Hedge Accounting considerations when refinancing debt facilities


CFO’s need to be well-armed when refinancing company debt. We often see the CFO win the ‘visible’ fight but lose the ‘invisible’ one. If you are not armed with a comprehensive understanding of the transaction economics, you may miss an opportunity to negotiate more favourable covenants or lower lending spreads.   

What is the opportunity?

Banks view your relationship with them on a total return basis, consequently, if you give them plenty of business in one service line (transactional, hedging etc) you can use that as leverage when negotiating the terms of your new financial agreement. Rochford provides you with the visibility of the economics across your banking relationships, so you can accurately and effectively negotiate.    

An often neglected and misunderstood aspect of a debt financing transaction is the interest rate hedging covenants. Spreads and bank profit are less transparent with interest rate hedging, especially when looking at more dynamic products. It’s important to negotiate the hedging in conjunction with the overall lend and if the debt is syndicated, drive competition between the syndicate members to fight for a hedging allocation.

Hedge accounting to smooth P&L volatility…

Unless you can structure the IRS close to the market (i.e. negotiating out as much of the bank spread as possible) different structures can result in unwanted outcomes, when measuring hedge effectiveness.

This is because the derivative contains a ‘financing’ element (the initial fair value), gains and losses on which will not be replicated in the hedged item and therefore the hedge contain an inherent source of ineffectiveness, for example:

  1.  Floating-rate debt plus out of the money derivative on Day 1 (Results in hedge ineffectiveness for hedge accounting purposes)
  2. Floating-rate debt plus derivative with close to nil fair value on Day 1 (Results in an effective hedge for hedge accounting purposes)

How we can help:

At Rochford, we help clients negotiate with the bank to achieve the right commercial and accounting outcome. We provide upfront analysis of the holistic deal that will arm you with the information to win both the visible and invisible fight.

  • A thorough evaluation of IRS structure and pricing
  •  Benchmarking to industry standards
  • Cutting edge market analysis and insights
  • Mark-to-market valuations at inception
  • Prospective hedge effectiveness testing at inception
  • Review of the term sheet and clauses contained within SFA
  • Financial covenant(s) oversight

Contact me here or visit our Hedge Accounting page for more information.

“I was really impressed with the work that Kevin and the team at Rochford did for SG Fleet in relation to our ongoing interest rate risk management. Rochford’s approach and independence ensured we had the best possible visibility of the economics of our re-financing and ensured that our hedge accounting strategy was aligned to our commercial risk management objectives. “

Kevin Wundram, CFO at SG Fleet Group Limited

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