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CREFW-Fall2014 10.15.14

A publication of Autumn issue 2014 sponsored by CRE Finance World Autumn 2014 39 Swap Maturity Mismatches Are Key Problem The sample of swap cases we have been provided with is relevant for the commercial real estate sector, as it includes over 71% of swaps by value above the GBP 10m mark, which are not eligible for the FCA redress scheme (Figure 1). Despite the limited sample size, we are happy to accept its limitations and look forward to expanding it in future. According to Collyer Bristow, the key to a successful redress claim is that the swap’s key features do not match the loan’s risk profile. For example, when the swap maturity is longer than what was required under the associated loan agreement. Also another issue occurs when the loan agreement did not state that LTV or other financial covenants could be triggered into breach based on changes in the calculated swap break costs. This is further aided, if the swap provider has a one-sided option to terminate the swap at regular intervals after the original loan agreement. This leaves the borrower with no control over break costs. Based on our sample, most swaps have a maturity term mismatch. But, many also show a swap notional below the loan, which was unexpected (Figure 2). Apart from mismatches, Collyer Bristow also considers whether the borrower was sufficiently informed when signing up to the swap. If they were not provided with any indication of the magnitude of possible swap break costs under different swap maturities and/or future interest rate scenarios, this might be a red flag. If they were not made aware that the swap was an independent agreement, which might create a significant liability separate from the loan agreement, this could provide another argument that the contract was not properly sold. Finally, if they were not informed that a callable swap was likely to have a higher break cost than a non-callable swap, this could also pose a problem. Even if we accept that it is not only term and notional mismatches that will provide relevant arguments in contesting swap contracts, it is still noticeable that based on our limited sample: the larger the swap notional value the higher the percentage with double (both notional and term) mismatches (Figure 3). Our interpretation of this is that larger swaps might have been even more poorly structured than the small ones, which were part of the FCA pilot study. This would leave the 90% non-compliance conclusion from that study conservative. Figure 1 Sample of 41 Swap Cases of GBP 290mn Source: Collyer Bristow Solicitors Figure 2 Distribution of Swap Notional and Term Mismatch (as % of loan amount and term respectively) Source: Collyer Bristow Solicitors Swaps Impact on the UK Lending Market: A Closer Look at the Evidence


CREFW-Fall2014 10.15.14
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