Regulatory/change in law risk

Hydro power Hydro power

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 mostly sits with the Private Partner.

Change in law is often included within the definition of force majeure, which relieves the Private Partner from default. However, the Private Partner is generally not entitled to deemed energy payments where it has been unable to generate because of a change in law.

Where the change in law increases the private Partner's costs, adjustments to the tariff (if any) are often dependent on the Contracting Authority's ability to recover the change in law through the end user tariff. Alternatively, the term of the power purchase agreement may be extended to allow the Private Partner the opportunity to recover the extra costs arising from the change in law.

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

The tariff may be subject to a market indexation mechanism, which provides a degree of protection against changes in law that have a material impact on that market index.

Comparison with Emerging Market

Contracting Authorities assume little risk for change in law.

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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

In emerging markets without a previous track record of private participation in the power sector, the Contracting Authority takes change in law risk for all changes in law, subject to de minimis thresholds.

However, as an emerging market's private power industry matures, the risk of change in law will be shared as follows:

The Private Partner can expect to be protected against changes in law which are: (i) discriminatory (to the project or the Private Partner) (ii) targeted at the power sector). But even such change in law protection may be subject to a de minimis threshold before the Private Partner is entitled to compensation. The Private Partner will not be compensated for general changes in law which as the name suggests are of general application to a whole country e.g. changes in general income taxes.

Changes in law typically result in an adjustment to the tariff so that the original economic basis of the transaction is preserved. This adjustment reflects both increased costs and savings. In theory this means that the tariff may be adjusted in the Contracting Authority's favour.

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).

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.

The Contracting Authority has an obligation to use all reasonable endeavours to minimise and mitigate the effects of any change in law.

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

Depending on the credit rating of the Contracting Authority, Government support may be required to guarantee the energy payments to the Private Partner, as well as termination payment under the power purchase agreement where change in law has rendered performance of the power purchase agreement illegal.

Comparison with Developed Market

The Private Partner is likely to have a greater level of protection from changes in law to reflect the greater risk of change and to attract investors. Emerging markets may provide protection for all changes in law, with the possible exception of taxes.

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