Multilateral Guarantee Structure
Multilateral development bank
Long-dated cross-currency swaps are credit and capital intensive, so hedging banks have limited appetite for them, and capital allocation makes pricing expensive for lower-rated counterparties. A multilateral development bank sought to guarantee such a swap between an African regional bank and a West African sovereign. It had not issued a guarantee of this type before.
Scope of work
Dual requirements met in the structure: the guarantor's own risk criteria, and the risk and capital thresholds of the hedging banks that would have to approve credit against it. Guarantees over mark-to-market instruments are harder to structure and price than those over vanilla exposures.
Terms defined to give the beneficiary effective protection against counterparty credit risk:
- Claim triggers and step-in rights for the guarantor
- The claim settlement process
- Participation in recoveries between the parties
Tail risk assessed where retained by the beneficiary, against both its risk position and its regulatory capital treatment, a consideration sharpened by the expected credit loss regime for the banking book.
Capital minimised under Basel III rules so the structural efficiency of the guarantee passes through to the pricing offered to the sovereign, with guarantee pricing set against the rating of the guarantor.
Beneficiary support provided directly, so the regional bank understood the structure and could approve credit and allocate capital accordingly.
Outcome and value
- At least ten banks secured credit approval to participate in the hedge.
- Pricing tension created among participating banks, improving terms for the sovereign.
- Regulatory capital minimised, further optimising pricing.
- A reusable structure the institution can apply to guarantees beyond hedging transactions.