Swaps toxicity when interest rates are negative

Why are swaps toxic when rates are negative? After the euro, the case of the USD approaching negative zone under D. Trump pressure.

Since April 21st 2015, the 3-month Euribor has been in negative territory. It has created « technical » problems linked to interest rate swaps (as well as « tunnels » or « collars »), that were theoretical until this day. But those began to morph into real issues in management and in IFRS. Nevertheless, several types of solutions exist depending on the case.

The animation below illustrates the problem from a technical and accounting angle (de-qualification of swaps as a hedging product and transition to Isolated or « speculative » Open Position).

The figures mentioned in the video date back to April 2015 (date of publication of the video), but the principle remains valid for theses days’ Euribor.

In addition, it may soon apply to the Libor GBP as well as to the Libor USD because President D. Trump is pressuring the FED to cut the fed funds in negative territory in order to equalize them with Europe. As a result, on May 7, the markets began to anticipate negative USD rates by December 2020, January 2021. Market participants therefore believe that the FED will be forced in coming months to lower its rates further down because of the long-term economic damage induced by the Covid19. On the side of the UK, the governor Bailey said that it is time to review how low the bank of England rates can go.

And you, do you have outstanding simple (“vanilla”) swaps on dollar or pound interest rates? Have you already secured them against negative rates?