Resilient Infrastructure Public-Private Partnerships (PPPs): Contracts and Procurement The Case of Japan ©2017 The World Bank International Bank for Reconstruction and Development The World Bank Group 1818 H Street NW, Washington, DC 20433 USA December 2017 DISCLAIMER This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Nothing herein shall constitute or be considered to be a limitation upon or waiver of the privileges and immunities of The World Bank, all of which are specifically reserved. The report reflects information available up to November 30, 2017. RIGHTS AND PERMISSIONS The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. Cover image: MediaFOTO / PIXTA Used with permission. Further permission required for reuse. Table of Contents Abbreviations    3 Acknowledgments    4 Executive Summary    5 I Project Framework 1. Introduction 1.1 Background   14 1.2  Challenges and Approaches to Resilient Infrastructure PPPs    15 1.3  Scope and Objectives of This Study    19 1.4  Selection of Cases for the Japan Case Study    20 1.5  Structure of This Report    21 II Case Study on Japan Policy and Legal Frameworks 2.  for PPPs and Disaster Risk Management in Japan 2.1  Overview of PPPs in Japan    24 2.2  Legal Frameworks for PPP and DRM    27 2.3  Risk Sharing between Public and Private Entities    28 2.4  Disaster Risks in the PFI Act and Guidelines    31 2.5  Summary and Key Takeaways    32 3. Contracting and Disaster Risk Allocation 3.1  Definition of Force Majeure    33 3.2  Risk Allocation: Contractual Concepts and Effects    42 3.3  Disaster Response in Contracts    49 3.4  Summary and Key Takeaways    57 Procurement, Monitoring, and Payment Mechanisms 4.  4.1  Incentive Mechanisms in Procurement    60 4.2  Incentive Mechanisms in Monitoring and Payment    65 4.3  Summary and Key Takeaways    70 5. Insurance and Financial Institutions 5.1  The Public Sector Role on Insurance    72 5.2  The Private Sector Role on Insurance    73 5.3  Insurance Policies for Additional Cost Deduction    74 5.4  Insurance Availability    76 5.5  Role of Financial Institutions in Disaster Risk Management    80 5.6  Summary and Key Takeaways    81 Conclusion and Lessons Learned from Japan 6.  6.1  Policy and Legal Frameworks    83 6.2  Contracting and Risk Allocation    85 6.3  Procurement, Monitoring, and Payment    89 6.4  Disaster Risk Finance, Insurance, and Financial Institutions    91 References     93 Appendix A: Legal and Policy Frameworks in Japan for Public-Private Partnerships and Disaster Risk Management A.1  PPP-Related Laws and PPP Promotion System    95 A.2  Disaster-Related Laws    96 Abbreviations BOT ......... build-operate-transfer BTO ......... build-transfer-operate DRM ......... disaster risk management EMDE ........ emerging markets and developing economies O&M......... operation and maintenance PDCA ........ Plan, Do, Check, Act PPIAF ....... Public-Private Infrastructure Advisory Facility PFI .......... private finance initiative .......... public-private partnership PPP  VfM .......... value for money 3 Acknowledgments This report was prepared by PwC Advisory LLC for the World Bank’s Global Infrastructure Facility (GIF) Tokyo Disaster Risk Management (DRM) Hub and the Public-Private Infrastructure Advisory Facility (PPIAF). PwC Japan received guidance from the World Bank task team comprising Sanae Sasamori (senior infrastructure specialist) and Naho Shibuya (DRM specialist). The report greatly benefited from insights and guidance from the Japanese experts, including Yasufumi Shiraiwa (Sendai City), Kazuaki Miyamoto (Tokyo City University), Akio Isayama (Maeda Corporation), Makoto Inoue (Mizuho Bank Ltd.), Reiji Takahashi (Anderson Mori & Tomotsune LPC), Tokuji Sagi (Maeda Corporation), and Yasushi Tanno (Kyoritsu Insurance Brokers of Japan Co. Ltd.). The draft version of the report was discussed at the experts’ meeting in June 2017, and a summary of the discussion and important insights have been incorporated into the report. The team extends special gratitude to Sendai City for providing extensive support including making useful information available. The team extends thanks to internal peer reviewers, namely Philippe Neves, Jack Campbell, and Fiona Collin as well as inputs and support from Shoko Takemoto, Vibhu Jain, Akiko Toya, Haruko Nakamatsu, and Mayumi Asakura. The team also thanks support from Luis Tineo, Francis Ghesquiere, and Jason Lu. The report greatly benefited from professional editorial works by Mary A. Anderson and professional graphic design by Interbooks Co. Ltd. The World Bank Tokyo Disaster Risk Management Hub supports developing countries to mainstream DRM in national development planning and investment programs. As part of the Global Facility for Disaster Reduction and Recovery, the DRM Hub provides technical assistance grants and connects Japanese and global DRM expertise and solutions with World Bank teams and government officials. The DRM Hub was established in 2014 through the Japan-World Bank Program for Mainstreaming DRM in Developing Countries – a partnership between Japan’s Ministry of Finance and the World Bank. For more information, visit http://www.worldbank.org/drmhubtokyo The Global Infrastructure Facility (GIF), a global collaborative platform, coordinates and integrates the efforts of multilateral development banks, private sector investors and financiers, and governments that seek to invest in infrastructure in emerging markets and developing economies—fostering collaborative action on complex projects. For more information, visit www.globalinfrafacility.org The Global Facility for Disaster Reduction and Recovery (GFDRR) is a global partnership that helps developing countries better understand and reduce their vulnerabilities to natural hazards and adapt to climate change. Working with over 400 local, national, regional, and international partners, GFDRR provides grant financing, technical assistance, training, and knowledge sharing activities to mainstream disaster and climate risk management in policies and strategies. Managed by the World Bank, GFDRR is supported by 36 countries and 10 international organizations. For more information, visit www.globalinfrafacility.org PPIAF, a multi-donor trust fund housed in the World Bank Group, provides technical assistance to governments in developing countries. PPIAF’s main goal is to create enabling environments through high-impact partnerships that facilitate private investment in infrastructure. For more information, visit www.ppiaf.org 4 Executive Summary Key Challenges in Incorporating Resilience into Infrastructure PPPs Resilient economic infrastructure plays an increasingly significant role in mitigating natural disaster risks, including hydrometeorological and geophysical hazards, especially in the contexts of climate variability and change. The impacts of extreme natural hazards and climate change are becoming increasingly visible over the past decades. Between 1994 and 2013, natural disasters claimed the lives of 1.35 million people, more than half of whom died in earthquakes, and the remainder owing to weather- and climate-related hazards (CRED 2015). Since 2000, an average of 341 hydrometeorological disasters (mainly floods and storms) occurred annually—a 44 percent increase from the 1994–2000 average and well over twice the frequency in 1980–89 (CRED 2015). In addition to climate variability and change, rapid urbanization is concentrating risk in vulnerable regions of the world. Without major investments in resilience, climate change may push up to 77 million people into poverty by 2030 (World Bank 2016). In emerging markets and developing economies, the largest source of infrastructure investment is still domestic public spending. It is estimated that it will cost trillions of dollars to meet rising aspirations for better infrastructure, health, and education in these countries—more than multilateral development banks or international donors can provide by themselves. Therefore, there is an increasing demand for and attention on public-private-partnerships (PPPs) to maximize finance for development. Most of the countries face the following key challenges in incorporating resilience into infrastructure PPPs: (a) contractual allocation of natural disaster risks between the public and private sectors; (b) management of long-term contracts under uncertainty; and (c) commercial viability and uncertainty in the cost implications of resilience investments. Project Framework Scope and Objectives of this Project Building on the theoretical approaches to the key challenges outlined by Public-Private Infrastructure Advisory Facility (PPIAF), the World Bank’s Global Infrastructure Facility (GIF) and the Tokyo Disaster Risk Management (DRM) Hub have initiated a knowledge project on “Resilient Infrastructure PPPs—Contracts and Procurement” to harness the knowledge and expertise gained from PPP projects in selected countries to help the governments of low- and middle-income countries to prepare and structure disaster-resilient infrastructure PPPs. The overall knowledge project consists of two components: (a) knowledge development, and (b) knowledge exchange and dissemination (table ES.1). Good practices and lessons learned from case studies are incorporated into the separately developed technical guide. 5 Table ES.1 Overall Scope of Resilient Infrastructure PPPs Knowledge Project of the Global Infrastructure Facility and Tokyo DRM Hub Issues Objective Outputs • Increasing climate and disaster • Capture the evolution of Development Knowledge risks disaster-resilient PPP • Increasing needs in private projects/programs particularly • Case Studies of PPP projects in financing and participation for focusing on their contractual and three countries infrastructure procurement structure Knowledge Exchange and Dissemination • Limited capacity of policy makers, • Share and discuss lessons learned project implementation agencies from the case studies among policy from low- and middle-income makers, project implementing • Technical Guide countries agencies, and stakeholders from • No opportunities to have discussions developed and emerging countries on resilient infrastructure PPPs Note: PPP = private-public partnership. The Tokyo DRM Hub refers a secretariat of the Japan-World Bank Program for Mainstreaming Disaster Risk Management in Developing Countries, administered by the Global Facility for Disaster Reduction and Recovery (GFDRR), World Bank Group. The Global Infrastructure Facility (GIF) is a partnership among governments, multilateral development banks, private sector investors, and financiers and provides a new way to collaborate on preparing, structuring, and implementing complex projects that no single institution could handle on its own. Selection of Cases for the Japan Case Study This report presents a case study of infrastructure PPP projects in Japan under the knowledge development component. Japan is highly exposed to natural disaster risks ranging from earthquake, tsunami, cyclone, floods, and landslides to volcanic eruptions. Japan’s experience in structuring resilient infrastructure PPPs offers policy recommendations and insights on how disaster and climate risks can be managed under PPPs. The cases selected for the Japan case study are summarized in figure ES.1. Figure ES.1  Cases Reviewed for the Japan Case Study, by PPP Business Model PPP methods Selected cases Summarizing cases in Sendai city in chronological order BOT Sendai Health Facility Project (Spopark Matsumori) (March 2004 – April 2020), (availability payment Sendai Astronomical Observatory Project (June 2008 – March 2038) and or user payment) Sendai School Meal Supply Center Project (December 2006 – March 2023) Sendai International Airport Project (December 2015 – November 2045), Concession Kansai International Airport Project (December 2015 – March 2060) and Aichi Toll Road Project (August 2016 – March 2046) Note: BOT = build-operate-transfer. PFI = private finance initiative. PPP = public-private partnership. Durations within parentheses show contract period. 6 Policy and Legal Frameworks for PPPs and Disaster Risk Executive Summary Management in Japan Underpinning Resilient Infrastructure PPPs with DRM Policy and Legal Frameworks To promote infrastructure development via PPP, the Japanese government enacted the Act on Promotion of Private Finance Initiative (PFI Act) in 1999 and established a PPP/PFI Promotion Office, which has developed guidelines on risk allocation and contracting. Although the PFI Act does not specifically focus on DRM, public authorities embed the DRM legislations in bidding documents and technical specifications to ensure development of risk-informed infrastructure (figure ES.2). These include the 1961 Disaster Countermeasures Basic Act, the 1950 Building Standard Act, and municipal DRM plans. Instead of standardization, the bidding documents of each project and their contracts provide detailed DRM specifications considering the nature of each project and its geophysical and hydrometeorological characteristics. Also, when DRM policies and legislations are amended, private operators are required to comply with such amendments. Figure ES.2  Policy and Legal Frameworks for Resilient Infrastructure PPPs DRM PPPs Basic Act on Disaster Countermeasures PFI Act Building Standard Act Acts related to public works Cabinet Office or line ministries Infrastructure sectoral PPP standard contract guidelines (water, transport, energy) PPP contracting guidelines Hazard maps PPP risk guidelines Municipal DRM ordinances Municipal Municipal DRM plans Municipal PPP guidelines governments Regional hazard maps DRM plans Bidding documents Emergency preparedness and Project parties response plans Technical speci cations Project contract Business continuity plans Resilient Infrastructure PPPs Note: PPP = public-private partnership. PFI = private finance initiative. DRM = disaster risk management. Understanding Risks and Open Data A basic information database on past natural disasters and anticipated risks enables the private entities to estimate long-term disaster risks. To communicate the disaster risks to the public and encourage preparedness, Japanese municipalities produce and disseminate hazard maps on earthquakes, floods, storm surges, tsunami, landslides, and volcanic eruptions. Sharing information from the public sector on past natural disasters can reduce uncertain risk factors for private operators. Also, open data such as hazard maps and regional DRM plans facilitate effective disaster risk assessment by insurance companies. Sendai City innovatively considers resilience when conducting a value for money (VfM) analysis in terms of the efficiency of disaster response and recovery (box ES.1). 7 Box ES.1.  Case of Sendai City: Accounting for Disaster Risks in a Value for Money Analysis The choice of a conventional public works model or PPP is decided considering the legal regulations, urgency, and characteristics of each project, including bankability. In addition, Sendai City considers resilience and business continuity in VfM analysis by comparing two scenarios: (a) where the project is handled by a public administrator, and (b) where a private operator builds and operates the facility under the build-operate-transfer (BOT) scheme. In the first case, disaster response would require time and human resources from Sendai City to evaluate damage, apply for a contingency budget, and submit documents to the municipal assembly. As a result, Sendai City considers the BOT model to have more advantages than traditional public works for the municipal administration, in terms of the municipality’s personnel and time saving in response to a natural disaster. Notably, VfM analyses that include operational resilience in terms of the efficiency of disaster response and recovery will strengthen the project’s—and the government’s—disaster resilience, resulting in the selection of an effective method that will minimize social and economic loss when disasters occur. Project Structuring: Contracting and Disaster Risk Allocation Defining Force Majeure Large-scale natural disasters that cannot be foreseen and managed by a private operator are among the risk factors in a PPP project. Therefore, defining force majeure—recognized as a large-scale disaster in a PPP project—and contractually allocating the disaster risks between the public and private entities are essential for structuring a resilient infrastructure PPP project. The “Guidelines for Contract: Points to Consider for PPP Project Contracts” released by Japan’s PPP/PFI Promotion Office defines force majeure as follows: “a natural disaster that is generated externally without any relation to the actions, such as an agreement, made by the entities and cannot be prevented even if the generally required precautions and preventive actions are taken.” More specifically, it “is not attributable to the contracting authority and the private operator; in particular, a storm, torrential rain, flood, high tide, landslide, cave-in, lightning strike, earthquake, fire, generation of poisonous gas, etc., which fall under natural disasters, as well as a disturbance, riot, war, and act of terrorism, which fall under man-made disasters.” However, the final definition of force majeure is not confirmed until both public and private entities agree. Therefore, it is defined separately for each project by reflecting the project characteristics and site conditions. Based on lessons learned from the 2005 Miyagi Earthquake and 2011 Great East Japan Earthquake as well as the accumulation of project experience, Sendai City has iteratively clarified the force majeure provisions (box ES.2). Case of Sendai City: Iterative Processes to Enhance Understanding and Risk Sharing Box ES.2.  between the Public and Private Sectors In the chronological review of cases in Sendai, force majeure events were listed as examples in the earlier projects and defined as foreseen phenomena under normal circumstances and for which no concerned entity was responsible. Based on lessons learned from the 2005 Miyagi Earthquake, the 2011 Great East Japan Earthquake, and other disasters, force majeure provisions specified the seismic intensity, and by taking into account historical disaster damages, Sendai City also added a numerical standard that regarded an event of at least a certain level as a force majeure event. Furthermore, there was past controversy on the difference between the damage caused by a private operator due to facility defects and damage caused by a natural hazard. 8 Sendai City clarified in the PPP contracts that damage caused by a natural hazard will be judged based on whether similar buildings in the vicinity suffered similar damage. Such clarification of force majeure provisions resulted in Executive Summary • Fewer questions and uncertainty on the DRM responsibility of the public and private sectors; • The private sector’s clear consideration of disaster risks during the project planning stage; and • Prompt emergency responses by the private sector. Risk Sharing between Public and Private Sectors Because Japan is prone to natural disasters, the public sector has typically borne the disaster risks, and this has partly contributed to the development of PPP markets in Japan. Under the traditional public procurement in Japan, the costs of force majeure risks are 99 percent borne by the public sector. Japan’s PPP projects of the first generation— mainly build-transfer-operate (BTO) projects with availability payment (governments pay unitary charges to operators)—adopted the same risk sharing as in the traditional procurement. However, as both the public and private entities accumulate PPP experience, disaster risks that the private sector can reasonably manage have been transferred to the private sector depending on the project type and characteristics (figure ES.3). For example, Sendai City PPPs were mostly BOT projects that transferred ownership of the assets to the private sector and elaborated upon the definition of force majeure to share risks with the private sector, if the private sector can bear these risks. In addition, profitable BOT projects allocate force majeure risks mainly to the private sector. Figure ES.3.  Transfer of Natural Disaster Risks in PPP Projects, by Project and Payment Type Project type Characteristics Scope of force majeure and risk allocation Small Large Natural disaster risks BTO Force Majeure • Samples of force majeure are identified. (availability • Force majeure risk will be mainly borne by payment) the public. Private Public • Provides more clarity on definition of force Force Majeure BOT majeure than the above. (availability payment) • Private party owns facilities and bear a part Private Public of natural disaster risks in some cases. BOT • Force majeure risks will be borne by the Force Majeure (user payment and private party under a project with high high profitability) profitability. Private Public Note: BOT = build-operate-transfer. BTO = build-transfer-operate. PPP = public-private partnership. “Availability payment” refers to government payment of unitary charges to operators. “User payment” refers to payment to operators from user fees. Among the still-limited number of concession projects, risk sharing varies between road projects (with low profitability and high public nature) and airport projects (with high profitability). In the case of Aichi Toll Road Concession Project, standards for disaster recovery projects in public works were referenced to determine how additional costs resulting from natural disasters that fall under force majeure should be allocated between the public and private entities (box ES.3). 9 Box ES.3.  Case of Aichi Road Concession Project: Risk Sharing Policy by Circumstance Force majeure includes a storm, torrential rain, flood, high tide, landslide, fall of ground, strike of lightning, earthquake, fire, other natural disaster, or uprising, riot, disturbance, act of war, epidemic, or other human-made disaster, of which the cause is not attributable to either the government or the concessionaire (Table ES B3.1). Table ES B3.1  Risk-Sharing Policy, by Disaster Type, for Aichi Toll Road Project Disaster type Events for which additional costs are borne by the public sector Earthquake •  Damage based on normal social conventions •  Maximum rainfall of 80 millimeters or more in 24 hours •  Even if the rainfall is below the above standard, it is considered heavy rain if the hourly Heavy rain rainfall is significant (20 millimeters or more), provided that the hourly rainfall is observed at the nearest weather observation station (managed by the public corporation) from the damaged place. Storm •  Maximum wind speed of 15 meters per second or more (average in 10 minutes) •  Extraordinarily high tide, storm surge, or tsunami caused by a storm or its aftermath with High tide, storm surge, tsunami relatively nonminor damage The public sector shall bear the cost if the concessionaire cannot foresee or cannot be reasonably expected to establish measures to prevent additional costs. More precisely, additional costs resulting from natural disasters that fall under force majeure would be borne by the public sector if (a) the disaster recovery project is in accordance with the National Government Defrayment Act for Reconstruction of Disaster Stricken Public Facilities, and (b) the public sector agrees that there were no reasonable measures that the concessionaire could have taken to prevent the additional costs from being incurred because the event was unforeseeable. Source: Contract documents, Aichi Toll Road Project. Incentive Mechanisms in Procurement, Monitoring, and Payment DRM Tender Specifications and Evaluation Criteria during Procurement In Japan, resilience of facilities is promoted through the overarching legislations that have been revised based on experiences from past disasters. Additionally, private operators may be asked to deal with disasters by following the project-specific specifications defined by the contracting authorities during the procurement stage. The DRM specifications usually cover robust facility designs, resilient operation and maintenance (O&M), emergency preparedness, and response planning including emergency inspection and evaluation of damages. Also, during the investor selection phase, the public and private entities discuss the definition of force majeure through questions and answers and competitive dialogues and agree on a final definition and a scheme of risk allocation that are commercially acceptable to private operators and investors. Another approach adopted in Japan is to request that private operators submit proposals for DRM and include DRM as an evaluation criterion when assessing proposals. This incentivizes private DRM initiatives and innovation so that they can obtain higher evaluation points. For example, in the case of Sendai School Meal Supply Center PPP Project, Sendai City highly evaluated proposals on engineering measures to protect and minimize seismic risks as well as nonstructural measures and institutional arrangements that enable prompt emergency response and recovery. When disaster struck, the project recovered about 2.5 months earlier than did facilities directly operated by the government, owing to the private operator’s flexible selection of suppliers for emergency goods and equipment. 10 Resilience-Linked Monitoring and Payment Case studies on Japan demonstrate merit in applying incentive mechanisms to procurement procedures that Executive Summary encourage private operators to effectively manage the disaster risks in their projects. According to the “Guidelines for Monitoring” released by the PPP/PFI Promotion Office, if the monitoring indicates that services have not been provided in accordance with the specifications or proposals, providing an economic motivation such as a reduction in the availability payment is considered an effective method for encouraging the appropriate performance of services. Appropriate payment mechanisms also can incentivize the private operators to invest in DRM. For the Astronomical Observatory PPP Project, Sendai City established a policy for reducing the private operator’s contracted amount in case of facility defects that do not meet the specifications and performance standards, taking into account the importance of the facility component, degree of defects, time required for corrective actions, or other factors. Sendai City developed the approach to incentivize the private sector’s investment in DRM as a lesson learned from the facility defects in its previous Sports Facility Project, which were triggered by the 2005 Miyagi Earthquake. Insurance and Financial Institutions Insurance as a Risk Transfer Measure and Availability In Japan, fire insurance covers damages caused by fire, winds, snows, lightning strikes, and the like but does not cover fire damages induced by disasters such as earthquakes, tsunamis, and volcanic eruptions (table ES.2). Therefore, in Japan, where there is a high risk of earthquakes, business operators may be required to add an earthquake rider to the fire insurance for the O&M period. However, earthquake insurance is not easily available in Japan because of the limited capacity of the reinsurance market and the required high premiums. As a result, private operators are concerned that if the contracting authority asks them to add an earthquake rider to their fire insurance, they may have difficulty continuing the PPP project because of reduced profitability. Hence, despite recognizing the need to obtain insurance, decisions are made by considering the regional characteristics and availability of insurance. Table ES.2  Insurance Typically Required of Private Operators in Japanese PPP Projects Phase BTO project BOT project Concession project •  Construction insurance •  Construction insurance Construction n.a. •  Public liability insurance •  Public liability insurance •  Fire insurance (rarely, but •  Fire insurance with an sometimes private operators are earthquake rider O&M •  Public liability insurance required to add an earthquake •  Liability insurance for rider to their fire insurance) facility administrators •  Public liability insurance Note: n.a. = not applicable. BOT = build-operate-transfer. BTO = build-transfer-operate. O&M = operation and maintenance. Role of Financial Institutions in Resilience As a requirement to secure financing from financial institutions including commercial banks, there are cases in Japan where private operators are asked by the lender’s advisers (such as insurance or engineering consultants) to assess and evaluate disaster risks, develop a business continuity plan and DRM plan, and prepare a technical due diligence report to review the engineering designs of assets during the financing stage. Also, insurance covering force majeure, as well as its premium, affects overall project cash flows. Financial institutions do not set insurance as a requirement for approving a loan but take it into consideration in credit assessment. Early involvement of financial institutions is important to help incorporate the necessary financing structures from the early stage of the project. 11 I Project Framework 1. Introduction 1.1 Background Resilient infrastructure plays an increasingly significant role in coping with natural disasters, including hydrometeorological and geophysical hazards, especially in the contexts of climate variability and change. In emerging markets and developing economies (EMDE), the largest source of infrastructure investment is still domestic public spending. It is estimated that it will cost trillions of dollars to meet rising aspirations for better infrastructure, health, and education in these countries—more than multilateral development banks or international donors can provide by themselves. Therefore, there is an increasing demand for and attention on public-private partnerships (PPPs) to maximize finance for development. Although PPPs are widely recognized as a way to provide public infrastructure services, climate and disaster resilience has not yet been considered in many countries under the PPP policy frameworks. Increasing Natural Disaster Risks and Impact of Climate Change The impacts of extreme natural hazards and climate change are becoming increasingly visible over the past decades. Between 1994 and 2013, natural disasters claimed the lives of 1.35 million people, more than half of whom died in earthquakes, and the remainder owing to weather- and climate-related hazards (CRED 2015). Since 2000, an average of 341 hydrometeorological disasters (mainly floods and storms) occurred annually—a 44 percent increase from the 1994–2000 average and well over twice the frequency in 1980–89 (CRED 2015). In addition to climate variability and change, rapid urbanization is concentrating risk in vulnerable regions of the world. By 2020, nearly 1.5 billion people are estimated to live in urban slums, where the concentration of climate and disaster risk is highest (UN-Habitat et al. 2015). Also, sea-level rise in the 136 largest coastal cities could result in losses of US$1 trillion or more per year by 2050 (Hallegatte et al. 2013). Without major investments in resilience, climate change may push up to 77 million people into poverty by 2030 (World Bank 2016). Increasing Trends of Infrastructure PPPs The number of projects using PPP as a model of service delivery has increased in EMDE. Between 2004 and 2013, G-20 (Group of 20) countries accounted for 14 of the top 20 countries in terms of PPP project numbers, based on PwC analyses. Of those, three countries (China, India, and the United Kingdom) accounted for almost half of the total number of projects carried out by the top 20 countries. EMDE have tended to focus on more-fundamental economic infrastructure such as energy and transport, while high-income countries have implemented social infrastructure PPP projects, such as schools, hospitals, and leisure facilities. In EMDE, there is a steady and recognizable demand for investment in PPP infrastructure; overall PPP investment was around US$110 billion in 2015, a level similar to previous years (figure 1.1). 14 Figure 1.1  Total PPP Investment and Share of GDP, 2006–15 US$ Billion Investment as % of GDP 160 0.007 140 0.006 120 0.005 100 0.004 80 0.003 60 0.002 40 Ⅰ Project Framework 0.001 20 0.000 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: World Bank 2015. Investment Percent of GDP Note: PPP = public-private partnership. Challenges and Approaches to Resilient Infrastructure PPPs 1.2  This section summarizes the issues identified in past studies on structuring and implementing resilient infrastructure PPPs as well as a theoretical framework for addressing the key issues. Key Challenges in Incorporating Resilience into Infrastructure PPPs In traditional public works, governments promote resilience of public services by designing and constructing infrastructure in accordance with laws and building codes that promote robust designs to protect against external shocks including natural hazards. Although infrastructure PPPs should be designed and constructed in accordance with the building codes and national infrastructure standards, disaster risks cannot be eliminated, and the risks need to be understood, contractually allocated, and managed by the public and private sectors. Based on a literature review, the key challenges for incorporating resilience into infrastructure PPPs are summarized in table 1.1. 15 Table 1.1  Resilient Infrastructure PPP Issues Identified in Past Studies Area Category Issues Relationship between •  Climate and disaster resilience is not discussed in PPP policy Policy and disaster management framework. legal framework and PPP infrastructure •  Stakeholders are not aware of importance of disaster resilience. development policy •  Contracts cannot flexibly deal with uncertain or unforeseeable risks on force majeure. How to deal with •  There are no appropriate measures to compensate increased costs due uncertain events under to increased natural disaster risks for a private sector entity under a long-term contracts long-term contract. •  There are no incentives to promote resilient infrastructure development and active disaster risk management. Project Preparation •  All disaster risks cannot be covered comprehensively. Clear definition of and Structuring •  It is difficult to set appropriate standards on force majeure and disaster risks and force (Contracting) exemption. Lack of international standard contracts causes uncertainty majeure at decision making on investments. •  There is no mechanism to eliminate information asymmetry on climate change by increasing transparency and disclosure. •  Risk allocation between the public and private causes moral hazard. Risk allocation •  The pricing mechanism by the public sector does not include costs for compensation on disaster management. •  There is insufficient risk management ability by the public sector. •  There are no incentives for innovative private proposals based on Procurement and Promotion of disaster appropriate life-cycle costs. Implementation risk management •  There is no balancing on CAPEX and OPEX considering economic life of infrastructure assets. •  Limited products to mitigate disaster risks are available in the market. •  Limited financing tools benefiting disaster resilient projects are Risk transfer and Financial products and available. financing disaster risk finance •  Limited availability of insurance causes high exposure to natural disaster risks in the long term. •  No insurance is available at reasonable costs. Source: PwC based on PPIAF 2016 and World Bank 2016. Note: CAPEX = capital expenditure. PPP = public-private partnership. OPEX = operational expenditure. The challenges highlighted in table 1.1 fall into three overarching areas of concern, further discussed below. Allocation of natural disaster risks between the public and private sectors. PPP contracts often include provisions for and allocation of unforeseen risks, which are categorized under force majeure (or “acts of God” including natural disasters). Although neither the public nor the private sector is responsible for “acts of God,” the risk still needs to be contractually allocated between them in PPPs. Usually, it is difficult to identify a boundary of responsibility between the two parties as well as whether a natural hazard event can be considered force majeure. The range of responsibility that the private sector can take will depend on (a) the availability of insurance and (b) whether the private sector can reasonably estimate the risks. Management of long-term contracts under uncertainty. PPP contracts are typically long-term ones. For a project period that runs for 20 or 30 years, the possibility that natural disasters occur will constantly exist. Because of its public nature, it is essential to continue a PPP infrastructure project even after a natural disaster occurs. Furthermore, long-life economic infrastructure assets (for example, hydropower dams, rails, and metros) that could last for more than 50 years will likely face an increasing climate risk. In this sense, it is critical to incorporate DRM into the 16 project design, construction, operation, and maintenance to ensure sound and long-term implementation of PPP projects. In addition to setting appropriate design specifications to minimize structural vulnerability and exposure of infrastructure assets, a thorough review and discussion on force majeure or relief events among the public and private project stakeholders is required during the project development phase. Project economics and uncertainty in cost implications of resilience investments. Investments in DRM or the costs associated with unexpected emergency response and recovery from a natural disaster can affect the project’s VfM. Disaster risks should be incorporated into early infrastructure development stages; however, it is not often within the private sector’s commercial interest to invest in measures against long-term and uncertain risks, given the Ⅰ Project Framework uncertainty of return on investment. In addition, it is necessary to avoid moral hazard1 and incentivize the private sector to lower the risk through DRM practices. A thorough examination is required to determine cost allocation between both parties as well as the nature and scope of incentives, if any, and these need to be defined in a project agreement. However, it is often difficult to define these beyond a certain level of details and scopes in contractual arrangements because of the associated uncertainty. A Theoretical Framework for Structuring Resilient Infrastructure PPPs The World Bank-managed, multidonor Public-Private Infrastructure Advisory Facility (PPIAF) has developed a theoretical approach to addressing the challenges laid out in the preceding section for developing resilient infrastructure PPPs. The World Bank (2016) study identifies the measures to be taken by stakeholders at each stage of a PPP project: policy and legal frameworks. contracting, procurement, and risk mitigation and finance (figure 1.2). Figure 1.2 Theoretical Framework for Structuring Resilient Infrastructure PPPs Actor Area International Organization Awarding Authority Private Sector • Foster political will on resilience • Bolster DRM and resilience in PPP • Introduce exibility into existing PPP technical assistance policy frameworks to enable integration of • Promote awareness of climate and disaster Policy and resilience • Encourage emphasis on climate risk in public risk in insurance Legal • Level the playing eld on disaster risk and • Support to improve disaster resilience by Framework investment management frameworks • Strengthen country’s capacity to make resilience in PPP procurement advisers robust decisions in face of uncertainties • Review language of PPP contracts • Shareholders: Understand implications of • Bolster climate risk and resilience in PPP • Incorporate climate and disaster resilience natural disaster for investment technical assistance in project preparation and transaction performance Project • Strengthen country’s capacity to make structures • Insurers: Promote awareness of climate Preparation robust decisions in face of uncertainties • Level the playing eld on climate risk and risk in insurance and Structuring • Leverage climate nance and nancial risk resilience in PPP procurement • Advisers: Develop capacity on climate mitigation instruments resilience by advisers • Insurers: Promote awareness of climate • Leverage climate nance and nancial risk • Incorporate climate and disaster risk in insurance Procurement mitigation instruments resilience • Advisers: Develop capacity on resilience • Harness private sector DRM expertise • Project company: Incorporate resilience Implementation measures through project life cycle • Leverage climate nance and nancial risk • Lenders: Incorporate DRM and resilience in Risk Transfer mitigation instruments lending criteria and loan covenants and financing Source: World Bank 2016. Note: PPP = public-private partnership. TA = technical assistance. 1   In this context, “moral hazard” occurs when the incentives to perform are distorted by removing risks and rewards. 17 Staged Approaches by Project Stakeholders This analysis suggests actions to be taken by stakeholders—including governments and agencies (as awarding authorities), the international organizations that support them, and the private sector—to resolve challenges that arise during various project stages. Resilience should be integrated into the preparation for and transaction of projects, including procurement at the national policy level. Furthermore, the analysis suggests introducing flexibility into PPP contract management and policy frameworks to enable integration of resilience against climate change as well as to differentiate “acts of God” from climate change. It also suggests the necessity of improving the national-level capacity to make robust decisions in the face of uncertainties through the support of international development partners. In addition, the analysis suggests, the private sector would ideally play the following key roles in promoting resilient infrastructure PPPs: •  Private project companies incorporate resilience throughout project life cycle. •  Commercial lenders reflect resilience in lending criteria and loan covenants. •  Stakeholders such as investors understand the implications of climate and disaster risks for investment performance. •  Insurance companies incentivize resilience through insurance terms and advice on risk mitigation instruments. Active Management by Public and Private Parties PPIAF emphasizes that, as natural disaster risks increase, there will be a need for more proactive control of PPP projects and implementation of contracts in cooperation with the public and private parties, instead of simply treating the increasing risks as acts of God (force majeure) (PPIAF 2016). In particular, the PPIAF report •  Questions the availability of mechanisms to compensate private operators for the increased cost by taking the increase in natural disaster risks into consideration for long-term contract periods; •  Suggests arrangements for compensation to the private sector to be included in contracts; •  Questions whether tight contracts can flexibly deal with uncertain and unforeseeable risks treated as acts of God, suggesting that there is a limit to treating all climate risks as acts of God; and •  Suggests the need to examine (a) whether the focus on the benchmark of economic assessment is so great that PPP procurement systems prevent private companies from offering innovative measures for climate risks that may require additional compensation, and (b) whether incentives are given to private companies to set proper life-cycle costs. Although adaptation measures and the need for resilience are increasingly incorporated into the strategy for each sector, the strategy must be adjusted depending on the requirements for each project—for example, in terms of risk sharing—if PPPs are implemented. This is recognized as a problem that should be shared by all sectors (PPIAF 2016). Accordingly, it is necessary to provide incentives to stimulate private investors and clarify the support provided by public entities for DRM. It is also important to clearly indicate the responsibility assumed by private operators while discussing DRM measures and formulating a legal framework and plan to implement the DRM measures as seen in Japan. Furthermore, Japan’s Ministry of Land, Infrastructure, Transport and Tourism looks at the division of roles between the public and private sectors regarding the prevention and mitigation of disaster and climate risks (MLIT 2013). The research indicates that the public sector should take greater responsibility for responding to disasters while 18 emphasizing (a) the importance of dividing roles between the public and private parties, and (b) the need to provide rules that clarify the roles of private operators at the time of disaster and how they should handle the situation. It concludes that private operators should support the public entities and suggests that the costs incurred during a disaster should be borne by public entities so that private operators will not assume responsibility relating to damages and other consequences resulting from disaster prevention and mitigation activities. 1.3  Scope and Objectives of This Study Ⅰ Project Framework Building on the theoretical approaches outlined in the preceding section, the World Bank’s Global Infrastructure Facility (GIF) and the Tokyo DRM Hub have initiated a knowledge project on “Resilient Infrastructure PPPs— Contracts and Procurement” to harness knowledge and expertise learned from PPP projects in selected countries of all income levels to help low- and middle-income country governments prepare and structure disaster-resilient infrastructure PPPs. In particular, this project provides practical examples for addressing the issues identified in previous studies, including the following: •  Reflection of disaster risks in PPP legal frameworks •  Flexibility of PPP contracts in responding to disaster risks •  Scope of appropriate risk allocation including compensation to the private sector in case of a natural disaster •  Availability of risk mitigation measures in financing, such as insurance to transfer disaster risks for the private sector This project also highlights legal frameworks for PPP and DRM, PPP procurement methods, contracts, and risk mitigation measures based on an analysis of case studies. The case studies were conducted by reviewing terms and conditions of PPP contracts such as definition of force majeure, risk allocation, and incentives as well as insurance as part of risk transfer measures. The overall knowledge project consists of two components: (a) knowledge development, and (b) knowledge exchange and dissemination (table 1.2). Table 1.2  Overall Scope of Resilient Infrastructure PPPs Knowledge Project of the Global Infrastructure Facility and Tokyo DRM Hub Issues Objective Outputs • Increasing climate and disaster • Capture the evolution of Development Knowledge risks disaster-resilient PPP • Increasing needs in private projects/programs particularly • Case Studies of PPP projects in financing and participation for focusing on their contractual and three countries infrastructure procurement structure Knowledge Exchange and Dissemination • Limited capacity of policy makers, • Share and discuss lessons learned project implementation agencies from the case studies among policy from low- and middle-income makers, project implementing • Technical Guide countries agencies, and stakeholders from • No opportunities to have discussions developed and emerging countries on resilient infrastructure PPPs Note: PPP = private-public partnership. The Tokyo DRM Hub refers a secretariat of the Japan-World Bank Program for Mainstreaming Disaster Risk Management in Developing Countries, administered by the Global Facility for Disaster Reduction and Recovery (GFDRR), World Bank Group. The Global Infrastructure Facility (GIF) is a partnership among governments, multilateral development banks, private sector investors, and financiers and provides a new way to collaborate on preparing, structuring, and implementing complex projects that no single institution could handle on its own. 19 This report presents a case study of infrastructure PPP projects in Japan under the knowledge development component. Good practices and lessons learned from case studies are incorporated into the separately developed technical guide. 1.4  Selection of Cases for the Japan Case Study The following criteria were used to select project cases under the Japan Case Study: (1) PPP business models and (2) experience of natural hazards. Criterion 1: PPP Business Models Project risks, including natural disaster risks, are treated differently based on the type of PPP business model (table 1.3). Although build-transfer-operate (BTO) projects represent about 60 percent of private finance initiative (PFI) or PPP projects in Japan, the transfer of project risks to the private sector is limited under the BTO model, leaving the public party mainly responsible for natural disaster risks, in accordance with the standard conditions of public work contracts. In build-operate-transfer (BOT) and concession projects where private operators have operating rights and asset ownership, the private operators bear natural disaster risks to some extent or are responsible for a portion of risks, with a clear risk allocation between the public and private parties. Therefore, this case study focuses on BOT and concession cases. Table 1.3  PPP Business Models and Risk Allocation PPP or PFI Method Ownership and Management Right Project Risks Natural Disaster Risks The public possesses ownership and management right. Upon Contractor retrieves project costs The public mainly bears natural BTO completion of construction, from unitary charges paid by the disaster risks, same as in the (availability private contractors transfer its public. There is limited risk standard condition of contracts for payment) facility and are responsible only allocation to a private party. The public works, and the private for operation and maintenance of public is responsible for contractor bears only 1/100 of the the facility. management. incurred costs. The private contractor is BOT Contractor retrieves project costs responsible for ownership and Private contractors possess from user fees and unitary charges management of a facility and (availability facilities and manage them by from the public. There is a risk of bears certain degree of disaster payment or themselves. risks. The contractor can bear receiving less facility development user payment) fee and a management risk. most of the risks as a principal implementer. The public possesses facilities and Contractor retrieves project costs Risks are to be divided between separates a management right only from user fees. Facility the public and private parties by Concession from facilities, sells its right to development is not necessarily clearly de ning the risks borne by private contractors. included in a contract. the private. Note: BOT = build-operate-transfer. BTO = build-transfer-operate. PFI = private finance initiative. PPP = public-private partnership. Criterion 2: Natural Disaster Experience This study aims to capture key drivers for resilience and lessons learned from past natural disasters as well as the benefits accrued from PPPs. Therefore, this project mainly focuses on cases from Sendai City because the city has implemented several PFI projects and experienced large-scale earthquakes such as the Miyagi Earthquake in 2005 20 and the Great East Japan Earthquake in 2011. This study summarizes how Sendai City’s current project structure, formation, contracting, and implementation processes reflect lessons learned from the past disaster experience. Selection of Cases The cases selected in this study are summarized in figure 1.3. Figure 1.3  Classification of Cases Reviewed for the Japan Case Study PPP methods Selected cases Ⅰ Project Framework Summarizing cases in Sendai city in chronological order BOT Sendai Health Facility Project (Spopark Matsumori) (March 2004 – April 2020), (availability payment Sendai Astronomical Observatory Project (June 2008 – March 2038) and or user payment) Sendai School Meal Supply Center Project (December 2006 – March 2023) Sendai International Airport Project (December 2015 – November 2045), Concession Kansai International Airport Project (December 2015 – March 2060) and Aichi Toll Road Project (August 2016 – March 2046) Note: BOT = build-operate-transfer. PFI = private finance initiative. PPP = public-private partnership. Durations within parentheses show contract period. 1.5  Structure of This Report The “Resilient Infrastructure PPPs: Contracts and Procurement—The Case of Japan” is structured as follows: •  Chapter 2, “Policy and Legal Frameworks for PPPs and DRM in Japan,” summarizes the PFI disaster-related laws and framework in Japan. •  Chapter 3, “Contracting and Disaster Risk Allocation,” examines contracting and disaster risk allocation between the public and private sectors. •  Chapter 4, “Procurement, Monitoring, and Payment Mechanisms,” reviews systems design and incentives provided in the procurement procedures. •  Chapter 5, “Insurance and Financial Institutions,” reviews the roles and benefits of insurance in infrastructure PPPs. •  Chapter 6, “Conclusions and Lessons Learned from Japan,” summarizes the implications and lessons learned for policy makers based on the results of the Japan case study. 21 Ⅱ The Case of Japan  olicy and Legal Frameworks 2. P for PPPs and Disaster Risk Management in Japan Chapter 2 describes the public-private partnership (PPP) in Japan by summarizing the current status of the PPP legal framework and the transition to developing disaster-related legal and institutional systems. This chapter also explains the size and trends of the Japanese PPP market as well as the development of the PPP framework behind such historical trends. In addition, it describes the legal framework for disaster risk management (DRM) and summarizes how disaster resilience has been embedded in the PPP-related legal framework in Japan.2 2.1  Overview of PPPs in Japan Size and Characteristics of the Japanese PPP Market After the Act on Promotion of Private Finance Initiative (PFI Act, hereafter) came into force in 1999, both the number and size of PPP projects have steadily increased. Since the law’s enactment, a total of 527 PPP projects have been implemented as of March 31, 2017 (Cabinet Office 2017).3 A need for public works as a means to stimulate the economy (Noda 2003), coupled with increasing pressure to reduce project budgets, has meant that PFI—a form of PPP that uses private finance, management abilities, and technical capabilities in the construction, maintenance, and management of public facilities—has attracted more interest. The PPP/PFI Promotion Action Plan aims to promote PPP or PFI projects totaling ¥10–12 trillion between 2013 and 2022 (Cabinet Office 2013). In particular, the 2014–16 period saw intensive efforts (figure 2.1), and further efforts were expected during 2017–19 to meet this target. Figure 2.1  Growth in PPP Projects and Cumulative Contract Values in Japan, FY1999–FY2016 700 60,000 600 50,000 Number of Projects Executed under PFI Act Cumulative contract sum, ¥100 millions 500 40,000 400 30,000 300 20,000 200 Source: Cabinet Office 2017. Note: PPP = public-private partnership. 10,000 100 Numbers do not include projects whose contracts were cancelled either during the designated service period or before 0 0 disclosing implementation policies. The 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 “PFI Act” refers to the Act on Promotion 20 20 20 20 20 20 20 20 20 20 20 20 19 20 20 20 20 20 FY FY FY FY FY FY FY FY FY FY FY FY FY of Private Finance Initiative (Act No. 117 FY FY FY FY FY The number of project excecution information plan Cumulative contract sum of 1999, amended in 2006 and 2011). 2   In this chapter, to distinguish types of public-private partnership schemes, “PFI” refers to a project aligned to the PFI Act, and “PPP” includes other broad schemes related to public-private partnerships. 3   The number does not include the projects whose contracts were cancelled during the designated service period or before disclosing implementation policies. 24 Infrastructure renovation costs (for facility renovation, maintenance, and disaster recovery costs) in Japan will reach an estimated ¥6 trillion in 2020 (MLIT 2011). Given shrinking public budgets, more PPP projects are likely to be developed to meet infrastructure needs. In addition, the wake of the 2011 Great East Japan Earthquake has highlighted not only aging infrastructure but also weakened capacity due to a declining number of public servants; therefore, PPP has been drawing more attention to make use of the “know-how” of private operators. Figure 2.1 indicates the growth in the number of projects and cumulative contract values since fiscal year (FY) 1999. Local governments are the implementation entities for about 80 percent of PPP projects in Japan (table 2.1), which implies that PPP has mainstreamed at the local government level. Table 2.1 also explains the features of PPP projects in Japan with a focus on social infrastructure sectors. The PPP method in Japan has been commonly used in social infrastructure sectors such as education and health. The deteriorated status of public sector finances has resulted in an increased need for efficient renovation and operation and maintenance (O&M) in social infrastructure. This has meant the use of the capacity of the private sector via PPP for social infrastructure development. Meanwhile, to develop an economic infrastructure that can yield revenue, the public sector has started to introduce the concession method to respond to the need for efficient infrastructure management by operators in light of ongoing decreases in population. Ⅱ The Case of Japan Table 2.1  Number of Disclosed PPP Implementation Plans in Japan, by Sector Implementation Entity Sector Total State government Local government Others Education and culture (schools, cultural 3 160 37 200 facilities) Life and welfare 0 23 0 23 Health and environment (medical facilities, waste management, funeral 0 97 2 99 facilities) Industry (tourism, agricultural promotion 0 14 0 14 facilities) City development (roads, parks, sewers) 14 116 2 132 Security (police, fire stations, prisons) 8 17 0 25 Government offices and their housing 42 14 4 60 Others 7 49 0 56 Total 74 490 45 609 Source: Cabinet Office 2017 (as of March 31, 2017). Note: PPP = public-private partnership. Business Models in Japanese PPP Projects More than 60 percent of PPP projects in Japan use the build-transfer-own (BTO) model, under which the ownership of facilities will be transferred to the public sector at the completion of construction (figure 2.2). In contrast, under the build-operate-transfer (BOT) model, the contractors own the facilities during the contract period, The BTO model 25 has been common in Japan because real estate acquisition taxes and property taxes are not imposed on infrastructure owned by the public. In addition, because the public has ownership of facilities built via the BTO model, potential contractors consider the tax burden on them to be lower, and unitary charges from the public will be reduced compared with other methods. The amendment of the PFI Act in 2011 introduced the concession model. The concession model sells the management rights to a private entity whether or not new construction works are planned. Airport and toll road projects have already started to introduce the concession model, including projects such as Sendai Airport, the Kansai International Airport, and Osaka International Airport. More projects using the concession model are likely to be developed in the future alongside existing PPP models. Figure 2.2  Business Models in Japanese PPP Projects, 2016 13% 4% 5% BTO BOT 12% BT 66% RO Others Source: “Number of PFI Projects by Project Structure,” [in Japanese], Private Finance Initiative Association, http://pfi-as.jp/case/cat4692/post_29.html. Note: BOT = build-operate-transfer. BT = build-transfer. BTO = build-transfer-operate. PPP = public-private partnership. RO = rehabilitate-operate. “Others” includes BOO (build-own-operate), DB (design-build), and so on. There are three approaches to pay unitary charges in PPP: (a) availability payment (governments pay unitary charges to operators); (b) user payment (operators earn income from user fees); and (c) joint venture (operators receive fees from users as income, but also receive a subsidy to make up for shortfalls). Eighty-seven percent of Japanese PPP projects have introduced the availability payment method, and this approach is the premise for social infrastructure development projects in Japan (figure 2.3). Figure 2.3  Business Approaches in Japanese PPP Projects, 2016 6% 7% Availability Payment 87% Joint Venture User Payment Source: Japan PFI/PPP Association 2016. Note: Chart shows the methods by which charges are paid in PPPs (public-private partnerships)—that is, how payment is bundled to the private sector for capital spending as well as ongoing operation and maintenance costs. 26 Selection of the Procurement Method Typically, a procurement agency is entrusted with the selection of procurement methods for public works projects. The agency considers whether projects should be developed as a traditional public project or as a PPP based on the project’s characteristics. The government prefers PPP for projects that can benefit from private sector’s know-how and whose budgets exceed a certain value. It is also possible for a contracting authority to select a procurement method that considers legal framework limitations, emergency conditions, and the uniqueness of the project. Moreover, if a PPP offers an attractive project scope to private operators, it encourages private operators to participate in further such projects and will expand the PPP market. In addition to selecting a procurement method, a value for money (VfM) analysis is conducted. A PPP is chosen as the development model when a procurement agency judges that a project is suitable for being implemented as a PPP and would yield positive effects. In the case of Sendai City, resilience is considered when conducting a VfM analysis in terms of the efficiency of disaster response and recovery. Box 2.1   Case of Sendai City: Incorporating resilience in VfM analysis Ⅱ The Case of Japan Although business continuity is not regularly tested through the VfM analysis, Sendai City’s approach is to consider resilience during selection of the procurement method. It compares two scenarios: (a) where the project is handled by a public administrator, and (b) where a private operator builds and operates the facility under the BOT scheme. In the first case, disaster response required time and human resources from Sendai City to evaluate damage, apply for a contingency budget, and submit documents to the municipal assembly. As a result, Sendai City considers the BOT model to have more advantages for the municipal administration than traditional public works or regular BTO projects, in terms of the municipality’s personnel and time saving in response to a natural disaster. 2.2  Legal Frameworks for PPP and DRM PFI Act Japan introduced the PPP model on a large scale by enacting the PFI Act and making subsequent efforts to promote its spread. In addition to the 1999 enactment of the PFI Act, the Cabinet Office has established a PPP/PFI Promotion Office, which plays an advisory role to the prime minister and other relevant public agencies. It has developed several guidelines that help local governments understand the process of PPP projects and contracting. Moreover, the same office provides the public with information that promotes PPPs and coordinates PPP promotion across various agencies at the central government level. Given its advisory role, it neither prepares individual projects nor provides financing to PPP projects. Disaster Countermeasures Basic Act The Disaster Countermeasures Basic Act (the Act, hereafter), enacted in 1961, serves as the basis for the DRM system in Japan. The Act clearly defines the roles and responsibilities of the central and local governments for all phases of DRM such as risk identification, risk reduction, preparedness, emergency responses, and recovery. Regarding activities related to disaster recovery efforts, the relevant entities of the public and private sectors will work together to implement various disaster countermeasures by ensuring the cooperation of private organizations. The Act has constantly been reviewed and amended since its enactment, taking into account the lessons learned from large- scale disasters. 27 In Japan, the Cabinet Office is responsible for ensuring cooperation and collaboration among related government agencies on wide-ranging issues, and it is mandated to plan basic DRM policies and responses to large-scale disasters as well as conduct overall coordination. Both prefectures and cities are responsible for leading the preparation of concrete DRM plans at the local level in accordance with the central DRM policies and plans (figure 2.4). Figure 2.4  Institutional DRM Responsibilities and Coordination in Japan, by Level Prime Minister Central The Central Disaster Management Council government (formulating and promoting implementation of the Basic Disaster Management Plan) level Designated local government organizations and local public corporations (formulating and implementing the Disaster Management Operation Plan) Governors Prefectural Disaster Management Council Prefecture (formulating and promoting implementation of Prefectural Disaster Management Plan） level Designated local government organizations and local public corporations (formulating and implementing the Prefectural Disaster Management Operation Plan) Mayors of Cities, Towns, and Villages Municipality （formulating and promoting implementation of the Municipal Disaster Management Plan) level Municipal Disaster Management Council Source: Cabinet Office 2016b. Note: DRM = disaster risk management. In addition, laws and standards related to public infrastructure, such as the Building Standards Act and infrastructure sector-specific laws and standards, have been enacted, reviewed, or strengthened with each occurrence of a large- scale disaster (as further detailed in appendix A.) 2.3  Risk Sharing between Public and Private Entities Standard Contract Condition for Public Works In PPP projects in Japan, “division of responsibilities against force majeure among public and private entities” (defined in Article 29, Paragraph 4, of the Standard Condition of Contracts for Public Works) is used as a reference to respond to disasters resulting from force majeure. Regarding damages caused by force majeure in a public work, damages up to 1 percent of the contract value will be borne by the contractor, while the contracting authority (public sector) generally bears damages that exceed 1 percent of the contract amount. Similarly, in many PPP cases, the private operator bears expenses up to 1 percent of the amount of the initial investment cost when the facility is 28 damaged during construction, or the expenses up to 1 percent of the amount of the annual O&M costs when the facility is damaged during the O&M phase. In cases where the above “1 percent rule” in the standard condition of contracts for public works is not applied, the relevant entities discuss and agree on the extent of payment increases for the private operator or the public entity. This is done by examining whether the payment of 1 percent by the private operator is appropriate while taking into account the characteristics of the relevant PPP project to determine risk sharing between the public and private entities. Thus, it can be inferred that PPP projects in Japan allocate additional costs resulting from force majeure based on the rules stipulated in the standard condition of contracts for public works. On the other hand, for concession model projects, the rule mentioned above is not always followed. The risk sharing between the public and private entities is generally determined on a case-by-case basis without following the standard condition of contracts for public works. This is most likely because a concession model involves the sale of operating rights of public facilities to private operators; therefore, greater risks, including the events of a disaster, are to be transferred to private sectors. Concession projects are thus prepared based on the premise of disaster responses by private operators. Ⅱ The Case of Japan Disaster Recovery Subsidy Systems in Public Works If disaster affects a facility constructed in a public work and owned by a local government, local governments can obtain public support and subsidies from the central government to raise money for recovery costs. The definitions of eligible disasters and the defrayment and subsidy rate vary according to the type of facility (table 2.2). The defrayment rate for public civil engineering facilities such as roads, harbors, and sewerage systems as well as educational facilities is two-thirds or more, and disasters for which the central government will bear the cost for recovery are defined relatively clearly. However, for medical and welfare facilities, the subsidy is relatively small, and the definitions of eligible disasters are not clearly stipulated. 29 Table 2.2  Disaster Recovery Defrayment and Subsidy Systems in Japan for Public Works, by Project Type Defrayment Disaster recovery Target facilities Definitions of eligible disasters or subsidy project type rate Disasters from abnormal natural phenomena: 1. Rivers: water level exceeding (a) the warning water level; (b) approx. 50 percent of the river bank (where the warning water level is not determined); or (c) snowmelt for a long period Public civil engineering facilities 2. In facilities other than rivers: (a) maximum rainfall of 80 Roads, harbors, Governing laws: millimeters or more in 24 hours; or (b) rainfall of 20 millimeters or fishing ports, National Government more per hour 2/3 or Sewerage systems, Defrayment Act for more parks, sediment 3. Maximum wind speed of 15 meters or more (average in 10 Reconstruction of control facilities minutes) Disaster-Stricken Public Facilities 4. High tide, wave, or tsunami causing nonminor disasters 5. Disasters due to an earthquake, landslide, or lightning strike 6. Disasters due to snow depth of 1 meter or more that exceeds the average of the maximum snow depth in the past 10 years Public school •  Rainfall: (a) maximum rainfall of 80 millimeters or more in 24 facilities (buildings, hours; (b) continuous rainfall in significantly large quantity (180 structures other millimeters or more in three days (72 hours); or (c) hourly rainfall in Educational facilities than buildings, significantly large quantity (20 millimeters or more) Governing laws: lands, facilities) •  Storm: maximum wind speed of 15 meters per second or more Act on National Joint-use facilities (average in 10 minutes) Treasury’s Sharing of (jointly used school •  Flood, high tide, tsunami, and other disasters causing relatively 2/3 Expenses for Recovery of Public School meal preparation nonminor damage Facilities Damaged by facility, joint school •  Others: amount of falling ash from January 1 to December 31 of that Disaster dormitories, joint year is 1,000 grams per square meter or more training centers for industrial •  Others: eruptions, earthquakes, great fire, snowmelt, tornados, education) lightning strikes, and others Public medical Medical facilities facilities, political Governing laws: Storm, torrential rain, flood, high tide, earthquakes, tsunami, medical facilities, 1/2 Various laws controlled eruption, and other abnormal natural phenomena medical personnel by MHLW training facilities Social welfare Welfare facilities, facilities nursing facilities, Storm, flood, high tide, earthquakes, and other abnormal natural Governing laws: 1/2 to 4/5 children’s facilities, phenomena Various laws controlled and the like by MHLW For construction required because of a disaster such as an earthquake, high tide, or an abnormal natural phenomenon, the costs for damages shall be allocated based on the following policy: •  Airport set up and managed by the central government: 80 percent and Airports Runways or landing 20 percent of recovery costs shall be paid, respectively, by the Governing laws: strips central government and the prefecture in which the airport exists. Airport Act •  Airport set up and managed by a local government: 80 percent and 20 percent of the recovery costs shall be paid, respectively, by the central government and the prefecture that manages the airport. Sources: Websites of Public Interest Incorporated Association of Nationwide Disaster Prevention (http://www.zenkokubousai.or.jp/ download/09saigaisaitaku.pdf); Ministry of Education, Culture, Sports, Science and Technology (http://www.mext.go.jp/a_menu/shisetu/bousai/011101/ gaiyou.htm); Ministry of Health, Labour and Welfare (http://www.mhlw.go.jp/shinsai_jouhou/dl/iryoushisetu_04.pdf); Iwate Prefecture (https://www.pref. iwate.jp/dbps_data/_material_/_files/000/000/002/418/05_yomikaego.pdf); and e-Gov (http://law.e-gov.go.jp/htmldata/S31/S31HO080.html). Note: MHLW = Ministry of Health, Labour and Welfare. 30 2.4  Disaster Risks in the PFI Act and Guidelines The PFI Act itself does not specify the responses to resilient infrastructure development and natural disasters, but infrastructure development follows legal frameworks for DRM prepared and implemented by the central and local governments. The Fundamental Plan for National Resilience, approved by the Japanese Cabinet in 2014, aims to strengthen infrastructure resilience at the policy level by specifying policies and programs, taking into account the results of vulnerability assessments (Cabinet Office 2014). This plan focuses on both structural and nonstructural DRM measures (the latter including DRM education) and considers PPP/PFI is to be a tool for infrastructure development and managing or reconstructing aging infrastructure. Meanwhile, guidelines for implementation of PPP projects and the PPP standard contract point out the importance of handling force majeure, including disaster risks. The guidelines are not mandatory; additional references on how force majeure is treated in other legislation can also be referred to in the development of PPP projects. Moreover, not all the agreements and rules specified in the standard contract and guidelines have to be applied to all the projects, because these are just resources to facilitate implementation. Referring to responses to disaster preparedness and force majeure applied in existing laws and regulations, the guidelines recommend further Ⅱ The Case of Japan discussion to take specific features of each project into account (table 2.3). Table 2.3  Disaster Risk Management Guidance in the Japanese PPP Guidelines Guideline Content Disasters can affect any stage of PPP projects, such as planning, acquisition of lands, construction, and maintenance and operations; therefore, to avoid causing disputes over additional costs, it is Guideline on Risk recommended that, as much as possible, the agreements specify the level of disasters, the range of compensation, the guidelines on the use of insurance to compensate costs, the procedure to handle Allocation in PFI cumulative damage, and the damage reporting and confirmation process. For a definition of force Projectsa majeure, the guideline exemplifies the definitions in the Disaster Countermeasures Basic Law and the cost sharing in the Construction Contract Agreement for public works (standard condition of contracts for public works). Guidelines for Private operators are required to bear a partial cost burden of any increased costs or losses, which Contract: Points to should incentivize them to minimize losses caused by force majeure. The public sector will commonly Consider for PPP be responsible for the remainder of the costs. The contract for public works will be used to decide the Project Contractsb damage range. PFI Standard Contract Reflecting the contents explained in the guidelines above, this standard contract is the practical guide (for public facility for availability payment PPP projects. However, there is no mandatory requirement as to its use; rather, development and based on this standard, it is recommended that each contract take into account the particular project availability payment)c details. Note: DRM = disaster risk management. PFI = private finance initiative. PPP = public-private partnership. a. http://www8.cao.go.jp/pfi/hourei/guideline/pdf/risk_buntan_guideline.pdf. b. http://www8.cao.go.jp/pfi/hourei/guideline/pdf/keiyaku_guideline.pdf. c. http://www8.cao.go.jp/pfi/hourei/keiyaku1/pdf/pficontract1.pdf. In this way, although the PFI Act does not specify disaster resilience in infrastructure development, disaster resilience is embedded as a part of the disaster resilience policy at the central level. While PPP/PFI has been promoted as one of the means for infrastructure development, the PFI Act and related guidelines do not set unique standards towards resilient infrastructure. The PPP contract instead conforms to existing laws and regulations on public works and DRM. Therefore, implementation guides and bidder information sheets for PPP projects usually require compliance with the standards of DRM specified in the Disaster Countermeasures Basic Act, or local DRM plans. 31 2.5  Summary and Key Takeaways This chapter highlights the following recommendations for the policy framework of resilient infrastructure PPPs. Select a Procurement Method Based on Risk-Informed VfM Analysis The choice of a conventional public works project model or PPP for procurement is decided considering the legal regulations, urgency, and characteristics of each project, including bankability. Sendai City innovatively considers resilience and business continuity in VfM analysis. The investigation and verification of VfM in terms of resilience enables the contracting authority to select the most effective method to minimize economic losses when disasters occur. It is necessary to establish an enabling environment to estimate disaster risks to quantitatively evaluate the benefits of resilience in VfM analysis. For example, a contracting authority can compile and analyze past disaster data and information and make these available to the public. Underpin Resilient Infrastructure PPPs with DRM Policy and Legislative Frameworks The level of disaster resilience that PPP projects should have is specified in accordance with regulations at both the central and local government levels, similar to other public works projects. Although the PFI Act does not specifically mention disasters or resilient infrastructure development, DRM policies and legislation at both the central and local government levels are similarly applied to infrastructure PPPs in terms of both structural and nonstructural measures and standards. These include the Disaster Countermeasures Basic Act, business continuity planning guidelines, and local DRM plans and hazard maps developed by municipalities. Also, when DRM legislation is amended, private operators are required to comply with such amendments. With respect to risk sharing and cooperation between the government and private sector in public works, the public sector often bears major disaster risks and is responsible for securing public resources for emergency response and recovery of infrastructure services in Japan. In addition to the certain level of public commitment in DRM, the guidelines for PPPs recommend appropriate risk allocation between the public and the private sectors based on the nature of projects (for example, criticality), commercial viability, and VfM. Disaster resilience is usually ensured by complying with these construction and operation standards initially, rather than by individually adjusting the resilience requirements for each project. However, it is recommended that more- detailed standards be established that can be tailored to the characteristics of each project. 32 3. Contracting and Disaster Risk Allocation This chapter summarizes how disaster risks are contractually defined and allocated between the public and private sectors in Japanese infrastructure public-private partnership (PPP) contracts. 3.1  Definition of Force Majeure In a PPP project, roles and risks should be allocated between the public and private sectors in a long-term contract, and the provision of facilities and services should be defined. In a user payment PPP project (whereby operators earn income from user fees), a financing method such as a project finance scheme is frequently adopted where a project cash flow is used as the only source of repayment. This method is different from financing methods based on the creditworthiness of enterprises or the government. For projects that adopt project finance schemes, an appropriate plan must be established to generate sufficient cash flow for a given period of years in order to raise funds from investors and banking organizations. Ⅱ The Case of Japan Large-scale natural disasters that cannot be foreseen and managed by a private operator are among the risk factors in a PPP project. Therefore, defining force majeure—recognized as a large-scale disaster in a PPP project—and contractually allocating the disaster risks between the public and private entities are essential for structuring a PPP project. The subsequent subsections summarize the definition of force majeure in PPP projects in Japan. They also cover the guidelines for setting this definition and review the methods for defining force majeure in actual infrastructure PPP projects. Methods for Defining Force Majeure As shown in Box 3.1, the “Guidelines for Contract: Points to Consider for PPP Project Contracts” released by the PPP/ PFI Promotion Office of the Cabinet Office defines force majeure as follows: “an obstacle that is generated externally without any relation to the actions, such as an agreement, made by the entities and cannot be prevented even if the generally required precautions and preventive actions are taken.” More specifically, it is categorized as “a natural disaster that is not attributable to the contracting authority and the private operator; in particular, a storm, torrential rain, flood, high tide, landslide, cave-in, lightning strike, earthquake, fire, generation of poisonous gas, etc., which fall under natural disasters, as well as a disturbance, riot, war, and act of terrorism, which fall under man-made disasters.” However, the final definition of force majeure is not confirmed until both public and private entities agree. Therefore, it is defined separately for each project by reflecting the project characteristics and site conditions. 33 Box 3.1   Guidelines for Risk Sharing in PPP Projects (Excerpts) Risks common to all phases (1) Force Majeure Force Majeure is an obstacle that is generated externally without any relation to the actions (such as contracts) made by the entities, and cannot be prevented even if the generally required precautions and preventive actions are taken. In any phase of the project, including design, securing a site, construction, maintenance, management and operation, the project can be affected by Force Majeure, such as a natural disaster that is not attributable to the contracting authority and private operators. This may result in damage to the temporary buildings in the investigation phase; damage to the construction activities in the construction phase; damage to the facilities in the maintenance and management phase; suspension and/or delay of the project during the design, site procurement and construction phases; larger costs incurred for each phase than the contract value; and other issues. Therefore, it is recommended to consider and examine who should bear the additional costs and how to extend the project period in advance, and set up a detailed agreement as much as possible. (Reference) 1) Regarding natural disasters, item (i), paragraph 1, Article 2 of Disaster Countermeasures Basic Act (No. 223, 1961) stipulates “disaster means a storm, tornado, torrential rain, heavy snow, flood, coastal landslide, debris flow, high tide, earthquake, tsunami, eruption, landslide or other unusual natural phenomena, or a conflagration, explosion, or any other damage of similar extent from a cause prescribed by the ordinance.” Article 1 of the enforcement ordinance of the same act stipulates the “release of a large amount of radioactive materials and large-scale accidents including shipwreck involving a large number of victims” as causes defined by the ordinance. On the other hand, in some contract documents used for regular public works, a disaster is defined as “a natural disaster or man-made disaster including a storm, torrential rain, flood, high tide, earthquake, landslide, cave-in, fire, disturbance, and riot.” It is also beneficial to consider the inclusion of extraordinary long-term rainfall, long-term snowfall, avalanche, discovery of a buried cultural property, unpredictable soft ground, and eruption of poisonous gas in the definition. 2) To avoid a dispute when actual additional costs are required based on an agreement, it is recommended to determine which occurrences should be considered as disasters, the scope of payment, handling of the compensation by insurance, handling of accumulated damages, and the ways of notification or confirmation when damages occur and to reflect them in the agreement. 3) In addition to fire insurance and earthquake insurance, weather insurance has become commoditized in recent years. Combined with new insurance and financial technologies and the development of the market infrastructure, it is required to consider broad ways of mitigating risks. Therefore, it is recommended to consider and examine risk reduction measures at the point of time. It is also beneficial for the contracting authority to stipulate an agreement that will allow them to ask the private operator to submit its insurance certificate, so that disputes regarding actual additional costs that are incurred in the event of Force Majeure can be avoided. 4) As an example, a contract document used for regular public works contained the following clause: If any of the target objectives is damaged (excluding those that have been damaged due to the contractor’s negligence to duty of care or any damage that can be compensated by the insurance defined in the design documents) by a disaster that is not attributable to both the contracting authority and private contractor (referred to as “Force Majeure”) before delivery of the objects of the public works, the contracting authority shall pay XX percent of the contract payment. Source: “Guideline on Risk Allocation in PFI Projects,” Cabinet Office, http://www8.cao.go.jp/pfi/hourei/guideline/pdf/risk_buntan_guideline.pdf. In Japan, a contracting authority generally drafts the definition of force majeure based on the guidelines listed in chapter 2, table 2.3. During the investor selection phase, the public and private entities discuss the definition through questions and answers and competitive dialogues and agree on a final definition of force majeure that is acceptable to private operators and investors (box 3.2). 34 Box 3.2   Case: Invitation for Bids Q&A Example, Sendai Astronomical Observatory Project The definition of force majeure in your proposal says that the criterion concerning earthquakes should be “seismic intensity 4 Q:  or lower.” I think we should determine specific points for observation in advance for the contract. If you already have such specific observation points in mind, please let us know. I would also like to know whether this rule applies to similar earthquakes that are recorded in an instance. We are planning to set up observation points on the first floor and top floor of the building. Since the exact observation points A:  can change depending on your plan, we will discuss the issue and finalize it before concluding the contract. The rule shall apply to all seismic intensity recorded in the seismometer. Photo 3.1  Sendai Astronomical Observatory Source: Sendai Astronomical Observatory. ©Sendai Astronomical Observatory. Reproduced, with permission, from Sendai Astronomical Observatory; Ⅱ The Case of Japan further permission required for reuse. Evolution of Force Majeure Based on Lessons Learned Build-Operate-Transfer Projects The original definition of force majeure for PPP projects was not complete, but it has been gradually clarified through the accumulation of project experience, as seen in the case example of Sendai City, which progressively introduced the PPP model in Japan. The “Spopark Matsumori” health facility project (2004 – 2020), which uses waste heat from the “Matsumori Plant,” was an early PPP project of Sendai City. In this project, the definition of force majeure simply lists examples of disaster types and stipulates that no attribution of responsibility exists (box 3.3). For this reason, the application of this article was eventually entrusted to discussions between the public and private entities, and it might have been difficult for private businesses to determine to what extent damages would be covered by the article on force majeure before the project had even started. 35 Box 3.3   Case: Definition of “Act of God,” Sendai Health Facility Project “An act of God means a storm, torrential rain, flood, high tide, landslide, cave-in, lightning strike, earthquake, fire and any other natural disaster, or a disturbance, riot, uprising, and any other manmade disaster, which are not attributable to the city and business operators.” Source: Project Contract, Attachment 14, List of Definitions (extracted) Photo 3.2  Aerial View of Spopark Matsumori Health Facility Project Source: City of Sendai. ©City of Sendai. Reproduced, with permission, from Sendai City; further permission required for reuse. During project implementation, the 2005 Miyagi Earthquake occurred, which affected the project facilities. About 90 percent of the ceiling of the warm indoor pool collapsed, injuring 35 people. After the accident, the Spopark Matsumori Accident Response and Investigation Committee was established. The committee pointed out problems with the risk management between the public and private entities, and suggested clarifying the way to handle force majeure going forward. As a result, the definition of force majeure and the disaster level at which private businesses should take measures were clarified for the New Sendai Astronomical Observatory Development and Management Project (hereafter, Sendai Astronomical Observatory Project), which was the next PPP project undertaken by Sendai City. Disaster risk management by private businesses was enhanced in this project. In Attachment 13 of the contract, the criterion for risk sharing was defined as seismic intensity 4 (box 3.4).4 This is because the costly reflector of the old astronomical observatory was damaged during the 2005 Miyagi Earthquake of seismic intensity 5, which occurred before the start of the new Sendai Astronomical Observatory Project (2008 – 2038), but the reflector had never been damaged with an earthquake of seismic intensity 4 before. Thus, it was assumed possible for companies to take necessary measures as part of regular business activities after an earthquake of seismic intensity 4 or lower. 4   “Seismic intensity” is measured on the Japan Meteorological Agency’s seismic intensity scale. 36 Definition of Force Majeure and Related Risk Sharing, Sendai Astronomical Box 3.4   Case:  Observatory Project Chapter 1 of Project Contract: Article 1, Definition of Terms “Force Majeure means a phenomenon that normally cannot be foreseen (limited to phenomena that exceed the level or range defined in the bid document or design document, if any). Such phenomena include a storm, torrential rain, flood, high tide, lightning strike, landslide, cave-in, earthquake and any other natural disaster, or a war, act of terrorism, radioactive contamination, fire, disturbance, riot, uprising, and any other man-made disaster, which are not attributable to the city and private operators. Note, however, that amendments to the law shall not be included as Force Majeure.” Attachment 13: Additional Costs due to Force Majeure and Sharing the Burden for Damages (extracted) If an earthquake of Seismic Intensity 4 or lower has occurred or a lightning strike has occurred due to a faulty lightning protection system or insufficient measures, the additional costs and damages incurred by the private operator shall be borne by the private operator. In this case, compared with the preceding example of the Spopark Matsumori (health facility) project in Sendai City, not only are examples of force majeure listed but the predictability is also incorporated as the basis for determining Ⅱ The Case of Japan whether an event should be treated as force majeure. Furthermore, the public sector and private sector have been attempting to clarify the scope of force majeure using numerical objective criteria. One example is the stipulation that damages and additional costs shall be borne by the private operator in case of an earthquake of seismic intensity 4 or lower or a lightning strike due to a faulty lightning protection system that could have been foreseen by the private operator. Therefore, whether a seismic event is substantially determined as force majeure depends on its seismic intensity (an earthquake exceeding seismic intensity 4 being deemed as force majeure). During the bid invitation stage for the Sendai Astronomical Observatory Project, Sendai City indicated that seismometers would be installed on the first and top floors of the building to serve as earthquake observation points that would be used to determine whether an earthquake fell under the force majeure provisions (as seen in box 3.2). The public authority also gave clear demonstrations of the observation method. Similarly, in the Shin Nomura School Meal Supply Center Development Project (hereafter, Sendai School Meal Supply Center Project), which was launched after the Sendai Astronomical Observatory Project, clarification on the definition of force majeure was also pursued. In addition, the scope covered under force majeure for earthquakes, storms, snowfall, and terrorist attacks was clearly defined in Attachment 13 of the project contract. Here, the risk shared between the public and private entities during force majeure was clarified by defining force majeure more clearly. In particular, for earthquakes and storms, not only were the numerical criteria clearly listed, but the surrounding conditions were also used to determine whether they should be treated as a force majeure. Moreover, facility damage due to defects in maintenance were clearly differentiated from force majeure, prompting the private operator to carry out maintenance of the facilities to ensure its safety (table 3.1). 37 Table 3.1  Scope of Force Majeure, Sendai School Meal Supply Center Project Classification Scope of acts of God It shall be regarded as Force Majeure if the earthquake has a measured Seismic Intensity of 6.5 or higher, has a Japan Meteorological Agency Seismic Intensity scale of 7, has a surface horizontal acceleration of Earthquake approximately 500 gal, occurs rarely, is bigger than the Great Hanshin-Awaji Earthquake, and has damaged more than half of the surrounding buildings that were built around the same time under similar conditions equally or more severely [than] the building of the project.a It shall be regarded as Force Majeure if the wind pressure on each part of the building exceeds the reference wind speed of 30 meters per second (average wind speed in 10 minutes at 10 meters above the ground), which is defined in the Building Standard Law, and at the same time, more than half of the Storm surrounding buildings that were built around the same time under similar conditions have been damaged equally or more severely [than] the building of the project. Although localized seismic singularity and phenomena such as downburst shall be regarded as Force Majeure, the private operators have to probe these phenomena to contracting authority. For heavy snow, the private operator can estimate whether the amount of snow will eventually exceed the design load if it was left alone and can prevent damages resulting from heavy snow by removing the snow Snowfall as needed or taking other measures. Therefore, it shall not be regarded as Force Majeure even if the amount of snow has exceeded the design load. Organized, well-planned terrorist activities that cannot be prevented despite taking crime-prevention Act of terrorism efforts that are generally considered reasonable shall be regarded as Force Majeure. Source: Contract documents (only those that have been disclosed), Shin Nomura School Meal Supply Center Development Project, Sendai City. “Seismic intensity” is measured on the Japan Meteorological Agency’s seismic intensity scale. Seismic intensity is the value observed at a site where a a.  seismic intensity meter is installed, and may vary within the same city. It is a scale of 1 to 7, with 5 and 6 each divided into “lower” and “upper.” In the case examples of Sendai City, as seen above, the definition of force majeure is clarified based on the experiences of past disasters. For the Spopark Matsumori (health facility) PPP project, the scope of force majeure was not shown using objective criteria (such as numerical criteria); the article on force majeure in the contract simply listed examples of force majeure and stipulated that the entities (city and private operator) are not attributable. When the Miyagi Earthquake occurred in 2005, damage to the facilities was considered to be caused by defects that could have been attributed to the private operator. However, it was recognized that the criteria for judging a force majeure event were unclear. Having learned from this experience, the definition and risk sharing between the public and private entities have gradually been clarified for subsequent PPP projects of Sendai City. In the case example of the Sendai Astronomical Observatory Project, the predictability factor was added to the definition and a numerical criterion (seismic intensity) added to determine whether damages from an earthquake should be borne by the private sector, thus clarifying the risk shared between the public and private entities. This allows business operators to consider and examine concrete risk reduction measures more easily when submitting a proposal for a project. For the School Meal Supply Center Project, the numerical criteria were clarified, particularly for earthquakes and storms, and the definition added a criterion that “more than half of the surrounding buildings that were built around the same time under similar conditions have been damaged equally or more severely compared to the building of the project.” This clearly distinguishes the damages from force majeure from those attributed to the weakness of the facilities caused by defects in maintenance, thus incentivizing the private operator to ensure maintenance. Concession PPP Projects In recent years, the concession scheme has gradually been introduced to airports in Japan. In the concession scheme, the right to operate public facilities such as water and sewerage systems, toll roads, and airports is purchased from the government by private operators, who operate and maintain the infrastructure with an income from user fees as their funds (figure 3.1). 38 Figure 3.1  Structure of a PPP Concession Scheme in Japan Lender (banking organizations, investors) Loan / Set mortgage investment Property rights Operating rights for facilities Give operating rights Provide services Awarding Authority Private Operator Users Pay compensation Pay fees for for operating rights the services Source: “Concession Method,” website of the PPP/PFI Promotion Office, Cabinet Office, Government of Japan, http://www8.cao.go.jp/pfi/concession/pdf/ con_houshiki.pdf. Translation by PwC. Note: PPP = public-private partnership. Ⅱ The Case of Japan In the concession scheme, in principle, private operators are to bear the risk of force majeure events. To make such a risky project bankable, private operators need to improve the predictability of cash flow; therefore, the definition of force majeure tends to be narrowed further. The Sendai Airport Operation (hereafter, Sendai International Airport Project) was the first airport privatization project in Japan. A tsunami induced by the 2011 Great East Japan Earthquake inundated and damaged the electrical and mechanical equipment, ventilation system, and sanitation system in the terminal building as well as the airport rail line (Miyagi Prefecture 2012). Miyagi Prefecture expected that privatization of the airport operation would help quickly revitalize the local economy. The concession scheme was introduced in this project, which defined force majeure as shown in box 3.5. Box 3.5   Case: Definition of Force Majeure, Sendai International Airport Project Attachment 1 of the Project Contract: List of Definitions Force Majeure is a factor that affects the performance in this contract directly and adversely, and any of the phenomena listed below (limited to those that exceed the criteria that have been determined in advance based on the agreement between the contracting authority and the private operator with administration rights), which are not attributable to both the central government and the business operator with administration rights and can be foreseen by neither the central government nor the owner of the right, or from which, even if it was possible to foresee it, no reasonable means of preventing the occurrence of losses, damages, or failures due to the factor can be expected. (i) Extreme weather (including storm, lightning strike, torrential rain, strong wind, hurricane, typhoon, cyclone, abnormal heat wave, and abnormal cold wave, which are more extreme than those that usually or regularly occur in or around this airport) (ii) A natural disaster (including a flood, high tide, landslide, lightning strike, earthquake, fire, tsunami, and any other natural disaster that cannot be avoided and foreseen, which bring significant and inevitable damage to this airport) (iii) A civil war or act of hostility (including a riot, disturbance, uprising, act of terrorism, and act of war. The central government’s use of this airport in such circumstance is included.) (iv) An epidemic (cases where quarantine is required forcibly by the law are included.) 39 Photo 3.3.  Sendai International Airport Terminal Building Source: Pixta.jp. In the example of the Sendai International Airport Project, the criterion “even if it was possible to foresee it, no reasonable means of preventing the occurrence of losses, damages, or failures due to the factor can be expected,” has been added, which did not exist in earlier availability payment projects. In addition, force majeure is classified clearly into different types: extreme weather, natural disaster, civil war or act of hostility, and epidemic. The earlier availability payment projects of Sendai City included storms, torrential rain, floods and other natural disasters as force majeure, but there was no differentiation between extreme weather and natural disasters. The case example of the Sendai International Airport Project also defines “epidemic,” which is an event specific to airports that should be taken into consideration. It further narrows the definition of a “natural disaster” by limiting it to those that “bring significant and inevitable harm to this airport.” Regarding the description of “extreme weather,” the provision on “more extreme than those that usually or regularly occur in or around this airport” offers a clearer definition of force majeure, prompting other PPP projects to take into account extreme weather that has been frequently seen in recent years. Box 3.6 provides international examples of how force majeure is recommended to be defined. 40 Box 3.6   Defining Force Majeure: International Examples Standardization of PF2 Contracts (United Kingdom) In the United Kingdom, a guidance known as the Standardisation of PF2 Contracts was published in 2012 (HM Treasury 2012). In this standard contract, natural disasters are defined as “Relief Events,” which are distinguished from “Force Majeure Events.” Relief Events include direct phenomena, such as fire; explosions; lightning; storms; tempests; floods; bursting or overflowing of water tanks, apparatus, or pipes; ionizing radiation (to the extent it does not constitute a Force Majeure Event); earthquakes; and riot and civil commotion. It also includes some indirect phenomena, such as failure by any statutory undertaker, utility company, local authority, or other like body to carry out their works or provide services as well as accidental loss or damage and any failure or shortage of power, fuel, or transport. This standard contract considers that Relief Events are likely either short-lived or lead to an alternative supply source; therefore, the contractor still can provide contracted services despite the occurrence of Relief Events. Meanwhile, Force Majeure Events are likely to have catastrophic effects in both public and private entities, and neither of the entities is likely to be in a better position to manage such risks. Such events are typically limited to wars, terrorism, and nuclear contamination. Legislative Guide on Privately Financed Infrastructure Projects (UNCITRAL) The United Nations Commission on International Trade Law (UNCITRAL) published the Legislative Guide on Privately Financed Infrastructure Projects in 2001. This guide defines Force Majeure as risk that the project may be disrupted by unforeseen or Ⅱ The Case of Japan extraordinary events outside the parties’ control. These include events such as natural disasters—floods, storms, or earthquakes— or the events that result from human action, such as war, riots, or terrorist attacks. Guidance on PPP Contractual Provisions (World Bank) In 2017, the World Bank compiled the “Guidance on PPP Contractual Provisions.” In this report, sample drafting of a “Definition of Force Majeure Event” covers two types: “natural Force Majeure” (such as natural disasters and epidemics) and political Force Majeure” (such as general strikes, nationalization, and the refusal to grant licenses). According to this report, force majeure refers to events that occur outside either entity’s control. Neither entity is better placed to manage the risk of such occurrences or their consequences, and therefore such risks will be shared. Examples of force majeure events are listed as follows (World Bank 2017): (a) plague, epidemic and natural disaster, such as but not limited to, storm, cyclone, typhoon, hurricane, tornado, blizzard, earthquake, volcanic activity, landslide, tsunami, flood, lightning, drought; (b) fire, explosion, or nuclear, biological or chemical contamination (other than a fire, explosion, or chemical contamination caused by the negligence of the Private Partner, its contractors, or any subcontractor, supplier or vendor); (c) war (whether declared or not), armed conflict (including but not limited to hostile attack, blockade, military embargo), hostilities, invasion, act of a foreign enemy, act of terrorism, sabotage or piracy [in each case occurring outside the Country]; (d) civil war, riot rebellion and revolution, military or usurped power, insurrection, civil commotion or disorder, mob violence, act of civil disobedience (in each case occurring outside the Country]; (e) radioactive contamination or ionizing radiation [occurring outside the Country]; or (f) general labor disturbance such as boycotts, strikes and lock-out, go-slow, occupation of factories and premises, excluding similar events which are unique to the PPP Project and specific to the Private Partner or to its sub-contractors [and occurring outside the Country]. Sources: HM Treasury 2012; UNCITRAL 2001; World Bank 2017. 41 3.2  Risk Allocation: Contractual Concepts and Effects Risks in PPP projects are to be assumed by the entity that can control the risks in the most efficient and effective manner. However, it is not reasonable to assume that either of the parties to a contract should bear the risks arising from force majeure, which are not attributable to either entity, although who should bear the risks remains an issue. On the other hand, it is difficult to anticipate all possible events that may occur during a long-term PPP project and decide how the risks should be shared in advance for all cases. Measures to take for each individual project are, in principle, decided through discussions between the public and private sectors. This section looks at contractual provisions, including how natural disaster risks are shared between the public and private sectors and which events and matters are anticipated as possible causes for terminating the contract. Furthermore, the issues are summarized by extracting concepts and backgrounds of the provisions from case examples, standard contracts, and other sources found in leading countries that have implemented PPP projects. Contractual Provisions Project contracts contain provisions set for cases in which additional costs are required or services cannot be provided because of the occurrence of force majeure. More specifically, provisions are set for procedures, handling of liabilities, division of responsibility for damage, and changes in contractual conditions for the design and construction and operation and maintenance (O&M) phases. Major items specified in contractual provisions are as follows: •  Details of damages and additional costs to be covered, as well as risk allocation between the public and private sectors •  Changes in obligation to provide services •  Changes in date scheduled for delivery of facilities •  Changes in the operating period •  Handling of insurance Risk Sharing between the Public and Private Entities The scope of force majeure, as well as natural disaster risks to be contractually shared between the public and private entities, are dependent on the ownership of facilities, profitability, and other characteristics. Under the traditional public procurement in Japan, the costs of force majeure risks are 99 percent borne by the public sector. Examples of force majeure events are defined in the contract, but most natural disaster damages are interpreted as force majeure in reality. Japan’s PPP projects of the first generation, mainly build-transfer-operate (BTO) projects with availability payment, adopted the same risk sharing as in the traditional procurement. On the other hand, Sendai City PPPs, as described in the previous section, were mostly build-operate-transfer (BOT) projects that transferred ownership of the assets to the private sector and elaborated upon the definition of force majeure to share risks with the private sector, if the private sector can bear these risks. In addition, profitable build- operate-transfer (BOT) projects allocate force majeure risks mainly to the private sector (figure 3.2). 42 Figure 3.2  Transfer of Natural Disaster Risks in BTO and BOT Projects, by Project Characteristics Project type Characteristics Scope of force majeure and risk allocation Small Large Natural disaster risks BTO Force Majeure • Samples of force majeure are identified. (availability • Force majeure risk will be mainly borne by payment) the public. Private Public • Provides more clarity on definition of force Force Majeure BOT majeure than the above. (availability payment) • Private party owns facilities and bear a part Private Public of natural disaster risks in some cases. BOT • Force majeure risks will be borne by the Force Majeure (user payment and private party under a project with high high profitability) profitability. Private Public Note: BOT = build-operate-transfer. BTO = build-transfer-operate. Ⅱ The Case of Japan Among the still-limited number of concession projects, risk sharing varies between road projects (with low profitability and high public nature) and airport projects (with high profitability), as shown in figure 3.3. Figure 3.3  Transfer of Natural Disaster Risks in Concession Projects, by Project Characteristics Project type Characteristics Scope of force majeure and risk allocation Small Large Natural disaster risks Concession Force Majeure • Natural disaster risks will be mainly borne by (strong public nature the public for concessions with strong public or low profitability) nature or low profitability. Private Public • Private parties bear risks, but force majeure is Force Majeure Concession limited to the risks they will be able to manage. (high profitability) • Other large natural disaster risks will be borne Private Public by the public. Damages and Additional Costs Risks are shared between the public and private entities for damages and additional costs resulting from force majeure. Compensation for lost earnings may become a point for discussion if the private sector’s profit-making business is included. However, the risk of lost earnings is not shared, and private businesses bear such risk in most cases. For damages or additional costs incurred by private businesses resulting from force majeure, risks are shared between the public and private entities as defined below for availability payment and concession projects. Availability Payment Projects As described earlier, many Japanese cases, especially availability payment PPP projects, require the public sector to bear the primary responsibility for risks resulting from force majeure and the private sector to bear the secondary 43 responsibility in accordance with standard stipulations for public works. Because economic incentives are limited for private businesses to minimize damage resulting from force majeure, contracts generally specify obligations for minimizing the damage so that moral hazard can be avoided. Although a cap is typically set on risk bearing for a private operator (equivalent to the small percentage of the annual payment amount), a project with a small annual payment may force the private sector to bear a greater share of the increasing cost than a standard contractual definition, thereby serving as an appropriate incentive (table 3.2). Furthermore, as in the case of Sendai City, some BOT projects provide private sectors with proprietary rights for facilities to increase their ownership awareness during the project period. Risks for certain disasters (for example, earthquakes of seismic intensity 4 or below) are assigned to private operators clearly to urge them to take appropriate disaster risk management (DRM) measures. Table 3.2  Risk Sharing Policy, by Project Phase, Sendai Health Facility Project Category Risk sharing policy •  Up to 1 percent of the initial capital investment costs shall be borne by the private operator, and the remaining amount shall be borne by the city. Construction •  However, if the amount covered by the insurance policy that had to be obtained under the project phase contract exceeds 1 percent of the initial investment costs, the excess shall be deducted from the amount of costs borne by the city. •  Up to 1 percent of the amount equivalent to the annual O&M costs shall be borne by the private operator, and the remaining amount shall be borne by the city. O&M phase •  However, if the amount covered by the insurance policy that had to be obtained under the project contract exceeds 1 percent of the amount equivalent to the annual O&M costs, the excess shall be deducted from the amount of costs borne by the city. Source: Contract documents, Spopark Matsumori Health Facility Project, Sendai City. Note: O&M = operation and maintenance. User Payment Projects Some user payment PPP projects, as well as the accompanying projects including profit-making facilities, require private operators to bear the risks resulting from force majeure. For instance, all risks resulting from force majeure are borne by the private operator in the Haneda International Airport Terminal Building Project because it is a user payment project and high profit is expected. Concession Projects Some concession projects define the risks shared between the public and private entities in accordance with the nature of the facility—whether it is basic infrastructure or a private profit-making facility. For instance, the Sendai International Airport concession project defines three types of risks to be shared depending on the situation (including national government intervention for continuing services) so that the runway and other airport facilities needed for aircrafts to take off and land can be operated on the occurrence of force majeure (box 3.7). On the other hand, the Sendai International Airport Terminal Building Project, which generates income, requires the concessionaire to bear all costs for disasters resulting from force majeure regardless of the situation and to continue services on its own responsibility because the government does not provide any business continuity measures. 44 Box 3.7   Case: Risk Sharing, Sendai International Airport Project Runways Three types of policies cover different situations for risk sharing between the public and private sectors when force majeure occurs. Additional costs for disasters resulting from force majeure are borne by the concessionaire; however, if the damage is massive and if government interventions are implemented two-thirds of the additional costs for recovering the facilities commissioned to the operator will be borne by the government and one-third by Miyagi Prefecture based on the Airport Act. Furthermore, if an event makes it impossible for the operator to run the airport, emergency measures will be implemented so that the government can operate the services until the situation improves. Thus, the public sector will bear more risks if “government interventions”—which has a stricter definition than force majeure—are implemented, or if critical emergencies have occurred from. Table B3.7.1  Risk Sharing Policies, by Circumstance, Sendai International Airport Project Status Definition Risk sharing policy Force Majeure is a factor that affects the performance in this contract directly and adversely, and any of the phenomena listed below (limited to those that exceed the criteria that have been determined in advance based on the agreement between the contracting authority and the private operator with administration rights), which are not attributable to both the government and the concessionaire Ⅱ The Case of Japan and can be foreseen by neither the central government nor the owner of the right, or from which, even if it was possible to foresee it, no reasonable means of preventing the occurrence of losses, damages, or failures due to the factor can be expected. (i) Extreme weather (including storm, lightning strike, torrential Occurrence rain, strong wind, hurricane, typhoon, cyclone, abnormal heat Additional costs shall be borne by the of force wave, and abnormal cold wave, which are more extreme than concessionaire. majeure those that usually or regularly occur in or around this airport) (ii) A natural disaster (including a flood, high tide, landslide, lightning strike, earthquake, fire, tsunami, and any other natural disaster that cannot be avoided and foreseen, which bring significant and inevitable damage to this airport) (iii) A civil war or act of hostility (including a riot, disturbance, uprising, act of terrorism, and act of war. The central government’s use of this airport in such circumstance is included.) (iv) An epidemic (cases where quarantine is required forcibly by the law are included.) The government shall take “government Circumstances interventions” to restore facilities in which commissioned to the operator by bearing the The government implements measures to continue services in the “government required costs based on the Airport Act so event that all or most of the additional costs required for restoring the interventions” that the operator can continue its services. facilities damaged by force majeure are not covered by insurance. are The operator shall take necessary measures implemented so that the government can receive the benefits covered by the operator’s insurance. •  If any emergency situation is recognized, The following events or equivalent situations are considered the government can decide whether to emergency situations: order the suspension of the operating •  Any situation that may significantly prevent the concessionaire right for the period and scope necessary. Critical from conducting operation safely •  In this case, the government can operate emergency •  Any event that may jeopardize the national security or the safety the suspended airport services. situations of the airport •  If the operating right is suspended, the •  Any event that may cause damage to human bodies, lives, and government shall be responsible for properties within the airport compensating the operator for losses that would normally occur. Terminal Building Services Private businesses shall bear all costs for disasters resulting from force majeure. Source: Contract documents, Sendai International Airport Project. 45 Depending on the scale of the project, the costs borne by private operators are limited to those that could have been avoided. Moreover, the government can step in, if necessary, in case of emergencies. For instance, in the Kansai International Airport concession project—a large-scale project in which the concession right of the airport was priced at approximately ¥2.2 trillion—the amount to be borne by the operator in the event of force majeure was highly debated (photo 3.4). After a series of discussions between the public and private entities, it was decided that in principle, New Kansai International Airport Company (the contracting agency) would have no obligation to pay for services performed by the operator. However, the company is required to bear risks if the physical damage to airport facilities resulting from force majeure exceeds the amount covered by the operator’s insurance (table 3.3). Insurance advisers were hired to examine the possibility of insurance coverage in advance and show numerical estimates indicating the extent of risks (maximum costs) that the private sector should bear according to the insurance market. Photo 3.4  Kansai International Airport Source: Kansai International Airport. ©Kansai International Airport. Reproduced, with permission, from Kansai International Airport; further permission required for reuse. 46 Table 3.3  Risk Allocation Policies, by Circumstance, Kansai International Airport Project Status Definition Risk allocation policy •  Additional costs shall be borne by the concessionaire. •  If the costs required to recover the airport facilities exceed ¥10 Definition of force majeure is limited as billion and it is estimated that it will take a year or more to below: recover major functions of the airport and if the operator takes Occurrence •  Extreme weather responsibility for restoring the facilities, the portion that exceeds of force •  Natural disaster ¥10 billion shall be compensated by New Kansai International majeure •  Civil conflict or hostile action Airport Company. On the other hand, if the Company takes •  Epidemic responsibility for recovery, an insurance company shall directly •  Radioactive contamination pay the benefits covered by the operator’s insurance to the Company. The following events or equivalent situations are considered emergency •  The Company can decide whether to order the suspension of the situations: operating right for the period and scope necessary. •  Any situation that may significantly •  The Company can operate the obligatory services based on the prevent the concessionaire from suspended operating right. The Company can also ask the Emergency conducting operation safely operator to cooperate with the Company to provide the obligatory situations •  Any event that may jeopardize national services. security or the safety of the airport •  If the operating right is suspended due to emergencies, additional •  Any event that may cause damage to costs or damages incurred by the operator shall be compensated human bodies, lives, and properties by the Company. Ⅱ The Case of Japan within the airport Source: Summary of contract documents, Kansai International Airport Project. In the case of Aichi Toll Road Concession Project, standards for disaster recovery projects in public works are referenced to determine how additional costs resulting from natural disasters that fall under force majeure should be allocated between the public and private entities. More precisely, additional costs resulting from natural disasters that fall under force majeure will be borne by the public sector if (a) the disaster recovery project is in accordance with the National Government Defrayment Act for Reconstruction of Disaster Stricken Public Facilities, and (b) the public sector agrees that there were no reasonable measures that the concessionaire could have taken to prevent the additional costs from being incurred because the event was unforeseeable. Specific standards for each disaster type are indicated in an assessment policy for the reconstruction of disaster stricken public facilities. In particular, risks shared between the public and private entities are clarified by incorporating numerical standards for heavy rain and storm (table 3.4). As for the accompanying sub-project components, the concessionaire bears the risks to raise the operator’s awareness of the need for disaster risk control. 47 Table 3.4  Risk Sharing Policy, by Circumstance, Aichi Toll Road Project Status Definition Risk sharing policy Force Majeure includes a storm, torrential rain, flood, high tide, landslide, fall of ground, strike of lightning, earthquake, fire, other natural disaster, or uprising, riot, disturbance, act of war, epidemic, or other human-made disaster, of which the cause is not attributable to neither the government nor the concessionaire. Type of Events for which additional costs are disaster borne by the public sector •  Damage based on normal social Earthquake conventions The public sector shall bear the cost if the •  Maximum rainfall of 80 concessionaire cannot foresee or cannot millimeters or more in 24 hours be reasonably expected to establish •  Even if the rainfall is below the measures to prevent additional costs. above standard, it is considered Definitions of disasters caused by heavy Main project heavy rain if the hourly rainfall is rain, storm, high tide, storm surge, and significant (20 millimeters or tsunami are shown in the summary on the Heavy rain left. Numerical standards are set for more), provided that the hourly rainfall is observed at the nearest heavy rain and storm as a specific weather observation station indicator of the scope of disaster. (managed by the public corporation) from the damaged place. •  Maximum wind speed of 15 meters Storm per second or more (average in 10 minutes) High tide, •  Extraordinarily high tide, storm surge, or tsunami caused by a storm surge, storm or its aftermath with tsunami relatively nonminor damage The public sector may bear the additional or revised costs resulting from force The operator shall bear all additional costs resulting from majeure if the costs are not covered by force majeure in the accompanying projects (parking Sub-projects “reasonable” insurance as requested by areas and the like) and optional projects implemented the public sector from the operator or along roads. exceed the limit covered by the insurance. Source: Contract documents, Aichi Toll Road Project. Lost Earnings Risks related to profitability are borne by the private sector in concession and user payment projects, and discussions should focus on whether lost earnings should be compensated after the occurrence of force majeure. In the case of the Sendai Health Facility Project, lost earnings were addressed as follows: “Lost earnings resulting from force majeure will not be compensated for private profit-making facilities.” 48 3.3  Disaster Response in Contracts Given that PPP projects tend to require long-term contracts, large-scale natural disasters that were unforeseeable at the time the contract was concluded may possibly occur during the contract period especially in the contexts of climate change and variability. Most contracts include a clause that requires discussion between the public and private entities if any adjustment is required. However, none of the contracts examined for this case study included any particular description of measures to be taken if natural disaster risks increased during the contract period. The following sections provide examples of how disaster response is contractually handled in infrastructure PPPs. Grace Period for Performance of Services When the performance of services becomes difficult because of force majeure, many projects have established rules for private entities to notify public authorities immediately in writing, detailing what services can no longer be performed and the reasons thereof. For the duration of such a period, private entities are exempt from contractual obligations. Detailed criteria for making decisions, however, are not indicated in cases where the performance of services becomes difficult, so decisions are made individually. Contract provisions tend to stipulate that the Ⅱ The Case of Japan necessary scope and length of any grace period should be discussed by both public and private entities. The Sendai International Airport project provides a specific example in which the length of a grace period (the number of days required for recovery) was estimated based on past disasters. At the airport, an area that had been affected in 2011 by the Great East Japan Earthquake, debris brought on by the tsunami piled up on the runways, and drainage canals were damaged when the area was hit by the earthquake; However, the runways were not destroyed and could still be used without conducting any recovery work. Therefore, the time and costs required for the removal of debris and other works were used as the criteria for estimating the time required for recovery, which was then set as the period in which the Sendai International Airport concession project was exempted from performing its obligations after the earthquake (box 3.8). An appropriate grace period can be set out based on the lessons learned from past disaster experience depending on the nature of the infrastructure. Contractual Provisions for Grace Periods or Performance Exemptions Box 3.8   in Sample Japanese PPP Projects Case: Sendai Health Facility Project If it becomes difficult for the private operator to carry out the construction or the O&M of facilities due to the risks caused by Force Majeure or if additional costs are incurred, the private operator is required to notify Sendai City. After this notification, if it becomes impossible to carry out the project due to Force Majeure, the private operator is exempt from its obligation to perform services. Case: Sendai International Airport Project If additional costs or losses are incurred for this project due to Force Majeure, and all or part of the project ceases, regardless of whether the government has implemented interventions, the concessionaire may request deliberations from the government regarding the following two points: • Extension of agreement through deliberations in cases where the government acknowledges the necessity of collecting losses or increased costs incurred by the concessionaire due to Force Majeure 49 • Exemption of the concessionaire or building and facility operators from performing contractual obligations that cannot be performed due to impediments caused by Force Majeure until the impediments are removed, or the contract is cancelled If Force Majeure continues for more than three months, the concessionaire may request deliberations from the government for the revision of the contract. If the government acknowledges the occurrence of significant changes in the environment due to impediments caused by Force Majeure, the government and the concessionaire may revise the contract to the extent necessary upon deliberation. Case: Kansai International Airport Project The concessionaire may be exempt from contractual obligations that have become difficult to perform due to Force Majeure, to the extent and period necessary. Case: Aichi Toll Road Project If it becomes difficult to perform all or part of the O&M services due to the occurrence of Force Majeure or when costs increase due to Force Majeure, the concessionaire should notify the public corporation in writing. With this notice, if the private operator cannot perform its obligations for the project, for which it has been granted the administration right, due to Force Majeure, the private operator is exempt from performing the said obligations. Sources: Contract documents for Sendai Spopark Matsumori Health Facility Project, Sendai International Airport Project, Kansai International Airport Project, and Aichi Toll Road Project. Compensation for Services during the Exemption Period If private businesses are exempt from providing services because of force majeure, compensation for services is paid based on the following examples from other countries (Allen & Overy 2013): 1. The public sector does not pay any compensation for services that were initially agreed, including facility construction costs and O&M costs, to the private sector (example: Bulgaria). 2. The public sector pays compensation for services to the private sector in accordance with the original payment schedule (example: Czech Republic). 3. The public sector pays the revised compensation for services to the private sector (debt services are paid, but the reduced part of O&M costs is not paid) (example: the Netherlands). Force majeure is not attributable to the private sector. Additionally, when the private sector is exempt from the performance of obligations, the case does not fall under the nonperformance of services. Therefore, compensation for services should not be reduced, as seen in example 1 above. On the other hand, in example 2, the public sector pays for services that it did not receive. Most of the availability payment projects in Japan fall under example 2 (box 3.9). In the event of disasters that were considered as force majeure, compensation for services was paid as long as business operators were not at fault. However, when there is no clear provision regarding force majeure, the decision on whether the case falls under force majeure is generally left for the public and private entities to determine, which takes time in many cases. 50 Compensation for Services during Exemption Period on an Availability Payment Box 3.9   Case:  Project, Sendai Health Facility Project Even when all or part of the services cannot be performed due to Force Majeure, compensation for services is to be continuously paid as usual on the condition that the business operator should attempt to remove the influence of Force Majeure with maximum effort. While the project contract and the service level requirements stipulate policies on emergency responses to be taken by private businesses when disasters occur, detailed and specific response methods are not provided. Source: Contract documents, Sendai Spopark Matsumori Health Facility Project. Changes in Contract Terms With the occurrence of force majeure, terms of payment that were initially agreed upon may be changed in accordance with the specific circumstances of each project (box 3.10). Risk sharing between the public and private entities for these items also needs to be provided in the project contract. For example, when force majeure causes a delay in the Ⅱ The Case of Japan completion of a facility that makes it difficult for private operators to meet the date of delivery, an arrangement is usually made to extend the date and to avoid incurring late charges. In some cases, the O&M phase of projects and the payment due date for compensation for services (business rights) are also extended to ensure that the revenue that was initially projected is achieved and to explore possibilities of a rate revision to cover increased costs. Contractual Provisions for Changes of Payment Terms under Force Majeure Box 3.10   Case: Kansai International Airport Project Extension of the due date for payment: As a measure for situations in which performing services becomes difficult due to Force Majeure, when it has been determined there is reasonable need to extend the payment due date for administration rights and change the payment schedule, the said changes shall be implemented. Case: Aichi Toll Road Project Possibility of rate change: The public corporation and the concessionaire must confer on the payment policy for increased costs incurred due to Force Majeure. If an agreement is not reached within 60 days, the public corporation will notify the concessionaire of its policies on actions to be taken. In this case, the public corporation shall provide policies on sharing the increased costs with the concessionaire within the scope of the aforementioned policies on sharing risks for Force Majeure. An extension of the project term and a rate increase on the grounds of Force Majeure are not to be conducted in principle; however, these can be performed when the public corporation gives approval. If the concessionaire requests a change in the original proposal in order to mitigate the influence of Force Majeure, the public corporation shall sincerely consider what actions to take. Sources: Contract documents for Kansai International Airport Project and Aichi Toll Road Project. 51 Photo 3.5  Aichi Toll Road Source: Aichi Road Concession Co., Ltd. ©Aichi Road Concession Co., Ltd. Reproduced, with permission, from Aichi Road Concession Co., Ltd; further permission required for reuse. Circumstances Leading to Contract Cancellation After the occurrence of force majeure, the performance of services may be stopped permanently, or the continuing the project may lack economic rationality because of excessive costs. In such cases, the project contract may be canceled in part or in its entirety according to provisions (table 3.5). In addition to cases where a request for cancellation can be submitted by the public sector, there are some cases where either side can submit a request for cancellation. Regarding the amount to be paid to private operators upon the cancellation of a contract, the public sector shall pay the amount equivalent to purchasing the facility and other rational costs according to provisions. 52 Table 3.5  Contract Cancellation Reasons and Effects, Sample Japanese PPP Projects Reasons for cancellation or Project Effects of cancellation or termination Remarks termination •  Prior to the commencement of the facility operations, the City may receive the completed part of the facilities by paying the amount of the initial investment costs multiplied by the percentage of work completed at the facilities, etc. When the private operator receives an indemnity from insurance due to the termination of the •  When Sendai City concludes contract caused by Force Majeure, the amount that due to an occurrence of equivalent to the insurance payment, etc., is deducted Force Majeure, the from the purchase price. continuation of the project is •  When operations have already commenced, the City Sendai Health difficult, or additional costs to purchases facilities for the amount calculated by Facility — be paid by the City are deducting the total amount of all insurance, and the Project considerable, the City may bond or indemnity received by the private operator or cancel (terminate) the its member companies due to the occurrence of the said contract after conferring with Force Majeure from the unpaid amount of the initial the private operator. investment costs. The City pays the said amount and the financial charges incurred to a reasonable extent due to the termination of this contract to the private operator. The City also pays unpaid compensation for services relating to the operations of facilities up to the Ⅱ The Case of Japan termination date of the contract to the private operator after reducing the necessary amount.a •  When an agreement is not reached on the changes in this project contract and on the •  Sendai City acquires the right of ownership upon the payment of increased costs delivery of facilities (the completed portion if the within 60 days from the date construction is incomplete) from the business operator that Force Majeure occurs, and takes over the remaining portion of the facility Sendai City may cancel the Sendai construction costs among the service purchase costs. entirety of the project contract •  The City pays the amount calculated by deducting the Astronomical after notifying the business insurance amount received by the private operator from — Observatory operator. the remaining amount of facility construction costs Project •  When facilities are damaged among service purchase costs. Charges incurred in or destroyed due to Force relation to the procedures for terminating the business Majeure, Sendai City may relationship and profit or loss from valuation, etc., cancel the contract without following the adjustment made by the private operator requesting repairs or are in principle paid by the private operator. renovation from the private operator after conferring with the private operator. •  Sendai City acquires the right of ownership upon the •  When an agreement is not delivery of facilities (the completed portion if the reached on changes in this construction is incomplete) from the private operator project contract and on the and takes over the balance portion of the facility Sendai School payment of increased costs construction costs among service purchase costs. If the Meal Supply within 60 days from the date private operator has already started maintenance and — Center Project that Force Majeure occurs, operation services, Sendai City pays the costs required Sendai City may cancel the to terminate the maintenance and operation services to entire project contract after the private operator. The payment method is notifying the private operator. determined through deliberations between the City and the private operator. 53 Reasons for cancellation or Project Effects of cancellation or termination Remarks termination •  When the airport is destroyed •  When facilities are destroyed due to Force Majeure, the due to Force Majeure, the administration right terminates as a matter of course. The implementation agreement The government pays the concessionaire the amount implementation terminates as a matter of corresponding to the remaining period of duration out agreement can course. of the value of the concession right paid by the be cancelled by •  When the government Sendai concessionaire. the government implements interventions due •  When the implementation agreement is cancelled due only. (There is International to Force Majeure, but the to Force Majeure, following the decision made by the no statement Airport recovery schedule for this government, the concessionaire is to relinquish the that mentions Project project cannot be established, concession rights or gratuitously convey the concession that the or the resumption of this rights to a third party appointed by the government. concessionaire project based on a recovery Losses incurred by the government and the can request the schedule turns out to be concessionaire due to the said Force Majeure are cancellation of unfeasible or extremely absorbed by each entity, and no compensation for the agreement.) difficult, the government damage is paid to either entity. terminates the agreement. •  When the agreement is terminated due to Force Majeure, following the decision made by New Kansai International Airport Company, Ltd., the concessionaire relinquishes the concession rights or gratuitously conveys the concession rights to a third party •  When the execution of this appointed by New Kansai International Airport project becomes difficult due Company, Ltd. New Kansai International Airport to Force Majeure, and the Kansai Company, Ltd. returns the unreturned portion of the Cancellation of recovery of facilities and the performance bond as on date of the cancelation to the the agreement International performance of contractual concessionaire. can be Airport obligations cannot be •  In this case, New Kansai International Airport Company, requested from Project completed within a year from Ltd. and the concessionaire absorb the losses that they both sides. the occurrence of Force themselves incurred due to the cancellation or Majeure, the agreement can termination of the implementation agreement. be cancelled. However, if they are unable to restore the facilities within a year from the occurrence of Force Majeure due to gross negligence or the intent of the concessionaire, the prescribed forfeit is paid to New Kansai International Airport Company, Ltd. •  When the contract is cancelled, the public corporation is to cancel the concession rights granted for the facilities (toll roads). •  The concessionaire must deliver the facilities to the •  When the public corporation public corporation in conformance with the service or the concessionaire level requirements. When the facilities do not conform conclude the continuation of to the service level requirements during the O&M phase the project is difficult or and the lack of conformance is the fault of the Cancellation can Aichi Toll requires enormous costs due concessionaire, the concessionaire is required to pay be requested Road Project to the occurrence of Force the costs of repairs, etc. from both sides. Majeure, the project •  The concessionaire is required to pay a forfeit to the agreement can be terminated public corporation amounting to 10 percent of the upon deliberation between annual payment for the concession rights of each the two entities. facility regardless of the time of cancellation. The concessionaire is also required to pay the public corporation 10 percent of the renovation service costs for the facilities to be renovated. Source: Contract documents of each project. Note: — = not available. O&M = operation and maintenance. PPP = public-private partnership. “Reasonable Financial Charges” of this project were not defined in detail. “Reasonable Financial Charges” include break funding costs in some other a.  PPP projects in Japan. 54 Box 3.11   Contractual Effects of Force Majeure: International Examples Standardization of PF2 Contracts (United Kingdom) In the Standardization of PF2 Contracts (HM Treasury 2012), the financial effects of delays caused by Relief Events (defined in box 3.6) are borne by private contractors, and the public authority will not pay any compensation on the occurrence of such delays. Therefore, although a contractor needs to cease the operation when disasters occur, the public authority does not offer the private contractor any contract extensions. This is because such compensation will reduce the incentives for a contractor to manage effects caused by natural disasters, which might result in restoring services very slowly. For instance, if an extension were given, then although a contractor does not receive the unitary charge during a Relief Event, its revenue period would remain intact. Moreover, the public authority would be taking on more risks of the occurrence of Relief Events. However, according to the same standard contract, “if a Relief Event occurs prior to Service Commencement any long-stop termination date will be put back by a period equal to the relevant delay. Liquidated damages prior to Service Commencement are designed to compensate the Authority for specific losses due to late Service delivery so that if the Contractor fails to commence provision of the Service due to a Relief Event, the Authority will still suffer this loss.” Additionally, since the public authority will not compensate any loss resulting from natural disasters, a contractor is expected to have loss-of-profit or business interruption insurance to compensate for any such loss. Regarding termination of contracts, it is stressed that in most cases termination should not follow a Relief Event although a Ⅱ The Case of Japan contractor may fail to deliver contracted services due to a Relief Event. In the past, discussion centered on the notion that a termination right should exist for instances where Relief Events were prolonged. However, there may be no incentive for a contractor to control Relief Events, and the effects of Relief Events may be short and can be coped with by alternative sourcing of the supply concerned by a contractor; therefore, termination is the last resort. In sum, the standard private finance initiative (PFI) contract in the United Kingdom specifies that a private contractor takes on most natural disaster risks, but this is to incentivize private contractors to handle such risks better. Moreover, a mature insurance market exists to mitigate such risks for private contractors. In addition, a policy of no termination by the authority can be a guarantee for private operators that find themselves in a breach of contract due to natural disasters. In the United Kingdom, natural disasters are considered preventable and relatively easy to recover from, but there is a different view in Japan toward natural disasters, which explains the different ideas on disaster risk allocation that have arisen in two countries. Legislative Guide on Privately Financed Infrastructure Projects (UNCITRAL) The Legislative Guide on Privately Financed Infrastructure Projects (UNCITRAL 2001) notes that there is often no single solution to cover the entire category of risks, and special arrangements are often made to deal with each of them. For example, the entities may agree to make contractual arrangements providing solutions for some of their adverse consequences, such as contract extensions to compensate for delay resulting from events or even some form of direct payment under special circumstances. If the public authority wishes to extend a greater degree of protection to the lenders, the guarantees may cover the project company’s permanent failure to repay its loans. In such a case, however, it is advisable not to remove the incentives for the lenders to arrange for the continuation of the project. Therefore, in any event, full loan guarantees by the public authority amounting to a total protection of the lenders against the risk of default by the project company are not a common feature of infrastructure projects carried out under the project finance modality. Furthermore, the Guide notes that certain natural disasters such as storms, cyclones, and floods may be normal conditions at a particular time of the year at the project site. As such, any public service provider would expect to assume that those natural disasters are likely to happen. However, the situation might differ depending on whether the facilities are permanently owned by the contracting authority or whether there is a requirement to transfer them to the contracting authority at the end of the project period. In the latter case, the contracting authority is authorized to make arrangements to assist the concessionaire to repair or rebuild infrastructure facilities damaged by natural disasters or similar occurrences defined in the project agreement, provided that the possibility of such assistance was contemplated in the request for proposals. In some countries, the contracting authority is authorized to agree to pay compensation to the concessionaire in case of an interruption of the work for more than a certain number of days up to a maximum time limit, if the interruption is caused by an event for which the concessionaire is not responsible. 55 Guidance on PPP Contractual Provisions (World Bank) The World Bank’s “Guidance on PPP Contractual Provisions” closely makes the case that the public sector bears the costs of damages caused by force majeure. If the revenue of the private contractor is paid by the public authority, then the possible options for cost allocation between the public authority and the private contractor are as follows: • The private contractor continues to be paid as if it is performing in full. • The private contractor is paid an adjusted amount to cover debt service costs (but not the O&M cost savings that may arise from not performing or lost profit). • The private contractor is not to be paid at all. This will in part depend on the availability of insurance (such as business interruption insurance). The availability of insurance for the events is a key when deciding the type of cost allocation. If there was insurance for a specific political or natural event, it could not be regarded as force majeure, therefore the private contractor is likely to be required to bear all the cost. Conversely, “uninsurable” events are treated as force majeure, so that the private contractor will not be required to cover all of the cost. It should be noted here that “uninsurable” typically does not mean that insurance is not available at all (further detailed in chapter 7 of this report). The Guidance highlights the following important aspects to be considered when deciding the effect on the contract and compensation (World Bank 2017): • “Interim costs compensation – Despite compensation being granted through one or more of the above means (such as by way of an extension to the operating period or increased tariffs), additional costs (e.g. for capital works), may nevertheless need to be incurred by the Private Partner before any actual compensation is received. One way for Contracting Authorities to address this, which is not uncommon in certain developed jurisdictions, is for the Private Partner to have an obligation to seek financing for such additional costs on the best possible terms. If such financing is not available or the Contracting Authority rejects the terms, the Contracting Authority either becomes the lender of last resort or is required to make an upfront payment” (24). • “Increased finance costs pre-completion – If Force Majeure delays completion of the PPP Project asset, the Private Partner will not be able to commence service operations and start earning revenue to meet its debt service obligations. It may incur additional interest and commitment fees and costs of rescheduling its repayment obligations. If the Private Partner adds in some contingency pricing against this risk, this will have value for money implications for the Contracting Authority” (23). In contrast to the United Kingdom’s Standardization of PF2 Contracts, the World Bank’s Guidance introduces several relief mechanisms for private partner nonperformance other than the extension of time performance. For instance, the private contractor may be liable to pay liquidated damages to the contracting authority if it fails to meet certain construction phase milestones (such as the scheduled date for commencing operations). However, in the context of a force majeure event, the contractor may typically want to be expressly relieved from such requirements to the extent that these relate to the obligations it is unable to fulfill because of the event. Additionally, the contracting authority usually expressly grants the private contractor an extension of time in respect of delays to the commencement of operations that are attributable to force majeure events during the construction phase. As highlighted above, the World Bank’s Guidance identifies the possibility that value for money will decrease if the private contractor bears all the force majeure risks and compensation for the damage. The public authority should cover part of the compensation for any damage caused by uninsurable force majeure events. Sources: HM Treasury 2012; UNCITRAL 2001; World Bank 2017 56 3.4  Summary and Key Takeaways Definition of Force Majeure In the chronological review of cases in Sendai, force majeure events were listed as examples in the earlier projects and defined as foreseen phenomena under normal circumstances and for which no concerned entity was responsible. Based on lessons learned from the 2005 Miyagi Earthquake, the 2011 Great East Japan Earthquake, and other disasters, force majeure provisions specified the seismic intensity, and by taking into account historical disaster damages, they also added a numerical standard that regarded an event of at least a certain level as a force majeure event. Furthermore, there was past controversy on the difference between the damage caused by a private operator due to facility defects and damage caused by a natural hazard. Sendai City clarified in the PPP contracts that damage caused by a natural hazard will be judged based on whether similar buildings in the vicinity suffered similar damage. Such clarification of force majeure provisions resulted in •  Fewer questions and uncertainty on the DRM responsibility of the public and private sectors; •  The private sector’s clear consideration of disaster risks during the project planning stage; and Ⅱ The Case of Japan •  Prompt emergency responses by the private sector. For concession cases, a reasonable definition of force majeure and risk sharing from the viewpoint of profitability was clarified based on opinions of private operators and lenders. Risk Sharing between Public and Private Sectors When allocating risks between the public and private sectors in infrastructure PPPs several major issues are to be considered, as summarized below. Positioning Infrastructure PPPs as Public Services It is necessary to decide on a form of risk sharing that is cognizant of the nature of infrastructure projects. For example, in the case of infrastructure that must continue to function without suspension during disasters, it is necessary for the contracting authority to be involved in securing business continuity since it is important to restore such projects promptly to avoid any interruptions to public services. Illustrations from an airport project in Japan include the following: •  Runways are part of the infrastructure at airport facilities that need to be restored urgently after disasters because they are necessary for transporting search and rescue personnel, emergency reliefs, and goods. •  A terminal building is often a for-profit business, and it is assumed that the public entity will not be involved in the recovery of commercial business such as terminal building operations. •  An airport is a large-scale public service project. Given that airport infrastructure cannot be transferred easily and risks cannot be shared and diffused, risk sharing by the public entity was considered appropriate to a certain extent. Consistency with the Overarching Legislations Public works are designed, constructed, operated, and maintained in compliance with the risk allocation specified in the relevant legislation in Japan (for example, the Disaster Countermeasures Basic Act and each sector-specific law). Infrastructure PPPs follow the overarching laws, which are listed in tender specifications issued during the procurement stage. 57 Acceptance or Avoidance of Risks by Private Operators Evaluation of disaster risks. Risk sharing by the public and private entities is considered, based on an evaluation of disaster risks and the significance of impacts and damages on the project in terms of technical and commercial viability. The project stakeholders often refer to the hazard maps developed and disseminated by the public sector as well as the historical disaster databases when evaluating the disaster risks at the project level. Project profitability. In the case of highly profitable projects, it is considered that all force majeure risks should be borne by private operators. It is necessary to analyze whether projects have appropriate business structures from which the private entity can obtain a return on investment and how much revenue can be generated. This is because it is usually expected that private operators can improve their ability to enhance profits and minimize expenditures, compensating their losses by their own efforts even when a force majeure event occurs. Therefore, it is critical to consider whether a project has enough profitability to enable the private operator to establish a risk-informed financial plan. In particular, since it is not easy to predict natural hazards without a certain degree of uncertainty, it is reasonable for project entities to consider whether risks can be comprehensively avoided taking into account the project profitability. Availability of insurance. In cases where natural disaster risks are borne by private operators, an important criterion is whether insurance can be purchased at a reasonable cost. In some countries where insurable events can be insured at a reasonable cost in the insurance market, the insurable events are not force majeure but should be borne by private operators. The availability of insurance for the events is key when deciding the type of cost allocation. In Japan, because force majeure events are widely understood and there have been many cases where the public entity has borne almost all force majeure risks, private operators are not necessarily required to bear risks even if such risks can be insured. Furthermore, there are many cases where a contracting authority determines the necessary insurance during the procurement preparation stage. The contracting authority confirms the availability of insurance in the market and carries out a market sounding to identify suitable conditions for procuring insurance. Furthermore, it is important to establish standards that take region-specific insurance markets into account. For example, there may be cases where it is considered difficult to insure earthquake risks in Japan at a reasonable cost. As a result, if private operators are required to pay a premium, such costs may be an excessive burden. Recent large-scale concession projects have implemented a burden ratio to limit the amounts to be borne by the private operators. This was aimed at limiting the burden on private operators to an appropriate level while taking into account market availability for procuring insurance. By implementing such measures, private operators have less uncertainty for risks to be borne by them and can take suitable risk mitigation measures. Financial institutions have highlighted the importance of ensuring that the public entity bears risks that cannot be reasonably insured to increase the possibility of viable financing arrangements and ensuring value for money. Bankability. Financial institutions that finance projects analyze a cash flow of risk scenarios in detail, which includes an assessment of both disaster risks and the level of risks that private operators can accept. For earthquakes, financing levels are decided based on the probable maximum loss (PML) computed by the casualty insurance company and by calculating other necessary fixed expenses. It is necessary for the public sector to establish an appropriate level of risk allocation to the private sector, maintaining project bankability. Understanding of risks through dialogues and open data. It is important to enhance understanding about the risks that the private sector is responsible for so that it promotes appropriate DRM measures and investments by the private sector. Also, early information disclosure as well as dialogues between the public and private sector can contribute to appropriate risk allocation schemes. Specifically, the following steps have been identified in the cases 58 highlighted earlier: •  Ensure understanding of risks among the public and private sectors: In the case of the Spopark Matsumori (health facility) project in Sendai, both Sendai City and the private operators lacked the awareness to identify risks and prepare measures, which increased the chances of defects in the private operator’s facility structure and construction works; consequently, these defects led to damage during the 2005 Miyagi Earthquake. Subsequently, the development of the New Sendai Astronomical Observatory Project reflected lessons learned from the earlier experience. Risk workshops were held periodically in which Sendai City staff responsible for the project and representatives of the private operator discussed the possible occurrence of risks including earthquakes. The workshops allowed both Sendai City and the private operator to review and operate the project by recognizing disaster risks more clearly. •  Facilitate proactive DRM measures and investments by the private sector: Reflecting the fact that the damage on the Spopark Matsumori PPP Project was caused by defects on the part of the private operator in constructing facilities, the risks to the project, including the possibility of collapsing ceilings, were identified and addressed in the design and construction of the facility. Countermeasures for such risks were considered. In addition, a policy was established that if a facility failed to meet the specified standards, the contracted amount for the facility’s construction would be reduced based on the degree of importance of the facility, the degree of failure, time Ⅱ The Case of Japan needed for improvement, and other factors. The same policy would be applied if defects were caused by the failure of maintenance services, which encouraged the private operator to be more proactively involved in DRM. In addition, based on the damage suffered by Sendai Astronomical Observatory from earlier earthquakes, the seismic intensity to which the private operator could respond was identified and reflected in the specifications. •  Provide early disclosure and dialogues: In the Kansai International Airport Project, a project scheme including risk allocation between the public and private entities was disclosed at an early stage, and efforts were made to refine the scheme while continuing the dialogue with private companies. Such efforts secured a suitable competitive environment and enabled international private players to participate in this project. 59 Procurement, Monitoring, and Payment 4.  Mechanisms The benefit of introducing public-private partnerships (PPPs) is that it enables the contracting authority to maximize value for money (VfM) by encouraging private operators to exercise their own ideas and efforts and to implement methods for efficient, effective facility construction and project operation. The same way of thinking applies to disaster response, which requires efficient, effective disaster risk management (DRM) and improvement of VfM by using the efforts of private operators when disasters occur. In Japanese PPP projects, having accumulated various disaster responses handled by private operators, a contracting authority expects that private operators would be accustomed to emergency responses and are capable of responding promptly. In addition, in constrained circumstances where government agencies need time to execute disaster response procedures stipulated in the contract, awarding authorities appear to expect prompt disaster responses by agile, flexible private operators. The efficient and effective handling of disaster responses by private operators is expected to improve VfM. Hence, this chapter describes methods to motivate private operators to implement disaster responses. In Japan, it is common practice to incentivize private operators through procurement procedures. Furthermore, efforts are being made to strengthen DRM by private operators through monitoring and payment mechanisms. 4.1  Incentive Mechanisms in Procurement Specifications on DRM Resilience of facilities is promoted through the overarching legislations that have been revised based on experiences from past disasters. Additionally, private operators may be asked to deal with disasters by following the project- specific specifications defined by contracting authorities during the procurement stage. The specifications are the minimum requirements to be fulfilled by private entities, which are expected to attain this minimum level without failure. When defining the specifications, setting them too high may lead to deterioration of VfM because of the associated costs and create a barrier for the private sector’s participation in PPP. For this reason, it is important to set a reasonable and acceptable service level for private sectors based on communication between the contracting authority and private entities, such as competitive dialogues and Q&A sessions during the procurement stage. The specifications on DRM cover emergency response, inspection and evaluation of damages, robust facility designs, and robust operation and maintenance (O&M) system, as two of the Sendai City examples illustrate (boxes 4.1 and 4.2). 60 Specifications on Emergency Response and Business Continuity, Sendai Box 4.1   Case:  Astronomical Observatory Project Operation Level Requirements (extracted) Security service level requirements • In the event of an emergency such as an occurrence of an accident, crime, and disaster, the police and the person in charge at the municipality will be notified. • In the event of an earthquake or a disaster caused by wind and floods while security services are being provided by automated alert when the observatory is closed or at night, or in the event that such a situation is likely to occur, the staff in charge will immediately hasten to the scene, verify the situation and take initial measures. Development and Maintenance Level Requirements (extracted) Information systems: display-type information service system • A system should be established where information can be continuously displayed by installing equipment that can supply electricity for a certain period, even during emergencies such as disasters. Source: Contract documents, Sendai Astronomical Observatory Project. Ⅱ The Case of Japan Design Specifications on Seismic Resilience and Emergency Response, Sendai Box 4.2   Case:  School Meal Supply Center Project (excerpts) Design Level Requirements • Basic requirements for safety »»Regarding resistance to flood, wind, snow, cold, and lightning, the necessary functions should be secured in compliance with the Standards for Basic Functions of Government Facilities. • Basic requirements for structural planning (B) Required functions Facilities with required functions shall have the following levels or higher. Levels of items that are not stated below shall be at the same level as the Basic Standards for Basic Functions of Government Facilities. (1) Seismic and structural safety: Seismic and structural safety of facilities shall be classified as Class II in the Standards for General Seismic Plans of Government Facilities. (2) Classification of seismic safety performance of nonstructural components: Seismic safety performance of nonstructural components at facilities shall be classified as Class A in the Standards for General Seismic Plans of Government Facilities. (3) Seismic measures for facilities: Regarding seismic measures for facilities, the seismic class shall be Class Otsu in the Standards for General Seismic Plans of Government Facilities. In consideration of their disaster prevention abilities, water tanks, heat source equipment, power source equipment and anti-disaster facilities are all characterized as important equipment. Security Service • Response to emergencies A. An emergency system for the security service for facilities (a system where people can arrive at the scene within 30 minutes) should be established for when persons in-charge are absent. B. Prompt and appropriate initial action should be taken, including reporting to the agencies concerned if necessary. Required Level Concerning Operation Services • Response to emergencies (1) A manual should be prepared in advance for responding to emergencies such as earthquakes, fire and accidents, and approval should be obtained from the municipality. Source: Contract documents, Sendai School Meal Supply Center Project. 61 Evaluation Criteria on DRM One approach to ensuring private operators’ performance on DRM is to make it compulsory for private operators to invest in DRM through the specifications. Another approach is to request that private operators submit proposals for DRM and include DRM as an evaluation criterion when assessing proposals. The latter incentivizes private operators to propose and implement appropriate DRM measures so that they can obtain higher evaluation points. This approach is effective for the contracting authority when proposals of specific methods for dealing with disasters are expected from private operators. Details of the proposals from private businesses will finally be evaluated by the contracting authority. Another advantage of this approach is that the proposals from private businesses can be evaluated based on their balance between quality and price. When the price of a proposal is too high, the points for price will be reduced despite its high quality, which may lower its overall evaluation score (where both prices and quality are taken into account) compared with other bidders. Therefore, this approach can lead to obtaining practical cost-balanced proposals. The case study projects provide specific details of such evaluation criteria (box 4.3). For Sendai’s school meal supply center project, for example, private operators took into account the seismic risks and proposed efforts—such as taking measures to prevent equipment mounted on the ceiling from falling and using durable materials—to endure earthquakes of a certain magnitude. For the Aichi toll road project, an evaluation revealed that, under the category of “ensuring the safety of roads,” a private operator proposed specific measures and approaches to deal with large-scale disasters and prevent traffic accidents. Additional proposals concerned the functions of primary emergency transportation roads, the formulation and implementation of a business continuity plan, and the expansion of emergency stockpile warehouses. Also, under the category of “risk countermeasures,” a private operator’s inclusion in the proposal of specific insurance coverage details was highly evaluated. As these examples show, evaluations were conducted on DRM measures and plans and on risk transfer policies with insurance. When evaluating the criteria using a score, there is a way to avoid subjectivity. It is common to set up a third-party committee in Japan to evaluate PPP projects—including experts from different backgrounds such as professors, lawyers, and financial specialists—to increase the objectivity of the evaluation. In addition, for instance, at the screening of Sendai International Airport case, the evaluators had various types of expertise, and the final scored evaluation eliminated the extreme scores (namely, the evaluators’ maximum and minimum scores) and averaged the other scores. In addition, each evaluated item had a maximum score, and such information was publicly open for bidders before they submitted their proposals. This system eliminated excessive bias in the scores for each item. Box 4.3   Private Operator Evaluation Criteria on DRM from Japanese PPP Projects Case: Sendai Health Facility Project, Criteria for Choosing Successful Bidder (extracted) • Risk management planning »»Viewpoint of evaluation Whether an effective backup system is secured for continuing operations when an incident occurs »»Point of evaluation (example) Whether project safety is assured by obtaining other insurance than is obligated Case: Sendai Astronomical Observatory Project, Criteria for Choosing Successful Bidder (extracted) • Risk management planning 62 »»Whether measures for mitigating risks have been developed, such as establishing an effective risk management system or obtaining additional insurance Case: Sendai School Meal Supply Center Project, Criteria for Choosing Successful Bidder (extracted) • Facility preparation »»Whether structural proposals are presented to prevent or mitigate seismic disasters »»Whether practical proposals are presented to maintain the functions of each facility (e.g., electric, mechanical and cooking equipment) or to recover and restore those facilities in case of a disaster • Maintenance »»Maintenance service system »»Whether proposals are presented for measures, systems, etc., to promptly recover or restore functions in case of an emergency such as earthquake • Other operational services »»Whether efforts have been made to promptly deal with natural disasters or accidents such as food poisoning, to share information with business operators accurately and to communicate and appropriately cooperate with the municipality Case: Sendai International Airport Project, Criteria for Selecting Entities with Preferential Negotiating Rights (extracted) • Proposals for safety and security Ⅱ The Case of Japan • Basic concept regarding measures for addressing problems (e.g., incidents or accidents, disasters, and epidemics) • Evaluation points »»Whether safety and security maintenance operations have policies that establish a highly reliable implementation system by securing qualified individuals and selecting appropriate contractors »»Whether necessary and adequate self-check functions have been proposed »»Whether measures to address problems have been examined sufficiently Case: Kansai International Airport Project, Criteria for Selecting Entities with Preferential Negotiating Rights (extracted) • Items examined during first and second evaluations »»Evaluation details Appropriateness of basic project implementation policies and project plans »»Evaluation items (safety and assurance, environmental measures and coexistence with local communities) Measures for addressing problems (e.g., incidents or accidents, disasters, and epidemics) Case: Aichi Toll Road Project: Criteria for Selecting Entities with Preferential Negotiating Rights (extracted) Crisis management • Whether proposals are specific, feasible, and meet the required level »»Whether implementation and communication systems are feasible, specific and in a form that is suitable for crisis management operations »»Whether proposals are specific and highly reliable (certain) for addressing individual and specific problems (e.g., traffic accidents, snowfall, torrential rain, and reckless driving) in crisis management operations »»Whether the implementation of efficient and effective operations has been proposed • Whether proposals are efficient and effective when they exceed the required level, and whether they are feasible and specific Sources: Project documents. Note: DRM = disaster risk management. 63 Box 4.4 summarizes the use of DRM evaluation criteria to screen the concessionaires bidding to participate in two airport PPPs: the Kansai International Airport Project and the Sendai International Airport Project. Box 4.4   Concessionaire Screening Using DRM Evaluation Criteria in Airport PPP Projects Case: Evaluation of a Concessionaire for Kansai International Airporta Nine Japanese companies and 11 international companies declared their intent to participate in the project and passed the participation eligibility screening. In particular, the contracting authority hoped to attract international operators by specifying risk allocation between the public and private entities. That the announcement attracted interest from many international companies proves that private operators judged that the implementation policy was appropriate. Subsequently, a tender document was distributed, and three companies participated in the competitive bidding. The only private operator that passed the first screening was ORIX-VINCI Airports Consortium. The criteria for the first screening contained evaluation on several components—proposed operating right price, appropriate business policy and plan, and the basics on running operation (technical and logical aspects)—by scoring each component on a 100-point scale. Three operators submitted their proposals, and another two did not meet the requirement for the representing entity in joint venture. After competitive dialogue between each of the private entities and the contracting authority, a second screening was executed that included activities such as site inspection of the participant and interviews of the stakeholders. A key point of the screening was that, although it was not restricted to natural disasters, it gave a positive evaluation to private operators that secured stable and reliable operation by allocating sufficient funding for DRM as well as reserve funding for airport operation. It also gave a positive evaluation to private operators that prioritized safe and secure airport operations by executing maintenance and renovation investment in a preventive and systematic manner. A safety control plan and the securing of a system for executing an appropriate business continuity plan were also positively evaluated (such items adding points worth up to 10 percent of the total maximum score). Evaluation of a Concessionaire for Sendai Airportb Four consortiums participated in the first screening for the project, and all groups passed it. Three consortiums participated in the competitive dialogue with the participants before the second screening, which helped secure competition. The result of the screening was that Tokyu-Maeda-Toyotsu Group was selected as the preferred bidder. In the quantitative evaluation in the second screening, all consortiums proposed a concession fee greater than zero yen for the revenue and expenditure in the Sendai Airport Specified Operation Project, which had been posting losses for three consecutive financial years. Therefore, it was judged that VfM had been considered in the proposals. The preferred bidder presented a value of ¥2.2 billion. During the second screening, the following proposal items received positive evaluations: proactive detailed measures to prevent security incidents and accidents, to minimize damage from disaster, and to obtain insurance. (Because the airport is located in an area struck by the Great East Japan Earthquake in 2011, standards relating to tsunami and other DRM were clearly indicated in the conditions to obtain insurance for this project.) The preferred bidder also established a “Sendai Operation Center” that included aviation security, security guards, DRM, and facility management departments for the safe operation of the airport. Such plans contributed to the positive evaluation. Source: Results of objective screening for selection of private operators, including results of the first screening by New Kansai International Airport a.  Company (NKIAC). b. Source: Ministry of Land, Infrastructure, Transport and Tourism, http://www.mlit.go.jp/report/press/kouku05_hh_000070.html. 64 Disclosure of Disaster-Related Information To minimize the uncertainties of risks assumed by private operators, efforts have been made to properly disclose the information held by public entities about past disasters. For example, for the Sendai International Airport concession project, details were disclosed concerning the safety management at airport facilities and the inspections and examinations conducted after the Great East Japan Earthquake (box 4.5). In addition, information about past earthquake damage was disclosed in the local DRM plan prepared by the municipality where the airport is located. Treatment of Disaster Risk-Related Questions on Application Guidelines for Sendai Box 4.5   International Airport Project Question: “Regarding the criteria that you have indicated we should refer to, please give us more information on those that are not available on the Internet or sold as publications (such as guidelines on the facility maintenance inside the airport, regulations concerning aeronautical safety services, criteria for the establishment of a safety management system at the airport, and a tsunami evacuation plan for Sendai International Airport).” Question: “Regarding civil engineering, construction, electricity, and machine equipment, please provide drawings and specifications on the inspection, structural verification, and functional recovery after the Great East Japan Earthquake.” Ⅱ The Case of Japan The contracting authority replied that information would be disclosed in the second evaluation for both questions. Source: Project documents on questions and answers on Sendai International Airport Project. 4.2  Incentive Mechanisms in Monitoring and Payment The contracting authority needs to conduct appropriate monitoring to make sure that disaster responses are performed as initially planned based on the specifications and the proposals from private operators. According to the “Guidelines for Monitoring” released by the PPP/PFI Promotion Office (Cabinet Office 2015), monitoring is “an important method to confirm whether the provision of appropriate and reliable services that conforms with the contract has been ensured with regard to the public services performed by private operators; and indicates an act of monitoring (measuring and evaluating) the level of public services provided by private operators under the responsibility of the administrators.” If the monitoring indicates that services have not been provided in accordance with the specifications or proposals, providing an economic motivation such as a reduction in the availability payment is considered an effective method for encouraging the appropriate performance of services. The “Guidelines for Monitoring” states that the implementation of this method needs to be considered while paying attention to several points (box 4.6). 65 Recommended Handling of Service Defaults by Private Operators in PPP Projects, per Box 4.6   Monitoring Guidelines (excerpts) • Method for dealing with cases where appropriate public services are not provided »»Ensuring the performance of appropriate public services when such services are not provided (default of obligation) (1) A reduction in the availability payment must be provided as an economic motivation for encouraging proper improvement. When this method is used to ensure the performance of appropriate services, it may be necessary to set the time period for improvement. (2) It should be noted that the method of reducing the availability payment may worsen the financial condition of the private operator in the short run and may cause them to lose the ability to ensure the service level expected by contracting authority. However, the level of public services can be maintained or improved by introducing, for example, a system where reducing points are given according to the state of the default of obligation, and the availability payment is reduced when the points reach the specified level (penalty point system), instead of immediately reducing the availability payment. Another example is a system where recovery points are offered when a private business operator provides public services at a higher level than required, and the recovery points can be offset with reducing points (recovery point system). (3) In accordance with the basic principle of respecting the independence, originality and ingenuity of private entities, it is recommended that a contracting authority develop a scheme on the condition that it will take responsibility in improving the performance of obligations if a default of obligations is ascertained. It is also important to clarify the procedures for the above beforehand. (4) A PPP project contract must clarify the requirements for the default and provide procedures, etc., in the event that the administrator and private operator are involved in it. Source: Cabinet Office 2015. Many PPP projects in Japan have provisions for reducing the availability payment, a form of economic motivation for private operators. The Spopark Matsumori Accident Response and Investigation Committee, which (as discussed in chapter 3) was established in 2005 after a ceiling collapsed at Spopark Matsumori (Sendai Health Facility Project), made seven proposals on management to minimize the influence of the accident. One of the main measures taken in response includes the “restructuring of a mechanism for the payment (stricter penalty).” As a result, the contracting authority started considering a reduction in the availability payment when the specifications of the services were not achieved. In this case, a point of consideration is whether the scope for reducing the availability payment includes not only the payment for maintenance cost but also the payment for capital expenditure (the so-called unitary payment). Since facilities are delivered to the public sector before the start of operations for projects that adopt the build- transfer-operate (BTO) scheme, payment for facilities is a fixed claim for private operators, and it is difficult to include it as part of the amount to be reduced. Build-operate-transfer (BOT) projects, however, may introduce a unitary payment system to provide strong motivation for private operators to maintain service levels. The New Sendai Astronomical Observatory Improvement and Management Project, which adopted the BOT scheme, included development costs as part of the amount to be reduced (box 4.7). This is an example of providing stronger motivation for private operators to implement appropriate DRM measures including other incidents. However, it should be noted that the reduction of the availability payment will not be made when the specifications of the services were not achieved because of force majeure. 66  ontractual Provisions for Availability Payment Reduction, Sendai Astronomical Box 4.7   C Observatory Project (excerpts) Attachment 10: Monitoring and reducing the amount of service purchase costs Section 4: Reducing the availability payment 1. Reducing the amount equivalent to development costs When it is concluded that the specifications are not fulfilled, the amount of development costs shall be reduced, depending on the importance of the facility, the extent to which the specifications is not achieved, and time required for improvement. This method also applies to cases where the specifications and other specifications are not achieved due to the non- performance of maintenance services. Specifically, the reduction amount is calculated by multiplying the following: “hourly unit price per m2 of the room,” “time subject to the reduction amount,” “area of the room that cannot be used” and “coefficient of the reduction amount” according to the importance of the room (refer to the formula below). Reduction amount = Hourly unit price per m2 of the room × Time subject to the reduction amount × Area of the room that cannot be used × Coefficient of the reduction amount Ⅱ The Case of Japan “Hourly unit price per m2 of the room” is the total amount equivalent to the development costs divided by the floor space of the facility and the time (in one hour units) from the opening of the facility until the termination of the project period. “Time subject to the reduction amount” is determined according to the response time from when staff acknowledge that the facility has not fulfilled the specifications until each step is taken, as well as the required response time set by the importance of each room. In principle, the importance of each room is as indicated in the material called “Specifications for each facility” in the Specifications for Facility Building and Maintenance. The importance of the rooms that are combined or newly established based on the proposal from the private operator is to be determined through deliberations in consideration of the importance of the combined room and the frequency of usage of the new room. Source: Contract documents, Sendai Astronomical Observatory Project. For an educational facility PPP project in Sendai City (the School Meal Supply Center), more attention was focused on reducing disaster risks through the mechanism for the availability payment (box 4.8). If a school meal supply service is maintained or quickly restored because of the ingenuity and efforts made by the business operator during a disaster caused by force majeure, points for reducing the compensation amount are decreased, which indicates that responses to disasters and other risks for force majeure are being taken into consideration. 67  ontractual Provisions for Availability Payment Reduction, Sendai School Meal Box 4.8   C Supply Center Project (excerpts) Attachment 10: Monitoring and reducing the amount of service purchase costs Section 4: Reducing the availability payment (4). Cases of decreasing the amount of recovery points for outstanding service performance and the method of reduction When the private contractor provided outstanding services, which are shown in the following a) or b), the contracting authority may decrease the amount of recovery points upon request from the private contractor. This relief measure through decrease of recovery points is maximum 30 points and cannot be applied to the case when critical issues occurred in providing the school meals. a) The private contractor can receive relief measures to decrease recovery points by 10 to 20 points in the case where the high quality services which exceed the level of business requirement specification and the level suggested in the proposal, as explained in the following cases. In this case, the decreased amount of recovery points shall be notified to the private contractor within 7 days after submission of the work record. (omitted) 3) the case where the private contractor sustain or immediately restore the school meal supply service when Force Majeure occurs b) In the case where the total of the recovery points every 3 months for the preceding year was 20 or less, 20 points shall be subtracted as a remedy measure when the recovery points exceed 50 points. Source: Contract documents, Sendai School Meal Supply Center Project. When the Great East Japan Earthquake struck the area in 2011, the School Meal Supply Center at Sendai responded quickly and was restored more than two months faster than other similar facilities that were affected and directly managed by Sendai City. This was mainly owing to independent actions for recovery taken by the private operator that were not restricted to administrative budgetary procedures while municipal staff had to deal with many affected buildings and infrastructure. Because the private operator had an economic motivation such as a reduction in the availability payment, they responded quickly to restore the facility. Another reason for the speedy recovery is that the private operator had the flexibility to procure materials required for recovery by using its supplier network. Box 4.9 provides international examples on developing incentive mechanisms. 68 Incentive Mechanisms in Procurement, Monitoring, and Payment: International Box 4.9   Examples Incentives for Private Operators through Procurement Process Standardization of PF2 Contracts (United Kingdom) In the Standardization of PF2 Contracts (HM Treasury 2012), incentives to private operators are strongly related to the effects on contracts. It states that since the financial effects of delays caused by Relief Events are borne by private contractors, the public authority will not pay any compensation on the occurrence of such delays. Therefore, although a contractor needs to cease the operation when disasters occur, the contractor cannot expect any compensation from the public authority. The lack of support incentivizes a contractor to manage effects caused by natural disasters, in order to resume their service and keep the profit loss minimum. Allocating natural disaster risks to contractors is to incentivize private contractors to handle such risks better. Legislative Guide on Privately Financed Infrastructure Projects (United Nations Commission on International Trade Law) The Legislative Guide on Privately Financed Infrastructure Projects (UNCITRAL 2001) introduces a few contractual examples during the procurement process to incentivize private contractors to handle the risks related to disasters. For example, the entities may agree to make contractual arrangements providing solutions for some of their adverse consequences, such as contract extensions to compensate for delay resulting from events or even some form of direct payment under special circumstances. If the public authority wishes to extend a greater degree of protection to the lenders, the guarantees may cover the project company’s Ⅱ The Case of Japan permanent failure to repay its loans. In such a case, however, it is advisable not to remove the incentives for the lenders to arrange for the continuation of the project. Therefore, in any event, full loan guarantees by the public authority amounting to a total protection of the lenders against the risk of default by the project company are not a common feature of infrastructure projects carried out under the project finance modality. Furthermore, the Guide notes that certain natural disasters, such as storms, cyclones, and floods, may be normal conditions at a particular time of the year at the project site. As such, any public service provider would expect to assume that those natural disasters are likely to happen. However, the situation might differ depending on whether the facilities are permanently owned by the contracting authority or whether there is a requirement to transfer them to the contracting authority at the end of the project period. In the latter case, the contracting authority is authorized to make arrangements to assist the concessionaire to repair or rebuild infrastructure facilities damaged by natural disasters or similar occurrences defined in the project agreement, provided that the possibility of such assistance was contemplated in the request for proposals. The contracting authority will be expected to assume those risks that relate to events attributable to its own actions, which includes inadequacy of technical specifications provided during the selection process. Therefore, the contracting authority needs to set appropriate specification requirements for the private contractors to respond to disasters. Disclosure of Disaster-Related Information “Guidance on PPP Contractual Provisions” (World Bank) Many jurisdictions have policies, laws, or regulations imposing disclosure obligations on contracting authorities and/or ensuring the public has access to public procurement information for public policy reasons. Therefore, these policies can be applied to disaster-related information. Mandated proactive disclosure can be incorporated into either of the following: the country’s freedom of information (FOI) legislation; PPP policies, laws, and regulations; procurement legislation; public financial management (PFM) legislation; sector-specific legislation; and legislation relating to budget transparency. Some jurisdictions have even developed standard clauses related to transparency and confidentiality in PPP contracts. There may also be international financial institutions and multilateral agencies supporting the PPP project that, as a condition of their support, require contracting authorities to comply with their own policies on transparency. However, the information disclosed under such policies does not usually include disclosure of commercially sensitive or proprietary information. Sources: HM Treasury 2012; UNCITRAL 2001; World Bank 2017. 69 4.3  Summary and Key Takeaways The previous sections introduced the incentives for private operators to invest in DRM through procurement procedures (including specifications and evaluation criteria), monitoring, and payment mechanisms. It is important to consider these factors in an integrated manner. The payment mechanism needs to be coordinated with specifications, and monitoring is required to confirm compliance with specifications because these are closely connected and cannot be separated. Therefore, to secure effective DRM investments, emergency response, and recovery by private operators, it is important to prioritize and narrow the monitoring indicators in accordance with the specifications, as well as to develop payment mechanisms that follow the monitoring indicators. Although the priority lies with the public sector’s DRM efforts and creation of incentives for the private sector, the methods summarized below could serve as a reference for countries that will introduce PPP for the first time in the future. Encouragement of private sector innovation through payment mechanisms The private operator can be incentivized to invest in DRM throughout the project life cycle through contractual implementation of a payment reduction mechanism applicable not only to performance but also to the infrastructure asset itself to ensure compliance with the specifications during both the construction and O&M phases. As a result, a private operator proposed obtaining earthquake insurance. Furthermore, when an earthquake struck Sendai, the private sector proactively and immediately implemented emergency response and recovery works as in the case of Sendai International Airport Project. Encouragement of private sector innovation through evaluation criteria Incentives can be contained in the evaluation criteria for strict DRM and additional procurement of insurance to motivate the private sector’s investments in DRM as in the case of Sendai Astronomical Observatory Project. The evaluation criteria for selecting successful bidders also introduced a mechanism to award higher, more favorable evaluation scores for innovative efforts on DRM. Although the evaluation criteria on DRM are not so detailed and the scores on DRM are relatively minor relative to the overall technical scores, contracting authorities are increasingly evaluating the DRM measures proposed by private entities. When disaster struck, the PPP facility recovered about 2.5 months earlier than directly operated facilities by the government, owing to the flexible selection of suppliers for goods and equipment in the case of Sendai School Meal Supply Center Project. In the selection criteria for preferred bidders, a more favorable evaluation is to be given to proactive measures to minimize damages at the time of a natural disaster, as well as to emergency backup systems. For example, proposals to facilitate disaster recovery in coordination with the local government in order to promptly resume operations were welcomed in the case of Sendai International Airport Project. Evaluation based on life-cycle costs and innovation to secure a balance between capital and O&M costs. Project costs are evaluated considering the project duration, so that the evaluation is made based on the life-cycle cost. Furthermore, specifications require a certain level of facility construction (capital cost), and the contracting authority expects private sector proposals that exceed the expected cost to ensure efficiency and effectiveness. 70 Dialogues during the procurement stage The feedback from the private sector is collected at an early stage through Q&As held at the time of disclosure of tender documents and the competitive dialogue. Such steps facilitate the specification on risk allocation. Furthermore, as it is not easy to anticipate force majeure events without uncertainty, the risk taking by the public sector is important while considering the profitability of projects. In addition, the maximum amount of damage to be borne by a private operator was regulated in that the amount of a loss exceeding the amount of insurance obtained by the concessionaire would be paid by the public sector. This scheme that specified the risks allocated to the private entity contributed to participation by international operators in the bidding as seen in the Kansai International Airport Project. Specifications on DRM Tender specification on DRM were developed and iteratively reviewed based on lessons learned from the past natural disasters including the Great East Japan Earthquake. The specifications on DRM cover robust facility designs, resilient O&M, emergency preparedness and response planning including emergency inspection and evaluation of damages. Ⅱ The Case of Japan 71 5. Insurance and Financial Institutions During public-private partnership (PPP) projects, risks are allocated between the public and private entities. A common practice is to enter into insurance contracts to secure business continuity when risks would have serious impacts if they materialize or to cover risks for which neither the public nor the private entity is responsible, such as force majeure events. Insurance contracts are classified into those that are mandatory and those that are voluntary for private operators. Risks are transferred to the insurance company by paying a premium. This chapter studies the responses to changes in insurance availability during a long contractual period as well as the handling of insurance by public and private entities. 5.1  The Public Sector Role on Insurance In PPP projects, where the construction and operation and maintenance (O&M) of facilities are comprehensively commissioned to private operators, project contracts require the operators to obtain insurance for the construction phase as well as the operation, maintenance, and management period to ensure continuity of public service (table 5.1). For either of these periods, they often must obtain damage insurance for the property and for third entities. Table 5.1  Insurance Typically Required of Private Operators in Japanese PPP Projects Phase BTO project BOT project Concession project •  Construction insurance •  Construction insurance Construction n.a. •  Public liability insurance •  Public liability insurance •  Fire insurance (rarely, but •  Fire insurance with an earthquake sometimes private operators are rider O&M •  Public liability insurance required to add an earthquake rider to their fire insurance) •  Liability insurance for facility administrators •  Public liability insurance Note: n.a. = not applicable. BOT = build-operate-transfer. BTO = build-transfer-operate. O&M = operation and maintenance. Insurance and Value for Money In general, fire insurance covers damages caused by fire, winds, snows, lightning strikes, and the like but does not cover fire damages induced by disasters such as earthquakes, tsunamis, and volcanic eruptions. Therefore, in Japan, where there is a high risk of earthquakes, business operators may be required to add an earthquake rider to the fire insurance for the O&M period. However, earthquake insurance is not easily available in Japan because of the limited capacity of the reinsurance market and the required high premiums. As a result, private operators are concerned that if the contracting authority asks them to add an earthquake rider to their fire insurance, they may have difficulty continuing the PPP project because of reduced profitability. Thus, given Japan’s high risk of large-scale damages caused by earthquakes, there is a need to study the necessity of asking private operators to obtain earthquake insurance while taking into consideration the circumstances of individual projects. 72 Insurance for Seismic Risks Build-Operate-Transfer Model In the build-operate-transfer (BOT) model, which requires private operators to bear all the maintenance risks, they often must obtain various types of insurance to bear those risks. Build-Transfer-Operate Model With the BTO model, the facility is owned by the public sector during the O&M period. Therefore, the public sector, which is eventually liable for damages, often bears the risks, and the business operators are rarely required to obtain many types of insurance. One possible reason is because when a building suffers from a disaster, all or part of the damages caused by the disasters can be covered by mutual aid fund from a public mutual aid program. This is based on Article 263-2 of Local Autonomy Act (“a local public entity is allowed to have a mutual aid program with other ordinary local public entities to cover property damages caused by fire, flood, earthquake, and other disasters”). For infrastructure owned by the central government, the public and private entities have the same understanding that in the event of a disaster, the central government is eventually liable for the damages caused by the disaster. In addition, the central government has properties with various functions throughout the country, allowing for a certain Ⅱ The Case of Japan level of risk dispersion in terms of area. There is also sometimes a belief that if the central government paid the premium for national insurance through service compensation (as it does under the BOT model), the value for money (VfM) would drop instead. For infrastructure owned by local public entities, little of the damages can be covered by relief money for seismic disasters under the mutual aid insurance program.5 In a few cases, additional insurance has been obtained to cover disaster risks in the construction phase, and there are limited cases where adding an earthquake rider to fire insurance is required for both construction and operation of public office buildings via PPP.6 Concession Model With the concession model, a private organization purchases the right to operate a public facility or the like from the public sector and continues to run the infrastructure with fare revenues. Compared with the more common BOT and BTO models, the business operator bears more risks, including the risk of low demand. Therefore, there are cases where private operators are not required to obtain insurance for facilities in projects where the risks caused by force majeure, such as a large-scale disaster, are not transferred to private operators. However, in concession projects, such as those for airports, private operators are required to obtain corporate fire insurance, corporate property insurance, and wooden structure insurance for facilities for which they have purchased the operation rights, as well as earthquake insurance. 5.2  The Private Sector Role on Insurance Even if private operators are not required by the public entity to obtain insurance to reduce disaster risks, they may obtain such insurance after proposing it to the public entity. In fact, private operators are expected to show ingenuity and obtain insurance to reduce disaster risks while taking into consideration the insurance market situation and 5   “Relief Money for Seismic Disasters under the Mutual Aid Insurance Program” [in Japanese], Mutual Aid Insurance Agency, Zenkoku Shiyu Bukken Saigai Kyousaikai, http://www.city-net.or.jp/products/earthquake/index.php. 6   For example, the PPP project for construction of the Kudan Common Government Office Building No.3, Chiyoda Ward Office. 73 efficient risk bearing. For example, in Sendai City’s Astronomical Observatory Project, the private operator proposed adding an earthquake rider to its fire insurance even though it was not required to do so by the public authority. The policy on whether to request the private operator to obtain insurance may depend on the characteristics of the infrastructure sector and its profitability. For example, concession projects for airports and the like are expected to have a positive cash flow. Private operators are thought to have a certain level of risk-bearing capacity and are assumed to want to pay the insurance premium in preparation for disaster risks. However, in concession projects where profitability is expected to be low, operators are unlikely to want to pay the high premium during the operation period and may try to limit the scope of insurance. 5.3  Insurance Policies for Additional Cost Deduction When additional costs are incurred due to force majeure, the policy for allotting insurance payout is roughly classified into four types. In Japanese PPP projects, the allotment of payout is determined by setting the threshold levels for risk bearing between the public and private entities based on the criterion that 1 percent of the total damage is paid by the private sector according to the risk-bearing policy for public works contracts (policies 1–3). In many concession projects, however, private operators are supposed to pay damages caused by force majeure and, without setting the threshold levels for risk bearing between the public and private entities, the payout is basically made to the private operators (who have the operating rights and who paid the insurance premium (policy 4). However, if the public sector is involved in restoring the facility, part of the insurance money is paid to the public sector. Policy 1: Insurance Payout First Deducted from Damages In early PPP projects in Japan, based on the concept for public works contracts, it was common that the private operator paid 1 percent of the additional cost incurred from the damages while the public sector paid 99 percent of it. The most common policy for allotting a payout is to cover the amount paid by the public sector. In this case, the amount of money paid by the private operator equals 1 percent of the additional cost, regardless of whether the additional cost is covered by insurance (figure 5.1). In other words, this policy type does not reduce the burden on the private operator even though it has paid the insurance premium. Figure 5.1  Payout Allotment Policy 1 Total damage Insurance to be applied to the Private borne Insurance Public borne amount borne by the public party Policy to apply to insurance Although insurance can cover all the public-borne amount, the private Private borne Insurance party pays for 1/100 of the damage 1/100 Policy 2: Received Money Deducted from Amount Paid by Private Sector In the second type of policy, the payout is first allotted to cover the additional cost paid by the private operator, so the private operator can expect a reduction in its burden. If the payout exceeds the amount of money paid by the private sector, the excess is deducted from the amount of money paid by the public sector (figure 5.2). 74 Figure 5.2  Payout Allotment Policy 2 Total damage Insurance to be applied to the Private Insurance Public borne amount born by the private party borne Policy to apply to insurance If insurance exceeds the amount paid by the private, the excess is deducted Insurance Public borne from the amount paid by the public 1/100 Policy 3: Payout First Allotted for Damages Paid by Public, the Balance Deducted from Damages Paid by Private Sector In the third type of policy, the payout is first allotted for the additional cost paid by the public sector, and if the payout exceeds the amount of money paid by the public sector, the balance (if any) is deducted from the amount paid by the private operator (figure 5.3). Ⅱ The Case of Japan Figure 5.3  Payout Allotment Policy 3 Total damage Insurance to be applied to the amount Private Insurance Public borne born by the public party borne Policy to apply to insurance If insurance exceeds the amount paid by the public, the excess is deducted Private Insurance from the amount paid by the private borne 1/100 Policy 4: Payout Allotment in Concession Projects The fourth type of policy applies to concession projects. When damages are incurred owing to force majeure, the entity with the right to operate the facility pays the cost for recovery and receives the payout paid based on the insurance policy. However, if the public sector is involved in recovery to ensure project continuity or in case of an emergency, the payout is allotted to the public sector (figure 5.4). Figure 5.4  Payout Allotment Policy 4: Concession Projects Total damage Usually, insurance to be applied to the contractor who conducts recovery Private borne Insurance activities Policy to apply to insurance Through emergency and business continuity measures, when the public intervenes in recovery, insurance to be Public borne Insurance applied to the public party 75 5.4  Insurance Availability Characteristics of Insurance Products for Disasters in Japan Fire insurance and earthquake riders can cover a wide range of property damage, including those caused by wind and flood disasters and earthquakes or disasters arising therefrom. However, fire insurance and earthquake riders only cover property damage. In PPP projects, a disaster may damage not only the property but also other facilities related to the project. Moreover, the insurance product lineup offered by insurance companies is the same regardless of the project model (concession or BOT). Construction Insurance and Fire Insurance Damages caused by winds and floods are covered by common construction insurance, fire insurance, and other types of insurance to compensate for property damage. In many PPP projects, it is mandatory to obtain such property insurances. However, fire, explosion, rupture, damage, burial, and other damages caused by earthquakes are usually not covered. Earthquake Rider In general, as previously mentioned, damages due to tsunami, eruption, and other disasters caused by earthquakes are not covered by common fire insurance. Therefore, some disaster risks, such as earthquakes and tsunami, should be covered by adding an earthquake rider to the fire insurance. In most cases, earthquake riders use the reduced payment method or limited payment method. With the reduced payment method, the amount of money to be paid as insurance is calculated by deducting the amount of money to be paid by the private operator (deductible) from the amount of damages incurred by an earthquake and multiplying the resulting value by the predetermined reduction rate. With the limited payment method, the amount of payout to be made is calculated by deducting the amount of money to be paid by the private operator from the amount of damages incurred, but a maximum payment limit is set. Setting the deductible to a high value can reduce the premium. Profit Insurance The losses incurred by the equipment and material vendors, and business interruption due to the suspension of power service, water supply and sewerage service, and other public services may lead to a prolonged sales slump, and the sales loss may exceed the property loss. In many Japanese PPP projects, the lost profits are not included as damages even if the public sector pays damages and additional costs. Therefore, if the loss due to business interruption caused by a disaster can be covered, it is recommended that the sales loss due to business interruption be covered by the profit insurance. In the insurance market, profit compensation is not included in property insurance and requires a separate insurance policy; therefore, private businesses need to obtain two types of insurance, resulting in an increased cost burden. According to a Cabinet Office report, 96 percent of Japanese companies have bought property insurance, but only 44 percent have bought profit insurance (Cabinet Office 2016a).7 In addition, companies consider earthquake insurance to be expensive, and it is considered financially difficult for companies that have bought earthquake insurance to also buy profit insurance. The report also shows that, of the 36 percent of companies that have bought earthquake insurance, only 13 percent have bought profit insurance. 7   In the United States, property insurance and profit insurance are offered as a package under one insurance policy, so more companies can afford to buy profit insurance. 76 In Japan, there is a growing interest in compensation for lost sales due to business interruption after the Great East Japan Earthquake in 2011. However, Japanese insurance companies have been limiting the underwriting of such insurances, and it is difficult to cover losses due to business interruption by purchasing earthquake insurance from overseas insurance companies and transferring the risks to them. More companies are taking more proactive DRM measures and obtaining risk finance against earthquakes, and the reinsurance and alternative risk transfer (ART) markets are growing steadily (box 5.2). Therefore, more companies are expected to buy profit insurance (METI 2006). Box 5.1   Alternative Disaster Risk Finance Products If disaster risks were underwritten only in the insurance market, relying on the abovementioned types of insurance would be a fundamental measure to reduce disaster risks. In Japan, however, there is an increasing interest in alternative risk transfer (ART) methods, by which risks are transferred to the entire capital market. The main advantage of ART is that, unlike insurance, it does not require damage assessment, so payments are made quickly. For example, weather derivatives use the weather as an indicator, and a payout is made when the specified threshold value is exceeded. There is no need to assess whether the damages are caused by force majeure. An option fee is paid to purchase the option to execute the right, and a judgment is made based only on whether an objective value has been exceeded, making it Ⅱ The Case of Japan possible to differentiate risks clearly. However, it must be noted that the option fee depends on the finance market situation and may be affected by elements other than the probability of disasters. Overseas investors have an increasing interest in financial products related to Japanese disaster risk coverage to stabilize their portfolios. The use of ART, which has not been implemented in many infrastructure operations in Japan, may be an effective solution for the private sector to underwrite disaster risks in the future. Table B5.2.1  Types of Alternative Risk Transfer Methods Method Description •  A catastrophe bond (cat bond) is a bond issued by insurance companies, reinsurance companies, and ordinary companies to avoid or reduce losses caused by earthquakes, hurricanes, and other major Cat bond disasters and is a means of securitizing major disaster risks. •  A cat bond is used to transfer major disaster risks to the bond investors, or the third entity. •  Weather derivatives are financial derivatives that represent weather phenomena, such as abnormal weather and bad weather, in indexes based on weather data, including temperature, rain, and snow Weather derivatives data. Money is paid based on the difference between the predetermined indexes and indexes obtained based on the actual weather phenomenon. •  A captive is an insurance company that is founded by a company and operates only for the parent company. The risks borne by the parent company are transferred to the captive with insurance Captive contracts. •  Captives can offer insurance policies that are not easily available in the insurance market and pursue lower premiums than existing insurance premiums. Source: MLIT 2006. Earthquake Riders to Public Liability Insurance Earthquake riders to public liability insurance are not available in the market, and it is considered difficult to cover third-entity damages caused by earthquakes and similar disasters. When the ceiling of the facility constructed in the Sendai Health Facility PPP Project collapsed after the service began, the Spopark Matsumori Accident Response and Investigation Committee was formed to study risk management measures. The committee discussed the need for insurance to cover third-party damages caused by a disaster but concluded that it would be difficult for regular insurances to provide such compensation. 77 Premiums Differences by Disaster Type Insurance payments for damages caused by earthquakes tend to be large, and the insurance premiums and payments for earthquake coverage differ greatly from those for other disaster types. After the 2011 Great East Japan Earthquake, some insurance companies have had difficulty underwriting earthquake insurance because of the reinsurance market situation.8 In addition, the insurance premium is the same regardless of the PPP model, such as concession and BOT. In Japan, the premium for earthquake insurance is high because earthquakes occur frequently. After the Great East Japan Earthquake, the premium for earthquake insurance rose further, and it is now more expensive for private operators to obtain earthquake insurance. Therefore, the operator needs to consider carefully whether earthquake insurance should be obtained from the perspective of commercial viability. The premium is expected to remain high for the time being, which will likely cause a decline in the VfM. Differences by Region The premium rate for earthquake insurance differs depending on the seismic risk of each area. The premium tends to be higher in areas with a high disaster risk and limited capacity of reinsurance. Currently, the premium is said to be high in the Kantō area and other areas with a high seismic risk. Premium Review and Commercial Viability The insurances that private operators obtain are renewed every year. The insurance companies review the premiums periodically, and if the premium rises at the time of renewal, an additional cost needs to be paid from the cash flow of the project, which can decrease the profit of the private operator. Market for Earthquake Insurance As mentioned earlier, private operators are concerned that adding an expensive earthquake rider to their fire insurance would reduce the commercial viability. Private operators have a growing interest in earthquake insurance, but the supply capacity and the number of insurance companies that can underwrite earthquake insurance in the reinsurance market has grown sluggishly, resulting in a supply shortage in some areas (table 5.2). Table 5.2  Recent Status of the Earthquake Insurance Market in Japan Factor Status Demand and •  There is a need for earthquake riders for seismic risks, but the supply cannot meet the demand because of supply rising premiums and insufficient supply capacity on the insurance company side. Insurance •  The insurance companies have difficulty underwriting new policies. They need to make a large payout if an company earthquake occurs, so they need to conduct careful screening to underwrite earthquake riders. supply •  Some insurance companies have difficulty offering new insurance policies, especially in areas from Kantō to capacity Chūbu and Kansai. •  In general, the insurance companies do not bear all the risks associated with the earthquake insurance that they have underwritten but instead transfer the seismic risks to reinsurance companies. However, Japan has few reinsurance companies, and there are insufficient reinsurance opportunities available. Reinsurance •  For seismic risks, Japan actually has the world’s largest protection gap (difference between uninsured and market insured damages), so overseas reinsurance companies see this as a good opportunity to enter the Japanese situation reinsurance market. •  The growth of the reinsurance market in Japan is a good opportunity to expand the availability of earthquake insurance. Sources: Meeting documents on risk finance concerning large-scale natural disaster (Cabinet Office) and interviews with experts. 8   Information from interviews with industry experts. 78 Box 5.2   Insurance for Infrastructure PPPs: International Examples Standardization of PF2 Contracts (United Kingdom) Standardization of PF2 Contracts (HM Treasury 2012) obliges private contractors to insure both construction and operation periods. Required insurances should include third-entity liability insurance, contractors’ “all risks” insurance, and property damage insurance during operation. However, if a private contractor purchases insurance to cover all identified risks, it will reduce the VfM; therefore, the public entity may consider providing private operators with the minimum protection. Against the three insurances mentioned above, the public authority will provide the relief in case of nonavailability of insurance and a significant increase in insurance premium in the insurance market. When insured risk becomes uninsurable, the authority will no longer ask a contractor to insure the same risk. Meanwhile, when terms and conditions become uninsurable during the insured period, the authority will not take its uninsurability as breach of contract. If such terms and conditions become uninsurable, the public authority will reduce the risk to a private contractor by reducing the value of the unitary charge. When an insurance premium significantly goes up, a private contractor is responsible for 15 percent of the increase. This arrangement aims to encourage and incentivize private contractors to look for cheaper insurance when renewal is due. The remaining 85 percent of the cost burden will be borne by the public authority. Thus, contractors in general are affected by significant changes in premiums and factor such risks into business planning. Although the public sector in Japan takes responsibility for some elements of relief when disaster risks themselves are passed to private contractors, contractors in the Ⅱ The Case of Japan United Kingdom will take natural disaster risks and mitigate such risks with insurance coverage. Given the limited availability of insurance, the public authority would provide the minimum relief for private contractors to reduce such risks. Legislative Guide on Privately Financed Infrastructure Projects (UNICITRAL) The Legislative Guide on Privately Financed Infrastructure Projects (UNCITRAL 2001) explains the necessity of insurance as follows: Except for cases in which the Government provides some form of direct support, privately financed infrastructure projects are typically undertaken at the concessionaire’s own risk, including the risk of losses that may result from natural disasters and other exempting impediments, against which the concessionaire is usually required to procure adequate insurance coverage. Thus, some laws expressly exclude any form of compensation to the concessionaire in the event of loss or damage that result from the occurrence of exempting impediments. It does not necessarily follow, however, that an event qualified as an exempting impediment may not, at the same time, justify a revision of the terms of the project agreement in order to restore its economic and financial balance. (145) Guidance on PPP Contractual Provisions, 2017 Edition (World Bank) In the “Guidance on PPP Contractual Provisions, 2017 Edition” (World Bank 2017), insurability is a key that determines the allocation of compensation for the damage caused by force majeure. Usually, the contracting authority bears the compensation when the risk is “uninsurable,” defined as follows: (a) the unavailability of insurance on the international insurance market by insurers of an adequate credit rating/reputable insurers of good standing; and (b) where insurance premiums are prohibitively high (not merely more expensive)—for example, at such a level that the risk is not generally being insured against in the worldwide insurance market with reputable insurers of good standing by contractors in the same country. (27) Equity investors and lenders may seek protection in the PPP contract for the private contractor in case required insurance cover becomes unavailable, less extensive, or more costly. This is because uninsurability makes the private contractor bear the uninsurable risk, which will be reflected in an expensive premium (if indeed it is bankable). Sources: HM Treasury 2012; UNCITRAL 2001; World Bank 2017. 79 5.5  Role of Financial Institutions in Disaster Risk Management In PPP projects, project monitoring with financing from private financial institutions is important to confirm the financial, technical, environmental, and social soundness of the projects. Today, it is common for financial institutions to request that private operators formulate DRM plans such as business continuity plans and emergency drill plans (frequency) when they are developing a proposal. In so doing, several types of considerations must be kept in mind. Disaster risk assessment in cash flow analysis In financing for PPP projects in Japan, although there are some regional characteristics, earthquakes and tsunamis are always included in the risks that must be assumed. Some financial institutions have incorporated risk scenarios based on the assumption that a major earthquake or tsunami occurs every 30 years. In studying the different types of disasters that must be dealt with, it is important to take regional characteristics into due consideration. When conducting cash flow analysis for each risk scenario, it is important to determine how much is covered by insurance. For seismic disasters, the probable maximum loss (PML) value is obtained and theoretical damages are taken into consideration. In addition, the expense items that always appear in a cash flow (concession fee, tax, fixed labor cost, and other expenses) are calculated to analyze each risk scenario quantitatively. Cash reserves for disasters, additional subordinate financing by sponsors, and payments for commissioned projects that can be withheld or deferred are closely examined and incorporated into contracts to make the project more resilient to disasters. Business models and nature of public works In BTO (availability payment) projects, the public sector bears 99 percent of the risks for force majeure, and for the remaining 1 percent that the private business is required to deal with, the use of reserves and support from sponsors is stipulated. In user payment projects, the impact of force majeure on the cash flow is studied in detail. Also, financial institutions pay attention to the nature of public works. Even for the same type of airport infrastructure, the availability of support from the public sector can differ, for example, between an irreplaceable national hub airport and a regional airport that can be replaced by other transportation means. Due diligence and monitoring on DRM In user payment projects, reports are obtained from independent insurance consultants or engineering consultants employed as lender’s advisers before a financial close as well as during the construction and O&M phases. In addition to assessment by independent consultants, financial institutions assess risks on their own based on their experience and other methods. Based on the results of due diligence and monitoring before financial close and during the construction and O&M phases, financial institutions may request that the private operators implement preventive or corrective actions (for example, develop a business continuity plan) to enhance the resilience of the projects. Insurance and bankability In many PPP projects, the public sector is required to obtain the necessary insurance. Financial institutions do not set this as a requirement for approving a loan, but insurance is taken into consideration in credit assessment. If insurance is obtained, it is assumed that risks are calculated as a cost. 80 Insurance covering force majeure, as well as its premium, affects overall cash flows and the project’s business. For example, when profit insurance is obtained, the premium is high, which causes the cash flow to decline. The appropriate insurance to purchase is discussed between the financial institution and private operator, bearing in mind the project’s commercial viability. For all projects except user payment projects, a high premium is paid by the public sector. If the private operators need to pay high premiums, the VfM may decline and it may no longer be advantageous to commission the PPP projects, which in turn would also be unwelcome for the public sector. Correspondingly, there is a belief that premiums should be paid by the public sector if the probability of occurrence is low and it is difficult to obtain insurance with a reasonable premium. 5.6  Summary and Key Takeaways Consider value for money and commercial viability when requiring or purchasing insurance for infrastructure PPPs In infrastructure PPPs, each entity controls the risks that can be taken by themselves through their effective efforts on facility development, operation, and maintenance. Although insurance contracts are arranged for risks when Ⅱ The Case of Japan significant impacts are anticipated, the insurance premiums can be highly expensive and do not necessarily contribute to enhance the VfM. Therefore, whether to require the private entities to obtain insurance for the infrastructure projects shall be carefully studied. In addition, there is a requirement that insurance voluntarily procured by private operators be an efficient and effective means of improving the VfM. Appropriate risk management should be considered through various instruments (for example, insurance, structural or nonstructural DRM measures, and reserves or contingency funds for reconstruction). Consider risk profiles and insurance availability Japan is a particularly earthquake-prone nation, so there may be cases where it is difficult to obtain insurance for seismic risks at a reasonable cost; hence, despite recognizing the necessity of obtaining insurance, decisions need to be made by taking into account the regional characteristics and availability of insurance. Financial institutions encourage DRM measures by the private sector For financing arrangements, financial institutions request risk assessments and due diligence from independent insurance and technical advisors and require private entities to enhance DRM measures such as business continuity plans and emergency preparedness and response plans. Early involvement of financial institutions is important to incorporate necessary structures for financing from the early stage of the project. 81 Conclusion and Lessons Learned 6.  from Japan Based on the case studies described in the preceding chapters, this final chapter summarizes the lessons learned from Japan and implications for infrastructure public-private partnership (PPP) project development at each stage of a PPP project (figure 6.1). Figure 6.1  Overview of Japan’s Lessons Learned from Infrastructure PPP Projects Disaster risk finance Risk sharing between public and private sectors Measures to incentivize private sector DRM and insurance Disaster Countermeasures Basic Act is the fundamental basis for DRM and resilience in Japan. Develop a legal framework that takes into account project characteristics for each sector and indicate the possibility of risk sharing and intervention by a public entity. Expand the insurance Policy and PFI projects are to comply with the DRM policy and legal frameworks. (including reinsurance) Legal Framework market Prepare PPP guidelines on risks and standard contracts. Establish a forum for the public and private entities to enable exible responses to increasing climate risks. Evaluate the disaster risks and identify the scope of risk sharing between the public and private sectors. Transfer a certain degree of natural disaster risk to private operators to promote their e orts on When considering risk sharing to maximize VfM, resilience and innovation. review structural and nonstructural DRM Encourage to insure Project measures, nature of the project, project Disclose information on past disaster damage, insurable risks. Preparation pro tability, and the private sector’s capacity to and encourage DRM e orts from the private absorb the risks. entities. Identify insurable risks and that can be insured at a Structuring Organize workshops to enhance understanding Incentivize the private operators to proactively reasonable cost to (Contracting) on disaster risks to promote DRM. develop DRM measures by introducing a maximize VfM. monitoring and payment mechanism to reduce Depending on country and regional facility development fees in case of characteristics, de ne force majeure based on noncompliance with the speci cations on DRM. risk assessment to minimize uncertainty among This would incentivize the private sector’s DRM. both public and private sectors in preparing for and responding to a natural disaster. Decide appropriate project schemes and risk sharing through Q&A sessions between the Set evaluation criteria on DRM measures such as public and private entities at a selection stage. BCPs and additional insurances. Consider whether agile Procurement and Encourage private operators to procure robust disaster recovery is Evaluate technical robustness and price in the possible by using Implementation context of life-cycle costs. materials and use supply chains for risk reduction and quick emergency response and insurance or derivatives. Evaluate both structural and nonstructural DRM recovery. measures. In addition to predictability, determine the Financial institutions are to require the private scope of risk sharing based on the potential operators to prepare a BCP, DRM plans, and risk Arrange nancing based impacts reduction investments. on the results of project’s Consider preferential nance and insurance risk assessment. Financing Taking into account the possibility of fund raising, use the risk assessment conducted by arrangements (such as lower interest rates, lower Develop innovative nancial institutions. premiums) for companies with robust DRM system nancial products. including a BCP. Note: Italicized items have not been implemented in Japan, but are under consideration for the future. BCP = business continuity plan. DRM = disaster risk management. PFI = private finance initiative. PPP = public-private partnership. VfM = value for money. 82 6.1  Policy and Legal Frameworks Create Synergy between PPP and Disaster-Related Policies and Legislation To promote infrastructure development via PPP, the Japanese government has enacted the PFI Act, published guidelines on risk allocation and contracting, and published a standard contract (as detailed in chapter 2). The Japanese government also analyzed actual projects to understand useful lessons for other implementation agencies (as covered in chapter 3). However, the importance of climate-resilient infrastructure within the legal and policy framework on PPP (such as the Act on Promotion of Private Finance Initiative [PFI Act]) is unclear. Instead, the importance of disaster resilience has been manifested in other policies developed by the government or municipalities, thus ensuring the public sector’s commitment to developing resilient infrastructure (figure 6.2). For instance, the principal legal framework related to infrastructure development standards, such as disaster- related laws and the Building Standard Act, has been developed and continuously revised to reflect lessons learned from the past disasters. This legal framework is the basis for public infrastructure projects. During the development of PPP projects, public authorities embed the principles of this framework in bidding documents (that is, Ⅱ The Case of Japan documentation that defines the specifications of disaster risk management [DRM] standards) to ensure development of risk-informed infrastructure because PPP is one of the forms of public procurement. Instead of standardization, details of the specifications of resilience are provided in the bidding documents of each project and their contracts, taking into account the geophysical and hydrometeorological characteristics as well as the nature of the projects. Figure 6.2  Policy and Legal Frameworks for Resilient Infrastructure PPPs DRM PPPs Basic Act on Disaster Countermeasures PFI Act Building Standard Act Acts related to public works Cabinet Office or line ministries Infrastructure sectoral PPP standard contract guidelines (water, transport, energy) PPP contracting guidelines Hazard maps PPP risk guidelines Municipal DRM ordinances Municipal Municipal DRM plans Municipal PPP guidelines governments Regional hazard maps DRM plans Bidding documents Emergency preparedness and Project parties response plans Technical speci cations Project contract Business continuity plans Resilient Infrastructure PPPs Note: PPP = public-private partnership. DRM = disaster risk management. 83 In a PPP, it is necessary that both the public and private entities have a common understanding of risk sharing and share important information. Although the guidelines developed by the Cabinet Office serve as a useful tool for implementation, the contracting authorities should also take into account geophysical, hydrometeorological, and project characteristics and incorporate them into procurement and contracting. Therefore, it is essential that contracting authorities have the capacity and knowledge to understand disaster risks. An effective, specialized capacity-building program for the contracting authorities may be required to evaluate natural disaster risks and subsequently structure projects and develop risk-informed bidding documents. Box 6.1   Selection of Procurement Methods Selection of the procurement method for public works is important to ensure infrastructure resilience. In Japan, there is a general understanding that, regardless of disaster risks, a public entity should bear general project risks for public projects of importance, that is, infrastructure that cannot cease operations at any times. Therefore, such projects should be implemented as traditional public works projects, or the public should share such risks with the private operator. During the selection of the procurement method, beyond the aforementioned consideration, value for money (VfM) will also be examined. The most effective procurement method to reduce the economic impact of disasters can be selected if the examination takes account both structural and nonstructural measures for resilience to maintain business continuity. Understand Risks and Open Data A basic information database on past natural disasters and anticipated risks enables the private entities to estimate long-term disaster risks. Sharing information from the public sector on past natural disasters can reduce uncertain risk factors for private operators. Because hazard maps and regional DRM plans developed by municipal governments result in effective disaster risk assessment by insurance companies, it is important for the public sector to develop and share disaster risk information proactively. In addition, it is important for the government to develop case studies and summarize lessons learned from past disaster-affected projects and share success stories and know-how accumulated by awarding authorities, such as Sendai City, with potential implementation agencies and private operators. The central government will have a significant role to play in building such system. Respond to Increased Climate Risks in the Future Given the long contract periods typically seen in PPP projects, it can be estimated that natural disaster risks would increase during the contract period because of climate change. However, none of the case studies from Japan incorporated future climate risks and risk reduction measures. In the current PPP contracts in Japan, the scope of the private sector’s responsibility in responding to disasters depends on the results of discussions between the public and private entities. Given the uncertainty of climate change impacts at the project level, climate-risk-informed risk sharing between the public and private sectors as well as methodology to define risk sharing will be required for future projects. These should cover eventualities when climate change indicators exceed the originally estimated levels, private sectors have prolonged project losses for a certain period, and private operators cannot continue construction or operations because of weather extreme or increased cost of risk. Both public and private entities need to agree on and identify necessary steps for negotiating the contract in case of significant changes in project preconditions and environment for the comfort of the private sector. If necessary, such discussion points should be incorporated into the PPP standard contract and guidelines. 84 6.2  Contracting and Risk Allocation Clarify the Scope of Force Majeure in Contracts Although there is a certain understanding of the definition of force majeure and risk sharing between public and private entities, these concepts are not always clearly defined in a contract. When natural disasters occur, both entities need to discuss the response and recovery works to be implemented; however, unclear risk-sharing arrangements make it difficult for both entities to act promptly. Moreover, without clear definition, the private entity lacks a strong incentive to respond to disasters when a public authority bears most of the risks in public works. And when a private operator needs to bear most of the risks, the possibility of overburdens may result in reduced willingness to invest in projects. Clear definitions of risk and identification of private operators’ duties in a contract would avoid situations where private operators excessively bear uncertain risks. This practice also enhances their DRM awareness, which can contribute to early disaster response and recovery. Table 6.1 presents the sample provisions related to force majeure that can be included in a contract. Ⅱ The Case of Japan Table 6.1  Sample Contractual Provisions of Force Majeure Objective Sample provision Remarks •  Specify the magnitude of an earthquake based Specify the level of risk at which the private entity is on the impact on a project. Based on lessons responsible for additional costs and/or damage learned from a seismic event in the past, for caused by force majeure events: example, the private entity was responsible for The contractor bears the costs and damage caused any damage caused by an earthquake below the by earthquakes of seismic intensity 4 or below), seismic level that would damage the large lightning that is attributable to inadequate telescope, which was an important project asset. maintenance of lightning protection equipment, or •  A seismic intensity level is not always adopted inappropriate response to an event. as an indicator to measure the impact on a project. (i) Definition: Specify Force majeure on earthquakes includes the that certain natural following level of phenomena: above the •  Refer to the past large earthquakes, determining disaster risks are to instrumental seismic intensity of 6.5, the degree not only the seismic intensity but also the be borne by the of seismic level 7 by the Japan Meteorological ground horizontal acceleration as the criteria for Agency, ground horizontal acceleration 500 gal, a private entity determining force majeure and the impact on a more disastrous earthquake than the Great project. Hanshin-Awaji Earthquake, whose seismic impact was unusual.a Risks concerning a maximum rainfall of 80 millimeters or more (24 hours average) will be borne by the public. •  Apply the same standards used in traditional Even if the rainfall is below the above standard, public works procurement, and limit the risks to this is considered as heavy rain if the average be borne by the private operator. hourly rainfall is significant (20 millimeters or more). 85 Objective Sample provision Remarks Provision on how to measure the scale of earthquake: •  Develop detailed provisions through dialogues between the public and private entities for Install seismometers on the first and the top floors mutual understanding. (ii) Methodology: of a designated building. Specify the methods for determining force Provision on how to measure a rainfall: majeure Hourly rainfall is observed at the nearest weather •  Clearly define the methodology for determining observation station (managed by a public a force majeure event in the contract. corporation) from the damaged location. Defects and force majeure: Force majeure is applied to the following case: •  Add an explanatory note to distinguish the more than a half of the buildings built at the same private operator’s defects and force majeure. time in similar conditions underwent the same •  The building comparison is only applicable degree of damage or more damage that was when there are buildings in similar conditions. (iii) Differentiate: undergone by the project assets. Clearly differentiate baseline conditions, Distinguish baseline characteristics and force •  Any obvious and apparent ground subsidence at O&M requirements, majeure: the project site should be handled by the and force majeure contractor; such subsidence should be Example: The contractor bears responsibility for maintaining reclaimed land, including responding distinguished from force majeure. to ground subsidence at the airport during the •  However, when an unforeseen event causes O&M phase. The contractor bears the related O&M ground subsidence that the contractor cannot costs within the range specified in the handle, any related additional damage and costs specifications. will be borne by the public entity. Note: O&M = operation and maintenance. “Seismic intensity” is measured on the Japan Meteorological Agency’s seismic intensity scale. Seismic intensity is the value observed at a site where a a.  seismic intensity meter is installed, and may vary within the same city. It is on a scale of 1 to 7, with 5 and 6 each divided into “lower” and “upper.” Gal is a unit of gravitational acceleration equal to 1 centimeter per second. The Great Hanshin-Awaji Earthquake reached the maximum “7” on this scale. Define and Allocate Risks between Public and Private Entities to Maximize VfM Because Japan is prone to natural disasters, the public sector has typically borne the disaster risks, and this has partly contributed to the development of PPP markets in Japan. However, case studies indicate that, as both the public and private entities accumulate PPP experience, disaster risks that the private sector can reasonably manage have been transferred to the private sector. Before allocating risks between public and private entities, it is important to •  Identify the level and scope of risks that can be managed by private entities and private financiers; •  Review the availability of risk transfer measures such as insurance at a reasonable cost; and •  Review the project’s financial capacity (for example, profitability) to absorb the associated costs. Factors to be considered when allocating risks between the public and private entities are summarized in table 6.2. Although private operators can bear a certain level of risk, there is a need to have a system for public entities to bear and compensate for the risks that have a critical impact on projects and that cannot be borne by private operators. 86 Table 6.2  Determining Factors in Risk Allocation between Public and Private Entities in PPP Projects Factor Principles Examples of risk allocation •  Airport projects are an important infrastructure facility for national and regional economic and security activities. The public sector will intervene and Interventions and emergency measures will be taken by the assure the continuity of critical government to mitigate the impacts of disasters on runways infrastructure that cannot stop and risks can be borne by the public. Nature and operations in the aftermath of a •  On the other hand, passenger terminal buildings are considered criticality of disaster. to be for-profit projects, and the public sector will not intervene public service to ensure business continuity. A large-scale public infrastructure •  The public sector bears a certain level of risk on airport cannot be easily relocated, and risk concession projects. sharing and diffusion are difficult. •  The 2005 Miyagi Earthquake, of seismic intensity 5, damaged When estimated damage poses a severe the main facility of Sendai’s astronomical observatory, while no impact on a project, the public sector is facilities have been damaged by earthquakes of seismic responsible. In case of minor impacts or Disaster risks intensity 4 or below. Based on the experience and lessons damage, the private sector is learned, it was determined that the private operator be capable responsible for emergency response and of absorbing the damage and impacts from hazards that are recovery. less than seismic intensity 4. Ⅱ The Case of Japan In addition to robust engineering design and materials, maintaining business •  Sendai adopted PPP as the most efficient model for procuring continuity and enhancing resilience school facilities because it was estimated to save public costs during the O&M phase is critical. A VfM of responding to a natural disaster (for example, human Value for money analysis should take into account both resources and time required for damage and needs assessment, and resilience structural and nonstructural DRM coordination with the municipal assembly) by sharing the measures that can minimize economic responsibility of emergency response and recovery with the losses from disasters as a result of private operator. appropriate risk allocation to the private operator. •  Unforeseeable and unavoidable risks were borne by the public sector since it was difficult to identify a reasonable range of unforeseeable events. The probability of avoiding risks was considered when analyzing project profitability. Natural disaster risks are borne by the •  Because price increases on road concession projects are not private sector when private operators Project usually at the discretion of the private sector, natural disaster are able to increase profitability and profitability risks are mainly borne by the public sector. National standards decrease costs by their own initiatives on public construction, which identify the public sector as a or innovation. main natural disaster risk bearer, elaborate on risk allocation between public and private entities. On the other hand, a private entity shall bear all additional costs resulting from force majeure for any subprojects initiated by the entity. •  In an airport concession project, the contracting authority identified the level of insurance to be purchased by the private operator, beyond which excess damage will be borne by the Insurance as a Risks that can be mitigated by public sector. risk transfer reasonably priced insurance are borne •  The contracting authority used an adviser to analyze the measure by the private sector. insurance market to identify the availability of insurance. •  In the case of countries like Japan that have a limited reinsurance market for earthquake insurance, excessive burden on the private sector is unrealistic. •  Contractual provisions on unavoidable risks are not common. However, risks that can be avoided by a private operator with When the costs of measures to avoid or implementation of DRM measures are borne by the private Acceptability of minimize expected risks are acceptable operator. cost of risk to the private sector, risks are borne by •  With a mechanism to compensate private operators for the private sector. additional costs associated with DRM measures, risks can be reasonably allocated to the private sector. 87 Factor Principles Examples of risk allocation Ensure appropriate risk allocation between the public and private entities •  Carry out a cash flow analysis of disaster risk scenarios and Bankability to secure reasonable project finance and determine possible project financing through a dialogue to avoid an excessive financial burden between public and private entities. on the private sector. •  When a private sector has borne similar risks on earlier projects and accumulated knowledge on DRM, risks are borne Maturity of the by the private operator. When the private sector’s market •  With increasing private sector involvement in infrastructure market or track maturity is high and the private sector PPPs, transferring of natural disaster risks to private operators record of private has accumulated experience in is increasingly considered. In Sendai, the definition of force entities and managing risks, risks are borne by the majeure was reviewed, and certain natural disaster risks were know-how private sector. allocated to the private sector. By allocating the risks to the private sector, the contracting authority encouraged active involvement of the private sector in DRM. •  In the case of greenfield infrastructure projects owned by Greenfield or If infrastructure is newly developed and private operators, the operators will have knowledge of the brownfield asset owned by the private sector, risks are physical and operational resilience of infrastructure and will ownership allocated to the private sector. control the maintenance of the infrastructure. Certain risks can therefore be allocated to the private sector. •  It is difficult to define all possible future risks, so impacts on the project’s profitability, which can result in business To deal with unknown risks in the continuity difficulties for a private operator, are measured to future, a mechanism to measure impacts trigger a negotiation between the entities if required. Future impacts on on project profitability over a certain •  As assumptions and preconditions of a contract can be changed the project period and a flexible mechanism to over a period of long-term contracts, critical factors are trigger negotiation between the entities monitored to trigger negotiation between public and private should be developed. entities to maintain contractual flexibility. •  Future climate risks with deep uncertainty can be dealt with using a similar structure. Note: DRM = disaster risk management. O&M = operation and maintenance. PPP = public-private partnership. VfW = value for money. A relationship among the factors highlighted in table 6.2 to help determine the level of risk allocation to the public or private sector is summarized in figure 6.3. Risk allocation for each project should be defined after comprehensive consideration of these factors. Figure 6.3  Principles of Disaster Risk Allocation to the Public Sector in PPP Projects Project characteristics Level of risk allocated to the public sector Criticality is high Disater risk is high Pro tability is low Risk transfer measures such as insurance are limited Large Cost of risk is high Financing is di cult Market maturity is low No private asset ownership Note: PPP = public-private partnership. 88 Use Iterative Processes to Enhance Understanding and Risk Sharing between the Public and Private Sectors In the case of Sendai’s Health Facility project, both Sendai City and the private operators lacked awareness on understanding and preparing for risks, which led to damage to the assets from the 2005 Miyagi Earthquake. Learning from the experience, for the New Observatory project, Sendai conducted risk workshops during the project development stage to identify risks for the public and private entities. Both entities clearly recognized the significant impact of disaster risks, which was reflected in the development and operation of resilient infrastructure. As a result, private operators were able to promptly manage recovery and reconstruction after the Great East Japan Earthquake. 6.3  Procurement, Monitoring, and Payment Conduct Dialogues between Public and Private Entities to Facilitate Project Structuring Ⅱ The Case of Japan Effective dialogues between public and private entities during the procurement phase enable development of a mutually agreed-upon definition of force majeure and allocation of risk that can help attract the private sector’s investment in PPP projects. In Japan, several question-and-answer sessions are conducted after the request for information (RFI) is issued, which enable enhanced mutual understanding between the public and private entities. A procurement authority aiming for a competitive bid environment should share the expected project structure at an early stage of the procurement process and conduct dialogues with the private entities to gain an understanding on the commercial viability of DRM measures that a private operator can invest in and implement as part of the project. Incorporate DRM into Evaluation Criteria of Bid Proposals Some projects incentivize private DRM initiatives and innovation by requesting proposals from the bidders on risk- informed infrastructure designs as well as by setting high evaluation points for strict DRM and additional insurance. The procuring authorities require design and construction of infrastructure in compliance with the relevant laws and regulations (such as building regulations and the Disaster Countermeasure Basic Act). The procuring authorities also ask the private sector to take into account resilience throughout the life cycle of infrastructure assets. A creative example includes a case where a private entity chose earthquake-resistant construction materials to minimize the potential damage. It is recommended to proactively use the private sector’s know-how and networks for quick disaster response and recovery. For example, a private operator can often access financing and insurance faster than a public entity in some cases to raise funds for reconstruction. It is important to include nonstructural DRM measures in the evaluation criteria, in addition to structural DRM measures such as engineering design and materials. Table 6.3 summarizes the lessons learned from the impact of the Great East Japan Earthquake on the Shin Nomura School Meal Supply Center Development Project in Sendai City. 89 Table 6.3 Lessons Learned from Japan on Evaluation Criteria in a Disaster-Affected Project: Sendai School Meal Supply Center Phase Practices, results, and lessons •  Evaluate proposals on engineering measures to protect and minimize seismic risks; evaluate nonstructural measures and institutional arrangements that enable prompt emergency response and recovery. •  Reduce penalty points when a private operator continues services or immediately recovers after a Contractual arrangement force majeure event by using innovative measures. •  The contract noted that the “City and a private operator shall take immediate measures according to the appropriate procedures in order to remove impact of force majeure immediately and need to make efforts to minimize damages from force majeure events to the other entity.” •  City officials were preoccupied with emergency response across the city, so the private operator took an initiative to restore the damaged facilities. •  A private operator was able to procure materials for emergency response and reconstruction in a flexible arrangement via its own procurement network. On the other hand, a facility owned and Disaster response managed by the city required administrative processes and longer time for recovery because of inflexible contract management systems in the public sector. •  The PPP project achieved recovery 2.5 months earlier than the facilities managed by the city. •  The associated costs of emergency response and recovery were covered by insurance. •  It is possible to have early recovery of facilities by using the private sector’s know-how and flexibility, such as its own procurement network for obtaining recovery materials etc. Lessons learned •  Compared with the constraints in annual budgets faced by the public sector, a private operator can ensure funds for reconstruction by using insurance. Payment Mechanisms to Incentivize DRM The project development phase should include mechanisms to encourage innovation from private operators. For example, appropriate payment mechanisms can incentivize the private operators to invest in DRM. General economic incentives include bonus payments and strict penalties (table 6.4). Table 6.4  Payment Mechanisms Used as Incentives Incentive Action Remarks •  If the project does not include any profit centers, additional Provide bonus payments or reduce penalty funds will be required for bonuses, which can be a hurdle points if the required service is Bonus provision for flexible or prompt response. appropriately managed during the •  No budgetary arrangements will be required for reduction operation and maintenance phase. of penalty points. •  The impact of reducing service payments on debt financing Reduce service payment with failure of should be considered. Strict penalty performance of private operator. •  The penalty shall be defined depending on the importance of the service to ensure its effectiveness as an incentive. For the Astronomical Observatory Project, Sendai City established a policy for reducing the private operator’s contracted amount in case of facility defects that do not meet the specifications and performance standards taking into account the importance of the facility component, degree of defects, time required for corrective actions, or other factors. Sendai City developed the approach to incentivize the private sector’s investment in DRM as a lesson learned from the facility defects in the Sports Facility Project, which were triggered by the 2005 Miyagi Earthquake (table 6.5). 90 Table 6.5  Lessons Learned on Incentive Mechanisms in Disaster-Affected Projects Phase Practices, results, and lessons Sports Facility Project, Sendai City •  The contract provided for no reduction in design or construction fees. There was little Contractual arrangement economic incentive to conduct appropriate monitoring of assets. •  The ceiling collapsed during the Miyagi earthquake (concluded to be a latent defect on Disaster event the part of the private operator). •  There is a need to restructure the mechanism of service payments, enabling more Lessons learned appropriate management and monitoring to minimize the effects of accidents. Astronomical Observatory Project, Sendai City •  The contract provided for possible payment reduction in design or construction fees. Contractual arrangement •  The private operator is exempted from responsibility for force majeure. •  The private operator took initiative to reconstruct the facility after the disaster after the Disaster response 2011 Great East Japan Earthquake. •  Monitoring and disaster response measures were considered in advance, and a private Ⅱ The Case of Japan operator responded to the damage caused by the disaster proactively and flexibly, Lessons learned allowing city officials to handle other disaster-related matters. •  It is important to allow a private operator to own assets, strengthen ownership, and develop a business continuity plan and a disaster response plan in advance. In the build-transfer-operate (BTO) project model, the ownership of facilities is handed over to the contracting authorities before the operation and maintenance (O&M) phase begins; therefore, it is difficult to include payment reduction mechanisms for the engineering designs of assets. Build-operate-transfer (BOT) projects, however, may introduce a unitary payment system to incentivize private operators to maintain the certain service levels. 6.4  Disaster Risk Finance, Insurance, and Financial Institutions Insurance Availability and VfM Although every risk in PPP projects is allocated to the public and private sector, it is effective to insure the risks when the risks have significant impact on the projects and are not attributable to either entity. This would secure business continuity of projects. In general, insurance against property damage is widely purchased. PPP projects may experience not only property damage but also other damages during implementation; therefore, projects should have suitable insurance coverage (for instance, third-entity liability insurance, liability insurance for airport management for airport projects). Furthermore, the economic losses caused by damage to suppliers of equipment and materials as well as interruption of utility services such as electricity, water supply, and sewerage may have prolonged impacts on the project’s business continuity. In such cases, profit losses may exceed the value of the property damage. Therefore, it is ideal to insure against business interruption losses. Meanwhile, because Japan is prone to earthquakes, the premiums for earthquake insurance have significantly increased. Although interest in earthquake insurance has grown among project operators, such insurance is not 91 readily available owing to capacity issues with suppliers and a weak reinsurance market that can bear such risks. Therefore, even if private operators insure against earthquakes, they may end up with higher costs relative to the period before several large-scale earthquakes occurred. Increased costs for earthquake insurance may lead to a deterioration of VfM. Therefore, the awarding authorities and private operators need to consider the cost- effectiveness of an insurance coverage. Encourage DRM by Financial Institutions As a requirement to secure financing from financial institutions including commercial banks, there are cases where private operators are asked by a third entity (such as insurance consultants or technical advisers) to assess and evaluate disaster risks, develop a business continuity plan and DRM plan, and prepare a technical due diligence report to review the engineering designs of assets during the financing stage. Financial institutions also ask the private operators to disclose the details of DRM measures. When disaster risks are to be allocated to private operators in PPP projects, it is important to confirm whether these risks are acceptable to the financial institutions, as providers of the project funds, in terms of project bankability. From the perspective of securing repayment sources, financial institutions have a strong incentive to promote stable projects and possess know-how on cash flow management (for example, secure cash reserve, insurance coverage, and measures to postpone payment to subcontractors for a certain period). During the dialogues with financial institutions, private operators shall seek advice from the financial institutions and develop a robust income and expenditure plan that can enable investments in DRM measures including emergency response. Moreover, the PPP project framework includes a concept known as the direct agreement, which allows direct discussions on business continuity measures between a contracting authority and a financial institution. This framework contributes to smooth financing arrangements and securing business continuity at times of disasters. Box 6.2 discusses potential financial products that may be developed in the future to incentivize resilience investments in infrastructure PPPs. Box 6.2   Innovative Financial Products for Future Development As discussed in the case studies, disaster risks were properly evaluated in a number of cases, especially in Sendai. However, because of an upper limit on the order price of a PPP project, there have been a limited number of cases where projects utilized risk hedging and innovative disaster risk finance measures, including insurance based on a quantitative assessment and evaluation of natural disaster risks at the project level. In addition, there is a common understanding and belief among the private operators that the public sector should bear disaster risks, especially when a large-scale disaster occurs. As a result, the availability of innovative disaster risk finance products that incentivize investments in resilience in infrastructure PPPs is limited in Japan. Although the reinsurance market especially on earthquake insurance in Japan has a little capacity to accept new insurance, it would be effective to use investors’ funds from capital markets. In the future, it will be necessary to identify the merits of alternative risk transfer approaches such as catastrophe bonds (cat bonds), weather and climate derivatives, and improvements required to expand such risk alleviation measures. Financial incentives to enhance disaster resilience and increase availability of financial products that consider disaster resilience should be promoted. For example, lowering premium prices by providing a preferential interest rate for resilient infrastructure services (for example, business continuity planning) may be considered. As private participation in this market increases, it may be possible to promote the development of new financial products. 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UN-Habitat (United Nations Human Settlement Programme) et al. 2015. “Habitat III Issue Paper 15: Urban Resilience.” Issue paper, United Nations Task Team on Habitat III, UN Conference on Housing and Sustainable Urban Development. https://unhabitat.org/wp-content/uploads/2015/04/Habitat-III-Issue- Paper-15_Urban-Resilience-2.0.pdf. World Bank. 2015. “Investing in Urban Resilience: Protecting and Promoting Development in a Changing World.” World Bank, Washington, DC. https://www.gfdrr.org/sites/default/files/publication/Urban%20 Resilience%20Flagship%20Report%20FINAL%20(10%2012%2016).pdf —. 2015. “2015 Global PPI Update.” Note of the Public-Private Partnership Group and the Private Participation in Infrastructure (PPI) Database, World Bank, Washington, DC. https://ppi.worldbank.org/~/media/giawb/ ppi/documents/global-notes/global2015-ppi-update.pdf. —. 2016. “Emerging Trends in Mainstreaming Climate Resilience in Large Scale, Multi-sector Infrastructure PPPs.” Global Knowledge Product, World Bank, Washington, DC. —. 2017. “Guidance on PPP Contractual Provisions, 2017 Edition.” Guidance report, World Bank, Washington, DC. 94 Appendix A: Legal and Policy Frameworks in Japan for Public-Private Partnerships and Disaster Risk Management A.1  PPP-Related Laws and PPP Promotion System Japan introduced the public-private partnership (PPP) model on a large scale by enacting the Act on Promotion of Private Finance Initiative (Act No. 117 of 1999) (PFI Act, hereafter) and subsequently promoting its spread (table A.1). In addition to the enactment of the PFI Act, the PPP/PFI Promotion Office was established under the Cabinet Office. The PFI Promotion Office plays an advisory role to the prime minister and other public agencies. It has developed several guidelines that help local governments understand the PPP project and contracting process (table A.2). The same office also provides the public with information that promotes PPP, and coordinates the PPP promotion across various agencies at the central government level. Given its advisory role, the Promotion Office neither prepares individual projects nor provides financing to PPP projects. Table A.1  PPP-Related Legal and Financial System in Japan Year Action Content References / Appendix Act on Promotion of Private This Act aimed to promote development of public infrastructure by using private financing 1999 Finance Initiative (PFI Act) and management and technical capacity. enacted To promote the concession model, the above Act enabled private operators to decide the level of user fees and to collect them, as well as to take out mortgages for operating rights Concession model in public infrastructure. This amendment to the PFI Act allowed private operators to introduced submit unsolicited proposals, while at the same time requiring the public sector to respond to such proposals from private entities. 2011 This amendment to the PFI Act allowed private operators to submit unsolicited proposals, Unsolicited proposal while at the same time requiring the public sector to respond to such proposals from specified private entities. Eligible sectors for PPP Ships, aircraft, and satellites were added to the list of sectors eligible for PPP projects. projects expanded Private Finance Initiative The public-private fund was established to expand financial arrangement opportunities for 2013 Promotion Corporation of user payment PPP projects. Japan established System introduced to deploy A system to allow retired public servants with expertise to work on concession projects 2015 retired public servants to was established. concession projects Note: PPP = public-private partnership. 95 Table A.2  PPP/PFI Promotion Office Guidelines to Support PPP Projects in Japan Any description of Year Guideline Content force majeure? 2001 Guideline on implementing PPP projects that explains the Guideline on process of PPP (amended procedure and the key points to be followed for preparing and No projects 2007) implementing projects Guideline on risk allocation Guideline that explains risk allocation considerations in PPP 2001 Yes in PPP projects projects Guideline that explains the assessment of VfM (value for money), 2003 Guideline on VfM No which will be calculated upon selecting an operator Guideline that includes an overview of objectives, applicable 2003 Guideline on Contracting Yes laws, and important points to be stipulated in a contract 2003 Guideline on Monitoring Guideline on considerations in monitoring in PPP projects No Guideline on operating right Guideline on important considerations and discussion points for 2015 and operation of public Yes the preparation and implementing of concession projects facilities PPP Standard Contract (for Prepared as a sample contract for availability payment contracts, 2010 public facility development but it is recommended that contracts be prepared based on the Yes with availability payment) characteristics of individual projects Note: PPP = public-private partnership. VfM = value for money. “PPP/PFI Promotion Office” refers to the Private Finance Initiative Promotion Office under the Cabinet Office. The introduction of the concession model (defined and further discussed in chapters 1 and 2 of this report) has helped prepare a base for private financing to fund existing infrastructure elements that have high profitability. The Private Finance Initiative Promotion Corporation of Japan was established in 2013 with public-private investment to provide funding support. The establishment of this agency has helped prepare the framework to support more user payment projects (including concession projects) by providing financing to private operators, and to further develop infrastructure with PPP models. A.2  Disaster-Related Laws Disaster Countermeasures Basic Act The Disaster Countermeasures Basic Act (Act No. 223 of 1961) (the Act, hereafter) serves as the basis for Japan’s disaster risk management (DRM) system. The Act clearly defines the roles and responsibilities of the central and local governments for all phases of disasters such as prevention, emergency responses, recovery, and reconstruction. Regarding activities related to disaster recovery, the relevant public and private entities will work together to implement various disaster countermeasures by ensuring the cooperation of private organizations (Cabinet Office 2015a). This Act, which is the pivotal legislation for disaster countermeasures systems in Japan, was enacted in 1961, taking into account the lessons learned from the Isewan Typhoon (also known as Typhoon Vera) in 1959. This Act aims to protect citizens’ lives, livelihoods, and property from natural disasters and to contribute to public welfare. It clearly stipulates the responsibilities of DRM administration, development of comprehensive and strategic DRM structures, social welfare, and other issues. It primarily focuses on seven points: 96 (1) Clarifying the definition of the responsibilities for DRM (2) Disaster-related organization (development and promotion of comprehensive DRM administration) (3) Planning disaster response (development and promotion of systematic DRM measures) (4) Promotion of disaster countermeasures (5) Protection of affected people and their livelihoods (6) Financial measures (7) Disaster emergency The Act has frequently been reviewed and amended since its enactment, taking into account the lessons learned from large-scale disasters. For example, after the Great Hanshin-Awaji Earthquake in 1995, an amendment in the same year included the codification of disaster relief requests for the Japanese Self-Defense Forces (JSDF). Similarly, after the Great East Japan Earthquake in 2011, the same Act was amended significantly in 2011 and 2012. Since then, measures against large-scale disasters have been taken by reviewing this Act almost every year. Table A.3  Major Revisions of the Disaster Countermeasures Basic Act, 1961–2016 Year of major revision Details of revision •  Clarification of responsibilities of DRM administration Enacted 1961 •  Development of comprehensive and strategic DRM structures Establishment of DRM mechanisms based on volunteer groups and private organizations, loosening 1995 requirements for the establishment of an Extreme Disaster Management Headquarters led by the prime minister, and codification of disaster relief requests for the JSDF 2011 Wide-area response for large-scale disaster and improvement of regional DRM capabilities Procedure for affected people to stay beyond the municipal and prefectural borders (enhancement of the 2012 measures concerning support activities mutually done by local governments, and the like) References / Appendix Measures for ensuring smooth and safe evacuation of residents, improving protection of affected people, 2013 and so on Strengthening of measures against unattended cars to promptly clear them from the roads for emergency 2014 vehicles 2015 Preparations for disaster waste disposal on a routine basis Promotion of reform to enhance regional autonomy and independence (delegation of powers and 2016 administrative work to provincial and local government) Source: Cabinet Office 2016b. Note: DRM = disaster risk management. JSDF = Japanese Self-Defense Forces. In Japan, the Cabinet Office, which is responsible for ensuring cooperation and collaboration among related government agencies on wide-ranging issues, is mandated to undertake the planning of basic DRM policies and responses to large-scale disasters, as well as to conduct overall coordination. In this structure, the Central DRM Council (with the prime minister as the chair and including all Cabinet members) decide DRM policies at the national level, which are then accordingly carried out by respective ministries and agencies. The Act mandates the formulation of DRM plans. The Basic DRM Plan is the highest-level plan prepared by the 97 Central DRM Council. Under the Basic DRM Plan, every designated government and public agency9 prepares a DRM Operation Plan, while every local government entity prepares a Local DRM Plan. Since DRM Plans are formulated on a municipal government basis, municipal DRM agencies stipulate specific tasks to be performed for DRM in that region in their DRM plans, in accordance with the circumstances of each region. Risk Approach in Disaster-Related Laws In Japan, which frequently suffers from natural disasters including earthquakes, laws and standards have been enacted, reviewed, or strengthened with each occurrence of a large-scale disaster by repeating the PDCA (Plan, Do, Check, Act) cycle to avoid the same tragedy in the future. As table A.4 indicates, the Building Standards Act related to infrastructure and PPP facilities has been revised after each major earthquake. Table A.4  Relationship between Major Earthquakes and Quake-Resistant Standards in Japan, 1948–2013 Earthquake event ➔ Result 1948: Fukui Earthquake ➔ 1950: Enactment of the Building Standards Act 1981: Amendment of Order for Enforcement of the Building Standards Act, 1978: Miyagi Earthquake ➔ introduction of current earthquake engineering laws 1995: Great Hanshin-Awaji ➔ 1995: Act on Promotion of the Earthquake-Proof Retrofit of Buildings Earthquake 2000: Amendment of the Building Standards Act –etsu Earthquake 2005: Partial amendment of the Act on Promotion of the Earthquake-Proof Retrofit 2004: Chu ➔ of Buildings 2013: Partial amendment of the Act on Promotion of the Earthquake-Proof Retrofit 2011: Great East Japan Earthquake ➔ of Buildings The Building Standards Act was last amended in 2012.10 There were many instances of collapsing ceilings and falling escalators in large buildings during the Great East Japan Earthquake in 2011. The 2012 amendment stipulates that the elevator hoistway area should not be included in the total area when calculating the floor area ratio. In addition, a partial amendment of the Act on Promotion of the Earthquake-Proof Retrofit of Buildings was passed in 2013 in response to the Great East Japan Earthquake. This Act makes it obligatory to test the earthquake resistance of the design of certain buildings used by the public. These buildings include hospitals, schools, and nursing homes that require special attention on users during evacuation, as well as waste management or other storage facilities that handle a certain amount of hazardous materials. As these examples show, the Japanese government anticipates the potential risks of the next disaster based on experience from past disasters, and promptly includes the lessons from such past experiences in legal systems and implementation plans to ensure that public facilities take strict measures against disasters. 9   There are 24 ministries and agencies designated as government organizations and 66 organizations (including independent administrative agencies, Bank of Japan, Japanese Red Cross Society, NHK, electric and gas companies, and Nippon Telegraph and Telephone Corp. [NTT]) designated as local public corporations (Cabinet Office 2015a). 10  “Partial Amendment of the Ordinance for Enforcement of Building Standards Act” (2012) by the Ministry of Land, Infrastructure, Transport and Tourism. 98 Disaster Risk Assessment in Municipal Legislation (Case of Sendai City) Sendai City, a municipality and one of the autonomous communities affected by the Great East Japan Earthquake, has also increased its resilience by learning from past disasters and amending relevant laws. In accordance with the provisions of Article 42 of the Disaster Countermeasures Basic Act (Act No. 223 of 1961), the municipality formulated the Sendai City Local DRM Plan in 1964, in which the Sendai City DRM Council has defined local risk reduction investment, emergency response, and recovery efforts (Sendai City 2014). This DRM plan has also been amended thoroughly with each occurrence of a large-scale disaster—most recently in 2016—showing that the local government is treating past disasters as potential future disaster risks and taking necessary measures against them. Table A.5  Formulation and Revision of Sendai City Local DRM Plan Earthquake event ➔ Result 1995: Great Hanshin-Awaji ➔ 1997: Total revision (seismic disaster countermeasures) Earthquake 2011: Great East Japan Earthquake ➔ 2013: Total revision (seismic/tsunami disaster countermeasures) Source: Sendai City 2014. The Sendai City DRM plan describes and addresses possible earthquake, high winds and floods. Earthquake The Headquarters for Earthquake Research Promotion, which falls under the Ministry of Education, Culture, Sports, References / Appendix Science and Technology (MEXT), releases the results and findings of research on earthquakes.11 The Sendai City Local DRM Plan uses these research data as the basis for making plans for possible disasters, drawing a long-term perspective from the assessments from earthquake sizes (magnitude) and probability of occurrence within a certain period. The Plan focuses on earthquakes that can affect Sendai City out of all the earthquakes in major active fault zones and trench-type earthquakes that are indicated in the research results. For example, the Sendai City Local DRM Plan lists earthquakes in the waters off Miyagi Prefecture as trench-type earthquakes. In this region, inter-plate earthquakes with magnitudes of 7.1–7.4 have been occurring repeatedly in specific areas since 1885. It is estimated that the average occurrence interval is approximately 38 years, and the probability of an earthquake with a magnitude of 7.0–7.3 occurring is 60 percent in the next 30 years and 80 percent in the next 50 years, excluding those that occur repeatedly. Wind and Flood Damages The Sendai City Local DRM Plan identifies possible danger areas for flooding, landslides, storms, and tornados that can occur in the city in the future based on past precipitation, wind speed, and topological characteristics. With respect to flooding, for example, the plan estimates flooded areas through computer simulations using statistical precipitation from previous extreme rains. The probability of flooding is calculated based on the results of simulations using different rainfall conditions for each river. Possible submerged areas identified by the simulations are shown in flood and sediment disaster-hazard maps that are distributed to the communities and citizens. 11  The Headquarters for Earthquake Research Promotion is directed by the Earthquake and Disaster-Reduction Research Division, Research and Development Bureau, of MEXT. 99 As for sediment disasters, hazardous areas are pointed out in the Act on Promotion of Sediment Disaster Countermeasures for Sediment Disaster Prone Areas and the three major acts for prevention of sediment disasters (the Sand Control Act, the Landslide Prevention Act, and the Act for Prevention of Disasters Caused by Steep Slope Failure). Most of these areas are also shown in flood and sediment disaster-hazard maps and similar maps. Moreover, this DRM plan uses data on population and building distribution across these danger areas to identify potentially hazardous factors in wind and flood damage to the city by combining these possible danger areas and the social conditions such as population and building distribution. It is likely that Sendai City’s continuous efforts toward improvements via the PDCA approach helped minimize damages during the Great East Japan Earthquake. 100 World Bank DRM Hub, Tokyo The World Bank Tokyo Disaster Risk Management (DRM) Hub supports developing countries to mainstream DRM in national development planning and investment programs. As part of the Global Facility for Disaster Reduction and Recovery, the DRM Hub provides technical assistance grants and connects Japanese and global DRM expertise and solutions with World Bank teams and government officials. The DRM Hub was established in 2014 through the Japan-World Bank Program for Mainstreaming DRM in Developing Countries – a partnership between Japan’s Ministry of Finance and the World Bank. GIF The Global Infrastructure Facility (GIF) is a global collaborative platform that facilitates the preparation and structuring of complex PPPs in infrastructure and the mobilization of capital from the private sector and institutional investors. GFDRR The Global Facility for Disaster Reduction and Recovery (GFDRR) is a global partnership that helps developing countries better understand and reduce their vulnerabilities to natural hazards and adapt to climate change. Working with over 400 local, national, regional, and international partners, GFDRR provides grant financing, technical assistance, training, and knowledge sharing activities to mainstream disaster and climate risk management in policies and strategies. Managed by the World Bank, GFDRR is supported by 36 countries and 10 international organizations. PPIAF PPIAF provides technical assistance to governments to support the creation of a sound enabling environment for the provision of basic infrastructure services by the private sector. PPIAF also supports the generation and dissemination of knowledge on emerging practices on matters relating to private sector involvement in infrastructure. Contact: World Bank Disaster Risk Management Hub, Tokyo Phone: +81-3-3597-1320 Email: drmhubtokyo@worldbank.org Website: http://www.worldbank.org/drmhubtokyo This publication is printed on recycled paper.