Brexit’s unusual visibility is forcing a different approach to inflationary risk management, writes Mace Cost Consultancy’s Steven Mason
This year marks the 25th anniversary of the publication of the seminal Latham review.
Sir Michael Latham’s work challenged conventional thinking and presented a roadmap to a more collaborative and considered way of working. His work has been a fundamental catalyst in driving the industry forward, but has his vision been fully realised? Sadly, in my opinion, the answer is no – and deeply entrenched attitudes to risk are largely to blame.
Latham cited four types of project risk: fundamental, pure, particular and speculative. Fundamental, pure and particular risks refer to significant and unmanageable external threats, including war, fire damage, nuclear pollution, collapse and subsidence. Developers, typically, seek to transfer these risks to insurance companies.
Speculative risk, Latham’s fourth category, covers a diverse spectrum including ground conditions, taxes, inflation, weather and shortages.
Some speculative risks can be easily managed. Ground condition surveys, for example, can help site specific threats to be assessed, enabling this risk to be transferred.
Building cost inflation is far more complex. There is a core, relatively manageable element – cost inflation fuelled by the strength of domestic demand, for example, should be reasonably foreseeable – but there are also unmanageable external threats such as political uncertainty. Basic risk management suggests that responsibility for risk should sit with the party most able to manage and, ultimately, mitigate it. Our industry’s approach to fundamental, pure, particular and many speculative risks, generally accords this principle but what about inflationary risk?
All too often, allocation of inflationary risk is determined by market conditions rather than a robust assessment of the different types of risks faced and full consideration of alternative approaches.
Brexit has the potential to be a major shock to construction cost inflation. The complexity of the potential impacts makes robust quantification of the risk practically impossible – but unlike other external inflationary shocks, we are aware Brexit is coming.
This unusual visibility is forcing a different approach to inflationary risk management. Brexit exclusion clauses have appeared, presenting an opportunity to craft more intelligent risk apportionment mechanisms, grounded in risk management theory, and structured to encourage a unified approach to tackling the commercial challenges that Brexit may present.
Commercial certainty is secured at a later stage. But on the upside, this approach may ultimately lead to a significantly lower outturn cost and, should we face external disruption, it creates a contractual framework within which the entire project team is motivated, and incentivised, to work collaboratively to find the best solution for each individual project.
This approach to unmanageable building cost inflation has the potential to deliver better commercial and operational outcomes and, potentially, it takes us one step closer towards realising Latham’s vision.