Our decision is to change the methodology
Our decision is to change our methodology for calculating the discount rate. This change to our methodology involves maintaining a cost of debt-based approach to calculate the discount rate, with a new risk adjustment.
This update to our method will better estimate the benchmark debt margin for all local councils by using a benchmark credit rating of A-, which is lower than the rating of A we previously assumed.
We consider this approach better reflects the risks councils face when they provide infrastructure through contributions plans.
We recommend councils that use an NPV approach to calculate contribution rates for their contributions plans use our updated discount rate.
Why we decided to change the methodology
We found there is a case to adjust the methodology for the discount rate to better align with the risks councils face in providing local infrastructure.
While councils are generally low-risk borrowers, contributions plans involve risks that are not fully captured by councils’ overall financing position.
The updated methodology may support councils that use an NPV approach to better manage funding risks and reduce the likelihood that ratepayers are required to fund shortfalls. However, we recognise stakeholder concerns that higher contributions may affect project feasibility in some circumstances.
Our process for the review
To make our decision, we considered stakeholder feedback, advice from HoustonKemp, and our own analysis. We consulted on an Issues Paper and Draft Report.
We considered several matters in undertaking this review. This included considering changes to our existing methodology, whether it would be appropriate to include a cost of equity in the methodology, potential proxy firms, and the reinvestment return of councils’ contributions balances.
Throughout the review, we had regard to any differences in the risk level faced by councils and the impact on the timeliness of infrastructure provision and development feasibility.
We also considered alternative methods proposed by stakeholders, such as a WACC-style approach, using NSW Government bond rates, and using NSW Treasury discount rates for project appraisal.
See more information about this review
For further information, please see https://www.ipart.nsw.gov.au/review/local-government-discount-rate-methodology.