The following Financial Services practice note Produced in partnership with Mike Wainwright and Juan Jose Manchado of Dentons LLP provides comprehensive and up to date legal information covering:
The financial crisis of 2007-2009 caused a spike in market volatility for which firms were ill-prepared. When the capital markets froze and the market value of securities collapsed, firms were not sufficiently capitalised to withstand the resulting mark-to-market losses. Volatility had a particularly severe impact in the derivatives markets, because the value of a derivative depends both on the value of the underlying asset that it tracks and on the ability of the counterparty to meet their obligations.
The regulatory response to the crisis has sought to ensure that firms hold enough capital to withstand a simultaneous increase in default risk caused by potential swings in the price of the underlying of a derivative, and decrease in the creditworthiness of the counterparty. These increased capital levels are also intended to incentivise central clearing of derivatives that are not subject to a central clearing obligation, because exposures to central counterparties (CCPs) are subject to smaller capital charges.
The experience of the financial crisis suggests that, in stressed conditions, reinforced capital levels would be insufficient by themselves to dispel concerns over the ability of counterparties to withstand losses and to meet obligations under derivatives and other transactions. Illiquidity in capital markets was compounded by a lack of transparency as to the solvency position of firms. That is why the regulatory response to the crisis also aims to improve
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This Practice Note explains certain common financial covenants used in commercial finance transactions including:•minimum net worth test•gearing ratio•leverage ratio (or debt to equity ratio)•current ratio (or acid test ratio)•cashflow ratio•interest cover ratio, and•loan to value ratioIt explains:
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