NZ media starts to catch up with reality

Someone in mainstream media is getting an inkling of the bigger picture of what is going on.

This story was covered previously by Rob Stock HERE and HERE

Banks 'plundering society' globally

Claims banks missold interest-rate swaps to businesses and local authorities have been making headlines around the world

Rob Stock

Stuff,

4 November, 2012

Interest rate swaps are a derivative financial tool used by sophisticated businesses with skilled treasury functions to limit interest rate risk.

But it is becoming clear that in places such as Britain, Italy and America, interest-rate swaps were sold by banks to organisations that did not understand the risks they were taking.

In case after case, interest rate swaps often sold in 2007 and 2008 as "protection" against interest rates rising sharply have served mainly to protect bank profits by locking businesses and local bodies into high levels of interest ahead of those rates falling.

In July, an investigation by the Financial Services Authority in Britain concluded that it had found "serious failings" by banks, including Barclays, HSBC, Lloyds and Royal Bank of Scotland in the way they sold interest-rate hedging products to small- and medium-sized businesses leading to a "severe impact" on their finances.

Banks agreed to a mechanism overseen by the authority to identify those sold swaps and provide compensation. Initially it thought compensation could be due in about 28,000 cases but that was revised up to as many as 40,000 businesses in late September.

In March, Germany's biggest bank, Deutsche Bank AG, lost a case over interest-rate swaps it sold to a paper company. It was ordered to pay damages, reported the Business Standard. The Federal Court of Justice found the bank didn't adequately disclose the risks of the products.

Presiding Judge Ulrich Wiechers said: "As an adviser to its customers, the bank must guard the customers' interest alone. But as a seller of the swap, a loss to the customer works to the bank's advantage." There are claims from across Germany that local authorities and companies were missold interest rate swaps.

London-based banks have been accused of misselling interest rate swaps to city authorities in Italy. The BBC reported in September that Nomura, UBS and Deutsche Bank were among those accused by Italian prosecutors of misselling derivatives in deals worth € 35 billion (NZ$54.7b). Some swaps have been reversed by banks. Milan, for example, got a € 500 million payout as a result.

Milan's chief prosecutor Alfredo Robledo told Britain's Newsnight that banks had been "plundering society".

United States cities such as Philadelphia and Oakland are investigating how they came to lock themselves into interest rate swaps that have cost them a fortune. Anger is growing but, as yet, there have been no lawsuits. The Financial Times reported in August that: "Various public groups estimate the deals, some of which were agreed decades ago, are now costing taxpayers billions of dollars a year."

Bloomberg reported that Holland had placed greater restrictions on banks' derivative sales after affordable-housing provider Stichting Vestia Groep lost € 1.3b as a result of soured interest-rate swaps. The case prompted hedge specialist Vedanta Hedging to comment: "As we frequently try to inform others about this issue, the potential problem of interest-rate swap misselling is not just confined to small- or medium-sized businesses."

Here is another article that I failed to pick up on

Farmers in too deep on swaps

Farmers were sold financial instruments that major companies manage through specialist departments, says the man responsible for the interest rate swap management programme at giant Auckland water provider Watercare.

Rob Stock

Stuff,

4 November, 2012

Jason Isherwood, Watercare's treasury manager, says companies must have deep balance sheets and high levels of sophistication to take on the risk of complex and volatile interest rate swaps.

The latest Watercare annual report revealed a $60 million loss on interest rate swap contracts in the year to June 30, highlighting the risks of derivative positions on interest rates.

Isherwood said that although $60m was not a "pretty number", it was relatively modest in the context of Watercare's balance sheet.

The Commerce Commission is continuing early stage inquiries into the sale of similar instruments to farmers in 2007 and 2008 by banks including Westpac and National Bank. The swaps were sold as protection against rising interest rates, but had the effect of locking farmers in to high rates just before a steep and prolonged downturn.

Claims of interest rate swap misselling prompted a national scandal in the UK with the Financial Service Authority finding banks culpable of mis-selling swaps to tens of thousands of unsophisticated small and medium-sized businesses.

In a statement the Commerce Commission may take note of, Isherwood said interest rate hedging was suitable for large organisations with big, long-term debts as it allows greater control over the long-term cost of funding by locking in attractive rates when available.

"I believe that you need to have a dedicated treasury function to adequately manage these risks and it needs to be staffed by people with market expertise," Isherwood said.

"It needs to have adequate systems as well to monitor the risks and report on those risks so that at any point in time you can tell your exact risk position."

Because derivatives exposures can be volatile, companies not only need to be able to understand when things are moving against them, they also need to be able to pay break fees should they need to shut down their exposure.

"An organisation with a turnover of $50m per annum is not necessarily going to have a sufficiently sized budget to justify having a dedicated treasury function," Isherwood said.

Around the world, even organisations fitting that description have run into serious trouble with interest rate swaps, and, like some farmers, have found their businesses left paying crippling interest rates.

Some farmers say they relied on their banks - notably National Bank and Westpac - for advice and did not understand the true nature of the risks they were taking on, though the contracts they signed stated they did understand and that the banks owed them no fiduciary duties.

The sale of the swaps to farmers, the scale of which is not yet fully known, is a hot topic among derivatives experts who believe the Commerce Commission needs to look at whether farmers had the sophistication, size, tools and support to "manage" their interest rate risk.

One said banks have sometimes insisted that larger

corporates wanting to manage interest rate risk through the use of swaps get specialist advice. When banks had concerns over the capacity of a borrower to cope with swaps, they have sometimes carried out due diligence on the borrower's treasury functions.

The commission has been told by another derivatives specialist that the swaps the farmers took out helped the banks manage the risks of their own, rapidly growing overseas borrowing, leaving them with large fixed interest payment obligations.

"It is apparent that the local banks receiving the hedge swapped New Zealand dollars have an asymmetric need to receive client fixed interest rate swap flows to offset those required to be paid under the terms of cross currency basis swap contract," he told the commission.

He believed this would provide a motive for banks to engage in "a concerted push" to engage borrowing clients into swap contracts to pay fixed interest to offset the banks' burgeoning exposure.

QUESTIONS EXPERTS SAY THE COMMERCE COMMISSION MUST ANSWER: 1. Were farmers advised it was prudent to protect themselves from spikes in interest rates when using swaps, and what did the banks selling swaps think was likely to happen with rates?

2. Did farmers understand the risks of the swaps, and did the banks take adequate steps to ensure they did?

3. Did the farmers have balance sheets large enough to cope with revaluations of their swaps, or the capacity to pay large break fees if their swaps soured?

4. How were farmers to monitor their swap position and make decisions to neutralise their exposure should rates move against them?

5. Did farmers realise that extra credit margins could be added by the banks should the revaluation of their swaps erode their balance sheet? 6. What risk modelling were farmers provided with, and did it accurately show the risks the farmers were taking?

7. What tools and ongoing support were farmers offered, and what support did they actually get?

8. What did frontline bank staff think they were selling, and are claims they did not understand the risks of the swaps fair?

9. What is the legal strength of the disclaimers that farmers signed? One National Bank document states: "Each party was capable of assessing the merits of an understanding (on its own behalf or through independent professional advice), and understands and accepts, the terms and conditions and risks of that transaction. It is also capable of assuming, and assumes the risks of that transaction."

10. Did the banks have any fiduciary duty to the farmers? One National Bank swaps presentation reads: "No party is acting as a fiduciary for or an adviser to the other in respect of that transaction." 12. Did the swaps sold to farmers differ from those used in the interest rate risk management programmes of large, sophisticated borrowers?