Interest rate floor

The interest rate floor is the clause that sets the minimum value used for the benchmark rate of a floating rate loan. When the published Euribor falls below the floor, the agreement applies the floor and adds the margin. The Haut Comité Juridique de la Place Financière de Paris analysed these clauses in its report of 30 March 2017 on negative interest rates. It concludes that an interest-bearing loan governed by the French Civil Code carries an implicit floor of 0% on its total rate, assessed over the life of the agreement, and that no implicit floor protects the margin without an express provision. The parties may provide that the index will not fall below 0%, which preserves the lender’s margin. The report specifies that the French law standard documentation of the Loan Market Association, amended in 2014, leaves the parties free to stipulate a zero floor on the index without imposing one. The floor affects interest rate hedging: when the loan has a floor and the hedging swap does not, the match between the two contracts is imperfect and hedge accounting becomes less effective. For the company, the floor sets a minimum cost of financing. It negotiates its level, its application to the index alone and its alignment with the hedging instruments.

A company borrows €100m at three-month Euribor plus 4.00%, with a 0% floor on the index. If three-month Euribor stands at minus 0.30%, the agreement uses 0% for the index and the rate for the period stays at 4.00%. Without a floor, the rate would be 3.70% and annual interest €0.3m lower.

• The floor level and whether it applies to the index alone or to the total rate
• The alignment of the loan floor with the floor of the interest rate hedge
• The wording of the interest clause, which determines what happens to the margin
• The cost of the floor option built into the price of the financing