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Negative Euro rates present an arbitrage opportunity for borrowers

Negative Euro rates present an arbitrage opportunity for borrowers

Benoit Duhil de Benaze Private Equity September 2019
With EUR rates in negative territory and continuing to drift lower, short-term many multicurrency borrowers are being presented with an arbitrage opportunity. Under the right circumstances, this could be exploited to reduce funding costs by up to 0.65% per annum.

Many international companies and asset managers meet their short-term funding needs with multicurrency facilities. A common set-up allows the borrower to draw funds in EUR, GBP or USD, with the same margin being charged over the relevant floating interest rate whichever currency is drawn. Frequently, the floating interest rate on each currency will be subject to a minimum level (a “floor”) of 0%.

With interest rates in the three currencies at very different levels, the 0% floor has a different value depending on which currency the borrower is drawing in. This opens up an interesting opportunity: the borrower can draw in a currency where the floor has little value (e.g. USD) and then use an FX derivative to “swap” into one where the floor has a big impact (e.g. EUR).

To give a worked example, a 6-month borrower with a margin of 1.50% could either:

  • Draw in EUR and pay € 3 month Euribor (currently -0.45%) floored at 0% + 1.50%, i.e. a total EUR interest cost of 1.50%
  • Draw in USD and pay $ 3 month Libor (currently at 2.13%) floored at 0% + 1.50%; hedge the EURUSD FX risk with a cross currency swap where the borrower receives $ 3 month Libor floored at 0% + 1.50% and pays € 3 month Euribor (not floored) + 1.30%.
    Overall, the borrower would pay € 3 month Euribor (not floored) + 1.30%, i.e. a total EUR interest cost of 0.85%

The use of the cross currency swap in the second scenario also fully covers the FX risk on the principal repayment. It is also possible to capture this opportunity using FX forwards.

If you are interested in discussing the above in more detail, please do not hesitate to contact Chatham to arrange a call or meeting.


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