Monday, March 19, 2012

UK Financial Regulators Probe Interest Rate Swaps

By Olivia Wang, PhD and Tim Dulaney, PhD

The Financial Times reported yesterday that the Financial Services Authority -- the counterpart of the SEC in the UK -- will investigate the possible mis-selling of interest rate swaps by banks, including Barclays. The regulator decided to look into the issue after The Telegraph provided detailed information about the potential misconduct of banks when selling interest rate swaps to small businesses.

In one of its reports, the Telegraph details a situation in which a manufacturing company owner was caught up in an interest rate swap sold by Barclays.
“It was stipulated that I had to take out cover for the period of the loan, which was for three years. What they sold me was a 10-year swap deal,” he said. “I am a young entrepreneurial person taking my first step into this and trusted the bank.” Mr Hawkes said no one from Barclays Capital, the investment banking division, sat down with him to explain the implications of taking out the swap.
Despite the bank’s emphasis in its presentation that “interest rates had 'never' fallen below 3.5pc,” when the base rate dropped below the floor-rate structured into the interest rate swap Mr Hawkes ended up paying much more than he expected. Naturally, Mr Hawkes wanted to exit his position in the swap, until he was told that he faced a termination fee of £160,000. “I saw it just like a house mortgage where I fixed the rate. I did not understand there would be such a large break fee,” said Mr Hawkes. Stories like these raise the question of whether banks should sell such products to unsophisticated retail investors.

We have worked on several cases involving the mis-selling of interest rate swaps by banks here at SLCG. Swaps can be very useful and powerful instruments that can help hedge interest rate exposure; however, interest rate swaps can also cause great harm when sold with complex or unclear terms. Investors should be very careful when entering into any such agreement, and should consult with experts in interest rate swaps to ensure the terms of the deal are fair and adequately meet their financial objectives.

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