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How much of a scandal are interest rate swaps?

An exposé into interest rate swaps products caught my attention earlier this week.

Sky News reported it had uncovered evidence of products being sold by banks to guard against interest rate rises on loan repayments, but which require customers to pay fees to the bank when rates fall.

Sky explained that the products, known as swaps, worked on the basis that if rates rise the bank would cover the increase in repayments. But if rates fall, the customer has to pay the bank.

Former HBOS and Lloyds TSB employee James Ducker told Sky: “We were selling protection against rates increasing with a lack of consideration if rates fell.

“The bank was protected more than the customer and it was normal practice to emphasise the rewards and de-emphasise the risks.”

He said staff were under huge pressure to sell these products.

Ducker added: “If rates go up, the bank wins. If rates go down, the bank wins. Was it ever explained to the customer in that way? No.”

Sky also spoke to two customers who felt they had been misled by the banks about the risks of these products.

Money Marketing began to look into it. Two phone calls and a quick google search establish that Ducker is the man behind Benchmark Treasury Pricing, who on leaving Lloyds TSB and HBOS set up a company which among its services offers… interest rate swaps.

Ducker’s company also offers to help customers who have hedging disputes with banks, to assess whether they have a viable complaint.

Interest rate swaps are less insurance, which offers a payout in the event of loss, and more of a hedge, where customers bet on rates going either up or down.

Customers with interest rate swaps that are facing charges would have bought the products before interest rates sank to the unprecedented low of 0.5 per cent in March 2009.

In addition to the payments in the event of rates falling, if customers choose to cancel the contract, a ‘break cost’ is applied. In a low interest rate environment the break cost is higher.

The products are often sold to larger corporate firms who want to hedge their risk, but have also been sold to small and medium-sized enterprises.

Interest rate swaps are regulated by the FSA but are aimed at professional investors, meaning that different regulatory rules, for example on disclosure, apply compared to the rules when dealing with retail customers.

An FSA spokeswoman says: “In selling swaps banks are under an obligation to think about whether the sorts of products they are selling match the financial needs of those buying them, and provide product information in a comprehensible way.”

The Financial Ombudsman Service says it sees a very a small number of complaints about these products. Decisions in these cases are quite evenly split between instances where the product was suitable, but complaints are also upheld  where consumers did not understand how the product worked.

In response to the Sky article, banks say that sales of these products are subject to robust reviews processes to ensure they are suitable.  Multiple client meetings and product presentations can be involved, and banks say it is clear that this process comes across as a sales presentation, rather than advice.

Money Marketing understands the number of interest rate swaps actually sold to corporate customers is extremely low, although this is no excuse for poor advice.

A spokesman for Lloyds Banking Group says: “Interest rates are at a 300-year low, and no-one saw that coming. The market has gone against the position these customers have taken. And we understand that is a concern for our customers.

“This does not mean that the products were missold or that customers did not understand the products.”

Lloyds adds it does not incentivise staff to sell more complex products.

So a murky picture begins to emerge. Is this a case of one man engineering a story to serve his own purposes? Perhaps customers knew exactly what they were getting into but resent being caught out by the fall in interest rates? Or are there potentially real issues with the way these complicated products are being explained to the people buying them?

Natalie Holt is the regulation reporter at Money Marketing – you can follow her on Twitter here

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Comments

There are 9 comments at the moment, we would love to hear your opinion too.

  1. This could be a serious issue for housing associations who are regulated by.. guess who.

  2. Sounded suspicious when I heard it on Sunrise this week. Thanks for digging into this MM. The quote that it could be a bigger scandal than PPI was what made me suspicious when I heard it,even if these are bigger losses per case (as its in the business market) I cant believe that their will need to be the Billions put aside that PPI misselling caused.

  3. I don’t know anything about these deals but it sounds reasonable. If interests rates go up the consumer is protected and if they go down the consumer makes a saving on the interest paid which is used to pay the charges. Either way the consumer gains certainty and a prudent business will have built in a margin of profit.

    Unfortunately, like so many of these reports,. they are written with hindsight and conveniently forget the gain (lower interest) whilst complaining about the pain (higher charges).

  4. Problem is that Banks sold these products as a way to guard against interest rate increases, telling their customers that this would make them a safer risk in the Banks eyes. The reality is that as interest rates have moved against the customer the Banks have then decided that the customer is now a bigger risk and increased their margin So the customer is actually paying a higher rate and in some cases this has led to Bank calling in debt as the swap is treated as a negative on balance sheet and means that the customer has breached their loan conditions

  5. This latest probe, believes that the banks involved knowingly understated the LIBOR rates thereby reducing borrowing costs and capping investor panic. When artificial LIBOR is entered into the market, this inevitably leaves lenders and investors out of pocket but this is good news for borrowers, interbank and via LIBOR mortgage rates which track these.

    The LIBOR, in early 2009 was on the decline, meaning lower rates for borrowers tracking this indicator. However, in the last year the LIBOR has increased considerably and outstretched the current Bank of England base rate of 0.5 per cent. The LIBOR currently sits at 0.8 per cent which makes this rate the less attractive of the two tracker options.
    http://britainloans.co.uk/

  6. As a customer who was sold one of these rate swap derivatives, I think the banks are completely in the wrong, these products are very complex and should only be sold to large companies with professional financially qualified people, I truly did not understand it, but trusted Barclays who i had banked with for over 20 years, and their advice, this has cost me nearly £1m so far!, and who do you go to for advice anyway? five years ago these things were all new anyway. There will be a flood of these cases, but again they are difficult to bring as its not easy taking on the banks…… how many years has it taken PPI to be won? they have deep pockets, and employ the best lawyers, and many of the people they sold these to cant afford to fight them because there still to busy trying to pay them off in the first place….. don’t underestimate this there are many businesses in trouble because of these instruments.

  7. I fully agree with the comments regarding that the bank is in the wrong. My client unfortuntately signed upto one of these products and was recieving a mere £30 a month. When interests rates moved against him he ended up paying £4,300 a month. To get out of the arrangement he has been advised by the Bank that he will have to pay in excess of £330,000!
    The banking staff earned ten of thousands in bonus/commissions and have in my client case totally mismatched the investment to the type of business he is!

  8. We are a small business who were sold a swap in August 2008 by HSBC on a £545k loan to acquire a property. Nothing in the paperwork told me the cost (in excess of £4000 per month) or the cancellation charge of £250,000. We are stuck with it now for the next seven years, even if we pay off the loan. There is no upside as, should interest rates rise, the bank will wait until they are at parity with the fixed rate of 5.97% when they can cancel at no cost. We too have been with the bank for over 20 years and simply trusted our “business manager” for the best advice. Lesson – don’t ever buy any financial product from a bank without seeking professional advice. Our case has been lodged with the FOS in the hope of compensation for part of our debt. For those of you who fancy selling one of these products in order to get rich quick I’m afraid you may be in breach of securities law and could end up being prosecuted, as is the case with three banks in MIlan.

  9. This is an issue that has affected over 100,000 people, mostly owner-managed businesses.

    We have developed a free online assessment system which can be found at at ukswaps.co.uk

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