Risk Management Levers to Balance the Risk-Reward Profiles of Infrastructure Projects

Profit sharing agreements

Profit sharing agreements distribute profits from an infrastructure asset to specific parties under stipulated scenarios (generally return scenarios). Examples of such agreements are:

• Cap and collar
• Cap only.

Political/Performance guarantees

Political or performance guarantees are typically provided by multilateral development banks or governments to facilitate foreign direct investments in emerging markets. They provide protection against losses resulting from the failure of a sovereign, sub-sovereign, or state-owned enterprise to fullfill contractual obligations (excluding payment obligations – see ‘Financial guarantees’ tab at left) like:

• Expropriation
• War, terrorism, and civil disturbance
• Breach of contract
• Change/sale of ownership restrictions
• Step-in rights
• Performance bond
• Security over assets.

Volume guarantees

Volume guarantees are formal assurances that a party will receive a minimum level of revenue during a concession period. Volume guarantees mitigate demand risk and allow investors to gain enough revenue to repay high initial investment costs for long-term concessions. Common types of volume guarantees are minimum volume-based guarantees and minimum revenue guarantees.

Financial guarantees

Financial guarantees provide protection against losses resulting from a range of risks that lead to the failure of a sovereign, sub-sovereign, or state-owned enterprise to make a payment when it is due under an unconditional financial payment obligation (defined as a credit enhancement product) or guarantee. Examples of financial guarantees are:

• Non-honouring of financial obligations
• Currency inconvertibility and transfer restrictions
• Condition precedent clauses
• Bank guarantee/letter of credit.

Hedging

Hedging is an investment position intended to mitigate currency risk in the event of significant exchange rate fluctuations. Hedging instruments are critical for foreign institutional investors and insurers in markets with high foreign exchange (FX) risk.

Bundling

Bundling involves combining several smaller projects, or projects with different risk profiles (for example brownfield and greenfield), into a single larger project or program to achieve economies of scale and/or a project risk-return profile that is more aligned to private investor appetite.

Pre-completion insurance

Pre-completion insurance is an arrangement where one entity provides formal assurances of guaranteed compensation in the event of specified losses, damages, or delays. Insurance mitigates execution risks for investors, but may be expensive – particularly in emerging markets and for greenfield projects.