In government-pays PPPs, the risk of default by the authority is obviously a private side risk inherent in the strategic decision of investing in a particular country market or in the projects promoted by a particular authority. We basically refer here to credit risk.
This is more an issue in sub-sovereign PPPs.
As a general statement, especially in emerging market and developing economy (EMDE) regions, for sub-sovereign PPPs, especially those of a government-pays type, it is good practice to provide some “wrap” mechanism (that is, a credit enhancement) from the central government to ensure access to the investors market (for example, Letters of Credit, guarantee by the treasury, and so on).
The private partner will also have the chance to contract political risk guarantees (such as with the Multilateral Investment Guarantee Agency [MIGA] or private insurers) and other mechanisms from Multilateral Development Banks (MDBs), such as partial risk guarantees to cover the debt to be raised.
In general terms, an authority should only tender out and enter into a PPP contract when an affordability test has been passed satisfactorily. In addition, the framework should provide clear rules for reporting and accounting for PPP commitments.
The contract should describe clearly how a private partner has the right to unilaterally terminate the contract early when the government is not paying as agreed. This should trigger the right to claim for the full outstanding amount invested, plus damages and losses, to compensate for any costs caused by the termination (for example, costs of breaking hedging agreements, demobilization costs, claims from contractors and subcontractors, and so on) plus the opportunity cost (see section 9).