Infrastructure financing: optimizing interest rate pre-hedging before financial closing

This article has been designed as an in-depth educational resource. Alongside the short and concise formats we also offer (Insight videos, Macroscopes, Perspectives), we have deliberately chosen density and detailed explanations in this article. The objective is to provide you with a comprehensive understanding of the topic by exploring every nuance.

In project finance (concessions, renewable energy, infrastructure), interest rates are not a “market detail”: they can alter bankability, coverage ratios (DSCR/LLCR), the level of required equity, and sometimes even the ability to reach financial close.
However, between the signing of term sheets, concession agreements, finalisation of documentation, conditions precedent and closing, several months may pass — enough for the yield curve to move significantly.

This is precisely where pre-hedging and contingent hedging become essential: protecting a future debt that is “highly probable” without unnecessarily locking the project or creating legal, accounting or financial risks.

Mini-glossary (for non-expert readers)

Financial close / closing: stage where documentation is finalised and funds become available (conditions precedent fulfilled).

“Highly probable” future debt: debt not yet drawn/contracted but whose implementation is highly advanced and documented (e.g. project close to closing). This concept is central in risk management and hedge accounting (cash flow hedge) under IFRS 9.

Pre-hedging: hedging action carried out before the debt actually starts, to protect against rising rates during the preparation/closing phase.

Contingent hedging / deal-contingent hedge: hedge signed before closing but which only becomes effective if the deal closes (otherwise it expires under predefined rules).

Forward-starting swap or cap / contingent swap / swaption: families of instruments commonly used in pre-hedging. What matters is not the product itself, but its alignment with the project timeline, risks and governance.

1- Why pre-hedging is a “project” topic before being a “product” topic

In infrastructure projects, interest rate risk combines with:

• a long and uncertain timeline (permits, grid connection, EPC, PPA, conditions precedent),
• often floating-rate debt and frequent lender requirements to hedge over the full project life or a large portion,
• market scenarios that can shift between signing and financial close.

Implication: deciding “swap or option” too early (or too late) can be costly. The right approach is to conduct a structured preliminary analysis answering three key questions:

• What is truly “highly probable”, and on what horizon? (amount, maturity, index, drawdown schedule)
• Which events could alter the future debt? (closing delays, sizing changes, margin changes, tranches, refinancing, index)
• What level of flexibility is required? (project not fully locked, timing risks, exit clauses)

2- When and how to hedge a “highly probable” future debt

Signals that pre-hedging becomes relevant

Pre-hedging is generally justified when:

• closing is near but not guaranteed at a fixed date,
• project debt is sized and sufficiently documented,
• the project is sensitive to rising rates (tight DSCR/LLCR, limited headroom),
• and a shift in the yield curve could jeopardise pricing or financial balance.

Under IFRS 9, the notion of “highly probable transaction” is critical if hedge accounting (cash flow hedge) is targeted: documentation and probability assessment matter as much as economic strategy.

3- Contingent hedging: securing without “locking” the project

The deal-contingent hedge is designed for a common reality in project finance: securing rates before closing, while avoiding carrying a derivative that would start before the project closes, exposing the consortium to a potentially significant break cost if rates fall between exit and hedge implementation.

Operational definition (key takeaway):

• signed before closing,
• becomes effective only if financing closes,
• if the transaction does not close within the agreed timeframe, parties separate under a contractual framework.

In practice, this structure is common in deals where a bank is explicitly mandated as “deal contingent hedge provider”.

Its feasibility relies on a precise risk analysis by the hedge provider. To price the contingency premium, the bank must identify objective and measurable trigger events. Whether it is obtaining a final building permit, securing land, or signing a PPA (Power Purchase Agreement), these milestones allow the bank to assess the probability of non-completion. The more these risks are documented and isolated, the more the hedge provider can refine pricing and propose a competitive structure, transforming binary uncertainty into a modelable financial risk.

4- The role of swaptions in large projects: not “a product”, but a flexibility tool

A swaption (like other contingent/forward structures) is typically used when the main issues are:

• timing uncertainty (closing may be delayed),
• sizing uncertainty (final debt depends on CAPEX, subsidies, contractual conditions),
• execution uncertainty (limits break costs to the swaption premium in worst-case scenarios),
• or the desire to retain decision optionality (hedge now or later) without immediately locking into a firm hedge.

However, the key challenge is not to “describe the swaption” but to determine:

• which assumptions must hold for a swaption to be rational,
• what premium/flexibility is acceptable in the financial model,
• and how the structure integrates into project governance (committee, lenders, audit, documentation).

5- The essential preliminary analysis (the real core of optimisation)

Below is a simple and actionable framework to build a robust strategy.

A) Project interest rate risk mapping

• target index (Euribor 1M/3M/6M and changes during project phases), margin, conventions
• expected drawdown schedule and key milestones (EPC, commissioning)
• DSCR/LLCR sensitivity to +50 / +100 / +200 bps (stress tests)
• interactions with other risks (inflation, FX, PPA/merchant revenues)
• sensitivity of the financial model and target IRR to hedging costs

B) Defining objectives (prioritisation)secure a rate cap compatible with bankability?

• stabilise a debt budget?
• maximise flexibility (if closing uncertain)?
• minimise total economic cost (premium + opportunity cost)?

C) Defining the uncertainty zone

• probability and magnitude of closing delays
• probability of structural changes (tenor, amortisation, refinancing)
• risks of over-hedging or under-hedging if final debt changes

D) Translating into strategy (not product-driven)

A structure is selected because it fits the trio:
 timeline / uncertainty / objectives, not because “it is fashionable”.

This is precisely the approach promoted by specialised firms such as Kerius Finance in complex transactions: analysis of hedging requirements, integration of future debt, multi-scenario simulations, banking consultation, negotiation and documentation, followed by post-implementation monitoring/valuation/back-office.

E) Practices adapted to modern infrastructure debt: Soft Mini-Perm and “Hedging Tail” risk

The structure of modern infrastructure debt, such as the Soft Mini-Perm, requires sophisticated hedging strategies. In this model, banks lend over a short period (typically 5–7 years), while the repayment profile aligns with the project life (20 years).

The borrower faces two key risks:

• Hedge maturity: should hedging cover only the loan tenor (7 years) or the full economic life (20 years)? Hedging 20 years creates a “Hedging Tail” beyond the legal debt maturity.
• Refinancing risk: if rates rise significantly at refinancing (after 7 years), project profitability deteriorates.

To address this, hedges can be structured to outlive the initial debt and be transferred to the refinancing bank pool. This allows locking the cost of capital over 20 years while retaining short-term bank financing flexibility.

6- Execution best practices before closing

Even with strong analysis, execution is decisive:

• Run competitive processes across multiple counterparties on identical assumptions (same dates, indices, structure).
• Require clear scenario analysis:
  • cost if rates rise,
  • cost if rates fall,
  • cost if closing is delayed.
• Secure documentation (trigger conditions, deadlines, non-closing events, “similar financing” clauses, etc.). Deal-contingent hedging is as much legal as it is pricing-driven.
• Negotiate robust exit clauses in framework agreements (ISDA, FBF, etc.), especially regarding xVA calculations, dispute resolution, termination rights, and conditions precedent.
• Draft a strong execution protocol to minimise the risk of margin adjustments by the hedge provider at execution.

FAQ SEO

What is pre-hedging in infrastructure financing?
It consists of protecting against rising interest rates before financial close, when the debt has not yet started but is considered highly probable.

What is contingent hedging?
A hedge signed before closing that becomes effective only if the deal closes. Otherwise, it terminates under predefined rules.

Why is preliminary analysis more important than product selection?
Because the right tool depends on timeline, uncertainties (timing/sizing), project covenants (DSCR/LLCR) and governance. Without this analysis, hedging may be too rigid, too costly, or misaligned with the project.

Warning / Disclaimer:

Kerius Finance is an independent advisory firm, authorised as a Financial Investment Advisor (CIF) – ORIAS No. 13000716 – Member of ANACOFI-CIF, an association approved by the Autorité des Marchés Financiers (France).

As such, Kerius Finance, which is product- and bank-neutral and does not distribute or sell any financial products, only provides personalised recommendations after signing an engagement letter specifying the client’s objectives and conducting in-depth, tailored analyses.

This document is therefore published for informational and educational purposes only. It does not constitute, under any circumstances, a recommendation to transact in any of the products described. Kerius Finance teams remain available to provide further clarification or personalised advice, and to offer tailored services where required.

Please note: banks may offer products that appear identical but include specific, sometimes subtle clauses that alter both the outcome and accounting treatment of the product. These may differ from the products presented here, even where the naming is identical or very similar. Banks may also offer “enhanced” or “dynamic” products. Such products must be handled with great caution and require prior outcome analysis.

In any case, we recommend that companies without access to an experienced treasurer and professional valuation systems seek support from qualified, regulated advisors to conduct the necessary analyses and select the appropriate strategy without conflicts of interest, and then negotiate optimal terms (legal and pricing) with their usual banking partners. It is also often advisable to monitor the strategy over time to ensure that any changes in the debt structure do not require adjustments to the hedging strategy.