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Market Volatility and Financial Covenants

by Stephen Walter, Structurer, Commerzbank Corporates and Markets

The financial markets tumult has left many corporates facing a series of challenging decisions; arguably none more so than the negotiation of funding or the maintenance of existing credit lines. With recent reports highlighting the onset of tighter financial covenants, to what extent will financial covenant ratios be impacted by the increased market volatility?

International Financial Reporting Standards requires all derivatives to be fair valued through the income statement

It can be argued that a financial covenant’s primary role is to forewarn the onset of financial difficulty – the latter often appearing in the form of an unmanageable exposure to risk. The flagging of a potential breach allows action to be taken by both lender and borrower to address the issue.

Ratio analysis is the most common method of policing the covenant – an area customised to accord both the lender’s and borrower’s requirements. Examples of financial covenant ratio categories are: