RISK ALLOCATION IMPORTANCE IN PROJECT STRUCTURING AND CURRENT PRACTICES
Project finance is best understood in terms of a risk allocation which reconciles the potentially conflicting objectives of borrowers and lenders by utilizing the long-term economic and commercial linkages between the sponsors, lenders and third party participants involved with a project. (Howcroft &Fadhley, 1998).
In theory, the basic principle of risk allocation for the project finance is “Allocating project risks to the most suitable participant whose risk preference is higher” (Xiao, 2003).
Severe consequences follow from the failure to accurately identify and allocate risks. These consequences often extend beyond the immediate parties to the…show more content… In this paper, an extensive literature review is undertaken to evaluate the importance of risk allocation to project stakeholders and discuss current practices. However, the complexity of this topic is beyond the scope of this paper. Hence, the attention is towards the direct participants, even though other stakeholders will also be tangentially mentioned. Also, as PPP is developing fast in the area of project finance and its importance is increasing, I have used it to illustrate some of the points made in the current risk allocation practices.
II. Importance of risk allocation in structuring from the angle of stakeholders
The structure of a project’s financing depends on the industry the transaction is taking place, the underlying business model and in particular the allocation of risks and responsibilities between the individual partners (Weber & Alfen, 2010).
Risk allocation is performed as part of the development of the project structure, which takes into account the distribution of responsibilities and risks during the planning, construction, financing and operating phases (Corner, 2006). The aim is to identify an efficient and effective structure that optimises the costs of the project and ensures that the risk occurrences do not damage the project (Delmon, 2009). According to Grimsey and Lewis (2007) risk allocation has two elements: optimal risk management and value for money. The first implies that the