RISK MANAGEMENT for Public-Private Partnership Projects

Transcription

1 Lenders Technical Advisor s Role in and Approach to RISK MANAGEMENT for Public-Private Partnership Projects

2 CONTENTS 3 Introduction 4 Risk Identification 6 Risk Management and Mitigation 7 Risk Allocation 9 Contractor Replacement Analysis 12 Contractor Security Package 13 Sizing the Security Package 14 Conclusion 15 About BTY Group 2

3 INTRODUCTION We created this short guide to help both public and private sector partners better understand the Lenders Technical Advisor s role and approach in risk management for Public-Private Partnership (P3) projects. In developing this guide, we drew on our wide-ranging experience on more than 70 transportation and social infrastructure P3 projects across North America, and overseas. The guide lays out in broad strokes the challenges of Risk Management particular to P3 projects, and how to systematically identify, allocate, manage, and mitigate risk at every stage of the Project. 3

4 RISK IDENTIFICATION A primary consideration for Public-Private Partnership agreements is the need to find the optimal mix of Risk Allocation between the public sector and the private sector parties of the agreement. Finding this optimal mix should result in a project that provides the best Value for Money proposition for those who will make use of the Project, and ultimately the taxpayers who fund it. Potential Risks for infrastructure projects fall into nine broad categories, summarized below: CONSTRUCTION RISK Sometimes called performance risk, this category would include the ability to construct the project on time and on budget, within the constraints of the specific project logistics (Constructability Risk). REHABILITATION RISK Being able to perform the periodic maintenance and rehabilitation activities on budget, and at the expected intervention intervals. Maintaining the asset in a condition that allows minimal effort at Project Handback. OPERATIONS RISK The ability to complete the Project Operations on budget, and to the level that satisfies the operations parameters while minimizing payment abatement. TECHNICAL RISK Ensuring that the project performs as expected by the Technical Requirements, in other words, making sure that the Design Solution works. 4

5 RISK IDENTIFICATION (CONTINUED) DEMAND RISK The risk that the actual usage of the project falls within a reasonable variance from the usage projections. On a toll roads project, if the number of users falls below projections, revenue will be negatively affected. On the other hand, on an Availability Project, if the number of users significantly exceeds projections, there will be undue pressure on the asset condition, requiring earlier lifecycle maintenance and rehabilitation. PUBLIC POLICY RISK Changes to the reasons for undertaking the project in the first place may reduce the need for the Project. An example would be a mass transit project funded by gasoline taxes that receives lower revenues because it is successful at getting those gasoline purchasers out of their cars. FINANCE RISK The cost of financing the construction and operations of the Project may be higher than budgeted, or, as recently experienced during the Financial Crisis of 2008, project finance liquidity may be severely curtailed. POLITICAL RISK The government changes its mind about the project. Bowing to public interest pressures could lead to requirements for modifications that would make the projects unviable. Legal challenges could also cause politicians to have a change of heart. REGULATORY RISK Changes to the regulatory environment may necessitate project modifications, such as new safety standards that would have an impact on the financial viability of the Project. One of the first steps in the Public-Private Partnership process is developing the Project Definition. Each Authority will have a view on how far to take the Project Definition, but it is at this stage that the Project Risks are identified. With input from Technical, Legal and Insurance Advisors, as well as the public policies of each Authority, there will be an initial allocation of each Risk to the appropriate project partner of the agreement, which is defined in the Procurement Documents. This Risk allocation will then be refined throughout the procurement process via negotiation, agreement amendments, and private sector proposals. 5

6 RISK MANAGEMENT & MITIGATION Your Risk is Someone Else s Profit Margin Risk is inherently uncertain. Simply identifying a potential Risk does not ensure that it will occur. In fact, with proper identification, allocation and management, the probability of negative consequences arising from most Project Risks is so low that it approaches zero. There are five basic ways to mitigate Risk: DESIGN FOR IT Ensure that the technical solution for the project addresses to the greatest extent possible the Risks of the Project. INSURE AGAINST IT The insurance industry in North America has a vast array of products to protect against all Risks imaginable but the cost effectiveness of this strategy needs careful study. TAKING A VIEW This is a commercial decision to ignore the Risk, not favoured by authorities or lenders. This is quite often the strategy cited after the winning proponent realizes they have not identified, allocated or mitigated an overlooked Risk. PASS IT DOWN Risk can be passed down through contracts to sub-contractors and suppliers appropriately suited to manage the specific Risk. PROVIDE A CONTINGENCY FOR IT While this may be the simplest mitigation strategy, it has to be carefully controlled and coordinated. There is a real danger of layering contingencies, where each link in the sub-contract chain adds a contingent sum to absorb Risk, and overall the project suffers from the burden of these cumulative contingencies. Unnecessary contingencies are profit to someone, and may render the private sector party s (Project Co s) bid uncompetitive. 6

7 RISK ALLOCATION To optimize value for money, the Public-Private Partnership Agreement should be structured so as to allocate the various categories of Project Risk to the party best suited to mitigate or manage the Risk. The table below provides an example of the risk allocation for a major interstate highway upgrade project located in the Southeast. RISK ISSUE Hazardous Materials AUTHORITY RISK CONCESSIONARE RISK Site Conditions Sink Holes Species at Risk Traffic Maintenance Availability Traffic Maintenance Volume Tolls Utilities Utility Delay (caused by Qualifying Utility Owner) Right of Way Acquisition Permits Modifications to Permits 7

8 ANALYZING THE RISK As Technical Advisors, one of our primary reporting functions is to assure the client that the Risk Management and Mitigation strategies employed by the private sector partner are reasonable. We have various analytical tools at our disposal to allow us to offer that assurance. PAYMENT DEDUCTION REGIME ANALYSIS We analyse the Payment Deduction Regime to determine its fairness, the likelihood of deductions, and an estimate of likely deductions if the private sector partner operates the project as they intend to. We also study the effects of the Payment Deduction Regime leading to various Concession Agreement Sanctions, and what it would take to lead to Termination. SHADOW ESTIMATE We prepare our own Estimate of Probable Costs of the project from first principles by measuring the quantities, building up unit rates, and applying industry norm markups. By comparing our Shadow Estimate with the private sector partner s estimate, we are able to identify, and assess the likely contingencies and risk allowances carried by the Project Co. COMPENSATION ON TERMINATION ANALYSIS All Concession Agreements contain provisions for Project Co to be compensated upon early termination of the agreement. The value of the Termination Payment varies with the cause; Authority initiated terminations generally are greater than Project Co initiated terminations. The likely value of the Project Co initiated Termination Payment is of great interest to Lenders, as it usually starts at a minimum value of some percentage of the Senior Debt, for example, 80%. While other factors may increase it beyond that floor value, the potential is there for the Senior Lenders to suffer a loss of 20% of their loan amount. SCHEDULE REVIEW We use sophisticated schedule analysis tools to test the private sector partner s schedule for completeness, the appropriateness of the production rates, and the logic of the sequencing. We determine the amount of float contained within significant activity blocks, and offer opinions on the adequacy of the Free and Total Float. DESIGN REVIEW We have specialist architects, engineers, and project managers available to assess the ability of a proposed design solution to achieve the Output Specifications or Technical Requirements of the project. CONTRACTOR REPLACEMENT ANALYSIS This is the most significant of our analytical tools, and the one that Rating Agencies and Lenders focus most of their attention on. With the replacement scenarios, we attempt to identify the impact on the project of a significant event occurring that would ultimately result in the replacement of one of the primary sub-contractors (either the Design- Builder or the Operator). 8

9 CONTRACTOR REPLACEMENT ANALYSIS We generally prepare between six and eight replacement scenarios in order to identify the crucial moment in the schedule where a probable delay might be caused, and its resultant costs would be maximized. We select key points in the schedule that could significantly impact achieving project completion on time. These could include both the start and target end dates, periods of maximum activity on site, just prior or post project blackout periods (either for weather conditions or species at risk protection), cash drawdown peaks, etc. We introduce a period of delay into the Concessionaire s schedule, and recalculate the target completion date. This gives us the delay for each scenario, which is a prime input into the calculation of the delay premium cost. A sample Contractor Replacement Scenario is illustrated gin the adjacent table: SAMPLE PROJECT Replacement Contractor: Constrution Contractor JV Default Scenario 3: DBJV Default at North Pylon Completion (April 1, 2016) Claim No. 32 Delay to progress of Works (Weeks) 23 Based on termination process, re-tender, evaluation, appointment, all discussions & mobilisation. Contract sum $ 902,000,000 Less drawdown $756,200,000 Maximum Value of Work Completed per Maximum Expenditure Curve. Balance to Complete $ 145,800,000 Additional Costs to Complete $ $ Termination procedure fees Legal, Tax, Accounting $ 1,000,000 Technical Advisory $ 500,000 Authority Due Diligence $ 500,000 $ 2,000,000 Based on allowance of 5 DBFO Contractor $150,000 p/a over delay period + $1,000,000 rebid process. Developer costs of Replacement Design-Builder Tender $ 1,333,000 Based on allowance of 5 DBFO Contractor $150,000 p/a over delay period + $1,000,000 rebid process. Replacement Contractor Mobilization $ 10,643,000 Based on allowance of 7.3% of Contract Price (same as original Mobilization costs). Retendered price uplift 9.8% $ 11,267,000 Based on 2.5% escalation rate over 6 months (Feb Aug 2013) for re-tendering (n.incl. Design Cost or General Expenses). Increased fee by new Construction Contractor 3.0% $ 4,374,000 Increased fee for new GC - provide 3% premium on Cost to Complete. Ransom Trades, Suppliers & Labourers $ 14,991,000 Assumes non GC/Indirect portion of previous months draw. Remedial works $ 6,620,000 Assume the Repair of 10% of the previous Quarter's work. Increase in Due Diligence (Post Replacement) $ 172,000 Based on 25% fee increase to LTA over remaining construction period. Daily Construction Contractor LD's Type 1 $ 137,037 $ 22,159,000 Applicable between Original date for SC and actual date of SC. Daily rate based on input from Proponent. Type 2 $ 46,050 $ 7,446,000 Applicable between Original date for D&C Completion and actual date of D&C Completion. Daily rate based on input from Proponent. Authority LD's Liablity $ - $ - Replacement Premium 9.0% $ 81,005,000 Revised Cost to Complete $ 226,805,000 9

10 CONTRACTOR REPLACEMENT ANALYSIS (CONTINUED) During our analysis we consider the following cost centres that would be impacted by the delay: TERMINATION PROCEDURE COSTS These are costs incurred during the run up period to contractor default and eventual replacement. These can include costs for external advisors, and for the Concessionaire s personnel to administer the default and arrange for a replacement contractor. REPLACEMENT CONTRACTOR MOBILIZATION Using the data collected with our shadow estimate, we calculate the replacement contractor s general fees, expenses, and costs to plug into the Project. RESET COSTS FOR SUB-CONTRACTORS Based on the particular circumstances of the contractor replacement scenarios we would either consider that trade contracts are assignable at the established contract amount, or are retendered, which would carry additional costs. CONSIDERING THE TAINT FACTOR We consider that there will be a negative perception of the Project when facing such a major delay, and that any replacement will carry a premium profit mark-up to allow for this perception. We consider many things in determining this Taint factor, such as the project location, availability of qualified replacement contractors and trade contractors, implications for retendering to new sub-contractors, the general economic conditions and potential inflation of construction costs, etc. Generally, the lower the value of the Replacement Contract, the higher the percentage we attribute to the premium applied. PAYMENT TO TRADES DURING DEFAULT We assume that the payable accounts for all trade contractors are current prior to a default. We then consider that in the month that the default occurs, the contractor will be unable to pay the progress amounts due to the trades and suppliers, which means there will be a cost to the Concessionaire as a percentage of the progress payment amount to the contractor for one month previous to the date of default. DESIGN COSTS We consider that all of the documented design utilized to define the Project and the consultants belongs to the Concessionaire. Consequently, there is no premium cost due in the event of a contractor replacement. WORK COMPLETED UP TO DEFAULT We consider that all work prior to the default has been inspected and approved. Thus there would be little or no cost allocated to redo previously constructed work. However, we allocate a percentage of the progress payment as a cost to the Concessionaire from the month prior to the default as the work during this period may not have been thoroughly inspected and approved. LIQUIDATED DAMAGES The Liquidated Damages suffered by the Concessionaire and/or the Authority resulting from project completion not being achieved on schedule generally account for Finance Costs from the target completion date to the Project Long Stop Date. The Long Stop Date is included in the Concession Agreement, and allows the Authority to terminate the agreement for non-completion of the project s construction component, usually 12 months after the target completion date. 10

11 CONTRACTOR REPLACEMENT ANALYSIS (CONTINUED) The resultant figure from this analysis is the premium cost to replace the contractor. By graphing both the delay and the delay premium cost against time (see below), we can interpolate the maximum delay premium cost and when it is likely to occur. Delay Premium (000's) $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 ê 25 wks 20 wks 15 wks 10 wks 5 wks Delay Period $ Project Month 0 wks ê From this example, we can see that the maximum likely delay premium is just over $120,000,000, and would occur around month 11 or 12. This value is an important factor in sizing the Security Package from the Contractor. 11

12 CONTRACTOR SECURITY PACKAGE Once the Concessionaire has successfully managed to pass the Design/Build and Operations Risk to the respective subcontractors, they want to ensure that those subcontractors will actually take on the responsibility for the risk they have been allocated. The vehicle used to ensure this Risk Transfer is the Security Package. What comprises the Security Package varies project to project, and can be different for the Design Builder and the Operator, but generally a mixture of the following elements is included: PARENT COMPANY GUARANTEE A promise to fulfill all of the obligations of the Design/Build or Operations Agreements. PERFORMANCE BOND Issued by a third party Surety, it is a demand instrument available to the obligee should the Design/Builder or Operator fail to perform its obligations. LETTER OF CREDIT Generally issued by a Tier 1 Bank, it is considered liquid security, available to the obligee immediately. CASH RETENTION This is a retention that grows in size as the Project progresses. It is a liquid security, in that it is available immediately to the obligee. However, as it increases in value over the Project s progress, it usually has little value as a credit enhancement should the Design/ Builder fail early in the Project. 12

13 SIZING THE SECURITY PACKAGE As noted, the Security Package is there to ensure that the sub-contractors are sufficiently motivated to undertake the Risk that has been passed down to them. It needs to be appropriately sized to be effective, and cost efficient. The size is determined by considering factors such as the strength of the sub-contracting parties, the balance of liquid, demand and guarantee type security to appropriately respond to the project cash flows, and the level of rating the proponent is seeking from the Rating Agencies. For example, if the target borrowing rates can be achieved with a B+ rating, there is little competitive advantage to pushing the security package to a level that would secure an A rating. Comparable security package levels also factor into the determination. The following table provides the typical range of values for Security Packages. TYPE CONSTRUCTOR OPERATOR Corporate Guarantee 40 50% of Construction Price % of Annual Operating Cost Performance Bond 25 50% of Construction Price 100% of Annual Operating Cost Letter of Credit % of Construction Price 50 75% of Annual Operating Cost Cash Retention 2.5 5% of each Construction Advance Not applicable The Security Package should be sized to cover both the maximum delay premium identified in our Contractor Replacement Scenarios, and any difference between the Senior Debt levels and the Compensation on Termination Sum. 13

14 CONCLUSION Using the tools and techniques explained in this short guide, many of them developed directly from our own experience as the Lenders Technical Advisor on P3 projects, Risk can be effectively identified, allocated, managed and mitigated to support project success in delivering value for money. Perhaps the key lesson is that these tools and techniques must be used systematically and with the clear understanding that project success remains the paramount objective. 14

15 ABOUT BTY GROUP BTY Group is one of North America s leading consultancies for Cost Management, Project Monitoring and Public-Private Partnership Advisory services. We provide professional expertise in managing risks and optimizing value for property, infrastructure and facilities projects. We conduct timely, thorough due diligence based on in-depth knowledge of local markets for those who design, build, finance and operate development projects. Over the last 35 years, BTY Group has gained a reputation for providing clients with professional and practical advice of the highest calibre. We have provided support in capital investment to clients in the health-care, education, research, transportation, energy and utilities, leisure, retail, residential and commercial sectors. SERVICE STREAMS $ PUBLIC-PRIVATE PARTNERSHIPS PROJECT MONITORING COST MANAGEMENT MANAGEMENT CONSULTING Business Case Development Development Proforma Applications Cost Planning and Control Sustainable Building Consulting Shadow Bid Cost Advisory Budget Review Mechanical & Electrical Costing Value Analysis Independent Certifier Schedule and Construction Review Quantity Surveying Risk Management Post Completion Monitoring Regulatory Approvals Scheduling Expert Witness Testimony Life Cycle Costing Progress Claim Reports Claim Management Depreciation Reports Bid Team Management Builders Lien Act Certification Change Order Review Facilities Management Lenders Technical Advisor Cash Flow Sustainable Construction Operational Modeling Sales & Marketing Value Management & Analysis Payment Mechanism Modeling Post-Contract Cost Control Facilities Management Analysis Risk Management & Analysis Secondary Market Due Diligence Payment Certifier Carbon Neutral Costing Program Management 15

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