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Hedging in illiquid interest rate markets
Case studies

Hedging in illiquid interest rate markets

Background
  • A PE backed corporate underwent a refinancing in two currencies, both of which had limited liquidity in the derivatives markets
  • The debt was provided by a unitranche lender and a bank RCF provider with limited flow in the two relevant currencies
  • Due to the increase in leverage following the refinancing and the relatively high interest rate risk in the two currencies, the client wanted to hedge a significant proportion of the debt notional
  • Hedging strategy needed to take account of a potential exit / refinancing within two years of the refinancing date
Our Approach
  • JCRA produced an analysis paper quantifying the interest rate exposure and laying out alternative solutions
  • Key aspects to consider were the potential for an early exit or another refinancing in the near term, interest rate floors on the financing, and the limited liquidity in the two relevant currencies
  • The eventual decision was to buy interest rate caps for both tranches
  • Following the decision on the hedging strategy, a competitive process was run with the RCF provider and relationship banks
Benefits
  • The client obtained highly competitive pricing on both tranches, splitting the hedges across two currencies
  • In one currency, a domestic bank introduced by JCRA was able to offer the most competitive terms
  • For the other currency, the RCF provider had interest in the opposite position and was hence able to offer the cap at a very low spread, making up significantly for the lack of liquidity
  • In total, JCRA saved c. EUR 67k vs. the second-best pricing by running a competitive process with multiple hedge counterparties
 

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Contact us

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