Careful planning can mitigate P3 risks

Taking into consideration the uniqueness of each public-private partnership (PPP; P3) project, identifying risks, allocating risk, and not overestimating demand are some of the steps that ensure good P3 planning, according to a new report by Fitch Ratings.

“PPPs provide public value, but they need to be crafted carefully,” the rating agency’s managing director of global infrastructure and project finance and report lead author Cherian George said in a statement announcing the release of “Global PPP Lessons Learned”.

“A key assumption is that a normal environment will prevail,” he continued. “But the uniqueness of each PPP and the impossible nature of predicting all future challenges in advance creates a crucial – and vulnerable – link in the chain.”

What can upset a ‘normal environment’, according to the report, can be economic recession, a change in political risk, or a shift in the regulatory environment. All these events can have a meaningful effect on the performance of a P3 project.

The report also highlights the importance of properly identifying risk, taking into consideration the size and complexity of a project; as well as the importance of allocating risk to parties that are best able to manage them economically.

“When all parties have appropriate levels of risk they are better incentivised to work together to find an amicable solution,” Cherian and his co-authors – Nicolas Painvin and Thomas McCormick – note.

Overestimating demand and over-leveraging an asset are also pitfalls to be avoided as they have often been the cause of failed P3 projects.

“Defaults in PPP transactions have largely been the consequence of weak project economics (e.g. overestimated demand or poorly estimated costs) rather than friction between the parties or outright default by the grantor,” according to the report.

Additionally, overestimating demand compounds the negative impact of over-leveraging. “In instances of high leverage, the credit decline was greatest when projects with traffic and revenue forecasting risk significantly underperformed their revenue projections,” according to the report, which also lists a number of projects around the world that have proved problematic and identifies the risks that negatively affected each project.

Nonetheless, most risks can be anticipated and mitigated, according to the report’s authors.

“The issues that arise, while problematic, are not deal breakers and sensible minds often prevail with enough mutual benefit remaining for both parties to take the transaction to term,” they conclude.