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CREFW-Fall2014 10.15.14

A publication of Autumn issue 2014 sponsored by CRE Finance World Autumn 2014 41 Market Implication is that UK Borrowers are in Line for GBP 5-10bn in Potential Redress We have carefully considered the evidence and attempted to estimate the overall market impact. In order to do this, we analyse possible loan refinancing and restructuring concessions and redress associated with borrowers’ existing swap positions. Therefore, we make the following assumptions: • 90% of the GBP 309bn UK lending market is floating rate, 75% of which are assumed to have floating-to-fixed rate swaps in place. The rest will have other hedging instruments, like interest rate caps. • One in five to one in ten borrowers in the UK commercial lending market will find significantly convincing issues with the structure or selling of their swap contract(s). This is conservative given the 90% from the FCA pilot study, but given the wider commercial interests with lenders not deemed to be unrealistic. • When successful, borrowers get 18% redress from banks in respect of their miss-sold and poorly structured swaps These assumptions result in an initial estimate of GBP 5bn to 10bn in potential loan refinancing or restructuring concessions and/or swap redress payments from banks to borrowers. As time progresses and swap contracts mature, the size of the mark-to-market on the swaps will reduce automatically. Also, if rates increase, there might be a reduction of the mark-to-market as well. Therefore, there is a level of uncertainty around the GBP 5-10bn estimate in future, depending on when swap breakage is crystallized. Apart from the impact on swap breakage costs themselves, timing also plays a major role in the legal process (where the swap does not qualify for the FCA compensation scheme). In the UK, there is a six year statute of limitations on contesting the validity of any legal contract. However, this statute might potentially be avoided in some exceptional circumstances. Definitions of Key Terms To avoid any misunderstandings, we provide below definitions of four key terms used in the article: • IRHP — Interest Rate Hedging Product (which incorporates an interest rate derivative) • Floating-to-fixed interest rate swap — This is one of the simplest and popular forms of derivative which allows a borrower with floating rate borrowing to convert this into borrowing at a fixed, known rate. • Mark-to-market position — The current market value of a derivative if it is to be cancelled or redeemed at the present time. This could be a positive value to the borrower ‘a breakage gain’ or a negative value to the borrower ‘a breakage cost’. • FCA – Financial Conduct Authority • SME – small and medium sized enterprises Swaps Impact on the UK Lending Market: A Closer Look at the Evidence


CREFW-Fall2014 10.15.14
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