2.31 The level of indexation of the unitary charge is a commercial decision for the Procuring Authority. Indexation relates to the level of the unitary charge which inflates over time. This is usually related to the movements in the Retail Price Index or Consumer Price Index. The research indicated that the level of indexation applying to the unitary charge varied significantly across Authorities reflecting their individual views on affordability and their willingness to accept inflation risk.
2.32 The Procuring Authority needs to understand how the proposed level of indexation:
o Impacts not just upon the first full year's unitary charge but the profile of the unitary charge throughout the concession.
o Exposes the Procuring Authority to inflation risk.
2.33 It is essential that detailed sensitivity analysis is undertaken prior to determining the most appropriate indexation level to be included within the tender documentation. Where projects receive Scottish Government funding support, the Procuring Authority will be required to confirm that the proposed project remains value for money and affordable under a range of inflation sensitivities.
2.34 The Bidder's financial model will include both fixed and variable costs. If the level at which the unitary charge inflates matches the split of inflating and non-inflating costs within the financial model, the model is protected against a mismatch of inflationary impacts. In this case, the financial model is referred to as being perfectly hedged (from the perspective of inflation risk.)
2.35 If the level of indexation of the unitary charge does not match the ratio of variable to fixed costs within the bidders' financial model, the bidder may propose a RPI swap. A RPI swap is where a future income stream inflating by RPI is swapped for a future income stream inflating by a fixed amount. RPI swaps are entered into at financial close and therefore the rate applicable to the RPI swap may rise or fall compared to earlier estimates. This is a Procuring Authority risk. It is therefore expected that the full benefit of the RPI swap should be included within the financial model.
2.36 Where RPI swaps are proposed the Procuring Authority should:
o undertake sensitivity analysis of the impact of the inclusion of the RPI swap at both the rate included within the Invitation to Participate in Dialogue and at the prevailing market rate. They should ascertain the rate of the RPI swap at which a net cost is incurred by the Procuring Authority as opposed to there being a net benefit that can be used to decrease the unitary charge.
o ensure that the financial advantage of including a RPI swap is passed in full to the Procuring Authority.
o be able to demonstrate that a project is still value for money and affordable, over its contract life, under a range of inflation and interest rate scenarios.
o consider, and take professional advice, on whether better value for money may be achieved by developing alternative unitary charge indexation mechanisms. For example, by linking a percentage of the increase in the unitary charge to inflation and a percentage of the increase to a fixed rise. For example, 10% of the unitary charge could increase by 2.5% per annum and 50% by the movement in inflation (which can be by reference to RPI, RPIx or CPI).
2.37 Procuring Authorities should include worked examples of the unitary charge indexation workings within the project documentation to ensure a common understanding and to avoid confusion during the operational stage.