Use of derivatives in a lending context—documentation issues
Use of derivatives in a lending context—documentation issues

The following Banking & Finance guidance note provides comprehensive and up to date legal information covering:

  • Use of derivatives in a lending context—documentation issues
  • Hedging bank and lending bank
  • Hedging strategy and hedging agreements
  • Tailoring the swap to the risk profile
  • Drafting issues
  • Using swaps in a secured lending context
  • Practical considerations

Borrowers often hedge against the following risks in the context of a lending transaction:

  1. interest rate risk by entering into an interest rate swap

  2. exchange rate risk by entering into a currency swap, and

  3. commodity price risk by entering into a commodity swap

Such swaps are typically entered into by a borrower with a bank, known as the hedging bank or hedging counterparty.

The hedging bank is in a better position than the borrower to take the risk of fluctuations in interest rates, exchange rates or commodity prices. Often, the hedging bank will hedge its own exposure under the swap through a back-to-back swap with a market counterparty.

This Practice Note explains the key documentation issues to consider when hedging risks in a lending context.

For more information generally on using derivatives in a lending context, see Practice Note: Use of derivatives to hedge against risk in a lending context.

Hedging bank and lending bank

When a borrower enters into a swap to hedge risks under its loan arrangements, it is often the case that the hedging bank is the same entity as the lending bank. Although the same bank is involved in both elements of the transaction, it is performing two different roles and acting in two different capacities. It will be necessary to refer to the hedging documentation and the hedging bank