Regulatory/change in law risk

Toll Road Toll Road

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 falls 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 sector or to PPP projects in the jurisdiction) or (iii) general change in law affecting capital expenditures. Such protection can be provided by virtue of statutory law. However, the Private Partner has to take the risk of changes in law and technical standards leading to increased capex to the extent such change was foreseeable at the time of submission of bid.

A change in law is often subject to a de minimis threshold before the Private Partner is entitled to compensation

The Private Partner may not be compensated for general changes in law that only affect operational expenditure or taxation (i.e. affect the market equally). Changes in law will always entitle the Private Partner to relief where this is necessary to avoid an impossible obligation. The Contracting Authority often has to consent to such Variation if the Private Partner is obliged to comply with the change in law.

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 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 back changes in the tariff charged on the project.

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).

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 SOPC model had already taken this approach. Accordingly the Contracting Authority should be mindful of how it will fund these changes should they arise.

Comparison with Emerging Market

In developed markets, the Private Partner will not be compensated for General Changes and likely will have less protection than in emerging countries where Contracting Authority will be expected to bear a significant portion of the change in law risk in order to attract private investment. Such risk may be heightened in jurisdictions where the PPP legislation allows for a local assembly to veto the project.

Back to Toll Road

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 made whole in respect of changes of law which are discriminatory (towards the project or the Private Partner), or specific (to the transport 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 tariff 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 otherwise should give rise to a right to terminate (typically on a Contracting Authority default basis).

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 stabilization 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 stabilization 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.

Back to Toll Road