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Interest Rate Hedging Products – are you ‘sophisticated’?

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In the summer of 2012 the FSA announced an agreement with certain banks that the banks would review the sales of interest rate hedging products to ‘unsophisticated’ customers and where mis-selling of such products was established that banks would give customers ‘fair and reasonable’ redress.

The test to be applied to establish whether a customer was ‘unsophisticated’ or ‘sophisticated’ became known as the ‘sophistication test’; it provided that a customer would be deemed to be ‘sophisticated’, and therefore ineligible for review, in the following circumstances:

The ‘sophistication’ test was refined on 31 January 2013 in the FSA’s Pilot Findings. The changes are intended to ensure that the review is focused on the correct customers and does not exclude/include certain customers.

The current test set out in the Pilot Findings, pending clarification from the FSA for the reasons set out below, is identical to the above test with the following factors also taken into account:

The reason we suggest clarification is required is that the FSA produced a flowchart alongside the Pilot Findings which at first glance appears helpful, but, in fact, when compared with the test outlined in the Pilot Findings it becomes apparent that the two are not accurate reflections of each other.

The test as set out in the flowchart produced alongside the Pilot Findings is as follows:

The problem presented by the flow chart is that it suggests that ALL customers must satisfy the requirement for a hedge value lower than or equal to £10m to qualify as non-sophisticated and therefore be eligible for review, whereas the Pilot Findings themselves suggest that the £10m limit should apply in two distinct situations only: to businesses with turnover of less than £6.5 million, a balance sheet exceeding £3.26 million and more than 50 employees; and to business which are SPVs connected to but not part of a group structure. Commentators are therefore seeking clarification in this regard.

If you require assistance in assessing whether you fall into the non-sophisticated category eligible for review, please do not hesitate to contact Dominc Blakeley in the dispute resolution team. For further discussion on the Pilot Findings click here.

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