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The Ins and Outs of Interest Rate Swaps in Project Finance
The Ins and Outs of Interest Rate Swaps in Project Finance
He concluded by saying OSFI will have increased focus on behaviour and risk culture not
just on rules being followed.
[Editors note: Robert McDowell is a partner of
Fasken Martineau DuMoulin LLP and Co-chair
of the Firms Financial Institutions Group. He
advises financial institutions on a wide range
International Institute of Finance, Reform in the financial services industry: Strengthening Practices
for a More Stable System (2009), 31.
1. they are highly leveraged with debt-toequity ratios often falling in the 8090 per
cent range
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The cash flows under the swap and loan are illustrated in the figure below. The Borrower
pays a fixed rate (4.5 per cent) to the hedge provider (a swap-dealer affiliate of the project
lender), and the borrower receives a floating
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In negotiating the loan agreement with the lenders and the ISDA Agreement with the hedge
provider, the borrower will want to ensure that
it is not subject to two parallel but differing contractual regimes. For example, the borrower
may have negotiated a cure period right with the
lenders in the loan agreement in respect of
the borrowers performance under an operation
and services agreement. The ISDA Master
Agreement, however, contains a cross-default
provision that might otherwise be triggered immediately upon a default by the borrower under
a third-party contract.
The solution to the potential inconsistency between the loan and ISDA agreements is relatively simple: (1) the events of default under the
ISDA agreement should be disapplied as they
relate to the borrower and (2) the events of default under the loan agreement should be incorporated by reference into the ISDA agreement.
This prevents the tail wagging the dog so to
speak, by effectively neutering the hedge banks
enforcement fights under the ISDA Agreement,
with the hedge banks ceding all enforcement
decisions to the project lenders. It is for this reason that the project lender and swap provider are
usually the same entity or an affiliate, as the
hedge desk will be relying upon its lending counterpart to make decisions that reflect a holistic
consideration of the financial institutions interests, both as a lender and hedge counterparty.
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