Regulatory/change in law risk

Airport Airport

Description (What is the Risk)

The risk of law changing and affecting the ability of the project to perform and the price at which compliance with law can be maintained.
Change in taxation.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

The risk of change in law sits mostly with the Contracting Authority but there will be a degree of risk sharing in the following manner:

The Private Partner will be kept whole in respect of changes in law which are: (i) Discriminatory (to the project or the Private Partner) (ii) Specific (to the airport sector) or (iii) General Change in law.

A change in law is often subject to a threshold before the Private Partner is entitled to compensation particularly in the case of general change in law where the threshold may be different depending on whether it relates to capital expenditure, increased operating costs or loss of revenue. It may also vary (or not exist) depending on if it is during the construction period and foreseeable or whether the cost of compliance can be passed on to passengers or airlines. There may be restrictions on what increases the Private Partner can pass on and also economic restraints and raising costs may reduce usage and so revenues.

Changes in law will always entitle the Private Partner to a Variation where this is necessary to avoid an impossible obligation or allow extra time to achieve compliance with the changed law. If this cannot be achieved the Private Partner will typically be entitled to terminate as if a Contracting Authority breach had occurred.

Where the payment structure of an airport project is a concession fee payable to the Contracting Authority based on gross, rather than net, revenues an increase in taxation will increase the costs of the Private Partner without providing any relief in relation to the amount of the concession fee payable. This will reduce the amount available to the Private Partner to pay operating costs and debt service. If there are restrictions on increases in airport charges then the Private Partner may not be able to pass the cost of the increase in the taxation on to the airport users, as would be the case with other businesses that were not operating in a similar price regulated environment.

Even if there are no price controls, the Private Partner cannot just increase charges to airlines without meeting resistance, either because they have printed their brochures and themselves cannot pass on the extra charges to their customers or because they will reduce their usage of the airport. For these reasons, Private Partners have often sought and received protection from tax increases above thresholds by reduction in concession fee rates. This has generally not been the case with increases in taxes and duties on duty free goods or food and beverage sales.

Mitigation Measures (What can be done to minimize the risk)

Change in law risk that is retained by the Private Partner may be mitigated by allowing increases in costs by virtue of indexation provisions (on the basis that general changes in law will affect the market equally and should be reflected in general inflation).

Change in law risk may also be mitigated where there is an ability to pass costs relating to changes in law to airport users (but see comments about limits on this).

Some projects only permit the Private Partner to claim relief for general changes in law occurring after completion of construction. This approach may be justified if the country's legal regime ensures that the prevailing legal regime at the start of construction is fixed until the works are complete (i.e. does not operate retrospectively to projects in progress) or the construction period is such that any further relevant changes in law have been announced or are foreseeable and can be taken account of in the construction budget and timetable.

Government Support Arrangements (What other government measures may be needed to be taken)

Past concession models (including that developed in the UK) used to require the Private Partner to assume, and price for, a specified level of General Change in law capex risk during the operational period, before compensation would be paid. The UK Government ultimately decided that this allocation did not represent value for money and reversed this position. Some countries which adopted the UK SOPC model had already taken this approach. Accordingly the Contracting Authority should be mindful of how it will fund these changes should they arise - changes in charges may be possible but given the demand elasticity in the airport sector this may have a detrimental effect on the number of flights and/or passengers.

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Description (What is the Risk)

The risk of law changing and affecting the ability of the project to perform and the price at which compliance with law can be maintained.
Change in taxation.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

The Contracting Authority typically bears principal responsibility for changes in law post-bid / post-contract signature.

There may be a degree of risk sharing with the Private Partner and there may be certain risks that the Private Partner is expected to bear alongside the remainder of the market.

The Private Partner would look to be kept whole in respect of changes of law which are discriminatory (towards the project or the Private Partner), or specific (to the airport sector).

The Private Partner may also receive protection against other (general) changes in law, however the level of protection will reflect the Private Partner's ability to mitigate this risk (through the cost increase or inflation regime, if applicable) and whether the risk is of general application to the market (e.g. an increased tax on corporate tax or dividends across the board). It may also be appropriate for the Private Partner to bear a certain financial level of risk before compensation becomes payable, to ensure that claims are only made for material changes in circumstances.

Changes in law should always entitle the Private Partner to a variation where this is necessary to avoid an impossible obligation or allow extra time to achieve compliance with the changed law, or otherwise should give rise to a right to terminate (typically on a Contracting Authority default basis).

In the Colombian context, the political risk is relevant to regulatory/change in law (see section on political risk). Nevertheless, when the regulatory change implies a lessening of the Private Partner revenue due to unfavourable effects derived from tariffs structure changes, the Public Partner is obliged to cover the loss of the Private Partner.

Mitigation Measures (What can be done to minimize the risk)

The Contracting Authority will need to ensure that various Government departments keep the project in mind when passing new laws to ensure that the Private Partner is not inadvertently affected.

The various Government departments that may impact on the project should therefore be cognisant of the risk allocation in the project when passing laws and regulations that may have an impact on it.

Government Support Arrangements (What other government measures may be needed to be taken)

Some projects may also provide for a stabilisation clause that entrenches certain legal positions (such as the current tax regime) against any future changes in law. This may require a level of parliamentary ratification of the concession agreement.

However, the stabilisation method is generally not favoured by Governments or NGOs (e.g. because of the concept of Private Partner immunity from updates to environmental laws, for example).

Comparison with Developed Market

In emerging markets, the Private Partner is likely to have a greater level of protection from changes in law to reflect the greater risk of change (including both likelihood and consequences) and in order to attract investors to the project. In that way, the Contracting Authority would be expected to assume more change in law risk than compared to a project in a developed market.

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