Page 59 - A U4SSC deliverable - Guidelines on tools and mechanisms to finance Smart Sustainable Cities projects

Operational risks

These are risks coming from the project operator once the construction is completed and the
project begins operations. Lenders are mainly concerned with the capacity of the project. The
ability of the operator to adjust to the operating budget, and have enough human and financial
resources, helps the operator maintain operations according to the plan. This concerns lenders, as
operational problems affect performance payments, including payments to financers.

Recommendation: it is best to agree on retainers and guarantees, covering not only the returns
but also liquidated damages, to the amount equal to the revenue generated if the real asset is
operated by a different operator. Avoid contracting operator companies and suppliers specifically
created to serve the project without bankable guarantees or mother-company guarantees.

Sponsor risks

Sponsor risks emerge from a lack of resources in the project sponsors (in SSC projects, usually cities
or municipalities) and the skills necessary to deliver the project on time and according to budget,
or a failure to resolve problems in the construction phase. Lenders also assess the levels of capital
available to projects, and the ability of the sponsors to raise additional capital, if required.

Recommendation: it is best to agree with the sponsors on retainers, guarantees and warrants
explicitly covering delays in the construction phase. If possible, make sure to include a first-refusal
bank guarantee, amounting to the costs expected in changing the contractor, even if this means
having to abandon on-site resources, materials and employees. Avoid construction companies
and resource suppliers specifically created to serve the project.

Technology and technical risks

Construction risks, such as equipment malfunctions or malpractice, can threaten the operational
phase or prevent the project from operating at all. These include poor construction, hidden defects
and obsolescence of assets. One of the main obstacles to financing infrastructure and smart
cities projects (particularly where technology is associated with long-term projects) is that many
construction companies articulate their activities through SPVs, with relatively weak mother-company
guarantees. If an SPV lacks the necessary technological and technical expertise to complete the
project, and problems emerge due to weak guarantees, the costs can be transferred to the project
itself, affecting returns for investors. Technology and technical risk in urban development projects
can therefore be high.

Recommendation: usually, only warrants and guarantees can mitigate technology and technical
risks. Ways to manage these include the provision of additional equity by the constructor or the
vendor, and public-sector support for the project by adjusting legislative requirements.

U4SSC: Guidelines on tools and mechanisms to finance Smart Sustainable Cities projects 41