The CFO’s Playbook for Navigating Interest Rate Volatility

Interest rate movements affect UK businesses through three channels: the cost of servicing debt, the headroom against covenants, and the demand conditions in their markets. A CFO cannot forecast rates, and should not try. What they can do is understand the exposure, know what a move costs, and make sure the business is not the one caught out when the direction changes.

This covers the practical side: where the exposure actually sits, how UK floating-rate debt is priced, what hedging does and does not achieve, and how to stress test in a way that produces decisions rather than a slide.

Where the Exposure Actually Sits

Floating-rate debt

The obvious one. Most UK mid-market term loans and revolving facilities are floating rate — SONIA plus a margin — so every base rate movement flows through to interest cost within a quarter or less. The exposure is straightforward to quantify: multiply the drawn balance by the rate movement.

Covenant headroom

Less obvious and frequently more dangerous. Rising rates increase interest cost, which reduces interest cover directly. A business comfortably compliant at one rate level can approach a covenant threshold without trading having deteriorated at all. This is the exposure that catches businesses out, because it appears in a covenant calculation rather than in the trading results anyone is watching.

Refinancing risk

A facility maturing into a higher-rate environment reprices entirely, not incrementally. A business with a facility expiring in eighteen months carries a materially different exposure from one that refinanced recently on a five-year term — even if their current interest costs look identical.

Demand and working capital

Rate movements affect customers too. Consumer-facing and discretionary-purchase businesses see demand soften as borrowing costs rise; B2B businesses often see customers extend payment terms, which lands as a working capital problem rather than a revenue one. Both effects lag the rate change and are easy to attribute to something else.

Quantifying It Properly

Before considering hedging, a CFO should be able to answer three questions precisely.

What does a one-point move cost?

Take drawn floating-rate debt and multiply by one percentage point. That is the annual pre-tax cost of a single rate rise. Express it as a proportion of operating profit — the resulting figure is usually more arresting than the absolute number, and it is the version that lands with a board.

What does it do to covenant headroom?

Recalculate interest cover and any leverage covenant at plausible rate levels, using the definitions in the facility agreement rather than the textbook. Establish the rate at which each covenant is breached, assuming trading is flat. That single figure tells you how much of a buffer the business actually has.

What happens at refinancing?

Model the maturing facility repricing at current market levels rather than the historic rate. For businesses that borrowed in a low-rate period, this step frequently produces the largest number on the page.

Hedging: What It Does and Does Not Do

Hedging converts uncertainty into a known cost. It does not reduce the cost of borrowing, and treating it as a way to beat the market leads to poor decisions.

Interest rate swaps

The most common instrument in UK mid-market lending. The business exchanges its floating obligation for a fixed one, fixing the interest cost over the swap term. Useful where certainty matters more than optionality — typically where covenant headroom is tight or a business plan depends on a known cost base.

Caps

A cap sets a maximum rate while leaving the benefit of falls intact, in exchange for an upfront premium. This suits businesses that want protection against a severe move without giving up the downside benefit, and it is often the better fit where the view is genuinely uncertain.

Collars

Combining a cap with a floor reduces or eliminates the premium, at the cost of giving up benefit below the floor. Commonly used where the premium on an outright cap is unattractive.

What to watch

• Break costs. Swaps can be expensive to exit if the business repays early, refinances or is sold. This catches out businesses heading towards a transaction, and the cost is rarely modelled at the point the swap is taken out.
• Accounting treatment. Whether hedge accounting applies affects how movements hit the profit and loss account. Worth establishing before entering the arrangement, not after.
• Proportion hedged. Hedging the entire facility removes all flexibility. Many businesses hedge a proportion — enough to protect covenant headroom — and leave the balance floating.

Stress Testing That Produces Decisions

Most rate stress testing produces a table nobody acts on. A few things make it useful.

Test to breach, not to a scenario

Rather than modelling a two-point rise, calculate the rate at which each covenant fails. A single threshold figure is far more actionable than a scenario matrix, and it gives the board something concrete to monitor.

Combine rates with trading

Rate rises rarely arrive alone. The realistic downside pairs higher rates with softer demand and slower collections, because the same conditions produce all three. Testing rates in isolation understates the risk.

Include the refinancing point

Extend the model beyond facility maturity at market rates. Businesses that stress test only to the end of the current facility miss the largest exposure they have.

Agree the trigger points in advance

Decide, before you need to, what the business will do at each threshold — when to open a refinancing conversation, when to hedge more, when to talk to the lender. Decisions made calmly in advance are better than decisions made in the week before a covenant test.

Managing the Lender Relationship

Where rates are moving against a business, the lender relationship becomes the most valuable asset the CFO manages.

Early conversations go better

A lender told three months ahead that headroom is tightening, with a plan attached, responds very differently from one that discovers it at a testing date. This is the single most consistent piece of advice from finance leaders who have been through it.

Understand what your lender needs

Banks have their own capital and credit considerations. A covenant waiver is easier to grant where the business has been transparent, the reporting is reliable, and the request is specific and time-bound.

Refinance from strength

The best time to refinance is when you do not need to. Businesses that leave it until maturity approaches, with covenant pressure visible, negotiate from a considerably weaker position.

What This Asks of the Finance Function

None of the above is possible without reliable underlying reporting. A business that cannot produce a dependable rolling cash forecast, or calculate its covenants exactly as drafted, cannot manage rate exposure regardless of what instruments it buys.

This is frequently the point at which businesses discover a capability gap. Modelling covenant sensitivity, running a refinancing process and holding a credible conversation with a lender under pressure are specific skills, and not every finance function has them in place before they are needed. Our guides to debt management and financial structure cover the wider picture.

Frequently Asked Questions

What replaced LIBOR in the UK?

SONIA — the Sterling Overnight Index Average — is the benchmark for sterling markets. UK floating-rate corporate debt is now typically priced as compounded SONIA plus a credit adjustment spread and the lender’s margin. Facility documents were transitioned, but internal models and forecasts sometimes were not, which is worth checking.

Should a mid-market business hedge its interest rate exposure?

It depends on how much floating-rate debt it carries and how much covenant headroom it has. Where a plausible rate rise would threaten a covenant, hedging at least part of the exposure is usually justified. Where headroom is comfortable and the debt modest, the premium may not be worth paying. The decision should follow the quantification, not precede it.

How much of our debt should be hedged?

There is no standard proportion. A common approach is to hedge enough to protect covenant compliance under a realistic downside while leaving the balance floating for flexibility. Hedging everything removes optionality and increases break costs if the business repays or refinances early.

What are break costs and why do they matter?

The cost of exiting a swap before its term ends. They matter because businesses frequently repay or refinance early — particularly around a sale or investment — and the break cost can be substantial. It should be understood before the swap is entered, not discovered during a transaction.

How do rising rates affect covenants?

Directly. Higher interest cost reduces interest cover, and can affect leverage covenants where these are calculated on a net debt basis with accrued interest. A business can approach a covenant threshold purely through rate movement, with trading unchanged — which is why testing to the breach point matters.

When should we start a refinancing conversation?

Considerably earlier than most businesses do — typically twelve to eighteen months before maturity. Refinancing from a position of strength, before covenant pressure is visible, produces materially better terms than negotiating against a deadline.

References & Further Reading

• Bank of England — Bank Rate
• Bank of England — SONIA benchmark
• ICAEW — Corporate finance resources

General information for UK finance leaders, not financial or treasury advice. Hedging instruments carry costs and risks including break costs and accounting consequences — take specialist advice before entering arrangements. Correct at the time of writing.

Adrian Lawrence FCA

Founder & Managing Director, FD Capital

Adrian Lawrence FCA is the founder of FD Capital and a Fellow of the Institute of Chartered Accountants in England and Wales (ICAEW). He holds a BSc from Queen Mary College, University of London, and has over 25 years of experience as a Chartered Accountant and finance leader working with private, PE-backed and owner-managed businesses across the UK. He founded FD Capital in 2018 to connect growing businesses with the Finance Directors and CFOs they need to scale — and personally interviews candidates for senior finance appointments.

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