An interest rate swap  (IRS) is a financial derivative product that consists of the profits from interest rate instruments. Professionals who are working in the hedging or speculating areas of finance often find these products attractive.

Interst Rate Swap Update: 

The first compensation payment for a firm mis-sold an interest rate ‘swap’ has been made – more than a year after the regulator ordered the banks to pay out. 

Swaps are insurance policies designed to protect against interest rate movements and were widely sold to businesses taking out loans between 2001 and 2008.

Regulators last year ruled that the banks had mis-sold swaps to about 40,000 firms, and the big four UK banks have set aside around £3bn in provisions to cope with potential claims.

Interest Rate Swaps

Essentially, two parties exchange interest rate cash flows, and the agreed upon contracts will specify the details of these exchange transactions. Hedging and speculating can be made more palatable with an additional product such as the IRS. The IRS will give more of a safeguard against a volatile market. Investing in interest rate behaviors often will soften a loss or add to a gain by either party. This type of product is similar to an insurance or assurance of a lesser kind of loss.

Structure of an Interest Rate Swap Product

Like any financial product, especially one that is derived, the IRS is made up of several different types of options that the buyer can select from. For example, each party may agree to pay either a fixed or floating rate by using a selected currency. The rate or fee is then multiplied by a principal amount, and a mathematical factor is determined by the timing of the rate swap. The size of the cash flow is often decided by alternative currencies selected by both parties. The calculation of the rate swap is, of course, a product of a mathematical formula.

Example fo an Interest Rate Swap (IRS)

For example, one party may decide to use a fixed rate against a reference rate, such as the LIBOR or EURIBOR. The financial markets determine these reference rates. Each party will gain from a determined formula set against certain market references and the timing of the exchange or rates. A floating rate is the norm across most of the financial markets. This floating rate may be compared to the reference rate, and the profit is gained.

Mis-Selling of these Swap Rates

As of late, there have been many market stories about the IRS’s being mis-sold. News events have occurred that have delineated the scandals involved in these market rates being inaccurate.

Initial use of these Rate Swaps

Initially, these rate swaps were created to allow international companies to profit from exchange deviations. With this beginning structure of hedging and speculating, the interest rate swaps took on more of a protection-type role against exchange hazards. When these instruments began to move into the popular and public markets, the IRS’s were unable to buffer themselves against the scandals that ensued. These interest rate swaps became popular for arbitrage opportunities. The credit-worthiness of various companies that were purchasing these rate swaps became a modern issue.

Mis-Selling of Interest Rate Swaps

Mis-selling of interest rate swaps began almost immediately. Since the IRS product was created for hedging and speculating among mostly private parties, the problems were initialized from the beginning. It seems that the financial instruments were not robust enough to take on a popular application. The buyers perhaps were not so credit-worthy, and the brief explanations of what was being sold were not adequate. The public investors began down a road of no return, it seems. The gains from purchasing these products seemed to be the selling focus. Little was understood about the exact nature of what was being purchased, however.

British Financial Authorities

British local authorities became involved in June of 1988 through the Audit Commission. It appears that a worker with Goldman Sachs became concerned about the validity of an interest rate swap transaction. There appeared to be a strategy of allowing the interest swap product to fall, and then profiting from the short sale-like scenario. After a lengthy investigation and a court decision, the contracts that had been purchased were declared illegal. There were five banks involved in the contract purchases that were determined to fall.

Claiming for Compensation

Whether the purchase was for a British company or for a public investor, the fall of the interest rate swaps was damaging to many. Small businesses were among the public purchasers of the IRS’s. Lenders had sold these complex financial contracts to small companies without explaining most of the risks involved. Many of the companies that purchased these financial contracts were unfamiliar with most financial transactions of this type of complexity. Small purchasers included pub owners, home-care operators, veterinarians, and hauling businesses. The small companies were offered this kind of contract when they went to their banker in order to take out a loan. The borrowers were instructed that the interest rate swap would provide a kind of insurance or hedge against the risk that interest rates would rise.

 Risks involved with Interest Rate Swaps (IRS)

The risk of the interest rate swap includes the possibility that the interest rates will fall from a natural progression. In this instance, the hedge or interest rate swap is unnecessary and costly. The small business borrowers are stuck with a financial product that is not needed. In order to cancel an interest rate swap, the borrowers were often told that a high cancellation cost would be in effect. The lender may be able to cancel the hedge without paying a compensation fee, also.

What to do about an IRS Claim

Four banks that include Barclays, HSBC, RBS, and Lloyds have set up a review committee to look over any contract that a buyer deems to be mis-sold. The businesses that seem to be affected are contacted by the banks in order to tell them that they are eligible for review. Information is then provided to the bank, and the review for a compensation payment is begun.


Interest Rate Swaps Resource

Small Business Disillusioned with mis-sold Interest Rate Swaps

Many businesses have become disillusioned due to the compensation schemes set aside for the interest rate swap mis-selling derivatives. The Financial Services Authority has agreed to look into the cases of the mis-sold financial products of the big four banks (Barclays, Royal Bank of Scotland, Lloyds, and HSBC). There are several other banking institutions that have become involved in this Swap claims dilemma, also.

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£10m Interest Rate mis-selling complaint against Lloyds by Alan Sugar

Lord Alan Sugar has sent a formal letter of complaint to Lloyds Bank for “mis-selling” of an Interest Rate hedging product. The apparent Break free sum amounts to £10m which was attached to the interest rate hedging product Lord Sugar used on his property.

The derivative was to protect against interest rate rises on a £97m Lloyds loan. Lord Sugar is undersatood to be considering legal action if the complaint is unsuccessful

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Interest Rate SWAP Claims

Maple Leaf Financial have a specialist team of solicitors dedicated to dealing with the mis-selling of interest rate swap protection products by the banks. We are happy to review these relatively complex swap arrangements and to claim compensation for our clients where appropriate.

If you believe you have incorrectly been classified as a ‘sophisticated’ customer and have, therefore, not been eligible for interest rate swap redress. Maple Leaf Financial will review your interest rate product and we will be happy to discuss your individual concerns and requirements

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Tim Capper reports on Financial Mis-Selling for Maple Leaf Financial. Our aim is to ensure you get honest advice and proper guidance to ensure a suitable recommendation can be made to pursue a financial claim

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Tim Capper

Bringing you financial news and information in plain english for Maple Leaf Financial. My aim is to help readers understand these often complex financial instruments.