Toolkit: Approaches to Private Participation in Water Services Module 6 Allocating Responsibilities...

Toolkit: Approaches to Private Participation in Water Services

Module 6

Allocating Responsibilities and Risks

Introduction:

Navigating through this E-Learning Module This is one of 9 Toolkit e-learning Modules. Each Module is created in PowerPoint, and you advance through the Module by pressing the right arrow or ‘Enter’ button. Core Module: The Module takes you sequentially through four or five major issues, depending on the Module. The progress through the Module is shown by the colored area on a logo on the top right hand corner of each slide. Here is an example: Supplementary Content: The Core module covers all key issues. However, you can choose to access additional information. These supplementary slides can be accessed by passing the cursor over colored buttons. The button colors relate to issues of various levels of detail:

Navigation through the supplementary material is also by pressing the right arrow or ‘Enter’ button. At the end of each section you will return automatically to the core Module. However, there is an extra button (to pass over) on the top right hand of each supplementary page that gives you the option of a shortcut back to the core Module:

Basic Concept Detail

Expert insight

Supplementary Information / Case studies

Back to Module

E-learning design: [email protected]

Elements of the Toolkit

TOOLKITTOOLKIT

1ConsideringPrivate Participation

2Planning the Process

5Standards, Tariffs, Subsidy, Financials

4Setting Upstream Policy

3Involving Stakeholders

6Responsibilities & Risks

7Developing Institutions

8Designing Legal Instruments

9Selecting an Operator

Additional MaterialCD-ROM

Appendix BPolicy Simulation

Model

Appendix AExamples of PP Arrangements

General Outline of Toolkit

TOOLKITTOOLKIT

1ConsideringPrivate Participation

2Planning the Process

4Setting Upstream Policy

3Involving Stakeholders

6Responsibilities & Risks

7Developing Institutions

8Designing Legal Instruments

9Selecting an Operator

Additional MaterialCD-ROM

Appendix BPolicy Simulation

Model

Appendix AExamples of PP Arrangements

Module 6

5Setting Service

Standards, Tariffs, Subsidies &

Financial Arrangements

Module 6

Allocating Responsibilities and Risks

Module 6 - What will we learn?

What are the key

areas of

RESPONSIBILITY

for provision of the

water services, and

how can they be

defined?

Is it possible to use a standard model of private participation for a specific case, or is some tailored or hybrid model required?

What are the key areas of RISK associated with the responsibilities, and how can they be defined?

Management Contract for

Jordan Valley Authority,

Irrigation Water Supply, may be

the first of its kind.

What rules or mechanisms can be

established to ensure

that the allocation of

risk is maintained in a

clear and effective

manner for the private

participation arrangement?

Who is best able to

manage these risks and

responsibilities, and how best to allocate these?

Plus!

Additional Material:

Tariff Reset

ANALYZING Responsibilities

& Risks

ALLOCATING Responsibilities

& Risks

DESIGNING Risk Allocation

Rules

EXAMPLES Allocation - Different PP Models


& Risks

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.

Risk associated with these responsibilities has also to be allocated between the parties, and this is also a key part of designing the Arrangement.

A big part of designing the PP Arrangement is defining and allocating the business responsibilities between the various parties.

Risk associated with these responsibilities has also to be allocated between the parties, and this is also a key part of designing the Arrangement.

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

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



& Risks


& Risks


Rules



& Risks


& Risks


Rules



& Risks


& Risks

Analyzing Responsibilities & Risks

In this section we ANALYZE key issues related to provision of water services, looking at two main areas:

• Key areas of RESPONSIBILITY. How can they be defined?

• Key RISKS related to these Responsibilities. How can they be defined?

In this section we ANALYZE key issues related to provision of water services, looking at two main areas:

• Key areas of RESPONSIBILITY. How can they be defined?

• Key RISKS related to these Responsibilities. How can they be defined?



& Risks


& Risks


Rules



& Risks


& Risks


Rules



& Risks


& Risks

Analyzing Responsibilities & Risks

Analyzing Risks

Analyzing Responsibilities

Module 6


& Risks


& Risks


Rules



& Risks

Allocating Responsibilities & Risks

A key aim of private participation is to allocate risks between the Operator and the Contracting Authority.

A key aim of private participation is to allocate risks between the Operator and the Contracting Authority.

Module 6 Allocating 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

Influence or control the risk factor

Control the impact of the risk on the value of the water and sanitation business

Diversify or absorb the Risk

NOTE: COST OF RISK

Bearing Risk has a cost. If Risk is allocated to the Operator, he will generally expect to be able to recover the cost. Allocating Risk to the party best able to manage it helps to reduce costs to the contracting authority and customers.

Example: One party may be better able to predict nonpaymentExample: one party may be better able to reduce nonpayment through customer management

Example: one party may be better able to reduce nonpayment through ability to offer credit termsExample: One party may be able to diversify risk

across a portfolio of projects

Allocating RisksExample (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 RisksExample (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.

“..or, for this we example, can show graphically how Currency and Convertibility Risks affect the value of the business through several mechanisms……..”

Cash Flow

Operating & Maintenance

Currency Convertibility Risk

Total Costs

New Investment

Input Prices

Financing Risk

Exchange Rate Risk

Allocating RisksExample (2): Currency Risk

Module 6


& Risks


& Risks


Rules


Plus!

Additional Material:

Tariff Reset


Rules

Designing Allocation of Responsibilities & Risks

“ The next step is to design the Rules that will allocate the risks and responsibilities”

Rules for adjusting Tariffs are an important mechanism for allocating Risk between the parties, including:

Cost Pass ThroughIndexationTariff Resets

Other risk-allocating rules are also reviewed (e.g. Bonuses and compensation on termination)

Rules for adjusting Tariffs are an important mechanism for allocating Risk between the parties, including:

Cost Pass ThroughIndexationTariff Resets

Other risk-allocating rules are also reviewed (e.g. Bonuses and compensation on termination)

Module 6 Designing Allocation of Responsibilities & Risks

“ We will consider two main subjects related to Risk Allocation”

TARIFF ADJUSTMENT MECHANISMS


ALLOCATION OF OTHER RISKS



“ Rules for adjusting tariffs are the key mechanism for allocating risk among Customers, the Operator and the Contracting Authority……





Cost pass-through

Tariff Indexation Formulas

Tariff Resets







Cost pass-through


Tariff Resets

Tariff Resets

Tariff Indexation

Cost Pass Through







Cost pass-through


Tariff Resets

Tariff Resets

Tariff Indexation

Cost Pass Through

Tariff ResetsExample:Why the need for Tariff Resets?


“ In addition to Tariffs…………………………. important mechanisms covering other risks must also be must be designed”





Cost pass-through


Tariff Resets

Bonuses & penalties

Government Guarantees

Termination Triggers & payments

Transition periods at commencement

Contract Duration

Module 6 Other Mechanisms for Allocating Risk

Some other key risk allocation mechanisms include:

Bonuses and penalties

Government guarantees

Termination triggers and payments


Contract Duration



“ Although Tariff adjustment rules are the main ways of allocating risks, other risks are allocated between Operator and the Contracting Authority by contract ”

“ Although Tariff adjustment rules are the main ways of allocating risks, other risks are allocated between Operator and the Contracting Authority by contract ”

Module 6 Other Mechanisms for Allocating Risk

Some other key risk allocation mechanisms include:

Bonuses and penalties

Government guarantees



Contract Duration

Bonuses & PenaltiesPerformance payments such as penalties and bonuses encourage efficiency gains by sharing some element of risk with the Private Operator

The Contract may lay out a list of penalties if the Operator does not perform.

The Contract may also include bonuses if the Operator exceeds certain targets

Bonuses are the main mechanisms for transferring risk in a Management Contract. A management Contract without performance bonuses only gives an Operator weak incentive to improve performance

Guarantees

The Contracting Authority or a Government entity may provide guarantees to the Operator against certain risks, such as:

Operating debt Exchange rate guarantees related to foreign debt

This guarantees downside risk, making it more attractive to the Operator.

Care must be taken not to included risks that the Operator might be able to cover by himself more effectively


An arrangement will usually set out a list of triggers that entitles parties to terminate early, for example: Requisition, expropriation or seizure of water systems by Government The occasion of force majeure that makes the contract unworkable If penalties exceed a certain threshold the Contracting Authority may have the

right to terminate.

Termination payments compensate the Operator for costs that would otherwise be lost under early termination (e.g. sunk investment costs by the Operator). The way that these payments are calculated and applied helps to determine the allocation of risk

Transition periods

Where information problems increase the risk a transition period can be built in at the commencement of the arrangement. This allows an initial grace period when the Operator to collect information needed to run the business on a commercial basis, without accountability for performance improvements.

Terms can be adjusted to reflect any major differences from the initial assumptions

The longer the Contract Duration the more difficult it is to predict the effect of various parameters for the life of the contract. This may make the risks and the costs become unacceptably high to the various parties.

Reset mechanisms can help reduce risks to manageable levels for long duration contracts, particularly where private investment is involved

Module 6


& Risks


& Risks


Rules



Different PP Models Allocating Responsibilities & Risks

In this section we look at the way that three standard PPP models deal with Risk and Responsibilities:

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 situations, or hybrid versions of these models used.

In this section we look at the way that three standard PPP models deal with Risk and Responsibilities:

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 situations, or hybrid versions of these models used.

Module 6 Different PP Models Allocating Responsibilities & Risks

Operator Risks:

Contract Form:

Operational Technical

Management Contract

Affermage - Lease

Concession

Service Contract (by comparison)

Regulation Financial Commercial Forex

“ Each of the three standard models of private participation is defined by the allocation of responsibilities and risks”

Risk Level:These are an indication of the level of Risk taken by the Operator for specific issues under the various PP models .

Risk Level:These are an indication of the level of Risk taken by the Operator for specific issues under the various PP models .


Operator Risks:

Contract Form:

Operational Technical

Management Contract

Affermage - Lease

Concession

Service Contract (by comparison)

Regulation Financial Commercial Forex

“ Each of the three standard models of private participation is defined by the allocation of responsibilities and risks”

Concession:

The Operator assumes full responsibility for service delivery, including: Management Operation Maintenance of existing assets New Investment

Concession:

The Operator assumes full responsibility for service delivery, including: Management Operation Maintenance of existing assets New Investment

Affermage – Lease

Responsibility for operating and maintaining assets plus commercial and management responsibilities, passes to the Operator

The publicly owned company continues to be accountable for new investments)

Affermage – Lease

Responsibility for operating and maintaining assets plus commercial and management responsibilities, passes to the Operator

The publicly owned company continues to be accountable for new investments)

Management Contract:

The Operator fills the Key management positions in the water company.

The publicly owned company continues to be accountable for other responsibilities (e.g. operating and maintaining assets, new investments).

Management Contract:

The Operator fills the Key management positions in the water company.

The publicly owned company continues to be accountable for other responsibilities (e.g. operating and maintaining assets, new investments).

“ …each model has a particular application to the balance between Costs and Revenues as well as Political and Regulatory Risks”


Political and

Regulatory Risk

Costs/Revenues

LOW HIGHOperator willing to sink capital

Operator willing to take operating and

commercial risk only

Operator will only take limited risk

Tariffs don’t cover O&M

costs

Tariffs cover O&M costs

only

Tariffs cover total costs Concession

Lease/Affermage

Lease/Affermage

Management Contract

Management Contract

“ Looking at the balance between Costs and Revenues and Political and Regulatory Risks for each model ………….”

Management Contract

The risk transferred to the Operator depends on a performance bonus.

The formula for the bonus sets how much risk is taken by the Operator.

In general, the least amount of risk is transferred to the Operator under a Management Contract.

Management Contract

The risk transferred to the Operator depends on a performance bonus.

The formula for the bonus sets how much risk is taken by the Operator.

In general, the least amount of risk is transferred to the Operator under a Management Contract.

Affermage – Lease

The risk transferred to the Operator is significant, but depends on the contract details and the way that the operator’s remuneration is determined.

Affermage: the tariff adjustment rules relating to the Operator’s tariff (or ‘affermage fee’) are the most important

Lease: the Operator gets the customer tariff minus the lease payment. Tariff adjustment related to customer tariff are the most important.

Affermage – Lease

The risk transferred to the Operator is significant, but depends on the contract details and the way that the operator’s remuneration is determined.

Affermage: the tariff adjustment rules relating to the Operator’s tariff (or ‘affermage fee’) are the most important

Lease: the Operator gets the customer tariff minus the lease payment. Tariff adjustment related to customer tariff are the most important.Concession:

The Operator takes the greatest overall risks or responsibilities of the three models

Concession:

The Operator takes the greatest overall risks or responsibilities of the three models


Political and

Regulatory Risk

Costs/Revenues


Operator willing to take operating risk only

Operator won’t take any risk


costs


only


Lease/Affermage

Lease/Affermage

Management Contract

Management Contract

HYBRID MODELS

In addition to the three basic PP Models, it is possible to design and implement ‘hybrid structures’ that combine effective elements of different structures, balance risk, mobilize capital but protect the poor

HYBRID MODELS


“ ….but it may be necessary to adapt the standard models to meet particular needs”


Political and

Regulatory Risk

Costs/Revenues


Operator willing to take operating risk only

Operator won’t take any risk


costs


only


Lease/Affermage

Lease/Affermage

Management Contract

Management Contract

HYBRID MODELS


HYBRID MODELS


Examples; Risk in Hybrids

- Amman (MC)

- Cartagena Affermage/Lease

“ ….but it may be necessary to adapt the standard models to meet particular needs”

Reviewing Module 6

‘The Module has looked at a whole range of issues for analysis and allocation of responsibilities & risks in PP design………….

Including

Tariff Reset


& Risks

ALLOCATING Responsibilities &

Risks

DESIGNING Risk Allocation Rules

EXAMPLES Allocation – Different PP Models

ANALYZING Responsibilities &

Risks

Checklist: Module 6

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

‘……..and the allocation process is detailed in this Checklist”

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]

http://rru.worldbank.org/Toolkits/WaterSanitation/

mailto:[email protected]

Toolkit: Module 6

End of Module

Toolkit: Module 6

Return to StartReturn to Start

Toolkit: Approaches to Private Participation in Water Services Module 6 Allocating Responsibilities...

Documents

Transcript of Toolkit: Approaches to Private Participation in Water Services Module 6 Allocating Responsibilities...