RISK MANAGEMENT

Most project finance structures are complex. The risks in the project are spread between the various parties; each risk is usually assumed by the party, which can most efficiently and cost-effectively control or handle it. All investment projects involve some risk, but infrastructure projects in developing countries are perceived as unusually vulnerable to risks, which constrains financing. Risks are perceived as high partly because projects are typically undertaken not by established utility companies with strong balance sheets but by special pur­pose companies executing individual projects on a build-operate-transfer or build-own-operate basis. Project financing is on a no recourse basis (that is, lenders do not have recourse to the sponsor company but look solely to the revenue stream of the project available to meet debt service obligations). The risks associ­ated with the revenue stream are therefore scru­tinized. Equity investors may be willing to accept higher levels of risk in return for higher expected returns on their equity, but lenders typ­ically have a lower tolerance for risk and a greater need for risk mitigation mechanisms. Although governments conduct project negoti­ations with the sponsors, it is the lenders behind the scenes who set risk mitigation standards and determine whether projects are financeable.

These risks  are not equally important in all projects. The significance of par­ticular risks will differ from project to project, depending upon sector characteristics.

The general principles for risk mitigation are well known. The various risks involved should be unbundled and assigned to the participants able to manage them at least cost.

Here, we discuss the major risks involved, the methods for handling these risks, the  problems that can arise in each case and provide the best solution to mitigate these risks.