The first and best risk identifiers are an early and systematic project feasibility study followed by a sound project economic evaluation as project particulars become better defined. In the due diligence phase, risk mitigation gets a lot more attention and focus by
the project potential lenders. For project risk mitigants to accomplish what they are intended for, the sponsor company needs to have risk management embedded in its corporate culture. In addition, a skilled and experienced project team supported by
competent external advisors and consultants should be in place from the screening phase of the project down to recommending appropriate risk management solutions.
An abbreviated presentation of risk mitigants commonly used by risk management and project teams for the threats enumerated in Section 10.2 includes the following
instruments according to type of risk:
A. Project Construction Completion
1. Independent validation and verification of project specifications and requirements by third party experts
2. Preparation of a sound feasibility study based on assumptions tested for validity and reasonableness
3. Selection of a well known, experienced, reputable, and trusted EPC construction company
4. Use of proven and tested equipment and technology that meets bid specifications and requirements
5. Turnkey engineering, procurement, and construction contracts 6. Technology and equipment warrantees by suppliers and vendors 7. Liquidated damages paid by the construction contractor
8. Project infrastructure failure risks are absorbed entirely by the host government B. Host Country's Macroeconomic Conditions
1. Comprehensive, upfront macroeconomic analysis to establish host country's economic environment stability
2. Project output demand and price escalation clauses in contracts
3. Agreed wage and other labor cost escalation provisions are included in contracts 4. Local currency hedging contracts against devaluation or currency depreciation 5. Local currency convertibility coverage is part of political insurance
6. Host government guarantees of free project company exports and imports 7. Contingency project company accounts established outside the host country 8. Project company's business plan modifications to offset impacts of the host
country's adverse economic conditions C. Political Risks
1. Wide ranging political, economic, social, technological, legal, educational, and
demographic (PESTLED) evaluation and report of risk findings impacting other areas of risk management
2. Continuous alignment of sponsor and host governments' interests and objectives 3. Sufficient political support and good relationships with the host government at all
levels
4. Host government's political risk assurances and counter guarantees
5. Political risk insurance from multilateral funding sources and private insurance companies
6. ECA, OPIC, and other agency guarantees and insurance coverage 7. Building up adequate project company offshore escrow accounts
8. ECA and multilateral institution involvement and intervention to resolve issues D. Environmental and Social Risks
1. Site inspections by professional environmental engineers and experts 2. In depth environmental due diligence and site risk assessment
3. Upfront assessment of social and labor market conditions and labor unrest issues 4. Verification of adequate qualified labor and living conditions for expatriates as part
of a sound project feasibility study
5. Ongoing monitoring of environmental and social conditions to ensure compliance with local and international laws and standards
6. Obtaining adequate insurance to cover adverse impacts of environmental problems E. Commercial/Market Risks
1. Comprehensive industry, market, and competitor analysis to ensure operational adequacy of the project company's industry structure
2. Market studies to determine consumer or user needs, willingness and ability to buy and acceptance and absorption of the project company's capacity output 3. Adequate offtake contracts and long term supply contracts with price protection
clauses for both
4. Building up material inventories and input supply cushions to weather short term disruptions
5. Futures contracts for project company production inputs and materials 6. Selection of appropriate technology to prevent obsolescence and discourage
competitor entry
7. Close relationships with host government agencies and regulatory authorities to help offset adverse impacts on project company operations
F. Legal and Regulatory Risks
1. The host country's political support at the central government, ceding authority, and local government levels
2. Close cooperation with the ceding and regulatory authorities from project inception to transfer of ownership to the host government
3. Close evaluation of the feasibility study and the due diligence report findings to address outstanding issues in need of contract negotiations
4. Scrutiny of the due diligence and risk management reports to uncover risks addressed inadequately
5. Offtaker and supplier contractual obligations to pay compensation to the project company when there are adverse law changes
6. Adequate ECA and multilateral institution legal and regulatory risk insurance 7. ECA and multilateral institution involvement and intervention to ensure a level
playing field
G. Project Financing Risks
1. Sound economic viability assessment with extensive data and information validation and testing of assumptions used in cost and revenue forecasts and reasonableness of forecasts
2. Consistency of project risk levels with sponsor company and investor risk tolerance 3. Validation of financial model inputs and outputs for consistency and
reasonableness and adequacy of financial ratios
4. Monte Carlo simulations performed for a number of possible scenarios to determine forecast center of gravity
5. Insurance coverage for project delays that lead to renegotiation of contracts and agreements
6. Sponsor and host government guarantees backed by counter insurance 7. Lending institution letters of credit to cover working capital needs
8. Early negotiation for commitment to convert short term to long term debt at market rates
9. Building acceptable flexibility in the debt service obligations and waterfall accounts 10. ECA and multilateral institution credit guarantees and insurance coverage
11. Futures contracts, hedging, and interest rate and currency swaps
12. Setting up waterfall accounts with appropriate covenants and restrictions Waterfall accounts area set of accounts created to separate and prioritize
project company cash flow so that repayment of debt and interest is made in descending order of seniority and where low tier creditors are paid after high tier lenders have received full payment.
H. Operational Risks
1. Sound project company business plan, operational targets, and course correction options when threats materialize
2. Experienced management secondments from the sponsor to the project company to implement its business plan effectively
3. Selection of a reputable, experienced, and reliable O&M company
4. Sound O&M contracts with output quantity and quality performance requirements 5. Appropriate performance incentive based O&M contracts with wage and benefit
controls
6. Close cooperation and ongoing relationship management with the ceding and regulatory authorities
7. O&M company performance guarantees and insurance contracts I. Organizational Risks
1. Skilled and effective project team, an outstanding project manager, and an experienced project company management team
2. All around unimpeded communication, coordination, cooperation, and collaboration
3. Congruence of sponsor corporate appetite with project risks and project lifecycle risk management embedded in its corporate culture
4. Complete and effective processes that assign clear roles and responsibilities to process owners in the sponsor and the project company
5. Close monitoring the implementation of both the project company business and the risk mitigation plans
J. Force Majeure
1. Obtain adequate force majeure insurance even though it is costly in developing countries
2. Allow some flexibility in schedules and extension of project timelines
3. Build up adequate debt service reserve funds, preferably outside the host country 4. Involve multilateral agencies to help resolve problems related to force majeure 5. Seek financial protection from insurance companies and re negotiate debt
payments
The following four key risk mitigants are worth elaborating on because they are useful in all risk categories and play a major role in project risk management, project
financeability, and project viability. They are:
I. Project economic evaluation. After the project feasibility study, a sound economic assessment reduces the number and potential impact of risks, first through validation of contract specifications and requirements and project cost estimates. Validation of the demand and pricing models and the assumptions used for cost and revenue
forecasts, along with verification of the reasonableness of scenarios used, are another avenue to reduce the number, likelihood of occurrence, and impact of risks. A sound project economic evaluation also requires development of a complete and well
structured financial model and thorough analysis of model inputs and outputs in order to minimize project risks.
II. Project due diligence. For all practical purposes, the project due diligence effort is an independent validation of the feasibility study and risk identification, assessment and mitigation. In the due diligence phase, all environmental, design, and technical aspects of the project are examined and expert advice is sought to minimize
construction completion risks. Then, the project company structure and the legal
aspects of the bid and procurement, licensing, and permitting are examined, as well as all the contractual agreements necessary to ensure a firm foundation for project
financing. Required insurance and security packages are also evaluated and changes and additions are made to validate project financeability. The financial aspects of due diligence at a minimum involve validation of the project's economic evaluation,
completeness of contracts, adequacy of the financial model, and sufficiency of the cash flow and the proposed financing structure.
III. Host government guarantees. These are guarantees that in most cases should span the lifecycle of the project and the majority of them are found in the
implementation agreement. Starting with permitting and license duration, the host government guarantees should cover project site and environmental conditions and easy access to the project site and utilities. Additional host government guarantees can extend to project grants, local currency loans, and regulatory noninterference; certain operational aspects of the project company, and equity contributions and credit
support when required.
IV. ECA and multilateral institution involvement. The participation of ECAs and multilateral institutions in a project finance deal is a major contributor to minimize project risks. This is so because these institutions bring discipline to project
structuring, and temper host government expectations and sponsor optimism. They also dictate the processes to be followed and the required analyses and documentation that need to be in place in order to obtain loans, insurance, credit support, and final project approval from them and project funding. ECA and multilateral institution involvement helps to successfully and expeditiously resolve conflicts between stakeholders induced by project risks.