These fiendishly-complicated financial products have left thousands of SMEs repaying their debts at a considerably higher rate of interest than they should be.
At the beginning of this year, the Financial Conduct Authority (FCA) said it believes many of these products were mis-sold and it is now carrying out a full review of interest rate swaps sold to small businesses by four of the big banks.
From mid 2005, many high street banks began selling complicated financial instruments known as Interest Rate Hedging Products (IRHPs or “interest rate swaps”) to thousands of SMEs that were looking to obtain a loan. In simple terms, the banks sold IRHPs as a form of insurance that would protect the company if the interest rates on their loan repayments were to rise above 5 per cent.
Few of those taking out the products stopped to check what would happen in the event of interest rates falling. When interest rates were cut to 0.5 per cent in 2009, many businesses that had taken out swaps saw their payments increase dramatically.
Added to this, the complex agreements meant that any business wishing to terminate the loan insurance would have to pay hefty fees, which often greatly outweighed the value of the loan. These and other more complicated interest rate hedging products were usually sold to businesses with little explanation of the risks involved. Many customers simply did not understand what they were signing up to.
The banks are now beginning to asses 32,000 cases where the FCA believes there has been wrongdoing, and they have collectively set aside £2bn to cover these pay outs. But this could be just the tip of the iceberg, as many analysts believe the true value of the compensation the banks have to pay will be much greater.
The “Consequential Loss” to an affected business is potentially far greater because it covers the long-term impact that the IRHP has had on the entity. For some companies, this additional and ongoing payment could have prevented them from making further investment into properties or perhaps other business ventures – resulting in the loss of huge potential earnings.
Perhaps one of the more detrimental impacts of an IRHP is the effect it has on the businesses ability to attract investors.
For any company looking to raise additional capital, their gearing is always an important factor, and large debts are a huge put-off to those looking to invest. Therefore, a business which has been trying in vain to raise capital since the interest rates dropped to 0.5 per cent could be considered to be lacking in several years’ investment potential, due to the negative impact of their mis-sold insurance.
The problem is that consequential losses are much harder to quantify than the straightforward numeric value of an overpayment. While overpayment for a mis-sold product can be calculated simply by totting up how much the business paid each month, working out the value of consequential loss is a more delicate task.
A forensic accountant needs to ascertain whether there has been any consequential loss stemming from the IRHP. Usually this involves a discussion with the business owners to understand their story, and discuss what areas of the business they feel have been impacted.
In the first instance, the accountant must ascertain which of the consequential losses they feel are valid for each claim before beginning the difficult process of giving a numeric value to them.
For business owners who believe they have been mis-sold IRHPs, it is important to get expert advice, as many SMEs could have substantial losses that they should not have incurred.
As the first 32,000 cases are assessed by the banks and the FCA in the coming months, the true scale of the scandal will become a lot clearer.
Rafi Saville is a partner at Fisher Forensic, part of chartered accountancy firm HW Fisher & Co.
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