In some projects, the payment schedule also provides a mechanism for the State and private party to negotiate in circumstances (usually a refinancing) where a change to the private party's debt profile is proposed. The floating rate component section of the payment schedule recognises that whilst the State takes the risk on movements in the base case interest rate, it should not accept the additional base interest rate risk which results from the private party proposing to increase the quantum of debt as part of a refinancing. Should the State agree to an increase in the private party's debt profile, it will need to be proportionately compensated for the incremental risk. This mechanism benefits both parties in circumstances where some of the gains from a refinancing proposal (which will typically be shared between the State and the private party) result from the private party increasing the amount of debt in the structure. The compensation can be made either:
• with an upfront payment where the base interest rate remains unchanged in the base case financial model, and the compensation is based on (a) the difference in the original base case interest rate and the interest rates as determined by the swap curve of the additional debt, plus (b) costs associated with entering into a hedge (either by the State or the private party); or
• by a change in the base case interest rate in the base case financial model where there is no upfront payment (compensation is effectively received over time), and the base case interest rate is amended to reflect a 'weighted' average interest rate, that includes (a) the interest rates determined by the swap curve with respect to the additional debt, plus (b) costs associated with entering into a hedge (either by the State or the private party).
This ensures the State has no liability for the additional debt to pay where interest rates are higher than the original base case interest rate.
Compensation can also be made through a combination of both an upfront payment and a change in base interest rate, but generally one of the two above approaches would be chosen.
In the event the base case interest rate is to remain constant in the base case financial model, the upfront payment provided for in the floating rate component section of the payment schedule is calculated as the difference in net present cost of the floating rate component before and after the refinancing (in order to keep the State whole with respect to base interest rate risk associated with an increased debt profile). If the refinanced facility is to be hedged by the private party, the net present cost of the floating rate component is calculated using standard swap market conventions (including a 'market' swap margin), whereas for State-implemented hedging, a TCV/State determined swap margin will be applicable. It is important to note that the methodology will also be based on standard swap market conventions including a TCV/State determined swap margin where the decision is made not to hedge the refinanced facility. This is because the only practical way to estimate the magnitude of additional base interest rate risk to be borne by the State is to adopt a revised swap curve at the time of the refinancing, as if the State was intending to hedge the additional debt. Note where ongoing floating rate component payments are made between the parties, these will be with respect to the total debt (original plus additional).