§2.6  Timing

If the Authority decides that interest-rate risk should be a pass-through from the Contractor, through a transparent (one time) adjustment to the Unitary Charge around the time of Financial Close based on the fixed or hedged interest rate at that time, the Authority must reserve for itself a right of approval over the timing of implementation of this fixed-rate finance or other hedging. This right should be clearly stated in the ITN,26 and the Authority must seek guidance from its financial adviser on a suitable approach.

However, this control over timing should not be exercised in such a way as to cause a significant delay in Financial Close, and so affect the overall project timetable and the Contractor's return.

In the case of bond issues carrying a fixed coupon, the interest rate will be fixed on the bond launch date, which will typically be a few days prior to the date of Financial Close. In the case of a major public issue, this launch date follows a 'road show' process, during which the lead manager will indicate to investors the proposed date and time of bond launch. It follows from this that the Authority should agree the commencement of the road show process and associated bond launch timing. In the case of a smaller private placement which does not have to go through this 'book building' process the Authority can exercise a more direct control over the timing of the placement.

In the case of loans carrying a variable interest rate, implementation of interest-rate hedges normally takes place at Financial Close, since hedge counter-parties required to take credit exposure either directly or indirectly on a Contractor with no assets will not be prepared to do so before then, and lenders do not want the interest-rate risk to be left uncovered for a significant period of time after Financial Close. Moreover, the Unitary Charge cannot be fixed until the interest rate has been fixed. However, it is also possible for the hedging to be put in place with the support of the Contractor's shareholders before Financial Close and then transferred afterwards.

Even if the Authority has agreed to bear the risk of changes in underlying interest rates prior to Financial Close impacting on the Unitary Charge, it should not provide contractual support for any hedging arrangements before Financial Close.27

The Contractor is not indifferent to the timing of the interest-rate hedging, because this will affect the level of interest accrued during construction, and hence project capital costs. But the Authority is obviously at much greater long-term risk, because its payments are determined by the swap rate achieved and so it should have the right to ensure that the hedging is executed under appropriate market conditions. This implies that Financial Close may, on occasions, be delayed if market conditions are unfavourable.28

In summary, for so long as the Authority carries interest-rate risk through potential adjustments to the Unitary Charge, it should have a right of approval both over how this risk is transferred back to the private sector, and when it is transferred. In practical terms this will require the Authority and its advisers to work closely with those actually implementing the policy, namely the Contractor, its advisers and lenders.

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26   And in the terms of a funding competition held after appointment of preferred bidder.

27  Except for a very large bond issue or hedging transaction, where the transaction itself may impact pricing in the capital markets. In such cases, it may be appropriate for a so-called 'market stabilisation exercise' to be undertaken-a strategy to mitigate potential disruption in these markets. This is a complex exercise for which Authorities should seek suitable specialist market advice.

28  If the Authority has agreed to accept adjustment to the Unitary Charge to take account of the interest rate determined by the hedging instruments eventually executed, there is no reason in principle why hedging may not take place shortly after Financial Close on a day of suitable financial market stability for the hedging to be carried out. Lenders and investors should be prepared to allow this degree of flexibility on the basis that variations in the Unitary Charge which are dependent on, inter alia, the hedges eventually implemented and the associated issue of affordability remain risks of the Authority.