1.48 When a project is financed by bank debt the contractor will usually draw down the funds as and when it becomes necessary to do so. Excluding any commitment fee paid to the bank for making funds available in tranches, a contractor will only pay interest on the total amount drawn down at any one time. The situation is different with a bond financed project. The bond proceeds are received as a lump sum as soon as the bond has been sold to investors. As a result the contractor can expect to receive a large sum of money which is not immediately required but on which interest has to be paid. To help meet the cost of such interest payments, the bond proceeds will therefore be placed on deposit where they will earn interest until they are used. The difference between the interest earned (on deposit) and paid (on the bond) will affect the contractor's forecast cash flow and hence the unitary payment it is able to offer.
1.49 The Treasury agreed to bear the interest rate risk of the deposit rate changing up to financial close on the basis that it was also competed for. A number of banks were asked to bid on the basis of a Guaranteed Investment Contract14 to provide banking facilities for the bond proceeds using a pre-determined profile of when the funds were likely to be needed during the construction period. Three banks were invited to bid to act as the bond proceeds holding bank and the difference between the highest and lowest rates bid was 49 basis points. This wide margin between bids suggests that the competition for the redeposit helped reduce the overall cost of the project.
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14 A Guaranteed Investment Contract usually sets out the amount to be deposited and the depletion profile of this deposit (i.e. when it is planned to be used, usually during the construction phase of a project) during the contract's lifetime.