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Irish treasurers are now able to access first zero interest synthetic currency Back  
The first synthetic currency with a zero interest rate and optimisation features is due to be introduced following months of research and strong client demand for improved foreign exchange (FX) borrowing structures. Ciaran Kane details the implemenatation of the European Borrowing Unit (EBU) and lists its benefits, advantages and risks.
After 18 months of research, Barclays Capital is introducing the European Borrowing Unit (EBU), the first synthetic currency with a zero interest rate and optimisation features. The EBU provides transparency and liquidity, and has a variety of applications as a funding currency. Its 0 per cent interest rate and historical spot behaviour makes it attractive for multiple funding uses for a range of clients, particularly those considering a reduction in cost of funding through controlled Foreign Exchange (FX) exposure. EBU was designed as the result of strong client demand for improved FX borrowing structures.

As economic conditions change, we believe that it is important for any FX structure to be able to adapt to new market environments. The dynamic rebalancing of the EBU composition on a monthly basis does exactly that. Given that the EBU is the first synthetic currency in the market place, it was critical to focus on transparency and liquidity. The EBU has a daily fix published in Bloomberg that is based on Central Bank fixings of the G10 currencies, and is calculated by an independent research group. On a historical basis, the EBU has negative cost of capital over the last 13 years for a euro borrower i.e. a zero interest rate currency with average depreciation against the euro. We have had ongoing client dialogue about optimising their funding costs on FX loans. EBU through its diversification, transparency and liquidity is designed to do just that.

Who will benefit from EBU?
A large number of institutions have been using the Japanese yen or other low yielding currencies to improve their cost of funding over the last few years. The EBU presents a more sophisticated FX funding solution in the form of a new synthetic currency. However, it is important to emphasise
that the EBU was not designed for speculative or short-term purposes. We believe that the EBU is suitable for medium to long-term financing solutions. Longer horizons mean higher number of dynamic optimisations.

Initial feedback has been very positive from a variety of clients - corporate treasuries, banks providing financing solutions, and other institutions using FX for funding purposes.

The EBU is a non-deliverable currency. As such, we believe that the most popular vehicles for client would include Cross Currency Swaps and Non Deliverable Forwards on the EUR-EBU exchange rate.

What are the key advantages of EBU?

- Simplicity: EBU is simply a basket of long and short positions against the euro. Its spot rate is simply the weighted average of the G10 spot rates against the euro.
- Solid methodology: EBU weights are calculated monthly based on a portfolio optimisation methodology.
- Low funding level: zero interest rate (no interest rate uncertainty).
- Diversified FX risk: optimisation approach takes into account correlations and volatilities of the 10 most liquid currencies (G10) to calculate optimal weights.
- Dynamic rebalancing: adapting to changing market conditions.
- Liquidity: intraday liquidity and daily fix based on the Central Bank fixings of the G10 currencies against the €.
- Transparency: independent research group responsible for the publication and maintenance of EBUTM.

What are potential risks to the EBU?
The EBU is a synthetic currency. As with every currency, there is risk of EBU appreciating against the euro, thus potentially increasing the size of the liability.

Even though EBU’s G10 positions are calculated using optimisation methods, the market can still go against them. This risk is particularly relevant for short term structures when the number of dynamic rebalancing is small.

Even though the historical EBU volatility has been low, institutions may want to quantify their maximum risk exposure. Barclays Capital has designed instruments that allow clients to define their maximum downside on EBU risk. Clients can hedge the EBU to contain any negative movements.

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