Market volatility can create risk management opportunities.  Are you prepared to act when opportunity knocks on your door?

Recent interest rate action creates opportunity for market participants such as private equity sponsors and their portfolio companies which frequently use floating rate debt and interest derivatives to create an optimal blend of fixed and floating rate debt.

Such market movements can provide opportune moments to hedge new exposures for the first time, top-up existing hedges, dollar cost average into total hedge positions at more attractive levels and enjoy further benefits from positive carry through locking in swap rates that are now even further below current floating SOFR rates.

While the opportunities may seem readily apparent, being able to act quickly and decisively when opportunities arise is frequently challenging for many sponsors.  A risk management program that is sufficiently nimble for this type of action requires daily focus and coordination between investing teams, capital markets teams, and risk management teams (whether internal or external service providers).  Technology also plays a key role.  Many sponsors maintain sizeable and diverse investment portfolios.  Manual and/or excel based processes frequently are not robust enough to quickly review investment and hedge portfolios to identify areas of opportunity. 

Examples of data sets & key processes to enable readiness to act quickly

1) Tracking hedge ratios: real-time tracking of hedge-adjusted fixed / floating ratios can enable firms to quickly identify investments in most need of hedging action.  Firms may consider an initial focus on deals with the lowest current hedge ratios or whose hedge ratios are below internally mandated target ratios.  Tracking this data set typically requires technology capabilities related to tracking both debt and hedge positions.

2) Tracking debt maturities vs hedge maturities:  sponsors frequently execute initial hedges that are shorter in tenor than underlying debt exposures which creates a regular need for extending hedges.  Being able to quickly identify investments with near-term hedge maturities but longer-term debt provides valuable information to identify opportunities in addition to more simplistic hedge ratio tracking.

3) Understanding business plans and potential capital structure changes: timelines for potential exit of investments and/or refinancing activities are key inputs for crafting appropriate hedge structures and strategies

4) Proactively preparing to trade derivatives:  to be able to transact in derivatives, numerous pre-trade processes need to be completed such as onboarding / KYC, regulatory adherence, hedge provider credit approval and underwriting, ISDA negotiations, etc.  These processes can take anywhere from a few days to multiple weeks.  Being proactive with pre-trade setup processes at the inception of an investment enables firms to take quick action as opportunities arise.

5) Holistic evaluation of market pricing, transaction charges, and potential liquidity considerations:  economics of hedges extend well beyond just the rate that is available in the market.  The ability to identify and quantify transaction charges and potential liquidity needs are key for successful risk management decisions.  These variables can be impacted by underlying deal structure, choice of hedge structure, levels of market volatility, etc.  Key data and understanding of these dynamics can help streamline prudent hedging decisions.

Derivative Path partners with its clients to act as extensions of their firms and provide additional expertise, manpower, and technology capabilities.  Our holistic understanding of our clients’ businesses and risk management needs enables white-glove advisory and technology services.  Reach out to start a discussion and ensure your business is ready to capitalize on market opportunities.