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Risk Management in Transport PPP Projects

In the Islamic Countries

37

binding obligations which can cover the failure of the public sector party to meet specific

obligations within a PPP project. Guarantees represent risk mitigation products and can cover a

whole PPP market, a program or single PPP projects. Moreover, they can be full or partial,

depending on the proportion of the amount of the transaction or the financial obligation that is

covered.

If state guarantees fail to gain the market’s trust, MDBs can play a significant role as well by

offering risk mitigation tools, among which credit enhancement products (e.g. MDB-issued

guarantees). In fact, Jett (2018) empirically proves that when credit enhancement is used by

MDBs, it can be a significant factor in attracting investment, by improving the risk profiles of

projects. Through credit enhancement products, projects become attractive for risk-averse

investors and crowd in private financial resources for infrastructure. For example, sovereign

partial risk guarantees issued by MDBs are used to mitigate country risk by funding projects

under preestablished legally binding conditions on both the grantor (typically a state-owned

enterprise or government agency) and the concessionaire (PPP project company). In case of

noncompliance, MDBs can apply penalties. Jett (2018) identifies two advantages over traditional

insurance:

Pricing: the agreement ensures that projects can be priced at a similar interest rate to

sovereign loans offered by MDBs;

Time: the system enables payments automatically based on preestablished triggers

defined in the PPP contract.

Despite the high potential in reducing risks in infrastructure financing, however, MDBs still face

structural constraints which limit their ability to mobilize private resources to the levels

required to meet infrastructure investment needs. For instance, limitations imposed on MDBs

by their business models, legal status, credit ratings, and need to implement countercyclical or

acyclical measures for borrowing members have traditionally led MDBs to be conservative in

the capital adequacy and liquidity treatment of guarantees (Pereira dos Santos and Kearney,

2018).

In Islamic countries, financing has particular features. The term

Islamic finance

refers to

banking or financing activities and instruments adhering to Shariah (Islamic law) standards.

Among the characteristics of Islamic finance the are the ban on usury (“riba”), which prevents

the use of interest; the prohibition of trading of debt, which implies that transactions must be

directly linked to a real underlying economic transaction; an emphasis on

risk sharing

among

different parties (as opposed to risk transfer) and the discouragement of excessive risk

undertaking. risk sharing, in fact, is considered as the essence of Islamic finance (Maghrebi and

Mirakhor, 2015).

Since infrastructure projects involve real assets and PPPs allow risks to be shared between the

parties involved, the use of Islamic finance for their development is compatible with Islamic

principles. In fact, as emphasized by the following Table, principles of Islamic finance fit well

with features of infrastructure PPP projects. In short,

the asset-based nature and risk-sharing

focus of PPPs make them an ideal investment opportunity for Islamic finance

.