If you are a treasurer planning fresh funding right now | KPMG | DE

If you are a treasurer planning fresh funding right now...

If you are a treasurer planning fresh funding right now

...then you will naturally be glad of the current low level of interest rates.


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...then you will naturally be glad of the current low level of interest rates. Even so, you would still be wise to coordinate your plans closely with the accounting department to ensure that all possible impacts are covered from an early stage.

When your loan is recognised in the books for the first time, you need to check whether the floor is above or below the current market rate of interest. In the former case, the floor must be presented separately, i.e. it must be measured and recognised as an interest rate option. For the whole of the company, you can then define whether the floor is to be compared with the current level of interest, e.g. the current Euribor, or with the average swap rate for the term of the loan.

There are two reasons why this subject is important today. Although average forward rates with terms of up to 5 years were above zero until recently, they have tended towards or even below zero in recent weeks. A floating-rate promissory note issued in this period with a 5-year term to maturity and a floor of 0% would thus contain an embedded derivative that must be presented separately, regardless of the method adopted.

In the past, floating-rate bonds, whose total rate (comprising the floating rate and the credit spread) must not be negative for legal reasons, were not critical either, as the reference rate was not so far below zero that the total rate (including the spread) was negative. Today, however, that can certainly be the case depending on the company's credit rating and, possibly, the maturity. Besides the impact on hedge accounting in place for existing bonds, any newly issued bonds would thus contain floors that must be presented separately.

At times, separate presentation of this kind of floor can be advantageous where hedge accounting is used, because it may be possible to set the derivative that must be presented separately against a separately concluded hedge. Either way, consultation on the correct method of presentation is necessary at the time when a loan is raised. In particular, there has to be a way to measure the embedded derivative.

Source: KPMG Corporate Treasury News, Edition 56, June 2016
Author: Andrea Monthofer, Manager, amonthofer@kpmg.com 

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