The terms and conditions of project bonds usually include break cost provisions where there is an early repayment of the bonds to compensate bondholders for the loss of yield over the remaining life of the bonds. The bond terms will therefore generally call for the payment of a prepayment fee to put bondholders in an equivalent position as if the bonds had not been prepaid. This is known as a "make-whole" payment and is calculated according to a specified formula which applies a particular discount rate (which will be based on the yield on a government bond with a maturity equivalent to the average life of the bonds), reflecting the fact that the payment is received early. Essentially, the make-whole amount would notionally allow the investor to invest the amount received in early redemption in a government bond and receive the same yield as if it had remained invested in the project bond. Contracting Authorities may wish to consider imposing more risk on investors by adding a margin to the government bond yield to produce the discount rate.
It may not be appropriate for the Contracting Authority to include such break costs in the termination compensation calculation for every termination situation. The recommended approach in some jurisdictions (e.g. the UK and Belgium) has been for the Contracting Authority to pay the full make-whole amount on termination for Contracting Authority Default71, a reduced amount on Voluntary Termination, and no payment on any other termination (including Force Majeure and Private Partner Default termination) although Contracting Authorities should consider whether a full make-whole payment is required in any circumstances. However, in emerging markets, for example, there may be justifications for including a make-whole amount in more termination scenarios (e.g. Force Majeure or potentially Private Partner Default, although - particularly in the latter case - the value for money question would have to be addressed). In relation to private placements, some investors (particularly US investors) will insist on currency swap breakage payments on early termination of non- USD instruments, since such investors fund themselves only in US dollars. Contracting Authorities will need to consider the value for money questions inherent in funding such payments. See Section 4, Termination Payments.
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71 By extrapolation, other termination events for which the Contracting Authority bears the risk (e.g. MAGA and Change in Law) might follow a similar approach.