ROWAN UNIVERSITY POLICY
Title: Derivative Management Policy
Subject: Financial Management: Guidance for the Use and Management of Derivative Instruments
Policy No: Fin: 2018:02
Applies: University-Wide
Issuing Authority: President
Responsible Officer: Senior Vice President for Finance and CFO
Adopted: 09/26/2018
Last Revision: 10/11/2018
Last Reviewed:
...
11/
...
21/
...
2020
I. PURPOSE
This Derivative Management Policy (“Policy”) is a subsidiary component of and should be read in conjunction with the Debt Management Policy. The purpose of this Policy is to establish responsibilities, objectives, and guidelines for the use of interest rate swaps and similar products to manage the University’s bond profile. As used in this document, University debt includes debt or other obligations issued by the Camden County Improvement Authority, Gloucester County Improvement Authority and New Jersey Economic Development Authority on behalf of the University.
...
- Attachment 1 - Risks Associated with Derivatives
Attachment 1
Risks Associated with Derivatives
- Basis Risk - Risk that the payment on the variable rate debt obligations will exceed the swap receipt (the Securities Industry and Financial Markets Association or “SIFMA” Index or a percentage of the London Interbank Offered Rate or “LIBOR”) due to an issuer-specific credit event or tax code change.
- Tax Event Risk - A form of basis risk - risk of higher tax-exempt interest rates (an increase in SIFMA Index) if tax law revisions lower the tax rate on interest income. In the extreme scenario, if a change in tax law eliminated tax-exempt interest income, the market would adjust “tax-exempt” security pricing so that there would be no material difference between the SIFMA Index and LIBOR.
- Credit Risk - Credit deterioration of the underlying debt obligations or any bond insurer, letter of credit provider, or liquidity provider insuring or enhancing the related debt obligations would result in basis risk discussed above.
- Counterparty Risk - Risk that the counterparty cannot make future payments or cannot make a termination payment due to the University.
- Credit Risk: Credit deterioration of the underlying debt would result in basis risk discussed above when underlying debt is in a variable rate mode or if the interest rate swap is used as a hedge of a future fixed rate debt issue.
- Disclosure Risk - Accounting standards may require balance sheet and income statement entries for swap agreement interim values.
- LIBOR Index Discontinuance Risk: The discontinuation of LIBOR may impact the effectiveness of the transaction as a hedge to underlying variable rate debt or other variable rate exposure and also may impact the mark to market value of this transaction. As a result, certain transactions may have to be amended during its term to address the potential discontinuation of LIBOR rate setting.
- Market Access Risk: Risk that certain market conditions or disruptions could hinder or preclude the Issuer from accessing the capital markets and/or securing attractive financing terms when necessary to restructure, refund or finance potential obligations (i.e. LIBOR and MMD rates disconnect).
- Rollover Risk – Potential rollover risk exists if the swap maturity does not match the maturity of the hedged debt.
- Tax Risk: A form of basis risk – risk of higher tax‐exempt interest rates (an increase in SIFMA Index) if tax law changes lower the taxation rate on interest income. In the extreme scenario, if a change in tax law eliminated tax‐exempt status, the market would adjust “tax‐exempt” security pricing so that there would be no material difference between the SIFMA Index and LIBOR.
- Termination Risk - Termination risk exists if (i) the University opts or is compelled to terminate the swap prior to maturity; (ii) credit ratings for any Financing Program are lowered to below specified downgrade thresholds and the University is unable or is not required to post collateral, as may be required by the swap agreements, to protect the counterparty against the risk resulting from the lowered rating; (iii) the counterparty is downgraded and the counterparty is unable to post collateral; or (iv) the counterparty is downgraded to a level that causes an involuntary termination. Early termination would be solely at the option of the University (except in certain credit events described in (ii), (iii) and (iv) above). It is University policy that the counterparty will not have the option to terminate at any time without cause.
- Yield Curve Risk: On transactions where an Issuer’s payment is based on a short‐term index and its receipt is based on a long‐term index, an Issuer faces potentially negative cash flows and market value implication in market environments when the yield curve is flat or inverted.
...