Energy from Waste Plant: management of foreign currency exchange risks.

ENERGY FROM WASTE PLANT

MANAGEMENT OF FOREIGN CURRENCY EXCHANGE RISKS

REPORT

MARCH 2009

TABLE OF CONTENTS

SECTION ONE ~ INTRODUCTION ....................................................................... 3 SECTION TWO ~ SUMMARY OF CONCLUSIONS............................................ 6 SECTION THREE ~ BACKGROUND TO THIS REVIEW................................ 11 SECTION FOUR ~ CHRONOLOGY..................................................................... 18 SECTION FIVE ~ 14 NOVEMBER 2008............................................................... 61 SECTION SIX ~ 17 DECEMBER 2008 .................................................................. 84 SECTION SEVEN ~ 10 JULY 2008 ........................................................................ 91 SECTION EIGHT ~ COST OF THE PROCUREMENT ..................................... 96 APPENDIX ONE ~ TERMS OF REFERENCE .................................................. 102

APPENDIX TWO ~ PEOPLE WHO PROVIDED INFORMATION FOR THIS

REPORT....................................................................................................... 103

APPENDIX THREE ~ LIST OF ABBREVIATIONS USED IN THIS REPORT 104 APPENDIX FOUR ~ SCHEDULE OF PAYMENTS UNDER THE CONTRACT 105 APPENDIX FIVE ~ EFW FUNDING OPTIONS PAPER (6 NOVEMBER 2008) 106

SECTION ONE ~ INTRODUCTION

1. In January 2009 I announced that I would investigate the management of foreign currency exchange risks arising from a contract for the procurement of an Energy from Waste (EFW) Plant. The terms of reference for this review are set out in Appendix One.
2. In brief, the background to these matters is that:

1. In 2005 the States approved in principle the replacement of the existing incinerator at Bellozanne;
2. In July 2008, the States approved a detailed proposal for the replacement of the incinerator and the proposed arrangements for financing the replacement;
3. In accordance with the States' decision in July 2008, a contract was signed on 14 November 2008 for the procurement of a new EFW Plant;
4. Although it was originally intended that all payments under the eventual contract would be made in sterling, the contract when signed provided that a substantial proportion of the payments due under the contract should be made in euros; and
5. In December 2008, following an unexpected and material decline in the Euro:Sterling exchange rate, concern grew about the way in which the States had managed its exposure to euro currency exchange risk and the implications for the overall cost of the project.

3. The background to this review is described in greater detail in Section Three of this report.
4. I began this review by preparing a chronology of the principal events and decisions which led to the action which was taken to manage the States' currency exchange risk under the Engineering and Procurement Construction (EPC) contract. This chronology was based on a detailed examination of all of the records pertaining to the contract and the organisation of the necessary finances, supplemented by interviews with the people who have been principally involved. A list of the people who were interviewed in the process of this review is set out in Appendix Two. In accordance with the normal practice of the States' Assembly, I have referred to people in this report by the titles of their positions rather than by name. The abbreviations that have been used in this way are listed in Appendix Three.

5. The chronology which resulted from this process is set out in Section Four of this report.
6. Having completed the chronology, it appeared to me that decisions made on two particular dates were crucial to the position in which the States now finds itself. Those dates are:

1. 14 November 2008: the date on which the EPC contract was signed; and
2. 17 December 2008: the date on which the Treasury and Resources Department (T&R) agreed the detailed policy for the purchase of euros which is now being applied.

7. However, as I will show, decisions made on 10 July 2008, the day after the States approved the procurement, were also important.
8. I have examined in detail the actions which were taken on these three days including the decisions which were made and the reasons for them. My analysis of these matters, together with my conclusions in respect of the appropriateness are set out in the following sections of this report:

1. 14 November 2008: Section Five of this report;
2. 17 December 2008: Section Six of this report; and
3. 10 July 2008: Section Seven of this report.

9. The consequences of the decisions that were made about purchasing euros are analysed in Section Eight of this report.
10. As will be seen from the list of people interviewed for the purpose of this report (set out in Appendix Two), a large number of people have assisted in the conduct of the review and the preparation of this report. I am grateful for all of the assistance that they have given me in the course of this work.

11. A summary of the conclusions that I have reached as a result of this review is set out in the following section of this report: Section Two.

SECTION TWO ~ SUMMARY OF CONCLUSIONS

Introduction

12. In this section of the report, I summarise the conclusions I have reached in respect of the action taken at three dates. I start with the action taken on and after the signing of the contract on 14 November 2008 and subsequently on 17 December 2008. However, it appears to me that action could have been taken earlier: when the States approved the procurement on 9 July 2008 and I have therefore considered and reached conclusions on the action that was taken on 10 July 2008, immediately after the States' decision.
13. The currency exposure (which was disclosed to the States in P73/2008) led to the cost of the procurement being higher than the cost originally indicated to the States. Following summaries of my conclusions, I set out a table showing the additional cost.
14. Finally, at the end of this section of the report, I make observations concerning administrative practices within the T&R.

14 November 2008 (Section Five of the report)

15. The conclusions that I have reached in respect of the action taken on 14 November 2008 may be summarised in the following way:

What action was taken?

16. The exchange rate was not fixed.
17. The approach eventually arrived at envisaged that all of the euros required would be purchased at a time of favourable rate' prior to when the first payment was due in January 2009.

Was the action appropriate?

18. I believe that the action taken was not appropriate because:

1. The States are not in a position to manage currency exchange rate exposures;

2. Rather than limiting the States' risk, it exposed the States to an extension of the period during which there was a risk of loss through variations in currency exchange rates;
3. The approach was inconsistent with the States' planning for the contracts;
4. The recommendation that was accepted by the TT&R was based on a flawed analysis of the relative costs of different approaches to fixing the exchange rate;
5. The approach was inconsistent with the normal approach of T&R; and
6. The approach was inconsistent with the statements made in P73/2008 about the management of currency exchange risk.

Why was inappropriate action taken?

19. Inappropriate action was taken because reliance was placed upon flawed recommendations made by a member of T&R staff with limited experience of currency exchange questions, without appropriate review.

What action should have been taken?

20. As far as concerns the actions that should have been taken:

1. There were strong reasons for fixing the exchange rate;
2. One of the means of fixing the rate should have been chosen;
3. The most straightforward means of doing this would have been to reach agreement with the contractor.

17 December 2008 (Section Six of the report)

21. The conclusions that I have reached in respect of the action taken on 17 December 2008 may be summarised in the following way:

What action was taken?

22. A policy was agreed by which euros would be acquired as and when needed to meet payments under the EPC contract, save that if the exchange rate passed various triggers' the opportunity would be taken to buy euros in advance of the contractual requirement.

Was the action appropriate?

23. I believe that the action taken was not inappropriate because:

1. Although the approach adopted left the States exposed to further unfavourable exchange rate movements and placed the States in a position analogous to that of a speculator; and
2. The approach adopted was the least unattractive of the choices available.

24. However, T&R should also have considered purchasing call options to ensure that if the exchange rate moved unfavourably, euros could be acquired at the rate ruling on 17 December 2008, thus creating a floor for the States' exposure.

Why did this happen?

25. That T&R found itself in this position is directly attributable to the policy mistakes made on 14 November 2008 and the failure of T&R to heed the warnings that these mistakes were likely to prove costly.

What action should have been taken?

26. Although action could have been taken to eliminate down-side risk (i.e. to eliminate the States' exposure to further unfavourable movements in the exchange rate), it is not clear that the costs that would have been incurred would have been justifiable.

10 July 2008 (Section Seven of the report)

27. The conclusions that I have reached in respect of the action taken on 10 July 2008 may be summarised in the following way:

What action was taken?

28. No action was taken to fix the exchange rate for the contract.

Was the action appropriate?

29. I believe that the action was not unreasonable in the sense that there remained some question whether the States' approval would prove to have been final and it was in any case consistent with the statements made to the States in P73/2008.

Why was this action taken?

30. The promised briefing paper (for the T&R Minister) was not prepared because there was thought to be material doubt whether the States' approval for the procurement would prove to have been final.

What action should have been taken?

31. The most straightforward approach would have been to transfer some of the States' liquid funds into euros.

Cost of the procurement (Section Eight of the report)

32. The report considered by the States in July 2008 estimated that the overall cost of the proposed procurement would be £106.36 million. It also stated that this estimate was subject to variations in the exchange rate at which the necessary euros would be purchased and that this rate would be fixed as at the date on which the contract was signed.
33. The effect on the overall cost of the procurement of the variations in the cost of acquiring euros is shown in the following table by comparison with the actual rate of exchange ruling on the date on which the contract was signed::

General observations

34. The problems encountered in managing the currency risks arising from this procurement were exacerbated by two factors:
35. Firstly, T&R does not have sufficient staff with appropriate skills and experience. I have referred in previous reports to the Department's difficulty in recruiting appropriate staff.
36. Secondly, this review has highlighted a number of instances in which T&R's performance suffered because of failures in basic administrative practice. For example, there is no record of TT&R's decision on 6 November 2008 about the way in which euros should be purchased with the result that there is some uncertainty about what it was and whether it was implemented correctly. As a further example, the handover from the Strategic Investments Manager on his departure on 3 October 2008 appears to have been unsatisfactory. As a further example, there appears to have been no follow-up for undertakings given in and at the time of the lodgement au Greffe of P73/2008.
37. These shortcomings may have been in part a result of the Department's limited resources.

SECTION THREE ~ BACKGROUND TO THIS REVIEW

Introduction

38. In this section of the report, I will review the background to the EPC contract and the eventual signing of the contract in November 2008.

Proposition P85/2005

39. On 13 July 2005, the States approved Proposition P85/2005 which proposed a Solid Waste Strategy and charged the then Environment and Public Services Committee:

"(v) to investigate fully alternative and conventional technologies to provide the final disposal route for the residual waste remaining following the implementation of the systems and facilities as set out in (previous) (paragraphs above) and to recommend a preferred solution for a replacement of the Bellozanne incinerator to the States with an accompanying cost/benefit analysis, environment and health impact assessment no later than December 2008."

40. The Proposition also charged the Policy and Resources Committee:

". . . to propose the inclusion of a funding strategy for the capital projects identified in (v) above (i.e. including the replacement facility) within the States' Business Plan 2006 to 2010, if necessary, reprioritising or deleting existing projects and identifying additional sources of funds".

41. On 28 June 2006, the States approved proposition P45/2006 that it be:

". . . agreed that any such technologies for the final disposal route for the residual waste to replace the existing Bellozanne plant should be located at La Collette II reclamation site, immediately to the south of the Jersey Electricity Company Power Station."

42. The Minister for Planning and Environment (P&E) gave Permission in Principle for the proposed replacement facility on 27 October 2007. It was anticipated that a detailed planning application, incorporating the preferred bidders' designs would be submitted to the P&E Minister on 24 May 2008 to meet all of the conditions and reserve matters set out in planning in principle.

Procurement process

43. The Public Services Committee initially placed a notice in the Official Journal of the European Commission to advertise the project on 19 August 2003. The notice was deliberately non-specific regarding the technology required but stipulated that the solutions presented had to be able to deal with the whole of the Island's residual waste stream and any technology employed within the solution had to have been commercially operated on similar waste for at least two years. At the start of the procurement a cost estimate was developed by Babtie Fichtner (Fichtner), the procurement's technical advisers, which was updated throughout the procurement.
44. Initially nine companies formally expressed interest in the procurement. Over the next four years (during which time the solid waste strategy and location for the facility were approved), due diligence on all of these companies, and in total over fifty companies, was carried out. Concerns over the technology or financial validity of other technologies presented resulted in a short list of four acceptable companies and three reserves being approved on 8 December 2006 by the Waste Strategy Steering Group established to advise the Minister on the implementation of the strategy.
45. An outline planning application for an EFW facility was submitted on 9 January 2007 but the need to review the land use planning implications of vapour cloud explosions (following the Buncefield fuel facility explosion in December 2005) and to re-design the appearance of the proposed facility at the request of the P&E Minister, meant that planning Permission in Principle was not achieved until 27 October 2007.
46. A design and build procurement strategy had been advised by Price waterhouseCoopers and the Institute of Chemical Engineers Red Book contract form was confirmed on 8 February 2007 by the legal adviser (Eversheds LLP) as being the most appropriate. A functional specification and contract terms based on the Red Book were prepared in the Summer of 2007 and confirmed by the technical adviser and legal adviser as being fit for purpose and a true and accurate representation of and consistent with the employer's performance requirements.
47. Tenders were issued on 1 November 2007 to the four short listed companies, including CNIM which eventually became the Preferred Bidder, with a deadline for the return of tenders by 29 February 2008.

48. In June 2007, CNIM confirmed they intended to bid as a joint venture together with Spie Batignolles/Camerons. Following discussions the proposed joint venture structure was confirmed as viable by the procurement legal adviser.  

Tender receipt

49. Three bids were received and opened in accordance with the financial regulations on 29 February 2008.
50. The tender received from the CNIM joint venture was confirmed as being compliant and was progressed to detailed evaluation.
51. A second bid was non-compliant on grounds of the parent company being unable to guarantee a fixed price tender, following a revised civil sub-contractor fee schedule being received on the day before the tender deadlines. Subsequently, on request, a fixed price tender was provided in 6 March 2008. This tender has been progressed for detailed evaluation but under financial regulations could only be considered for appointment if the compliant bid had proved unviable.
52. The third bid was non-compliant as it provided only a budget price and no securities and was therefore not progressed for detailed evaluation.
53. CNIM was eventually selected as the Preferred Bidder.

States' approval

54. After selection of a Preferred Bidder, the States approved P72/2008 Energy from Waste Facility: establishment and acceptance of tender' on 9 July 2008 which approved the preferred solution proposed by the Preferred Bidder. Subsequently the States also approved P73/2008 which permitted the withdrawal of an additional £102,810,000 from the Consolidated Fund to fund  the  provision  of  the  preferred  solution, in addition  to  £3.5  million  which  had  been allocated for the project in 2008.

Subsequent negotiations

55. Subsequently negotiations proceeded with the Preferred Bidder to the point where it was recommended that the contract should be entered into. The P&E Minister gave approval in respect of most reserved matters at the end of a Ministerial Hearing on 23 October 2008. A Transport and Technical Services Ministerial Decision which approved the signing of the contract was itself signed on 14 November 2008.

56. The contract as signed incorporated a number of variations from the proposal which was considered by the States in July 2008. In particular, additional costs were agreed in respect of:

1. The requirements of the P&E Minister for higher quality materials and standards of finish which were communicated in the process of securing detailed planning permission. The revised design received approval but led to an increase in cost;;
2. Clarification of the interface between the Jersey Electricity Company and the Engineering Procurement and Construction Contract following detailed design work also led to changes in cost;
3. An increase from the £10 million tendered to the £20 million professional indemnity insurance originally requested in the tender;
4. The cost of an advanced payment bond to ensure that the amount of payment outlay to the contractor does not exceed the value of the performance bond plus the value of where itis carried out; and
5. The cost of fixing the euro element of the contract works to be carried out by CNIM and Spie Batignolles within the consortium arrangements.

57. As a partial off-set to these cost increases, some detailed changes to the specifications which reduced costs were agreed with the CNIM joint consortium.
58. A comparison between the cost estimate contained within P73/2008 and the Total Project Cost as at the date the contract was signed is set out in Section Eight of this report.

Euro exposure

59. A Funding Working Group was established in August 2007 to consider arrangements for financing the proposed EFW facility. When bids were received for the Engineering Procurement and Construction Contract on 29 February 2008, these all envisaged that some element of the contract charges would be paid in euros rather than in pounds as stipulated under the tender. At the point of appointing the preferred bidder to the contract on 30 April 2008, the Euro/Pound exchange rate was 1.2729.

60. The Funding Working Group considered the option of fixing the Euro rate on 1 May 2008 and again on 1 September 2008 by which date the Euro/Pound exchange rate had fallen to 1.26. The Euro rate continued to fluctuate but remained above 1.20 to the pound between the start of September and the start of November 2008. Thereafter, the rate deteriorated quickly.
61. Graph One reproduced below shows movements in the daily :£ spot rate during 2008[1]:
62. To demonstrate the significance of these changes for the States' euro liabilities under the EPC contract, Graph Two reproduced below compares the daily spot rates shown in the above graph  with  the  rate  ruling  on  9  July 2008,  the  date  on  which  the  States  approved  the procurement.

63. Graph Three shows the effect of these changing rates on the cost of acquiring the euros required by the EPC contract[2]:
64. In the following section, Section Four, I will set out a detailed chronology of the steps taken to monitor and then manage the euro exchange rate risk from the creation of the Funding Working Group but especially during October and November 2008.

SECTION FOUR ~ CHRONOLOGY

Introduction

65. The chronology set out in this section of the report refers to the principal events in the consideration of the euro exposure arising from the EPC contract and the way in which that exposure was eventually managed. It does not therefore set out all of the events in the consideration of the procurement and the eventual contract, or all less significant administrative steps.
66. Moreover, as the chronology has been largely based on the records which still exist (e.g. letters, working papers and e-mails) it does not capture all telephone calls, informal meetings or conversations unless they are mentioned in the documents.
67. For ease of reference, a list of all of the people mentioned in this chronology (and elsewhere in this report) is set out in Appendix Two to this report. A list of abbreviations is set out in Appendix Three.
68. The period covered by the chronology is divided into three:

1. The period to the States' approval of the procurement and of the proposals for financing the procurement;
2. The period from the States' approval to the signing of the contract; and
3. The period from the signing of the contract until the beginning of January 2009.

Tuesday, 21 August 2007

69. The first meeting of the Funding Working Sub-Group[3] took place.
70. The meeting discussed the roles and responsibilities of the Group among other matters. and the minutes record that:

"GB [Strategic Investments Manager (SIMT&R)] and RF [Assistant Director, Finance and Investments (ADFIT&R)] asked whether, if the appropriate budget was secured and made available to the phasing required whether the T&TS wanted or needed to be involved in discussions and negotiations with funders. This was for two reasons. Firstly, if other sensitive projects were involved then Treasury needed a probity distance in the projects. Secondly, the independence of the EFW Project Board might be compromised if the scale of the EFW Project influenced the funding source unduly.

JDR [Chief Officer,T&TS (COT&TS)] indicated that as Treasury would have to formally request the money this was sensible and would avoid considerable work for the Project Team. WG [Director, Waste Strategy Project (DWSPT&TS)] indicated this would be acceptable provided that the funding could be secured on a sufficiently flexible arrangement to avoid penalties and claims under the contract.

[ADFIT&R] noted that the funding source risk then fell to Treasury and Resources and this would have to be considered against the amount of risk falling to the EPC contractor under the contract. [SIMT&R] and [ADFIT&R] would consider this further at the monthly Capital Projects Sub Committee meeting held in Treasury to consider amongst other things externally funded projects."

71. The meeting also discussed the procurement and role of a financial adviser:

"[DWSPT&TS] outlined the financial adviser brief that had been prepared for the project. [SIMT&R] indicated that he would have to review in detail but queried whether the role was needed if the funding source could be delivered by Treasury. [ADFIT&R] suggested it would be sensible if the EFW project adviser role were limited to providing financial models evaluations and life cycle analysis with the funding source role being a sub-cliented[4] role for Treasury to call on as and when required for negotiations with funders.

[COT&TS] indicated that this would be acceptable and asked [DWSPT&TS] to revise the brief to enable the financial advisor role to be procured as quickly as possible. [DWSPT&TS] indicated that the EFW project financial adviser role could then be reduced to developing a financial model based on the existing technical model commenting on the financial capability and suitability of the bidders and assisting in evaluation of whole life costs."

72. The Funding Group considered draft terms of reference for the financial advisers to be appointed. Among other matters, the financial advisers were:

"(i) To provide ongoing financial and commercial advice on the procurement

approach and ensure compliance with appropriate legislation and regulations liaising with legal and technical advisors when necessary.

(ii)  To investigate and advise the States of Jersey's Transport and Technical Services and Treasury and Resources Departments on the most appropriate (best value for money) funding source for the Energy from Waste Project, contributing to the Project Board Working Group on funding as required.

14. To monitor the commercial position and sensitivity analyses consequent on shifts in risk apportionments as the programme developed throughout the procurement process.
15. To regularly review and update the States of Jersey's financial position as the programme progresses to closure and review and advise on the value for money of the programme as it develops.

(xxv)  To ensure that proper financial advice is provided to States of Jersey to enable it to take a robust decision on the proposed scheme".

73. After a competitive process, Deloitte were appointed to act as financial advisers to the Funding Group.
74. It is clear from these minutes and the minutes of other early meetings of the Group that the initial assumption was that the procurement would be financed by borrowing, possibly by means of a bond issued by the States, and that companies tendering for the contract to build the new plant would be expected to denominate their bids in sterling so that the States would not be exposed to any currency exchange risk.

Thursday, 1 November 2007

75. On appointment, Deloitte quickly became involved in assessing the Invitation To Tender for the main procurement contract. It was clear from an early stage of Deloitte's involvement that foreign currency risk would be a significant matter in the evaluation of the various bids which might be received in response to the procurement invitation to tender. This was subsequently covered in Deloitte's Evaluation Report dated 9 July 2008.

Monday, 26 November 2007

76. The second meeting of the Funding Working Group took place. Amongst other matters, the Group discussed and confirmed the proposed role of the financial adviser and discussed the intended arrangements for the borrowing that was being considered at the time as a possible source of funds for the project. The minutes record that:

"[SIMT&R] indicated that the Minister for Treasury and Resources was now minded to fund the project from reserves rather than sovereign bond or other external funding. This would necessitate a requirement for an internal charge for the capital sum and a separate charge for an interest payment".

Tuesday, 18 December 2007

77. DWSPT&TS circulated a note on the milestones in the timetable for achieving approval for the proposed procurement. The key milestones were intended to be as follows:

1. 29 February 2008 – bids to be received;
2. A six week period for evaluation of bids leading to appointment of a preferred bidder by 17 April 2008;
3. It was envisaged that a meeting of the Funding Working Group would be required at about that time to discuss particular issues arising from the selection of the preferred bidder on the funding route;
4. It was hoped that a report and proposition on the procurement could be considered by the States meetings in the week commencing 1 July 2007 which would mean that the report and proposition would have to be submitted six weeks beforehand i.e. by 25 May 2008. The T&R Funding Paper would have to follow the same timetable;
5. The detailed planning application would have to be approved by 21 August 2008 so that contract completion could be achieved by 28 August 2008;
6. The EPC construction period would then commence on 29 August; and
7. Before construction could commence funding would have to be agreed and in place.

78. A copy of a T&R paper on options for funding the contract was attached to the e-mail from DWSPT&TS[5]. It considered five principal options:

1. Funding from reserves;

2. Funding from a sovereign bond;
3. Funding guaranteed on the energy from waste asset;
4. Hybrid option 1: re-finance during construction; and
5. Hybrid option 2: re-finance after the plant had been commissioned.

Thursday, 24 January 2008

79. As I have indicated, it was expected that tenders would be denominated in sterling, On this day, CNIM, one of the bidders, sent the following e-mail:

"You have stipulated that the tender prices should be given in pounds with a fix mechanism for the foreign currency.

As you may understand, most of your prices will be originated from the euro area. It would be very costly for us to obtain a guaranteed conversion rate at the date of tender submittal.

We propose to submit a price splitted in Pounds and Euros and to fix the conversion rate if we are declared preferred bidder."[6]

80. Having received this e-mail on 24 January 2008, BabtieFichtner sent the e-mail to DWSPT&TS and others saying:

"Please find below an email from CNIM on the submission of the euro priced elements of the bid.

This will affect all the bidders to varying degrees and we will need to be mindful of what is stated in tenders. It is likely that the successful bidder will fix the exchange rate at the effective date of the contract rather than at appointment as preferred bidder which is likely to be in September, 5 – 6 months ahead of appointment".

81. ADFIT&R responded to DWSPT&TS by saying:

"I think the important thing is to ensure that: a) all bids are compared on a like for like basis – I suggest that the submitted cost in sterling is used for comparative purposes and b) cost certainty in respect of currency movements is established at the contract date.

In practice as we are dealing with bids in versus £ and not multiple currency bids versus £ the impact of a move in the £/ conversion rate will have a similar effect on bidders so should be neutral in terms of assessing respective bids.

A significant move on the £/ exchange rate between tender and contract would impact on the budget position and is flagged up as a risk."

Friday, 8 February 2008

82. DWSPT&TS circulated a note to members of the Funding Group and others suggesting that it would be appropriate to brief the full Project Board and others about the state of this contract in view of certain material developments. One of these developments was:

"Recent (8%) detrimental movements in the currency markets with the increasing strength of the euro which may add 5% to the contract price."

Wednesday, 13 February 2008

83. BabtieFichtner sent an e-mail to DWSPT&TS concerning the latest estimate of project costs. His e-mail referred to the inclusion of currency as one of the outstanding risks and set the financial provision for this risk at 5% of the contract price commenting:

"Clearly this is just a guess and I don't pretend to be able to predict /£ rates but it highlights this is a sizeable risk."

Monday, 17 March 2008

84. In an exchange of e-mails between SIMT&R and DWSPT&TS, responsibilities for the development of proposed material for the reports and propositions to be laid before the States were clarified. In particular, it was noted that SIMT&R had agreed with Deloitte that they would provide information on options on hedging currency. This was confirmed in an e-mail from Deloitte to DWSPT&TS and others on 17 March 2008 which confirmed that "options around currency hedging" represented one of the principal areas to be dealt with by Deloitte in the context of the work required to complete the report.

Thursday, 20 March 2008

85. Deloitte sent an e-mail to SIMT&R setting out in an attachment the indicative quotes that had been received from certain banks in respect of financing and hedging options.

86. Deloitte also sent to SIMT&R an outline of the funding options memorandum which Deloitte were to produce in preparation for submission to the Council of Ministers. One of the sections of this memorandum was to include currency risk:

"[Exposure to currency risk due to a delay in the programme – exposure to currency risk and options to hedge against the risk, include summary of options and prices received from some banks – Deloitte to include]"

87. It was subsequently agreed that SIMT&R would produce the report incorporating input provided by Deloitte. This input was provided by e-mail.

Tuesday, 25 March 2008

88. Deloitte sent an e-mail to SIMT&R enclosing draft material on currency exposures and the way in which they could be managed.

 "Should the States of Jersey wish to hedge this risk there are two main options for hedging that could be pursued. Firstly, an amount equal to the expected euro element at today's rates could be transferred within reserves from a sterling account to a euro account. Secondly, an option could be purchased now to obtain euros equal to the expected euro element at a future date.

Transferring money within reserves from a sterling account to a euro account would provide an effective hedge as long as the actual euro amount requirement did not exceed the amount transferred. However, the following issues would need to be considered:

There is a significant difference between the bids in terms of the euro amounts known so it would be difficult to identify the correct amount to transfer in advance of appointing a preferred bidder.

This sort of hedging removes/mitigates upside and downside risks so any potential upside should sterling strengthen against the euro would also be removed.

Any mismatch between the amount transferred and the eventual euro requirement would result in a mismatched amount being transferred between currencies at a future date and profits/losses resulting.

Once transferred the money would accumulate interest at a rate in line with other euro deposits and it is likely that this interest rate would be lower than could have been achieved had the money remained as sterling.

After approaching several banks, one bank . . . provided an indicative price for a currency hedge of 15 basis points (BPS). This would equate to a fee of £117K for CNIM's bid and £59K for Earthtech. This is an indicative estimate and the actual amount would depend on the actual timing of the cash flows and prevailing market conditions. Issues with the currency option include:

The fee for the option would be payable upfront regardless of whether the project went ahead or was delayed. If sterling strengthened against the euro the option would be effectively worthless as the States of Jersey would allow it to lapse and obtain euros at the more advantageous rate at the time.

Any delay to the project timetable could take the draw-down of monies outside the option period, whereupon the option would lapse. At this point the States of Jersey would have to choose whether to exercise the option and obtain euros at the agreed rate or allow the option to lapse. Any attempt to make the option period longer at the outset is likely to result in significant increase in price.

As this is an option, the upside potential remains as the States could allow the option to lapse if interest rates have moved in their favour between taking the option out and the requirement for euro currencies.

There is a significant difference between the bids in terms of the euro amounts known and it would be difficult to identify the correct amount of hedge in advance of appointing a preferred bidder."

89. Subsequently, a draft of a report to the Council of Ministers was prepared incorporating Deloitte's material on currency exposures.

Thursday, 3 April 2008

90. The report was submitted to the Council of Ministers.

Friday, 4 April 2008

91. Deloitte sent an e-mail to DWSPT&TS seeking advice on the exchange rates to be used in evaluation exchange rate risk in the evaluation model.

"The exchange rate we are currently using in the financial model is that used by Fichtner in their payment schedules (1.30221 at 14 March 2008). We need to decide the following:

1. The rate to use for the base case scenario.
2. The rate to use as the sensitivity for sensitivity analysis.

For the base case rate it is difficult to argue that it should be anything other than the rate at the time the analysis is being done unless there is a particular reason for thinking that rate is anomalous (e.g. severe recent currency movements).

The sensitivity rate is more difficult as none of us are in a position to predict future currency movements . . . we have prepared the following analysis of how rates have gone over the last year and how they would look if exactly the same overall trend were followed.

This analysis showed that the to £ monthly average rate in December 2008 might be 1.19776 and that the to £ exchange rate at the end of December 2008 might be 1.14566."

Monday, 7 April 2008

92. Babtie Fichtner circulated advice on the rates to be used in the analysis:

"My view is that for evaluation purposes we fix the rate on the evaluation date (likely to be 29 April). Sensitivity should reflect the scale of the last six months exchange that is, if it were done today (1.28/£) I would model 1.08 to 1.48. Everyone should be aware that this is not a prediction but an indicator of what happens if things change outside our control".

Thursday, 10 April 2008

93. ADFIT&R responded:

 "For base case scenario modelling purposes I would suggest that you take the rate of 14 March 2008 as Louise suggests.

For sensitivity modelling – this depends on how we are going to manage arbitrage risk.

If we retain all funds allocated in £ then we will need a range. The current 1.25 /£ is probably at the lower end of any forecast range but it's anyone's guess as to where it will go over the course of the contract. Your 1.08 – 1.48 range is probably to wide to be of any use – I would suggest 1.15 – 1.40".

94. This suggestion was subsequently used in the evaluation model.

Tuesday, 6 May 2008

95. The third meeting of the Funding Working Group took place. The minutes record that:

"[DWSPT&TS] explained the evaluation process and indicated a clear winner in each of the categories (financial, technical and legal/commercial), and therefore CNIM Consortium were recommended to be the preferred bidder.

[Deloitte] explained that review of euro price sensitivity suggested that the CNIM Consortium bid would still be likely to offer the best value. The Group discussed whether the euro could weaken this year. Sensitivities conducted on general and power inflation had also been conducted also the 2.5% figure used was considered too low and would be revisited."

Friday, 16 May 2008

96. At this time, SIMT&R and others were completing a draft of the Proposition on the financing of the procurement to be put to Ministers for subsequent lodgement au Greffe[7]. In response to a request for information, at 1259 hours, Babtie Fichtner set out his understanding of the basis on which contract negotiations were proceeding:

". . . the basis of the contract is sterling and unless your Treasury advise they want the contract signed in euros and sterling the intention has always been to sign a fixed price sterling contract. CNIM have helpfully split their bid into euros and sterling at this stage as they have always said they will not take exchange risk prior to contract award. The fixed sterling price of £93.35M is therefore only valid at a /£ rate of 1.27285.

How the foreign exchange risk is covered will be up to Treasury to decide . . . Whilst CNIM can hedge if you insist, as this should be a case of just getting the best hedge rate commercially available at the time, it is probably better for you to arrange the hedging so it is open. Prior to contract award we would have a finally agreed contract price (in £ and ) and a milestone breakdown which will enable you to purchase the euros in advance at the time you need them. This is normal practice for this type of contract."

97. At 1518 hours, SIMT&R telephoned Hewitt, the States' strategic investment advisers, to pass on the details of a currency option for which a quotation was required[8]. The details of the option whose purchase SIMT&R was considering was that it was proposed to purchase 75.8 million on or before 31 October 2008 at a rate of 1.2729.
98. At 1910 hours, Hewitt responded to SIMT&R in an e-mail which read:

"Further to our telephone conversation earlier, we have received an indicative quote of c. £1.97 million (equivalent to approximately 3.2%).

This would involve purchasing an American style call option on the euro (contract size 75.8 million) with a strike price of 0.7856 (1/1.2729). The American style option effectively enables the option holder to exercise their right to execute at the strike price at any time between now and 31 October 2008, (this will cover the period 1 July to 31 October 2008). To cover the period between 1 July 2008 and 31 October 2008 exactly would require a tailored contract".[9]

Saturday, 17 May 2008 1613 hours

99. SIMT&R responded to Hewitt in an e-mail which read:

"Fantastic! Not the price! But thanks for getting me the quote in time! We weren't going to go for it at a cost of £1 million so think I can safely say it's out of the question now!"

100.  I infer that the reference to "we weren't going to go for it at a cost of £1 million" implies

that consideration had been given to purchasing an option provided that the cost was within £1 million. None of the officers within T&R can recall such a consideration or conversation.

Sunday, 18 May 2008

101.  SIMT&R sent to T&R Minister a briefing paper asking the Minister to consider the draft

proposition of the Minister for Transport and Technical Services to procure an Energy from Waste Plant and to agree a preferred funding solution for the plant and to lodge a report and proposition (which was attached in draft form).

102.  The briefing paper summarised the overall costs of the project in the following way:

Capital cost (£ million)

Enabling works  3.63 Engineering Procurement and Construction (EPC) Contract  93.35 Jersey Electricity Company (JEC) Connections  0.40 Decommissioning of the Bellozanne incinerator  2.08 Project Management (including incurred feasibility costs)  6.85 TOTAL COST  106.31

103.  It also referred to the risk of currency exchange rate fluctuations in the following way:

"The  Engineering  Procurement  and  Construction  (EPC)  contract  is  subject  to currency risk with exposure to the rate of exchange between the euro and sterling. The exposure relates to contract costs of 75.8 million or £59.5 million of the £93.35 million contract sum quoted above.

The exchange risk will be eliminated upon the signing of the contract at which time the  Euro/Sterling  rate  will  be  deemed to  freeze for  the  purposes  of  the  contract payments. All contract payments will be made in sterling. The sensitivity analysis below indicates the extent of exposure to currency fluctuation."

The Treasury has obtained an indicative quote for the purpose of the currency option that would eliminate the exposure to euro fluctuations between 16 May 2008 and 31 October (the date by which the contract must be signed). The option would cost £1.97 million. It should be noted however that this cost is based on buying the option now (before a States decision to proceed with the scheme). As the exchange rate will fluctuate over the six week period to 1 July 2008 the cost of the option will also vary.

To cover the period between 1 July 2008 and 31 October 2008 exactly as at 16 May 2008 would require a tailored contract. The cost of this has not been determined as it is not readily available in the markets. The tailored contract would in any event be of little use as the department would not purchase it prior to the approval of the scheme by the States. The cost would of course vary between now and that point in time.

A "worst case scenario" has been sought from the Treasurer's investment adviser Hewitt. Hewitt has indicated that is very unlikely the euro exchange rate would move below 1.10 to the in the period to 31 October 2008. This equates to an additional sterling cost of £6 to 7 million on the EPC contract.

In view of the risk detailed above, all of the £3.6 million unallocated balance in the fluctuations element of the States Capital Reserve Vote has been earmarked for this project. It is proposed that the currency risk be monitored up to the States approval of the scheme at which point a paper will be brought back to the Minister recommending how the risk should be managed between the approval date and the signing of the EPC contract. The earmarked £3.6 million is considered a reasonable sum from which to address the risk at that time. The cost of the risk being c.£1.97 million now (the price of the option) and a worse case scenario being £6 to 7 million with no option  in  place  for  the  entire  period  to  31  October  2008  (based  on  the  Hewitt exchange rate advice)."

104.  As far as I can discover, the papers held by T& R including copies of emails, do not

record any such advice provided formally by Hewitt. I have therefore sought from Hewitt

confirmation of the advice allegedly provided by Hewitt in respect of a "worst case scenario". 105.  I have received the following response from Hewitt:

"With regard to the point on the worst case scenario . . . this issue came up when I was talking to [SIMT&R] generally about whether he wanted to run exchange rate risk or take out some form of protection. I said to him that one of the things he needs to consider is possible worst case scenarios, then ask himself the question on whether the States could afford those positions. Hence, I would have used merely as an example a rate a long way away from the current rate and said to him why don't you work out the sterling costs of the contract using a rate like that and decide whether you could afford that particular amount of sterling outgo. I would also have encouraged him to use various rates to give him an idea of the sensitivity of the sterling capital cost to different scenarios on the exchange rate over time. At no time did I forecast an exact exchange rate by a particular period of time and I have made it very clear to the States that Hewitt does not forecast short term currency rates. What I have tried to do is explain some of the issues in working out whether protection or exchange rate risk is taken . . . I would not have included words such as included in the briefing paper to the T&R Minister . . . in any advice from me".

Tuesday, 20 May 2008

106.  Proposition P73/2008 entitled "Energy from Waste Facility: Funding" was lodged au

Greffe on 20 May 2008 by the Minister for Treasury and Resources and accompanied Proposition P72/2000 which was lodged by the Minister for Transport and Technical Services and dealt with the procurement itself. As far as exchange rate fluctuations are concerned, P73/2008 observed:

"The engineering and procurement construction (EPC) contract is partially subject to currency risk with certain agreed payments being quoted in euros. The States therefore has a currency exposure to the rate of exchange between the euro and sterling.

This exchange risk will be eliminated upon the signing of the contract with the preferred bidder at which time the Euro/Sterling rate will be deemed to freeze for the purposes of the contract payments. All contract payments will be in sterling.

The Treasury has conducted a sensitivity analysis of the currency exposure and obtained expert advice on anticipated currency fluctuations. As with all States capital projects the Treasury will monitor and manage the fluctuations risk. The cost of any currency fluctuations will be met from the Capital Projects Reserve vote in the event this increases the cost of the project".

107.  As I have observed above, I have attempted unsuccessfully to identify the "expert advice

on anticipated currency fluctuations" to which the proposition refers.

Wednesday, 9 July 2008

108.  The States approve Propositions P72 and P73/2008.

109.  Deloitte's signed Evaluation Report was received.

Friday, 11 July 2008

110.  SIMT&R submitted his resignation from the States' employment and requested that the

T&R Department should agree to shorten his period of notice. TT&R did not agree to this request.

Tuesday, 12 August 2008

111.  DWSPT&TS circulated an e-mail to SIMT&R, ADFIT&R, COT&TS, and Deloitte,

proposing that the Funding Working Group should meet in the first week of September which would act as a handover meeting for SIMT&R.

112.  The e-mail included the following observations:

"As discussed, a Hopkins Redesign has partially delayed our detailed planning submission and will have a significant impact on risk reserve estimated at £1.8 to £2.5 million at current figures.

We still hope to obtain financial close before indexing hits at the end of October – this now looks difficult however. We therefore have indexing details from CNIM attached and a Fichtner analysis of these.

You indicated that the exchange rate had moved in our favour this week for the first time since approval of funding and the need for expediency which we are striving for".

Thursday, 28 August 2008

113.  The Connétable of St Helier lodged au Greffe a Proposition which invited the States to

request the P&E Minister not to give final planning permission for the new EFW plant until a public inquiry had been held into the project.[10]

Monday, 1 September 2008

114.  A meeting of the Funding Working Group took place attended by COT&TS, ADFIT&R,

SIMT&R, DWSPT&TS and (by telephone) Deloitte.

115.  As far as exchange rate fluctuations are concerned, the minutes of this meeting read as

follows:

"[SIMT&R] noted that the euro element of the tender was approximately 78 million based on a rate of 1.2729 to the £. The rate was now 1.26 and could fall further. [ADFIT&R]indicated that the £ had fallen to 1.21 at one point and risen beyond 1.27.

Sterling had weakened considerably this year. The cost of making payments in euros could be of the order of £2 million. [SIMT&R] indicated that once the contract had been fixed the States could choose to hedge the payments in euros. [SIMT&R] confirmed Treasury would need to understand which contract payments when required to do so and what flexibility in these payments was likely to occur. It would be possible to transfer the full euro element into a euro account on the day of contract – either by the contractor or via the Treasury's currency advisors. [SIMT&R] would want a price for either to compare value as there might be a premium applied by the contractor. [SIMT&R] indicated Treasury would ideally want to close out the risk at the point of signature of contract. It may be possible to cut the cost of the euro pot over time through making investments in euros rather than sterling. However, this would reduce the flexibility of the investment manager. [Deloitte] indicated he had conducted euro sensitivity on the EPC contract awards and that the possible threshold had been 1.25. [SIMT&R] indicated that he had done work which indicated that the euro rate of 1.18 cost £7 million".

116.  It was agreed that DWSPT&TS would obtain a price for fixing the euro via the EPC

contractor and that SIMT&R would confirm what capability the States had for making euro investments.

117.  As I will show, DWSPT&TS did obtain a price from the EPC contractor. I have not

found evidence that SIMT&R confirmed the States' capability for making euro payments.

Thursday, 4 September 2008

118.  The Deputy of St Clement lodged au Greffe a Proposition which asked the States to agree

that a Committee of Inquiry should be established to investigate the procurement process for the replacement of the Bellozanne incinerator.[11]

Monday, 29 September 2008

119.  CNIM confirmed that CNIM's proposals for the arrangements surrounding fixing of the

exchange rate within the contract would be given during the next negotiating meeting on 1 October 2008.

Wednesday, 1 October 2008

120.  A formal negotiating meeting took place between the States and CNIM/CSBC[12] at

Eversheds offices in London. The minutes of the meeting record that as far as currency is concerned:

"CSBC outlined that the markets are moving every day. CSBC will confirm current position this week. The rate will be valid for one week. If the price is set at the signature date CSBC will hedge the rate.

CSBC outlined 1.75% of the euro amount is the hedging rate.

TTSD requested that the mechanism for hedging the outlined and indicative "on the day rate" and hedged rate would be provided for comparison.

TTSD to confirm whether a fixed rate is required".

Tuesday, 14 October 2008

121.  CNIM/CSBC confirmed the costs that might be incurred if the choice is made to fix the

exchange rate in the contract:

"Concerning the £ to £ conversion, we confirm our statement given during our meeting of 1 October.

There is two ways to convert the euro amount to £'s.

The first one is to calculate the conversion rate the day before the contract signature with a hedging rate that is, as today, equal to 1.75% of the euro amount. Despite that the /£ conversion changed since October 1 the hedging rate remains the same but could change until the end of the month.

The second one is to convert the £ to£ earlier and in such case CSBC will have to buy options on the currency markets. These options have a price that is presently with the hedging rate of 3 to 4 %".

Frida y, 17 October 2008

122.  DWSPT&TS confirmed this information to the colleagues within T&TS team in the

following way:

"If we wish to fix the euro rate at the point of contract CNIM have indicated that for the process elements of the EPC contract they were offered a rate of 1.75%. Spie Batignolles have indicated that for the civil element they were only able to get an RBS rate on Jersey of double this amount. Assuming the revised EBC cost indicated above this would indicate the cost of fixing the euro would be as indicated in the spread sheet. This is not included within the project costs as previously".

Friday, 17 October 2008

123.  DWSPT&TS circulated an e-mail to the following amongst others: DWMT&TS;

ADFIT&R; COT&TS.

124.  To the e-mail were attached draft spreadsheets for the design review anticipating the costs

that would be notified to T&TS by CSBC. These spreadsheets showed that the net position, after all of the cost provisions expected, would be an additional cost of £3.256 million.

125.  The e-mail continued:

"If we wish to fix the euro rate at point of contract CNIM have indicated that for the process elements of the EPC contract they were offered a rate of 1.75%. Spie Batignolles have indicated that for the civil element they were only able to get an RBS rate on Jersey of double this amount. Assuming the revised EPC cost indicated above this would indicate the cost of fixing the euro would be as indicated in the spreadsheets. This is not included within the project costs as previously.

I would be grateful if everyone would provide their comments on the above".

Sunday, 19 October 2008

126.  Subsequent responses by DWMT&TS, and ADFIT&R indicated that they both believed

that it would be unwise to embark upon the project with insufficient contingency. In other words, they agreed that it would be unwise to sign the contract unless the budget that had been approved was sufficient not only to cover the expected cost the time of signing, but also to provide a contingency which appeared sufficient to allow for contingencies. These would include increased costs arising from changes in specification that became necessary in the course of construction. The concern was that in effect, the cost of fixing the rate of exchange reduced the planned contingency margin. Whilst it was possible not to accept the contractor's charge for fixing the exchange rate, that would leave the States to bear the risk of exchange rate movements and this would have to be covered by the contingency margin.

Monday, 20 October 2008

127.  In an e-mail dated 20 October 2008 to DWMT&TS and others , ADFIT&R set out a

number of options for dealing with this problem. These were:

1. Increase the absolute budget;
2. Phase the project using approved funds for phase 1 and bid for new funds for demolition (phase 2);
3. Transfer funds from other projects; and
4. Postpone a T&TS project until the extent of the contingency sum applied is known.

128.  Finally, ADFIT&R commented:

"The currency markets are all over the place at the moment but as I write the euro is moving in the right direction to the tune of about £1 million favourable variance. Any scope here?"

Wednesday, 22 October 2008

129.  At 0954 hours, ADFIT&R sent an e-mail to the Deputy Treasurer (DTT&R) which reads

as follows:

"As you will be aware, [the former SIMT&R] sat on a funding sub group for the EfW project to provide advice and guidance from a Treasury/Investment perspective.

An issue which would have been for[the former SIMT&R] to take forward is now becoming urgent.

The majority of the contract sum for the main works is in (c75m). The two external parties involved in provision of the contract have provided a total price of approximately £1.28m to fix' the exchange rate on the date of contract signing (aiming for 31/10/08) for the duration of the contract. The rate to fix the actual sum will vary up to the point of fixing – in the current market such variation may be considerable.

This will provide us with a known sum in sterling for the staged payments throughout contract period and the project funding can be managed as a normal' capital project.

An alternative to this approach is to (simplistically) open a euro account with our bankers, deposit the sterling equivalent at current exchange rates and draw down the funds in euro's for each staged payment. There will be a direct cost in arranging and managing the account and an indirect (opportunity) cost in any differential between the interest available to invested general funds and the interest that may be obtained from the euro account. This needs some research for which the project team do not have the skills or resources – who in Treasury could obtain the information?

A third approach which I would not recommend – is to remain on a floating exchange rate basis throughout the contract duration and take the risk of arbitrage profits or losses through movements in the currency market.

Can you please give this some thought and advise on Treasury's preferred way forward."

Thursday, 23 October 2008

130.  DTT&R passed the e-mail from ADFIT&R to the Head of Decision Support

[HODST&R] (at 0928 hours) asking him to do an option appraisal ("mini business case") on the various ways of arranging for payment and to make recommendations. He set out his own thoughts in the following way:

"My own thoughts are:

It seems we have three options.

The criteria against which to assess them must be something like: certainty, risk, cost. This can then recommend a suitable approach for the project."

131.  HODST&R then (at 1035 hours) asked the Regulatory Adviser (RAT&R) whether this

was a suitable matter on which Hewitt might advise and RAT&R called Hewitt to seek advice on obtaining euros to meet obligations under the contract.

132.  HODST&R responded to DTT&R at 1457 hours in an e-mail to which a first draft of a

note on the available options was attached[13]. This note mentioned three options (i.e. fixing the exchange rate within the contract which the contractor had indicated would cost £1.28 million, depositing the full sum in an euro account at the beginning and making payments as they fell due, and making payments at the exchange rates ruling at the date of payment). He commented that to pay £1.28 million to fix at the current rate could turn out to be an expensive option.[14]

133.  DTT&R acknowledged receipt of this e-mail at 1523 hours, commenting:

"I'm also struggling with option 1 costing £1m to secure the same deal as placing cash in a euro account."

134.  Separately, the P&E Minister held a Ministerial Hearing at which he considered a report

concerning reserved matters relating to the EFW plant. The Minister received representations made by the Connétable of St Helier and the Deputy of St Peter. Although the Minister reserved his decision on the colours and materials to be used, all other reserved matters were approved subject to the conditions detailed in the officers' report which had been submitted to him.

Friday, 24 October 2008

135.  At 0927 hours, HODST&R sent an e-mail to Hewitt which reads as follows:

"I understand [RAT&R] spoke to you yesterday regarding a contract we have where payments are to be made in euros. We have the option to fix the exchange rate as at the date of signing (assume 31 October 2008) for £1.28 million. Other options we are considering are to deposit the full sum in a euro account or take a chance on the prevailing rates on the payment dates. No doubt there are others. I attach a payment schedule. I would be grateful if you could advise me what would appear to be our best approach".

136.  At 1541 hours, Hewitt responded to HODST&R (copying the e-mail to RAT&R). The e-

mail reads as follows:

"There is no single obvious way forward here which is necessarily better than the other alternatives, and much depends on your requirements on certainty of price of sterling and how much you wish to be dependent on the future vagaries of the foreign exchange markets.

Although sterling has been reasonably stable against the euro in recent weeks, it has today moved 2.5 cents down against the euro and we have seen by the movements of sterling against the dollar how large variations can occur in short periods of time. For example, the pound will have declined from $2 = £1 to $1.56 = £1 in less than three months. This shows the potential of gains and losses from foreign exchange on this type of transaction.

The most obvious way that most companies would deal with a payment series such as this would be to engage in a series of forward foreign exchange rate contracts for example, a contract for £15 million to deliver euros and receive pounds at a rate known today for January 2009. Money is not required to be put up front for these contracts. It may well be that the £1.28 million cost you mention is the difference between the spot and forward rates for all the cash flows for this series of transactions but I have been unable to contact you by telephone to ascertain this.

Your second suggestion is to hold a euro cash balance for the whole sum required for the relevant period. Again this achieves sterling price certainty for the cost of the initial euro balance for the total sum, although some uncertainty over euro interest payments (unless these are also agreed with the bank) will still be present. Since the pricing of forward foreign exchange contracts mentioned in the previous paragraph has regard to the levels of interest which are paid on balances in sterling and euros, you should not find a dramatic difference between the financial cost of this method and the method in the previous paragraphs.

It is possible to make no advance provision for the euro payments and to fund them as they come through. This may cause some concerns for budgeting in that you do not have control over the sterling cost of this project but it does give an opportunity for perhaps gaining, or losing, from a change in the fortunes of sterling. Since 35% of the total cost is payable within six months, there is more of a short term chance effect on exchange rate movement and little time for any long term macro effects to come through.

In summary therefore, most UK Treasurers would. I think, buy a series of forward exchange contracts to fix the sterling cost at this time and to remove exchange rate uncertainty".

Monday, 27 October 2008

137.  At 0755 hours, HODST&R forwarded Hewitt e-mail to ADFIT&R with the following

comment:

"For info. Will discuss with [DTT&R] but not sure that we are geared up to arrange a series of forward contracts."

138.  At 0926 hours, HODST&R forwarded Hewitt's e-mail to the Investments Manager

IMT&R, who was the principal day-to-day contact with HSBC, the States' bank, with the following request:

"Please see advice below. I have no idea how difficult it is to set up forward contracts or who would do it. If it's complicated it may be better to deposit the whole 75 million but get an interest bearing account. Should we discuss this with the bank? I have also attached the provisional payment schedule."

139.  In the event, IMT&R was not in the office so that no contact was made with the bank

until the next day.

140.  At 1109 hours, HODST&R sent an e-mail to DTT&R and ADFIT&R to which was

attached a paper[15] dealing with various options for funding the contract and commenting:

"Managing exchange risk is paramount."

141.  The e-mail invited comments.

142.  At 1242 hours, ADFIT&R responded to HODST&R (sending copies to DTT&R and

DWSPT&TS) in an e-mail which reads:

"Thanks for the speedy turn round – very helpful in assembling thoughts. I see the actions as:

Option 1 – obtain current costs of fixing – have they moved much due to volatility in the currency market - (T&TS) via consultants.

Option 2 – ascertain interest available (if any) for a euro account with this profile - (Treasury HODST&R via shared services)

Option 3 – discount NFA

Option 4 – Hewitt's to advise on complexity (Treasury HODST&R)

My current view is that Option 4 looks messy and complex and perhaps not possible in the time available but we need Hewitt's advice.

That then leaves a straight choice between Options 1 and 2. As security is the same, the choice comes down to cost. We will need to do a discounted cash flow model to compare the two costs at today's values and then translate the difference into a rate required on the euro account to achieve parity. This can then be compared to the actual rate.

[HODST&R], is this something your team could do when we have the data?"

Tuesday, 28 October 2008

143.  After an oral exchange with IMT&R (who had not been in her office on 27 October

2008), at 0838 hours, HODST&R asked her to:

". . . contact the bank asap to find out:

- If we can get an interest bearing euro account

- If so

• What rate would it pay
• And what charges would be

- If they can arrange 16 forward contracts for euros should we choose to go down that route."

144.  At 1540 hours, HODST&R sent the following e-mail to HSBC:

"Please find payment schedule. We are assuming Jan 09 for 1st payment but this could move slightly. On the basis we want to sign the contract on Friday (although this may move by 2 weeks) it would be ideal to know by then whether we are better going for the option of a fixed payment to the contractor to freeze the rate at the date of signing."

145.  At the end of the afternoon, CNIM agreed to extend by fourteen days the period during

which their bid was valid (i.e. the deadline for signing a contract was put off until 14 November).[16]

Wednesday, 29 October 2008

146.  At 1117 hours DWSPT&TS sent an e-mail to ADFIT&R (sending copies to Deloitte and

COT&TS). This e-mail read as follows:

"We would agree that 3 would be a nightmare and 4 too complex."

147.  At 1452 hours,IMT&R who had been out of the office on the previous day when

HODST&R sent an e-mail concerning the proposed contract payments, responded to that e- mail in the following way:

"I have just opened this one with the provisional payment schedule.

If you need £15,000,000 in January I need to let RLAM [the States' cash managers] know this NOW. I am just going to give them a ring and I will also make enquiries what they can offer us on euros."

148.  At 1459 hours, HODST&R responded:

"Until we know what we are doing I can't really confirm the payment schedule. It may be we want v£75 million next week.

HSBC have said interest on euros at the moment is virtually nil."

149.  IMT&R appears to have been responding to HODST&R as if she was being asked to

make arrangements for payments to be made as they fell due. She appears not to have been told that the object of the exercise was to ensure that managing exchange risk is paramount'. [17]

Friday, 31 October 2008

150.  Following her exchange of e-mails with HODST&R on 29 October 2008, IMT&R spoke

to RLAM. He responded in an e-mail on 31 October 2008 to which was attached a brief note setting out his preliminary thoughts on how the States' requirement for euros might be met. Two options were presented:

1. Book forward contracts through HSBC (the custodian for the liquid funds managed by RLAM for the States; and
2. Raise 75 million in January 2009 and make the payments to EFW as they fall due.

151.  It is evident from this note that RLAM were not aware of the exchange risk management concern to which HODST&R had referred in his first draft paper circulated on 27 October

2008. This is not surprising since he had been instructed by IMT&R who was herself not aware of this concern.

152.  Following receipt of RLAM's e-mail (at 1029 hours), IMT&R sent a copy to HODST&R

at 1119 hours. He then spoke to RLAM as he confirmed in an e-mail which he sent to ADFIT&R and to DTT&R at 1146 hours:

"Have just spoken to . . .Royal London. They are doing a cost comparison for us between forward contracts and a euro account. We can then compare this to the amount offered by the contractor to fix the rate. RLAM have promised to get back by the end of Weds so we should have an answer on Thurs."

Monday, 3 November 2008

153.  DWSPT&TS sent an e-mail to ADFIT&R asking whether a decision had been made

about the way in which the euro exchange rate risk was to be managed:

"Please can you confirm if we have determined which option is preferred. CSBC want to know if they should prepare a price for us or not by Wednesday."

154.  ADFIT&R replied at 1737 hours (also sending a copy to HODST&R):

"Waiting for feedback from Treasury – see attached.[18] [HODST&R] – any news?

My gut feel is to open a euro account."

155.  DWSPT&TS responded (at 1746 hours):

"Thanks . . ..

We need to bare[19] in mind the level of uncertainty associated with the CSBC solution too.

They were saying they were only able to fix that afternoon!"

Tuesday, 4 November 2008

156.  At 0729 hours, HODST&R circulated an e-mail to DWSPT&TS and ADFIT&R reporting

that he would not get any figures from RLAM until late Wednesday. The e-mail ended:

"Apparently the base rate for euro accounts is 0.75% less than sterling which by my reckoning means that we lose about £600k in interest compared to keeping it in sterling which makes a euro account cheaper on the face of it than the CSBC solution. It may be that forward contracts are cheaper still as the exchange rate is improving and we could earn sterling interest. On the whole I think it looks like the CSBC solution would not be the cheapest option for us but I won't be able to say for certain until late Weds or early Thurs."

157.  At 1018 hours, DWSPT&TS responded: "Excellent – thanks . . ..

That is helpful and enables me to know how to run with this. We have a contract meeting in London on Friday. That would probably be the latest we could opt for a CSBC driven solution if your analysis indicated this was worthwhile."

Wednesday, 5 November 2008

158.  At 1433 hours, in an e-mail to IMT&R, RLAM submitted some further suggestions

about how the euro exposure could be managed:

"It is very difficult to provide any definitive answer as to whether it is most cost effective to either raise 75million in January 09 or to use a series of forward foreign exchanges to purchase euros to co-incide with the dates that bills become due. This is because of the number of uncertainties involved in trying to calculate the costs of either option . . .

A further consideration may be the administration associated with each option? If the forward foreign exchange route is followed then it is very likely that HSBC will want additional documentation relating to the security that they will require in order to enter  into  the  forward  contracts.  As  the longest dated  contract  will  be  open  for approximately 18 months this may also present accounting issues? Certainly, it would be difficult for our systems to incorporate open foreign exchange liabilities into the current reporting package.

If the foreign exchange is done in one go in January 09 then the ongoing administration would be easier. . .

. . . I am sorry that I cannot offer a more definitive answer. However. . it is our opinion that option 3, purchasing all of the euros in January 09 is the preferred policy. It provides a known cost in sterling, ensures the euros are available when required and that the return on the euros is maximised in the intervening period."

159.  IMT&R sent a copy of RLAM's e-mail to HODST&R at 1446 hours and he in turn sent a

copy to DTT&R at 1511 hours with the following covering message:

"See attached. Will talk to [Hewitt] tomorrow but unless he violently disagrees suggest we go with the euro account."[20]

160.  At 1625 hours, HSBC, sent an e-mail to HODST&R to submit some solutions' to

manage the States' euro exposure. He indicated that he understood that the T&R preference was for a solution that offered certainty and did not involve complex structures.

161.  His advice was that the outlook was one of volatility so that the option of doing nothing

(i.e. paying euros at the rate ruling at the time of the payment) was relatively high risk'. He suggested two approaches that would better manage the risk and meet the States' needs:

1. To fix the rate of exchange by buying forward. A rate of 0.8192 (i.e. :£ 1.22) was quoted.
2. To enter into currency options or participating forward contracts which would offer some benefit if sterling should strengthen against the euro. A rate of .8395 (i.e. :£ 1.1911) was quoted.

Thursday, 6 November 2008

162.  At 0845 hours a meeting took place at Cyril Le Marquand House attended by the T&R

Minister, TT&R, ADFIT&R, T&TS Minister, COT&TS, the Finance Director, T&TS (FDT&TS) and DWSPT&TS.[21]

163.  The meeting was called to discuss the funding position of the Energy from Waste Plant Project. COT&TS explained that, following the intervention of the P&E Minister, a number of

design changes had been made to the original specification which had increased costs of the project by approximately £4 million. The result of this, together with variations in the sterling equivalent cost of the euro payments envisaged by the contract, was to exhaust the contingency provision which had been included in the original contract estimate published in P73/2008.

164.  COT&TS believed that it would be unrealistic to suppose that a further contingency

margin would not be required. It was agreed that T&TS has taken reasonable steps to control the costs of the project.

165.  The meeting briefly reviewed the steps that had been taken to manage the euro currency

exchange risk and was told that the preferred option was to transfer the euro element required into an euro account and to make the payments when due. Given the changing situation this was still under review. T&R would review the position with advisers and would advise T&TS on the preferred option prior to contract signature.

"In answer to a question from [TT&R],[DWSPT&TS] confirmed that euro currency risk had been included in the project's risk register but that the scale of any large scale movement in currency had been considered manageable within the £2 million contingency identified for the preferred bidder period. The £4 million impact of architectural requirements was not anticipated and therefore contingencies were deficient without the additional support identified in the affordability sheets."

166.  Later that day, at a meeting at 1630 hours with the TT&R and DTT&R, HODST&R

submitted a paper recommending the approach that should be used in dealing with euro payments under the contract.[22]

167.  This paper identified five principal options:

1. Fix the exchange rate as at the date of signing contracts for one off payment to the contractor (c. £1.28 million);
2. Deposit the full sum in an euro account and make payments when due;

3. Make payments at the exchange rate prevailing at due dates;
4. Purchase a series of forward contracts for the due dates at the date of signing contracts; or
5. Purchase a series of participating forward contracts for the due dates at the date of signing contracts (50% will be at an agreed rate, 50% at "capped rate").

168.  The full text of this paper is reproduced in Appendix Five to this report, however the

conclusions were as follows:

"The most risky and potentially costliest option is to make payments at the exchange rates prevailing on the due dates. Whilst a favourable movement in exchange rates would benefit the States, the difference in the cost between 52 week high and low rates would have been £7.8 million. This is considered to be too great a risk so the option has been discarded.

All of the other four options provide complete certainty for the States so cost is the deciding factor. The first option (paying c.£1.28 million) to fix the rate bracket would have essentially the same effect as depositing the full sum in a euro account although it would involve commission payments. RLAM have confirmed there will be no additional charges for operating the euro account. The interest earned on euros would however be slightly less than sterling (differential c.0.75% per RLAM) equating to c.440k.

Advice was sought from the States' Investment Advisors (Hewitt). Their recommendation was to purchase a series of forward contracts. HSBC could operate these straightforwardly and this would appear to be the second cheapest option (by c. £245k). Participating forward contracts are another action. With these should the sterling rate against the euro improve dramatically, the States would benefit from these improved rates but be protected from adverse moves. This option appears to be only fourth cheapest.

Advice was also sought from RLAM. For ease of operation they recommend operating euro account and depositing the full sum prior to first payment. With this option the States  would  retain  flexibility  e.g.  could  deposit  other  euros  as  received  but  not currently earning interest.

In summary this would appear to be a straight choice between operating a euro account and purchasing forward contracts. The euro account appears to be £245k cheaper, more flexible and simplest.

It is recommended that RLAM be requested to open an interest bearing euro account and that the full contract sum is deposited at a time of favourable exchange rate prior to the first payment date".

169.  There does not appear to be a formal record of the outcome of the meeting. The only note

takes the form of e-mails sent by HODST&R to various people informing them of the decisions reached.

170.  At 1703 hours, HODST&R sent an e-mail to DWSPT&TS and ADFIT&R to which the

options paper was attached and confirming that the CSBC solution would not be taken up:

"I can confirm that we will NOT[23] be taking up the CSBC solution based on the attached analysis."

Friday, 7 November 2008

171.  At 1338 hours HODST&R sent an e-mail to IMT&R confirming that the TT&R had

decided to go with' the euro account managed by RLAM and asking her to deal with the administrative steps that would be necessary to implement this decision. A copy of HODST&R's paper was attached to this e-mail which appears to have been the first occasion on which she was made fully aware of the issues under consideration. She in turn asked RLAM (by an e-mail at 1617 hours) to make arrangements for the opening of the account.

Tuesday, 11 November 2008

172.  IMT&R met RLAM to review the steps necessary to open an euro account and

subsequently (on 12 November 2008) sent an e-mail to RAT&R and HODST&R about decisions which would have to be taken.

173.  As for timing of the arrangement, the e-mail observes:

"[RLAM] is of the opinion that it would be better to buy the full 75million just before the first payment is due in January – Happy with this makes the year end much cleaner.[24] Do you agree?

RLAM will have to open a Euro Custody account with HSBC. They are going to get that in motion it should take 2 to 3 weeks.

Please let me have your views."

Wednesday, 12 November 2008

174.  At 1444 hours, RAT&R replied to IMT&R's questions about timing in the following

way:

"I think that we should take [RLAM's] advice on when to purchase the euros – he is the expert. It would be cleaner if after 1.1.09 but we would have to live with it if we needed to purchase before this.

Hope the above is a quick and dirty suitable answer."

175.  At 1551 hours, HODST&R sent an e-mail to DWSPT&TS and ADFIT&R asking for

detailed information about the contractors to enable the necessary payments to be made. The e- mail ended:

"Our cash manager's advice is to put the euros in the account in January just before the first payment is due. Trust this is acceptable."

Thursday, 13 November 2008

176.  COT&TS whose Minister was about to sign the contract, sent an e-mail (at 1010 hours) to

TT&R about the effect of movements in the euro exchange rate upon the contract price. Copies of this e-mail were sent to the T&R Minister, DWSPT&TS, FDT&TS), ADFIT&R , the T&TS Minister and the Chief Executive. (CMD).

"As a result of the very significant change in the euro exchange rate over recent days, we have incurred a large increase in the contract price for the new EFW plant. We are due to sign the contract tomorrow which is the last day of the extension we negotiated to the fixed price tender, thereafter we are faced with the indexing rates that are built into the tender.

As part of the project team's work, we have been working with the Treasury to establish the most appropriate method of paying for the euro element of the contract. The recommendation from the investment advisory team was to open a euro account and place the requisite amount in that account to meet the milestone payments throughout the contract.

The movement of the euro vs. sterling over the past 48 hours has had a very significant impact on the contract value as shown below:. . ."

The current view from the Treasury is that we should only deposit sufficient in the euro account to meet the first payment that is due 14 days after signing the contract which has a value of approx 13 million. The remainder of the euro contract value would be placed in the account in January by when it is hoped that the rate will have improved.  Indications  today  are  that  Germany,  France  and  Italy  are  likely  to announce that they are in recession which should help the euro.vs. sterling rate.

I would like confirmation from the Treasury that firstly, we should proceed with the contract signing tomorrow, and secondly, whilst TTS has made very effort to absorb the  fluctuations  so  far,  as  outlined  in  the  meeting  with  Treasury  on  Monday  10 November, it cannot meet these unprecedented fluctuations in the Exchange Rate. In the event of the euro staying at this all time low or falling further, the Capital Risk Reserve has sufficient funds within it to meet the currency fluctuations to ensure the EFW contract retains a minimum of 5% contingency."[26]

177.  TT&R asked HODST&R to prepare a formal response to this e-mail (by e-mail at 1042

hours).

178.  At 1130 hours, HODST&R sent an e-mail to RLAM which appears to have followed a

telephone conversation:

"As discussed I would be grateful if you would confirm as a matter of urgency:

That, given the current exchange rate, it would seem to be a reasonable course of action to deposit only sufficient euros to meet the initial payment due in December – the remainder to be deposited when the rate is more favourable.,

- In practical terms we would be able to set up the account and make the first payment before the due date of 11 December."

179.  At 1216 hours, HODST&R sent an e-mail to TT&R explaining one aspect of the e-mail

from COT&TS:

"The suggestion to deposit only the sum of euros needed for the initial 20% payment in December came from [ADFIT&R] at a meeting of their Project board this morning, I have spoken to . . . Royal London and he confirms that this seems like a sensible option in the current climate (am awaiting e-mail confirmation from him).

Have spoken to [ADFIT&R] and he confirms the Capital Risk Reserve can fund the currency fluctuation.

In summary I think we can say there is no reason from our perspective not to sign the contract tomorrow."

180.  HODST&R drafted a response for TT&R to send to COT&TS and (by e-mail at 1247

hours) asked ADFIT&R to confirm the draft response which was as follows:

"From the Treasury's perspective with regard to the arrangements for euro payments there is no reason why you should not proceed with the contract signing tomorrow.

Up until the date the euro account is set up and the relevant sum deposited TTS is at risk from two perspectives:

1. If the rate falls further between now and deposit of sufficient euros to make the first payment in December; and (if applicable)
2. If the rate falls further still from the rate of first deposit to deposit of the remainder of euros needed to make the account up to the full contract sum.

I can confirm however that sufficient balances will exist in the Capital Risk Reserve to transfer to the TTS capital head of expenditure to maintain contingency of 5% and that my minister would support and authorise such transfers.

Advice from Royal London (our cash managers) confirms that, unless the rate improves significantly in the next week or two, the initial deposit should be only sufficient to cover the first payment. This extends your period of risk but that risk will effectively be underwritten by the Risk Reserve. If the rate improves significantly in the next week or two we would deposit the full sum as soon as possible."

181.  ADFIT&R responded at 1250 hours: "Looks fine to me."

182.  At 1318 hours, HODST&R sent the draft response to the TT&R with a message

indicating that the response suggested would indicate that a subsidy of £1.1 million would be met by T&R.[27]

183.  At 1338 hours HODST&R sent a copy of this e-mail to ADFIT&R with the following

message:

"For information. Ian wanted to cap the subsidy. My calcs so may be slightly off but seems right."

184.  At 1551 hours, ADFIT&R responded:

"Didn't know [TT&R] had that much influence in the currency market."

185.  At 1320 hours, RLAM sent an e-mail to HODST&R which in part reads as follows:

". . . I have contacted our relationship manager at HSBC and we have begun the process of opening the required accounts. I have been told that they will be operational by 11 December.

Given the current economic climate your question with regard to timing is slightly more difficult to answer. I have attached a graph which shows how far the exchange rate has moved in the last few days. The Global outlook is bleak and currently the UK is seen as the most exposed European economy, hence the collapse in sterling. If the data continue to worsen and the UK is forced to cut rates more quickly than the Eurozone then sterling will continue to fall. However it may be that markets have overdone the pessimism over the UK and so the exchange rates moves back a bit in favour of sterling.

Whether it is better to buy in December or January will only be known in January and so buying some euros now and the balance later is a sensible way of dealing with this issue. You mention only buying sufficient euros now to cover the initial payment, a further development of this thought would be to buy half of the whole requirement now and half in January."[28]

186.  At 1323 hours, the TT&R sent the Treasury & Resources Minister the draft response to

COT&TS with the following message[29]:

"Please confirm that you would indeed support the transfers from Capital Risk Reserve to cover euro exchange rate fluctuations so I can send the e-mail below. My advice is that you should."

187.  At 1417 hours, the Minister confirmed his agreement to the transfers from the Reserve.

The confirmation was then duly forwarded to COT&TS and to HODST&R. TT&R's e-mail to COT&TS includes the following confirmation:

"I can confirm, however, that sufficient balances will exist in the Capital Risk Reserve to transfer to the TTS capital head of expenditure to maintain contingency of 5% and that my minister would support and authorise such transfers. I confirm that transfers would be made should the applicable euro rate(s) at the date of deposit fall below 1.2167, which I believe gives you your target 5% contingency including decommissioning Bellozanne. Should there be a balance on the head of expenditure on completion of the project this would be used to reimburse the Capital Risk Reserve for any subsidy provided."[30]

188.  Quite separately from these exchanges, at 1347 hours COT&TS and DWSPT&TS

received an e-mail from Babtie Fichtner:

"The incessant fall of the pound is obviously a major problem . . . We are not advisors on currency risk, but we have seen how this is done on various projects. I believe your current approach is to buy all the euros now, and put them in a euro account to earn interest. This is secure, but means that you are hit by the current low rate, plus . . . you will also take a hit from a lower interest rate . . .

Can I suggest you confirm this is still the best approach? Our understanding is that currently forward rates for £/ offer slightly more advantageous rates than buying euros today . . .

You clearly need better advice than this . . . but I think you need to make sure you are getting the best advice possible here as it is costing £Ms at present."

189.  COT&TS responded that he was in discussions with T&R about the matter in a reference

to the e-mail that he had sent the Treasurer that morning:

". . . the view seems to be to place sufficient euros in the account now to meet the first payment and then look forward. I am waiting for confirmation from Treasury on this point . . ."

190.  Later (at 1544 hours) DWSPT&TS sent a copy of the e-mail from Babtie Fichtner to

ADFIT&R.[31]

Friday, 14 November 2008

191.  The contract was signed.

192.  The Briefing Paper prepared by T&TS for the Minister for Transport and Technical

Services who was to sign the contract included the following observations on exchange rate risk:

"The cost of fixing the euro element of the contract has been considered by the Funding Working Group (Treasury and TTS) established to identify the funding for the Project. Four options were considered by Treasury and the preferred option when balancing cost against risk is to deposit the relevant euro sum in a euro account and make payments when due under the contract."[32]

193.  A related Ministerial Decision by the TT&R Minister approved the necessary budget

transfers and gave delegated authority to the Treasurer to approve the actual sum required once the exchange rate position had been finalised and to effect the budget transfer.

Thursday, 20 November 2008

194.  The Investment Officer, (IOT&R) sent to HODST&R a copy of an e-mail she had

received from RLAM setting out the stage which had been reached in arranging the euro account:

"Apologies for not getting back to [IMT&R] today, I was waiting for HSBC to come back to me and it took longer than expected. The current situation is that the necessary forms at HSBC need in order to open euro cash and security accounts are now completed and ready for signing by the States of Jersey".

Friday, 21 November 2008

195.  At 0803 hours, IOT&R confirmed to HODST&R that the agreement for opening an euro

account had been sent to T&R by RLAM on the previous evening.

Tuesday, 25 November 2008

196.  The Funding Group met again and the draft minutes recorded that:

"HSBC would establish a euro account within the current week. It would then be left to the States cash managers to advise when to deposit the sterling within the account. The latest advice was that it might be better to deposit half the euro amount initially and then the rest later. The position was changing fast so this may change over the period until payment was required . . . [HODST&R] had documented advice from Royal London and HSBC confirming the least risk approach. This had been confirmed verbally by [Hewitt] the States cash management adviser".[33]

Thursday, 27 November 2008

197.  HSBC sent an e-mail to HODST&R following a conversation on the previous day:

"I would just like to provide some extra information to you regarding the spot effects risk we briefly discussed. That is a drawback of your chosen strategy. By deciding to not fix your rates now and engage in a spot transaction in for example three weeks you are taking on . . .risk between now and then".

Tuesday, 2 December 2008

198.  At 1606 hours, IMT&R confirmed to HODST&R that RLAM had confirmed that the

accounts had been set up and asked:

"Are we still instructing RLAM to purchase the full 75m or has that changed at all?

As yet we have not had anything to instruct us to make the first payment to the contractor which I believe is due to be paid next week."

199.  HODST&R responded to the e-mail sent by HSBC on 27 November 2008 providing

some further information:

"Thank you for this information. As you know at the time we initially considered our options (three weeks ago) we concluded that depositing the full contract sum in an account denominated in euros was the best approach for two reasons:

At that time this was the cheapest option for the States by c.£250K.

It gave us more flexibility in dealing with euro income and any future contracts denominated in euros (one looks likely at the moment). It has never been our intention to engage in spot transactions and expose ourselves to FX risks.

Having said that however exchange rate movements since then may have reduced the price differential and possibly made the forward contracts even cheaper. I would be very grateful if, based on the attached updated payment schedule, you could advise me what the total cost to the States would be based on a series of forward contracts. Please note the first application for payment has not yet been made – payment will be due approximately 28 days after it is made. We therefore need to make a final decision very shortly."

Wednesday, 3 December 2008

200.  At 0737 hours, HODST&R responded to IMT&R's e-mail sent on the previous