S. Ümit DİKMEN2
David EATON3
1Düzce University, Faculty of Technology, Department of Civil Engineering
2Boğaziçi University, Kandilli Observatory and Earthquake Research Institute
3Madinah International Project Management and Investment Company, Turkey
RI R IS SK K MA M AN NA AG GE EM ME EN NT T I I N N P PR RI IV VA AT TE E F FI IN NA AN NC CE E IN I NI IT TI IA AT TI IV VE E ( (P PF FI I) ) R RO O AD A D P PR RO OJ JE EC CT TS S: : A A R RO OA AD D CA C AS SE E
IN I N T TH HE E UK U K
Keywords: PFI, Road Projects, Risk Management, Risk Transfer, SLEEPT
Abstract
Construction is a complex and dynamic industry; and the main procurement parameters are time, cost, quality and certainty. A managed approach to risk is a means for providing the client with fewer surprises and greater certainty. Central to all PFI transactions are the contractual agreements put in place between the parties and these define each party’s roles making clear their expected requirements and liabilities. The contractual agreements define the apportionment of risk between the contractual parties.
The incorporation of a risk register with identified risk owners as an addendum to the contracts clarifies the liabilities and responsibilities of the parties.
The fundamental principle of a PFI project is that risks associated with the implementation and delivery of services should be allocated to the party that is best able to manage the risk. In a PFI concession, the Government’s view has been that it is reasonable to expect the project consortium (SPV) to take on systematic risk. Systematic risks can be classified as economic risk, legislative risk, taxation risk and financial arrangements. The financing arrangement risk crosses the boundary between construction and operation and may persist for the life of the contract and beyond;
although there has been a tendency for re-financing early in the concession period. The Consortium Company (SPV) has separate contracts for the Construction Contractors and for the Operation and Maintenance Contractors and may have Services Contracts. The reason for this is to permit further transfer of risks to the party which has the ability to manage that risk.
This paper will examine risk with the acronym so-called SLEEPT methodology, including social, legal, economic, environmental, political and technological aspects within the domain of a PFI road project in the UK.
Introduction
According to Project Management Institute, PMI (2000, p.127) risk is
“an uncertain event or condition that, if it occurs, has a positive or negative effect on a project”. Another definition given by APM (1997, p.169) states that,
“risk is an uncertain event or set of circumstances that, should it occur, will have an effect on the achievement of the project’s objectives”.
Chapman & Ward (2003, p.6) state that these definitions embrace both welcome upside and unwelcome downside effects. The above definitions of risk include a restricted and limited focus on events, conditions, or circumstances which cause effects on the achievement of project objectives. Therefore, uncertainty is a very important starting point for risk management purpose. In Chapman & Ward (2003) words, “uncertainty management is not just about managing perceived threats, opportunities, and their implications; it is about identifying that give rise and shape our perceptions of threads and opportunities.
Key concerns are understanding where and why uncertainty is important in a given project context, and where it is not”.
Risk is an uncertain effect on project performance rather than as a cause of an uncertain effect on project performance. Such a definition of project risk is,
“the implications of uncertainty about the level of project performance achievable” (Chapman & Ward, 2003, p.12). Risk in construction projects is a complex phenomenon that has physical, monetary, cultural and social dimensions (Loosemore et al. 2006, p.1). As also indicated in Loosemore et al.
(2006), construction projects demand a different management approach compared to other industries due to problems specific to the industry; the uniqueness of every project, difficulties in the forecasting the future in the industry and construction being a high-risk business. Those are inward looking issues for the industry and those characteristics do not merit special rules. As in all industries, in construction also a balance is needed between the avoidance of risks in one hand and risk seeking behaviour on the other. The challenge is always have to be the calculation, recognition and management of the risks effectively.
Risks in PFI projects may also be caused by changes in relationships between the parties involved in supply, ownership, operation and maintenance of assets for public or private purposes. Risk management provides a structured way of assessing and dealing with future uncertainty. Project risk management applies across all project phases, and projects that arise at all phases of the asset life cycle.
Project risk management refers to the culture, processes and structures that are directed towards the effective management of potential opportunities and adverse effects (Cooper et al. 2005 p.3). Risk management processes are designed to assist planners and managers in identifying risks and developing measures to address them and their consequences. This leads to more effective
and efficient decisions, greater certainty about outcomes and reduced risk exposure (Cooper et al. 2005, p.4).
In this paper, SLEEPT (Social, Legal, Environmental, Economic, Political, and Technological) will be utilised as a methodology for explicating potential risk issues in a road Project in the UK.
Risks and Risk Management and Private Finance Initiative (PFI) PFI is a way of achieving the maximum possible involvement of the private sector in the construction of public facilities and infrastructure. A PFI project is divided into a number of separate phases and at the end of each phase an appraisal can be made and an assessment of risk involved in proceeding with the project can be established. The management of risk is therefore a continuous process and should span all the phases of a project. According to Jackson (2004) a major feature of the PFI process is that risks are identified and costed. The key assumption is that the PFI process will act as a catalyst to ensure that risks are more effectively allocated between the public and the private sectors (HM Treasury Taskforce, 1997). It is of the utmost importance that the public sector should not automatically seek to transfer all risks to the private sector but the public sector should transfer a risk when it can obtain Value for Money (VFM) by such a risk transfer.
There must always be an association between value for money and risk transfer in PFI deals. Value for money and risk management are the two key concepts of PFI. In relation to this association Illidge and Cicmil (2000) state that the intended complementary merger between the value for money objective and the idea of transferring project risk to the party best able to handle it has been an ideal solution to the persisting problem of escalating costs and uncertainty in public sector capital projects.
The notion that PFI contracts transfer risk from the public sector to the private sector has been seen as one of the advantages of the use of PFI.
Transferring risks to the private sector frees the taxpayer from unnecessary burden, creates a greater incentive for the private sector to deliver to budget and on time, and when they do, benefits the citizen the consumer of the services (Smith, 2001).
PFI also enables the public sector to tap into the private sector management expertise. The accumulated knowledge gained by the experiential learning of the private partner is in managing risk transfer negotiation and project management which give a substantial advantage over the public sector. It allows the public sector to focus on core issues and to focus on strategic priorities and leave the operational management tasks to the private sector. The focus and primary aim of the public sector will be on end results and service standards. PFI is an innovation in public procurement but, the public sector must decide on the route which gives the best scope for the private sector to add value and in all cases adhere to key principles such as Whole-life Value for Money
and Optimum Risk Allocation. Through such an attitude and approach it will be possible to deliver public services in an efficient, effective and innovative way.
In a PFI concession, the Government’s view has been that it is reasonable to expect the project consortium (SPV) to take on systematic risk (Gallimore et al, 1997). Systematic risks can be classified as economic risk, legislative risk, taxation risk and financial arrangements (ibid). In this paper it will be utilised the SLEEPT (Social, Legal, Environmental, Economic, Political, and Technological) as a methodology for explicating potential risk issues. The financing arrangement risk crosses the boundary between construction and operation and may persist for the life of the contract and beyond; although there has been a tendency for re-financing early in the concession period. The Consortium Company (SPV) has separate contracts for the Construction Contractors and for the Operation and Maintenance Contractors and may have Services Contracts. The reason for this is to permit further transfer of risks to the party which has the ability to manage that risk.
As stated above risk transfers are normally achieved by means of contracts. A thoroughly and correctly risk transferred PFI project has a greater chance to succeed to the satisfaction of the client and of the other parties in the concession and to be fit for its intended purpose.
When the UK entered into the funding of public services through PFI procurement, risk was at the centre of the discussion. There was a strong expectation that Private Finance Initiatives would allow the public sector to deliver services without risk. This expectation is largely valid for the PFI projects in UK and the private sector is expected to ensure that complex and expensive projects are managed efficiently, delivered on time and to budget; and they will ensure that risk is managed effectively.
PPP/PFI in a way is known as fast-track projects, where the normal project phases are compressed and the some extent overlap each other. Actually PPP/PFI projects take fast-track approach even further by shifting the assessment risk as well as that of detailed design and build risks to the front-end of the project. While the totality of this approach is perceived as being beneficial in shifting the bulk of the risk onto the private sector contractors, it has the detriment of reducing the step-by-step approach to management and decision- making which flows from the traditional multi-phase approach.
Construction is a complex and dynamic industry; and the main procurement parameters are time, cost, quality and certainty. A managed approach to risk is a means for providing the client with fewer surprises and greater certainty. Central to all PFI transactions are the contractual agreements put in place between the parties and these define each party’s roles making clear their expected requirements and liabilities. The contractual agreements define the apportionment of risk between the contractual parties. The incorporation of a risk register with identified risk owners as an addendum to the contracts clarifies the liabilities and responsibilities of the parties.
A fundamental principle of a PFI project is that risks associated with the implementation and delivery of services should be allocated to the party that is best able to manage the risk (HM Treasury, 1995).
The risk categories will be borne by different contracting parties in any PFI project which is detailed below.
A number of key areas of risk transfer noted in Fox and Tott (1999) are as follows:
1. Public Sector Risk Objectives:
Transfer of design risk: The public sector specifies the service it requires and the project company is responsible for delivering the service. Payments to the private sector against performance and/or level of performance will be defined and graded by incentives to the private sector. Achieving high standards of performance will be rewarded and poor performance will be penalised;
Transfer of planning risk: The private sector generally has wider experience in dealing with planning authorities than the public sector. Thus the public sector generally seeks to transfer this risk. Typically bankers will not be prepared to advance funds until detailed planning permission is obtained;
Completion risk: This risk encompasses a number of separate aspects such as completion on time, completion to cost and completion to quality. This risk relates to the transfer to the private sector of the risk that facilities are completed and services become operational to time, to cost and to quality;
Operational risk: The risk that facilities and services can be continuously provided, to the public authority throughout the contract term, to the agreed output specification, for the agreed unitary payment, will rest with the private sector. The payment mechanism will comprise an availability element or a performance element and a volume element;
Residual value risk: Residual value risk is the risk that facilities associated with a service will continue to be required and will then have a value at the end of the contract term. In terms of PFI philosophy this risk should generally pass to the private sector as the public sector is merely buying a service for a given period and is not concerned with acquiring the assets associated with the service. But, in practice it is not like this. In the case of the road projects the ownership interest in the road is not transferred to the private sector however the SPV has an exclusive licence to construct and or operate during the concession period and accordingly full ownership will then revert to the public sector at the end of the concession period;
Insolvency risk: The SPV in a PFI project is established with limited recourse to its consortium and will typically have no assets other than its interest in the project. Therefore the public sector’s objective will be to protect itself,
both financially and in terms of ensuring the continuity of what are often vital public services, in the event of the insolvency of the private sector provider.
2. Special Purpose Vehicle’s (SPV) Risk Objectives:
The SPV’s objectives in relation to risk transfer will be the opposite of the awarding authority and a compromise has to be found in the negotiation Project Agreement (PA). Once the risks accepted by the SPV are determined it will in turn, seek to pass them down to the construction subcontractors and operation and maintenance subcontractors and other third parties.
3. The Lender’s Risk Objectives:
Most PFI projects have been financed on a limited recourse project finance basis. The most common way in which limited recourse has been achieved in PFI projects is by the private sector raising the finance being established as a Special Purpose Vehicle (SPV) which holds only the project assets and which conducts no business other than that contemplated by the Project Agreement (PA). The Lenders are granted security over all of the SPV’s assets as security for its obligations under the contract. The primary goal of the Lenders will be to ensure that the risks encountered at each stage of the project have been analysed and the liability for such risks allocated in such a way as to ensure that few if any risks remain with the SPV.
The risks which the Lenders require managing are:
Completion risk: Key areas are planning, design and construction. Until the project is fully operational no unitary payment is made to the project company from which to service the debt;
Operation risk: This is the most important issue of PFI. Payment is only made against satisfactory compliance with the performance specifications;
Pricing risk: The Lenders will require to be satisfied that the SPV’s cost estimates for operating costs and initial capital expenditure are realistic and make satisfactory allowances for contingencies;
Revenue risk: The Lenders must ensure that the unitary payment is made as robust and as secure as possible by seeking to minimise and control the extent to which the under-performance of the SPV will result in non-compliance deductions;
Public Sector (Awarding Authority) risk: Associated with the Lenders’
evaluation of the payment mechanism is the strength of the covenant of the public sector and whether it has the power to enter into the transaction and perform its obligations. In some instances the proposal mechanism may be Ultra Vires;
Change of law risk: The effect of a change of law during the life of the project is a further matter for negotiation between parties. It is an important factor because PFI deals comprise a complex collection of individual contracts. Since the project organisations are subject to change of law and that it is common place to accept legislative risk in both the construction and operating phases of a PFI project, the Lenders are prepared to accept the change of law and the quantum of its effect;
Sponsor/Contractor risk: A fundamental risk assessed by the Lenders is that of sponsor risk. A sponsor risk is associated with the financial, management and technical strengths of the sponsor, behind the PFI project. Given the limited recourse nature of most PFI financings, the funders will want to be satisfied that the SPV has the qualifications, experience, technical competence and sufficient financial resources available to enable it to perform its obligations under the Project Agreement (PA).
For PFI schemes to succeed, two main issues are essential (Gallimore et al, 1997):
1. The private sector must take on risks which by definition have formerly been assumed by public sector occupiers; and
2. The price of this risk transfer must not be so expensive that it prevents satisfaction of the criterion of value for the public money expended in rewarding the risk.
Gallimore et al. (1997) argue that there must be sufficient convergence of opinion on the level and degree of risk between the public sector purchaser and the private sector supplier to enable agreement on price to take place. The PFI process added novelty to an increase of risks which have been highlighted above to be borne by the three main parties of PFI. The payment mechanism in a PFI contract is the typical mechanism used to transfer the more common risks, to give the supplier an incentive to perform.
The optimum risk transfer mechanism will vary widely from contract to contract and between different types of PFI service. The experience in the UK suggests that the public sector will seek to transfer design, development and operating risks in terms of both cost and performance. Demand and other risks have been most often a matter of negotiation between the service supplier and the service provider. The experience from executed PFI projects in the UK shows that the private sector is often considered to be best placed to manage the majority of risks regardless of whether this is strictly accurate. The private sector’s management of the majority of risks is always dependent on the fact that the public sector’s requirement is specified correctly.
Risk management is not about predicting the future, but understanding a project and making a better decision regarding the management of that project tomorrow (Smith, 1999). Risk management is a structured approach to
identifying, assessing and controlling risks that emerge during the course of the policy, programme or project lifecycle and its task is to ensure an organisation makes cost-effective use of a risk process that has a series of well-defined steps to support better decision–making through good understanding of the risks inherent in a proposal and their likely impact. (HM Treasury, the Green Book, 2003).
The major feature of any PFI appraisal is that risks are identified and then quantified. Risk analysis is crucial for the following reasons:
1. to prove Value for Money;
2. to prove the robustness of the assumptions behind the choice of the PFI alternative;
3. to make explicit the affordability assumptions;
4. to determine which risks are to be retained by the public sector and which risks are to be transferred to the private sector.
Some of the risks will be dependent on others and many of the probabilities, costs and outcomes will be uncertain. The concept of identification, analysis, mitigation, and control of the risks lies at the heart of the risk analysis and management of projects.
Risk management, according to Eaton (2003) primarily has two important missions:
1. to identify the risks which comprises analysis of the likelihood of each risk event and determination of how serious the consequences might be;
and
2. to identify the risk mitigation options where in each case there will be an inconvenience or cost factor and a decision will have to be made on whether mitigation is worthwhile.
Depending on the quality of information and unless all the risks are mitigated, some residual risks will remain. Those residual risks are the ones which are not avoided, eliminated or transferred in the mitigation strategy. The author is of the opinion that risk management is a forward looking proactive process and primarily deals with risks before they become problems. It is essential that knowledge and information should be provided about predicted events in order to ease decision making in any PFI project. According to Liu, Flanagan and Li (2003) risk management can help to reduce, absorb and transfer risk and exploit potential opportunities. Mills (2001) suggests that risk management is an important part of the decision-making process of all construction activity.
Eaton (2004 a and b) lists the aims of risk management as following:
1. Anticipate and influence events before they happen by taking a pro- active approach;
2. Provide knowledge and information about predicted events;
3. Inform and where possible improve the quality of decision making, recognising the preferred hierarchy of risk avoidance, risk reduction, risk control, and risk acceptance;
4. Avoid covert assumptions and false definition of risks;
5. Make the project management process overt and transparent,
6. Assist in the delivery of project objectives in terms of benchmarked quality, time and cost thresholds;
7. Allow the development of scenario planning in the event of the identification of a high impact risk;
8. Provide improved contingency planning;
9. Provide verifiable records of risk planning and risk control.
The authors believe that the key to effective risk management is ownership.
The Client should own any risks that affect the business or business case e.g.
those that would prevent the benefits of the project from being fully realised; the Project Manager should own any risks that might affect the delivery of the project e.g. those that affect the project schedule and, the Project Contractor should own any risks that might affect the Contractors’ ability to deliver the project objectives.
Furthermore we believe that risk management in PFI requires a ‘top-down’
approach; and key business risks should be identified, evaluated and managed.
In a ‘top-down’ approach management should allocate time at the start to lay the foundations for the ongoing risk management process. Good risk management should have the potential to re-orient the whole PFI organisation (either public or private sector) around continuous performance improvement. The overall aim is to instil and subsequently continuously improve a risk culture at all levels of the respective organisations and in all phases of the PFI procurement process.
Risk assessment focuses on how risks affect the objectives. The ultimate goal is the creation of an overall ‘big-picture’ of the uncertainty focusing on the public or private PFI organisations. To reach this ultimate goal the author believes in the creation of a culture of risk awareness in the organizations. Upon creation of such awareness the data is collected and risk models will be constructed. The risk assessment will be communicated transparently within the assigned participants, with roles and responsibilities for risk assessment stipulated. Risk assessment in order to be successful for the overall aim of the PFI procurement must be embedded into the management and planning process and not carried out in isolation.
Framework for Risk Management (RM) for PFI Road Projects
This section critically examines and proposes a whole life cycle risk management framework for PFI road projects.
This framework was conceptualised based on the empirical data collected. The risk framework took a risk register from the projects and through analysis
identified and allocated the risk to those parties (different stakeholders) significantly affected by the occurrence of a particular risk in the road projects utilising the tool Multiple Estimating Using Risk Analysis (MERA).
Risk management is central to a PFI project. It aims at identifying all the risks involved, to calculate the financial consequences, to establish mitigation procedures and to allocate the risks to be transferred to the party best able to manage them. Risk management is an interdisciplinary process where all stakeholders are involved.
The risk model in this paper is limited to the project specific risks. The risks in this research are grouped as per risk ownership. The risks are owned as:
(1) Granting Authority, (2) SPV and (3) Shared and tabulated in Table 1.
The list of the risks shown in the Table 1 was provided by the Granting Authority and it was a part of the “Instruction to Bidders” for that particular road project. This list is used during the Procurement Stages of the road project and it is quantified and included in the Financial Close. The Financial Close was not a cardinal part of the Project Agreement. The Financial Close and risk quantification has never been revealed to the researcher due to its commercial sensitivity.
In the project context the risks are analysed iteratively. In Fig.1 a risk framework with iterative flow is shown. PFI risks and risk management is explained in detail in above.
Fig.1. Iterative Risk Management Framework in PFI Road Projects
Risk Awareness
Risk Assessment
Risk Allocation
Risk Quantification
Risk Closure Business
Need
OJEU Notice
Best Three Offers
Preferre d Bidder
Financia l Close BIDDING AND PROCUREMENT PHASE
RISK MANAGEMENT
CONSTRUCTION & O & M PHASE
Table 1. Risk Allocation Matrix
Risk Description
Risk Ownership Granting
Authority
SPV Shared
Construction Risks:
1. Environmental Pollution
2. Results of further Environmental Studies
3. Archaeology finds during construction
4. Protester action
5. Delay to Construction Progress/Completion
6. Adverse Weather
7. Insufficient land (beyond Land Made Available and Access Rights)
8. Public Utilities
9. Contractor Insolvency
10. Construction inflation variance
11. Construction noise
12. Pest damage
13. Traffic Management
14. Road Safety Audit
15. Accommodation Works
16. Planning amendments/delay (compliant bid)
17. Planning amendments/delay (variant bid)
Ground Condition Risks:
18. Soft ground
19. Hard ground
20. Ground Water
21. Mine Workings
22. Rock quality and presence
Pre-contract risks:
23. Change in Interest Rate
24. Employee Requirements Changes
25. Scheme Cost Increases
26. Inflation Risk
Third Party Risks:
27. Relevant Authorities
28. Interested Parties
Risk Description
Risk Ownership Granting
Authority
SPV Shared
Design Risks:
29. Change in quantities
30. Changes from initial design
31. Change in design standards 32. Employers’ Requirement Changes 33. Council and Contractor Solution
Changes
Legislative, Financial and Economic Change Risks:
34. General Change in Law
35. Interest Rate Risk (Post Financial Close)
36. V.A.T. Status Risk
37. Inflation Risk
38. Availability Risk
39. Traffic Usage Risk
40. Performance Risk
Operation and Maintenance Risks:
41. Unforeseen Defects (including pavement failure)
42. Accident Damage
43. Vandalism
44. Weather
45. Traffic Loading
46. Renewal and Replacement of Structures and Infrastructures
47. Utilities Access
48. Replacement of drain, signs, barriers, etc.
49. Pavement patching
50. Existing structures failure
51. Hand back inspections
52. Road Safety Audits
53. Staff Costs
54. Inadequate performance of sub- contractors
55. Force Majeure
56. Termination for Contractor Default
57. Other Termination
Due to the long concession periods of PFI projects, the temporal aspects of risk are particularly important. The case study project have a 30 year concession period and the impact and probability of occurrence of a particular risk type changes as the project advances through the different project stages. As a consequence of this the uncertainty can either decrease or increase. The uncertainty attached to each risk is the key factor in managing it. With high uncertainty few mitigation measures are realistically available and if uncertainty can be reduced, the risks can be better managed and the possibility for project success increases. PFI projects are viable only if a reliable, long-term revenue stream can be established. The risk that the predicted revenues do not materialise is the greatest risk to the commercial viability (Grimsey and Graham, 1997).
This risk is borne by those providing finance or financial guarantees.
The critical question is whether revenue streams can cover operating costs, service debt finance and provide returns to risk capital. The profits of enterprise are a reward for facing this uncertainty (Grimsey and Lewis, 2002).
Risks can be broadly categorised as global or elemental (Merna and Smith, 1996).
Global risks are those risks that are normally allocated through the project agreement and typically include political, legal, commercial and environmental risks.
Elemental risks are considered as those associated with the construction, operation, finance and revenue generation of the project.
It is important to look at the nature and quantities of risk from the different perspectives of the main parties to a PFI project.
The risk quantification tool Multiple Estimating Using Risk Analysis (MERA) consists of producing a conventional base estimate using an appropriate technique to the level of information available. This base estimate (BE), which includes no allowance for risk, is accompanied by an analysis of known and predictable risks associated with the project. Each risk is then allocated an average risk estimate (ARE) and a maximum likely estimate (MRE). The risks from the empirical data provided by the Granting Authority are grouped in the SLEEPT (Social, Legal, Economic, Environmental, Political, and Technological) Framework. The quantified risk with dummy data was presented and validated at the SPV’s head office with the presence of company managers directly involved in the management of the case study projects for this thesis. The composite risk criteria weighting of the analysis show clearly that economic and technological risk criteria scored the highest weighting. This is a powerful tool for structuring the whole life cycle of a PFI road project and decision making.
Dummy data was required since the Granting Authority and SPV declined to reveal the quantified risk register claiming commercial confidentiality.
An issue that has emerged from the evaluation of the case studies is the emergence of differentiated Risk Profiles; differentiated by the class of party to the project and also differentiated by the prioritisation of the features for the specific PFI project.
Four generic groups of parties within a PFI project are:
1. the Public Sponsor;
2. the Concessionaire (SPV);
3. the Lenders;
4. the Contractors.
There are also four generic risk categories features of PFI that can be identified within each PFI project:
1. the Value for Money achieved within the Project;
2. the Robustness of the Project Arrangements;
3. the overall Affordability of the project scheme;
4. the Risk Transfer Approach.
This creates a 4x4 matrix of potentially competing objectives that need to be managed to deliver a successful project.
The Value for Money (VFM) Risk Category relates primarily to the Public Sponsor who has a statutory duty to demonstrate that their expenditure is being managed effectively and efficiently. This is typically done by reference to the PSC. It should also be remembered that the private parties within a PFI project all have a requirement to conduct profitable business, thus they will have their own ‘VFM’ evaluation requirements. PFI projects are supposed to generate
‘win-win’ opportunities rather than the more orthodox ‘win-lose’ situations.
The Robustness Risk Category of the Project arrangements refers to the congruence of the individual aims with the main project objectives. The project arrangements should be equitable between all parties, such that all parties should have the ability to complete a particular project without the necessity for ‘step- in’. Thus no party perceives the agreement as ‘unfair’. All parties should feel that they have not been disadvantaged by the arrangements. A satisfactory Robustness arrangement would be one that all parties would be prepared to execute for subsequent projects. HM Prison Service (mentioned in Chapter 4) identified this as a major risk when it publicly stated that it had forgone significant initial savings on the first two projects in order to create a long term competitive market in PFI Prison provision. A further question relating to the robustness of PFI project arrangements is the level of up-front ‘risk capital’
necessary to develop a PFI project. It is accepted that the ‘at risk’ capital needed for a PFI development has increased, however this is reflected in the level of
‘profitability’ sought within the PFI repayment model to demonstrate the
‘bankability’ of the project. The project case studies have identified that an
important stimulant to successful development of PFI is the previous expertise within a market sector that the prospective bidder can draw upon when developing the proposal.
The overall Affordability Risk Category of the project relates to the ability of all parties to complete the project with the available resources. The Public Sponsor has to ensure that it has access to funds, and that the expenditure of the available funds provides an adequate return when compared with other alternative investments. The private parties need to ensure that they have access to sufficient finance and other resources to complete the project and obtain an income from the operation of the facility over the concession period. In PFI road projects these are the shadow toll band payments. The aim of such a payment structure is to allocate a sufficient element of volume risk to the SPV and also to limit the authority’s exposure to an increase in payments arising from a greater than anticipated volume of traffic on the road. This is not necessarily guaranteed.
The Risk Transfer Approach Category refers to the balance achieved within the agreements between all of the parties in relation to accepting the financial consequences should a risk occur on a particular PFI project. As an illustration, Best Practice Guidance confirms that a risk should be allocated to the party best able to manage and control the risk. In the Prison Case studies a complete round of tendering was rendered invalid because the Public Sponsor had attempted to transfer the occupancy risks to the Concessionaire, when it is patently obvious that the Public Sponsor, HM Prison Service, was the only party that could manage the risk associated with the number of prisoners sent to a PFI prison.
The combination and balance between Risk Transfer, Robustness, VFM, and Affordability needs to be considered holistically.
The risk register from a road is taken and identified and allocated the risk to those parties significantly affected by the occurrence of a particular risk. It should be noted that risks can impact on more than a single stakeholder in the project. Some risks can impact on all parties which can be seen from the tables.
Equally some risks can impact on VFM, Robustness, Affordability and Risk Transfer.
The risk allocation was presented to the stakeholders for approval and comment.
The stakeholders approved the presented risk allocation.
Tables 2-5 represent the arithmetic count of the identified features (VFM, Robustness, Affordability, and Risk Transfer) for each SLEEPT category of risk for each stakeholder in the PFI Road Project.
Table 2. Summary of Critical Collated Features for Public Sponsor
NO. OF RISK CATEGORY (SLEEPT)
FEATURES
TOTAL VFM ROBUSTNES
S
AFFORDABILIT Y
RISK TRANSFE
R
SOCIAL 1 1 1 1 4
(7.84%)
LEGAL 1 4 4 4
13 (25.49%)
ECONOMICAL 6 5 5 5
21 (41.18%)
ENVIRONMENTAL 0 1 1 1 3
(5.88%)
POLITICAL 2 3 3 2
10 (19.61%)
TECHNOLOGICAL 0 0 0 0 0
(0.00%) TOTAL
10 (19.61
%)
14 (27.45%)
14 (27.45%)
13 (25.49%)
51 (100.00%
)
Table 3. Summary of Critical Collated Features for SPV (Special Purpose Vehicle)
NO. OF RISK CATEGORY (SLEEPT)
FEATURES TOTAL
VFM ROBUSTNESS AFFORD ABILITY
RISK TRANSF
ER
SOCIAL 3 2 2 3 10
(7.14%)
LEGAL 2 5 6 6 19
(13.57%)
ECONOMICAL 13 17 16 14 60
(42.86%)
ENVIRONMENTAL 0 4 4 4 12
(8.58%)
POLITICAL 2 3 3 2 10
(7.14%)
TECHNOLOGICAL 8 9 9 3 29
(20.71%)
TOTAL 28
(20.00%)
40 (28.57%)
40 (28.57%)
32 (22.86%)
140 (100.00%)
Table 4. Summary of Critical Collated Features for Lenders
NO. OF RISK CATEGORY (SLEEPT)
FEATURES
TOTAL VFM ROBUSTNES
S
AFFORDABILIT Y
RISK TRANSFE
R
SOCIAL 0 0 0 0 0
(0.00%)
LEGAL 1 2 2 2 7
(15.22%)
ECONOMICAL 6 8 7 8 29
(63.05%)
ENVIRONMENTAL 0 0 0 0 0
(0.00%)
POLITICAL 2 3 3 2 10
(21.73%)
TECHNOLOGICAL 0 0 0 0 0
(0.00%)
TOTAL 9
(19.57
%)
13 (28.25%)
12 (26.09%)
12 (26.09%)
46 (100.00%
)
Table 5: Summary of Critical Collated Features for Contractors
NO. OF RISK CATEGORY (SLEEPT)
FEATURES
TOTAL VFM ROBUSTNESS AFFORD
ABILITY
RISK TRANSF
ER
SOCIAL 3 4 2 2
11 (9.17%)
LEGAL 2 3 4 4
13 (10.84%)
ECONOMICAL 9 14 13 11
47 (39.17%)
ENVIRONMENTAL 0 4 4 4
12 (10.00%)
POLITICAL 2 2 2 2
8 (6.66%)
TECHNOLOGICAL 3 11 11 4
29 (24.16%)
TOTAL
19 (15.83%)
38 (31.67%)
36 (30.00%)
27 (22.50%)
120 (100.00%)
Table 6. Summary of Collated Features for each of Stakeholders in the PFI Road Projects
STAKEHOLDERS
CRITICAL COLLATED FEATURES (%)
VFM ROBUSTNESS AFFORDABILITY
RISK TRANSFER PUBLIC
SPONSOR
19.61 27.45 27.45 25.49
SPV 20.00 28.57 28.57 22.86
LENDERS 19.57 28.25 26.09 26.09
CONTRACTORS 15.83 31.67 30.00 22.50
Figure 4 represent an analysis of the proportionality of the critical collated features for different stakeholders in PFI road project.
Fig. 2: Critical Collated PFI road features for different stakeholders
CRITICAL COLLATED PFI ROAD FEATURES FOR DIFFERENT STAKEHOLDERS (%)
0 5 10 15 20 25 30 35
VFM
ROBUSTNESS
AFFORDABILITY RISK TRANSFER
PUBLIC SPONSOR SPV
LENDERS CONTRACTORS
Table 7: Summary of Critical Collated Features for Contractors
NO. OF RISK CATEGORY (SLEEPT)
FEATURES
TOTAL VFM ROBUSTNESS AFFORD
ABILITY
RISK TRANSF
ER
SOCIAL 3 4 2 2 11
(9.17%)
LEGAL 2 3 4 4 13
(10.84%)
ECONOMICAL 9 14 13 11 47
(39.17%)
ENVIRONMENTAL 0 4 4 4 12
(10.00%)
POLITICAL 2 2 2 2 8
(6.66%)
TECHNOLOGICAL 3 11 11 4 29
(24.16%) TOTAL
19 (15.83%
)
38 (31.67%) 36 (30.00%)
27 (22.50%)
120 (100.00%)
Reservation: The collated summary tables are a representation of the arithmetic count of identified features. No work has yet been executed to quantify the proportional contribution of each feature. This paper treats all features in an identical manner. Detailed quantification work is ongoing.
Table 8: Summary of Collated Features for each of Stakeholders in the PFI Road Projects
STAKEHOLDERS
CRITICAL COLLATED FEATURES (%)
VFM ROBUSTNESS AFFORDABILITY RISK TRANSFER PUBLIC
SPONSOR 19.61 27.45 27.45 25.49
SPV 20.00 28.57 28.57 22.86
LENDERS 19.57 28.25 26.09 26.09
CONTRACTORS 15.83 31.67 30.00 22.50
The risks from the empirical data provided by the Granting Authority are grouped in the SLEEPT (Social, Legal, Economic, Environmental, Political, and Technological) Framework. The quantified risk with dummy data was presented and validated at the SPV’s head office with the presence of company managers
directly involved in the management of the case study projects for this thesis.
The composite risk criteria weighting of the analysis show clearly that economic and technological risk criteria scored the highest weighting. This insight is a powerful tool for structuring the whole life cycle of a PFI road project and decision making.
In traditional risk analysis neither the stakeholder party nor the generic features are separately identified.
The analysis of the Critical Collated features shows clearly that the SPV and Contractors bear most of the risk features. The Public Sponsor and Lenders are protected by the Concession Agreement from the risk features. The result is shown in Table 9.
Table 9. Collated Summary of Number of Risk Category (SLEEPT) versus Stakeholders in a PFI road project
NO. OF RISKS BY CATEGORY
(SLEEPT)
STAKEHOLDER COLLATED
TOTAL PUBLIC
SPONSOR
SPV LENDERS CONTRACTOR
SOCIAL 4 10 0 11 25 (7.20%)
LEGAL 13 19 7 13 52 (14.98%)
ECONOMICAL 21 60 29 47 157
(45.24%)
ENVIRONMENTAL 3 12 0 12 27 (7.78%)
POLITICAL 10 10 0 8 28 (8.07%)
TECHNOLOGICAL 0 29 0 29 58 (16.73%)
COLLATED TOTAL
51 (14.69%)
130 (37.46%)
46 (13.26%)
120 (34.59%)
347 (100.00%)
Figures show the spider diagram for different stakeholders in the case study PFI road project.
Fig. 3. Spider Diagram for Risk Category for Stakeholders
Fig. 4. Risk Category (SLEEPT) for Public Sponsor
RISKS BY CATEGORY (SLEEPT) FOR STAKEHOLDERS IN PFI ROAD PROJECT
0 10 20 30 40 50 60
SOCIAL
LEGAL
ECONOMICAL
ENVIRONMENTAL POLITICAL
TECHNOLOGICAL
PUBLIC SPONSOR SPV
LENDERS CONTRACTOR
RISK CATEGORY (SLEEPT) FOR PUBLIC SPONSOR
0 5 10 15 20 25 SOCIAL
LEGAL
ECONOMICAL
ENVIRONMENTAL POLITICAL
TECHNOLOGICAL
PUBLIC SPONSOR
Fig. 5. Risk Category (SLEEPT) for the SPV
Fig. 6. Risk Category (SLEEPT) for the Lenders RISK CATEGORY (SLEEPT) FOR SPV
0 20 40 60
SOCIAL
LEGAL
ECONOMICAL
ENVIRONMENTAL POLITICAL
TECHNOLOGICAL
SPV
RISK CATEGORY (SLEEPT) FOR LENDER
0 10 20 30
SOCIAL
LEGAL
ECONOMICAL
ENVIRONMENTAL POLITICAL
TECHNOLOGICAL
LENDER
Fig. 7. Risk Category (SLEEPT) for Contractors
From the case study it was understood that the risk framework for the project existed but it was not being applied consistently. The Public Sector always tried to transfer all risks and Private Sector accepted too many (and for some they had no mechanism of control). The study has shown that the risk framework can be applied in an improved way to offer greater clarity in the risk input and the implications of risk transfer.
Summary
Construction is a complex and dynamic industry; and the main procurement parameters are time, cost, quality and certainty. A managed approach to risk is a means for providing the client with fewer surprises and greater certainty. Central to all PFI transactions are the contractual agreements put in place between the parties and these define each party’s roles making clear their expected requirements and liabilities. The contractual agreements define the apportionment of risk between the contractual parties. The incorporation of a risk register with identified risk owners as an addendum to the contracts clarifies the liabilities and responsibilities of the parties.
A fundamental principle of a PFI project is that risks associated with the implementation and delivery of services should be allocated to the party that is
RISK CATEGORY (SLEEPT) FOR CONTRACTOR
0 10 20 30 40 50 SOCIAL
LEGAL
ECONOMICAL
ENVIRONMENTAL POLITICAL
TECHNOLOGICAL
CONTRACTOR
best able to manage the risk. In a PFI concession, the Government’s view has been that it is reasonable to expect the project consortium (SPV) to take on systematic risk. Systematic risks can be classified as economic risk, legislative risk, taxation risk and financial arrangements. The financing arrangement risk crosses the boundary between construction and operation and may persist for the life of the contract and beyond; although there has been a tendency for re- financing early in the concession period. The Consortium Company (SPV) has separate contracts for the Construction Contractors and for the Operation and Maintenance Contractors and may have Services Contracts. The reason for this is to permit further transfer of risks to the party which has the ability to manage that risk.
In this study the so-called SLEEPT methodology is utilized as a risk management tool within the domain of a PFI road project in the UK. The risks from the empirical data provided by the Granting Authority are grouped in the SLEEPT (Social, Legal, Economic, Environmental, Political, and Technological) Framework. The quantified risk with dummy data was presented and validated at the SPV’s head office with the presence of company managers directly involved in the management of the case study project for this paper. The composite risk criteria weighting of the analysis show clearly that economic and technological risk criteria scored the highest weighting. This insight proved to be a powerful tool for structuring the whole life cycle of a PFI road project and decision making.
REFERENCES
[1] PMI (2000), A Guide to the Project Management Body of Knowledge: PMBOK [Project Management Book of Knowledge] Guide. (2000 edition). Upper Darby, PA: Project Management Institute.
[2] APM (1997), PRAM Project Risk Analysis and Management Guide. Association for Project Management, Norwich, UK.
[3] Chapman, C. & Ward, S. (2003), Project Risk Management – Processes, Techniques and Insights, 2nd Ed., John Wiley & Sons Ltd., Chichester, West Sussex, England.
[4] Loosemore, M., Raftery, J., Reilly, C., & Higgon, D. (2006), Risk Management in Projects, 2nd Edition. Taylor & Francis, New York.
[5] Cooper, D., Grey, S., Raymond, G. & Walker, P. (2005), Project Risk Management Guidelines – Managing Risk in Large Projects and Complex Procurements, John Wiley & Sons Ltd., Chichester, West Sussex, England.
[6] Jackson, P.M. (2004) ‘The Private Finance Initiative. From the foundations up-a premier’, Hume Occasional Paper No.64. The David Hume Institute.
[7] HM Treasury Taskforce (1997) ‘Partnerships for Prosperity’: The Private Finance Initiative, Treasury Taskforce Guidance, November, London.
[8] Illidge, R. and Cicmil, S. (2000) ‘From PFI to PPP: Is Risk Understood?’ Bristol Business School Teaching and Research Review, Issue 2, Spring, ISSN 1468- 4578.
[9] Smith, A. (2001), Speech by Chief Secretary to the Treasury at the OGC PUK Conference 23rd October.
[10] Gallimore, P., Williams, W. and Woodward, D. (1997) ‘Perceptions of risk in Private Finance Initiative’. Journal of Property Finance, Vol.8, No.2, pp.164-176.
ISSN 0958-868X.
[11] HM Treasury Taskforce (1995) ‘How to construct a Public Sector Comparator’
Technical Note 5, Office of Government Commerce (OGC), London.
[12] Fox, J. and Tott, N. (1999) ‘The PFI Handbook’. Herbert Smith – Jordan Publishing Limited.
[13] Smith, N.J. (1999) ‘Managing Risk in Construction Projects’, Blackwell Science, Oxford.
[14] HM Treasury (2003) The Green Book: Appraisal and Evaluation in Central Government, London, HMSO.
[15] Eaton, D. (2003), ‘Price Bidding, Bid Evaluation and Financial Management’
Lecture Programme 2003/2004 University of Salford, School of Construction and Property Management, SCPM.
[16] Liu,J., Flanagan, R. and Li,Z. (2003) ‘Why does China need risk management in its construction industry?’ ARCOM, Nineteenth Annual Conference, Sept.3-5, pp.453-462, University of Brighton.
[17] Mills, A. (2001) ‘A systematic approach to risk management for construction’.
Structural Survey, Vol.19, No.5, pp.245-252.
[18] Eaton, D. (2004a) ‘Introduction to Risk Management’ Presentation on April 27th in the University of Sakarya, Turkey.
[19] Eaton, D. (2004b) ‘Risk Transfer in PFI’ Presentation on April 27th in the University of Sakarya, Turkey.
[20] Grimsey, D. and Graham, R. (1997), PFI in the NHS. Engineering, Construction and Architectural Management, 4(3), pp.215-231.
[21] Grimsey, D. and Lewis, M.K. (2002), Evaluating the risks of public private partnerships for infrastructure projects. International Journal of Project Management, 20, pp.107-118.
[22] Merna, A. and Smith, N.J. (1996), Privately Financed Concession Contract, Vols.1 and 2. 2nd ed. Hong Kong: Asia Law and Practice.
