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A significant regulatory trend which has emerged as a result of the strategic role of the private sector and its long-term engagement in delivering infrastructure and public services reflects on the legal treatment of risk distribution between the public and private sectors within Public-Private Partnerships and in particular, the allocation and pricing of construction or project risk, which is related to design problems, building cost overruns, and project delays; financial risk, which is related to variability in interest rates, exchange rates, and other factors affecting financing costs; performance risk, which is related to the availability of an asset and the continuity and quality of the relevant service provision; demand risk, which is related to the on-going need for the relevant public services; and residual value risk, which is related to the future market price of an asset. Risk transfer from the public sector to the private sector has a significant influence on whether a Public-Private Partnership is a more efficient and cost-effective alternative to public investment and publicly funded provision of services. The cost of capital needed to finance a Public-Private Partnership should depend on the characteristics of project related risks and not on the source of finance. However, the source of finance can influence project risk depending on the maturity and sophistication of the risk bearing markets. On the one hand, within advanced risk bearing markets, it is irrelevant whether project risk is borne by the public sector or the private sector. On the other hand, when risk bearing markets are less developed, project risk depends on how widely that risk is spread. This outcome might contravene the assumption that private sector borrowing generally costs more than government borrowing. However, this mainly reflects differences in default risk. The public sector’s power to tax reduces the likelihood that it will default on its debt, and the private sector is therefore prepared to lend to the public sector at close to the risk-free interest rate to finance risky projects. The crucial issue is whether Public-Private Partnerships result in efficiency gains that offset higher private sector borrowing costs. Risk transfer from the public sector to the private sector has a significant influence on whether a Public-Private Partnership is a more efficient and cost-effective alternative to public investment and publicly funded provision of services. The public sector and the private sector typically adopt different approaches to pricing market risk. The public sector tends to use the social time preference rate (STPR) or some other riskfree rate to discount future cash flows when appraising projects. The private sector will include a risk premium in the discount rate it applies to future project earnings, where under the widely used capital asset pricing model (CAPM), the expected rate of return on an asset is defined as the risk-free rate of return plus a risk premium, the latter being the product of the market risk premium and a coefficient which measures the variance between the returns on that asset and market returns. A number of criteria have been devised to assess the degree of risk treatment in PublicPrivate Partnerships and these criteria involve asset ownership as an essential feature. The extent of risk transfer between the parties and the quantum for such transfer can be assessed by reference to the nature of contractual relations in a Public-Private Partnership. A

Risk in Public Contracts – The Treatment and the Regulation