Strategic Infrastructure, Mitigation of Political & Regulatory Risk in Infrastructure Projects

Strategic Infrastructure, Mitigation of Political & Regulatory Risk in Infrastructure Projects

by World Economic Forum, prepared in collaboration with the Boston Consulting Group, February 2015.

CICA Summary

The infrastructure is one of the most important elements for a sustainable and inclusive development. Traditional public financing is currently insufficient for the optimal infrastructural delivery. There is thus a need for private sector to fill this gap. But private sector is still cautious when it comes to infrastructural investments. One of its main concerns is public and regulatory risk that is often present in infrastructural projects. Efficient risk-mitigation is therefore able to offer sound incentives for a greater private sector investment in infrastructural projects.

Differentiation of political and regulatory risks is a prerequisite for risk mitigation. The report thus offers a brief description of political and regulatory risks distinguishing those affecting specific projects and those affecting a wider aspect of an entire sector or economy as a whole. The report then provides an outlook on measures to be taken by public sector, private sector and jointly in addressing political and regulatory risks.

The key measures that should be undertook by public sector for greater attraction of private sector infrastructure investment are summarized in the following paragraphs.

The public sector should assure “robust infrastructure regulation and contracts”. As infrastructure projects often involve long periods of delivery, the public sector should provide rules that are adaptive to societal and political changing circumstances, but that should at the same time be predictable enough for the investors. One of the practical solutions to this issue could be resolved by conducting “stress-tests for regulations under unfavourable conditions”.

But resolving the issues aroused by specific infrastructure projects is not enough. The public sector should be able to further provide “general stability of laws and regulation”. This assumes the existence of legal architecture assuring guarantees to private investors on the constitutional level and a non-partisan alignment on a broad infrastructure vision.

The public sector should also be able to rely on “efficient administration”, which should be constituted on a “clear agency set-up and efficient procurement and permit processes” where there should be a clear distinction of powers. An efficient administration is possible only through the implementation of harsh anti-corruption and transparency rules.

Since the public and the private sectors often have different, even conflicting interests, the disputes between the two are inevitable. “Reliable dispute-resolution mechanisms” must exist. They should rely on effective judicial capacity but also on a much wider range of dispute-resolution mechanisms (“the courtroom is not the only arena for discussion!”).

Putting all these criteria in place is essential for gaining the trust of private sector to act as an infrastructural investor. But it takes a lot of time, especially for the developing countries which are both more prone to higher political and regulatory risks and being in need for greater investment. “International commitments” could thus represent a great tool for the reduction of uncertainty of a country’s internal political environment.

The public sector doesn’t bear the full responsibility for an efficient risk management. The paper highlights measures that should be undertook by private sector as well.

There is a wide range of “appropriate financial instruments” that can help transfer the political and regulatory risk to actors that are better suited to bearing it. These involve risk guarantees, political-risk insurance, tradeable instruments and a trustworthy ownership structure.

The private sector is also responsible for the “effective interaction with the public sector”. There should be a constructive communication with public agencies. Private sector is able to contribute to the efforts of public sector through monitoring of political developments and advocacy strategy, where the communication should be widened from specific projects to wider industry regulation.

Infrastructure project have often huge societal impact. Private sector is thus also responsible for the “inclusive community engagement”.

Just like there should be an efficient, corruption-free public administration, the private sector should be able to assure a “responsible business conduct”. Internal regulations on corruption should be strict, but companies should also provide professional and sustainable services in their operations.

Finally, the successful infrastructure investment is conditional on the existence of the spirit of cooperation between public and private sectors. There are thus “joint public-private measures” that should be based on open dialogue both in the case of particular projects as well as in the case of the overall infrastructure vision. Public and private sectors often have a whole different risk perception, which then influences the expectations on returns. To reconcile risk and return perceptions of the two, the paper offers measures that are providing a transparent and open dialogue between public and private sectors as a key solution in narrowing the gap of the public-private risk and return perceptions.

Download the full World Economic Forum Report here