This blog was co-authored by Eric Geldenhuys, candidate attorney at Norton Rose Fulbright South Africa
The Credit Adjustment Spread (CAS) is a term which is used to calculate and to factor in the difference between JIBAR and ZARONIA. The CAS calculation is a structured as separate component of the interest rate calculation. The CAS is, if applicable, added onto the applicable daily ZARONIA rate.
Why do we need the Credit Adjustment Spread?
The JIBAR’s in-built credit and risk element reflects the bank’s cost of funds and incorporates a certain assessment of bank and term credit risk. The ZARONIA does not have a built-in credit element. This means that an interest rate calculated on ZARONIA may be lower than that of the JIBAR as calculated over the same period. The primary purpose of the CAS is that it is to be added upon transition from JIBAR to ZARONIA as an additional margin to the published daily ZARONIA rate to ensure that pre and post transition, parties remain in the same economic position.
The purpose of this CAS in the context of legacy JIBAR contracts is to attempt to place the lenders and the borrowers in the same economic position, post transition, as they were, pre-transition. In other words, to ensure that the transition does not advantage one party over the other.
How is the Credit Adjustment Spread calculated?
The likely approach to calculating CAS in South Africa, for loans, would be the “5-year historical median” calculation.
The 5-year historical median calculation will be based on the difference between a selected JIBAR tenor and the corresponding compounded in arrears ZARONIA over a historical 5-year period. The difference between the two rates becomes the CAS.
An alternative approach is where parties decide and agree their preferred methodology for calculating CAS or negotiate a fixed CAS.
Where and until when will the Credit Adjustment Spread apply?
The CAS only applies to transition / legacy agreements. It is necessary to apply CAS if a contract is linked to JIBAR because it would be expected that JIBAR, with its inbuilt credit margin, would be a higher rate than the published daily ZARONIA, and it would be inequitable for a lending party to receive a lowered rate of return post transition, to that which it was receiving pre-transition, on account of this transition. The purpose of the CAS is to preserve economic neutrality on transition.
It would not be intended that new ZARONIA contracts independently negotiated or concluded post transition would contain a CAS added to the published ZARONIA rate, on account that margin and pricing would have been independently quoted, assessed for commerciality and accepted. The new agreed margin and pricing (without CAS) should then reflect the required commercial outcome.