The dangers of local P3s(2)

New ways of safeguarding against risk are required as smaller contractors move into the market for the first time.

It’s a sign of the evolution of the US P3 market that the issue of sub-contractor risk is being fiercely debated. After all, up to now, the fledgling US market has been all about a handful of mega-projects overseen by blue-chip developers such as Kiewit and Skanska. But with deal flow now creeping into the mid-market space, smaller contractors are beginning to get a look in for the first time.

This brings with it new challenges around projects being delivered on time and on budget – and who carries the can (and how) when that fails to happen. The issue was given a lengthy airing this week at a New York seminar staged by law firm Dentons, risk specialist Aon and the International Project Finance Association.

When P3s go local, winning “buy-in” for the project means engaging local communities – and that means handing roles in projects to resident businesses, which will in turn provide jobs for the local workforce. The importance of this process was explained by Bo Kemp, financial adviser to the Mayor of Gary, Indiana – which notably agreed a P3 for Gary/Chicago International Airport earlier this year.

But from the point of view of the general (overall) contractor, the fear is that sub-contractor default or under-performance will not allow them to meet their contractual obligations. “We needed mega-projects to create an industry,” said one seminar participant. “But now mid-market P3s are bringing a different risk analysis.”

They are also bringing nightmare visions, alluded to in the seminar, of a brick wall where the “sub-contractor bricks” underneath collapse, bringing the whole edifice tumbling down – including the general contractor sat at the top.

One response to this is to effectively try and retain the mega-project status quo by way of “bundling”. Some states have coalesced small projects into one very large project – thereby having sufficient scale to attract the blue-chip developers. The Pennsylvania bridge replacement P3 – comprising 500 bridges – is a prime example of bundling.

But this approach will only apply in certain cases. As the P3 market grows, the big developers know they must engage more with local communities and find out how best to protect themselves against sub-contractor default.

Canada may be the best place to look for answers given its proximity and the fact that it has developed a strong pipeline of smallish P3 deals. The country has become a pioneer of sub-contractor default insurance (SDI), with Zurich’s Sub-Guard product having been followed by a number of others since its introduction in the early 2000s.

Whatever conclusions are reached regarding the optimal solution, the latest challenge for the US P3 market is also representative of the next stage of its growth.