Discounting in negative interest rate environment

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Marek Muc
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Discounting in negative interest rate environment

Post by Marek Muc »

We stumbled on an interesting discussion in one of our recent topics, but I thought that this issue is worth a separate topic, so here we are :)

More and more often we observe negative yields on government and even corporate bonds. Do you use a negative rate for discounting purposes? E.g. for provisions under IAS 37 or as incremental borrowing rate under IFRS 16.

I tried to google this issue but there is surprisingly little meaningful content.

One EFRAG paper, for example, states that it makes sense to use negative interest rate for discounting. This means that someone effectively pays you to hold money.
EFRAG TEG disagreed with this assessment – in a negative rate environment, the present value of a future cash flow is higher, because there is a cost to hold cash.
https://www.efrag.org/Assets/Download?a ... -04-11.pdf
pdolci
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Re: Discounting in negative interest rate environment

Post by pdolci »

Hi Marek,

I'm giving you un update after a meeting today with our auditors (big four).
Their view is that a negative rate wouldn't be a real solution, since if any company in the world (even AAA) would ask a bank lo lend money, it sure would turn out to ask for a positive rate, even if very very low.

Given the current market conditions, however, it would be reasonable to sustain that the interest rates would be so low that a "zero" could better approximate the real condition for the "negative period".

I think this is somehow a shortcut, but for the time being I'm happy with that :D
Happy to share more thoughts on this anyway.

The only thing I personally would not take as a view is to use "market curves plus your spread": that's not what Internal Borrowing Rate is about in my opinion (talking about IFRS 16... could be different for IAS 37).

Bye,
Paolo
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Re: Discounting in negative interest rate environment

Post by JRSB »

If banks are paying -2% on deposits then it still makes sense to loan at -0.01% etc? I'm not aware where negative rates have become significant, only modest negative rates which are signifiers I suppose of cheap lending and wanting a small penalty for holding cash rather than spending it.
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Re: Discounting in negative interest rate environment

Post by JRSB »

...in which case applying 0% would seem to be fair
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Re: Discounting in negative interest rate environment

Post by Marek Muc »

thanks for the update!

I agree that this is a neat practical shortcut and probably I would use it too :)

But conceptually I'm not sure if I agree with your auditors. If current market yields of your debt are negative, wouldn't you be able to issue new debt above face value?

As for you case (incremental borrowing rate for IFRS 16), you wrote that the yield turns positive after 4 years, and lease term is often longer than that, so this is another argument for a positive discount rate
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Marek Muc
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Re: Discounting in negative interest rate environment

Post by Marek Muc »

the question in my previous post was imprecise, I should have rather asked something like:

If current market yields of your debt are negative, would you be able to issue new debt above face value with e.g. 0% interest rate? That would give negative borrowing rate.

On the other hand, IFRS 16 requires the rate to be asset-specific in a way, and the basis for conclusions state that the observable rate needs to be adjusted (BC162):
The IASB noted that, depending on the nature of the underlying asset and the terms and conditions of the lease, a lessee may be able to refer to a rate that is readily observable as a starting point when determining its incremental borrowing rate for a lease (for example, the rate that a lessee has paid, or would pay, to borrow money to purchase the type of asset being leased, or the property yield when determining the discount rate to apply to property leases). Nonetheless, a lessee should adjust such observable rates as is needed to determine its incremental borrowing rate as defined in IFRS 16.
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Re: Discounting in negative interest rate environment

Post by pub_acco »

In practice I've been using 0% for discounting purposes when a straight forward calculation comes out a negative interest rate. But I don't think I'm doing right.... Currently, it's okay because of the modest negative rate environment, but perhaps in the future we might need to use negative rates for discounting....

Btw, negative interest funding is already quite common in the professional debt market. I've actually experienced to issue above-par commercial papers. Even when a loan itself has a positive coupon rate, we can sometimes combine it with a cross currency swap to structure a negative rate funding.
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Re: Discounting in negative interest rate environment

Post by Marek Muc »

thanks pub_acco for your insight

I also think we'll have to get accustomed to deeper real negative interest rates. This seems to be the world's way of outgrowing the piles of debt (i.e. low nominal interest rates combined with enormous supply of money)
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Re: Discounting in negative interest rate environment

Post by JRSB »

If any members wish to lend to me at negative rates, feel free.
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Re: Discounting in negative interest rate environment

Post by Marek Muc »

EU started issuing pan-European bonds, those with 7y maturity, so mid-term, were issued at a whopping -0.5% yield!

https://ec.europa.eu/commission/pressco ... /ip_21_209
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Re: Discounting in negative interest rate environment

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30-year EU bond? will the eurozone last that long....
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