Partner Article

Swaps and mis-selling

Over recent weeks I have noticed increasing coverage in the press on swaps, and more specifically on allegations that they have been mis-sold. I don’t want to jump on a bandwagon, or indeed start one rolling, but there is no doubt that this is a potentially huge issue for the banks.

Let me start by saying clearly that swaps do have a very real place in mitigating the risk of adverse movements in interest rates, foreign currency rates, and commodity price fluctuations. However it is worth remembering that a swap is just that – you are exchanging (normally) a variable rate for a fixed rate.

The Banks have realised that swaps are a very lucrative source of income and have sought to broaden their appeal by designing more and more types of contract and by making them available to ever-greater numbers of clients.

Some of these contracts are now so complex that you really do need to be very financially aware to understand the mechanics and the potential downsides. There are a myriad of types of contract, normally centred on interest rate management that, to one degree or another, help to mitigate exposure to the
movement of interest rates. The problem has arisen where bank customers have entered into these contracts without having fully understood the ramifications.

The sale of these instruments is regulated and as such only appropriately qualified staff can discuss with clients. So what has gone wrong? Well, many of the complaints appear to be coming from smaller, perhaps less financially complex customers who claim that they had not been properly advised at the outset. I have read about one case where Turkish customers with a poor grasp of English had entered into a contract.

A more complex complaint relates to LIBOR. These contracts are predicated using LIBOR, as are the break fees. There have been allegations that the banks have varied LIBOR in their favour in order to increase profits and break fees.

It is far from clear whether there has been any wholesale wrongdoing by the banks so if you have a swap and you expect the bank to roll-over I am afraid you will be disappointed. The bank will have calculated the rates for the swap based on it’s intended term and if asked to break the contract early they may well ask
you for a break fee based on the forecast of lost income. It is not unusual for these fees to run in to tens of thousands of pounds.

If you have a swap, or similar interest-rate-management contract in place about which you have concerns, then you should seek advice as soon as possible.

This was posted in Bdaily's Members' News section by Phil Dibbs .