Guidelines for hedging funds being prepared

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    Oct 4, 2018-

    The government is preparing guidelines to establish hedging funds, an insurance-like mechanism to cover currency exchange rate risks associated with infrastructure projects being developed with foreign direct investment. Hedging is a risk management strategy used to reduce risks due to asset price fluctuations.

    The hedging fund that the government wants to establish is a kind of insurance that will cover additional liability created to any party (the investor or the government) due to fluctuations in the exchange rate. In order to be eligible for coverage by the fund, the investor or the government has to pay a fee or premium determined by the volume of the investment as well as the time period.

    Nepal Rastra Bank (NRB), which was assigned to prepare the guidelines by the government, has already submitted a draft to the Finance Ministry. Currently, ministry officials are carrying out consultations with various stakeholders to finalise the draft. “We are planning to reach a conclusion and finalise the draft within a week,” said Uday Raj Sapkota, joint secretary of the Finance Ministry who refused to provide details of the draft guidelines.”

    On Tuesday, the ministry held discussions with officials of the Nepal Electricity Authority (NEA), the state-owned power utility. According to the NEA, the provisions in the draft are inadequate to address exchange risks that accompany US dollar-denominated power purchase agreements (PPA) that the power utility signs with projects being developed with foreign debt.

    While introducing guidelines for dollar-denominated PPAs, the government included a provision under which the foreign debt portion of the investment needs to be insured against exchange rate risks. “As per the guidelines for dollar-denominated PPAs, the government, the developer and the NEA are required to allocate a certain amount of money for the payment of premiums,” said a senior NEA official. “But the guidelines for hedging funds prepared by the NRB doesn’t include such a provision.” Sapkota said the final draft would address all the stakeholders’ concerns.

    There is an urgent need for hedging services in Nepal, especially in the hydropower sector. Due to lack of hedging services, the NEA is currently facing difficulties in signing PPAs in convertible currency with projects being developed under foreign funding.

    Around 10 months ago, the NEA signed a PPA with Nepal Water and Energy Development Company for the development of the 216 MW Upper Trishuli-1 Hydroelectric Project. As per the PPA, the power utility has to make payment in US dollars for the portion of the investment made with foreign loans.

    In order to mitigate exchange rate risks while making payment in US dollars, the developer and the NEA agreed to hedge the investment. In the absence of a hedging service in the country, the project developer is having a hard time arranging funds for the scheme.

    Source: The Kathmandu Post