Look out for the hidden dangers

Managing risks is central to the success of infrastructure projects. Not only is this true in emerging markets, where growing opportunities to invest mean elevated risks for investors and developers; it’s also the case in established markets, where unforeseen events can derail an infrastructure project, despite what may seem a familiar and reliable business environment.

Most investors and developers today consider a risk assessment an essential stage in evaluating infrastructure opportunities. Legal and financial risks, usually inherent to the project itself, tend to be well analysed and mitigated. Others, such as political and regulatory risks, typically receive less attention. Yet their impact can determine the success or failure of many projects.

Expanding the risk assessment scope to less-recognisable risk areas can help all actors in the infrastructure project cycle achieve objectives and complete the project within the planned timeframe and budget. Resilience and sustainability result from adopting this broader conception of risk.

POLITICAL RISKS

Governments advertising infrastructure investment opportunities usually focus on the positive aspects of the business environment, such as low labour costs or favourable tax obligations. But such benefits can be counterbalanced by political risks that are rarely mentioned by governments. Political risks in infrastructure projects can range from nationalisation and expropriation of assets by the state to unreliable contract enforcement. They are not always obvious before the start of a project, nor can they be addressed by extending deadlines and devoting more resources.

Even when construction-sector legislation is to the highest standard, inconsistent and patchy implementation can undermine it. For example, most Central and Eastern European states have, in the past decade, adopted legislation similar to that of their European Union peers in Western Europe. Weak institutional capacity however often means this legislation is not implemented fully or properly, creating delays and excessive costs for developers.

Unresolved land ownership issues can also affect the start or completion of construction projects. Escalating compensation demands from multiple parties claiming ownership can also arise out of this. Awareness of how state policies work, or fail to work, in practice is crucial to preventing disruption to the completion and profitability of infrastructure projects.

SOCIAL RISKS

Risks are related not only to state policies and actors but also local stakeholders. Most infrastructure developers are familiar with social-impact assessments, and understand the impact large-scale projects can have on the local economy, social dynamics, livelihoods and the environment. In particular, local communities and stakeholders may mobilise against controversial large-scale projects with protests and other forms of direct action against construction activities.

Direct action may be motivated by concerns about the potential socio-economic impact or disputes over compensation for land and buildings. It can take the form of violent or non-violent protests, site incursions and denied access. Social risks may also manifest in less direct and obvious ways. For instance, an influx of workers for a large-scale project may cause local resentment, particularly in low-income communities, and lead to an increase in ambient crime.

Social risks often present themselves even after all the required permits and licences have been obtained. Although a company may have complied with all legal and policy requirements, these may not capture the grievances of local communities. Mismanagement of such risks can lead to significant project delays, security threats to assets and personnel and reputational damage.

REGULATORY RISKS

Changes in the regulatory framework often go hand in hand with political risks, as an unpredictable political environment frequently results in elevated regulatory risks. But even where political risks are low, the difference in length between political and project life cycles – which can be decades – exposes infrastructure projects to regulatory risks. This is inevitable as changing political administrations amend regulatory frameworks to suit their own political goals.

Regulatory risks can be specific to a phase of a project or can apply to the project or sector as a whole. An example of the former might be delays in receiving permits or licences necessary to begin work on a project, which may then damage a project’s profitability by lengthening the construction phase.

Changing regulations governing the industry have the potential to threaten not just the profitability of a project but its very viability. One example is the reduction of tariffs or subsidies in the electricity sector, which may call into question the viability of a power plant project. There are also economy-wide measures, such as changes in the corporate taxation regime when a new government comes to power. These could work in a project’s favour or force a review of assumptions about a project’s profitability.

In jurisdictions where regulatory risks are high, infrastructure projects are often exposed to a greater risk of corruption. The bidding and contracting phases are particularly susceptible, and a lack of transparency in public procurement or tendering processes heightens the risk that project stakeholders will face bribe demands. ABC (Anti-bribery and corruption) activity is no longer confined to the FCPA (US Foreign Corruption Practices Act) or the UK Bribery Act.

HOW TO BETTER MITIGATE THESE RISKS

Risk management should be based on an “all hazards and threats” perspective. In an ERM (Enterprise Risk Management) approach, political, social and regulatory issues are measured alongside environmental, security and operational risks, as well as a myriad of other risks facing a particular project.

ERM allows you to recognise the integrated nature of a project’s risks and the interdependence and combined effect of available mitigation options.

Such an approach will help deliver operational and economic benefits through the entire lifecycle of any infrastructure project, and provide value to all stakeholders. Far from being a static document, it should be a dynamic process, regularly reviewed and updated to ensure effective mitigation of the identified risks.

Below are three key steps in this process, designed to help you mitigate political, regulatory and social risks:

ENGAGE WITH EXTERNAL STAKEHOLDERS

With such political risks as expropriation or nationalisation, purchasing insurance may be one course of action. However, accompanying this with deeper and broader public engagement, with national or local government or local communities, will likely mitigate the risk of political intervention in the first place. Targeted interaction with relevant public bodies also provides an avenue for project stakeholders to advise on and influence policy, helping mitigate the impact of political and regulatory risks further down the line.

The first step in managing social risk is building an understanding of the project’s local environment, its key stakeholders and their concerns. In mature markets, social risks are often centred on the perceived environmental impact of a project, and the range of stakeholders is relatively well defined. A complex environment requires more effort and a detailed understanding of local community dynamics. For instance, successful management of social risks will depend on an understanding of whether local leaders are seen as legitimate representatives within their communities.

MONITOR DEVELOPMENTS CONTINUALLY

An effective risk mitigation plan should include monitoring, assessment and review of relevant national and local developments. This may be achieved through a market-entry assessment, scenario analysis or stakeholder mapping. Such actions enable project stakeholders to anticipate developments that have the potential to cause disruption. Moreover, if adverse developments materialise, they can tailor their response appropriately to minimise impact on the project.

SOUND BUSINESS CONDUCT

Companies involved with infrastructure projects also have a responsibility for their own conduct, which includes mitigating risks to the project and to the local community. In particular, this requires ensuring that rigorous ABC policies and procedures are in place, that project staff receives anti-corruption training and that third-party contractors are also screened and compliant. When corrupt practices are uncovered during a project, companies have a responsibility to pursue appropriate disciplinary or legal action and demonstrate to external stakeholders that they are taking the issue seriously.

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