ECC members oppose new benchmark loan rate

Amid opposition from Chinese sponsors to Pakistan’s plans to adopt a new benchmark rate for IPP loans, the economic managers have raised serious objections to the proposal submitted by the Power Division for revising the borrowing rate.

The Power Division had called for a transition from the London Inter-bank Offered Rate (Libor) to the Secured Overnight Financing Rate (SOFR) for loans that would be secured from multilateral donors for power projects.

It was informed that Chinese sponsors of power projects including their lenders were of the view that due to various reasons including the registration process, they were only allowed to opt for the Daily Simple SOFR over SOFR that was not negotiable.

Sources told The Express Tribune that the matter was taken up in a meeting of the Economic Coordination Committee (ECC) held last month.

During discussions, the committee observed that such proposals should not discriminate against borrowers and their financial implications should be taken into account through a suitable simulation.

It was observed that the summary should clearly delineate whether there would be savings or otherwise as a result of adopting SOFR.

The ECC noted that exceptions in the case of Chinese contracts had not been mentioned in the proposal. It was also observed that there was no mention in the summary as to which type of SOFR would be preferred and why.

It was stressed that the impact of the proposed change should be analysed on contracts with the independent power producers (IPPs) and energy tariffs.

The ECC considered the summary submitted by the Power Division titled “Transition from London Inter-bank Offered Rate to Secured Overnight Financing Rate” and directed the division to submit a revised summary after incorporating financial implications of the shift.

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For that purpose, it was suggested, the Power Division should conduct a financial analysis based on simulation for the previous year.

The ECC further directed the Power Division to explicitly mention in the summary that the Credit Adjustment Spread (CAS) was only applicable to the legacy contracts/ loans and not to the future contracts.

It gave the directive to mention Chinese exception in terms of SOFR while submitting the proposal for approval and also mention that SOFR instruments should be aligned with the tenors agreed in legacy contracts.

The Power Division informed the meeting that IPPs and Independent Transaction Company (ITC) had obtained financing from various international financial institutions including the development finance institutions (DFIs) and commercial banks based on Libor. Accordingly, the same benchmark was reflected in project documents including financing documents, tariff determinations, implementation agreements, power purchase agreements and transmission service agreements.

However, due to manipulation by several financial institutions and weaknesses in oversight, the UK’s Financial Conduct Authority announced that Libor would cease to be applied as a benchmark for financial transactions after December 2021 and would no longer be available for quoting after June 2023.

The US Federal Reserve’s Alternative Reference Rate Committee selected SOFR, a robust benchmark and risk-free rate backed by the US Treasury as collateral, to replace Libor for both legacy and new contracts. Accordingly, several IPPs together with their lenders approached the Private Power and Infrastructure Board (PPIB) and other stakeholders like the SBP, Finance Division, CPPA-G and Nepra for transition from Libor to SOFR.

Published in The Express Tribune, October 19^th, 2023.

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