Derivative contracts: hedging: regulation 9: meaning of ‘interest rate contract’
This guidance applies to periods of account starting on or after 1 January 2015 where the company has elected for regulation 9 to apply.
Meaning of ‘interest rate contract’
‘Interest rate contract’ is defined in regulation 9(4) as
- a derivative contract whose underlying subject matter is, or includes, interest rates, or
- a swap (other than one falling within the first bullet point) in which payments fall to be made by reference to a rate of interest, or an index determined by reference to income or retail prices.
Regulation 9 is therefore capable of applying to a wide range of derivative contracts. It includes those contracts you would normally think of as interest rate contracts - interest rate swaps, futures, options, caps and collars, and forward rate agreements.
But some currency contracts will fall within the definition of ‘interest rate contract’. In a cross-currency interest rate swap, for example, the periodic payments are computed by reference to interest rates in the two currencies concerned. Such a swap will therefore be an ‘interest rate contract’.
On the other hand, a forward currency contract or a currency option, other than one which can only be cash settled, will be a ‘future’ or an ‘option’ for the purposes of the derivative contracts rules, and its underlying subject matter will be wholly currency - the property that falls to be delivered if the contract runs to delivery (see CFM50500+). Currency contracts of this type will be within regulation 7 (if they are hedging a forecast transaction or a firm commitment), rather than regulation 9.
Further examples of contracts that would fall within the definition of ‘interest rate contract’ are
- a credit default swap (CFM13370) or other credit derivative where payments are computed by reference to an interest rate,
- an equity swap, where payments based on a variable rate of interest are exchanged for payments linked to a share price, or a share index, and
- an ‘RPI’ swap, where payments based on a variable rate of interest are exchange for payments linked to the retail price index (RPI).
While there must be a hedging relationship between all or part of the interest rate contract and an asset, liability, receipt or expense of the company, there is no requirement that the derivative must be hedging interest rate risk although in many cases to which Regulation 9 applies, it will be. The regulation may also apply where foreign exchange risk is being hedged - see the second example at CFM57350.
It is possible that, where a currency contract falls within the regulation 9(4) definition, exchange gains and losses on the contract are disregarded under regulation 4 (or, exceptionally, under CTA09/S606(3) (CFM51100). Where this happens, the disregarded amounts cannot be brought into account under regulation 9.