Interest rate risk

Interest rate risk refers to the unpredictability of interest rate movements.
Materializing interest rate risk may mean that expenses on loan repayments will increase or the income from assets will decrease in uncomfortable scale.
Interest rate risk plays an especially important role in case of long term loan obligations with variable interest rates. The fluctuation of interest rates affects long term obligations more than short term ones.

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Interest Rate Cap

  • Interest Rate Cap
    An interest rate cap is a contract between two parties, whereby the seller agrees to pay the buyer, should an interest rate index (e.g. EURIBOR) exceed a specified level (the strike) on specific fixing dates. The eventual payment made by the seller is the difference in rate between the fixed rate and strike. Hence interest rate cap is a financial instrument that allows you to fix the maximum interest payment for the future in case of an obligation with a variable interest rate. On the other hand, selling the interest rate cap allows you to set a limit to the future interest income and receive a compensation for the sale.
  • The product might be interesting to you if
    • You have an obligation with a variable interest rate (in Danske Bank or elsewhere) and you wish to insure yourself against future increase in the interest rates.
    • You have assets earning interest at a variable rate (in Danske Bank or elsewhere) that you wish to profit from additionally today. If You are ready to forego the potentially higher profits in the future you could sell interest rate cap and earn extra income.
    • You want to hedge the interest rate risk but you are reluctant to change your payment obligations to fixed rate payments on constant basis (you consider for example likely that interest rates rise only slightly or rather fall).
    • You are planning to pre-hedge the planned investments or obligations.
  • Cap-deals are flexible and the customers can set the following terms
    •  The level of interest rate, from which interest payments are to be insured.
    • The period for which the maximum level of interest rates is hedged (it does not have to match with The duration of the loan; both the start date but also the end date may lie further in the future).
    • The share of the interest rate risk that is hedged (even managing a part of the risk gives more security than no managing of risk at all).
  • Prerequisites for the transactions
    • In case of Interest rate cap purchase the means for which to pay the cap premium. In case of interest rate cap sale the required collateral in the form of deposit or some other form recognised by the bank.
    •  Interest rate derivatives limit granted by the bank (only if customer is selling interest rate cap).
    • MIFID suitability assessment.
    • Derivatives Master Agreement.

Interest Rate Swap

  • Interest Rate Swap
    An interest rate swap (IRS) is an agreement between two parties to exchange different specified interest payments (usually fixed rate payments against floating rate payments) in the same currency during the agreed term.
    By signing the fixed for floating interest rate swap agreement, one party commits to make to the other party specific fixed interest rate related payments whereas the other party commits to make in return the specific variable interest rate (e.g. EURIBOR) related payments. 
  • You might be interested in this product if
    • You have an obligation with a variable interest rate (in Danske Bank or elsewhere) and You wish to insure Yourself against future increase in the interest rates.
    • You have assets earning interest at a variable rate (in Danske Bank or elsewhere) and You wish to insure Yourself against the future decrease in the interest rates.
    • You are planning to pre-hedge the planned investments or obligations.
  • Swap deals are flexible and the Customer can set the following terms
    • The period for which the level of interest rates to be hedged (does not have to comply with the duration of the underlying loan).
    • The share of the interest risk to be hedged (even managing a part of the risk gives more security than no managing of risk at all).
    • Swap-deal may include payments in different currencies (in most cases the calculations for interest amounts payable and receivable are based on a single currency).
    • Swap-deal may include a right of the Customer to withdraw from the deal at any moment. Such contracts are due to the extra feature usually more expensive than normal swap-contracts.
  • Typical conditions for swap-deals
    • The variable interest rate payable by the bank for the starting interest period will be determined by the rate effective two banking days before the start of the interest period.
    • Periodic settlement of accounts from the difference in the variable interest rate and the fixed interest rate during the contract period take place at the end of each interest period.
    • The minimum amount of a transaction is €200 000 or its equivalent.
  • Prerequisites for the transactions
    • Collateral in the form of deposit or some other form recognised by the bank
    • The Bank needs to perform a Customer assessment and grant to the Customer a limit for interest rate derivatives;
    • According to the MIFID requirements the Bank needs to assess the appropriateness of the product for the Customer;
    • The Customer needs to sign a Master Agreement on Derivatives;
    • The Customer must acquire an LEI code.

Interest Rate Option

  • Interest Rate Option
    If interest rate options are used for hedging purposes and are only bought, there is no risk: the only payment that the Customer will have to make and that will not be refunded is the option premium. After paying the premium, the Customer can only get interest payments but is not obligated to make any further payments in regard of the option. If the underlying interest index does not cross the strike interest rate during the entire transaction period, the Customer will not get any payment and that is the only potential risk, i.e. disappointment that could result in regard of the transaction.

    The Customer, that wants to buy interest rate options, does not need any limit. The Customer, that wants to sell interest rate options, needs a limit for interest rate financial derivatives, the amount of which depends exclusively on the term of the transaction – the longer the term of the transaction is, the bigger is the required limit amount.
Follow the instructions of regulators

Get adviced

  • EMIR

    EMIR (European Market Infrastructure Regulation or Regulation No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories) stipulates settlement of derivative instruments via central counterparties and the obligation to inform the trade repositories thereof and the new procedures for the management of derivative instrument contracts.

    The regulative changes resulting from EMIR have an impact on all counterparties within and outside the financial sector (except private persons) who operate on the market of derivative instruments. This is part of the global effort to increase the transparency of the market and to decrease operational and counterparty credit risks on the markets of derivative instruments.

    EMIR contains three main additional requirements compared to the previous provisions:

    • Risk management standards must be perfected.
    • All transactions with derivative instruments must be reported to trade repositories.
    • Transactions with derivative instruments which meet the established criteria must be settled via central counterparties.

     

    Trade reporting

    All derivative trades must be reported to trade repositories from 12 February 2014. A trade repository is an entity that centrally collects details about derivative trades in a register to which financial regulators have access for supervision purposes.

    The reporting obligation covers both over-the-counter (OTC) and exchange-traded derivative instruments. It is important to note that forward currency contracts are also covered by the reporting obligation set forth in EMIR.

    The reporting obligation applies to all parties that are registered in an EU/EEA country (except private persons, central banks and some public bodies). Danske Bank also reports transactions on behalf of its Customers if so agreed between the bank and the Customer. Danske Bank reports the transactions of its Customers to DTCC GTR (the Depository Trust & Clearing Corporation – Global Trade Repository).

    If the Customer has requested the reporting service and consents to the terms and conditions of the service, the Customer authorises Danske Bank to report transactions with derivative instruments made with the bank to the trade repository on its behalf. In order to do this the Customer must acquire an LEI (Legal Entity Identifier) and inform Danske Bank about this.

  • LEI (Legal Entity Identifier) code

    As of 3 January 2018, legal entities who wish to perform transactions involving securities or derivatives (such as FX Forwards, FX Swaps or Interest Rate Swaps) will need to submit to the bank their LEI (Legal Entity Identifier). This code is used globally to identify legal entities. It is a combination of 20 numbers and letters.

    HOW CAN AN LEI BE OBTAINED?
    You can request an LEI from an authorized LEI issuer, who assesses certain information about the company to which the LEI will be issued before issuing the LEI.

    • Choose an LEI provider. See section below.
    • Register your details on the provider's website.
    • Pay the charge for registration. The charge appears on the website of each individual LEI provider.
    • The LEI provider approves your details.
    • Please provide Danske Bank with your new LEI by sending it by email marketsoperations@danskebank.ee.
    • Renew your LEI every year.

    LEI PROVIDERS
    In Estonia it is possible to obtain LEI from Nasdaq CSD (Nasdaqcsd.com)You will find a list of authorised LEI issuers here.

    FEE
    Requesting a LEI is subject to a fee (ca. €100) and it can take up to a couple of weeks. An annual fee may also be applied (ca. €80).

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