4.6 Risk Management
Private financing of Port projects hereto has been very rare as it is full of risk and requires a lot to be done to promote better risk and requires a lot to be done to promote better risk sharing, accountability, monitoring and management. In some sectors like Power and Telecommunication, the scope is much more compared to that of Port and Roads.
A typical Port project runs through three phases:
- Engineering and Construction Phase
- Start-up Phase
- Operations Phase
In the first phase of Engineering and Construction, the amount of risk begins to increase sharply as funds are advanced to purchase equipments and materials. Interest charges on loans also start to accumulate.
The Start-up phase is associated with cost and time overruns. Successful commercial operation culminates in finally proving the correctness of the feasibility report. The risk is at its maximum in the Start-up phase.
A successful Operating phase brings down the risk as repayments start and liability gets reduced gradually. Analyzing the various type of risks in a Port project, we have the following:
(1) CREDIT RISK: Proper financial appraisal with sensitivity
analysis to indicate extent of cushion is important. Though
debt equity ratio of 4:1 is permitted, it is advisable to have
equity involvement of all connected parties so that debt equity
level of 1:1 is maintained. To minimize the credit risk, worst
case scenarios must be considered and contingency plans prepared
accordingly.
(2) SUPPLY RISK: There is a high degree of risk in projects
with respect to uninterrupted supply of key inputs and against
price escalation. A long term ‘supply or pay’ contract
or ‘put or pay’ contract would assure regular supply
of the inputs. Such long term supply contracts can also be made
transferable so that it can act as a security document to the
leading institution, besides minimizing the supply risk.
(3) MARKET RISK: Financial success of a project depends upon
the existence of a market for the product and anticipated cash
flows. Long-term buying contracts in the form of ‘take
or pay’ contracts or ‘take and pay’ contracts
are useful. In ‘take or pay’ contracts, the obligation
of the purchaser to pay is unconditional, even if the product,
commodity or service is not delivered. In a ‘take and
pay’ contract, the obligation of the purchaser to take
the product only if it is delivered. Take or pay contracts are
tantamount to guarantees of a stream of revenue if drafted carefully.
In a road project, we have a tolling agreement or what is called
a ‘through put’ agreement wherein a minimum pay
contract, an all events tariff or a deficiency agreement is
used.
(4) RISK OF SUITABILITY OF CONTRACTOR AND OPERATOR: The contractor
must possess technical expertise and financial strength. Ideally
it should be a company, which has undertaken similar projects
in the past. A lender must have a say in choice of suitable
contractor. Similarly, the operator must have the technical
and financial expertise to operate the project as per the financial
feasibility of the project.
(5) CURRENCY AND FOREIGN EXCHANGE RISK: As Port projects require
huge funding, there is a strong need for seeking cheap foreign
currency borrowings. But with devaluation, the repayment burden
becomes very costly unless the project has some foreign exchange
revenue as a natural hedge. Hence foreign currency borrowing
can be resorted to in a port project where future revenue in
foreign exchange is possible.
(6) RISK OF COST OVERRUN: Cost overrun is quite possible in
such projects. Unless this is tied up from the beginning, it
puts the entire project in jeopardy and the responsibility for
completion with additional finance comes upon the lender. This
aspect has to be covered by various methods such as,
(a) Assurance of putting in additional capital if need be by
the sponsor. The lender should satisfy himself about the capability
of the sponsor to this effect.
(b) The lender should also be prepared for a standby credit
facility in such eventuality.
(c) Cost overrun can also be guarded against by entering into
fixed-price contracts or turn-key contracts from the suppliers.
(d) Maintaining an ESCROW account for the funds required for
completion, so that the funds are utilized for the specific
purpose of completing the project and not otherwise.
(7) ENVIRONMENTAL RISK: Infrastructure projects can affect the
environment through,
- Deforestation and felling of trees
- Atmospheric pollution by emission
- Site contamination
- Resettlement of inhabitants at the site
(7) POLITICAL RISK: Inadequate clarity of government policies
and selection of entrepreneur are the major political risks.
| TYPE OF RISK | WHO CONTROLS | COVERING/ MITIGATING |
| i) Commercial: Project specific | ||
| (a) Project concept and cost | Sponsor | Independent cost review, review of similar projects, use of tested technology, contracts for construction and operation and supply |
| (b) Project suppliers | Supplier | Supply contract (e.g., coal to power station) sometimes “supply or pay” casis, Government guarantee for supplier performance |
| (c) Market (multiple users; toll read) | None | Independent surveys to verify demand forecasts; agreements to provide access to market (e.g., concessions to supply telecom services); competitors/substitutes |
| (d) Market (single purchaser; power) | Purchaser | Take or pay contract, revolving L/C from purchaser to provide advance payment cushion |
| (e) Sponsor commitment and strength | Sponsors | Substantive equity commitments, lead sponsor strength, credit review, technical strength, commitments to meet cost overruns. |
| (f) Contractor or operator | Contractor | Technical/geographical experience and performance; finance strength; contractual arrangements |
| II) Commercial: Economic Environment | ||
| (a) Currency/Interest risk | Varies, but partly host Government | Hedging, sponsor guarantees to cover cost overruns during construction, use of local financing, Government agreement to link project tariff to debt-service costs, if devaluation affects both |
| (b) Inflation | Partly host Government | If regulated, Government agreement to link tariffs for project’s output to an Inflation Index |
| III) Non-Commercial: Project Specific | ||
| (a) Regulatory | Host Government | Detailed concession agreement, specifying conditions |
| (b) Expropriation | Host Government | Previous record; concession terms; insurance |
| IV) Non-Commercial: Non-Project Specific | ||
| (a) Country risk | Host Government | Country exposure limits, Government guarantees of exchange availability, payments made to an off-shore escrow account directly. |
| (b) Political risk | Government | Insurance, buy out clauses |
| (c) Legal risk | Host Government |
International arbitration |
| (d) Force Majeure risk | No party | Insurance |