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ISLAMABAD: The National Electric Power Regulatory Authority (NEPRA) has supported one type of Secured Overnight Financing Rate (SOFR) uniformly across the power sector of Pakistan for consistent transaction, official sources told Business Recorder.

The power regulator in its comments on a summary of the Power Division titled “transition from LIBOR to SOFR” clarified that NEPRA determines tariff under Guidelines for Determination of Tariff for IPPs 2005 and relevant power policies which allow LIBOR as a cost of debt for adjustment of foreign debt component. The SOFR equivalence to LIBOR needs to be determined by the Finance Ministry, in consultation with Economic Affairs Division and State Bank of Pakistan for uniform application due to its implication on debt servicing/cost of debt.

According to the Power Division, IPPs and Independent Transmission Company (ITC) have obtained foreign financing from various International Financial Institutions including Development Financial Institutions (DFIs) such as ADB, IFC, IDB and other commercial banks based on LIBOR as an applicable benchmark rate and accordingly the same benchmark has been reflected in the project documents (Financing Documents, Tariff Determinations, Implementation Agreements (LAs), Power Purchase Agreements (PPAs) and Transmission Service Agreement (TSA).

SOFR likely to replace LIBOR as benchmark

Consequently, NEPRA revises the tariff of such IPPs, on periodic basis, based on LIBOR. However, LIBOR will be discontinued, and, no longer will be available in future. This discontinuation/non-availability of LIBOR warrants adoption of an alternate benchmark rate which is acceptable to lenders, IPPs and power purchaser enabling NEPRA to make requisite revision in tariff as well as IPPs to make repayment of their respective loans to lenders.

The US-based Federal Reserve’s Alternative Reference Rate Committee (ARRC) has selected the Secured Overnight Financing Rate which is more robust benchmark and risk-free rate (backed by US Treasury as a collateral) to replace LIBOR for both legacy and new contracts. Accordingly, several IPPs together with their lenders have approached PPIB including other stakeholders, ie, SBP, Finance Division, CPPA-G and NEPRA for ensuring a smooth transition from LIBOR to SOFR.

Currently three types of SOFR are used in market which are as follows: (i) daily simple SOFR which is based on weighted average of daily SOFR; (ii) SOFR Compounded in Arrears based on daily simple SOFR convention but includes the element of compounding each day of interest during the accrual period; and (iii) Term SOFR based on forward-looking SOFR rate, uses SOFR futures and benchmark SOFR derivatives to provide a forward rate for a given time period (e.g., one, three, six and twelve months).

The Power Division argues that since LIBOR and SOFR historically have not been equivalent, therefore an adjustment is required to bring SOFR as much as possible, at par with LIBOR. The International Swaps and Derivatives Association (the “ISDA”) recommended that a Credit Adjustment Spread (the “CAS”) be added to SOFR to bring SOFR tentatively at par with LIBOR for various tenors on legacy contracts. Accordingly, the proposed CAS for 6-month tenor is 42.6 bps, for 3-month 26.16 bps and for 1-month tenor 11.45 bps respectively. The CAS has been widely adopted in the international market for both derivatives and loans and Islamic financing as transition from LIBOR to SOFR. Consequently, in line with ISDA proposals for a smooth transition, CAS will be added to underlying SOFR to make it, as much as possible, equivalent to LIBOR.

On the issue, Finance Division in consultation with SBP held deliberations and conveyed decision taken thereof whereas the DFIs including ADB, IDB and IFC argue that “Term SOFR plus CAS” would be an appropriate alternate benchmark to replace LIBOR, the Chinese sponsors including their lenders contend that due to various reasons including registration of Chinese banks for SOFR, they are only allowed to opt “Daily Simple SOFR plus CAS as recommended by ISDA”. Both the Chinese lenders as well as DFIs have made it clear that CAS as recommended by ISDA is non-negotiable.

In order to select an appropriate benchmark for all stakeholders, Power Division constituted a committee having representatives from Finance Division, Economic Affairs Division, SBP, Nepra, CPPAG, PPIB. The committee in its meetings had detailed deliberations on all aspects and unanimously agreed that negotiating Credit Adjustment Spread (“CAS”) is not a feasible option keeping in view the cost-benefit analyses, as such, the earlier proposal of hiring a consultant to negotiate the CAS is also not required. In the light of discussions and decisions taken by the committee, following proposals have been made for consideration of the ECC of the Cabinet: (a) IPPs/ITC may be allowed to adopt either of the following as replacement for LIBOR notably (i) Term SOFR plus ISDA recommended CAS or (ii) Daily Simple SOFR plus ISDA recommended CAS.

It was also decided that power purchaser (CPPA-G) and power seller (IPP) shall approach NÉPRA for determination of alternative index to replace LIBOR in the light of agreed mechanism. The SOFR opted by IPPs for indexation purposes shall necessarily be reflected in the financing documents of the project. Nepra shall finalize all the procedural formalities required to replace LIBOR with SOFR for the purposes of tariff determination/indexation mechanism, to be effective from July 1, 2023.

The PPIB, AEDB, CPPA-G and NTDC would be authorized to execute appropriate amendments to the respective agreements, ie, IAs/PPAs/TSA, etc, to cater for change from LIBOR to SOFR.

Copyright Business Recorder, 2023

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