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4.risk Management

Risk management is a key part of successful project finance. It involves identifying risks, analyzing their potential impacts, and allocating each risk to the party best able to manage it. Risks are allocated through contracts to transfer construction risk to contractors and operating risk to operators. Residual risk remains with sponsors. Proper risk allocation ensures all parties have incentives to ensure project success and allows risks to be managed efficiently.

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Rahul M. Das
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240 views

4.risk Management

Risk management is a key part of successful project finance. It involves identifying risks, analyzing their potential impacts, and allocating each risk to the party best able to manage it. Risks are allocated through contracts to transfer construction risk to contractors and operating risk to operators. Residual risk remains with sponsors. Proper risk allocation ensures all parties have incentives to ensure project success and allows risks to be managed efficiently.

Uploaded by

Rahul M. Das
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Risk Management-overview

Participants in project finance.


What is risk-different perspectives
Risk Management process-what/why/how?
Types of Risk
Risk Analysis
Principle of risk
allocation/examples/mapping.
Need for contracts
Typical PF structure/Agreements/Risks.
Risk coverage-Construction/Operating.
Some project risks/Mitigation.

Participants in Project Finance

1. Sponsor
2. Lenders-Construction & Permanent
3. Contractor
4. Operator
5. Technology owner
6. Feedstock supplier
7. Output purchaser
8. Governments-Host and Others
9. Equity investor
10.Multilateral and bilateral agencies
Each PF participant has a different perspective on risk
allocation. Only by understanding risk perspective of
participants, can its appetite for risk acceptance be
understood.

What is Risk?
Uncertainty in regard to cost , loss
or damage.
Uncertainty is the most important
aspect.
Project finance abhors uncertainty.

Risk-Different Perspectives
An event or set of circumstances that
should it occur, will have an effect on
achievement of the project objectives.
Projects involve number of parties and
inter-acting activities (Areej house) .
Each activity carries risks which may
exert impact to some extent, upon the
cost, time and quality.
Requires a risk management system
which involves identification, analysis
and response.

What is a lender worried about ?


That he will not get back his interest and
principal.
Why may this happen?
Because the project does not generate the
budgeted cash flows in the budgeted time.
Why may this happen?
List the factors which could effect project
cash flows

Failure to identify a major risk or


requiring a wrong party to assume or
control a particular risk can result in:
1. Delays in project construction and
operation schedule. (Time and cost
overrun)
2. Revision of transaction documents at
additional cost.
3. Project company not able to repay the
lenders.
4. Ultimately loss or abandonment of the

Risk Management Process

Risk management process

What?
Why?
How?

Risk Management Process-What?


An important part of the successful closing of
project finance , where risks are identified,
analyzed, quantified, mitigated and
allocated .
Identify each material risk associated with the
design, construction and operation of the project.
Determine which participant is best able to bear
each risk and how each participant can do so.
In general terms, risks are allocated to the party
best able to control the risk or influence its outcome
(Risk Transfer).
In return for risks allocated, a party will demand
compensation that is consistent with the magnitude
of the risk assumed.

Risk Management Process-Why?


No single risk threatens the
development , construction or
operation of the project , thereby
hampering its ability to generate
sufficient revenues for debt servicing,
operating expenses and attractive
return to investors.
If the project is unsuccessful during
construction phase, it will not be able
to repay construction loans/debt.

Risk Management process-How?

Transfer by contract to another party best


able to bear the particular risk, with
guaranteed completion dates, prices, and
performance levels
Mitigate risk by sharing equity ownership
with an entity that can reduce the risk.
Risk minimization and loss prevention.
Credit enhancement- lenders may require
sponsors to guarantee availability of funds
for project completion, thereby requiring
limited recourse to sponsors for the
construction loan.

Risk Identification

Start up Risks

In between construction phase and


operations phase risks we have Start-up
risks. Start-up of a project is the most
important risk-shifting phase of PF.
Achievement of performance guarantees
through performance tests signals the end of
contractor risk period and beginning of risk
period for the operator and project company.
At start-up the contractor is required to
prove that the project can operate at a level
of performance necessary to service debt
and pay operating costs

Risk Analysis.
Key questions.
What exactly is the risk? (JNPT crane)
How serious is it a threat to the project?
What is the probability of it happening?
What is the likely impact on the project
if it happens?
What could be done to minimise its
impact on success.

Its All About Risk!


Management of risk is an important feature
of project finance ,because risk
management helps determine the viability of
a project.
The key to project financing is the
reallocation of any risk away from the
lenders to the project, which is done by a
network of contracts.
By the network of contracts the risk is
allocated to parties best suited to appraise
and control them. For example construction
risk is borne by the contractor and risk of
16

Risk Management System

From a contractual perspective.


Allocate risk in contracts.
Among different parties.
In such a way as to enable risks to be
managed efficiently and effectively
throughout the construction process.
Key Question-What are the risk
allocation principles that facilitate
producing the best possible project
outcome?

Principles of risk allocation-Abrahamson


Risk shall be allocated to the party:
1. If the risk of loss is due to his own willful
misconduct or lack of reasonable efficiency or
care.
2. If he can cover the risk by insurance and allow for
the premium in settling his charges , and it is the
most convenient and practical for the risk to be
dealt with in this way.
3. If the major benefit of running the risk accrues to
him.
4. If it is in the interests of efficiency to place the risk
on him.
5. If due to his conduct, the loss happens to him in
the first instance and there is no reason to transfer
the loss to another.

Examples of Risk Allocation

Examples of Risk Allocation

Examples of Risk Allocation

The Need for Contracts


Project financing arrangements involve strong
contractual relationships among multiple parties.
Project financing can only work for those projects that
can establish such relationships and maintain them at
an acceptable cost.
To arrange a project financing, there must be a genuine
community of interest among the parties involved in
the project. (Conflict of interest-Match Fixing).
In must be in each partys best interest for the project
financing to succeed.
Only then will all parties do everything they can to
make sure that it does succeed.
Contracts can be used to mitigate risk if the party best
able to control and manage the risk is also responsible
for the effects of risk occurance on project costs.
23

Main Agreements-TermoEmcali

Engineering, procurement and


construction (EPC) contracts.
Power Purchase Agreement (PPA)
Gas (Fuel) supply agreement
Gas transportation agreement
Operations and maintenance contract.

Typical project finance structure

Possible risks and coverage during construction period

Possible risks and coverage during the


operating period

Residual Risk.
Residual risk is the unallocated risk
which has to be borne (retained) by the
sponsor for the economic returns
expected from the project.
Risk retention is a common practice
because allocating to contractors or
insurance companies may be too
expensive .
It is important because it plays a key
role in the credit spread and debt/equity
ratio setting. It represents the most
relevant variable that financial investors

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