A margin ratchet is a loan clause that automatically adjusts the interest margin based on the evolution of an indicator, most often the leverage ratio (net debt / EBITDA) or, increasingly, ESG targets. As the borrower deleverages or improves performance, the margin steps down; it steps up in the opposite case.

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The mechanism aligns the cost of debt with the borrower's actual risk profile over time and incentivises deleveraging. It is common in LBO financing and lies at the heart of sustainability-linked loans.

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Example: a grid sets a margin of SARON + 3.0% above 3.5x leverage, reduced to + 2.5% between 2.5x and 3.5x, then + 2.0% below 2.5x. By deleveraging from 3.8x to 2.2x over three years, the company cuts its margin by 1.0 point, a substantial saving on debt service.

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At Hectelion, we model the effect of margin ratchets on debt service and free cash flow in our financial structuring analyses.