If so, it will undoubtedly be hurting.  I have worked as an expert on cases where clients have paid interest of 9% or more on fully secured lending, where businesses have gone into administration or liquidation, and where at the very least clients have suffered extreme stress and a huge loss in income and quality of life.

Of course your client is hurting if she is an African princess with an elongated neck, but that isn’t the subject of this article.  A structured collar is a sophisticated form of Interest Rate Swap Agreement (IRSA) regularly used by high financiers in Canary Wharf, but from about 2001 up to 31 January 2013 (the latter date is significant) sold by major banks to Small and Medium Sized Enterprises (SMEs).  And that’s where the trouble begins.

The banks have got into trouble with the FSA over selling IRSAs to non-sophisticated customers.  In an announcement on 31 January, the FSA says that sales of such products are inappropriate, and that bad sales practices have been revealed in 90% of a sample of such cases chosen for review by the banks!  These bad practices include:

  • Poor disclosure of exit costs (a £2m SWAP could cost as much as £300,000 to cancel);
  • Failure to understand customers’ understanding of risk (these contracts are in highly technical language which only financiers could expect to understand, yet in one case a couple who couldn’t even speak English were persuaded to have one);
  • Non-advised sales straying into advice (“I’m not authorised to give you advice, but you really ought to have one of these, and ours is the best on the market”);
  • Providing a contract for an amount higher than the loan being protected, and/or for a longer period than the loan;
  • Incentives (commission and bonuses) paid to the salesman not being declared to the customer, and
    • Poor record keeping.

And banks have pestered their customers, often over months, to agree to an IRSA.  In one case, the customer finally agreed in a recorded telephone call, when he told the bank that he was drunk because he had just had a liquid lunch to celebrate his birthday.

Things have been so bad that the banks have:

  • agreed not to sell “structured collars” to SMEs,
  • agreed with the FSA that selling a structured collar to a non-sophisticated customer is automatically mis-selling, and
  • agreed a procedure for payment of “fair and reasonable redress”.

So whatever is a structured collar, and how can it have done so much harm?

It works like this.  Let us say that the customer has a mortgage of £1m to buy the business premises, paying interest at 1% over base, and that at the time, base rate was 5%.  The bank approach the customer, and say that interest rates are likely to rise, and you need protection.  So enter this contract with us, whereby if base rate rises higher than 7%, we will pay you the extra.  But if base rate falls below 4%, you pay us the extra.  That way, you know the limit of your exposure.

There are three snags, perhaps obvious only to the sophisticated.  The first is that the bank are taking only half the risk of the customer, since the bank pays if base rate rises by 2%, but the customer pays if base rate falls by only 1%.  The second is that this is a long-term commitment, and a separate contract to the original loan, so it runs its course even if the loan is repaid early; the IRSA could be terminated early, but only on payment of a sum based on the NPV of the hedge likely to be payable for the remainder of the term – hence as much as £300k payable on a £2m IRSA.  Hence “poor disclosure of exit costs” – see above.

And the third snag is that interest rates fell, and fell again, so that customers are now paying far more with the “protection” of an IRSA than if they had gone with the flow – as most people do.  How many people find it necessary to deal with derivatives traders so as to protect the interest rate on their home mortgage?  Why then should such people with small businesses do so?  Yet for a £1m mortgage on business property, with a structured collar started when base rate was 5%, annual interest would now be at base + 1% on the mortgage (1.5%) PLUS 3.5% on the IRSA, an annual cost of £50,000 instead of £20,000.  This is a modest example compared with some I have seen, but even £30,000 a year can have a hugely damaging effect on a business.

Structured collars are an embarrassment to banks similar to PPI; they affect a smaller number of customers, but each claim is worth a huge amount, and banks have made huge provisions to pay redress.

So if you do have a client with such a problem, what do you do?  The redress should be fair and reasonable, and the banks’ FAQs state that the principles of tort apply.  The published redress procedure is for the bank’s agent to telephone the customer for a fact find, and say what they are prepared to pay, subject to review by an independent reviewer paid for by the bank.  But it is difficult to see how that would, for instance, reveal the full damage to a business’s profits from cash starvation.  For that, you need a forensic accountant to produce a report as if under CPR Part 35.

And I know just the chap for the job!  I already act for quite a few sufferers.  So if your client has neck ache, why not give me a ring?

Biog:  Chris Makin was one of the first 30 or so chartered accountants to become an Accredited Forensic Accountant and Expert Witness – see www.icaew.com.  He is also an accredited civil & commercial mediator and an accredited expert determiner.  He has given expert evidence at least 70 times and worked on a vast range of cases over the last 25 years.  For CV, war stories and much more, go to www.chrismakin.co.uk.