Structuring, Negotiating and Documenting Infrastructure Deals Osgoode Law School

1. Risk Allocation in Today’s Market A DEVELOPERS PERSPECTIVE Structuring, Negotiating and Documenting Infrastructure Deals Osgoode Law School 1

2. The Context Risk is defined as: The responsibility of bringing about misfortune or loss. A potential hazard. Risk Allocation: Risk is best allocated to the person who can manage it. Risk depends upon your perspective – Equity Investor, Contractor, Lender, Government Agency, Public User

3. Contents / Agenda • Introduction • Procurement Risks • Contract Structure • Lender Risks • Contractor Risks • FM Provider Risks • Pricing Risk

4. INTRODUCTION • Risk vs. Opportunity • Some risk is good • As a developer, you utilise your experience of risk management to make money • Too much risk transfer leads to unnecessary expense and perhaps failure • Not all Organizations / Individuals view risk equally • Experience; success / failures • Skills; competencies • Risk Allocation impacts: • Price • Behaviour • Relationships -- a PPP is a 30 year partnership • Trust • This is the key requirement of a successful partnership • Risk Allocation is one part of the Risk Management Process – continuous • Identify risk • Respond to risk • Allocate risk • Manage risk

5. Mastering Risk Allocation Issues Matters Impacting Risk Allocation Generally • Who can best understand, manage and price the risk? • Delay by Public Sponsor  Public Sector • Ground risk  Depends upon project • Is the risk clear and ring fenced  Priceable? • Can the risk be mitigated/managed (i.e. insurance or capped)? • Is the risk one commonly managed by the party? • Size of supply chain partner  Resources and skills Balance sheet • Pricing by supply chain partner  Not understood = high price + uncompetitive • Security arrangements  Amount and type of security impacts risk allocation • Lenders/TA’s view of risk transfer  Price / contingency / security • Deal structuring and strategic partners (i.e. JV’s, etc.)

6. PROCUREMENT RISKS Will the Procurement Process be Successful; Key Indicators • Agency experience • Political risk • Project type – value, complexity; content (i.e. IT)? • Availability or user usage (toll) income risk $? • Project Advisor’s experience • Was groundwork done? (i.e. permits, approvals, enacting legislation) • Is the bid timetable realistic? • Are agency expectations realistic? • Likely success of achieving value for money • Bid costs honorarium; see McGill • Standard documents and risk allocation • Pipeline? • The right Partners; Private & Public Sector

7. Tier 1 SPONSOR Direct Agmt Project Agreement Tier 2 EQUITY SPV LENDERS Credit Agreement Direct Agmt Direct Agmt Construction SC INTERFACE Tier 3 CONTRACT [ JV ? ] FM PROVIDER AGREEMENT Trade Contracts Service Agreements ELEVATOR Tier 4 MECHANICAL ELECTRICAL DESIGNER SECURITY PARKING MAINTENANCE BUILDING Tier 5 DUCTWORK CONSULTANTS CONTROLS Mastering Risk Allocation Issues Contract Structures and Impact

8. Mastering Risk Allocation Issues The Contract Mechanisms – Supervening Events (IO Template)

10. Mastering Risk Allocation Issues The Contract Mechanisms - Other • Change of Law • Works change in law  Matters affecting the facility which are “not” foreseeable • Relevant change in law  Discriminatory and as related to the facility  Not a general change in law • Liability Caps  Any carve outs? • The Payment Mechanism  Indexation (which index)  Benchmarking / Market Testing  Labour Costs escalation  Output Specification/ Performance Measures (number & tolerance)  Energy – Energy model • Insurance  Delayed start up, business interruption  Future costs adjustments

11. LENDERS RISKS Note: Risk allocation affects appetite and pricing damage. Note: The type of lending - Bank, Bond / Life Co’s and Rating Agencies Construction Phase • Risk of building to quality and time  Termination of GC • Step in and replacement of GC  Likely maximum loss of money • Security package  Liquidity – LCs, bonding, PCGs, etc. • Direct agreements with key trades • Gearing – Higher? • Reserves  Look ahead tests, milestones, DSRA • Lenders dictate risk allocation • Little “stranded risk” at Project Co • Unacceptable risk transfer – no funds • Damage or supervening events  Insurance

12. LENDERS RISKS Operations Phase • Risk of poor service delivery  Payment deductions and termination of FM • Step-In and replacement of FM Likely replacement cost • Security package Liquidity – LCs, PCGs, etc. • Direct agreement • Financial reserves DSRA, LLCR, MMRA • Defects leading to $ deductions  Interface agreement • Inadequate lifecycle fund Timing risk • Damage to facility Insurance / Business Interruption

13. CONTRACTORS RISKS • Bid costs • Supply chain partners Risk flows down Ability to win dependence • Project complexity Prior experience; heritage buildings, Brownfield • Resources / People Reputation and experience • Standard documents Risk allocation understood • Permits and approvals Schedule risk (i.e. public consultation) • Design process Design reviews by Sponsor / Users  Sign off at Financial Close  Fitness for purpose; requirements are achievable  Consultant experience; E & O insurance  Design development • Project security Letters of credit, bonding, subguard; all of the above; cost and constraints • Payment Timing; cash curve • Ground risk Contamination; unforeseen conditions • Variations  Resources and delivery

14. Mastering Risk Allocation Issues The FM Provider – Key Risks • Indexation  Wage creep and labour escalation • The output specification requirements  Are they deliverable? • The payment mechanism  Detailed payment mechanism schedule is appropriate, tolerances, likely money risk • Design  Access, product selection, materials • Pensions & labour agreements  How onerous? Is there a union? • Interface issues  Warranty, future defects • Lifecycle & handback obligations;  Replacement cycles & product life, flexibility • Price  Services complexity, payment income variable, data availability

15. Mastering Risk Allocation Issues Lifecycle Risk Issues & Considerations • Where should lifecycle risk sit  SPV, Contractor, Operator? Interface issue • Pricing  Usage, vandalism, obsolescence, component life • Reserves MMRA or not • Inflation Risk  Erosion of price • Payment for lifecycle works  When and by whom? • Adequacy of fund Look ahead tests; reserves? • Variations to the works  Who is responsible? • Timing risk If lifecycle profile is wrong who funds? • Planned maintenance v lifecycle expenditure; delineation • Handback requirements  none or 5 year requirement?

16. Mastering Risk Allocation Issues Pricing Risk • Risk Register Process identify risk, likelihood / probability, risk value, max/min likely • Mitigation/action / Response  Price; contingency  Insurance  Transfer  Contractual – negotiation with Sponsor; caps  Security – bonding, cash  Revise design to eliminate risk  Management plan to control Simulation = Value addition to each element of price, construction, FM, etc. • Note – The risk allocation will affect the price to the Sponsor or numbers of bidders

17. Risk Allocation in Today’s Market A DEVELOPERS PERSPECTIVE THANK YOU 1