FSA has published an update on its work and findings relating to the sale of interest rate hedging products. It found serious failings in the way banks sold these products to small and medium-sized businesses (SMEs). FSA found that, although these products can be appropriate when sold in the right circumstances, they will often not be appropriate for unsophisticated investors. FSA noted four types of interest rate hedging product:
- collars; and
- structured collars.
It had most concerns about structured collars, as these require a very finely balanced judgement from the customer if they are to work in the customer’s favour. Many SMEs complained they thought they were buying products to reduce vulnerability to interest rate increases or fluctuations on loans, but did not get an adequate explanation of the risks involved. FSA found evidence of practices among large retail banks that included:
- poor disclosure of exit costs;
- failure to ascertain the customer’s understanding of risk;
- non-advised sales which in fact gave advice;
- over-hedging; and
- rewards and incentives as drivers of all these practices.
FSA wants to address the problems quickly, and has reached agreement with the four largest banks on a plan of redress. It has communicated its findings to each bank. The agreement involves each bank:
- providing redress on all sales of structured collars made on or after 1 December 2001 to non-sophisticated customers. The banks will no longer sell these products to retail customers;
- reviewing sales to these customers since that date of all interest rate hedging products except caps and structured collars; and
- reviewing sales of caps to these customers if they receive a complaint during the review period.
An independent reviewer will scrutinise the exercise, and there will be a method to work out fair and reasonable redress for affected customers. FSA intends to contact all other banks that may have sold these products with a view to agreeing a similar exercise with them. (Source:Interest Rate Hedging Products)