ECB
Forex Markets

External Commercial Borrowing (ECB)

ECB has 3 risks

  • Fx risk on the principal
  • Fx risk on the coupon
  • Floating Libor risk

Prevailing strategies in the market for ECB hedging are as follows –

  1. CCS – Cross currency swap is a standard way of hedging USD loans and it covers all the three risks and converts the USD floating loan into INR fixed rate loan for all practical purpose.
  2. IRS + Forward contracts: Another way of hedging ECB is to hedge the Libor risk using a simple IRS and hedge the Fx risk on principal and coupon using forward contracts. This also essentially hedges all the risks and completely converts the loan into an INR loan.  The only difference here is, that Fx premiums are not payable on per annum basis and instead are payable towards the end as it’s inbuilt in the forward rate.
  3. Libor Options – caps and floors: Instead of hedging the Libor using IRS,  one can hedge the same using options on Libor as well which are called Caps / Floors. Some of the commonly used structures are –
    • Caps: For example, a cap strike 3.00% will ensure the company never need to pay over 3.00% as Libor cost, but if Libor comes down to 1.00% then there is no obligation to company. The cap strike can be choosen and will have a cost payable on per annum basis.
    • Collars: Collars have a cap and a floor, for example, a cap of 3.00% and a floor of 1.00%
  1. Fx risks can also be hedged using options and common hedge structures for long term ECBs are as follows –
    • Plain Call option strike spot: For example, a plain call option at strike = spot during hedging 71.00 will ensure that the company’s loan liability is crystallized in worst case scenario. This will have per annum cost a bit higher than forward but if INR appreciates there is no risk.
    • A plain call can be availed at strike close to forward or higher for example 90.00: That ensures running cost is low but protection also is at a much higher level.
    • Call spread – A call spread provides protection up to a point. For example, a call spread starting 71.00 till 91.00 will cost lower than forward however any depreciation beyond 91.00 is not covered.

Overall for hedging a combination of different products for Libor and Fx hedging can be chosen. Indicative cost of various hedges are given below assuming L+3.00% –

Indicative cost of various hedges

TenureCCSPOSCOSIRS
1Y10.27%4.22%6.05%5.80%
2Y10.16%4.04%6.12%5.74%
3Y10.34%4.15%6.19%5.69%
5Y10.71%4.26%6.45%5.67%
7Y10.95%4.19%6.76%5.71%
In INR PremiumForward RatesCall @ ForwardCS (S-F)CS (S-S+3)CS (S-S+6)CS (S-S+9)CS (S-S+12)CS (S-S+15)CS (S-S+18)
1Y74.163.67%3.09%3.18%4.47%----
2Y77.172.53%3.04%1.91%3.09%3.76%---
3Y80.731.91%3.28%-2.39%3.20%3.66%--
5Y88.791.15%3.53%--2.14%2.71%3.21%-
7Y97.071.31%3.58%---1.95%2.38%2.77%

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