A Guide to Interest Rate Swaps Redress and Compensation
As the scandal escalates over mis sold interest rate swaps more and more businesses are wondering if they have been mis sold this highly complex hedging product by their banks and if so, are they entitled to redress? Directors of SMEs are looking for a guide to interest rate swaps not so much to understand what they are, but rather how they can reclaim money they shouldn’t have paid.
If you took out a commercial loan on or after 1 December, 2001, you indeed may have purchased some form of hedging product as a condition of the loan. Claiming redress will not be as easy as it should be, primarily because of the complexity of the product, but the place to begin is with a basic understanding of exactly what interest rate swaps (IRSs) are.
A Brief Synopsis of Interest Rate Swaps
Fundamentally, interest rate swaps are sold alongside a loan so that the borrower can be protected against future rises in interest rates. It is a separate financial contract to the underlying loan in which floating rates are swapped for fixed rates. In theory, a floating rate would rise if the current interest rate rises. This would increase the customer’s payment accordingly.
Banks knew that customers don’t want their interest rates to rise so they sold them an interest rate swaps package to ‘protect’ them against rising costs. It is the contention of many customers who purchased these packages that they were unaware of the costs associated with the IRS. The complexity of repayment calculations was far beyond the scope of their understanding and they were certainly unaware of the enormity of exit penalties.
Unfortunately, further confusion rests in the fact that there are more than just simple interest rate swaps which were sold and some customers weren’t advised of the risks they would be taking on. There may have been a better hedging product to suit their needs and banks weren’t forthcoming with that information.
The Financial Service Authority’s Involvement in Interest Rate Swaps
As a result of literally thousands of complaints, the Financial Service Authority (FSA) began to evaluate the situation. As recently as this year, they revised how banks were to review any IRS sold after December 2001 and how to handle those sales that merited financial redress. The FSA appointed independent reviewers who would oversee each bank’s review in order to assure unbiased reviews of any claims.
In order to do this, the FSA had to establish guidelines to go on. The main aspect of interest rate swaps reviews is in determining whether a business customer was sophisticated or unsophisticated. To put it plainly, did a business have the acumen to understand these complex hedging products before being sold the package?
There are several ways in which the FSA sees a business as being unsophisticated such as whether they had fewer than 50 employees, an average of full and part-time workers. As well, the FSA looked at the company’s balance sheet and their annual turnover – but even these have shades of grey since other factors needed to be considered as well.
Complications in Claiming Redress and FSA Revisions to Review Criteria
Banks that agreed to the pilot review in the summer of 2012 (Lloyds, Barclays, HSBC & RBS) began reviews based on the criteria set forth by the FSA. They looked at when the IRS was sold and whether or not the customer was considered sophisticated or unsophisticated. Unfortunately, this opened up a number of appeals which they then had to consider.
For example, a business could be considered unsophisticated according to size and annual turnover but might be savvy enough to have a solid understanding of hedging products. On the other hand, a business with employees numbering over the 50 mark cutoff could have a majority of workers only on the job seasonally.
At the moment, the FSA is taking these things into consideration and as of March 2013, banks will need to make reviews based on these revisions. Then there are also a great number of questions which needed to be addressed such as what to do with interest rate swaps that were mis sold to companies that have been wound up.
It is the finding of the FSA that companies no longer on the register are no longer considered to be entities. Consequently, these companies are not entitled to redress or compensation for any losses incurred due to mis sold interest rate swaps.
In their most recent publication dated 13 March 2013, Interest Rate Swaps Questions, the FSA suggests that there are a number of extenuating circumstances that should be considered under appeal. Any business that feels a review by the bank is incorrect should get legal representation to file an appeal with the court. Micro enterprises (fewer than 10 employees) may file an appeal with the Financial Ombudsman Service.