Risk management by the terminal operator involves a number of steps. Based on the approach adopted by many financial institutions for funding projects with limited or no recourse, these steps are:
Two principles should be applied in situations where the activity of the operator represents the delegated management of a public service. First, the reduction of the project’s global risk (and consequently of project cost) requires the proper allocation of risk. Risk sharing between concessioning authority and concessionaire on the one hand, and the various sponsors and lenders on the other, must be based on analyses designed to identify and allocate risks to those parties that can carry them best (with least negative impact). Second, any risks allocated to the operator will be reflected in a requirement for higher profits, in terms of level or duration, with a resultant increase in the cost of the service provided. It is, consequently, in the interest of the concessioning authority to restrict, as far as possible, the unnecessary imposition of risks on the operator when the operator is not in a position to manage them. In other words, it is undesirable to make the operator carry risks that the public sector would be able to carry at a lower cost.
This section explores the approaches operators can use to manage the various types of risk previously identified, and applies the principles set out above to suggest equitable systems for risk sharing between concessioning authority and concessionaire.
Detailed below are risks resulting from the national and international framework within which the projects must operate.
Legal risks arise in connection with the lack of precision in and the possibility of changes in the legislation and regulations governing the project. It must be assumed that a set of rules exist at the time the project is initiated.
Insufficient precision in applicable laws and regulations can lead to disputes and misinterpretations and therefore creates risk. In some cases, legal issues can be extremely complex, not only because laws and regulations can be subject to a variety of interpretations, but also in terms of jurisprudence. Furthermore, common practice frequently imposes a number of mandatory rules in terms of port operation (for example, FOB [free on board] Dunkirk, Antwerp). Consequently, a thorough legal analysis should be undertaken prior to the implementation of the project. When the project is located in an area unfamiliar to the operator, it is particularly prudent to call on the services of local legal advisors specializing in the various disciplines involved in the project. This will help to reduce the incidence of circumstances that might delay project implementation. The risk of noncompliance by the operator with legal or regulatory requirements through ignorance is one carried exclusively by the operator.
The risk of changes in legislation or regulations stems from the possibility that circumstances in effect at the time of the agreement may change at a later date. According to the principles put forward at the beginning of this chapter, one can argue that the operator is justified in calling for guarantees of legal stability to guard against changes over which the operator has no control. Any such guarantee of legal security should not come at the expense of fair competition among operators or jeopardize the continued operation of any public service. On the other hand, in the case where management of public service is delegated to an operator, the operator is not in an ordinary business situation. First, because the permanency of the operator’s activity is essential to ensure continuity of the public service, and second, because the degree of regulation imposed on the operator may well prevent it from adapting to such changes in the legal environment. Consequently, it is desirable either to guarantee stability or to include a contract revision clause to avoid situations where a change in the legislation or regulations could put the financial viability of the project in jeopardy.
The risk of changes in legislation relating to the environment can be particularly significant, and can materialize during the construction or the operational phase. Prior to any decision concerning privatization, the prudent concessioning authority should undertake an environmental study of the project. Conventionally, such studies include:
With respect to environmental risk management, the aspects specific to environment-related regulations should be established prior to the bidding process and, where appropriate, negotiated at the time of signature of the contract. Any increased construction costs caused by changes in environmental legislation during the life of the concession should trigger renegotiation of the contract between the two parties to define the amount of and procedures for indemnification of the operator by the concessioning authority.
In a country where the national economy is weak or unstable, macroeconomic problems or fiscal rules imposed by the host country create a risk, for both shareholders and lenders, that the project may be unable to generate sufficient income in strong currencies. The main monetary risks that can create this situation include:
Where the project can generate foreign currency income, which is frequently the case when services are invoiced to foreign shipowners or shippers, the foreign exchange and convertibility problems can be easily overcome. The best way of hedging the transferability risk is for the operator to be paid via an account opened outside the host country (offshore account). Use of such accounts frequently requires approval by the local authorities. When an offshore account can be opened, exchange controls or the prohibition of the export of foreign currency from the host country would have no direct impact on the economics of the project. In this case, the monetary risk is not hedged, but eliminated. In the contrary case, where no authorization can be obtained to open an offshore account, other measures must be considered. The concessionaire should seek convertibility and transferability guarantees from the government or central bank. Decisions about such guarantees often become political issues.
As for the exchange risk, this can be partially hedged by ensuring that the majority of expenses are paid in local currency; for example, by raising part of the debt in the currency of the host country. However, frequently this is not sufficient; it is rarely possible to raise the required funding for large projects locally. Further, foreign investors must be remunerated in foreign currency. The latter also applies to part of the purchases and personnel expenses (expatriate personnel). Where conditions allow, hedging products (for example, exchange rate swaps) can be used to manage the exchange risk. If, on the contrary, such products do not exist due to the instability or weakness of the host country currency, the exchange risk represents a major problem as it can only be carried by the shareholders and lenders, unless an exchange rate guarantee can be obtained from the central bank of the host country. The latter solution can only be envisaged in the event the project is of critical importance for the host country. Such considerations again add a political element to management of exchange risk.
Port activities form part of national and international transport chains. The volume of trade moving through these chains depends to a large extent on macroeconomic factors, namely population, consumption, production, exports, and so forth. Consequently, the macroeconomic situation and its expected evolution have a strong impact on the level of activity in a port. It is essential to take this element into account in the market survey conducted to estimate the traffic and throughput risk. The principles of traffic and throughput risk sharing are analyzed in a later section devoted to this topic.
Force majeure generally covers all events outside the control of the company and events that cannot be reasonably predicted, or against which preventive measures cannot be taken at the time of signature of the contract, and which prevent the operator from meeting its contractual obligations. Apart from this general definition, examples of force majeure are generally stipulated in the contract, including:
local authorities can be included in the list of events covered by force majeure, in particular where such decisions discriminate against the operator.
These risks are included under country risks, as it is the national context that determines the probability of their occurrence. It is reasonable that if any such event occurs, it should result in the suspension of reciprocal obligations of the parties involved, with a resultant limitation (although not elimination) of their consequences. The contract can also include procedures for sharing the burden of the consequences of such events between the parties, in particular where the operator is managing a delegated public service.
Interference or restraint of prices risk covers those risks that relate to the direct intervention of the public authorities in the management of the project. Public service requirements are normally defined in contract specifications, and the concessioning authority should not, in principle, interfere in any way during the construction or operating phases, provided the concessionaire complies with these requirements. However, concessioning authorities frequently do intervene in the name of public service or for the protection of the users, for reasons of security, for the protection of the environment, or simply on an arbitrary basis. Such interference can take the form of the imposition of new operating requirements, additional investment, or new constraints, the result of which is to increase operating costs or reduce revenue.
Intervention by the government may be well founded, but the concessionaire can then legitimately expect compensation from the concessioning authority for the constraints imposed and indemnification of losses resulting from the concessioning authority’s actions.
The best way of attenuating the interference risk is to have a contract that not only states unequivocally the objectives of the parties, but also specifies the limits on government authority to intervene. The contract may also include provisions that will obviate the need for arbitrary government intervention, for example, price escalation clauses or the obligation to increase capacity above a certain traffic or throughput level.
Clearly, it is impossible to foresee all events that might give rise to intervention by the government. Hence, it is a good idea to include contract provisions that call for periodic meetings to discuss the status of the contract and allow for renegotiation of the contract to account for significant changes in circumstances.
The operator cannot control the risks inherent in decisions taken by public authorities. The operator naturally seeks protection against harmful decisions through the clauses of the contract by transferring this risk to the concessioning authority. This is not sufficient, however, since noncompliance with the terms of the contract by the concessioning authority or the government is just one of the risks facing the operator. In addition, the approval of contracts or the issuance of authorizations from administrative authorities can cause delays and increase costs for the operator. Finally, the risks of expropriation and nationalization are also a danger. The risks of noncompliance, inefficiency or expropriation, and nationalization are grouped under the designation of political risk.
Apart from the detailed analysis of contractual commitments, there is also the problem of the credibility of the applicable legal system. The effectiveness of contractual commitments depends initially on the mechanisms available for settling disputes. Recourse to international arbitration is desirable, involving a neutral jurisdiction applying recognized international rules, such as those of the International Chamber of Commerce. Likewise, the applicable contract law can be that of a mutually acceptable third-party country.
This purely contractual approach, while useful, is frequently inadequate to ensure the acceptable management of the political risk. In practice, the arbitration phase of disputes is rarely reached, but when it is, it reflects the degradation of relations to such an extent that the future of the project is very often threatened.
There are, however, other strategies for protecting against political risk. The inclusion of multilateral organizations, such as the World Bank or the International Finance Corporation (IFC), among the shareholders or lenders represents a form of protection for the operator. The presence of these institutions is not a formal guarantee, but governments generally seek to avoid antagonizing these important multilateral institutions by imposing measures that would upset the equilibrium of a project in which they are involved. Similarly, the financial involvement of sponsors or lenders from the host country can also serve to limit the political risk.
Another approach involves recourse to the export credit agencies such as COFACE in France or Export-Import Bank in the United States, which act as guarantors for the political risk during the loan period.
Actual insurance cover can also be obtained to hedge certain specific risks. Such policies can be obtained from both public insurers such as MIGA (World Bank Group) and private insurance companies.
Quantification of the political risk is always a delicate matter, and there are no reduction or hedging methods that make it possible to eliminate the political risk entirely. Thus, if the perceived political risk is great, and the ability to mitigate those risks is slight, the operator may opt to abandon the project.
Project risks are those risks associated with the investment in and operation of the resources required for implementation of the project by the operator as set out in the contract between the operator and the port authority. The majority of these risks are carried by the operator, who therefore manages and assumes their consequences.
Project risks include:
Risks associated with the construction of the project involve unforeseen cost increases or delays in completion. A construction delay also translates into increased costs, principally for the operator, in one of several forms:
In turn, the principal causes of excess costs or delays are:
These project design and management tasks are under the control of the operator, thus the operator should carry these associated project risks. The operator can then conclude a “design and build” type contract with the construction company so that it can be associated with the project from the design phase on and help shape the project for which it will be responsible. If not involved from the outset, the operator must analyze and accept imposed specifications (for example, basis of design), proposing alternative solutions or refusing certain aspects that it considers unacceptable, but may ultimately have to accept a less than optimal design (for which it will bear the consequences). Increased costs or delays caused by the government or concessioning authority are considered as country risks (for example, political, restraint of prices, or legal risks) rather than project risks. In particular, this is the case when the functional definition of the project is modified or when, subsequent to signature of the contract, constraints are introduced concerning the choice of technical solutions.
Hedging of excess cost increases and completion delay risks by the operator are generally undertaken simultaneously. A common method of managing these risks is to transfer them to the construction company or equipment supplier. When the project includes a major construction phase, the financial package generally requires the inclusion of the primary construction company among the project sponsors. The construction risk (and design risk where applicable) is then allocated to the shareholding construction company, enabling the nonconstruction company shareholders to avoid bearing a risk for which they have little or no control. Transfer of the risk to the shareholding construction company is achieved via the construction contract or the design and build contract. From the operator’s perspective, then, the objective is to bind the construction company in a lump-sum design and build a turnkey contract that incorporates a performance guarantee and appropriate penalty clauses. This makes it possible to convert the construction risk of the project promoter into a credit risk for the construction company.
Careful selection of a technically competent and financially sound construction company makes it possible to reduce both construction and credit risks because of the assumed capacity of the construction company to honor its contractual, technical, and financial commitments.
It should also be noted that the sponsors of the project (future shareholders) and lenders to the project do not always carry the construction risk in the same way. The lenders will often call on the sponsors for a credit guarantee covering the construction phase, since the lender is protected by limited recourse for the operating period.
Hand-over risks arise when the operator takes over the management of existing infrastructure and facilities, including operation and maintenance, and in some cases must first begin rehabilitation work. The general rule is that the operator takes over the existing facilities at its own risk and peril. The operator is authorized to carry out prior inspection of the facilities to assess their condition and estimate the rehabilitation and maintenance costs to which it will be exposed.
Even with the ability to inspect facilities, it is desirable to include a clause in the concession contract to safeguard the concessionaire against recourse relating to events and conditions existing prior to the contract, thereby exempting the operator from resulting liabilities.
The concessionaire operates the facilities necessary to meet its contractual obligations at its cost, risk, and peril. Consequently, operating risk is allocated entirely to the operator. Operating risk principally comprises:
Nonperformance risks can be minimized by selecting an operator with recognized experience in port and terminal management. Cost overrun and loss of revenue risks can be transferred to the operator through use of a fixed-price contract between the master concessionaire and operator (which may provide for escalation by application of an indexing formula), with the possible inclusion of a variable component designed to reward better-thanexpected commercial performance. Concessionaires and port authorities should avoid cost-plus-fee type contracts with operators because they do not transfer any of the risks.
Like the project construction company, the operator may become one of the project sponsors. This then makes it possible to associate the operator at the outset with the definition of the operating system and its cost, thus making the operator fully responsible for the aspects of the project for which it will subsequently carry the risks.
Such measures, however, do not eliminate the operating risk completely. The responsibility of the operator is necessarily capped. Furthermore, this approach in fact converts the operating risk into a credit risk for the operating company. The latter generally has limited initial capital, which will not exceed its working capital requirement because it has no investment expenses. The responsibility of the operating company can then be covered by shareholder guarantees or a bond system.
In any case, the concessionaire should have the resources to manage this endogenous operating risk, and it is therefore logical that this risk be allocated to the concessionaire in full.
Procurement risks arise due to the potential unavailability of critical goods and services and unforeseen increases in the cost of external resources necessary for the project. This is significant for port projects since they often depend on public monopolies to supply critical services, for example for the supply of water and electricity.
Two approaches can help the operator to reduce or eliminate this procurement risk. The operator can choose to produce the critical resource itself. For example, the installation of a dedicated generator in a refrigerated container park or refrigerated warehouse makes it possible to reduce the cost of the resource in some cases and limit the risk of power cuts (which, in addition to simple interruption of the service, can cause damage to the merchandise). This solution often requires specific authorization from the local authorities. Furthermore, providing such goods and services oneself may not always be possible or financially feasible for the operator.
Alternatively, the operator can sign a long-term purchase contract with the producer of the resource. This makes it possible to set the purchase cost using a predetermined price escalation formula, and to limit the risk of a unilateral price adjustments or restrictions on supply. Further, the contract may include a clause to indemnify of the operator against losses incurred in the event of interrupted supply of a critical resource. This is referred to as a “put or pay” contract.
The concessionaire may require the assistance of the concessioning authority or the government to be able to conclude a put or pay contract with the public monopolies concerned. This usually can be justified in cases where the project has a substantial public service dimension.
Where the procurement of imported supplies is concerned, the procurement risk can stem from customs-related problems; thus, it becomes a component of the country risk. In such cases, the concessioning authority may reasonably bear a portion of the risk.
The operator bears all risks associated with raising the shareholders’ equity or obtaining loans required for funding the project. Likewise, the operator carries all risks associated with formation of the project company (the special purpose company or SPC). Contractual documents define the relationships among the various private players involved in the project (for example, the shareholders’ pact and loan agreement). Apart from raising the initial tranche of shareholders’ equity and loans, the establishment of standby credit loans should also be considered because it makes it possible to fund any excess costs with which the project company may be confronted.
Likewise, the interest rate fluctuation risk is carried exclusively by the operator. This risk arises when loans used to fund the project are based on floating rates (for example, Euro Interbank Offered Rate [EURIBOR] plus margin). An increase in the reference rate consequently increases the amount of interest to be paid, and hence the project costs. This risk can be hedged by means of appropriate financial instruments (for example, rate caps, ceilings on variable rates, or rate swaps).
When projects are built or operated with the aid of subsidies, there is the risk that the government will fail to make good on its subsidy payments. This risk is relatively small where investment subsidies are concerned, as the construction phase covers a relatively short period. However, international agreements (for example, the Marrakech Accords) or the dictates of internal law can still intervene to prevent the payment of subsidies.
The social risk arises when operators have to restructure the workforce and bear the cost of severance payments, retraining, and other employee issues. The risks of general strikes or civil disturbances in the host country are frequently classified as cases of force majeure (see country risk), which means that they are often only partially covered by the protections afforded in the contract. Additional insurance can be obtained to cover residual social risks.
The port sector presents special challenges relating to social risk:
In addition to the social risk relating to dock workers, the presence in the port of other categories of personnel with special status (for example, seamen, customs officers, and port authority personnel) can amplify the social risks. Module 7 describes port labor issues in depth.
Commercial risks arise from potential shortfalls in projected traffic and from pricing constraints. Traffic and pricing risks are significant in port reform projects due to the high degree of uncertainty associated with medium- or long-term projections of port activity. These risks are affected by the operator’s pricing decisions and by any price regulation imposed by government.
The nature of the partnership between the operator and the port authority leads, in practically every case, to sharing of traffic risk, both in terms of responsibility and consequences. The terms of the concession agreement effectively allocate these risks between the two parties. However, even though they are partners in port reform, there is a natural tension between the port authority as a custodian of the public interest and the operator as a profit-maximizing business.
When the number of customers using a port, a terminal, or other facility is limited, or when a small number of customers represents a major share of the activity, the operator can protect itself against traffic or commercial risks by means of establishing minimum volume guarantees. This is a long-term contract under which the customer undertakes to generate a minimum level of traffic and agrees to pay a fixed sum to the operator whether or not the service is required or used.
A terminal’s main customers—shipping lines or large shipping companies—will frequently become project sponsors, much like construction companies or operators. In such cases, the customer-shareholder carries part of the commercial risk. However, this arrangement has a number of disadvantages, particularly the risk of discrimination against nonshareholder customers. Nonshareholding customers can guard against this possibility by entering into a minimum guarantee contract with the terminal operator (see Box 1).
The relationship between the concessionaire and the port authority or other government agencies is important in defining the rules of the game for the concessionaire and, hence, its risks.
The concessionaire generally desires to limit the scope of the vertical partnerships with the port authority, taking the view that operator activity should be regulated predominantly by market conditions. Consequently, the operator seeks greater freedom of action in the management of its project to be in the strongest possible position to manage risks.
The concessioning authority is concerned with protecting the user, safeguarding the general interest, and avoiding abuse of dominant market positions. The concessioning authority, consequently, seeks to restrict the operator’s freedom of action through technical or economic regulatory measures.
The search for a fair balance between regulation imposed by the concessioning authority and the discipline imposed by the market is complex and effectively determines how the commercial risk will be shared (see Module 6 for a detailed discussion of economic regulation).
Regulation invariably generates costs. These include costs for the concessioning authority in the form of additional compensation it may have to pay to the concessionaire plus the direct costs of enforcing the regulations through inspections and other measures. Regulation also generates costs for the concessionaire, which bears greater risks and has less freedom of action than it would in the absence of regulation. Thus, the concessionaire will expect this higher risk level to be rewarded.
The costs or regulation are ultimately borne by the port users or by the taxpayer. Government regulation, therefore, should be kept to the minimum necessary to correct market imperfections and protect the public interest.
The nature and extent of government regulation in connection with port reform are many and varied. Ideally, the concessionaire and the port authority or other regulating entity can arrive at a compromise acceptable to both parties by adjusting regulation and the guarantees and compensation allowed to achieve equitable risk sharing. Because situations affecting port reform vary so widely, there is no single set of rules applicable under all circumstances. Instead, this section describes the different regulatory tools available to the port authority and identifies how each might affect the distribution of risk.
Regulation often takes the form of specifications and performance standards included in the concession contract itself. These might be set by the concessioning authority in detail prior to the initiation of the selection procedure. Or, they might be defined only in broad terms, with the bidders required to provide details in their proposals (for example, maximum price levels, fee, or expected amount of subsidy to be received). In the latter case, these elements serve as a means for comparing the submitted bids, and then become the performance standards to be applied to the winning bidder.
Regulation by the concessioning authority can be classified as either technical or economic.
Technical Regulations. These regulations define the minimum technical requirements of the project. They establish a set of parameters within which the concessionaire must operate, and go a long way toward defining the risks to which the concessionaire will be exposed. Technical regulation includes regulation of investments, maintenance, and performance.
Regulation of investments. Regulating investments is necessary only when the operator is itself responsible for the execution of the project. The port authority may then choose to impose a number of regulatory measures:
Oversight by the concessioning authority should be limited to the verification of compliance with the defined measures, and should not extend to the imposition of specific technical solutions, as long as the concessionaire meets the performance standards. Any requirement on the operator to obtain approval of various aspects of the project by the port authority, above and beyond these predefined standards, creates uncertainties that increase the concessionaire’s risks. This makes it difficult for the operator to properly estimate future costs for the project, adding an element of risk for which the operator will seek compensation.
Tenders should not be judged solely on the basis of the amount proposed to be invested by the candidate. Indeed, making sure that a minimum amount is invested is not an end in itself (except perhaps for the construction company). Such one-dimensional measures can have adverse effects by possibly encouraging noneconomic investment. It is preferable to impose functional obligations and performance requirements on the operator and to leave to the ingenuity of the operator the task of finding the best way to meet those requirements.
Regulation of maintenance. Defective maintenance of port facilities creates three types of risks: commercial risk for the operator as a consequence of the deterioration in the level of service offered to customers, risk of default by the operator with respect to the public service obligations contained in the contract, and risk of deterioration of assets during the term of the contract. The commercial risk is properly borne by the operator, and poor service will be penalized by the market. No regulation by the concessioning authority is required to guard against this aspect of maintenance-related risk. The public service obligation, in particular the obligation for the operator to provide continuous service, typically is defined in performance requirements contained in the concession contract or subcontract with the operator. An interruption of service resulting from a failure to perform maintenance can then give rise to penalties.
In the case of a concession where assets are handed over to the port authority on termination of the contract, the need for regulation can go beyond a definition of functional obligations. It is normal for the concessioning authority to require that repair and maintenance work is correctly carried out to ensure that the installations are handed over in good operating condition at the end of the concession period. The concessioning authority can impose specific maintenance standards in the contract to ensure the satisfactory preservation of the assets.
Regulation of performance. Finally, where the lack or absence of competition is liable to discourage the operator from providing an adequate level of service, the concessioning authority can include specific performance standards in the concession contract, for example, minimum levels of productivity. While sometimes deemed necessary, this approach is not without difficulties, since it assumes that the concessioning authority:
Beyond productivity criteria and service standards, performance standards can also include a minimum capacity for the terminal. These standards might be based on investment levels or on direct measures of storage and throughput capacity. Generally, it is preferable to permit the concessionaire sufficient flexibility to meet the standards in the most cost-effective manner (for example, extension of yard space versus the purchase of higher stacking equipment).
Virtually all concession contracts contain economic and financial provisions defining the scope of permissible activity, the minimum services required, the degree of competition the operator can expect, the freedom to set prices, and any fees or subsidies associated with the project. These provisions are designed to establish some level of certainty for the operator with respect to its flexibility to manage the project so that the operator can assess risks and ways to manage them.
The concession contract should define the activities the operator is authorized to conduct in the area defined by the contract. The port authority will define this scope based on its reform strategy and operational needs. For example, the port authority may prohibit the operator from engaging in any activities other than the handling and storage of merchandise within the project’s defined domain, or specify the types of traffic the operator will be authorized to handle. In the latter case, such limitation may be the consequence of an exclusivity guarantee previously granted by the port authority to another operator in the port.
By restricting the scope of permissible activity, the port authority increases the commercial risk for the operator. With a narrow scope, the operator’s capacity to adapt or diversify its activity in response to market changes is limited. On the other hand, the port authority could allow the operator considerable freedom of initiative and action to exploit port land and facilities in return for the operator’s performing unprofitable public service activities.
The port authority may require the operator to comply with principles governing the provision of a public service. This obligation typically imposes requirements for service continuity, with the assessment of penalties or early termination of the contract in cases where the service is interrupted due to the fault of the operator, and also requires equal access and treatment for users (nondiscrimination with respect to pricing, priorities, level of service, and so forth).
It is not always possible or desirable to avoid all discrimination among an operator’s customers. For example, obliging an operator who is a subsidiary of a shipping line to serve other competing shipping lines under the same conditions as its affiliated company, irrespective of contractual stipulations, is unrealistic. This problem can and should be avoided when developing the concession bidding qualifications. Business affiliations of the bidder, and any restrictions thereon, should be taken into account when designing the concession and awarding the contract.
The principle of nondiscrimination among users does not prohibit prudent commercial management of the affected activity, including differentiation in tariff or pricing, berthing priority, and service levels, provided these are based on objective criteria such as annual traffic or throughput volume, the period of commitment of the parties, or the characteristics of call or vessel, and provided these are applied uniformly to all similarly situated users.
Under certain circumstances it may be reasonable for the concessioning authority to grant the concessionaire a noncompetition guarantee to compensate for the imposition of strict regulation, if such regulation may deprive the concessionaire of the normal means available to a company for positioning itself in a competitive market. This type of guarantee is generally limited in time and terminates on a specified date, or when the level of traffic reaches a predefined threshold.
Although they can be useful in limiting a concessionaire’s risks, we do not recommend creating monopolies de jure unless necessary, even if they are limited in time. Instead, we recommend that the concession contract provide for renegotiation in the event that the competitive situation significantly changes. Renegotiation may include a review of the regulatory clauses to adapt them to new market conditions. In certain cases, this could lead to the indemnification of the operator where the newly created situation calls into question the viability of the project.
The procedures for setting tariffs represent a critical element of the economic regulatory system. Prices and pricing flexibility affect the terminal’s level of traffic and throughput and the profitability of the concessionaire’s operation. Regulation of prices by the public authority affects the operator’s flexibility in two key ways: the ability to negotiate the terms of service provided to the customer on a case-by-case basis or the obligation of the operator to publish a list of charges applicable to all users, and in the case of a published list, the ability to set the level of charges.
Operators should be free to set tariffs without significant government oversight when the market is effectively regulated by competition. Competition can come from another terminal in the port, another port, or another means of transport (air, land, or coastal transport). Estimation of the true level of competition can be difficult (see Module 6 for a methodological approach). From the concessioning authority’s perspective, the objective of price regulation should be to limit the risk of the operator abusing a dominant market position. As indicated above, when sufficient competition exists to discipline pricing, the tariff regulation need be nothing more than an obligation to treat all users on an equal basis and the requirement to publish a tariff.
Government oversight can also be kept to a minimum when the activity in question does not constitute a public service. This is the case where the operator only conducts its activity for its own account or on behalf of its shareholders. This is also the case where the port customers are not national economic units (for example, when they represent transit traffic or transshipment activity). The operator should then be free to negotiate charges with its customers on a case-by-case basis.
Pricing regulation is necessary, however, in other cases, namely when the operator provides an essential public service and is in a position of strong market dominance. Apart from the requirement of equal treatment of users and the publication of prices, in such cases the administrative authority may choose to establish a maximum charge (a price cap). This maximum charge can be set initially by the market, as the set of tariffs submitted by the terminal operator as part of the bid. The price caps are generally accompanied by price escalation formulas indexed to a set of economic indicators. However, these escalation formulas are generally applied only for a short term (for example, for a period of up to five years). Following that, periodic renegotiation of the price caps is required, which becomes another source of uncertainty and, hence, risk for the operator.
The problem of regulating public monopolies over the life of a long-term concession continues to be a subject of concern in industrialized countries.
So far, no clear and fully satisfactory response has been produced. The problem is even more acute in the developing countries where regulatory oversight capabilities may be weak.
A radical approach to regulating such monopolies would be to recompete the entire concession at periodic intervals, at the same time setting new tariffs according to market conditions. But such a recompetition of the concession cannot be envisaged every five years. Moreover, a recompetition would also require the inclusion in the contract of provisions on equitable withdrawal conditions for the concessionaire, including concession repurchase clauses. These are generally based on the discounted value of anticipated profits from the concession through the original termination date. This amount depends directly on the tariff assumptions for the residual period.
Another approach might be to require the concessionaire to use several handling companies for the same facility, as in Réunion Island (see Box 2).
Vertical partnerships between the concessioning authority and concessionaire involve some form of fees or subsidies. This constitutes another form of regulation, as the level of the fees or subsidies is closely linked to the tariff policy. The fees or subsidy mechanism typically has a fixed and variable component.
The fixed component can be a fee equivalent to a rent paid by the operator to the port authority for the use of land and facilities or utilities provided by the public sector. This fee also incorporates profit sharing, that is, the rental fee effectively includes an element to reward the concessioning authority for permitting the operator to profit from the operation of the terminal. Conversely, the fixed component can be a subsidy paid to the operator when the concession is acknowledged to be an unprofitable undertaking. This is a way of compensating the operator for providing essential public services. In this kind of concession, the subsidy level will usually be one of the main award criteria during the selection process.
The variable component of compensation to the concessioning authority can be a payment by the operator of a fee based on the level of activity. The variable component can also be an indexed subsidy based on traffic level. These same things include a minimum traffic threshold that can be used to share the traffic risk and indemnify the operator if the level falls below the predefined threshold. This latter approach may be most appropriate when there is significant uncertainty about the potential traffic moving through the terminal and when the concessioning authority desires to impose tight technical and pricing regulations.
Experience shows that these fee and subsidy levels and any escalation clauses should be decided as part of the concession contract and should be based on traffic levels rather than the degree of profitability for the operator.
The port authority could choose to set the initial levels for the fixed and variable components of subsidies or fees. However, these levels represent the most frequently adopted financial criterian for judging bids and, therefore, preferably should not be set by the port authority, but left for the bidders to propose.
Over and above the contractual conditions included in the bid specifications, the concessioning authority can retain a “right to know” concerning decisions taken by the concessionaire. The most commonly used techniques for this are to hold an equity interest in the project company and to hold a “golden share,” or blocking minority. This enables the concessioning authority to exercise oversight from within, but also can invalidate the risk sharing balance by introducing chronic interference by the concessioning authority in the management of the concessionaire company.
Despite its drawbacks, this form of government oversight is widespread. In over one-third of the privatized port terminals worldwide, the port or municipal authority owning the port also has an ownership interest in the terminal operator company (International Association of Ports and Harbors [IAPH] Institutional Survey, 1999). For example, in the case of Hamburg, the port (owned by the Hamburg regional government) has a majority interest in the operator company. This situation often gives rise to conflicts of interest between the shareholder and regulator roles of the concessioning authority, which tend to outweigh the perceived benefits of such a scheme. Control and monitoring of the concessionaire’s behavior generally is best carried out through a well-drafted concession contract, making proper allowances for the concessioning authority’s interest in reviewing certain strategic decisions of the concessionaire. This will safeguard the concessioning authority’s role as an impartial regulator with all its operators, which runs the risk of being compromised if it becomes involved as an equity holder in any of the private parties it is supposed to oversee.
Risk sharing and the extent of required government oversight can also be influenced by the nature of the terminal operations being concessioned. This section identifies several different types of operations and the resultant implications for regulatory oversight and risk sharing.
This method of operating is frequently encountered in the case of a terminal handling industrial bulk (ore or oil) and general cargoes (forest products or fruit). Under these circumstances, it is frequently the shipper, a group of several shippers, or the shipowner itself who serves as the operator of the terminal. This type of special purpose operation does not necessarily represent a public service, hence, it does not require systematic regulation by the port authority. Nevertheless, standards governing the maintenance of the facilities can be imposed for the preservation of the assets given in concession.
The administrative document formalizing the contractual relationship between the port authority and the operator of special purpose facilities merely needs to authorize the use of the site for the defined activity. A fixed fee is typically paid for the occupation of public land, and where appropriate, the provision of infrastructure or equipment by the public sector. Port dues billed directly to users (shipowners and shippers) by the port authority already generate remuneration for the use of the general infrastructure, and therefore would not be further billed to the terminal operator (see Box 3).
In this case, it is desirable for the traffic risk to be carried in full by the concessionaire. This means that the concessionaire must be able to manage this risk by controlling the operating parameters affecting its competitive position. This assumes substantial freedom for the concessionaire in terms of investment, level of service, and the tariff, although some limited regulation may still be necessary to ensure compliance with public service obligations, preservation of public assets, and maintenance of minimum capacity. Because the market is regulated by competition, the tariff can be set freely. The contract is awarded to the candidate proposing the highest rental fee or the lowest subsidy requirement, whichever is relevant (see Box 4).
This situation is relatively common in developing countries, particularly in African and insular countries. The existence of a natural monopoly of the port terminal management activity undeniably introduces a public service dimension requiring close economic oversight. This can involve the setting of charges and awarding of the concession to the candidate proposing the highest fee (or lowest subsidy), or, alternatively, setting the amount of the fee (or subsidy) and awarding the concession to the candidate proposing the lowest weighted mean tariff rates. Price escalation and indexing clauses are essential in all cases.
There are several ways that traffic risk and profit can be shared between the concessioning authority and private operator. First, the concessioning authority can guarantee that the monopoly will be protected from competition for a specified time or until a specified traffic level is reached. The agreement may contain clauses providing for modification of the regulatory system or even indemnifying the concessionaire from completion of the contract should the monopoly disappear.
Second, the concessioning authority can guarantee minimum traffic levels when the volume of traffic forecast by the concessioning authority is regarded as highly uncertain by the concessionaire. When such uncertainties exist, the concession agreement typically limits the amount of the fixed part of the fee and introduces a variable part (reduction) if traffic fails to reach a minimum threshold to protect the operator from significant revenue shortfalls.
Finally, the concessioning authority and the operator can agree to share profits when traffic exceeds a specified volume (see Box 5).
Transit traffic refers to goods whose origin or destination is a country other than that of the port. Transshipment is the discharge of cargo or containers from one ship and the loading of them onto another in the same port (vessel-to-vessel). Both activities may have a positive impact on the economy of the country, generating opportunities for value-added activities, jobs, and national wealth.
When the customer is not an economic unit in
the country of the port, the government does
not have the same interest in protecting the customer.
Consequently, in the absence of any
special agreement, there is little reason for the
government to accept any of the risks associated
with transit and transshipment traffic or to
regulate economic activity by the operator.
In fact, the port may benefit from the operator’s market dominance in handling transit traffic, which is disciplined by the existence of alternative transport systems (transit), the capacity of competing ports in the region (transshipment), and the degree of international competition. Under these circumstances, it is reasonable for the port authority to seek to obtain maximum profit from this favorable (although perhaps transitory) situation. In this case, the port authority charges an operator with the managing of this “natural resource” (that is, the country’s geographic advantage) with the objective of maximizing spin-off benefits for the country.
Regulation of the activity is not required, apart from the actual authorization and an obligation to preserve existing assets where appropriate. There is no need to subsidize the activity nor to share commercial risks because they are fully carried by the operator. On the other hand, the port authority will seek to maximize its profit by awarding the concession to the highest bidder, namely the candidate proposing the most favorable profit-sharing arrangement (fixed and variable fee) to the authority (see Box 6).
The situation frequently existing in ports is a mixture of the configurations described above, further complicating decisions about the procedures to be adopted. This leads to a hybrid approach, combining compensation systems, regulatory oversight mechanisms, and encouragement of “situation rents” (highly profitable operations in select activities to help fund a needed public service that might otherwise generate a loss) (see Box 7).
The existence of a horizontal partnership between the various players in the port community and its relationship with the transport chain was described earlier. The operator will often seek to combine the various services required by customers into an integrated whole or, alternatively, give contractual guarantees to customers as to the level of service provided in these various domains.
It is logical for the port authority to provide the operator with guarantees concerning standards of facilities and performance of services in the port (for example, depth of access, buoying, operating hours, and ship services), whether provided directly by the port authority itself or delegated to other service providers within the framework of a vertical partnership. These commitments, frequently grouped in a clause headed “concessioning authority’s obligations,” can result in financial penalties against the port authority in the event of failure to meet its obligations. The resultant commercial risk for the operator is then transformed, theoretically, into a credit risk for the port authority. Clearly, it is important for the operator to conduct a thorough analysis of the complete port community, its operations, and its reputation before committing to the project. Irrespective of the clauses included in the contract with the port authority, the operator will inevitably suffer the consequences of any defective operation of the port.
Likewise, while it may be useful to include guarantees regarding land transport modes (for example, hours of operation, access to carriers, creation of new infrastructure, maximum charge, or minimum capacity for a rail service), the quality of the intermodal service at the port is critical to efficient and cost-effective operation and should be analyzed before the operator puts in a bid (see Box 8).
Relationships between the port authority and concessionaire, as well as between the concessionaire and its suppliers, lenders, customers, and subcontractors, are defined in contracts. This section highlights the principal risks involved in the drafting and implementation of such contracts.
To protect both the concessioning authority and the concessionaire, contracts typically include provisions governing the possibility of changed circumstances or disputes about contract implementation. The main elements of the contract governing such developments include:
Indexation formulas have been mentioned on a number of occasions in connection with changes in tariff levels, long-term contracts with customers or suppliers, operating contracts, and so forth. Indexing designed to enable the operator to cover or reduce certain risks (in particular the inflation risk) itself induces other risks, such as risk of significant deviation of real-world conditions from the indexation formula over a certain period and the risk of divergence between the indexing conditions of different contracts signed by the port authority and the operator (procurement, operation, and sale). The risk for the operator is that the indexing formulas can lead to an increase in costs that exceed the increase in revenue or the potential reduction in negative effects. The risk for the concessioning authority is that the operator’s prices rise too high when competition is inadequate.
Sharing or mitigating the many risks associated with port projects frequently gives rise to contractual obligations and attendant financial sanctions if one party’s or another’s obligations are not met. Sanctions convert the risk into specific financial obligations (payment of penalties). This, in turn, generates the credit risk of the partner that is unable to meet its financial obligations.
The most efficient method of ensuring that the partners honor their financial commitments is to require bank bonds. These are frequently demanded from the concessionaire or by the operator from its private partners. The amounts and call conditions for these bonds must accurately reflect the respective commitments of the parties. However, the operator’s credit risk with respect to the concessioning authority cannot be covered by bonds, and generally remains a political risk.
Part A of this module has been largely devoted to analyzing the principles of risk sharing between the public port authority (as the entity offering the concession) and the private concessionaire. This section looks in general terms at other aspects of risk sharing from the perspective of each party and the particular risks affecting it.
The primary challenge for the port authority is to identify and define a balanced set of risk management measures. This requires expertise in numerous areas, which can lead to the use of specialist consultants. In addition to the terms of the contract concluded with the operator, which defines risk sharing between the port authority and the operator, the composition and characteristics of the sponsors raise major issues for the port authority in terms of:
This means that the process for selecting the partner is a matter of prime importance for the port authority. Apart from selecting a partner who can meet financial objectives (for example, reasonable tariff levels, minimization of subsidies, and maximization of the fee), the port authority must also be able to select a reliable partner, one capable of complying with all the terms of the concession contract and capable of carrying all of its allocated risks.
Recommendations relating to the management of calls for tender are published by the principal international financial institutions (IFIs). These documents describe in detail relevant selection criteria and methods for achieving the satisfactory selection of candidates. The involvement of the IFIs in these privatization initiatives also may permit port authorities to avail themselves of additional assistance provided by these entities. These sponsors can thus play the dual role of lenders and advisors to the concessioning authority.
Apart from the challenge of selecting the original partner, as time passes there is also an issue associated with the continued commitment of the shareholders. A particular risk arises if the initial shareholders decide to dispose of their interests in the project company to third parties that do not meet the expectations of the concessioning authority. This risk must be anticipated by appropriate contractual clauses.
Having first analyzed the risks of the project, the shareholders will logically seek to align the level of risk with the expected return on the operation. Their decision to become involved, consequently, depends on their assessment of indicators such as the project internal rate of return, investment coverage ratio, or return on equity.
However, apart from this determination, which is the same one every investor must make, each sponsor generally adopts its own particular approach according to its own agenda, enabling it to reduce this risk/shareholder return profile. For example:
The agendas of the various sponsors can lead to different expectations in terms of concessionaire policy. This situation also creates major differences in each sponsors willingness to carry risk or in the length of time over which they expect to earn a return. The concessionaire consortium clearly must manage possible differences in objectives among the sponsors; but these differences also concern the concessioning authority because they can lead to situations that are prejudicial to the general interest, for example, service continuity.
The project’s lenders primarily look for the project to have the capacity to repay its debts. They consequently adjust the amount of the debt and the repayment profile according to the annual and actuarial debt coverage ratios (see Part B of this module for a precise definition of these concepts).
Apart from these financial ratios, the lenders frequently impose other constraints on the sponsors to ensure their continued commitment throughout the defined repayment period. This stems partly from the fact that the loans are not (or are only partially) guaranteed by project assets (which tend not to be liquid in port projects), but principally from the cash flows forecast for the period of the loan.
The lenders, therefore, invariably call for a minimum equity investment on the part of the sponsors. Alternatively, lenders may consider the replacement of equity participation by subordinate debt (which presents the same advantages) as acceptable. Furthermore, reserves can be set up for the purpose of earmarking cashflow surpluses for debt repayment, thereby preventing the shareholders from recovering their equity contributions before loans have been repaid. It is also rare for “nonrecourse” loans to be genuinely without recourse, and the lenders frequently impose guarantees on the part of the sponsors, particularly during the construction period.
The techniques adopted by the lenders to limit their risk also include other measures including comfort letters or commitments by the concessioning authority, domiciliation of revenue or debt, assignment of debt, and technical and financial performance bonds.
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