks include:

(a) Risk of political instability such as riots, revolution, terrorism, guerrilla warfare,

(b) War, whether declared or undeclared, International sanctions,

(c) Expropriation, Nationalization, Creeping Expropriation,

(d) Failure to grant or renew approvals, and

(e) Excessive interference in the implementation of the project, thereby causing


severe prejudices to the concessionaire.

vii. Legal Risk:

These are risks presented by the legal framework governing the project and include the
possibility of alteration of the concerned legal framework to the prejudice of the
implementation of the project on commercial lines.

viii. Environmental Risks:

These are risks relating to occurrence of environmental incidents during the course of
implementation of the project. These risks are generally within the control of the
construction, and the operation and maintenance consortium. This risk has increased
due to the presence of strict legal liability in relation to such environmental incidents,
which can result not only in adverse effects on the financials of a project but may also
cause a closure of any work or operations of and in relation to the facility.

ix. Force Majeure Risks:

These risks are regarding the events that are outside the control of any party and cannot
be reasonably prevented by the concerned party. These risks generally arise due to
causes extraneous to the project. The defining of force majeure events, these include:

i. Natural Force Majeure events.

ii. Direct political force majeure events, and

iii. Indirect political force majeure events.

Natural force majeure events comprise of all events that can be attributed to natural
conditions or under act of god such as earthquakes, floods cyclones, and typhoons.
These risks should be shared equally among the parties.
Direct political force majeure events, which are attributable to political events that are
specific to project itself such as expropriation, nationalization.

Indirect political force majeure events are events that have their origins in political
events but are not specific such as war, riots etc.

However, the mechanism of managing and mitigation for such risks cannot be
categorically stated as they vary with each project and the circumstances surrounding
each project.

RISKS IN PPP PROJECTS

Political
Regulatory Commercial

Operational/
Maintenance Financial

RISKS
Force
Majeure Market

Cost Overrun Land


Acquisition
Technology Construction

Risk Management Techniques:

Risk management is a planned and structured process aimed at helping the project team
makes the right decision at the right time to identify, classify and quantify the risk and then to
manage and control them. The aim is to ensure best value for the project in terms of cost,
time and quality by balancing the input to manage the risk with the benefits from doing so In
other words it is cost-benefit analysis of any project for a company.

The main techniques of risk management that have evolved and are generally applied to
infrastructure projects are:
i. Risk Avoidance:
Risk avoidance signifies the giving up of an opportunity to invest, as the probability of
loss is too high as compared to the potential profit. In adopting risk avoidance
technique, the concerned party may opt to either completely exit from the proposed
project or restrict its role, rights and exposure to a particular project.

ii. Loss Prevention:


Loss prevention techniques are directed towards formulating structures for reducing the
frequency of loss or the severity of the loss.

iii. Risk Retention:


Risk retention techniques recognize that not all risks are capable of being avoided or
prevented or transferred, and the party agrees to absorb the exposure to the risk and
formulate suitable mitigation structures, such as creation of a distinct fund. A planned
risk retention strategy provides definite measures for absorbing the risk losses upon
occurrence. However in many circumstances an unplanned risk retention technique
would be preferred as the cost of treating the risk is too great as compared with the loss
if the risk is left untreated or that the risk is financially relatively insignificant and there
is no other viable alternative.

iv. Risk Transfer:


Risk transfer is the technique that plays a far greater role in infrastructure development
projects and involves the complete or partial transfer of risks among the various parties
involved in the implementation of the project. This is achieved through the web of
documents that is formulated during the course of implementation of infrastructure
projects. The documentation structure provides for the flow of risk transfers that are
negotiated and agreed to in the course of development of an infrastructure projects. For
example, the construction consortium would distribute and transfer the risks among
themselves or to various sub-contractors.

v. Insurance:
Insurance is the mechanism that allows parties regulating a risk to bring down their
expected exposure to any loss from the occurrence of such risks. The costs of loss due
to specific risks are transferred to insurers for a specific consideration in the nature of
concerned insurance policy payments.

The nature of risk management techniques adopted in relation to an infrastructure project is


generally linked to the policies of individual parties and investment policies and decision
taken by each party involved in the development of a project.

Allocation of Risks:

Allocation of risks would entail a party to undertake:


i. The measures of control or mitigate a risk, and

ii. Bear the adverse consequences if it is not able to redress the risk, thereby insulating the
other participants from the direct adverse consequences entailed with the risk.

Consequently it is not surprising to find that most of the negotiations involved between the
various participants centers around the allocation of risk with each participants eager to
allocate the risks to some other participant and unwilling to bear any risks directly. The main
principle for evaluating an adequate allocation of risks is that the party can best placed to
control or reduces the risk or the circumstances that may arise if the risk occurs should be
allocated the risk.

Risk Categories, Phase of Dominance & Allocation

Risk Categories Phase of Dominance Allocation of Risk


Land Acquisition Project Development Institution/ Private party
Delays in Project development
 Design risk Project Development Private party
 Planning risk
Project completion risk Construction Period Private party
Project cost risk/ Cost over-runs Construction Period Private party
Technology risk Construction/ Operations Period Private party
Regulatory & administrative risk Operations Period Institution/ Private party
Commercial risk Operations Period Private party
Operations & maintenance risk Operations Period Private party
Financial risk
 Interest rate risk
 Foreign exchange exposure risk Operations Period Private party
 Tax rate change risk
 Inflation risk
Termination risk Operations Period Private party
Insolvency & outside creditor risk Throughout Project Cycle Private party
Force Majeure Throughout Project Cycle Institution/ Private party
Environmental risk Construction/ Operations Period Institution/ Private party
Political & social risk
 Events of wars
Throughout Project Cycle Institution/ Private party
 Nationalization or revocation
 Social risk
Risk Mitigation:

‘Risk response and mitigation’ is the action that is required to reduce or eliminate the
potential impact of risk. There are two types of response to risk:

i. One is an immediate change or alteration to the project which usually result in


elimination of the risk,
ii. Second is a contingency plan that will only be implemented if an identified risk should
materialize.

i. Risk Avoidance: Risk avoidance includes review overall of project objective leading to
reappraisal of project as a whole. Risk avoidance is often perceived as ultimate
mitigation strategy in that it implies that project may be aborted.

In simple terms, this method of mitigation involves removal of cause of risk, by risks
itself. Ideally any approach involving avoidance is best implemented by consideration,
adoption of alternative course of action. Other examples of risk avoidance include use
of exemption clauses in contracts, either to avoid certain risks or to avoid certain
consequences following from risks. Risk avoidance is most likely to take place where
level of risk is at level where project is potentially unviable.

ii. Risk Reduction: This method adopts an approach where by potential exposure to risks
and their impact is alleviated. Often this is achieved by the managing or designing out
of potential risk. Risk reduction occurs where the level of risk is unacceptable and
alternative action is available. Typical action to reduce risk could be:

 Detailed site investigation where adverse ground condition are known to exist but
full extent is not known; detailed ground investigation will improve the information
upon which estimate has been prepared.
 Alternative procurement route by utilizing an alternative contract strategy risks will
be allocated between project participants in a different process.
 Changes in design to accommodate the findings of the risk identification process.

Risk reduction invariably leads to greater confidence regarding the project outcome.
However risk reduction will result in an increase in the base cost but should offer a
significantly greater reduction in the level of contingency required. It goes without
saying that risk reduction should only be adopted where the resultant increase in costs is
less than the potential loss could be caused by the risk being mitigated.

iii. Risk Transfer: This method involves the transfer of risk to other project participants.
Commonly, risks are transferred through the placement of contracts, the appointment of
specialist sub contractors or suppliers or by taking out an insurance policy.

Transference of risk should comprise passing of risks to those better placed or more
capable to maintain control, influence outcome of the risk. Transference should never
be viewed as negative risk response. Its intention is not to pass buck by making
someone else responsible. When transferring risk it is important to differentiate between
the transference of risk itself and the allocation of risk responsibility. Where a risk is
transferred the intention should be to transfer the whole of h risk including its potential
impact. Where a portion of the risk is transferred whilst some risk is retained this is
known as risk sharing. This approach may be adopted where the risk exposure is
beyond the control of one party. In such instances it is imperative that each party
appreciate the value of the portion of risk for which it is responsible.

iv. Residual or Retained Risk: Once all the avenues for response and mitigation have been
explored a number of risks will remain. This does not imply that these risks can be
ignored; indeed it is these risks, which will in most instances, undergo detailed
quantitative analysis in order to assess and calculate the overall contingency levels
required. The aim of the previous responses is to reduce project uncertainty and in so
doing increases the base estimate to reflect the more certain nature of the project.
However it does not imply that these retained risks can simply be ignored. Indeed they
should be subject to effective monitoring, control and management to ensure they are
contained within the contingency allowance set.

It should be noted that this contingency should be made up of residual risk, which are
assessed, to be of a low likelihood and low potential impact. High probability and high
impact risks should undergo further rigorous examination so that an alternative response
can be found.

Risk Mitigation Steps

Identify Determine Allocate Mitigate Price the


Risk Severity Risk the Risk Risk
of Risk

Steps/
Identifying
Identifying In case the actions
and
the events event occur which can
allocating
or actions the effect be taking
Cost of
addressing
the risk
has
to be
determined
TYPICAL RISK ALLOCATION IN INDIA

Construction Operation Interest Rate Regulatory


Risk Participants Role Revenue Risk Market Risk
Risk Risk Risk Risk
Equity Holders,
Promoter No Yes Yes Yes Yes Yes
Developer
Lenders Lender No No No No Yes No
Awarding
Government No No No No No Yes
Agency
Sub -
EPC Contractor Yes No No No No No
Contractor

Developers’ carries all type of risk in India unlike industrialized countries where government guarantees minimum revenue and share the
same also in case that exceeds threshold limit.

Management of Risks in various types of projects

Construction Interest Rate


Type of Project Operation Risk Market Risk Payment Risk Regulatory Risk
Risk Risk
Road High Low Project Specific Project Specific Medium Medium

Port High Medium Medium Project Specific Low Low

Airport High High High Project Specific Low Medium

Power Medium Low Low Project Specific High High

Page | 14
DEVELOPMENT OF MUNDRA PORT IN GUJARAT

Salient features:

Mundra Port is located in the Gulf of Kutch, in the southern part of the Kutch peninsula.
Kutch (or Kutch) is the largest district in Gujarat (and in India) and has an area of 45,652
sq.km constituting 23% of the State. It is bound by the sea in the South and West and by the
Ranns (salt marshlands) in the East and North.

In the global context, Mundra port located on the Western coast of India is ideally located to
access the Asian, European, American, South American and African Markets. Moreover,
Mundra has an attractive and large hinterland spread over Western, Northern and North
Eastern India covering 70% of India’s GDP. Large Industries already exist in the vicinity.

Page | 15
 One of the deepest ports on the coastline of India blessed with a natural draft of 17 M.
and capable of berthing Capsize vessels up to 1,50,000 DWT.

 Proximity to Northern & Western hinterland of the country which generates over 42% of
the total international trade of India. Mundra port is over 180 KM. Closer to Delhi than
Mumbai Port & JNPT.

 The Port has dedicated infrastructure to cater to various cargo like Grain, Liquid, POL
and coal amongst others.

 Back-up Infrastructural facilities developed in an area of 300 acres for Dry, Liquid &
Container cargo.

 State of the Art mechanized Bulk handling system.

 Ample closed and open storage space for Dry cargo.

 In-house wheat cleaning as well as rice sorting & grading facility.

 Large tank farm area for storage of wide variety of Liquid cargo.

 Connected to NH-8 of the National Highway network.

 Linked to the national railway grid through a self-developed 57 KM. Long railway link
capable of handling 24 rakes per day.

 Can accommodate 4 Single Point Moorings inside the Port’s limits.

 An area of 5,000 acres available for further developing the Port back up related
Infrastructural facilities.

 With a total quay length of 895 M, the Port has four berths ranging from 180 to 225 M in
length and 31 M in width, besides an 85 M barge berth for handling a wide variety of
cargo. These berths can easily handle 9 MMTA of cargo per annum on the existing
infrastructural facilities.

Overview of the Project:

 Total Project cost – Rs 2151 Crore

 Multi-terminal Greenfield port developed through PPP by the state of Gujarat.

 Traffic is at 9 MMTA.

 One of the first ports to secure rail connectivity by putting up the investment for it
through PPP (Rs 136 Crore)

 Private party - Gujarat Adani Port Ltd. (GAPL) and P&O


RISK MANAGEMENT IN THE PROJECT

Allocation of Risks

Risks borne by Government of Gujarat/ Risks borne by Private party (Gujarat


Gujarat Maritime Board (GMB) Adani Port Ltd)
 Revenue  Design & Construction
 Regulatory & administrative  Operation & Maintenance
 Political & social  Subcontractor
 Creditor  Financing
 Environmental  Revenue
 Financial
 Technology
 Environmental
 Connectivity – Rail, Road

Risk Mitigation

Risks mitigation by Government of Gujarat/ Risks mitigation by Private party


Gujarat Maritime Board (GMB) (Gujarat Adani Port Ltd)
 Traffic risk sharing  30 years Concession agreement with
GMB.
 Required clearances obtained
beforehand.  Future development rights and sub-
concession contracts.
 Transparent and clear-cut BOOT policy
in place.  Tariff set by P&O (independent of
TAMP).
 Sustained political support to the non-
major port development cause.  Developed own rail connectivity.
 Various bodies constituted for  Heavy machinery & equipments
reviewing and monitoring the PPP taken on lease basis
process.  GAPL sold stake to P&O ports.

Private Sector Risk Mitigation Mechanisms:

i. Pass through to third parties:

 Creates a chain of risk bearers - Builder bearing the construction/completion risk,


facility operator bearing operating risk, material supplier bearing input quality
risk, market/demand risk with financiers etc.

 However, private party retains the primary liability for the risk under the contract.
ii. Insurance:

 Specialized form of passing risk - Covers aspects of project risk like owner’s
liability, some Force Majeure Events, owner’s asset risks, business interruption,
some policy risks such as convertibility of local currency etc.

 Increasing number of insurance products offer special recourses.

iii. Financial market instruments

 Mitigate risks arising from inflation, interest rates, foreign exchange rates etc.

iv. Diversifying project portfolios:

 Premiums accumulated from un-materialized risk on one project may sustain


liabilities accumulated when risk materializes on another.

 A form of self insurance

Public Sector Risk Mitigation Mechanisms:

i. Research before issuing tenders:

 Specify desired project outcomes, taking account of government policy.

 Apply ‘public interest’ test to the project.

 Ensure legal ability to contract with the private party – sometimes enabling
legislation may be required.

 Construct the ‘Public Sector Comparator’ to determine what constitutes value for
money – infrastructure and service delivery options, technologies available etc.

 Identify and facilitate necessary government approvals – planning,


environmental, land related etc.

 Anticipate, identify and resolve land tenure issues – acquisition, title,


encroachments, usage etc.

ii. Strategic planning, development of regulatory framework:

 Strategic long term industry planning.

 Development of economic regulatory framework.

iii. Best practice tender and evaluation procedure:

 Develop clearly defined bid criteria.

 Create a framework to handle probity issues.


 Construct clear and informative bid documents – enable bidders to assess risk so
that they may quantify and price that risk.

 Adopt appropriate evaluation procedure to ensure bids are financially robust – so


that bidders may avoid aggressively valuing the risk simply to win the bid thereby y
compromising long term value for money.

iv. Best legal, commercial and technical advice:

 In the engineering and technical aspects

 In structuring the project

 In drawing up the bid documents and managing the bid process

v. Reducing scope for unintentional risk take-back:

 Preventing unnecessary involvement by Government in the design and


construction or in the ancillary service delivery processes

 Care during contract monitoring stage to prevent any take-back of operating


risk

vi. Developing contingency plan for lack of service delivery:

 To ensure continuity of service in case of private parties’ inability to face major


risk or project becomes unviable.

 Should be consistent with default, step-in and termination procedures.

 Should extend beyond contract provisions to cover: -

o Options after step-in or termination.

o Strategies for dealing with major force-majeure events.

o Continuation of core and ancillary services.

o Communicating events and progress to the public

vii. Insurance:

 To the extent possible cover through insurance where it represents good value for
money.

SITE RISK

 Site Risk is a collection of risk that flows from the project land.
Risk that the project land will be unavailable or unable to be used at the required time, in
the manner or cost anticipated, or that the site will generate unanticipated liabilities, thus
adversely affecting service delivery and/or project revenues.

 Arises from land interests and acquisition, statutory approvals, environmental issues,
indigenous issues, suitability of the site/existing infrastructure.

Mitigation measures:

 Careful site selection backed by investigation of history and characteristics.

 Systematic provision of land related information to the bidders.

 Addressing all environmental issues before the bid process, including impact
assessment.

 Interfacing with concerned departments to ensure land approvals in place or face least
obstacles.

 Community consultations to ensure least resistance from local population.

 Ensure Concession Agreement deal with the approval issues – for example, making
certain critical approvals ‘conditions precedent’ to the Agreement/commencement of
construction.

DESIGN & CONSTRUCTION RISK

 Construction Risk is a collection of risk that faces the project during its initial stages of
design, implementation and commissioning.

Risk that the design, construction and commissioning are carried out or not carried out in
a manner that will adversely impact cost and/or service delivery consequences.

 Arises from possible design flaws, time and cost over-runs, default in meeting
construction and commissioning deadlines, construction defects, keeping pace with
technological changes.

Mitigation measures:

 Specifying Concessionaire responsibility for construction and commissioning as per


terms specified in the Agreement.

 Proper specification of project outputs and of the core services to be delivered.

 Linking contracted services to key performance indicators and, in turn, to the


payment mechanism.

 Government review of proposed design and begin briefed of design evolution.


 Clear commissioning tests to establish the ability of the asset to deliver the required out
puts to the specified performance standards under full range of operating standards.

 Ensure correction of design and construction defects before commencing service


delivery.

 Prescribing agreed timeframes for Government testing and approvals.

 Having an independent commissioning tester to ensure objectivity.

 Appointing a high quality project manager to monitor and also consult with the private
party on risk management.

SPONSOR RISK

 Sponsor Risk stems from the complex nature of the consortium that form the Special
Purpose Vehicle (SPV) that becomes the project or concession company

Risk that members of the consortium/SPV or the sub-contractors are unable to fulfill their
contractual obligations and government is unable to enforce the obligations or recover
compensation or remedy for the loss sustained from the SPV breach.

Mitigation measures:

 Parent guarantees and/or performance bonds.

 Prescribe conditions for SPV shareholding, changes in such shareholding, minimum


level of shareholding by key consortium members (such as major-sub contractor,
operator, technology provider etc) at the Bid stage itself, exit conditions.

 Provide flexibility for the SPV regarding change in ownership provisions, while
having some control over any changes to the ownership pattern to ensure qualification
and suitability of the new entrant.

 Ensure ongoing tests for probity, capability, and on-going financial requirement.

 Step in rights to Government as last resort.

FINANCING/ FUNDING RISK

 Non-availability of sufficient funds to complete the project.

Mitigation measures:

 Promoter guaranteed short term loans converted into long term limited recourse project
financing facilities on project completion.

 Allowing private party for the public issue of the equity.


MARKET & REVENUE RISK

 Market Risk is risk that demand or price for a service will vary from forecast levels,
generating less revenue.

Risk of negative impact on project revenues due to reduction in demand or price for the
concessioned services adversely impacting project revenues over the project term.

 Arises from possible general economic downturn, changes in government policy,


substitute products or competitors, competing pricing for alternate services, change in
target market composition, technical obsolescence, shift in industry focus.

Mitigation measures:

 Quantify demand, providing demand related information at the bid stage.

 Undertake feasibility study, demand forecasting, sensitivity analysis.

 Use traffic management measures, incentives to stimulate use by consumers.

 Provide redress to private party if government acts to increase competition to the


project, for example subsidizing alternate public services.

 Exclusive concession agreement (some cases) giving exclusive geographic rights to


provide the specified services for a specified period of time.

 Price/tariff indexation.

FINANCIAL RISK

 Financial Risk is a collection of risks that would affect the financial strength, performance
and robustness of the project.

 Arises from possible financial/funding uncertainty, changes in financial costs affecting


viability and robustness of the project.

Mitigation measures:

 Ensure project structure, contractual provisions and risk sharing make the project
bankable, addressing lender related issues.

 Ensure credit worthiness of bidders and prima facie firm credit approval from
lenders.

 Ensure the robustness of the financial case or model upon which the private party has
based its participation in the project.

 Avoid only looking for lowest cost bid – rather choose a bid with financially robust
structure and sound business plan.
 Provide for assignment of SPV rights under the contract to the lenders, as well as other
rights such as step-in/substitution rights.

 Government right to take over some or all of the sub-contracts of the private party in
case of its failure to perform.

ENVIRONMENTAL RISK

 New conditions attached to resource consent impacting on access to long-term supply of


funds putting the project in jeopardy.

 Significant additional cost incurred to rectify environmental damage caused by the


project.

 Arises in case of displacement of local population due to project activities.

 Dredging activities for constructing, jetties, etc.

 Reclamation of Land for port related infrastructure.

Mitigation measures:

 Ensure the project is always operated within the conditions of the resource consent.

 Obtain insurance where possible to protect against large-scale environmental damage.

 Consider risk transfer to DBO or BOOT provider.

 Addressing of potential environment and social issues associated with the project.

 Working with the environmental organizations/ Government authorities.

 Specific environmental mitigation program for the project.

OPERATION & MAINTENANCE RISK

 Operating Risk is a collection of risk that faces the project after commissioning and
during its operational stage.
Risk that the process for delivering the concessioned service will be affected in a manner
that will adversely impact the delivery of services as per specified standards and/or
increase cost.

 Arises from possible increase in operating costs, deterioration of performance standards,


design flaws, technological obsolescence, inherent defects, default.

Mitigation measures:
 Specifying Concessionaire responsibility for operation and maintenance as per terms
specified in the Agreement.
 Draft service standards with clear outputs, objectively identified and measured.

 Address future service delivery demands also.

 Inbuilt options for upgrading technology as the contract terms proceeds.

 Incentivize private sector to incorporate latest technology by making the


designer/builder and the operator part of the core consortium/SPV.

 Operating guarantees/performance bonds to ensure service continuity and


compensation for default.

 Escrow mechanisms that will ensure project cash flows are protected and may be
enforced in case of service/operational default.

 Step-in/termination rights where there is break down in service provision

REGULATORY RISK

For Developer:-

 If despite tariff and indexation formula in contract.

- Approval of Government is required for revising of tariff.

- Notification of revised tariffs is required and there is no time limit for Government to
ensure such notification

 If Government’s track record in honouring contract provisions is poor

 As mid-way change in service specifications require additional investments & possible


re-negotiations.

 Absence of independent regulator

– Possibility of Govt. as grantor of concession influencing the regulator introduces


uncertainty

 Uncertainty in principles that will be used to regulate

– Tariff setting subject to unfettered discretion of Government/ regulator

– Imbalance in regulator’s attention on efficiency vis-à-vis viability

 Rate of return versus incentive based regulation (RPI-X)

– Tariff setting based on Rate of return (cost plus) regulation means that risks
associated with higher construction & operation costs are passed on to users
– Incentive based regulation on the other hand forces concessionaire to reduce costs,
thereby leading to higher risks

For Government:-

 If high tariff indexations are provided - Government is locked in and cannot effectively
ensure efficiency benefits for users.

 In case of inadequate service specifications

 Inadequate contract monitoring mechanisms

 Capture of regulator by industry

 Rate of return versus incentive based regulation (RPI-X)

– Under Rate of return regulation concessionaire has an incentive to show higher capital
and operating costs – “Gold Plating”.

– Under Incentive based regulation, regulatory capacity required is high and cost of
regulation is likely to be higher

Mitigation measures:

 An effective regulatory system needs credible regulatory substance and robust


regulatory governance.

 Enhancing regulatory substance implies improving the quality and sustainability of


decisions.

 Regulatory governance structures and processes should constrain arbitrary


administrative action.

 Success of a regulatory system depends on compatibility with country’s regulatory


commitment and institutional and human resource endowment.

 Select from a menu of regulatory options to create hybrid model that suits the country.

 Build capacity and mandate reviews of regulatory performance.

 If necessary – employ additional risk mitigation measures such as partial risk


guarantees.

POLITICAL RISK

 Political Risk is risk that government will exercise its powers and immunities including
its power to legislate and determine policy and the way in which negatively impacts on or
disadvantages the project.
 Arises from possible perceived immunity of government from legal action, government’s
refusal to grant approvals, alternate legislations/policy or regulatory changes, excessive
use of government powers, demand for changes in service scope and specifications,
government take-over of project facility.

Mitigation measures:

 Have clear contractual provisions on ‘change-in-law’, during different stages of the


project, to ensure that –

o ‘change-in-law’ is defined as a change in policy or enactment that impacts which


requires addition to the project structures or systems or results in substantial addition
to operating costs.

o ‘change-in-law’ does not include change in the way law is interpreted or applied,
change in taxes, fees or levies, or where the concessionaire has alternate price/fee
adjustment or compensation under other provisions.

 Have clear contractual provisions under ‘Political Force Majeure Events’ (where this
is not covered under change-in-law) during different stages of the project, covering
conditions and compensation for termination.

FORCE MAJEURE RISK

 Force Majeure (FM) is a risk that a specified event entirely out of the control of either
party will occur resulting in a delay or default by the private party in the performance of
its contractual obligations.

 Arises from natural events, political events, non-political events which are beyond
control, preventing discharge of obligations and unable to overcome despite diligence and
having a Material Adverse Effect.

Mitigation measures:
 Minimize the consequence of the materialized event through appropriate insurance,
which transfers the risk to the insurer.

 Regularly review insurance policies to ensure coverage is adequate and effective.

 Draw up and appropriate action plan for dealing with consequences of FM events such
as temporary service arrangements which may be included in service specifications.

 Suspension of performance obligations during the occurrence of FM event with


termination provision after an appropriate period.

 Ensure that FM events do not include events that may be prevented, overcome or
remedied so as to ensure vigilance eon the part of the private party to prevent a risk event
before it occurs.
New project risks:

The scale and nature of new projects can significantly influence the risk profile of any issue.
Unrelated diversification into new products is invariably assessed in greater detail. The main
risks from new projects are: Time and cost overruns, even non-completion in an extreme
case, during construction phase; financing tie-up; operational risks; and market risk. Besides
clearly establishing the rationale of new projects, the protective factors that are assessed
include: track record of the management in project implementation, experience and quality of
the project implementation team, experience and track record of technology supplier,
implementation schedule, status of the project, project cost comparisons, financing
arrangements, tie up of raw material sources, composition of operations team and market
outlook and plans. The impact of project risk on the rating depends on the scale of projects in
relation to the size of assets and cash flows of the existing operations.

Management quality:

The importance of this factor cannot be overemphasized. When the business conditions are
adverse, it is the strength of management that provides resilience. A detailed discussion is
held with the management to understand its objectives, plans & strategies, competitive
position and views about the past performance and future outlook of the business. Other
important factors are : labour relations, track record of meeting promises specifically relating
to returns and project implementation, performance of “group” companies transactions with
the “group” companies etc.,

Funding policies:

This determines the level of financial risk. Management’s views on its funding policies are
discussed in detail. These discussions are generally focused on the following issues:

 Future funding requirements

 Level of leveraging

 Views on retaining shareholding control

 Target returns for shareholders

 Views on interest rates

 Currency exposures including policies to control the currency risk

 Asset-liability tenure matching

Financial flexibility:

While the primary source for servicing obligations is the cash generated from operations, an
assessment is also made of the ability of the issuer to draw on other sources, both internal
(secondary cash flows) and external, during periods of stress. These sources include:
availability of liquid investments, unutilized lines of credit, financial strength of group
companies, market reputation, relationship with financial institutions and banks, investor’s
perceptions and experience of tapping funds from different sources.

Generally financial flexibility factor facilities determination of the relative strength within a
rating category (i.e., + or - prefix with the rating) and has a greater bearing on the short term
ratings.

Indicators of financial performance:

i. Profitability:

 Return on capital employed

 Return on net worth

 Gross operating margins

Higher profitability implies greater cushion to debt holders. Profitability also


determines the market perception which has a bearing on the support of share holders
and other lenders. This support can be an important factor during stress.

ii. Gearing or level of leveraging:

This is an important determinant of the financial risk. Some important indicators are -

 Total debt as a % of net worth

 Long term debt as a % of net worth

 Total outside liabilities as a % of total assets.

It needs to be emphasized that business risk is a prime driver, which gearing has a
secondary role in determining the overall rating (especially long terms). To illustrate, an
issuer whose gearing level is favorable out relative business fundamentals are weak is
unlikely to get a favorable long term rating. This is so because gearing is considered to
be a “controllable” factor while business factors are relatively difficult to alter
significantly.

iii. Coverage ratios:

This is considered to be of primary importance to the debt holders. The important ratios
are -

 Interest coverage ratio (OPBDIT)/Interest)

 Debt service coverage ratio


 Net cash accruals as a % of total debt.

iv. Liquidity position:

The indicators of liquidity position are the levels of -

 Inventory

 Receivables

 Payables

PROPOSED PLAN OF ACTION

Based on the feedback & concurrence obtained from the task force, appropriate matrices both
for the macro & micro systems would be developed and suitable weightages would be
allotted to various attributes. Few cases would be tested for calibration and readjustment of
the weightages allotted and a process of iteration shall be adopted to arrive at the proper
calibrated matrices. Cases belonging to Maximum & Minimum categories would be used
based on the recent post performances. It is proposed to develop 14 levels, alpha numeric
grading scale to assess the displayed delivery potential of the constituent. As an example the
grades proposed to be awarded to the construction companies shall have following
nomenclature and explanation the grading would be given the nomenclature, which shall be
awarded to the constituent for the level of assessed potential of delivery.

The detailed working mechanism shall thereafter be detailed.

Awarded grades shall remain valid for a period of 3 years, with provision of surveillance at
annual interval.

The grades awarded could be used for -

 Pre-qualifying the agencies,

 Granting then value added premium for moderation of given prices,

 Availing finances on better terms from institution, and

 Indemnities from the Insurance Companies at economical rates, thereby lowering the
overall procurement costs.

i. Lack of Experience and Professional Pride: Lack of experience can be a lack of risk
management knowledge, but in this situation it also has another meaning: The talent
and education of the respondents varied significantly. This has direct effect on the
quality and productivity of the work. A lack of common education and the personal
qualities which contribute greatly to the performance level, make it very difficult to
evaluate the time spent on a certain task. It also makes it difficult to prepare beforehand
for possible problems or for the amount of work needed for the guidance of crews.
The skills of the craftsmen, as well as the skills, abilities and personal character of the
project manager had great influence on project success. According to the interviewees,
risks, project team integration and a common atmosphere on site was related to the
project manager, and that in extreme cases extra amounts were added to project tenders.
The overall environment in the current labour markets does not place enough value on
trades. Other professions are more attractive to young people and not enough of them
seek vocational education in the field of construction.

ii. Adverse Relationships: The reason for adverse relationships is caused by severe price
competition. Traditionally adverse relationships make coordination and co-operation
difficult. Competition has caused margins to diminish and additional rewards are
sought. Interviewees admitted that, for example, due to the high degree of competition
even the smallest changes in the work is fought for, contracts are read very carefully
and there are cases where interpretations may differ considerably. This is not very
fruitful ground to build co-operation, not to mention that it means extra investments on
behalf of the actors. Adverse relationships also restrict the sharing of experiences and
information. Lessons learned in one project are not applied in other projects since
thought that the relevance of a solution in one situation can not be repeated in another,
since there was little chance that a comparable situation would present itself in the
future.

iii. Incomplete Designs: Incomplete designs are a widely recognized problem on


construction sites. Everybody can understand the complexity and potential damage of
how complicated a situation when, for example, an electrician must decide how to
complete the work on a certain part of work at the site. Incomplete designs are one of
the biggest reasons for the demand for co-ordination and co-operation. These are also
situations where the professional capability of employees is measured; the solution has
to be compatible with every job to be performed.

iv. Information Flow Breaks: Information that does not flow through the whole project
organization causes misunderstandings, delays and logistical problems. This was named
many times as the most severe threat to the smooth completion of a project. It was
recognized that since information does not move in the project network, it also does not
go through a single actor’s organization. Though, in light of previous findings of
adverse relationships and a business practice that do not support co-operation,
information delivery problems are not unexpected. Problems included people not
always attending the right meetings, or those who did attend, failed to deliver the
message to their respective organizations.

v. Foreign Workers: Construction industry will be facing a severe shortage of skilled


labours in the coming years with the quantum of projects and foreign workers are
necessary to fill this gap. Problems occur, when language skills are poor, professional
qualifications unclear and quality viewpoints differ from the local. On the other hand,
many respondents noted that most foreigners are extremely motivated and hard
working. Risk is the investment that is needed to bring their skills to the level required
professionally, linguistically and culturally.

vi. Competition Based on the Lowest Bid: As a client, this is especially difficult, since
they are forced to take the lowest bid. There is no possibility of thinking about total
costs, related, for example, to possible complexities in relationships or quality failures.
That results in low motivation for extra work and small chances for development
programs. Project networks become short-lived and long-term relationships are difficult
to build. Severe competition over price does not provide any concrete resources or
motivation for long-term skills development or motivation to consider the interests of
any other parties (or the network as a whole) than own.

vii. Force Majeure: This is an aspect that never can be excluded from the construction
projects. As one interviewee put it; it is impossible to build a whole house before the
actual project has begun. Thus not all risks can be anticipated. An interesting point is
that whether these seemingly “force majeure” risks really are “force majeure”. Is it
possible that they could be avoided, or at least renamed if some more systematic risk
management means were used?

viii. Extensive Subcontracting: Extensive subcontracting was seen as a problem. Reasons


for this were not very clear. If all of the individuals on a site are from different
companies than main contractors’, “problems occurred”. Interviewees were not able to
give any concrete reason for the higher number of problems in construction sites where
there are no employees of the main contractor.

ix. Contractors’ Subcontractors: Another risk involved in subcontracting is that one can
never be completely sure who will actually perform the work; subcontractors may have
subsequently contracted the job to someone else. In such cases, many of the
aforementioned problems are magnified. For example an increased risk that information
is not transmitted to all parties involved.

Grading Scale for Construction Entities:

Grading symbols for the Contractor/Construction Company and their implications shall be as
follows: -

a) Very strong contract execution capacity: The prospects of timely completion of projects
with minimal cost overruns are best and the ability to pay liquidated damages for non-
conformities highest.

b) Strong contract execution capacity: The prospects of timely completion of projects


without cost overruns and the ability to pay liquidated damages for non-conformance with
contract are high but not as high as in point (a).

c) Moderate contract execution capacity: The prospects of timely completion of projects


without cost overruns and the ability to pay liquidated damages for non-conformance with
contract are moderate. Contract execution capacity can be affected moderately by changes
in construction sector prospects.

d) Inadequate contract execution capacity: The prospects of timely completion of projects


without cost overruns and the ability to pay liquidated damages for non-conformance with
contract are inadequate. Contract execution capacity can be affected moderately by
changes in construction prospects.

e) Weak contract execution capacity: The prospects of timely completion of projects


without cost overruns and the ability to pay liquidated damages for non-conformance with
contract are poor.

CONCLUSION

Infrastructure projects in public-private participation mode are long gestation projects will lot
of dynamics and flexibilities embedded into it. However, such projects are structured and the
parties are bound by the provisions of a rigid ‘concession agreement’ prior to the
commitment of large amounts of capital. Incorrect decisions made at the early stages can
have a large impact on the future outcome of the project. Though previous studies have
proposed structured risk management processes, integrated with the overall project
management framework, unresolved difficulties still exist.

Project risk dynamics are difficult to understand and control and not all types of tools and
techniques are appropriate to address their systemic nature. Past research has shown that
project management activities can be improved through system dynamics modeling. It is
suggested that emphasis should be placed on understanding how dynamics can alter the
project performance, so that appropriate responses can be designed and undertaken to
maximize the effect of positive dynamics and minimize the effect of negative ones. Systems
Dynamics, as a proven tool in project management can be extended to manage the risks and
uncertainties in PPP infrastructure.

 PPP Projects are complex projects that require effective attention to risk and their
mitigation.

 Risks are inherently related to returns and the service/expertise which yields those
returns.

 This gives a good perspective on who is best placed to bear the risk.

 Objectives of the government in taking up a PPP project are essential to decide who
bears a particular risk.

 PPPs in Western India:

 Very active as compared to other parts of the country and ever increasing activity.

 Activity is mainly confined to transportation sector.


 However some landmark projects have failed because risks were not properly
identified.

 Some General Principles in Risk Management:

 Thoroughness in identification of risks.

 Lessons from similar projects.

 Should be borne by party best placed to bear it.

 Quantification of financial impact to the extent possible

 Thoroughness of documentation.