Case Study Details - Playbook of Solutions

Description

When a project's currency risk is not operationally hedged (e.g., via natural currency hedges, exchange rate indexed contracts), non-commercial and commercial hedging solutions can be mobilized to reduce the exposure to currency exchange rate fluctuation risks. These solutions include many different types of financial products but higher risk and lower liquidity limit their availability in emerging or frontier markets.

FX forwards are agreements to buy or sell a specified amount of a foreign currency at a specified price and time in the future. Cross-currency swaps are products in which two parties agree to exchange multiple fixed amounts (usually, a loan principal and interest amounts) denominated in two different currencies. Cross-currency swaps can be tailored to the project and country context (e.g. fixed or inflation-linked) and can be provided either to the lender or the borrower.

Benefits

Managing currency risk is a significant challenge for project developers and is often beyond the control of government agencies responsible for infrastructure development. It poses a significant threat to project financiers, as currency fluctuations can jeopardize the ability to service debt or impact profitability.

The price and availability of hedging solutions in frontier markets can therefore have a significant impact on the financial viability of projects. By transferring currency risk from borrowers to the hedging entity, or taking advantage of MDB financing conditions, these solutions increase the transparency and efficiency of development finance.

Case Study

TCX’s solution to currency risk in Sierra Leone

Supported by a group of Development Finance Institutions (DFIs), impact investors, donor governments and the European Commission, TCX is a fund established for the sole purpose of reducing currency risk in developing countries. It offers financial instruments—cross-currency swaps and FX forwards—to hedge currency risk embedded in US dollar or Euro financing to emerging and frontier markets. TCX works with lenders (DFIs, impact investors and commercial banks) to hedge the risk and takes it on its own balance sheet. As a development finance initiative, TCX is not a commercial hedging provider and is able to offer a solution to currency risk even in the most challenging markets and for longer tenors.

In 2016, Easy Solar was founded to provide solar solutions such as lanterns and stand-alone solar systems to households and businesses throughout Sierra Leone. In 2021, the company faced significant currency risk due to its local currency assets and USD-denominated debt. Easy Solar refinanced its USD loans with a USD 5 million loan from the Energy Inclusion Facility's Off-Grid Energy Access Fund (OGEF) and an associated cross-currency swap provided by TCX, which indexed the loan to the Leone. In practice, this means that Easy Solar still received USD financing but without any embedded currency risk. With the hedge, debt service repayments are fixed in the Leone and not impacted by currency fluctuations.

This approach allowed Easy Solar to build resilience and become a financially sustainable business despite significant local currency devaluations. In 2022, the Leone depreciated by more than 60%. Without the hedging, Easy Solar would have faced increased debt service costs of up to 180% in Leone terms.

Additional Sources

Currency Risk Hedging