Topping-Up Clause

What Is a Topping-Up Clause?

A topping-up clause is a contractual provision generally found in loans including more than one currency. It is planned to shield lenders and borrowers from the risk of foreign-currency devaluations.

In particular, topping-up clauses require the borrower to make extra payments to the lender to cover any devaluation in the currency being borrowed. In exchange, the lender consents to remunerate the borrower if the borrowed currency appreciates during the life of the loan.

Figuring out Topping-Up Clauses

Topping-up clauses are a method used to reduce foreign-exchange (forex) risk. Accordingly, they are particularly helpful when the value of the currencies engaged with the loan are expected to vary against each other during the term of the loan. Appropriately, the more volatile two currencies are with respect to one another, the more forex risk is implied with the loan.

Albeit topping-up clauses can't reduce that underlying volatility, they can assist with remunerating the gatherings to that loan for the impact of that forex risk. For instance, assuming one of the loaned currencies is devalued by 10%, the borrower would have to make extra payments equivalent to 10% of the loan's value to compensate for that currency devaluation. Additionally, on the off chance that the value of the loaned currency increments by 10%, the lender would be required to reduce the outstanding balance of the loan by 10%.

Topping-up clauses truly do have their limitations, be that as it may. In any case, they are normally just enacted once the variance in exchange rates outperforms a certain level, like 3% or more. Likewise, the extra payments required by the topping-up clause can lead to undesirable tax liabilities for the getting party.

Risk Management versus Hypothesis

In contrast to derivative instruments, for example, currency advances, topping-up clauses are generally not utilized as a method for hypothesizing on currency changes. All things considered, they are seen mostly as a measure to reduce forex risks.

Real World Example of a Topping-Up Clause

In certain countries, for example, the United Kingdom, court decisions can in some cases expect gatherings to deliver funds in currencies not quite the same as that of the court. In those circumstances, a topping-up clause is utilized to require the debtor to pay any extra amount expected to create the amount in the communicated currency.

In different countries, in any case, bankruptcy laws expect that foreign obligations be communicated in the nearby currency. In those conditions, topping-up clauses might be overlooked, making the obligations be effectively devalued in the event that the nearby currency is worth not exactly the foreign currency. This is one of many risks which lenders must know about while stretching out loans to debtors in foreign countries.

Features

• It is generally utilized as a risk-management measure instead of for the purpose of guessing on future currency values.
• A topping-up clause is a legal provision intended to shield the gatherings to a loan from the risk of currency devaluation.
• Topping-up clauses will commonly just become effective once certain edges have been reached, for example, when currency values stray by in excess of a predetermined percentage.