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Proper Risk Allocation Promotes PPP Success

Alberto Jones - Moody's
Director General
Home > Infrastructure > Insight

Proper Risk Allocation Promotes PPP Success

Adrián Garza - Moody's
Vice President and Senior Analyst
Adrián Garza

STORY INLINE POST

Wed, 11/01/2017 - 09:57

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PPPs promote the development of infrastructure by evenly distributing risks and responsibilities but they are not as commonly used as they could be, according to IADB’s Infrascope 2017. Moody’s Investor Services offers riskdistribution assessments and performance diagnoses to ensure the success of PPPs.

Reducing and evenly distributing financial risks in PPP projects is fundamental to ensure the completion of the project, but both parties tend to commit errors. “The usual mistakes private companies make in infrastructure PPPs are trying to meet unrealistic deadlines that do not consider the project’s conditions and also, failing to prepare for the worst,” says Alberto Jones, CEO of Moody’s Investors Service. “On the government’s side, the mistakes are designing unfeasible projects and over-pushing developers to deliver,” adds Adrián Garza, Vice President and Senior Analyst at Moody’s Investors Service.

Moody’s Investor Services helps assess the operational and financial performances of both public and private parties in PPP projects and the distribution of risks between players. These ratings help PPPs acquire financial products to develop the project at hand. There are, however, challenges to risk mitigation. “Freezing capital in an account during the construction period or the whole life of a project to guarantee financial readiness is a common government requirement that harms the viability of projects,” says Jones. “Incorporating international practices such as using rated company bonds or letters of credit is easier for companies and reduces financial risks.”

Garza adds that Mexico has many areas of opportunities when it comes to institutional strength and transparency “but PPP’s have the advantage of clearly highlighting and isolating the financial and operational obligations that governmental and private entities must honor.” These obligations can be more efficiently allocated. Governments could, for example, help developers obtain the rights of way for projects because they are better positioned to do so. “Rights of way are significant challenges for construction companies and their sponsors, especially in emerging economies like Mexico,” says Garza. “If companies issued bonds during a project’s construction phase when risks are being adequately managed within PPPs, that could help these companies receive the financing they need to build the infrastructure.” Difficulties in obtaining rights of way inhibit the amount of project bonds that exist in the market. Most bonds in the market are for infrastructure that is already generating revenue, such as operating toll roads. In this sense, the lack of rights of way prevents new projects from receiving finance as it harms the ability to produce project bonds.

PPP infrastructure projects in Mexico are not new. Between 1990 and 2016, 266 PPP projects have been awarded by Mexico, according to IADB Infrascope 2017. The federal government strongly promotes PPPs, which are an explicit objective of the federal government’s National Development Plan 2012-2018. This policy is regulated through the Public Private Partnerships Law that came into force in 2012 and implemented through the Program for Promotion of Public-Private Partnerships in Mexican States (PIAPPEM). An increasing number of market-oriented states are starting to adopt these mechanisms to build the infrastructure they require, according to IADB.

WEF Global Competitiveness Report 2016 ranks corruption as the most problematic factor for doing business in Mexico. The inadequate supply of infrastructure ranks seventh. An increasing level of transparency in bids for projects and the promotion of PPPs can tackle both elements. “Tenders are increasingly transparent, which makes investors feel safer about placing capital in the country and more certain about how and when the awarded tenders are decided,” says Jones.

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