While the payment protection insurance scandal is still being felt across the UK, another scandal is growing on the financial scene as interest rate swap mis selling is becoming a very significant issue. With banks now already setting aside billions of pounds, they are now forced to set aside more money to cover this new interest rate swap mis selling scandal.
What are Interest Rate Swaps?
Basically, an interest rate swap is a financial product that was sold to a great number of businesses in conjunction with their loans to protect them against rising interest rates. In theory, this type of swap seemed practical on the surface since the value of the product would act as a hedge against the rise in interest rates.
What Went Wrong with the Swaps?
While the swaps were described to be similar to insurance in their effect, they were actually derivative products that actually backfired in their effect. When the recession hit, many of the companies that participated in these swaps were left with rates that were unexpectedly very high.
Who Stepped In?
Britain’s Financial Services Authority conducted a series of 173 tests on these interest rate swaps that were based on the actual transactions that occurred. In over 90% of the cases, it was revealed that at least one or more regulatory requirements were violated.
Furthermore, the sophistication of these swaps meant that many of the firms that didn’t conduct any in-depth research were simply not clear about the potential effects or even what they were truly buying into when engaging in these swaps.
Why are Larger Businesses Complaining about the FSA caps?
The Financial Services Authority has imposed a 10 million pound cap on all claims made against the lending institutions for the mis-representations of their interest rate swaps. While the losses of many businesses do not reach these heights, the larger companies that were mis-sold the products lost considerably more.
However, the Financial Services Authority deemed that these larger companies had the resources to contact lawyers and financial experts that would have warned them about the dangers about these interest rate swaps. Although it is admittedly debatable that lawyers from smaller provinces or even many accountants would have been able to predict the impact of the recession and its effect on the value of these products.
Of course, the cap limit means that the banks and lending institutions are protected as well from losing far more money to the larger companies that bought into the interest rate swap mis selling products.
What has been the Impact?
Basically, many of these businesses where hit harder than those who were mis sold payment protection insurance in terms of the impact alone. Many people and businesses that invested in these interest rate swaps lost practically everything as these products were simply toxic in their effects.
For the smaller investor, they are going to be compensated as their losses are less than the 10 million set by the FSA. But for larger institutions that lost so much capital, they will not be fully compensated for their losses and the result may take years to sort out.