During the past few years, many banks have advised small-business borrowers to make use of interest-rate derivatives, notably interest-rate swaps. An interest-rate swap is a means of exchanging (i.e. swapping) a variable-rate loan for a fixed-rate loan. The customer pays a fixed swap rate, plus an agreed surcharge (‘mark-up’) on the loan. The variable-rate interest payable under the terms of the original loan is offset by a countervailing flow of variable-rate interest paid by the bank under the terms of the swap, so that the two flows cancel each other out. This is how the interest rate is fixed.
Although interest-rate swaps are regarded as complex financial instruments, they tended to be arranged as snap decisions, and many banks failed to properly inform their customers about the specific risks associated with the combination of a swap and a loan.
It has now become clear that banks had a practice of charging hidden mark-ups on interest-rate derivatives, as a result of which customers paid interest at a fixed rate that was higher than the market rate. This also meant that swaps already had a negative value when they were issued. With interest rates in permanent free-fall since 2008, the negative value only increased over time. The consequence was that borrowers were able to repay or roll over the underlying loan only if they were prepared to pay the swap’s negative value to the bank at the same time. And experience has shown that other banks were not prepared to lend borrowers money to pay this ‘fine’.
The upshot of all this is that what appears in theory to be a flexible, variable-rate loan is in fact not flexible at all: although the borrower remains entitled to repay the loan free of charge before its maturity date, he or she is then saddled with a hefty ‘fine’ to cover the swap’s negative value.
Moreover, the swap’s negative value means that the customer has to meet what is known as a ‘margin requirement’. Banks are under a statutory duty to ensure that their customers have sufficient funds in their accounts to meet their margin requirements. In other words, banks have a duty of care to monitor their customers’ margins and account balances. This means that, if a customer sees their liabilities running up – for example, as a result of falling interest rates, the bank is required to ask the customer for additional security. This is known as a ‘margin call’.
In the case of interest-rate swaps, the solution usually adopted for this problem has been the use of what are known as an ‘internal credit limit’. Different banks tend to use different terms for this, for example ING refers to an ‘allowance facility’, ABN AMRO calls it an ‘OBSI limit’ and Rabobank talks about a ‘treasury exposure limit’ or an ‘agreed sum’, but they are all basically the same type of facility. They all involve the opening of a credit facility, which provides the bank with a source of the security that it needs (on paper) for meeting its margin requirements relating to the negative value of the derivative.
In many cases, the bank tells the customer that the credit facility comes free of charge. The problem, however, is that this type of internal credit limit has the effect of degrading the customer’s risk profile, which may cause the bank to raise the interest mark-ups and/or to refuse to grant the customer any further loans. Moreover, it may make it impossible for the customer to roll over an existing loan.
The Uniform Recovery Framework for Interest-Rate Derivatives Sold to Small and Medium-Sized Enterprises (UHK)
A great deal of criticism has been levelled in recent years at the way in which banks have sold interest-rate derivatives to their customers. In 2016, the controversy surrounding the issue spurred the then Dutch Minister of Finance to set up an independent committee, known as the Derivatives Committee, that was tasked with agreeing a recovery framework with the banks. The Committee has since published a document entitled the Uniform Recovery Framework for Interest-Rate Derivatives Sold to Small and Medium-Sized Enterprises, or UHK for short.
In recent times, many small-business account-holders have been informed by their banks that they are eligible for a compensation payment under the UHK scheme. Any account-holders who were not notified by their banks that they were entitled to compensation could still register for compensation themselves – in theory, as long as they did so by 30 September 2017. However, if you believe that you should have registered for compensation but did not do so by the 2017 deadline, our advice to you would be to register anyway as the 2017 deadline has not been strictly enforced and banks have been accommodating to their customers.
Is going to court an option?
In many cases, there’s a good chance that you can obtain a higher – perhaps even a much higher – level of compensation by going to court rather than applying for compensation under the UHK scheme. This is because the court takes account of all relevant factors in assessing the extent of your loss, including the degree to which the bank failed to observe its duty of care. This is something that is not done in assessing compensation payments under the terms of the UHK scheme, where the amount offered by the bank is intended to be ‘in full and final settlement’. In other words, if you accept the amount offered under the UHK scheme, you automatically forfeit any rights you might have against the bank in connection with the swap that was sold to you.
Our SWAP team
Interested in obtaining a legal opinion on a compensation payment to which you are entitled under the UHK scheme? Or would you like to find out whether there’s more to gain from court action? Why not get in touch with the Swap Team at RWV Advocaten? Matthy van Paridon, Harjo Bakker, Marco Anink, Jasper Schnezler and Elias van Mourik are all specialists in interest-based derivatives, including interest-rate swaps. In addition to regularly advising, litigating and publishing on derivatives, our Swap Team also assist a wide range of customers in obtaining compensation under the UHK scheme and negotiate with banks on matters such as the refinancing of loans.
Why not watch one or more of our 12 webinars on interest-rate derivatives?
You may be interested to hear that we have recorded 12 short (Dutch-language) webinars on the subject of interest-rate derivatives. If you’d like to find out more about derivatives, it’s simply a question of clicking on one or more titles listed below.
The first webinar is a general introduction. In the second webinar, Marco Anink explains what interest-rate derivatives, and interest-rate swaps in particular, are designed for and how they work. In webinars 3 to 9, he goes into the things your bank may not have told you about your derivative. He also explains how much compensation you can obtain from the courts for each individual risk, and how large the compensation payment is that is offered under the UHK scheme. In webinars 10 and 11, Marco goes into the UHK compensation scheme, explaining the circumstances in which you are entitled to compensation, whether it’s a good idea to accept an advance payment, and how your compensation payment is assessed. The series concludes in webinar 12 with a discussion of various points relating to limitation periods and the complaints procedure. Key here is the need to decide as quickly as possible after you receive either an offer or a notice of rejection whether you wish to take the matter to court.
The webinars (in Dutch):
- Rentederivaten: wat komt er aan de orde? (General introduction to interest-rate derivatives)
- Wat is een renteswap en wat zijn de haken en ogen daaraan? (What is an interest-rate swap and what are its pros and cons?)
- Risico 1: opslagverhogingen op de lening (The first risk: a higher interest mark-up on your loan)
- Risico 2: gevolgen van de negatieve waarde van uw rentederivaat (The second risk: negative value)
- Risico 3: verborgen provisie (The third risk: hidden fees)
- Risico 4: mismatches en overhedges (The fourth risk: mismatches and overhedges)
- Risico 5: renteverwachtingen en rentevisies (The fifth risk: projecting future interest-rate movements)
- Risico 6: de extra kredietfaciliteit en de Margin Call (The sixth risk: the extra credit facility and the margin call)
- Complexe, ‘gestructureerde’ derivaten (Complex, structured derivatives)
- Komt u in aanmerking voor de compensatieregeling van het UHK? (Are you eligible for a compensation payment under the UHK scheme?)
- Moet u een voorschot accepteren? En is uw vergoeding wel juist berekend? (Should you accept an advance payment? Has the size of your compensation payment been properly assessed?)
- Verjaring en klachtplicht (Limitation periods and complaints)