In June 2012, the FSA published the findings of their review into the sale of interest rate hedging products to small and medium sized businesses (‘SMEs’).
The FSA “found that when properly sold, in the right circumstances to the right customers” hedging products “can protect customers against the risk of interest rate changes.” However, they cautioned that some sales to ‘non-sophisticated’ businesses “may not have been appropriate for their needs.”
The initial review included Barclays, HSBC, Lloyds and RBS (including Natwest) and the FSA has reached an agreement with those banks on the next steps they will take. Another seven banks agreed to participate in the exercise namely Allied Irish Bank (UK), Bank of Ireland, Clydesdale, Co-operative Bank, Northern Bank, Santander UK and Yorkshire Bank.
The term ‘hedging’ describes ways that borrowers can manage the costs of their loans using financial products called Swaps, Caps and Floors. As at 31st December 2011, there were reported to be nearly £2 billion+ of sterling denominated interest rates swaps and options outstanding globally with non financial institutions. More than 9 out of 10 were swaps.
This paper looks at why and how SMEs ‘hedged’ loans from banks at the time, what issues were highlighted in the review and whether Swaps, Caps and Floors still have a role to play in the future. What can borrowers and lenders do to re-build mutual confidence in these essential hedging instruments, especially now interest rates are still at historic lows.