Real estate finance—LMA updates documents to reflect market practice and publishes new financial covenant cure rider

Hedging provisions

Hedging arrangements are an important element in real estate finance transactions. They are used to minimise the risks associated with floating interest rates. Both the lender and the borrower's perspectives are aligned here—both parties wish to ensure that the borrower's rental income (which will be fixed) is sufficient to service interest repayments under the facility agreement.

The most common hedging strategies which are used in REF are the interest rate swap and the interest rate cap, both of which were reflected in the previous draft of the LMA REF documentation (cl 8.3 for the investment facility agreement and cl 8.4 for the development facility agreement). The effect of a swap arrangement is that the borrower swaps a floating rate of interest for a fixed rate. By contrast, the effect of a cap is that the borrower and hedging counterparty agree to an upper limit on LIBOR (the strike rate) for an upfront fee.

The revised documentation splits out the old provisions to make it clearer which terms should be incorporated into a draft facility agreement depending on the type of hedging which is to be put in place.

A new provision has been incorporated into the wording which applies to swaps—there is now an obligation to notify the agent if, in certain circumstances, the swap is terminated or there is a close out.

Two new provisions have been incorporated into the wording which applies to caps:

• a maximum strike rate for the cap—this rate is agreed between the parties and documented in the facility agreement. This new provision will benefit lenders since it allows the borrower the freedom to enter into a cap within parameters acceptable to the len