Risk reduction of bonds worth DKK 78.6 billion

Many bond issuers are right now in the special situation that the bonds have negative interest rates. Issuers should therefore receive money from investors. The phenomenon has been known for some years, and so far, a negative coupon has been handled partly manually. This September VP SECURITIES launched an automated process for handling negative coupon.

At the end of this year’s third quarter, there were bonds, issued through VP, in circulation with a negative coupon with a total nominal value of DKK 78.6 billion. However, manual handling with the corresponding increased operational risk is not feasible with figures counted in billions.

“It is important that payment of interest and redemption is safe and at the same time cost effective. Billions are transferred in a short timeframe, hence, it is crucial with support from secure systems,” says Henrik Hjortshøj-Nielsen, Executive Vice President and Head of Group Treasury at Nykredit.

Keeping investors’ trust

The stakes are high and large amounts are transferred, when interest rates and redemption are settled. On the global financial market, it is crucial to maintain investors’ confidence in the mortgage system.

Deputy Director Peter Jayaswal from the Association of Danish Mortgage Banks says: "Large sums are affected by negative interest rates. It is complicated and difficult to handle manually for both VP and the mortgage banks. At the same time, there is a risk of operational errors with manual handling. The automated process contributes to an effective and correct handling of negative coupons, hence borrowers and investors can continue to have confidence in the mortgage system, even when the payment goes from investors to borrowers.”

Over the past year VP have worked closely with the financial industry preparing the automated solution for handling bonds with a negative coupon. The solution has been tested during the summer and went into operation in September. Furthermore, the automated and simplified process will reduce the cost of handling those bonds.

"Our automated solution for handling negative coupon is a showcase of the strength of our close cooperation with customers. In relation to interest rates, we are in a special period, and there is a need for a solution due to the large amounts in play. In addition, it is very important to maintain the investors trust in Danish bonds," says Chief Commercial Officer Birger Schmidt, VP SECURITIES.

Unique benefits

For those investors who have these bonds in the portfolio, the current interest rates means that they have to pay an amount of DKK 16.7 million in negative interest rates on floating rates bonds.

"In the Danish mortgage system there is always a direct relation between loans and bonds. The borrower’s payment of interest rate and instalment are channelled directly to the holder of the bonds. Therefore, it is important that the relationship between loans and bonds is maintained, even in the current situation with negative interest rates. VP's infrastructure makes this possible, and it is quite unique that borrowers with Danish mortgage loans can benefit from negative interest rates," says Peter Jayaswal, Deputy Director at the Association of Danish Mortgage Banks.

“Due to VP's solution we can provide our customers with loans based on floating rates bonds and the possibility of negative interest rates,” concludes Henrik Hjortshøj-Nielsen, Nykredit.

Technicalities

There are three models for handling negative coupon, which are based on standard functionality. The models are described here.

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