In January 2013, the FCA published what it found with regard to the pilot review scheme for the mis-selling of IRHPs, or interest rate hedging products, otherwise known as swaps. In a number of ways, the results were welcomed: the company found over 90 percent of sales to “non-sophisticated” customers did not comply with regulatory requirements, such as the COBS Rules. In addition, the FCA noted that most of these sales have the chance to result in redress to the customer.

However, there were changes made to the test this time, meaning some businesses that were otherwise excluded historically could not be a part of the review, but many who were previously reviewed were no longer eligible this time around.

Originally, a customer was categorized as sophisticated when they had at least two of these:

– over 50 employees; or
– a balance sheet of over £3.26m; or
– a turnover of over £6.5m

FCA Sophisticated Customer Review

However, in January, the parameters were revised so that if the business exceeds the thresholds for balance and employees but not turnover, it is not considered to be sophisticated. The rules were changed to exclude a business that had a value exceeding £10 million, which includes a considerable number of businesses, especially those involved with property; property businesses regularly have swaps that exceed £10 million but have a low figure for turnover and employees.

In addition, the changed rules note that if a business is part of a group, and if that group is sophisticated, then the business is also noted to be sophisticated.

Following these findings, there was a movement to challenge the changes that the FCA had made, especially with the removal of embedded swaps and professional customers. This went as far as adding a funding campaign to try to bring enough customers interested in challenging the review and to pool resources, leading to the launch of judicial proceedings this past April.

Unfortunately, the review did not succeed in its process; claimants were provided a month of time to plead the issues again in order to move on past the sift process and to go to the next point. However, at the most crucial point of the process, the group ran out of funding for its services. Because it had no more investment to offer, it was not possible for the group to proceed to success, and the judicial review has therefore derailed recently as a result.

What does this mean for those who are excluded from the process? Customers with live hedging beyond £10 million remain outside the review, as are professional and intermediate customers and those with embedded swaps. Those who are outside of the review may only intervene with court action.

It is obviously bad news for those looking to be included in the FCA review process that the judicial review was met with failure. Unfortunately, the only option now for those looking to be included is the Financial Ombudsman route if a small enough business, with litigation being the other option; anybody who looks for court action should think about the ability to enter a Standstill Agreement or working to preserve their position.

The criteria that was outlined above remains a part of the sophisticated customer test, but the way they are applied as changed, as previously mentioned. Only customers who meet the employee and balance sheet numbers can be included, provided the live IRHP is up to and not exceeding £10 million. Subsidiaries of a large group will be excluded from the review, and company groups that cannot take advantage of the Companies Act 2006 for lighter reporting requirements can also expect to be excluded.

The FcA recently published a flowchart to help determine whether or not a business will qualify as a sophisticated customer or if it would be classified as a non-sophisticated seller under the new sophisticated customer test. Though it has not been mentioned explicitly within the pilot findings of the FSA, this flowchart shows where one has an aggregate notional value of live IRHP over £10 million after a sale was completed, then they will be sophisticated. This may include excluding customers with large exposure that would otherwise be listed as an unsophisticated customer to the test.

FCA Sophisticated Customer Test Flowchart

Interest Rate Swap News

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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.