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Hedge Interest Rate Swaps & Caps Cost Effectively

How to hedge interest rate risk

The interest on your business loan has two components; a Loan Margin agreed at the outset, plus a variable rate of interest that reprices periodically. Interest rate risk arises from changes in the variable rate (often Base Rate, LIBOR, SONIA or EURIBOR). Interest rate hedging products like an  interest rate cap and interest rate swap (swap rate) can be used to protect you against rising variable rates.

Loan Margin 1

Risks

An increase in the variable interest rate cost (SONIA, LIBOR or EURIBOR) can significantly affect the financial health of your business. It can negatively impact the income statement and cash flow of the business. Hedging is like a form of insurance, providing less uncertainty over future cashflows and profitability. Rates are anticipated to rise in the EU and UK in 2022. Have you conducted cashflow forecasts and debt covenant analysis of what a 0.1% -1% rise in interest rates means for your business?  

Hedging allows you to better manage the interest covenant ratios/debt service coverage ratios specified in your facility agreement. A rising rate environment could see businesses with variable rates struggle, resulting in their covenants coming under pressure or worse, breached. Has your company conducted an interest rate stress test in 2021? Our models can tell you the impacts the recent rate hikes will have on cashflows and profitability. 

Our Role

– Assist with registering a Legal Entity Identifier (LEI) for the Borrower
– MIFID, EMIR, FATCA, ISDA, Long Form Confirmation etc
  • – Develop Strategy (model cashflows against covenants, balance risk V cost)
  • – Get indicative prices from market
  • – Select provider(s) based on price, rating and/or other factors
  • – Review Facility agreement for Hedge clauses
  • – Commercial view on Long form Confirmation or ISDA
  • – Confirm with Cap Provider and Borrower that all parties are ready to trade
  • – Circulate Term Sheet and indicative price on morning of trade
  • – Manage trade call so that purchase is managed professionally
  •   and price agreed is benchmarked
  • – Receive transaction summary from provider
  • – Review Confirmation for Key Terms
  • – Co-ordinate the payment if necessary 
Interest Rate Swap

Managing the risk associated with variable interest rate (SONIA, LIBOR or EURIBOR) expenses on debt can be an irregular exercise for some treasurers. This can make the task seem an expensive and complex. VUCA Treasury is in the market daily, we partner with our clients to help level the playing field when negotiating with the bank. 

The hedging material provided by banks can be significant in size and appear daunting with the varies products along with their pros/cons. VUCA Treasury helps guide companies through this process, conducting stress test analysis to identify the upper limit on your rate exposure and building the optimal hedging solution on the back of this. We stay independent throughout the process meaning we are on your side, making sure the banks stay honest in their pricing. 

We have inserted a timeline below of how long a typical hedge will take to implement. Delaying getting your documents back to the financial institute can hold up the KYC process by days.    

Interest Rate Hedge Timeline for SONIA, LIBOR & EURIBOR

Timeline for hedging SONIA LIBOR or EURIBOR

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Whitepaper
Conor Deering
17 October 2021

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For 2022, markets have priced in three rate hikes from the Bank of England, and one hike from the ECB. Why not speak to one of our experts to see how this might impact your debt covenants and cashflow? Or find out how you could optimise your hedge with a few simple steps.

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Central Bank Rates 2022