Regulatory/change in law risk

Water Distribution Water Distribution

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 water sector, for example a change in mandatory standards for water quality, or to PPP projects in the jurisdiction) or (iii) general change in law affecting capital expenditures.

A change in law is often 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 that only affect operational expenditure or taxation (i.e. affect the market equally). Changes in law will always entitle the Private Partner to a Variation where this is necessary to avoid an impossible obligation. If this cannot be achieved the Private Partner will typically be entitled to terminate as if a Contracting Authority breach had occurred.

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).

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)

The Contracting Authority should be mindful of how it will fund these specific/discriminatory changes should they arise.

Comparison with Emerging Market

Projects in the water sector involve a close interaction with consumers and public health regulation plays a paramount role. A change in the public health and water quality legislation may well be of general effect but may have a disproportionate effect on the water sector, and in particular, on distribution network to consumers. For this reason, the parties may seek to adopt definitions of discriminatory/specific change in law to include any general changes in law that have this disproportionate effect.

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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.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

The risk of change in law sits with the Contracting Authority. The Private Partner will be entitled to claim for any increased costs and in relation to delay arising from a change in law.

A change in law is generally specifically defined and may include:

(i) any law coming into effect after the effective date, or existing law being modified after the effective date; (ii) any required Private Partner consent being terminated or the introduction of conditions upon renewal which materially adversely affect the Private Partner; (iii) the unjustified refusal to grant a permit and (iv) a change in water quality standards.

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:

(a) 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;

(b) the Private Partner does not generally have to prove that it could have anticipated the change in law, provided that it occurred after an agreed base date; and

(c) changes in the environmental, safety and health law which are no more onerous than those prevailing internationally and changes in the exchange rate between local currency and USD are often specifically excluded as changes in law. This reflects both the Contracting Authority's expectations about the Private Partners (ie as international developers, contractors and operators) and the developing nature of legislative reform in these areas.

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