How floating rate notes stopped floating: Evidence from the negative interest rate regime

Abstract

We analyse the impact of stakeholder interactions with the market as a consequence of the negative interest rate regime on the pricing of selected Floating Rate Notes (FRNs). The range of reactivity of financial markets and issuers to uncertainty caused by an untested boilerplate term in bond contracts are thoroughly outlined. The subject clause stipulates ‘not applicable’ as the minimum rate of interest, raising confusion regarding payment obligations between issuers and investors. We highlight the range of challenges by drawing parallels with the pari passu saga, noting a comparatively faster qualitative response to legal uncertainty across the FRN industry. We support these findings empirically, by observing that markets do –to varying degrees– price stakeholder activities with possible impact on the legal certainty of FRNs, like court decisions, industry association statements, and public positions of sovereigns. In turn, issuers are willing to react to legal risks quickly, if costs of inertia are low. This is reflected also in the relevant changes in the FRN issuance structure in the past few years. The announcement of further lower for longer rates in the Euro Area provides evidence that the FRN market appreciates the current protection of negative coupons even under a lower Euribor. Consequently, this appears to confirm a situation where Floating Rate Notes turned de facto into Floored Rate Notes, in part because of legal uncertainty in the N/A clause.