Transcript Toolkit: Approaches to Private Participation in Water Services

Toolkit: Approaches to Private
Participation in Water Services
Module 6
Allocating Responsibilities and
Risks
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E-learning design: [email protected]
Elements of the Toolkit
1
Considering
Private
Participation
2
Planning the
Process
9
Selecting an
Operator
8
Designing
Legal
Instruments
3
Involving
Stakeholders
TOOLKIT
Appendix A
Examples of PP
Arrangements
Appendix B
Policy Simulation
Model
4
Setting
Upstream
Policy
7
Developing
Institutions
6
Responsibilities
& Risks
5
Standards,
Tariffs, Subsidy,
Financials
Additional Material
CD-ROM
Module 6Outline of Toolkit
General
1
Considering
Private
Participation
2
Planning the
Process
9
Selecting an
Operator
8
Designing
Legal
Instruments
3
Involving
Stakeholders
TOOLKIT
Appendix A
Examples of PP
Arrangements
Appendix B
Policy Simulation
Model
4
Setting
Upstream
Policy
7
Developing
Institutions
Module 66
Responsibilities
& Risks
Allocating Responsibilities
and Risks
5
Setting Service
Standards, Tariffs,
Subsidies &
Financial
Arrangements
Additional Material
CD-ROM
Module 6 - What will we learn?
Plus!
Additional Material:
Tariff Reset
Module 6
Allocating Responsibilities and Risks
A big part of designing the PP Arrangement is
defining and allocating the business
responsibilities between the various parties.
ANALYZING
Responsibilities
& Risks
ALLOCATING
Responsibilities
& Risks
The basic process for allocating Responsibilities
and Risks is:
• Identify the main areas of Responsibility
involved in delivering the services and the
Risks associated with each Responsibility
• Allocate each area of Responsibility and Risk
to the party best able to manage it
• Design the Arrangement to achieve the best
allocation of risks and responsibilities
Risk associated with these responsibilities has
also to be allocated between the parties, and
this is also a key part of designing the
Arrangement.
DESIGNING
Risk Allocation
Rules
EXAMPLES
Allocation Different PP Models
Module 6
Analyzing
Allocating Responsibilities
Responsibilities
& Risks and Risks
In this section we ANALYZE key issues related
to provision of water services, looking at two
main areas:
ANALYZING
Responsibilities
& Risks
• Key areas of RESPONSIBILITY. How can
they be defined?
ALLOCATING
Responsibilities
& Risks
• Key RISKS related to these
Responsibilities. How can they be defined?
DESIGNING
Risk Allocation
Rules
EXAMPLES
Allocation Different PP Models
Module 6
Analyzing
Allocating Responsibilities
Responsibilities
& Risks and Risks
ANALYZING
Responsibilities
& Risks
Analyzing Responsibilities
Analyzing Risks
ALLOCATING
Responsibilities
& Risks
DESIGNING
Risk Allocation
Rules
EXAMPLES
Allocation Different PP Models
Allocating
Module
6 Responsibilities
& Risks
ANALYZING
Responsibilities
& Risks
ALLOCATING
Responsibilities
& Risks
A key aim of private participation is to allocate
risks between the Operator and the Contracting
Authority.
DESIGNING
Risk Allocation
Rules
EXAMPLES
Allocation Different PP Models
Allocating
Module
6 Responsibilities
& Risks
“How can we best allocate Risks and Responsibilities between the Contracting
Authority and the Operator? ”
Some Guidelines:
 Each Responsibility is allocated to the party best able to undertake it
 Each Risk is born by the party best able to manage it, taking account of the
parties’ ability to:
 Predict changes in the
relevant
factors
NOTE:
COST
OF RISK
 Influence
or control
theparty
risk factor
Example:
One
may be better able to predict
Bearing Risk has a cost. If Risk is allocated to the Operator, he will
nonpayment
 Control
the to
impact
of the
risk on the
value
of the water
andtosanitation
generally
expect
be able
to recover
thebetter
cost. Allocating
Risk
the party
Example:
one party
may be
able to reduce
business
best able
to manage
it helps
to reduce
costsmanagement
to the contracting authority
nonpayment
through
customer
andcustomers.
Diversify
or absorb
Risk
Example:
onethe
party
may be better able to reduce
nonpayment through ability to offer credit terms
Example: One party may be able to diversify risk
across a portfolio of projects
Allocating Risks
Example (1): Demand Risk
“Example: Demand Risk affects many elements of water and sanitation
companies , it can have a significant impact on the business value, and
fluctuations in demand can drastically affect investment needs.”
The extent to which Demand Risk is shared between the Contracting Authority
and the Operator depends on the particular circumstances of the project
including:
 Availability of good information on Demand
 Economic Stability
 The Operator’s willingness to accept Risk
In practice the Operator will be reluctant to accept full Demand Risk, and will
seek to pass it onto customers through:
 Tariffs or …….
 Reduced Service Levels
Allocating Risks
Example (2): Currency Risk
“Example: Currency Risk is made up of Exchange Rate and Convertibility Risks.
Exchange rate risks comes from unpredictable variation in Exchange Rate.
Convertibility Risk comes from uncertainty as to whether the Government will
restrict conversion of the local currency into foreign currency”
Currency Risk affects the business value through several mechanisms:
 Operational Costs
e. g. Affects costs of imported inputs, such as energy costs
 Maintenance and construction Costs
e.g. Affects price of imported parts used in new construction
 Finance Costs
e.g If Loans in foreign currency but revenues from local currency,
then exchange rate fluctuations will affect business profitability.
Allocating Risks
Example (2): Currency Risk
“..or, for this we example, can show graphically how Currency and Convertibility
Risks affect the value of the business through several mechanisms……..”
Operating &
Maintenance
Input Prices
Exchange Rate
Risk
New
Investment
Financing Risk
Currency
Convertibility
Risk
Total Costs
Cash Flow
Module
Designing6 Allocation
of Responsibilities & Risks
“ The next step is to design the Rules that will allocate the risks and responsibilities”
ANALYZING
Responsibilities
& Risks
Rules for adjusting Tariffs are an important
mechanism for allocating Risk between the parties,
including:
Cost Pass Through
Indexation
Tariff Resets
ALLOCATING
Responsibilities
& Risks
Other risk-allocating rules are also reviewed (e.g.
Bonuses and compensation on termination)
DESIGNING
Risk Allocation
Rules
Plus!
Additional Material:
Tariff Reset
EXAMPLES
Allocation Different PP Models
Module
Designing6 Allocation
of Responsibilities & Risks
“ We will consider two main subjects related to Risk Allocation”
TARIFF ADJUSTMENT
MECHANISMS
ALLOCATION OF OTHER
RISKS
Module
Designing6 Allocation
of Responsibilities & Risks
“ Rules for adjusting tariffs are the key mechanism for allocating risk among
Customers, the Operator and the Contracting Authority……
TARIFF ADJUSTMENT
MECHANISMS
Cost pass-through
Tariff Indexation Formulas
Tariff Resets
ALLOCATION OF OTHER
RISKS
Module
Designing6 Allocation
of Responsibilities & Risks
“ Rules for adjusting tariffs are the key mechanism for allocating risk among
Customers, the Operator and the Contracting Authority……
TARIFF ADJUSTMENT
MECHANISMS
Cost pass-through
Cost Pass Through
Tariff Indexation Formulas
Tariff Indexation
Tariff Resets
Tariff Resets
ALLOCATION OF OTHER
RISKS
Module
Designing6 Allocation
of Responsibilities & Risks
“ Rules for adjusting tariffs are the key mechanism for allocating risk among
Customers, the Operator and the Contracting Authority……
TARIFF ADJUSTMENT
MECHANISMS
ALLOCATION OF OTHER
RISKS
Cost pass-through
Cost Pass Through
Tariff Indexation Formulas
Tariff Indexation
Tariff Resets
Tariff Resets
Tariff Resets
Example:
Why the need for
Tariff Resets?
Module
Designing6 Allocation
of Responsibilities & Risks
“ In addition to Tariffs…………………………. important mechanisms covering other
risks must also be must be designed”
TARIFF ADJUSTMENT
MECHANISMS
ALLOCATION OF OTHER
RISKS
 Cost pass-through
Bonuses & penalties
 Tariff Indexation
Formulas
Government Guarantees
Termination Triggers & payments
 Tariff Resets
Transition periods at commencement
Contract Duration
Module
6
Other Mechanisms
for
Allocating Risk
“ Although Tariff adjustment rules are the main ways of allocating risks, other risks
are allocated between Operator and the Contracting Authority by contract ”
Some other key risk allocation mechanisms include:
ALLOCATION OF OTHER
RISKS
Bonuses and penalties
Government guarantees
Termination triggers and payments
Transition periods at commencement
Contract Duration
Module
6
Other
Mechanisms
for
An arrangement will usually set out a list of triggers that entitles parties to terminate
early,
for example:
Allocating
Risk
 Requisition, expropriation or seizure of water systems by
Termination triggers and payments
Government
“ Although Tariff adjustment rules are the main ways of allocating risks, other risks
 The occasion of force majeure that makes the contract unworkable
are allocated between Operator and the Contracting Authority by contract ”
 If penalties exceed a certain threshold the Contracting Authority may have the
right to terminate.
Some other key risk allocation mechanisms include:
Termination payments compensate the Operator for costs that would otherwise be lost
Bonuses (e.g.
and penalties
under early termination
sunk investment costs by the Operator). The way that
these payments
are calculated
and applied helps to determine the allocation of risk
Government
guarantees
Bonuses & Penalties
PerformanceTermination
payments such
as penalties
and bonuses encourage efficiency gains
triggers
and payments
Guarantees
by sharing some element of risk with the Private Operator
Transition
periods
at commencement
The Contracting
Authority
or a Government
entity may provide guarantees to the
Operator
against
certain
as:
Transition
periods
The
Contract
may
lay Duration
outrisks,
a listsuch
of penalties
if the Operator does not perform.
Contract
 Operating debt
Where information problems increase the risk a transition period can be built in at
The
longer
the
Duration
theifmore
difficult
itexceeds
is to predict
the targets
effect of
Contract
Exchange
rate
related
to foreign
debt
The
mayContract
alsoguarantees
include
bonuses
the
Operator
certain
the
commencement
of
the arrangement.
This
allows an
initial grace
period when
various parameters for the life of the contract. This may make the risks and the
the Operator to collect information needed to run the business on a commercial
costs
become
unacceptably
to
various
parties.
This
guarantees
risk, high
making
ittransferring
more
attractive
Operator. Contract.
Bonuses
are thedownside
main mechanisms
forthe
risk intoathe
Management
basis, without
accountability
for performance
improvements.
A management
Contract
performance
bonuses
only
gives
Operator
weak
Reset
help reduce
manageable
levels
for
long
duration
Care
mustmechanisms
be taken
notcan
towithout
included
risksrisks
thatto
the
Operator
might
bean
able
to cover
by
Terms
can
be
adjusted
to
reflect
any
major
differences
from
the
initial
assumptions
incentive
to improve
performance
contracts,
particularly
where private investment is involved
himself
more
effectively
Module PP
6 Models
Different
Allocating Responsibilities & Risks
In this section we look at the way that three
standard PPP models deal with Risk and
Responsibilities:
ANALYZING
Responsibilities
& Risks
ALLOCATING
Responsibilities
& Risks
 Management Contract
 Affermage/Lease
 Concession
Each of these models is defined by the
particular allocation of Risks and
Responsibilities.
These models can be tailored to meet specific
DESIGNING
situations, or hybrid versions of these models
used.
Risk Allocation
Rules
EXAMPLES
Allocation Different PP Models
Module PP
6 Models
Different
Allocating Responsibilities & Risks
“ Each of the three standard models of private participation is defined by the
allocation of responsibilities and risks”
Operator
Risks:
Contract
Form:
Operational
Technical
Commercial
Regulation
Service
Contract
(by comparison)

Management
Contract



Affermage - Lease




Concession




Financial
Forex
Risk Level:
These are an indication of the level of
Risk taken by the Operator for specific
issues under the various PP models .


Management Contract:
Affermage – Lease
Module PP
6 Models
Different
The Operator fills the Key management positions in the water company.
Responsibility for operating
and maintaining assets plus
commercial
and
Allocating
Responsibilities
&
Risks
management responsibilities, passes to the Operator
The publicly owned company continues to be accountable for other
responsibilities
(e.g. operating
and maintaining
new investments).
“ Each of the three
standard models
of privateassets,
participation
is defined by the
The publicly owned company continues to be accountable for new investments)
allocation of responsibilities and risks”
Operator
Risks:
Contract
Form:
Service
Concession:
Contract
(by comparison)
Operational
Technical
Commercial
Regulation
Financial
Forex

The Operator assumes full responsibility for service delivery, including:
 Management
Management



Contract 
Operation
 Maintenance of existing assets
- Lease
New Investment
Affermage




Concession






Module PP
6 Models
Different
Allocating Responsibilities & Risks
“ Looking
at themodel
balance
between
and Revenues
and Political
andCosts
Regulatory
Affermage
–Costs
Lease
“ …each
has
a particular
application
to the balance
between
and
Risks
for
each
model
………….”
Revenues
astransferred
well as Political
Regulatory
Risks” but depends
The risk
to theand
Operator
is significant,
Costs/Revenues
on the contract details and the way that the operator’s
remuneration is determined.
Tariffs don’t
cover O&M
costs
Affermage:
the tariff
adjustment rules relating to the
Management
Contract
Operator’s tariff (or ‘affermage fee’) are the most important
Lease: the Operator gets the customer tariff minus the lease
Concession:
payment. Tariff adjustment related to customer tariff are the
Management Contract
Tariffs cover
most important.
Management
Lease/Affermage
O&M costs
Contractrisks or
The
the greatest
overall
Theonly
risk transferred to
theOperator
Operatortakes
depends
on
a performance bonus.responsibilities of the three models
The formula for the bonus sets how much risk is
Lease/Affermage
Tariffs cover
taken
by
the
Operator.
Concession
total costs
In general, the least amount of risk is transferred
to the LOW
Operator
under
Contract.
Operator
willinga
to Management
Operator willing
to take
sink capital
operating and
commercial risk only
Political
and
Operator will only HIGH
Regulatory
take limited risk
Risk
Module PP
6 Models
Different
Allocating Responsibilities & Risks
“ ….but it may be necessary to adapt the standard models to meet particular needs”
Costs/Revenues
Tariffs don’t
cover O&M
costs
Management Contract
HYBRID MODELS
Tariffs cover
O&M costs
only
Tariffs cover
total costs
LOW
In addition to the three basic PP Models, it is
possible to design and implement ‘hybrid
Management
Lease/Affermage
Contract
structures’ that combine effective elements
of
different structures, balance risk, mobilize capital
but protect the poor
Concession
Operator willing to
sink capital
Lease/Affermage
Operator willing to take
operating risk only
Operator won’t
take any risk
Political
and
HIGH
Regulatory
Risk
Module PP
6 Models
Different
Allocating Responsibilities & Risks
“ ….but it may be necessary to adapt the standard models to meet particular needs”
Costs/Revenues
Tariffs don’t
cover O&M
costs
Examples; Risk in Hybrids
Management Contract
HYBRID MODELS
Tariffs cover
O&M costs
only
Tariffs cover
total costs
LOW
- Amman (MC)
- Cartagena Affermage/Lease
In addition to the three basic PP Models, it is
possible to design and implement ‘hybrid
Management
Lease/Affermage
Contract
structures’ that combine effective elements
of
different structures, balance risk, mobilize capital
but protect the poor
Concession
Operator willing to
sink capital
Lease/Affermage
Operator willing to take
operating risk only
Operator won’t
take any risk
Political
and
HIGH
Regulatory
Risk
Reviewing Module 6
‘The Module has looked at a whole range of issues for analysis
and allocation of responsibilities & risks in PP design………….
ANALYZING
ANALYZING
Responsibilities
&
Responsibilities
&Risks
Risks
ALLOCATING
Responsibilities &
Risks
DESIGNING
Risk Allocation
Rules
Including
Tariff Reset
EXAMPLES
Allocation –
Different PP Models
Checklist: Module 6
‘……..and the allocation process is detailed in this Checklist”
Define the major areas of responsibility (management, operations &
maintenance, new investment)Understand what services customers want
Define specific responsibilities for each area
Identify the risks that are associated with each responsibility
Note the direct and indirect relationships between risks and
responsibilities
Establish how the risks are interrelated
For each risk, identify which party ( the operator, contracting authority or
customers) is best able to bear the risk , and in particular who can:
Predict the risk
Influence the risk
Control the impact of the risk
Diversify or absorb residual risk
Decide whether the risk should be fully allocated to one party or shared
Check for any constraints on the ability of the parties to bear risk (e.g.
information problems; unwillingness of any of the participants to bear risk
they appear best able to manage)
Based on the risk analysis, assign a party to :
Assume each responsibility
Bear each risk
More Information:
Module 6
More information on Allocating Risks and Responsibilities:
Allocating risk generally: Asian Development Bank 2000, Beato and Vives 1996, Delmon 2001,
Finnerty 1996, Kerf and others 1998, Johnson and others 2002, Levy 1996, Nevitt and Fabozzi
2000, Victorian Department of Treasury and Finance 2001a and 2001b
Political and Regulatory Risk: Smith 1997a
Exchange rate risk: Gray and Irwin 2003a and 2003b, Mas 1997, Matsukawa and others 2003.
Debt levels and effect on risk allocation: Ehrhardt and Irwin 2004
Implementing a tariff reset: Green and Rodriguez Pardina 1999, PPIAF and World Bank
Institute 2002.
Estimating the cost of capital: Alexander 2000, Benninga 2000, Brealey and Myers 2001.
Government guarantees: Irwin and others 1997, Irwin 2003.
Supporting Material
• The Toolkit Financial Model
• Toolkit Case Study material
• Toolkit Website:
http://rru.worldbank.org/Toolkits/WaterSanitation/
• For comments or further details contact Cledan Mandri Perrott at
[email protected]
Toolkit: Module 6
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