The selling of interest rate swaps to Small and Medium Enterprises (SMEs), by the high street banks, looks set to engulf those institutions just as they seem set to deal with the final froes of the PPI mis-selling pay outs.
The final bill for is set to be billions, again, and it is set to be another fair showing of our banks being driven by greed. This time, the ‘victims’ are those at the very heart of small business in Britain. They are farmers, bar owners, restaurant bosses and it is estimated that thousands have been affected.
I know all about interest rate hedging as I sold structures when I worked in banking. Before I set up Benchmark Treasury Pricing. I wanted to enable SMEs to have independent advice and access to live market pricing.
Hedging is intrinsically a complicated bet against interest rates changing, using derivative products. Many SMEs who borrowed money before the financial crisis of 2008 were forced to accept interest rate hedging as a condition of the loan, to insure against major upward swings in interest rates leaving them unable to make the repayments. But when interest rates went the other way in 2009, plunging to the record lows at which they now stand, many borrowers were left facing six-figure bills as a result of the interest rate swaps they had been sold.
The problem originates in how banks sell the structures, the excessive profits made and the customer’s lack of ability to make an informed decision - they are relying on information provided by their bank, which may not explain the whole story, such as the potential cost of coming out of the hedge, should it be settled early, for example.
I have found it is common practice to highlight the rewards of any given structure whilst not identifying the risk. It is also common to put in place unnecessarily complicated structures, which generate more profit, where a simpler structure would be more appropriate.
Bank salesmen are under intense pressure to hit ever increasing targets and hedging is very lucrative. The practice continues today.
I believe that FSA rules and regulations surrounding banks being clear, fair and not mis-leading are not being met. I also believe that banks are not ensuring that their customers understand fully the products that are being sold to them.
But many of the thousands of SMEs hit by this alleged mis-selling face a fight to even get their cases to court. It seems the only route open to them is litigation but the cost of taking on their bank is one which most cannot afford.
The cases seem to be too vast, too expensive and too complex for many solicitors to act on a no-win, no-fee basis, so have been stacking up without action. The Financial Ombudsman Service has strict thresholds for complainants, and has also hinted that it won’t take on cases worth more than £150,000.
The SME hedging cases do however appear to be potentially lucrative for investors and funds willing to pump millions of pounds into funding the litigation, in return for a slice of the eventual pay outs.
One company, Norton Accord, which acts as an introducer to different litigation funding models for claimants, has 30-plus SMEs ready to take on the banks, and is working with seven different law firms.
There are estimated to be 4,000 ‘fundable’ claims out there, with the average pay out being between £2m and £4m and the average length of litigation being between 12 and 18 months.
Hedging is and was a good theoretical principle, but the way they were sold to SME’s by the banks, the profit based incentive, and the fact that clients were not properly informed about what they were taking on has caused a further mis-selling scandal which could cost the banks - and the tax-payer - billions.
James Ducker is a former financial markets advisor at Lloyds Banking Group who is now a director of Benchmark Treasury Pricing, the FSA-regulated firm he founded to advise customers on FX and Interest Rate Derivatives.