The Impact of Swap Based Treasury Loans (Interest Rate Swaps) – on SME’s & Large Companies

Treasury Based Loans Using Stand Alone & Embedded Interest Rate Swaps – Impact on SMEs & Large Companies.

By Terry Mulvenna Workout & Corporate Finance Specialist.

The impact of the almost imperceptible change from Banker/ Customer Relationships moving from being one of Agency (no conflict of interest, pre-default) to one of confrontation (based on caveat emptor and contractual exclusions) has come to a head since 2009 because of the impact of Treasury Based Loans (TBLs).

More recently, 2012+, this confrontation has become more heated, as increasing losses have crystalised from the mis-sale of these TBLs, and redress has been denied to customers, especially those that have been made insolvent or bankrupt.

TBLs are essentially Fixed Rate Loans (FRLs) where the “Fix” is derived by an Interest Rate Swap (IRS), its derivative or synthetic/ surrogate. These TBLs were perfected in the late nineties and widely sold to SMEs late 2006+ to protect the banks from falls in interest rates.

In addition, to improve Bank profitability, TBLs also enable Banks to “arbitrage” customers’ lack of knowledge and the Banks interest rate data monopoly.

Please note, that the stated reason banks sold these products was to protect their customers from “rises in future interest rates.” This “protection” was often sold on a “predicated” basis, the predication being introduced late in the application/ renewal cycle.

Essentially, IRSs give rise to undisclosed running (margin calls) and termination losses (Breakage Costs) because of movements in current and forward interest rates. The implications of both the margin calls and Breakage Costs (BC) were not disclosed to the customers and are based on the dynamics of movements in the forward market in interest rates. These movements in rates, impact on the TBL by the process of Discounted Cashflow Analysis, on which the valuation of IRSs are based.

TBLs are essentially totally rigid vis a vis SMEs as they are locked within the terms of the IRS’s Amortisation Schedule and the TBL’s Terms & Conditions.

The concepts of forward rate curves, Swaps and their valuation being driven by the dynamics, and mathematics, of Discounted Cashflow are all alien to SMEs and most businesses who are totally risk averse regarding Capital risk. Most SMEs are also mathematically and Derivative illiterate.

The Banks also “hedged” their positions regarding the IRSs by making them cancellable, often totally at their volition.

1. Essential Pre-Understanding

Before describing the process and effects a Stand Alone or Embedded Swap have on a business entity, it is necessary to appreciate the role of Commercial Banks in the economy in general and their role in lending to SMEs in particular. The role of Security in Lending is critical to that lending process and to the Default/ Collections process which essentially backstops this lending process.

This analysis would normally be classed as “potty training” and relegated to an Appendix. However, the philosophy and impact of the Treasury Based Loans (TBLs), sold by UK Commercial Banks (1997+) is so far from normal historic UK (and most other countries) banking practices that it is included in the main body of this report.

Treasury Based Lending, related to SMEs, can be classed as predatory and deviant in that its rigidity undermines the SME by its very design and implanting process. The espoused characteristics of the simple, simple fixed rate loan, that it is “simple” and “flexible,” are the opposite in practice: total rigidity with absolute adherence to the Amortisation Schedule, save that the margin (on a Fixed Rate Loan! – FRL) can be increased, without default occurring.

2. Simple Economics

2a. The Basis of Banking

From an economic perspective, Commercial Banking is seen as a key Primary Economic function. It is the link between Macro and Micro economic activity. One key function of Banking is the process of Financial Intermediation: the linking of savers & borrowers. Idle funds are collected from savers in return for a reward, interest, on their deposits. These funds are then on-lent by the Bank to businesses needing funds in return for fees and interest. The bank makes a profit on its “turn” and the business puts these funds to work, hence creating products and services. This process produces employment etc. Banks (and Casinos) are the only businesses whose main stock in trade is cash – a commodity all other businesses crave. Via fractional Reserve Banking, Banks can generate their own stock in trade.

The Commercial Banks role in financing SMEs is particularly important as these firms have nowhere else to go. The SMEs role in employment creation is also critical, being the largest source of employment and job creation in a capitalist economy.

Lending to SMEs is, however, intrinsically risky. The viability of the business is the best security for any lender, BUT in the real world, this viability has to be backstopped by perfected Banking Security. Security is the key to successful lending – it is last, but not least. Tangible security is the preferred means of offsetting the intrinsic riskiness of SME lending.

As successful businesses (and their owners) build up profitability, they also build wealth, both within and outside the business. This wealth can be used as security to backstop any residual risks to the bank.

Perfected, Banking Security is easily foreclosable upon, if/ when a business defaults. This aspect of foreclosability is known to borrowers, although the extent of the Banks favourable legal status has been publicly toned down in the last 30 years.

The main pillar of any successful economy is a fully operational Commercial Banking system. The role of the bank is to add value to its borrowers’ business via relaxing the SMEs financing constraint (cash availability) hence allowing the entity to grow faster.

When successful, this is a ‘win, win, win’ situation: the business grows faster; the bank grows its income; and the economy grows quicker, employment is created and taxes are paid/ collected (and paid) by all parties.

Commercial Banks are the key stone of capitalism: by financing SMEs, Banks facilitate a massively Positive Sum Game that drives production, employment and economic growth: 1 + 1 = 3, hopefully 3++ !

Banker/ Customer relationships are symbiotic relationships: the bank being the parasite which provides the essential ingredient of cash liquidity to cash starved businesses. In return for this rare ingredient, the Bank is rewarded with an income stream from lending and fees for services provided. When successfully applied by an SME, this wonder ingredient (cash), allows the SME to grow much more rapidly than relying on its own ability to generate funds. This process not only assists the entity owner, and banks, to enrich themselves but benefits the whole community by wealth and tax creation/ collection.

2b. Banking Principles.

2b.i. Business Basics.

An entity’s Trading Requirements are market driven (product, final and raw material markets, plus production processes). Assets are therefore derived by basic market needs: financial speculation apart, the reason for a business holding assets is that these assets are required to service customer needs. Servicing/ satisfying customer needs produces the sales which drive the cashflow and profitability of any business.

Assets are the tools of the business and are not required per se: asset structures therefore drive liability structures, not the other way round.

2b.ii. Term & Tenor.

Subject to entity viability, success in lending/ borrowing is based on matching Term and Tenor: the longer the term of the asset, preferably the longer the Tenor of the Loan. Ideally, Term and Tenor should match. Banks cannot match the funding requirements of long term assets due to funding, liquidity, interest mismatch and regulatory constraints.

Long Term assets usually have low cash generating capacities and therefore (usually) very long paybacks.

The inabilities of banks to match the funding requirements of their customers (for instance, by providing a10 year repayment loan for an asset with a 20 year payback), means that the Loans are draining their customer entities of cash per se: the bigger the mismatch between Term and Tenor, the bigger the drain on borrower’s cash resources. The pressure on cashflow caused by the premature paying down of loans means that companies etc. must refinance almost continually.

Flexibility in the structuring of long term facilities is therefore essential.

2b.iii. Sources of Business Risk.

The main risk in any business (in a competitive market) comes from the market and technology. These risks are normally outwith the entity’s control. The entity must have
the flexibility to manage its assets to reflect these dynamic risks and cope with changes in technology. Add-in the vagaries and consequences of the Economic Cycle and these market risks can be lethal.

Flexibility of asset (and therefore liability) management does not guarantee survival during recession. However, rigidity within the financing structure; particularly rigidity within long term loans, can accelerate, or even precipitate collapse. To ossify a Liability is therefore a very dangerous matter for a trading entity. This risk is compounded for a Capital Intensive entity which has taken on Long Term Liabilities where any rigidities, and any Contingent Liabilities, are disguised/ hidden and not declared at outset.

2b.iv. Banking Principles & Banking Security: Implications for Swaps/ TBLs.

Due to the reality of “on demand” deposits and the illiquid nature of bank assets (Loans), the legal system has always supported banks. Due to the inherent mis-match between the liquidity of deposits and illiquidity of banks advances, “on demand” loans effectively have no legal protection, when in default.

Banking security has evolved so that upon Perfection of the Banking Security, the customer holds his property “in Trust” for the Bank.

Overdrafts and “on call” loans are repayable “on demand.”

Once a Facility is “in default” it is repayable on demand. Once demand is made and the money not paid, the customer’s security can be liquidated with very little interference from the Courts.

When one Facility is in default, all connected facilities are “in default” due to “cross default” clauses: if one facility is callable, ALL facilities are callable, “on demand” across the connection.

This legal support has evolved due to the implications of bank runs on economic activity: a financial crisis brought on by a run on the bank, quickly spreads to the real economy.

Once an “on demand” facility is called, the Bank can liquidate the customer’s security, in most cases, without recourse to the Courts. However, the responsibilities (and liabilities) of holders (in possession) of land/ property are onerous. Banks therefore prefer to avoid direct possession and work via agents/ surrogates appointed under the mortgage or debenture: these agents are often token “Officers of the Court” including Administrators, Receivers, Liquidators and Trustees. In England and Wales, via the 1925 Law of Property Act (LPA), Banks can appoint LPA Receivers. The power of these LPA Receivers has been extended to include appointments under the Terms of the Mortgage, when they are known as Fixed Assets Receivers – but the common name remains LPA Receivers (LPAR).

The benefits of appointing an LPAR is that, although appointed by the Bank, they are the Borrowers Agent. This is a quick and easy way to foreclose on a “defaulting” borrower without reference to a Court or transparent disclosure of costs. This lack of transparency concerning LPA costs can prove lethal to the residual value (and wealth) of customers in difficulties: whether these difficulties occur per se, or are engineered by the structure of the bank facilities is irrelevant; the end result is the same, the annihilation of the borrowers wealth.

2b.v. Monitoring: Current Account & Covenants.

The benefits of a sole banking relationship, via provision of the payment mechanism
(current account) by the lender for the customer are awe inspiring:
If necessary, the bank has full knowledge of the customer’s activities – the current account being the customer’s wallet.
Complete knowledge of monthly and seasonal patterns of trading and payments.
Lumpiness and signs of distress in payments and receipts.
Detection of hard core developing.
Monitoring (and control of) of excesses, carry forwards etc.
Signs of over trading.
Signs of losses occurring.

Detection of diversions etc., etc.
Detection of inter company/ cross company/ group cross firing.

In addition to real time monitoring of the business via the current account, the business can be monitored periodically by the bank including Covenants within the Facility. Covenants, if designed properly, are essentially a built in monitoring device, a means of detecting and forestalling problems. If these covenants are breached, they can be waived, rectified, or a plan for managing (rectifying/ working out) the causes and consequences of the breach can be made and implemented. Breaches are Defaults but if a workout plan is formulated, this plan should override the Default until the plan has been demonstrated to fail.

Covenanting, when combined with the benefits of running the account, put the bank in a position to monitor the riskiness of the business and therefore the safety of their lending virtually in real time.

In extremis, during workouts of critical importance, the bank is essentially, de facto, in control of the business, by the power of vetoing payments not within the Workout. However, this close control during workout, is often better, and cheaper, for both the bank and customer than invoking legal recovery routes.

The above presumes a viable business, a willing customer and that the covenants and current account are not being window dressed.

IF these prerequisites are not met, the legal recovery/ security realisation options should be considered, urgently. Rigidity Within Facilities.

Rigidity means lack of flexibility in a bank’s ability to restructure/ reschedule/ rollup servicing of medium /long term loans by the loans very design. The greater the rigidity
of the Loan, the greater is the likelihood of the entity breaching Loan Covenants.

Badly designed/ inappropriately structured facilities within an entity’s financing structure can “engineer” Defaults by their poor or intended design. If these breaches cannot be rectified by the entity; or by resetting the loan, or the breach being waived, the entity is in default. Default can lead to foreclosure.

3. Interest Rate Swaps (IRS).

An Interest Rate Swap, or its derivative or synthetic derivative/ surrogate, is a Contract for Difference (CfD) based on current and forward interest rate curves. By definition, a CfD is a zero sum game: meaning one party’s loss is the other party’s gain. Leaving aside, dealing costs, the two party’s profits and losses equate to zero.

However, including, the Banks “arbitrage” opportunities and the Bank’s information monopoly, the mis-quoting of IRSs (at prices above Fair Execution) can make the CfD an absolute winner for the Bank, before making bulk profits are added!

3a. Treasury Conventions & Amortisation Scdedules.

In a Fixed Rate Amortising Loan, with a Stand Alone IRS or Embedded IRS, of whatever tenor, the cashflows (loan repayments) are contractually fixed by the Amortisation Schedule. In turn, the payment periods are fixed by convention: Day Count Fraction Actual and Following Business Day Conventions. The use of these Conventions are unusual for business loans for SMEs per se: the interest calculations have to be executed within these conventions rather than the use of standard Loan Amortisation packages such as Excel, or, manual equivalents. Access to the Convention’s underlying framework is not made available to customers in open Excel formats, so the calculations cannot be checked. Alternative financing scenarios cashflow implications cannot be tested or costed.

The use of these Conventions, when accompanied by non provision of open Excel sheets, is a major “Barrier to Entry/ Lack of Transparency” as the figures cannot be verified by non treasury specialists. These loans therefore totally lack transparency, the customer effectively being told “take it or leave it,” or, Aunty knows best.” Few accountants know how to check interest calculations within an amortising loan using Excel, or a manual equivalent. I have yet to meet one who can check an amortising loan within the Treasury Conventions!

The absolute none-availability of the interest rate data compounds these Analytical Framework issues exponentially. Data concerning the actual market rates is not available to the public at an absolute level: without subscription to Reuters or Blomberg, the data is simply not available.

This means it is not possible to check the accuracy of any quotes without significant cost. This constraint should be sufficient for the authorities to act: either prohibiting the use of these products completely or the establishment of a “default” rate database. Alternatively, the authorities can use competition/ market abuse Laws to smash this cartel.

Please note the impact of our inability to remodel Treasury Based Loan Terms: it is not possible to model Interest Overpayment Calculations, without access to the basic Interest Rate Data and Day Count Calendars. Without these basic parameters it is impossible to model/ reprogramme Working Sheets within Excel. Therefore, it becomes impossible not only to quantify Primary Losses under a “Reset” but to quantify the interest charges and repayments under different loan resets: amounts, tenor and interest rates.

Amortising Schedules/ Interest Refund Calculations must be provided in open Excel Sheets, to facilitate checking and remodelling. Interest Rate must be verifiable from a Public Data Base. Without commonality of data, we would be having “parallel conversations” with the Bank concerning Redress, both per se and concerning specific “Resets.” Difference in process could divert from the key issue: differences in outcomes/ losses/ consequences created by the TBL.

The non-provision of Amortisation Schedules in an open Excel format, and a verified Interest Rate Data Base, by all UK banks is a major example of Obfuscation regarding the TBLs.

3b. Swaps: Running Losses (Margin Calls) & Breakage Costs.

The running loss/ profit on the Swap is derived by the use of Discounted Cash Flow (DCF) Analysis to determine the Net Present Value of the Cashflows. Under DCF, as interest rates fall, the Present Value (PV) of a given Cashflow stream rises: the longer the cashflow stream, the greater the impact of the fall in rates; the shorter the cashflow stream the smaller the impact. Likewise, the greater the fall in interest rates, the greater the rise in the PV of a given cashflow.

The difference between the PV of the Cash Inflows and the PV of the shorter cash outflows, gives the Net Present Value (NPV) of the Swap – its market price. As the price of the Swap varies from the Original contract price, the difference is paid/ received by the buyer – known as margin calls. This is why Swaps are CfDs – it is the difference between the agreed price (at Date of Execution – DOE) and current price at swap reset (monthly, three monthly etc.), which is payable under the contract by one counterparty to the other.

The terms “Day Count Fraction Actual,” “Following Business Day Convention,” “Date of Execution” and “Counterparty” are Treasury Terms, totally alien to SMEs and, more critically, their borrowing needs.

In embedded Swaps, the margin call is not paid but rolled up in the “bucket account”/ Breakage Cost, which is secured against the entity’s Banking Security.

3c. DCF Process, Margin Calls & PVO1.

With FRL TBLs, the interest rate “protection” (the fix) is derived by an Interest Rate Swap: short term (one/ three/ six month), variable rate loans are swapped for long term fixed loans (one to fifty years), via a banking entity, which are then on lent to customers.

Given a normal yield curve, long term money is more expensive than short term money. Forward curves determine the predicted forward rates for a particular rate.

IF long term rates fall and short term rates stay the same, the PV of the Cash inflows, determined by the Repayment/ Amortisation Schedule, rises significantly compared to the PV of the outflows which stay the same. Thus the NPV (the value) of the Swap rises. In the case of the TBL, with an embedded swap (for the borrower), these margin calls are represented by the Breakage Costs (BC) and bucket accounts.

The DCF process itself is dynamic: small changes in current short term interest rate or long term interest rates can produce major changes in the swaps NPV, its value. These changes in NPV are the “margin calls” for either party at reset dates. The Breakage Cost (BC) represents the NPV of all “future” resets using the forward rate for the given reset tenor of the variable rate leg of Swap. The longer the Tenor of the whole loan, the greater the variation in NPV/ margin call and BC.

This “dynamic” is recognised by Bankers as the “PVO1” (Price Value of one One Basis Point). This figure represents how many £s are lost/ made for a one hundredth of one per cent move in interest rates (one basis point). Thus a position with a PVO1 of £4500 would lose/ gain by £4500 for every move of one basis point in interest rates.

Putting this in comprehensible English: the borrower will lose £450,000 per 1% fall in interest rates if he has a FRL fixed by a Swap/ embedded Swap with a PVO1 of £4500.

The higher the PVO1, the higher the risk but the PVO1 of £4500 is not made up, it is the actual figure for a loan to an SME, with a Networth of £1.5m!

With TBLs using embedded swaps, the margin calls are rolled up for the customer but (theoretically) made by the bank to the seller of the Swap, the Bank’s exposure to the customer hence increases. As the exposure increases the Bank’s Security Cushion is eroded. Covenants are also breached but not declared to customers.

This DCF concept is unknown to most owners of SMEs. The DCF “dynamic” – the PVO1 – is totally alien in both concept and application to owners of SMEs and even large companies. Most SMEs are totally risk averse: unquantifiable and unpredictable (dynamic!) cash losses and BCs are to be avoided like the plague.

3d. The Legal Management of Swap Contracts.

This is done via the International Swap Dealers Association (ISDA) Master Agreement (MA). An ISDA MA is attached as Ex. I. This is well worth reading.

For embedded swaps (derivatives and synthetics), the rules of the loan (the Amortisation Schedule), the Terms & Conditions (T&Cs) and Covenants are sufficient to legally enforce the embedded Swap. The Amortisation Schedule, in conjunction with the T&Cs is sufficient to act as a surrogate for the ISDA agreement. The implications of the rolling up of any margin calls under the embedded swap will be examined later. The T&Cs of these TBLs are well worth reading. It is these T&Cs upon which the Bank is reliant in terms of legal enforcement.

An intimate knowledge of the ISDA MA and Loan (& mortgage) T&Cs, plus the origins and compilation of the Amortisation Schedules is a pre-requisite for understanding TBL FRLs.

How many SMEs possess this knowledge?

3e. The Legal Position of Swaps.

The ISDA MA forms part of the Loan Agreement for stand alone Swaps and its variants (Collars, Caps, Participating Collars etc., etc.). Similarly, the Amortisation Schedule and T&Cs forms part of the Banking Security for an embedded swap.

These agreements are all embedded within the Banks security. Thus, essentially a Securities Transaction (a Swap or embedded Swap) which is undeclared to the customer, avails the Bank of the protection of its perfected security over the customer’s tangible assets. Embedding the Swap in the Banking Security, ensures the Bank can access the Court’s rubber stamp procedures or the LPAR route, in terms of the liquidation of the customer’s security.

Did the customer know what a Securities Trader was?

Was the customer aware he was becoming a Securities Trader?

Was he warned he was becoming a Securities Trader?

Did the customer (now a Securities Trader) know that the trade (with the mandated ISDA MA, and T&Cs) he was making would be embedded in his banking security, thereby exposing his banking security (and possibly the whole of his wealth) to finance “cash losses” under this security contract?

4. Credit Implications of the Swap/ Bet on Interest Rates.

Both Stand Alone Swaps and embedded Swaps have the same implication on the credit status of the customer: if the customer has bet the wrong way, it loses money and the banks exposure to the customer increases, if “only” by the increase in BC.

Bet the wrong way?

If the customer bets that rates were going to stay the same/ rise and they fall, the customer loses.

If the bet is made by the customer fixing a variable rate loan by a swap at near the initial rate, it pays these losses by margin calls.

If the customer fixes his rate via a TBL, with an embedded swap/ derivative/ synthetic, the losses are rolled up and undeclared to the customer.

BCs under both types of loan, increases the banks exposure proportionately to that customer. The rolling up of margin calls with an embedded swap, further increases the banks exposure to the betting customer. These exposures are an entirely predictable consequence of the loan process: therefore, at least on a contingent basis, the increased bank risk will have to be sanctioned in advance. Interest rates fell further and faster than expected (or did they?): the increased exposure will have led to “undeclared” Covenant Breaches; and these ever increasing breaches will have put lenders under pressure to seek to have the breaches remedied.

Did the customer know he was making a bet?

Did the customer know he was responsible for the losses made under a bet he knew nothing about?

Did the customer know about BCs at all, and that he was responsible for them.

Did the customer know about the Contingent Liability (CL) associated with the BC at all?

Did he realise the implications of this CL on his accounts and Fiduciary Responsibilities?

Did the customer know about the increased credit exposure to him by the bank and the fact that this will have been approved in advance of the sale?

Did the customer know that he was exposed to Covenant Breaches,” engineered” by the DNA of the loans?

Did the customer know the absolute contractual rigidity of the ISDA MA (or its synthetic derivative) would stand the logic of the Workout Ethos of the traditional Bank Loan on its head? The covenant breaches engineered by the losses on the Swap and the Contingent Liabilities under the Swap, would enable the Bank to “protect” its position by taking over the working of the company and its assets to minimise its losses, without regard to the “engineered” and “misrepresented” causes of these losses and covenant breaches.

The answer to ALL these questions is obvious for the overwhelming volume of borrowers affected by these loans – whether large or small!!

Treasury Based Loans are totally unsuitable for the overwhelming majority of SMEs.

5. Why Use Swaps to Underpin FRLs at all ?

5a. Benefits of the Swap Based FRL for Banks.

By the use of the Swap, the bank providing the Fixed Rate Loan (FRL) has passed the risk of changing rates to the customer. This increases the availability, and tenor of FRLs available.

The Swaps “created” by the FRL can be sold onto investors, increasing the range and scope of the market.

The use of these products increases the availability of instruments for investors who have constant inflows but want to put their money to use in the long term (paying Pensions etc.).

It enables Banks to speculate and hedge their view of future interest rates.

It creates new profit opportunities by creating new customers and “breaking/ making bulk” opportunities.

These new Swap opportunities increase the volume of the market and enable arbitrage opportunities to be eliminated, increasing market efficiency. Capital allocation is thus improved.

The bank can book the Mark to Market profit/ loss on the undeclared Embedded Swap in its Treasury, whilst not declaring the CL to the customer. The IRS product is thus the link between MTM accounting and GAP accounting, enabling banks to arbitrage the accounting system.

The bank can use the basis of banking security (the Court’s “rubber stamp” repossession or the threat of this) to exert absolute control over the borrowers cashflow and assets in a predatory, undisclosed way, posed to the borrower as being in the “normal course of banking business.”

5b. Benefits To Small Customers.

I see no benefits for even quoted companies in this type of product unless they understand the risks and are willing to “elect” to be Professional Investors or Eligible
Counterparties. The prerequisites for understanding these risks are five fold:

‘A’ Level in Pure Maths – at absolute minimum.
Degree in Mathematical Economics/ Quantitative subject.
Masters Degree in Business/ Economics with Special Subjects in applications of DCF, Derivatives and Treasury.
Access to Screens for Market Data.
Proof of Experience in Market Trading.

There may be other businessmen with attitudes to risk which suit these products but again they must elect and also have Spread Betting experience.

Finally, there may be businesses with very long term contracts and cashflows projectable with high degrees of confidence for whom the Swap and TBL FRLs may be suitable. These Trust types of businesses can simply elect to become Professional Investors or Eligible Counter-parties. Many companies involved in Private Finance Initiatives may be suitable for these products but again must elect etc.

5c. Benefits to Large Bank Customers.

For multi national companies, I see no problems with these products as long as the users are classified, or are willing to “elect” to be classified, as Professional Investors or Eligible Counterparties.

ii. Likewise for quoted and very large private companies, as long as they again
elect to be classified as Professional Investors or Eligible Counterparties.

However, the pre-requisites listed in 5b. sic apply. I would go further regarding public authorities, government owned social enterprises, nationalised companies etc. ALL IRSs should be Ultra Vires, for these Government controlled entities, save with specific written authority from the Government as the ultimate Counterparty is the Sovereign Entity. This reflects the UK Local Authority experience in the 1980s.

Likewise, for large charities (and their operational entities) the Ultra Vires doctrine should apply, unless both the controlling charity and operational entity, specifically elect to be Professional Investors or Eligible Counterparties.

6. Problems with Swaps for Retail Customers.

(i.e. ALL Customers who have NOT elected to be “Eligible Counterparties” or “Professional Investors”).

These loans have the effect of “strapping the business of cash.” They are designed to make businesses “fall off their perch.” Whether this was a deliberate “designed in”
attribute or not, is irrelevant, this is the effect! To reiterate, a few of the negative attributes of these loans are:

6a. Misrepresentation/ Obfuscation Regarding FRLs based on Swaps/ Embedded Swaps:


DCF analysis is unknown to most owners of SMEs.

The DCF “dynamic” is totally alien in both concept and application to owners of SMEs and even large companies.

This “DCF dynamic” is known as the PVO1 of the Swap. PVO1’s are unknown to SMEs.

Did the Bank explain the PVO1 per se?

Did the bank explain the role of the PVO1 in the TBL?

The ISDA MA and T&Cs, plus the origins and compilation of the Amortisation Schedules is a pre-requisite for understanding FRLs derived by Swaps and TBLs.

Was the customer informed of these documents role? Did he understand these documents?

Was the customer aware he was becoming a Securities Trader?

Was he warned he was becoming a Securities Trader and hence could quickly make/ lose money?

Did the customer know he was making a bet?

Did the customer know that the (bet) trade (and the associated ISDA MA, and T&Cs implications) he was making would be embedded in his banking security.

Did the customer know he was responsible for the losses made under a geared bet he knew nothing about?

Was the customer made aware that he was exposing his banking security (and possibly the whole of his wealth) to finance “cash losses” under this security/ betting contract?

Losses on the IRS product will have been budgeted for by the Bank, therefore the bank has sanctioned an increased exposure via hidden credit facilities and “bucket” accounts to accommodate these losses.

Did the customer know about BCs at all, and that he was responsible for them.

The “locking in” effect of the BC was not explained or demonstrated at all.

Did the customer know about the Contingent Liability (CL) associated with the BC at all?

Did he realise the implications of this CL on his accounts and Fiduciary Responsibilities?

The CL at the entity’s year end was not quantified or declared.

The implication of the CL, and the quantum of the CL, was not explained, or notified, to the customer: when exposed retrospectively, it means the basis of the accounts may be destroyed and solvency issues raised – RETROSPECTIVELY. The entity may have been illegally trading for many years.

“Bucket accounts” and undeclared credit lines affect Covenants even when undeclared. They “engineer” defaults and can lead to the bank altering its stance regarding the customer.

In extremis this can lead to the engineered demise of the business, a la GRG, or SBS.

If the CL raises solvency issues most businesses would have reacted to these issues and manage their activities very differently, especially regarding, CapEx, employment and the payment of taxes. The deliberate hiding of the CL means many businesses ceased to exist needlessly.

Did the customer know about the increased credit exposure to him by the bank and the fact that this will have been approved in advance?

Did the customer know that he was exposed to Covenant Breaches,” engineered by the DNA of the loans?

Did the customer know the absolute contractual rigidity of the ISDA MA (or its synthetic derivative) would stand the logic of the Workout Ethos of the traditional Bank Loan on its head?

Covenant breaches are “engineered” by the losses on the Swap and the CL under the Swap

As the undeclared CL grows uncontrollably, the bank can start to use the “workout” power embedded in the security, not to protect the customer but to protect/ maximise its position.

The bank can become a Shadow Director (Controller) of the business, ignore its Section 251 and 187 responsibilities and prefer itself to the customer’s cash, via fees, rises in margins, cash sweeps, piks, special investigations and supervisory tasks etc.

This interference can accelerate the entity’s demise if these services are charged for in cash – i.e. these charges, per se, force the entity over its limit and into default. If this doesn’t occur by paying the banks charges (these will be debited when cash is available), it will mean others are denied payment or their payments are “bounced.” This is the opposite to the intent of the workout regime borne out of the benefits of controlling “Banking Security.”

6a.II. Misrepresentation/ Obfuscation: Stand Alone Swaps.

A Swap is a Cap and Floor set at the same rate. The Costs of the Cap and the revenue benefits of the sale (to the customer) of the floor are obfuscated by conflating them into a “Swap.”

Whilst it all depends on the shape of the forward curve at the Date of Execution (DOE), the dissection of the Swap into its component parts (Cap & Floor) is essential. There is evidence that on many DOE, the cost of Caps were very cheap (sometimes, very, very cheap).

The sale of the Floor should have been very profitable to the seller. The seller of the floor (to the bank) in this instance is the borrowing customer. Was the customer rewarded for selling the Floor to the Bank or was the customer’s reward gobbled up by the Bank in its extraordinary Value added?

The Swap is often callable by the bank: usually at the point at which the customer is “in the money.” This destroys the basis of anyone speculating in Swaps, never mind using them to protect against changes in rates. The use of “Calls” can turn the Swap into a Heads the Bank wins, tails you lose contract.

Where the purchase of the Swap became mandatory late in negotiations or upon renewal, especially post February/ March 2007 – until 2012, this amounted to a “Savilling” of the business in Broadmoor – i.e. the business was “locked in” and then abused by its cashflow being stolen and then the misapplication of “workout methods” by the Bank to maximise its own position.

6a. III. Misrepresentation/ Obfuscation: Embedded Swaps (their Derivatives or Synthetics).

As above but even worse as the Swap was not declared at all.

Breakage Costs (related to CfDs/ quasi CfDs, surrogate CfDs) are not rigidity, they are concrete ossification via the ISDA influenced T&Cs and Amortisation Schedule. The TBL turns otherwise successful businesses into the walking/ lying dead. The TBL is the opposite to what was advertised – a flexible loan.

TBLs ossify the cost structures, turning what should be a short/ medium term semi-variable cost into a totally nonnegotiable fixed cost. The raising of Fixed Costs is a per se bad outcome for both the entity and its lenders: it raises the Break Even point and means Losses will increase significantly as turnover declines, especially in a recession.

The fixed repayment on a TBL should be likened to a tax on both turnover and profitability.

BC is not only a tax on profitability it is a tax on Capital. In many cases it is a Death Tax which is imposed as a consequence of the premature demise of the entity – a demise which has been accelerated (and sometimes initiated) by the TBL’s effect (the rigidity tax) on cashflow and profitability.

The Death Tax is collected (and divvied up) by the Bank’s surrogates: LPAR, Administrators, Receivers, Liquidators, Trustees etc.

6b. Comparing a Normal FRL and a Treasury Based FRL.

One of the key economic roles of banking is financial intermediation, the linking of savers and borrowers. Regarding SMEs, the Commercial Bank is the only source of outside funding for most entities. As such Commercial Banks are pivotal to the health and survival of the SME sector, the key driver of economic growth: many would say that lending to SMEs is the reason banks are allowed to exist.

6b.i. Problems With Normal FRLs Sold to SMEs.

Lending to SMEs is classified as being intrinsically risky. This characteristic goes with the sector. Candidates for lending therefore must be assessed thoroughly in terms of viability (Products, Markets, Technology, Production, Cost Structure etc., etc.) and management capacity. After meeting these perquisites the entity must also be bankable in terms of security and that security’s structure.

To reflect the inherent riskiness of the sector, flexibility in the provision of facilities is a prerequisite: cashflow crisis are a fact of life for most SMEs. To facilitate this flexibility, competent SME management by lenders needs a cushion of security.

Bankers to SMEs need: adequate security to be in place; have confidence in the SMEs management to sort out its problems; and, have sufficient knowledge of the business to appreciate its risk and the impact of “point of inflection” risks.

Under most circumstances this risk management can be “hands off” and can be achieved by monitoring the borrower’s bank account: a pre-requisite of the lending being that the entity runs its banking/ current account through the lender.

Covenants, current account monitoring and visits can act as the main means of monitoring. These are expensive services to provide, therefore margins and charges need to recover these costs. A margin of 1 – 1.5% (the margin charged on many TBLs) is totally inadequate, so there must be a hidden margin IF these rates are being charged. This lack of “margin” transparency is itself obfuscation, which is only possible because Interest Rates quoted are not verifiable from a Public Data Base.

When problems arise in a borrower, the manager must have access to the data which he can turn into information to isolate the problems’ impact on the risk in the business. Following from this, any increase in this risk’s impact on the bank’s exposure/ risk to the company can be assessed and reacted to.

Most changes in risk, assuming the loan was properly assessed/ structured in the first place, can be catered for by defensive lending: i.e. the provision of more cash to “bridge” the problem. This money should be expensive and the “bridges” cost effectively capitalised within the facility – for the duration of the problem. IF the bridge works it should then be hived off into the other facilities which should be reset to match the entity’s cashflow via adjustments in the repayment profile.

IF the manager is not impressed with the performance of the entity’s controller during the crisis, the reset should include notice of exiting the relationship by incremental margin increases and more frequent reviews.

The borrower can then reassess his performance and possibly find a new banker before the incremental margin increases bite and the reviews and raised charges hit. Any exit fees (3-6 months interest on FRLs) can be negotiated as part of the exit strategy. In extremis, partial debt forgiveness can be included but this is the ultimate sign of a bad lend in the first place: i.e. the money should never have been lent.

Looking to security realisation as a means of repayment is last on the list but realisation proceeds and costs would be reviewed during crisis periods.

The raison d’etre of lending to SMEs is that it is a positive sum game: the provision of cash by the bank enables the SME to grow quicker, often much quicker. The banker then rides this growth by providing more facilities to a safer entity of which he has intimate knowledge and full confidence.

Flexibility is the key to managing crisis and to managing the lenders risk/ exposure.

6b. ii. FRLs & Treasury Based Loans (the Fix being derived by a swap/ synthetic/ surrogate).

TBLs are FRLs based on Stand Alone and Embedded Swaps/ derivatives/ synthetics/ surrogates.

With TBLs, underlying entity risk is assumed away and the zero sum game is pursued: the customer’s loss is the banks gain. The alternative applies but the TBL is cancellable by the Bank. How many “winning” customers have been paid out by Banks?

The customer cannot exit the loan, or renegotiate the loan under any circumstances: its Amortisation Schedule forms the basis of the contract along with other conditions enshrined in the ISDA/ T&Cs, which are not variable.

TBLs were mainly sold when the alternative, a Variable Rate Loan with a Cap were available and cheap. Why were these not offered?

Why was the Cap cheap? The Long Term Interest Curve was flat/ falling: the shape of the Forward Curve on DOE demonstrates obfuscation. Hidden (and undisclosed) margins were also built into the loan as were inflated quotes relative to Best Execution on the DOE.

TBLs were sold with the intent of inflicting losses on the borrower by the sale of the wrong product under conditions where the borrower would lose and when he could not exit the loan and relationship, without paying these losses.

The TBL is totally rigid and the conditions enforced relentlessly. In spite of being “strapped for cash” by the TBL, many customers never missed a payment.

The bank then attempted to “engineer” default by margin increases, when the supposed “defaults” were actually a function of its own loan. The “presumption” of default then facilitate the Bank into forcing the “defaulted customer” into managing his business in a far from optimal and market related manner.

The fact that many customers did not default is nothing short of miraculous, a sign of the financial conservatism of the SME owner and his integrity. The abuse of the “Workout Ethos” to pressurise the SME owner business is counterproductive: the Bank process assumes SMEs need help, when the cause of the problem was the TBL per se.

Helping many SMEs was, and is, simple: remove the “fix;” relax the tenor (life) of the loan; and get rid of the BC to facilitate SME safety, cashflow, profitability,
and ultimately, rebanking!

None of these “Workout Strategies” were even contemplated with most SMEs!


They were outwith the terms of the (mis-sold) TBL within which the SME was entombed! The bank wanted its winnings under the contract and the only way to do this was via engineering default and liquidating the SME’s assets, then bankrupting him, to ensure the non-compliant doesn’t seek redress!

6b.iii. Summarising the Differences between a Treasury & Normal Loan.
I. Normal Loans To SMEs:

Historically, pre-default, the Bank has always been the customer’s agent. This means the Bank and the entity must work together, with no Conflict of Interest.

This is the reason that Bank managers in the UK are/ were held in such high esteem.
Lending to SMEs is about managing risk,

BUT this lending should be a positive sum game, especially within a well balanced portfolio of loans.

Managing risk requires complete flexibility in the DNA of the loan.
Rescheduling, Resetting and Rolling up Loans are essential if the banks capital is to be protected in lending to SMEs.

II. Treasury Loans for SMEs:

Treasury loans are zero sum games where the counterparty risk is assumed away in the DNA of the loan.

The basis of the “in it together” ethos is built on the “Agency” Agreement between Bank & Customer. Agency consensus is destroyed and replaced by near continuous conflict over small deviations from forecast in the entity’s cashflow.

Counterparty risk in this case is offset by the entity’s security and its owner’s wealth: entity viability being of secondary consideration.

The only critical assessment therefore, for the bank, is whether the security is adequate as this is what will underwrite the banks winnings.

The game is rigged by the obtaining of security followed by migration of the customer to the Treasury Loan, whose conditions are already embedded in the Banking Security.
The rigged game then “straps for cash” the borrowing entity.

For its own good, the entity enters “Workout” but this is not “Workout” as it is intended: this is the assessment and preparation of the entity for slaughter but after the last once of flesh (cash) has been stripped out.

When the entity does not comply with instructions or does not default, again for its own good, the entity is placed under “protection and supervision.”

The acid test of who benefits from this “protection and supervision” is the charging for this help. If the costs are reasonable and capitalised, I would say, probably OK! IF the costs are high/ debited to the account I would class them as predatory, intended to engineer the very default they are supposed to avoid!

Likewise the role of valuations. IF the entity is in default and this default has not been caused (engineered) by the loan per se, I would say this is reasonable. IF the loan is not in default what is the role of revaluation?

Post Big Bang, the role of Agency has been eroded, with bankers increasingly (ab)using their trusted status as a means of accessing the customer’s security and wealth to sell unsuitable products by mis-representation, lack of transparency and non-disclosure of risks. The banker then quotes caveat emptor contractual “exclusions,” “boilerplating T&Cs” and contractual estoppel to protect its winnings.

This is a major consequence of lack of regulation and the mis-application of Professional Investor cases to SMEs.

Please look at the sample ISDA MA at Ex. 1. This document is the ISDA MA of a Retail Customer sold an IR Swap. By definition, a Retail Customer is not an “Eligible Counterparty or a Professional Investor.” By definition also, an IRS is a CfD, a heavily regulated product.

Please go to p. 25 & 26 of Ex. 1: clauses 2, 4, 6 and 7 are specifically designed to co-opt the Retail Customer into being a Professional Investor and prevent him pursuing breaches in those rights by signing away the rights of action.

The ISDA MA is not only a legal “try on” but, much more importantly, flies completely in the face of the rationale of lending to SMEs: lending to SMEs being a positive game; the role of the bank as agent to facilitate pre-default risk management of the relationship; and, SMEs lending being one of the main raison d’etres of Commercial Banking.

Treasury based loans are simply unsuitable for more than 99% of SMEs.

Minsky/ Pryamid Loans: An Economic Rationale of TBLs.

The author has searched long and hard for an overall rationale of why a supplier (the Bank) should sell a customer such a toxic product (the TBL) and under such terms that the product, by design, would eviscerate large numbers of its customers.

Rather unwillingly, I have come to the conclusion that this was because of a combination of greed and opportunity facilitated by Regulatory “benign” neglect.

Greed, because: the positive sum “Agency” game of historic Commercial Banking has been supplanted by the zero sum, non-advice game of “no customer recourse” based on contractual estoppel.

The customers had the cashflow and the wealth and their Bankers wanted it. Also, and, absolutely critically, the game could be rigged by the supplier. The upfront profit opportunities gained via mis-quotes were themselves potentially extraordinary and untraceable.

These inflated positions could then be bulked up and on-sold in the market with the mis-sale and mis-quote profits immediately pocketable. The Swaps were cancellable, at the volition of the Bank, for both Stand Alone and embedded Swaps. The Banks bets became: heads the Bank wins, tails the customer loses.

Opportunity, the Regulators were asleep: Regulators believed that the application of financial engineering techniques were improving Capital Allocation and the efficiency of markets with risk being diluted and spread further amongst investors and customers.

For the Regulators, these assumed consequences were per se, good outcomes for the banks, their customers and the economy. Unfortunately, the opposite was true, the Regulators had missed that, in reality, most financial engineering was simply a mechanism for increasing gearing/ leverage, often by the manufacturing of Contingent Assets and Contingent Liabilities which were themselves rollable. MTM accounting enabled profits to be booked, whilst losses were rolled.

The author is a Modigliani & Miller fan: the greater the gearing the greater the risk. Even more critically: that as gearing increases, risk increases proportionately! The main consequence of Sleeping Regulators, combined with a light touch regime, was that gearing rocketed whilst asset quality declined exponentially: a devastatingly toxic mix for Bank viability per se.

With SMEs, a combination of Sleeping Regulators and the historic esteem (and awe) in which UK bank managers are held by their SME borrowers, meant that the scene was set for rogue bankers to stuff their customers with toxic but extremely profitable products for the Banks.

But why would the Banks do this? What is the driving force, the economic rationale?
This is the Minsky moment: Western economies had become “candy floss” economies by the late nineties, with the frothiness spun by bank money.

This can best be illustrated by the Leveraged Buy Out, Hedge Fund and Private Equity movements: extraordinary gains were available to investors who “had the cash” or could access cash (mainly Bank cash). The profits earned by these “Shadow Banks” were pure economic rents, hedged by tax based leverage arbitrage.

At the SME level, these gains in wealth, especially where gained via property assets, were embedded in the SMEs wealth. In the Bankers eyes these gains (economic rents) were financed by the Bank facilities, and, the Banks wanted these gains.

Thus TBLs became a way of accessing the accumulated and current wealth of SME and large customers. At the level of last resort, the embedding of the TBL in the Banking Security accessed this wealth via the Courts “rubber stamping” of foreclosure.

Also, due to loose money, these gains would “roll on” in perpetuity. Ergo the losses caused to the individual SME customer by these losses would be transitory to the economy as a whole, as the resources would be redeployed to the “fittest” to use them.

Thus a “survival of the fittest,” evolutionary argument was used to rationalise a simple hunt for wealthy targets to ensnare and legally deprive them of their assets.

TBLs were simply a method of turning the SME into a surrogate, a Serf of the Bank, by which the bank could access the gains from the Asset Bubbles – the Candy Floss – the Banks (and the Regulators) were themselves creating.

The Minsky/ Pyramid Loan had arrived, with the Bank sitting at the top of the Pyramid and in de facto, soon to become de jure, control of all he surveyed.

Minsky stated that “periods of stability, created instability” per se, because Bankers wished to pursue/ maximise their short term profit. TBLs were precisely that profit reaping mechanism: a doomsday product which, from 2005 onwards, having been perfected as a useful annexe to the Bankers armoury 1997+, could create havoc amongst the finances of SMEs and large borrowers!

7a. Why Would Banks Sell Toxic Products To SMEs.

The profit opportunities (running losses for Stand Alone Swaps and BCs for all TBLs) were immense, especially IF interest rates fell; the customer was locked into the loan; and, the embedding of the swap in the Banking security allowed the bank full control of the customer’s cashflow and assets via perversion of “Workout” and reconstruction techniques.

Within an easy money regime, monetary policy would always be eased to rescue “investors” from the aftermath of bubbles – “the Greespan Put.” Regarding IRSs, “investors” are defined as the Banks. “Reconstruction Regimes & Techniques” had been legally perfected to allow the assets of failed business to be recycled efficiently, under the control of the Banks and their other surrogates, the Insolvency Practitioner (IP), investigating accountant, Administrator, Receiver, LPAR, Trustee etc.

IRSs allowed the Bank to obtain unlimited advantage from the “Greenspan Put.”

If, Swaps could be made “predicated” parts of the Loan, the bank could not only gouge the customers with mis-quotes and by “making bulk,” it could access the customers wealth by mis-pricing the “Floor” component of the Swap.

To repeat (6a. II p. 15 and p. 18 sic):
An IRS is a combination of a Floor and a Cap set at the same rate. Within an IRS, the SME buys the Cap, but sells the floor to the bank. If, interest rates are perceived to going to fall, Caps will be cheap to the buyer. However, Floors, at that rate should be extremely expensive to the buyer. Was the seller of the Floor, the SME customer, even aware he was selling an insurance policy to his Bank?

The answer to that question is a resounding, NO! Most customers are unaware that the components of an IRS are a Cap and Floor, set at the same rate, never mind that effectively they are selling the bank a Floor.

What was the SME customer selling to the Bank?

An unlimited indemnification of the Bank against falls in interest rates! What was underwriting the risk of these falls in rates? In most cases, the extent of the Bank’s security, but with cash shortfalls, most of the customer’s wealth was totally exposed via PGs, Cross Defaults and bankruptcy.

The value of the Floor element of the Swap to the customer was totally withheld (obfuscated) by the Bank, as was the low cost of the Cap to the customer. These (Value Added!) profits could be immediately booked along with the mis-quote and making bulk profits.

IRSs were sold to protect the Customer against rises in interest rates. This could have been achieved by selling a Cap.

Why wasn’t this done?

Firstly there was no profit in the Cap, but more importantly, it was the Floor the Bank was after: the Bank needed the protection from falling interest rates under the “Greenspan Put Regime.”

Is there any evidence that the market view was that rates would fall?

See below for the SONIA (Sterling Overnight Index Average) Forward Interest rate Curve on 3rd September 2007. This Curve looks forward 30 years and the summation of the market bets on interest rate moves on 3rd September 2007.

The yield curve is not just negative it is markedly negative: i.e. the market has put its money on interest rates falling.

Against this market view, who in their right minds would bet significantly against the market and in favour of interest rates rising? Yet that is precisely the stated objective of a “predicated” (mandatory) Swap: it is meant to protect the customer from rising rate!

Why were the banks forcing their customers to take out “protection” against rising rates when their market said the opposite. Why weren’t customers simply sold a Cap?

The answers are obvious: the bank needed to stuff their customers with the “Floor”
which the bank needed to protect itself against the very falling rates they were predicting. Plus, there was no profit in Caps.

7b. How Could Banks Sell Such Toxic Products to SME Customers?

The Customer/ Bank “Agency” Relationship had been terminated by the Regulators, who unfortunately had omitted to tell the SME customers of this change.

As importantly, the Regulators had not thought through (or were possibly unaware of) the implications of the end of the Agency Relationship: that there is no legal protection from foreclosure, resulting from possible abuses, enabled by the ending of the “Agency Relationship.”

The most attractive “on demand” facility for SMEs is the overdraft which was widely used by Banks to finance permanent assets in UK SMEs. Thus a large number of SME were reliant on “on demand facilities” in any case. In addition, and by definition, all facilities “in default and in breach” are “on demand.”

The Agency role was terminated, upon signing of facilities by “No advice” exclusions. Thus, toxic/ unsuitable facilities were sold abusing the “Agency” relationship of “trust and no conflict of interest” between customer/ banker. Having breached the “Agency” relationship to lever the mis-sale, rights of redress were then signed away (contractual estopped) by the exclusion clauses.

The legal process, resorting to caveat emptor, was then used to “strike out” attempts at redress by using “Professional Investor” Cases (Peekay & Springwell) to ignore attempts to negotiate and force legal redress.

At the Regulatory Level, Section 200 was used to exclude huge numbers of mis-selling claims from SMEs claiming redress using COBs/ MiFID because they happen to be limited companies.

Finally, the implications of the Libor Mis-quote fraud must be mentioned.

Libor was quoted below actual, i.e. low balled. What is the impact of Libor being mis-quoted downwards?

It increases the value of the mis-sold IRS to the Bank and increases the SMEs loss.

Terry Mulvenna, 16 06 2014.

NAB Customer Support Group Head John Glare Press Release



In February 2013, John Glare commenced proceedings against Clydesdale Bank plc (“CB”) in the Court of Session arising out of the miss-selling of a tailored business loan (“TBL”). In their Defences served in May 2014, CB denied that the TBL had been miss-sold. CB have now conceded in the litigation that the TBL was miss-sold. They have admitted that John Glare should not have been sold a 25 year loan. They have admitted that the loan was in breach of their own internal standards.

This is a significant U-turn on the part of CB. Throughout the course of this long-running dispute with Mr Glare, they have maintained that there was no miss-selling of the TBL and that the 25 year loan sold to Mr Glare was appropriate. This recent admission is in stark contrast to a letter sent to Mr Glare in November 2010, in which CB insisted that they had acted “in a professional and understanding manner when dealing with his lendingrequirements”. In the same letter, CB described the 25 year loan provided to Mr Glare as “financially the most suitable option for him”.

The litigation will now continue with the focus being on firstly whether the miss-sold TBL caused the serious losses suffered by Mr Glare and, if so, what were his total losses.

This concession on the part of CB arises from CB’s concerns about having to deal with a number of difficult issues raised in Mr Glare’s Court of Session Summons. Mr Glare had submitted several reports from experts in the financial services industry in support of his claim that the TBL was not an appropriate product. These included reports by Professor Michael Dempster of Cambridge University and Simon Jacquiss, a leading expert in this field.

One of the difficult questions facing CB was how it quantified the “break costs” that it imposed on Mr Glare’s account when his fixed rate TBL was terminated. In his Summons, Mr Glare had argued that these break costs were not recoverable. CB could not demonstrate a direct link between the termination of the TBL and any alleged “break” in a corresponding hedging instrument.

Mr Glare has also raised a claim under Section 140B of the Consumer Credit Act 1974 to the effect that the relationship between himself and CB was “unfair”. In conceding that the loan was miss-sold, CB have acknowledged that Mr Glare has a right to pursue a claim under the 1974 Act. This Act gives a Court a wide discretion to compensate any customer in an “unfair relationship”. It is understood that there is currently no judicial decision in respect of the interaction between Section 140 and tailored business loans.

Litigation is continuing in the Commercial Court of the Court of Session. Mr Glare’s solicitors are Balfour+Manson LLP. His Counsel is Iain Mitchell QC.

Questions Needing Answers – Interest Rate Swap Mis-selling NAB David Thorburn TSC Witness Oral Evidence

David Thorburn NAB Treasury Select Committee interview SME Lending, Tailored Business Loans

17 June 14

Comments from Nab Customer Support Group (in respect of the oral evidence given by David Thorburn Debbie Crosbie).

1. David Thorburn states (on page 1) “The difference was simplicity essentially.” Simplicity for whom, the customer, the bank or both? Simplicity implies a simple, transparent, suitable product which is easy to understand.

Given NAB’s similar historical problems with loans sold to farmers in Australia, should this product not have had clearer guidance and explanation? Does the simplifying of documentation in this scenario not amount to duping the customer? “Sign at the bottom and we’ll fill in the details later?”.

2. David Thorburn states (on page 1) “It was modelled on a domestic mortgage product to try to make it more understandable”.

If it was “modelled on a domestic mortgage product” then precisely which domestic mortgage product sold by NAB (containing hedging products/derivatives and macro hedged) was it modelled on?

3. Andrew Tyrie asks (on pages 1 and 2) “Is not all logic pointing to exactly the opposite? Is not what you are offering something that is much more complex?” David Thorburn replies “It depends on the nature of the TBL. If I might explain, a TBL can mean many different things”.

But we are told that a TBL is a simple, transparent and easily understood product. It seems that it is now indeed many things, ever evolving, ever changing to suit the needs of the bank.

4. David Thorburn states (on page 2) “What the customer got in that case is guaranteed payments for the duration. It is certainty of payments for the duration of the loan regardless of what happens with interest rates over that time”.

In one case, when a customer asked whether there was an interest rate swap attached to his fixed rate TBL in 2013, his Business Relationship Manager at Yorkshire Bank answered: “You have a fixed rate loan offering guaranteed payments for the duration of your loan!”, omitting to mention swaps, derivatives or break fees. David Thorburn gave the TSC the same answer, almost word for word, as the customer received from his Business Relationship Manager in this example. The reality is that the bank did not provide certainty of fixed payments, as the payments

‘varied’ to increasing margins as a result of engineered defaults, ie loan to values changing etc. The “loan to values” changed because the bank persistently changed the basis of the valuations by providing different valuation parameters to their ‘valuers’ (valuation panel).

5. David Thorburn states (on page 2) “Almost without exception it would not have an individual hedge on the other side of these loans”.

If the Tailored Business Loans loans did not contain embedded swaps then why did NAB/Clydesdale/Yorkshire Bank ‘imply’ that there was a swap in their documentation provided to customers?

6. David Thorburn states (on pages 2 & 3) “The original concept of these products developed by our parent company was to give SMEs access to some of the hedging instruments ­ particularly to hedge against interest rate risks ­ that they did not previously have”.

But customers wanted a ‘fixed rate mortgage/loan’ not commercial spread bet contracts which added a contingent liability to businesses. Clearly there was a risk element, however unlikely that the occurrence of a catastrophic fall in interest rates was. A regulated IRHP would require this ‘risk’ to be clearly set out in documentation on which the customer could have sought advice. Regulated investment products require a customer ‘attitude to financial risk’ questionnaire / fact find to be completed. This was not done for NAB Fixed Rate Loan TBLs.

7. David Thorburn states (on page 3) “I have seen no evidence of people trying to involve regulatory involvement” and again (on page 4) “We have seen nothing that suggests that anyone had in mind in the design of these products avoiding regulatory oversight”.

The original ‘Explanation of break cost’ document produced in 2001 was modified at some point to produce a new version. The new version was amended by i)removing the detailed example, ii)removing an explicit paragraph adjacent and iii) changing the term “economic cost” to “break cost” throughout. This evidences an attempt to avoid regulation and assist in the selling process.

8. David Thorburn states (on page 3) “Clearly also it is a commercial endeavour. In selling these products there are profits and new customers. It was used to attract new customers to the organisation as well”.

These products in many cases were sold conditionally. Customers were given no option to remain on variable rate products. The bank knew in early 2008 which way interest rates were going medium term and they ‘advised’ customers to the contrary, or at the very least ‘failed’ to warn of the downside risk of a drop in interest rate vis a vis to the extent of loan break costs.

9. David Thorburn states (on page 4) “I cannot guarantee there is not an e­mail where someone said something but looking back in time I do not believe that was the motivation at all. Indeed our parent company sold these through a regulated sales force even though the product was not regulated. These people were CF30s under the FCA and previously the FSA”.

If the products were ‘simple’ and did not contain individual embedded swaps, derivatives etc, then why the need to involve a separate treasury advisor? Why the need to link the loan to the best rate offered at point of sale? Why the need for a treasury checklist? Why did customers not receive ‘copies’ of these documents? Where was the customer ‘Risk Analysis’?

10. David Thorburn states (on page 4) “Not at this point. We have seen nothing that suggests that anyone had in mind in the design of these products avoiding regulatory oversight. As I say, although it was not required, the sales force that sold them were voluntarily regulated”.

What were the commissions/fees paid for selling these products? Were they more or less the same as for the selling of an equivalent loan and IRHP? We have evidence of 5.5% of the loan.

11. David Thorburn states (on page 4) “In particular, for the more complex products, the fact that with the benefit of hindsight it was clear we were selling them to customers who did not always understand what they were getting into in a falling interest rate environment. That was a matter of great concern to us”.

But David Thorburn stated that TBLs were ‘simple’ products. Were some less simple than others? Exactly which element of the ‘less simple’ product (ie cap, collar etc) makes it disadvantageous to a customer?

12. David Thorburn states (on page 5) when asked by Andrew Tyrie if it is simpler to offer these products as Tailored Business Loans compared with offering them as a standalone products :­ “Yes, I think it is a lot easier for the customer because they do not have to wade through an ISDA; they do not have to deal with the complexities of the standalone product.”

Is it not simpler to NOT tell the customer that the Bank will group the customer’s loan together with other customer loans and then enter into an interest rate swap agreement with a third party to hedge the risk to the bank and make the bank more money? Is it not simpler NOT to explain the complexitys of trapping an SME customer into a pooled derivative? Is it not simpler NOT to explain the possible potential break fees to an SME customer? Is it not easier for the bank to sell these loans, without disclosing this information? But the impact of the products are precisely the same as standalone swaps, except that one is regulated and one is not. If the main TBL agreement is ‘not in plain English’ then how is the addition of another document, an ISDA, any different? Surely all documentation must be understandable.

13. David Thorburn states (on page 6) “There is no individual embedded swap in any of these loans. The swaps are aggregated by a parent company as part of the broader balance­ sheet management activities and funding”.

So most fixed rate loans, including TBLs were pooled together and then attached to a complex interest rate swap agreement, without informing the customer. Clearly these are not individual swaps, or standalone swaps, but they have exactly the same effect on the customer. It makes no difference whether the loan was hedged in a pool or hedged individually, the effect on both the customer and the bank is the same.

14. David Thorburn states (on page 7) “They were introduced in 2001 and as I mentioned earlier the wholesale division of our parent company was used to providing hedging instruments to corporate customers globally and felt at the time there was demand among the SMEs to access fixed­rate products and some of the other categories that we talked about earlier”.

What part or feature of a fixed rate TBL / embedded swap was more useful or deemed to be more advantageous to SMEs compared with conventional fixed rate loans (ie ones which were not hedged to the extent that there could be substantial break costs)?

15. David Thorburn states (on page 7) “It devised a way of hedging its interest rate risk and then providing these individual loans to SMEs. It was a commercial endeavour”.

What was the rationale for offering a single loan product ‘with hedging’ (or potentially significant break costs) as opposed to a standalone IRHP and associated loan? Is it not the case that NAB knew that within the term of the fixed rate loans being offered (typically 5 years to 20 years) that interest rates were likely to reduce and remain low for a prolonged period of time? When precisely did the banks form a view that interest rates were likely to fall after 2008?

16. David Thorburn states (on page 8) “It was an opportunity for a parent company with subsidiaries that did not have that degree of sophistication to make that available to its customer base and therefore our business grew in the UK on the back of that”.

Was it not also an opportunity for the NAB to take advantage of customers with NO degree of sophistication?

17. David Thorburn states (on page 8) “It was quite a broad range. It was anybody who wished to borrow initially over half a million pounds and latterly it came down to about quarter of a million pounds. It was a very broad range of SMEs.”

So both sophisticated and unsophisticated?

18. David Thorburn states (on page 9) “There were a number of different components to the sales process. It would involve the relationship manager initially in discussion with the customer about lending opportunities”

Are these mainly lending opportunities for the customer or the bank? What would be the banks worst case scenario? Did the bank price the hedged element fairly? What was the cost/benefit to the bank as opposed to the customer?

19. David Thorburn states (on page 9) “…..talking about the various risks that the customer might face….”

Really? The Relationship Manager discussed the risks? Is this risk in general or investment risk? The job of explaining these non regulated products was supposed to be with the treasury rep, according to the bank, and not the relationship manager.

20. David Thorburn states (on page 9) “……including interest rate risks and introducing the concept of these products”.

So, in discussing interest rate risk, the relationship manager would also have discussed the potential impact of interest rates going down as well as up and the potential effect of breaking the loan?

21. David states (on page 9) “If the customer was interested in that, a representative from our parent company would come to a subsequent meeting, explain the range of products, explain the features of them and also issues such as break costs”.

Which products? What features? How were they explained?

22. David states (on page 9) “…..which again would include a separate flyer which set out the nature of the products and had an explanation of break costs”.

This flyer to which is referred does not adequately explain loan break costs, that is, if it was ever distributed anyway.

23. David Thorburn states (on page 9) “The final stage in the process, if the customer signed the facility letter—sorry, there were two more stages. One is that on the way through, we would say to the customer that they should take independent advice before they entered into these products”.

From whom? Independent financial advice or independent legal advice or both? If these products were not regulated and ‘simple’ with clear written estimates of break costs and commission/fees paid then the customer or his representatives could have given advice as to their suitability. It is a well known fact that very few lawyers, accountants, actuaries, financial advisors, barristers etc knew before today that these loans were macro hedged and not considered ‘embedded interest rate swaps’.

24. David Thorburn states (on page 9) “Then finally before the transaction was committed, there would be a phone call to either the representative or another representative of our parent company who would remind them of the risks of the break costs before they committed to the transaction”.

Do these telephone calls record detailed explanation of break costs? They did not. How could they serve to remind the customer of the “risks of the break costs”?

25. David Thorburn states (on page 9) (referring to the staff) “They were trained to sell this product range. They were regulated”.

Regulated staff were being used to sell the product as the bank perceived the products to be regulated. If the bank perceived the products to be regulated, surely the FCA should do also. The reality is that they were trained to make sure that the customer adopted a fixed rate which earned the 5.5% instant commission for the bank.

26. David Thorburn states (on page 9) “…a strategy paper would then be prepared and submitted by the representative of our parent company, which set this out in more detail and gave a range of options but did not point to one. They gave a range of usually 3 options….”

The reality is that the variable rate option earned no commission for the treasury rep, but the fixed rate option earned an instant commission of 5.5% of the loan. Which one would the treasury rep advise the customer to adopt?

27. David Thorburn states (on page 10) “Yes that is particularly so because if you look at the full range of the Tailored Business Loans, a subset of them were things like structured collars or collars. They are complicated, and they are beyond the ability of the relationship manager”.

But David Thorburn said that Tailored Business Loans were ‘simple products’. Exactly which part of a collar or structured collar fundamentally differentiates these products from a standard fixed rate TBL or a normal loan with a standalone IRHP or makes it intrinsically more complex or difficult for the relationship manager to understand? It follows that if these products and their intrinsic IRHP features could not be understood by relationship managers, then how was the customer supposed to understand them also?

28. David Thorburn states (on page 10) “With the benefit of hindsight it was not good enough for structured collars, so we accept that fully”.

So if the process was not sufficiently robust for structured collars, again, what makes it sufficiently robust for fixed rate loans without collars?

“We regret that and have learned from that”.

Exactly what do you regret and what have you learned?

“But there was a really sincere attempt here to design a process with various break points”

What break points? Please elaborate?

“…..and a recommendation of independent advice so that the customer had time to assimilate it and would understand what they were getting into.”

What were customers getting into? According the the bank, were they not simple fixed rate loans?

29. David Thorburn states (on page 10) “My colleague, Ms Crosbie might like to come in because she is leading our work in the redressing programme, but some people have crossed that line—we can see from the correspondence, our staff have done that—and where they do, that is unacceptable and we will remediate it”.

How did staff cross this line? Can David Thorburn give some examples?

30. Debbie Crosbie states (on page 10) “ To date we have received 550 complaints about the sales process and on most occasions, we believe when we examine the case file the sale was conducted in a manner that was I think entirely fine”.

Does Debbie Crosbie think that it was entirely fine or does she know that it was entirely fine? Can Debbie Crosbie identify the process and confirm from a random sample of cases that correct procedures have been followed to the letter?

31. David Thorburn states (on page 13) “…That is why we have a voluntary review of Tailored Business Loans….”

The reality is that the bank’s voluntary review has been a farce from the day it was set up, some time in October 2012, approaching 2 years ago. None of the 5 members of NCSG who were invited to have their loans included in the voluntary review have received any level of compensation or even reached the point of having detailed discussions. The voluntary review was set up in order to keep the FCA happy and to postpone / avoid any redress to affected customers. It was nothing more than a stalling tactic.

32. David Thorburn refers to a flyer (on page 17) that he says sets out the nature of the products.

The flyer does not explain that break costs are dependent upon the markets and could exceed 40% of the value of the loan. The reality is that the flyer was never distributed anyway and was produced “to tick a box”.

33. Debbie Crosbie states (on page 18) that “Davis has outlined that we are fully participating in the FCA review”.

The reality is that virtually all of the bank’s lending was done via TBLs on fixed rates. As TBLs on fixed rates fall outside the scope of the FCA review, consequently, the bank has so far avoided an effective redress scenario intended by the FCA review.

34. Debbie Crosbie states (on page 19) “…that the redress programme that we are running for fixed rates has been fully informed by any adjudications we have had from FOS and we have made sure that our processes line up with what FOS expects us to do.

This is incorrect. The bank has so far resisted the recommendations of the FOS in all decisions in respect of NCSG members.

35. David Thorburn (on page 20) in conversation with the chair tries to give the impression that decision making is generally made by Clydesdale Bank.

However, this would only be in respect of the future running of the bank and not in respect of the disposal of the CRE portfolio, which is entirely in the hands of NAB, given that NAB has taken financial responsibility for the CRE portfolio.

36. David Thorburn (on page 21) refers to the flyer being “in pretty plain English”.

This might be the case, but it does not warn the customer about the potential magnitude of break costs. The flyer does not explain that break costs are dependent upon the markets and could exceed 40% of the value of the loan. But the reality is that the flyer was never distributed anyway and was produced “to tick a box”.

37. David Thorburn (on page 22) states “There was a worked example in the documentation the customers were given that set out ­ a pretty straightforward example ­ a 10 year loan for £1 million and so on and gave an example of the break costs…..”

David Thorburn may be referring to the original document produced in 2001 that was intended to be issued to each customer, but the reality was that no system was ever implemented to monitor or enforce the issue of it. This document was soon replaced by a second version which was the same as the original but i) omitted the example to which David Thorburn refers ii) omitted the paragraph adjacent to the example to which David Thorburn refers and ii) replaces the term “economic cost” with “break cost” thereby avoiding drawing customers’ attention to “mark to market” break costs. If there is another flyer in existence, please could David Thorburn provide a copy?

38. David Thorburn states (on page 24) “There was also a worked example given in the flyer that was attached to the facility letter”

Please could David Thorburn provide a copy? Whether the flyer was being distributed generally or not, the contents are not legally binding due to the fact that it is not an integral part of the facility letter.

39. David Thorburn (on page 25) focuses on the failure of staff to warn customers of the possible magnitude of break costs, explaining that no one expected the base rate to fall to such a low level and remain low for so long.

But the bigger issue is that staff were steering all customers onto the fixed rates, driven by the commission reward. What does David Thorburn have to say about that? As no system was in place to prevent mis selling, and as staff were being rewarded by instant commissions of 5.5% of the loan for steering a customer into a fixed rate, it is absolutely certain that mis selling would be occurring.

40. David Thorburn states (on pages 25/26) that two thirds of the fixed rate TBLs have “done what the customers wanted them to do”.

This is incorrect. Over 5 years, the exorbitant break costs have locked the customers into the TBLs whilst rates have been low. The fact that the fixed rate period has expired and that the loan is no longer subject to the fixed rate is irrelevant. The TBLs certainly did not do what the customers wanted them to do. The product did not work. If the product had worked, it would have allowed a customer to break without incurring a ruinous break cost.

41. David Thorburn states (on page 27) “Our parent company did the hedging and nothing has failed in respect of their own interest rate hedging”.

The fact that the portfolio collapsed and had to be transferred to the parent company’s books evidences that the hedging strategy was a total disaster.

42. Debbie Crosbie states (on page 28) “What we found—and today we are only part way through the complaints review—is the mis­selling that we see and the lack of understanding through the sales process that was evident in standalone review, we do not see that mirrored.”

But the issue is that staff were steering all customers onto the fixed rates, driven by the commission reward. As no system was in place to prevent mis selling, and as staff were being rewarded by instant commissions of 5.5% of the loan for steering a customer into a fixed rate, it is absolutely certain that mis selling would occur in a scenario with no controls. How can Debbie Crosbie possibly make this statement?

43. George Mudie (on page 29) asks David Thorburn “Did you supply customers—Tailored

Business Loan customers—with written figures for break costs at any time in the sale

process?”David Thorburn replies “Yes we did”.

This is not true. As the conversation continues, George Mudie asks David Thorburn to be more specific. David Thorburn refers to a double sided flyer. Double sided flyers were not issued to customers. There was no system in place policing the issue of these flyers. These were not an integral part of the agreement and would not be legally enforceable.

44. David Thorburn (on page 33) states “The process was enhanced on the way through, so for most of the time there was that flyer. I cannot remember whether the contents of the flyer changed”.

This is not true. David Thorburn may be referring to an early document produced in 2001 that was intended to be issued to each customer but no system was in place to monitor or enforce the issue of it.

This document was soon replaced by a second version which was the same as the original but i) omitted the example to which David Thorburn refers ii) omitted the paragraph adjacent to the example to which David Thorburn refers and ii) replaces the term “economic cost” with “break cost” thereby avoiding drawing the customers’ attention to “mark to market” break costs. If there is another flyer in existence, please could David Thorburn provide a copy?

45. In Debbie Crosbie’s exchange with Jesse Norman (pages 36 ­ 42), it transpires :­

i)    550 complaints received

ii)   8,372 fixed rate loans offered

iii)  none have been upheld

iv)  330 are expected to receive redress (but no indication of what this is

v)   250 complaints reviewed to date

vi)  50 / 60 settlements agreed (but not implying that the complaint was upheld)

vii) 150 some form of redress will be due

viii) approx 67 FOS adjudications against the bank

46. Debbie Crosbie states (on page 39) “This review started in earnest in late January”.

However, the bank agreed to implement a voluntary review in October 2012 (15 month previous). Why was there such a long delay? Debbie Crosbie uses the expression “in earnest” simply because her conscience prevented her from saying “The review started in October 2012”. The reality is that there was no movement until late January 2014, despite the fact that the bank was giving the opposite impression to the FCA over these 15 months. 2

47. When asked by Jesse Norman (on page 40) “How much redress has been paid out to customers with a fixed­rate TBL, Debbie Crosbie replies “I think the number is quite low.”.

The reality is that the figure is so low that she is too embarrassed to state the figure. Someone in Debbie Crosbie’s position attending such a meeting should have this figure in her head or at the very least in notes at the meeting. The reality is that the figure is zero. She confirms to Jesse Norman that the figure is less than £10 million. Zero is less than £10 million.

48. David Thorburn states (on page 43) “The whole Tailored Business Loan range, most of the revenue, somewhere between 90%, 75%, in fact went to the parent.”

In effect, NAB was generating enormous profits at the expense of British jobs using Clydesdale and Yorkshire Banks as vehicles.

49. Customers who adopted TBLs after March 2009 (after the base rate had dropped to 0.5% and whose TBLs were fixed at low rates) were being quoted similar break costs to those who adopted TBLs at much higher rates pre Oct 2008. It is clear that there is malpractice here.

Could this be investigated?

50. Why does the bank believe that using the current market value of a swap for the residual term of the TBL is a suitable methodology for the calculation of break costs when it does not in any way align to or reflect the true costs to the bank in the event of prepayment?

51. Why does the bank call a fixed rate TBL a ‘hedged product’ when it leaves the borrower with a fixed interest rate risk that is not hedged?

52. Does the bank, by using an imbalance of knowledge between that available to the borrower and that available to itself, agree that it contravened Section 140B of the Consumer Credit Act?

53. Customers’ files do not give an accurate depiction of what happened during the sales process. There should have been a clear fact find document, which documented what was said at the sales meeting, which was then signed by the customer. The reality is that the Business Relationship Manager and the Treasury Partner did not do this and simply said anything to achieve the sale. Could the TSC visit the bank and conduct a review of 10 customers’ files without giving any notice to the bank?

54. NCSG has 3 whistleblowers (ex bank staff) who are willing to give evidence to the TSC. One was the head of one of the bank’s Financial Solutions Centres. Does the TSC wish to interview these people?

NCSG 3 July 2014

NAB Yorkshire Clydesdale Bank Tailored Business Loans Fixed Rate Loans Statements

Did NAB Owned Yorkshire / Clydesdale Bank Fail to Keep to Their Promises in Respect of Tailored Business Loans – Fixed Rate Loans?

Here are some of the written promises/statements. If you are a law firm, preparing a complaint to the bank or a submission to the Financial Ombudsman Service (FOS) then contact Nab Customer Support Group or Bully-Banks for help and support.

Download February 4th 2008 ‘TREASURY SOLUTIONS’ Document from a snapshot of Yorkshire Bank’s Website

This document was taken from a snapshot of Yorkshire Banks Website as at February 4th 2008 and is available at this link (currently).

Here is the Treasury Document used to sell interest rate hedging products for Clydesdale Bank as of the 12th January 2008 on Clydesdale Bank’s website.

(With thanks to Bully-Banks for commenting on my research below)

1. It describes TBLs as ‘fully flexible’! This could not be more incorrect and misleading.
2. It sells TBLs as offering protection against adverse interest rate movements. I cannot see how this does not make this a regulated product under RAO 2001 Section 85 – it is designed to avoid a loss by reference to fluctuations in an index.
3. It promises that experts will look at interest rates with you. Which means they will give you advice then?
4. It emphasis the potential up-side but fails to mention the down-side. It says that TBLs are potentially profitable as they allow you to benefit from favourable rate movement BUT breakage costs are not mentioned at all! If this isn’t mis-representation I don’t know what is.

Fiona Sherrif – Bully Banks

Here is what Yorkshire Bank said on their website in respect of Tailored Business Loans December 2008 to September 11th 2012.

Yorkshire Bank Website 2008 to 2011

Funding to suit individual business needs

Capitalise on flexible lending facilities. A Tailored Business Loan from Yorkshire Bank offers a lending solution that suits your needs. By providing medium to longer-term funding, Tailored Business Loans can help protect you against interest rate movements too.

  • Fully flexible lending for amounts over £250,000
  • Provides a known maximum interest rate
  • Can be structured to match specific cashflow requirements

To find out more:

  • Call into your nearest branch or call 0845 606 4477
  • If you’re an existing Business customer, contact your Business Manager
  • Existing Business Direct customers, call 0845 606 4477

More Benefits

  • Personal attention – dedicated pro-active relationship management
  • Certainty – aids cashflow projection by providing a known maximum rate of interest to be paid
  • Protection – against adverse interest rate movements
  • Secure and potentially profitable – allows you to benefit from favourable rate movement whilst still protecting your exposure
  • Flexible – profiles can be restructured should the interest rate view change
  • Freedom – experts look after the interest rate risk with you, allowing you to concentrate on running your business

Further Features

  • Fully tailored to cover all or some of the debt
  • Can be structured to match specific cashflow requirements
  • Available in Sterling, Euros and US Dollars

Complementary Solutions

  • Interest Rate Risk Management

Important Information

  • Interest rate – agreed when deal is transacted. Speak to your Business Manager or Business Advisor for more details
  • Interest type – debit interest priced to London InterBank Offered Rate (LIBOR)
  • Interest calculated varies depending on the specific solution agreed with you. Please speak to your Business Manager or Business Advisor for more details
  • Interest paid typically monthly or quarterly
  • Minimum amount – £250,000
  • Maximum amount – unlimited


  • Apart from the various lending fees, most products within the Tailored Business Loan suite are zero cost. Please speak to your Business Manager or Business Advisor for more details
  • Terms and conditions
    • Available up to 30 year term
    • Full terms and conditions are available on request
    • Credit line may be required

In the event of non payment, breach of covenant, or non compliance with terms and conditions, we may proceed to make a call on, or realise any security pledged in support of the borrowing.


Terms and Conditions apply. All facilities are subject to status and applicants must be aged 18 or over.

Yorkshire Bank is a trading name of Clydesdale Bank PLC which is authorised and regulated by the Financial Services Authority. Credit facilities other than regulated mortgages are not regulated by the Financial Services Authority. Clydesdale Bank PLC, Registered in Scotland (No. SC001111), Registered Office: 30 St. Vincent Place, Glasgow, G1 2HL. A member of the National Australia Bank Group of companies.

Control your exposure to interest rate risk

A business banking solution to protect cashflow against interest rate fluctuations. Interest Rate Risk Management from Yorkshire Bank offers a flexible way to minimise your exposure – and benefit from favourable rate movements.

  • Potential for profit with known maximum rate of interest and ability to benefit from favourable rate moves
  • Allows you to concentrate on running your business
  • Can be tailored to suit your business needs

To find out more:

  • Call into your nearest branch or call 0845 606 4477
  • If you’re an existing Business customer, contact your Business Manager
  • Existing Business Direct customers, call 0845 606 4477

More Benefits

  • Personal attention – Business Manager or Business Advisor can make fast decisions
  • Flexible – profiles can be restructured should the interest rate view change
  • Debt management tool – can be used to manage core and non-core debt

Further Features

  • Fully tailored to cover all or some of the debt
  • Can be structured to match specific cashflow requirements
  • Full term of the debt need not be covered
  • Available in Sterling and major foreign currencies
  • Premium-based or zero cost structures available

Complementary Solutions

Important Information

  • Interest
    • Agreed when deal is transacted. Interest varies depending on the agreed solution. Talk to your Business Manager or Business Advisor for details
    • Debit interest priced to London InterBank Offered Rate (LIBOR)
    • Typically paid monthly or quarterly
  • Minimum amount – £250,000
  • Maximum amount – unlimited
  • Costs
  • Depends on the specific solution agreed but can be zero-cost. Please speak to your Business Manager or Business Advisor for full details
  • Terms and conditions
    • Available up to 30 year term
    • Credit line may be required
    • Full terms and conditions are available on request


Spot and forward foreign exchange deals or wholesale deposits in the London market are undertaken in accordance with the Bank of England’s Non-Investment Products (NIPS) code which is available on the Bank of England’s website ( or direct from the Bank of England, Threadneedle Street, London EC2R 8AH.

Yorkshire Bank is a trading name of Clydesdale Bank PLC which is authorised and regulated by the Financial Services Authority. Credit facilities other than regulated mortgages are not regulated by the Financial Services Authority. Clydesdale Bank PLC, Registered in Scotland (No. SC001111), Registered Office: 30 St. Vincent Place, Glasgow, G1 2HL. A member of the National Australia Bank Group of companies.

Freedom of Information Request Financial Conduct Authority Fixed Rate Loans Embedded Interest Rate Swaps

Republished with kind permission of Bully-Banks

Hidden Swaps – Freedom on Information: Right to Know Request

On 6th May Bully-Banks sent a Right to Know Request (“the Request”) to the FCA.  It is seeking disclosure of the advice given to the FCA that led to their decision not to treat Hidden Swaps as “regulated products”.

We have been asked by a number of members of the Hidden Swaps’ Team to make the Request public because it directs their legal advisors to the issues which we consider are key to the issue of whether a Hidden Swap is a “regulated product”.

Here is the text of the letter:

Martin Wheatley
Chief Executive
The Financial Conduct Authority
25 The North Colonnade,
Canary Wharf,
London E14 5HS.

6th May 2014
Dear Martin,

Freedom of Information: Right to Know Request

We should be grateful if the FCA would provide the information requested in paragraphs 1 to 5 below.

Ordinary People in Business is requesting this information under the Freedom of Information Act 2000 on behalf of one hundred of its members who each allege that they have been mis-sold a “Hidden Swap” by their bank.

Hidden Swap

For ease of reference may we first define the term “Hidden Swap”.

“Hidden Swap” is a term that we use to describe a fixed interest business loan the break cost of which is linked to the value of an underlying swap entered into between the lender and a third party (which may be another division or subsidiary of the lender).  Hidden Swaps are sometimes called “Embedded Swaps” or “Tailored Business Loans” and may have other names.

A Hidden Swap contains a term providing for “breakage costs” to be payable in the event the customer terminates the Hidden Swap prior to expiry. The unusual feature of a Hidden Swap is that the quantum of these “breakage costs” is unknown at the date the Hidden Swap is entered into. These “breakage costs” are determined when the Hidden Swap is terminated (or proposed to be terminated) by reference to either the then current Bank of England Base Rate or the then prevailing LIBOR rate AND the then outstanding term of the Hidden Swap.

You will be aware that the FCA has recently confirmed that a number of banks sold some 70,000 of these products in the period since 2001.

You will also be aware that some hundreds of SMEs have alleged that they were mis-sold a Hidden Swap by their bank and maintain that this mis-sale is substantial misconduct by the bank.


For the purposes of this letter, “advice” means advice from an external solicitor or barrister AND / OR advice from the legal department of the FCA AND / OR advice from the legal department of any government ministry or department AND / OR guidance or direction from any government ministry or department.

The Information Requested

We are requesting a copy of each of the following documents:

A copy of the written advice given to the FCA (or to any official of the FCA) that the alleged mis-conduct of a number of banks and building societies in mis-selling Hidden Swaps is not an issue of “conduct” sufficient to bring the mis-sale of Hidden Swaps within the FCA’s jurisdiction to investigate (i.e. the FCA does not have the jurisdiction to investigate the allegations of mis-conduct made by some hundreds of SMEs that have been sold Hidden Swaps).

In the event that such written advice exists, a copy of any letter of instruction from the FCA (or any official of the FCA) requesting such advice together with any appendices or enclosures submitted with such letter of instruction.

In the event that such written advice does not exist, a copy of the minutes of any meetings when the FCA (or any official of the FCA) took the decision that the alleged mis-conduct of a number of banks and building societies in mis-selling Hidden Swaps is not an issue of “conduct” sufficient to bring the mis-sale of Hidden Swaps within the FCA’s jurisdiction to investigate.

A copy of the written advice given to the FCA (or to any official of the FCA) that the breakage clause contained within a Hidden Swap is not a derivative.

In the event that such written advice exists, a copy of any letter of instruction from the FCA (or any official of the FCA) requesting such advice together with any appendices or enclosures submitted with such letter of instruction.

In the event that such written advice does not exist, a copy of the minutes of any meetings when the FCA (or any official of the FCA) took the decision that the breakage clause contained within a Hidden Swap is not a derivative.

A copy of the written advice given to the FCA (or to any official of the FCA) that the breakage clause contained within a Hidden Swap does not fall within Section 85(1) of the Financial Services & Markets Act 2000 (Regulated Activities) Order 2001 i.e. is not “a right under a contract the purpose of which is to secure a profit or avoid a loss by reference to fluctuations in …. an index or other factor designated for that purpose in the contract”.

In the event that such written advice exists, a copy of any letter of instruction from the FCA (or any official of the FCA) requesting such advice together with any appendices or enclosures submitted with such letter of instruction.

In the event that such written advice does not exist, a copy of the minutes of any meetings when the FCA (or any official of the FCA) took the decision that the breakage clause contained within a Hidden Swap does not fall within Section 85(1) of the Financial Services & Markets Act 2000 (Regulated Activities) Order 2001.

A copy of the written advice given to the FCA (or to any official of the FCA) that the breakage clause contained within a Hidden Swap does not fall within Article (4)(1)(17) of the Markets in Financial Instruments Directive 2004/39/EC.

In the event that such written advice exists, a copy of any letter of instruction from the FCA (or any official of the FCA) requesting such advice together with any appendices or enclosures submitted with such letter of instruction.

In the event that such written advice does not exist, a copy of the minutes of any meetings when the FCA (or any official of the FCA) took the decision that the breakage clause contained within a Hidden Swap does not fall within Article (4)(1)(17) of the Markets in Financial Instruments Directive 2004/39/EC.

A copy of the written advice given to the FCA (or to any official of the FCA) that “the deposit” made by the bank as one party to the Hidden Swap does not fall within Question ID 289 in the Commission’s Question and Answers on MiFID which states, inter alia, “Equally, a deposit with an embedded derivative that has the potential of reducing the initial capital invested is a financial instrument under MiFID.”

In the event that such written advice exists, a copy of any letter of instruction from the FCA (or any official of the FCA) requesting such advice together with any appendices or enclosures submitted with such letter of instruction.

In the event that such written advice does not exist, a copy of the minutes of any meetings when the FCA (or any official of the FCA) took the decision that “the deposit” made by the bank as one party to the Hidden Swap does not fall within ID 289.

Given the high level of sensitivity attaching to this issue we should be grateful if the FCA would make every effort to disclose the requested information. The FCA’s reliance on a claim of legal privilege (which is how the FCA has responded to other requests for disclosure on the issue of Hidden Swaps) is inappropriate in the circumstances.

On behalf of our members we are seeking confirmation that each one of the various questions raised has been properly considered by the FCA and its advisors. We are also seeking an explanation of the reasons behind the decisions taken by the FCA in regard to each of the questions.

With many thanks for your help, yours sincerely,

Ordinary People in Business

The FCA confirmed receipt of the Request and noted the following:

“Out of interest, I note your description of how the break costs are calculated:

“These “breakage costs” are determined when the Hidden Swap is terminated (or proposed to be terminated) by reference to either the then current Bank of England Base Rate or the then prevailing LIBOR rate AND the then outstanding term of the Hidden Swap.”

I don’t think this is technically correct – I understood that break costs were determined with reference to prevailing forward interest rate curves (rather than the current base rates or LIBOR rates). This is illustrated quite well today – the base rate has not moved but break costs on many live base rate swaps will have fallen because of expectations about the future path of interest rates.”

Bully-Banks immediately agreed with the correction i.e. the break costs in a Hidden Swap are determined with reference to the prevailing forward interest rate curves (rather than the current base rates or LIBOR rates).

The FCA has helpfully put its finger exactly upon why a Hidden Swap is “a regulated product” i.e. the breakage cost a Hidden Swap contains is clearly a derivative because it is determined with reference to prevailing forward interest rate curves.

We await the FCA’s response to our request for information with great interest.

Jeremy Roe
Ordinary People in Business

FCA Treasury Select Committee Submission SME Lending Contract For Difference Interpretation

FCA’s Position on Interest Rate Hedging Products, Stand Alone and Hidden or Embedded as Reflected in Their Submission to the Treasury Select Committee on SME Lending

Extract from FCA Letter to a member of NCSG 25th April 2014 relating to ‘Embedded Interest Rate Swaps’

The definition of a ‘contract for difference’ (CFD) as defined by Article 85 of the Regulated Activities Order 2001 (RAO) includes rights under a contract “the purpose of which is to secure a profit or avoid a loss by reference to fluctuations in … an index or other factor designated for that purpose in the contract”. Where interest rate contracts are purchased separately to a loan which a customer wishes to hedge, our view is that they are a form of CFD, as the purpose of the contract, from the customer’s viewpoint, is to avoid a loss by reference to interest rate fluctuations.,

Where an IRHP is referred to as “hidden” or “embedded”, this will generally mean that a customer has taken out a commercial loan but may be faced with the same repayment features and potentially significant break costs that a customer would have faced had they taken out a variable rate loan and a standalone IRHP. This is because the bank will have entered into a separate IRHP with a third party in order to manage the financial risk of entering into the loan. The terms of the loan will provide that the borrower will bear the bank’s break costs of terminating the IRHP early should the customer terminate the loan early.,

While the economic effect for the customer may be similar, our view is that the loan the customer has entered into is not a CFD because the purpose of the loan is not to secure a profit or avoid a loss by reference to fluctuations in interest rates. Rather, the purpose of the loan from the customer’s perspective is to borrow money on the specified terms in the loan, for example, relating to the interest rate payable on the loan.,

To confirm, as these products fall outside our remit, the FCA’s regulatory powers are much more limited. The Government has been clear in outlining this to MPs and to organisations representing customers, including Bully Banks. It is for Parliament to decide whether the FCA’s remit should be extended to cover these loans. However, even in the event that our remit was extended, we could not take action retrospectively

Interest Rate Swap Misselling Fixed Rate Loans – Contracts For Differences

Contracts For Difference – The Essence of the Embedded Interest Rate Swap – Fixed Rate Loan Mis-Selling Issue

 Contracts For Difference

1.  A Tailored Business Loan (TBL) relies on a Synthetic Derivative or an Over The Counter (OTC) Derivative of an Interest Rate Hedging Product (IRHP), which itself is a Derivative of a Money Market Instrument.  The further away from the Money Market instrument a derivative gets, the less transparent it is.
Lacking Transparency =  easier to fiddle.
2.  By definition, these instruments are Contracts For Differences (CFDs)
3.  CfDs are “designated investments.”
4. “Designated Investments” can only be sold to “Eligible Counterparties” & Professional Investors.  Others customers can “elect” to be Professional Investors, BUT the implications in terms of reminders, annual renewals and information disclosure are ‘onerous.’
5.  Have you elected to become a “Professional Investor?”
6.  The banks will respond that they had FCA permission to sell these products both as ‘stand alone’ IRHP and embedded (TBLs).
This is the Concentration Camp Guard Defence – we were only following orders, BUT is THE reason we are in such difficulties: This is a ‘government approved’ RF!
The FSA “overlooked”  that the basis of the TBL is a “Designated Investment” and hence illegal.  The consequences of this “approval” is the potential insolvency of the UK “Banking Sector” – again!
7.  Also, as an aside, there is a very good chance that the MTM ‘profit’ on embedded swaps/ IRHPs kept UK Banks from totally disappearing in 2008/ 09.  This is one reason that the Senior Management of most of our UK High Street Banks are “Treasury” inclined and why they have not been replaced/ sacked/ prosecuted!
An admission of liability by the FCA would eviscerate UK Bank Management and Regulators, as well as bankrupting the sector.

Tailored Business Loans – Time Bomb Loans


Tailored Business Loans Contain Embedded Interest Rate Swaps


The Bankers’ Lethal Deceptions – Tailored Business Loans

 By Terry Mulvenna, Financial Specialist, For, and on behalf of, NAB Customer Support Group. © Terry Mulvenna, May 2013.

A. Defining a Tailored Business Loan TBL:

A Fixed Rate Loan (FRL) where the “fix” is derived from an Interest Rate Swap which is embedded within the Loan Contract.

B. Premeditated Deceptions By Bankers & Their Unforeseen Consequences:

B (1). Bankers’ Deliberate, Premeditated Deceptions:

1.1. The embedded Swap Contract (an insurance policy based on a Derivative Product) is hidden within the Facility Letter (the Contract) and therefore is included within the SME’s Banking Security! The presence, and intrinsic structure of the Swap, turns the Fixed Rate Loan into a lethal Time Bomb Loan.

1.2. The FRL is often one of several purported options, including an option of variable rate facilities, which are offered within the Facility Letter.  Interest Rates are quoted at very fine margins, even teaser rates.  HOWEVER, interest protection/ insurance is mandatory.  THE SWAP/ IRHP THEREFORE BECOMES A PREDICATED SALE, i.e.the Swap MUST be taken!  Therefore, the variable rate option is removed, post signing.

1.3. The  “embedding” of the Swap within the Facility Letter ensures that the liabilities associated with the Swap are part of the Contract between the Bank and the Customer.  The Courts therefore “rubber stamp” Foreclosure Proceedings by the Banks.  The contractual relationship between Bank & Customer is based on the Facility Letter:  The cornerstone of Banking Stability & Viability is a Bank’s ability to Foreclose on its Security.

1.4. The FSA/ FCA refuses to differentiate between Standard FRLs & TBLs which is a Sleight of Hand by the Regulator: Swap contracts are highly regulated and are only tradable between Professional Investors and Eligible Counterparties under the FSA/ FCA rules. Swaps are the basis of TBLs. Therefore, the Regulator’s approach is logically inconsistent within its own rules and policies.

1.5. Due to the embedded Swap, TBLs can only be sold by “Authorised Individuals” but can be sold to anyone. The Bankers’ response (get out of jail, card) to this is for the customer to “seek independent financial advice.”  However, this highly specialist (and regulated) financial advice, was not available before 2010. Again, the Regulator’s position is illogical within the terms of its own rules, regulations and policies.

1.6. SMEs did not know that they were entering into a Swap agreement by signing a TBL as it is hidden and NOT declared by the Bank.

1.7. Did SMEs know they therefore became a Counterparty to a Derivative Product (Swaps used in Fixes are OTC – Over The Counter – products and are therefore Derivatives), which are highly risky and therefore highly regulated products (MiFID and COBs), except in THIS instance?

1.8. Were SMEs aware, that by signing the TBL, they were electing to be classed, by default, as a Professional Investor or Eligible Counterparty?  These are the only Regulatory Classes of Investors who can Trade in this Class of Derivative Investment.

1.9. Were SMEs aware that Breakage Costs under Swap contracts were based on a “no loss clause” to the Bank (i.e. Heads the Bank wins, Tails, the customer loses) as determined by the Swap Market Contractual Terms and supervised by the ISDA as it is an OTC product?

1.10. Were the SMEs aware that by signing the contract (Facility Letter) their property, pledged as security to the Bank, became security for the Counterparty Deposit for margin calls if the bet went against the SME?

1.11. The Banks’/ Regulator’s Review of IRHPs is a distraction from the Core issue of TBLs: an attempt to divert attention from the damage being done by TBLs by saying that the IRHPs used to hedge interest rate risk were regulated and hence grant SMEs some means of recompense for the mis-selling of these IRHPs.The review is a smokescreen.

 All Swaps / Contracts for Differences are Regulated Products: they are intrinsically dangerous (and therefore regulated) for investors even when they are aware of the risks.

1.12. The Bank relies on the small print in the T&Cs to enforce the embedded Swap: hide the Swap and then enforce it by relying on obscure clauses in the T&Cs which in many cases were not supplied in advance, or at all, to the SME.

1.13. NO Formulae of the underlying Swap were provided as part of the Facility Letter (or the T&Cs), nor mentioned at all. Reliance is made on recovering “economic/ breakage costs” clauses in the T&Cs. No worked examples are provided.

1.14. The Breakage Cost of the embedded Swap is determined by the market rates applicable at the date of breakage. The Breakage Cost is therefore indeterminable, even via estimate, on a pre contract, consummation basis!By signing the Facility Letter (Contract), the SME is taking on immense but unquantifiable risk. Scenario creation and Termination Matrixes are necessary if the SME was to even comprehend the risks associated with the Swap.A post graduate degree in Financial Mathematics and subsequent professional education in Actuarial Studies/ Association of Corporate Treasurers is required to understand the risks.

1.15. Even if the educational background is present, the customer needs access to, and massive experience using, the relevant Blomberg Screens. The only proof of this particular pudding is extensive proven experience in Swaps or other CFDs.

1.16. By forcing the SME to buy a Swap, the bank is forcing the SME to take an unlimited (and unhedged) risk ‘vis a vis’ downward movements in interest rates, save if interest rates drop to zero. Every Spread Better knows about Stop Losses, an SME does not.

1.17. By embedding the Swap in the TBL and within the Banking Security, the Bank is knowingly forcing the SME into becoming a CFD trader/ Spread Better, without alerting the SME to this fact and the risks involved.

1.18. By making the SME a Spread Better by default, and without making him aware of this fact, no Stop Loss strategy was put in place. The impact of this risk during the current downturn meant that the Swap would prove to be lethal to many SMEs.  By signing the Facility Letter and Legal Charges, many SMEs have accidentally signed their own Death Warrant.

1.19. The size, and longevity of the interest rate collapse was unforeseen in the original RF plan: many customers have been busted by the consequences of the RF; many more are drained of cash, demoralised and on the verge of collapse.

However, the Bank is not Breaking the Swap at the point of Foreclosure, nor after the Point of Crystallisation.  The TBL is still being serviced post Foreclosure. Why? How is it being serviced? The answer to this is alluded to in B (2) No 3 below, but this is the nub of the matter: the Banks have stopped claiming micro hedges existed and some are denying they were ever taken.  If this is so, what is the basis of the Breakage Charge?

Before accusing the Banks of Enron Accounting on a massive scale, further investigation is required.  This will be covered in my next report.

1.20. TBLs are sold as Loans when the most critical (predicated but hidden) component is an insurance contract – for the management of interest risk via a Derivative Contract.  However, the basis of selling an Insurance Policy – Uberrima Fides – is completely ignored!

B (2). Unexpected Consequences of the Banks’/ Regulator’s Deceit/ RF.

1. By forcing the SME to buy a Swap, the Bank is forcing the SME to make a continuous bet on one (of many) future outcomes, for one of many important business variables. This forces the SME to make a continuous bet on possibly the wrong horse in the wrong race.

2. To repeat (B(1), 2sic.): The embedded nature of the Swap and the establishment of the Contractual Relationship, via the Facility Letter (i.e. the need for Interest Rate Hedging and its Method) and the associated Banking Security, forces the Swap onto the SME. The embedded Swap/ IRHP is therefore a Predicated Sale which increases the risk to the SME (and its unquantifiable Contingent Liabilities) exponentially.

Is this desirable?

Most SMEs are averse to risking their capital. The Contingent nature, and the Capital Risk of the Swap, is not mentioned at all!  Most companies (including Quoted Companies) are totally unfamiliar with the management of Contingent Liabilities, especially when they are totally unaware they have signed up to a Contingent Risk in the first place!

3. The Losses on the swap are serviced from the Fixed Interest Rate Payment. The shortfall on the interest is capitalised into a Contingent Liability which, if crystallised, becomes the Breakage Cost.

Due to the collapse in interest rates brought about by the current economic catastrophe, the Contingent Liability for most Loans is huge relative to the size of the loan, e.g. 20 – 25% of the remaining Loan Value! The size of the Contingent Liability is also unexpected!

This raises many interesting issues:

3. (a) How is the Loan Servicing being kept current?

3. (b) How is the Loan accounted for under the FRSA accounting rules?

3. (c) Where is the Contingent Asset for the Bank hidden?

3. (d) Where is the Contingent Liability for the Customer quantified?

3. (e) Why hasn’t the customer been informed of this Contingent Liability?

3. (f) Given that the Contingent Liability arises out of a naked, and highly geared, Spread Bet, why wasn’t this Contingent Liability data available, real time, to the punter?

3. (g) If I am wrong concerning keeping the servicing of the Swap current, the issue is simply inverted: how are the losses on the Swap being serviced and being accounted for?

3. (h) As at least one or other of the Swap Costs, or Interest Costs is not being serviced by the Customer in cash, what provisions for B&D are being made under the FRSA?

3. (i) How many customers are in Breach of their Debt AND Swap Servicing obligations?

3. (j) Where are the provisions arising from these Defaults in the Bank’s Fiduciary Accounts?

3. (k) Are “bucket” accounts being used to keep both the Swap and Loan Servicing current?  If so, where are these customers’ liabilities hidden? Are other Derivatives or synthetics being used to hide this lack of servicing?

3. (l) IF the lack of cash servicing of either the Swap or the Loan Interest is occurring, as it must be, how is the credit risk associated with the now overwhelming Counterparty Risk being accounted for?

3. (m) How are the Banks reporting these Contingent Liabilities internally, to Credit Reference Agencies and other Banks under customer referencing and Fraud Prevention Schemes?

3. (n) Some Banks are not providing customers with their Interest Paid Certificates for the preparation of their Fiduciary Accounts. Why is this? They are forcing customers into breaches of their accounting and taxation responsibilities as well as their Banking Covenants.  These breaches invite investigations by the HMRC.

4. By forcing unsuitable and highly risky TBLs on SMEs, the Bank is Ossifying the SMEs’ existing Assets, eliminating the essential flexibility that the SME needs to mange its business to the benefit of ALL stakeholders, including the Bank.  The Breakage Cost reduces flexibility and significantly increases the cost of restructuring.  This is not beneficial to any party, especially the SME’s staff, customers, suppliers, taxman, owners and Bankers.

5. EBITDA (Earnings Before Interest Tax Depreciation & Amortisation) is the prime means of measuring corporate performance and operational cash generation capacity.  EBITDA and asset structures drive financial structures, including the gearing decision.  EBITDA is the residual between two large figures driven by the market and the cost/ asset structure (i.e. Operational Cash Inflows and Operational Cash Outflows).

Business success is normally driven by the management’s ability to manage these revenue and costs.  By hiding a Swap, with unlimited downward risk and high leverage, within a Loan, the Bank forces the tail to wag the dog: as losses occur under the TBL, the SME is drained of cash and ends up running the business to pay the TBL.

6. When the Bank sells the TBL to the SME, the Bank is turning a Semi-Variable Cost into a Fixed Cost – for the duration of the Fix. This prevents the benefits of reduced interest rates reaching where it is needed.  TBLs increase the risk profile of the SME as the composition of cost changes (more costs become fixed) and costs cannot be shed as turnover decreases. The Operational Gearing of the Company is therefore increased, a per se bad outcome to ALL parties, especially the economy, as Losses increase as a downturn occurs in turnover.

C. The Solution and a Historic Perspective.

The current TBL debacle is simply déjà vu. The mis-sale of Interest Rate Swap Contracts to Local Authorities in the mid 1980s was virtually identical to the current debacle: the perpetrator is the same (The Banks); the product is the same (Interest Rate Swaps) and the financial naivety of the target is the same – in this case the SME.

Local Authority Swap contracts were declared illegal in the 1980s via the Audit Commission’s (Howard Davidson) intervention: the Swap Contract was declared illegal, by being ultra vires, for Local Authorities.  By utilising ultra vires, the Government found a silver bullet to protect the public purse and the naivety of its employees.

In the case of TBLs, a similar silver bullet is required.   In this case, simply declare TBLs void ab initio (void from the outset).  The rationale is simple: See deceptions above sic, but the Cost of the Collapse of SMEs will be borne by the whole society in the form of loss of jobs, loss of investment, loss of tax revenue, etc., as well as by the totally expropriated SME owners!

Essentially, by failing to act on TBLs, the Government is suffering a Double Whammy:

1. Cash Support for Banks.  The Government has bailed the Banks out at a massive cost to the taxpayer by funding: capital injections; emergency liquidity injections; Open Market Operations; QE; Lowest Interest rates in History; Funding For Lending scheme; destruction of saving incentives; over target inflation and now the Support For Home Buyers Scheme.

2. Losses Under Swap/ CFD Mis-selling: The Government, as a consequence of the demise of SMEs, now has to suffer and fund further massive losses via reductions in: employment; VAT, NHI, PAYE, self assessed income tax; corporation tax; macro demand; macro supply of goods and services; Capex; and the reduction in economic growth brought about by the skinting and demise of long established SMEs.

The poor SME owner also loses his property, his pension and in many cases his home via bankruptcy!

SMEs employ 40% of the working population and are currently being eviscerated by Swaps and the abdication of Regulatory Responsibility!

D. Note About The Author: Terry Mulvenna.

My background is Mathematical Economics at first degree, followed by a 2 year MBA at Manchester Business School (MBS).  After MBS, I had intended to become a Corporate Treasurer: my education and background are therefore inclined towards the Trading Approach to markets and capital allocation, including operationalising the Capital Asset Pricing Model for trading and investment purposes.

Instead of working in a Treasury function for a MNC, I developed MBS’s courses for Commercial Bankers from Developing Countries.  Having perfected the product, I then internationalised it for MBS. In the early 1980s I then established a joint venture with the Chartered Institute of Bankers in the UK and other Banking Institutes around the world facilitating their post qualification, professional development efforts.  My courses were then run mainly in-house based on the Banks own Default/ Problem files and were very “hands on.”

My speciality is Problem Loans in Problem Banks, especially Banks and their subsidiaries’ which are technically insolvent – at best.  Given the nature of the Banker (worldwide) I am akin to the Bridegroom with Syphilis: no one wants me (at least, initially) unless they have no choice!  Bust Banks wishing to reinvent themselves (and having usually changed their Senior Management) have no choice!

I have worked in 23 countries over 25 years and have 800 banks in my Client List, including most British Banks which operate internationally.  Literally thousands of bankers have attended my courses, some many different courses.

The more senior courses were built around the Bank’s own cases and files.  My approach emphasises effective appraisal and control of the lending process and the symbiotic nature of the Banker/ Customer relationship.  Within Problem Loans the emphasis is placed on identifying/ establishing viability via the Turnaround Process and then Debt Equity Swaps and loan restructuring including CULS to enable Workout.  The use of “under the water” options to incentivise management to facilitate corporate revival is demonstrated.

My pension is a portfolio of 53 properties in Manchester which operate like an inflation proof annuity/ Gilt.  I have built the portfolio over twenty years and have built out the Blocks as Project Manager.  I manage the portfolio myself.

I have been dragged into the TBL debacle by my Bankers extorting (RFed) a five year TBL from me in June 2008 on a £1,420,000 loan: I said “over my dead body” as I knew the markets had frozen in July 2007 and the Governments finances were in such a diabolic state that interest rates would collapse, the alternative being hyper inflation; but, they said that they would place me “on demand and call” the following day; plus, would freeze my account.  As I was building, and spending £20K a week in cash, I was given the choice of going bust by the end of the week or probably 2 years later!  Truly, Hobson’s choice?

Had this choice been extorted from me 12 months earlier, I would simply have: sacked my contractors who were about to start a new, but huge refurbishment; diverted all undrawn funds (£380,000+) and rental cashflow; defended the flat portfolio; and then frozen the account myself!

Life does not have to be like this!  However, to change the current legal reality, politicians have to start to manage the consequences and aftermath of 15+ years of regulatory abdication of responsibility, in a business friendly manner.  A New Magna Carta For Business is required!

Terry Mulvenna

30th May 2013 (updated 28th February 2014)

Legal Opinion Tailored Business Loans and Misselling

Tailored Business Loans and Mis-selling – Sean Kelly Barrister

Freestanding hedging products

When a bank lends money to a customer, it must borrow that money itself at a variable rate based either upon base rate or LIBOR. Normally, a bank will lend the money to its customer at such variable rate plus a margin so that the margin is its profit. Where the bank lends money to its customer on any other basis, this will involve “hedging” in one form or another. Hedging involves the replacement of such a variable rate arrangement with one under which the interest rate is limited or fixed in one way or another.

The most common way for a customer to hedge is to purchase a product (“a freestanding
hedging product”) which runs side by side with the variable rate loan. The freestanding hedging product need not necessarily be with the same bank, be for the same amount or have the same period. The combined effect of the freestanding hedging product and the variable rate loan is to produce an arrangement whereby the total sum paid by the customer (that is to say interest and hedge payments) is limited or fixed.

The most common freestanding hedging product is a base rate swap. Under a base rate swap the hedge bank (which might not be the same as the lending bank) agrees to pay interest at a variable rate to the customer and the customer agrees to pay interest at a fixed rate to the hedge bank. If the variable rate exceeds the fixed rate, the customer profits. If the variable rate is less than the fixed rate, the hedge bank profits. The combined effect of the base rate swap and the variable rate loan is to produce an arrangement which approximates to that of a fixed rate loan.

The Financial Control Authority (“the FCA”) places freestanding hedging products in four
categories being caps, base rate swaps, collars and structured collars. All work by creating a
system of payments by or to the customer which when combined with the variable rate loan limit or fix the total sum paid. Viewed in isolation, a freestanding hedging product is akin to a bet. Viewed in conjunction with a variable rate loan, it is more akin to insurance. Caps limit the interest payable to a set level. Collars impose and upper and lower limit on the interest payable. Structured collars involve one or more “rebound” whereby the interest payable increases if base rate or LIBOR falls to below a set level.

Tailored Business Loans

Until 2005 Yorkshire Bank PLC was a subsidiary of Clydesdale Bank PLC. In that year,
Clydesdale Bank PLC took over the activities of Yorkshire Bank PLC and the two banks have operated under one licence since then with Clydesdale Bank PLC trading under its own name or as “Yorkshire Bank”. Clydesdale bank PLC has assumed the obligations of Yorkshire Bank PLC and it is convenient to treat all products sold over this period as “Clydesdale” products.

A tailored business loan is a Clydesdale product which effectively includes both the loan and the hedge in the same agreement. Tailored Business Loans include fixed rate loans (“FRLs”) but it is more convenient to treat FRLs separately. I use the term “TBLs” to mean Tailored Business Loans excluding FRLs.

An FRL effectively combines a variable rate loan and a base rate swap. A Range Rate Loan
effectively combines a collar with a variable rate loan. A particularly onerous product called a Modified Participating Fixed Rate Loan effectively combines a structured collar with a variable rate loan.

A particular feature of the sale of TBLs by Clydesdale is the use of a number of different TBLs (often combined with FRLs) for the same customer for reasons which are not obvious. Usually the facility letter will make reference to a number of different types of TBL (setting out the terms of each) and the choice is made later. There are a dozen types of TBL and it is often difficult to determine which one was actually chosen. Indeed, I have seen cases where the terms of the product change over time with no documents to explain the change.

Regulation of the sale of hedging products

The sale of hedging products since 2001 is regulated by the FCA under the Financial Services and Markets Act 2000. Such regulation is in two forms. The first form relates to any products sold by regulated bodies. The second relates to particular products known as “designated investments”.

The regulation which applies to all products is known as the Principles. The Principles include an obligation to “pay due regard to the interests of its customers and treat them fairly” and an obligation to “pay due regards to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading”. Breach of the Principles cannot give rise to a claim which can be enforced by Court action. However, the Financial Services Ombudsman (“the Ombudsman”) does consider breaches of the Principles when assessing whether compensation should be awarded to a customer.

The term “designated investment” is defined by Article 85 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 to be:

“(a) a contract for differences or

(b) Any other contract the purpose or pretended purpose of which is to secure a profit or avoid a loss by reference to fluctuations in-

(i) the value or price of property or any description; or

(ii) an index or other factor designated for that purpose in the contract”

The term contract for differences is not defined.

The rules set out in the Conduct of Business Sourcebook (“COBS”) apply to designated investments sold since November 2007. An earlier version of the same (“COB”) applies to designated investments sold between 2001 and such date.

The obligations placed on banks by COBS are far wider than those imposed by the Principles.

These include:

1) An obligation to act honestly, fairly and professionally.

2) An obligation to provide communications which are clear, fair and not misleading

3) Where a personal recommendation is made, an obligation to take reasonable steps to
ascertain the needs of the customer and an obligation to take reasonable steps to
recommend a suitability product

4) An obligation to describe the nature and risks of the product
Many customers complain about the “mis-selling” of hedging products. This expression is wide enough to include common law claims such as misrepresentation and negligence. However, the expression is usually confined to breaches of the Principles and COBS.

A corporate body (such as a company or an LLP) cannot bring a claim for breach of COBS in a Court (see Grant Estates Limited v The Royal Bank of Scotland [2012] CSOH 133). The effect of this decision is to prevent the majority of business affected by the mis-selling of hedges from bringing a claim in Court. This problem is part of the motivation behind the FCA Review. The FCA has power to require a bank to provide compensation for breaches of its rules and it is this power which underlies the decision made by banks to participate in the FCA Review. Logically, the FCA cannot compel a bank to participate in the FCA Review in respect of the sale of products which are not covered by COBS.

The FCA Review

The FCA Review only deals with designated investments and the process is aimed at an
assessment of whether the bank has complied with its obligations under COBS.
Misrepresentation claims cannot be dealt with under the FCA Review and have to be re-cast as breaches of the obligation to provide communications which are clear, fair and not misleading.

Clydesdale has produced a leaflet setting out how it intends to review hedging products.
Freestanding hedging products are part of the FCA Review. FRLs are not covered at all. TBLs are reviewed outside the terms of the FCA Review but the procedure is broadly similar to the FCA Review. The “sophisticated customer” test is the same. The major differences are (1) that Clydesdale has not agreed to the measures in the FCA Review which are designed to protect customers pending the determination of the same; and (2) that redress for TBLs equivalent to structured collars is not automatic. While Clydesdale has not accepted that COBS applies to TBLs for the purposes of its review, it is difficult to see how the sale of TBLs can be reviewed otherwise than by reference to COBS.

The position which has been adopted by Clydesdale is the result of negotiations between it and the FCA. Clydesdale does not want to accept that TBLs are designated investments because this would open it up to a multitude of Court claims by individuals. It is unfortunate that the FCA has not forced the issue and brought Court proceedings to establish that TBLs are designated investments and that is entitled to require Clydesdale to review the sale of TBLs under the full terms of the FCA Review. However, it is difficult to see why Clydesdale would have agreed to review TBLs under a like procedure to the FCA Review if it had confidence in the strength of its argument. It is difficult to see how a TBL can be anything other than a designated investment. It makes use of a published index (either base rate or LIBOR) and its purpose is to avoid the loss associated with the liability to pay interest at base rate. It is no different in this respect from a freestanding hedging product. On this basis, a private individual who is outside the scope of Clydesdale’s review (or is dissatisfied with the same) should be able to bring a claim for breachof COBS. A number of TBL customers have commenced proceedings in the Administrative Court in order to establish that the decision by the FCA to exclude TBLs from the FCA Review is unlawful.

Permission to apply for judicial review has been refused. The case is called R (on the application of Dr. Julian Jenkinson, Simon Bridbury Properties (St. Albans) Ltd, Summerpark Homes Ltd and UK Estates Ltd) v the Financial Control Authority). Unfortunately, the extempore judgment is not yet available. The judgment does not establish that TBLs are not “designated investments”. It only deals with the legality of the actions of the FCA.

The sale of fixed rate loans

The sale of FRLs is subject to the Principles and the 2005 Business Banking Code. These can be relied upon in any reference to the Ombudsman. There is a good argument that the Principles have been breached where the customer is forced to consolidate its borrowings and include them all within a single FRL (so that the customer is effectively required to hedge in respect of previous borrowings which were not hedged when made) and where the FRL is sold after the collapse of Lehman Brothers on 15th September 2008. It is difficult to see any justification for the sale of any hedging product after that date.

There are a number of FOS adjudications where the adjudicator has relied upon breaches of the Principles or the 2005 Business Banking Code in finding in favour of a customer of a FRL. The most widely reported is that of Jim McGrory.

The application of COBS to FRLs is more difficult because they do not obviously involve the
avoidance of loss by reference to a published index. Indeed, the normal payments made under an FRLs are set and do not fluctuate by reference to any published index (base rate or LIBOR). This is a difficult point for a non-lawyer to appreciate because the reality of the situation is that a base rate swap is designed to turn a variable rate loan into an FRL. A base rate swap is a designated investment but the agreement which it seeks to create in substance might not be.

The arguments that need to be raised in order to establish that an FRL is a designated investment have to be more subtle and include the following:

1) The break cost on termination of an FRL is calculated by reference to a published index.
Break costs are calculated by reference to anticipated future base rates or LIBOR over the
remaining term of the FRL Precisely how break costs are calculated is a closely guarded
secret and no bank will reveal precisely how they are calculated on a voluntary basis.

2) The bank will normally enter into a freestanding hedging agreement with another bank
which mirrors the FRL. This will be a designated investment. The FRL is a designated
investment because it is associated with and passes on the risks of a designated

At some stage, the application of COBS to FRLs will need to be determined by the Court. Any such claim will need to be brought by an individual with a good claim for breach of COBS on its merits. Ideally, such a claimant would be someone who did not need a hedge at all (because he or she had sufficient resources to live with a sustained period of high base rate) or someone whose FRL is for far too long a period. An ability to bank elsewhere and an ability to finance  expensive litigation would also be required.

If FRLs are not subject to COBS, then the customer will be left to pursue common law claims.

The claims which apply in particular to Clydesdale include the following:

1) Misrepresentation as to the terms of the FRL as opposed to the bank’s view of future
interest rates (see Lakeside Inns v Yorkshire Bank). The most significant terms of an FRL
are not difficult to explain. However, there is an argument that the use of the term “fixed
rate loan” in this context is a misrepresentation because until recent times fixed rate loans
could be terminated on notice with relatively modest tapering beak costs.

2) Negligence. In the light of Green & Rowley v The Royal Bank of Scotland [2012] EWHC
366, it will be necessary to show that the bank has crossed the divide between providing
a recommendation and giving advice as the suitability of the FRL for the requirements
of the customer.

3) A redemption action. If the FRL is secured by a charge over land and the customer is in
a position to terminate the FRL and redeem the charge, it can apply to the Court to set the
terms of redemption. In effect, it can require the bank to prove its entitlement to its break
cost. There are two elements to this. The first is the entitlement of the bank to break costs
at all. The second is the quantum of the same

a) As to the first point, Clydesdale’s standard terms sand conditions limit its ability to claim break costs to an indemnity for its costs of breaking its own hedging arrangements. It is widely believed that Clydesdale did not enter into any formal hedging arrangements with other banks. If this is the case, it cannot claim any break cost. This point remains untested.

b) As to the latter point, the position of Clydesdale is no different to other banks. No bank will provide a proper explanation of break costs other than that they are calculated by reference to anticipated future interest rates. Even at a time when the Governor of the Bank of England has stated on record that base rate will not change for the next two years, break costs can vary significantly from month to month. How this can be the case is not clear. There is no reason why any customer should accept a break cost provided without a detailed methodology and calculation. My own personal experience of Clydesdale is that its calculations can produce figures which are difficult to understand. I have a case where the customer took out two completely different products on the same day for the same amount and same period, yet the break costs were the same. I would love to know how this can be right.

Sean Kelly
Chancery House Chambers
Leeds LS1 4LY
Tel: 0113 244 6691
Fax: 0113 244 6766
Friday 13th December 2013