x
_thumbnail_id: Array
article_primary_tag: Array
_article_primary_tag: Array
author: Array
_author: Array
article_modules_0_title: Array
_article_modules_0_title: Array
article_modules_0_content: Array
_article_modules_0_content: Array
article_modules_1_quote_author: Array
_article_modules_1_quote_author: Array
article_modules_1_enable_tweet: Array
_article_modules_1_enable_tweet: Array
article_modules_1_quote: Array
_article_modules_1_quote: Array
article_modules_2_title: Array
_article_modules_2_title: Array
article_modules_2_content: Array
_article_modules_2_content: Array
article_modules: Array
_article_modules: Array
page_summary: Array
_page_summary: Array
modules: Array
_modules: Array
_yoast_wpseo_primary_category: Array
_yoast_wpseo_content_score: Array
_wp_old_slug: Array
_yoast_wpseo_title: Array
_yoast_wpseo_metadesc: Array
article_modules_3_title: Array
_article_modules_3_title: Array
article_modules_3_content: Array
_article_modules_3_content: Array
modules_0_module_title: Array
_modules_0_module_title: Array
modules_0_background_color: Array
_modules_0_background_color: Array
modules_0_module_type: Array
_modules_0_module_type: Array
modules_0_filter_posts_by_taxonomy: Array
_modules_0_filter_posts_by_taxonomy: Array
modules_0_filter_posts_by_tags: Array
_modules_0_filter_posts_by_tags: Array
modules_0_link_text: Array
_modules_0_link_text: Array
modules_0_link_url: Array
_modules_0_link_url: Array
modules_1_text: Array
_modules_1_text: Array
modules_2_module_title: Array
_modules_2_module_title: Array
modules_2_background_color: Array
_modules_2_background_color: Array
modules_2_column_ratio: Array
_modules_2_column_ratio: Array
modules_2_editor_content_left: Array
_modules_2_editor_content_left: Array
modules_2_button_text_right: Array
_modules_2_button_text_right: Array
modules_2_button_type_right: Array
_modules_2_button_type_right: Array
modules_2_button_url_local_right: Array
_modules_2_button_url_local_right: Array
_yoast_wpseo_focuskw: Array
_yoast_wpseo_linkdex: Array
_wp_old_date: Array
_dp_original: Array
_edit_lock: Array
_edit_last: Array
Are borrowers adjusting their hedging strategies ahead of the General Election?
Views

Are borrowers adjusting their hedging strategies ahead of the General Election?

Rhona Macpherson Weekly bulletin November 2019
How are borrowers adjusting their interest rate hedging strategies to take account of the impending General Election and the uncertainty surrounding the UK’s future relationship with the EU? Negative interest rates and refinancing risks remain hot topics. Some borrowers focus on certainty of funding costs while others are adding flexibility to their hedging plans.

The hedging decision is often driven by how long the debt is expected to be in place, which is a key factor in formulating any strategy. Alongside this are any hedging requirements within the terms of the debt facility, including covenant tolerance to higher cost of funds.

Last summer there were plenty of discussions around the prospect of negative interest rates in the UK as fears of a no-deal Brexit increased. Negative rates affect any borrower with a Libor floor in a debt facility that is hedged with an interest rate swap. If Libor were to turn negative, the borrower would be required to pay the negative floating rate in the swap but not receive the offsetting cashflow from the loan.

It is possible to add a 0% floor to an interest rate swap, but when swap rates are very low, as they were over the summer, this can be extremely expensive. Now that swap rates have moved higher, the cost of buying a 0% floor has fallen, but so has the perceived risk of negative rates. With this we have seen a drop in the number of borrowers actively looking to incorporate floor into their interest rate swaps, despite the potential disruption that could be caused by the General Election.

Swaptions favoured for longer dated flexibility

Flexibility continues to be an important factor if there is a chance the debt facility may be refinanced before it has matured. Interest rate caps were previously a popular choice for many of our clients faced with this situation. More recently, though, swaptions have grown in popularity. This is particularly true if hedging for five years or beyond as the premium for a longer dated cap can be relatively expensive. Indeed, the breakeven rate, (the level the average Libor needs to fix below for a cap to be more economic than a swap), can be 20 – 30bps below where Libor is currently fixing.

Interestingly, the current low interest rate environment has encouraged some borrowers to look to hedge longer than the underlying debt facility. With interest rates so low it is tempting to lock in to a longer dated interest rate swap in case the General Election brings an upwards shock to interest rates. But that strategy brings with it the risk of break costs if the debt is not extended. There is also no guarantee the lender will extend the debt even if it provides an interest rate swap for an extended maturity, so again swaptions are considered a suitable alternative.

The change in borrowers’ hedging behaviour since the announcement of the General Election has been subtle. What is clear is that borrowers do not want to introduce any unnecessary risks – but instead neutralise the risks they can control. Swaptions offer flexibility at a fraction of the cost of interest rate caps and have gained in popularity to mitigate both General Election and Brexit related risks.

For more information, please contact Rhona Macpherson, Associate Director at JCRA, at rhona.macpherson@jcrauk.com.

 

Recent Insights

Views
TARFs are back in the headlines
Jackie Bowie Private Equity December 2019
Views
Polls and the pound
Chris Towner Weekly bulletin December 2019

Contact us

If you need hedging or debt advice or would like to speak to the team, please get in touch.