Interest Rate Swaps: Application to Tax-Exempt Financing

The Orrick Public Finance Green Book Series


The global interest rate swap market is remarkably vast, both in terms of size and scope of products, and it continues to grow rapidly. Within the U.S. public finance sector, the use of interest rate swaps and their close relatives is becoming more common as increasing numbers of governmental entities utilize them to reduce their borrowing costs, better manage or limit their interest rate risk, and effect better matching of assets and liabilities. Written for the benefit of issuers of tax-exempt debt (referred to herein as “Agencies”) and other entities that have access to the municipal capital markets, this booklet serves to help Agencies enhance their understanding of interest rate swaps and related financial tools.

Included is an overview of common types of swaps and discussions of how they work. Additional topics addressed are transaction mechanics and documentation, potential benefits and risks, legal and tax issues, and post-trade management. Special emphasis is placed on the most common type of transaction, the so-called “fixed rate swap,” in which an Agency receives a floating rate and pays a fixed rate. When combined with an issue of floating rate bonds, this swap is intended to create a structure which, on a net basis, results in synthetic fixed rate debt for the Agency.

Like other areas of finance, the swap industry has developed its own terminology to describe the financial and legal terms of a transaction in a practical and concise manner. Several of the most commonly used terms are listed in the Glossary of Key Terms at the end of this booklet.

This booklet is a joint effort of Bond Logistix LLC (“BLX”) and Orrick, Herrington & Sutcliffe LLP (“Orrick”). BLX is a financial and investment services advisory firm, dedicated to governmental and other users of tax-exempt debt. BLX maintains an 2 interest rate swaps: active swap advisory and monitoring practice in addition to investment advisory and brokering, arbitrage rebate compliance, continuing disclosure and program administration practices. Orrick is a global, full-service law firm with a finance emphasis. Over the past decade Orrick has ranked number one in the country as bond counsel and has represented numerous governmental issuers and swap providers in hundreds of swap transactions of every type. Orrick attorneys have also crafted legislation authorizing swaps and other hedging instruments in a number of states.