The Cabinet on Thursday approved a draft regulation created to establish and operate a hedge fund intended to reduce investment risk. The planned hedge fund will address the foreign exchange risk that comes with foreign direct investment in public infrastructure projects.

The draft regulation was tabled by the Finance Ministry, and its approval paves the way for the establishment of the fund at Nepal Rastra Bank, the country’s central bank.

Hedging is a risk management strategy used to reduce the risk due to fluctuations in the asset price. The hedge fund which the central bank will set up is a type of insurance that will cover additional liability created to any party (investor or government) due to exchange rate fluctuations.

As per the draft regulation, Nepal Rastra Bank will establish and operate the fund which will cover risks due to a depreciation of the domestic currency by charging a premium, according to ministry sources.

“Any party to be eligible to receive coverage from the fund has to pay an annual premium equivalent to 3.5 percent of the amount covered,” said a source.

According to the ministry source, the government introduced the regulation so that the 120 MW Rasuwa-Bhotekoshi and the 216 MW Upper Trishuli-1—both of which have signed dollar-denominated power purchase agreements with the Nepal Electricity Authority—are able to complete financial closure.

As per the agreement signed between the Nepal Electricity Authority and the two project developers, the state-owned power utility will buy electricity generated by these plants and pay for it in US dollars for a period of 10 years, or until the portion of the investment made with foreign loans is recovered by the developer, whichever comes first.

In order to mitigate exchange rate risks while making payment in US dollars, the power utility and the project developers had agreed to hedge the investment by creating a fund with both parties contributing to it. But due to lack of a mechanism to hedge the investment, the project developers were having a hard time completing financial closure.    

“The regulation was created with these two hydropower projects in mind,” said the source. “In the future, the regulation might even be changed to accommodate entire infrastructure projects with foreign direct investment.”

Sources at the Nepal Electricity Authority said the hedge fund regulation was not enough for the two project developers to complete financial closure. The power utility and the project developers still disagree over how much each should contribute to the premium, and the hedge fund regulation will not help to break the stalemate.

The project developers are willing to contribute only a nominal amount for the premium, but the Finance Ministry is asking them to contribute half of the premium.