Risk allocation and incentive systems in the case of a PFI

Not every public sector investment project can be realized as part of a public-private-partnership (PPP). For those projects that cannot be realized in this form alternative forms of financing are available. Nevertheless, the penalties suffered by the public sector partner are normally much greater if it consents to a disadvantageous allocation of the project risks and allows the PPP project to be performed uneconomically. Consequently, an advantageous allocation of risks and the creation of an incentive system are two inseparable key elements when structuring the public-private-partnership to the advantage of the public sector.

Projects realized in Germany to date do not allow any uniform risk structure to be discerned. This is partly due to the fact that the projects themselves differ too greatly and the aims of the public sector are too varied. Consequently, there is only a limited degree of comparability. Moreover, the negotiating power of the public sector and the appreciation of the risks on the part of those acting for the public sector may also vary to a very great extent. At the time of planning and realizing the projects, there is a focus on the benefits of mutual success and an unwillingness to discuss the consequences and remedies of failure. Experience shows that specific risk allocation tends to be based on random considerations than on any form of systematic planning. It is necessary to say that there is no such thing as a generally acknowledged market standard in this area. Instead, it is possible to elaborate an individual risk profile tailored to the circumstances of the specific case.

The involvement of private capital and private expertise in public infrastructure projects is not an automatic guarantee of the economic efficiency of the PPP model. The private partner’s pursuit of profit in the transaction in accordance with the commercial principles can only be an incentive for cost-effective project realization if the public partner does not unilaterally bear the risk of the costs. For this reason, these risks must be structured and shared in such a way that private and public partners benefit equally from cost advantages and optimization. If the private partner has no particular incentive to realize the project better, faster and more cost-effectively than the public partner could do alone, the PPP model will gradually lose its attraction. For this reason, the creation of an incentive system is particularly in the public interest. Experience has shown that, in practice, it is impossible to separate risk allocation and the establishment of this incentive system and this must be regarded as a single structuring task.

Construction of a public infrastructure project involves a large number of different types of risks. It makes sense to define and classify the specific risks when they can be, and will be, divided between different parties. Accordingly, public-private-partnership is a matter that necessarily requires careful evaluation of any existing risks.

Advisers and consultants are familiar with different risk classifications. On the one hand, origin-based criteria are defined and a distinction is made between commercial risks, political risks and force majeure. Secondly, there is a phase-related classification of risks during planning, construction and operation. Nevertheless, schemes of this kind are only of limited value to the public partner because it depends on implementation in the individual case. What is required is a multi-dimensional risk matrix geared to the individual measure that also takes account of any conceivable "worst case" scenario. If no proper care is taken to identify the nature, probability, time of occurrence and amount of damages of the conceivable risks, the ability to distribute the risks fairly between the parties is also impaired

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