What Are Interest Rate Hedging products?
IRHP’s, Interest rate hedging products have been designed to manage interest rate fluctuations. Unlike embedded IRHP’s In the main, these are stand alone, ie separate from a loan (unlike embedded IRHP, the subject of much continued controversy).
There are 4 categories of interest rate hedging products sold by many of the High St Banks which are under review:
1. Swaps: ‘Interest rate swaps’ allowing clients to fix the rate of interest of their loan.
2. Collars: These allow customers to restrict the effect of interest rate fluctuations according to a defined range.
3. Structured collars: again these restrict the effect of interest rate fluctuations similar to 2. above, but leave customers more vulnerable to rises in interest rate.
4. Caps: these place a limit on interest rate rises.the bottom of the range, the interest rate payable by the customer may increase above the bottom of the range.
Interest Rate Swaps
‘Stand alone Swaps’ are separate contracts from loan agreements where one type of interest payment is ‘swapped’ or exchanged for another, ie a floating payment for a fixed payment.
A contract separate to the loan agreement, the idea is that if interest rates rise then increases in customer loan repayments are limited. Upfront fees or regular ‘premiums’ are usually paid for caps or the cost of the cap is sometimes added to the loan.
Limit effects of interest rate fluctuations within pre-determined levels, collars are again separate from the underlying loan agreements. There are two types of collars, simple and structured.
What Should You Do if You Have Bought any of These Products (IRHP)?
Cap – you need to complain to the bank if you bought one of these after 2001 and your claim will only be considered if you are a ‘non-sophisticated’ customer.
Swap or Simple Collar – Again after 2001 then if you are a if you are a ‘non-sophisticated’ customer then the bank should contact you, (best to be safe and register a complaint with them).
The problem seems to be that many customers were unaware that they even had a fixed rate loan, let alone one that contained a complex financial derivative!