Mis-selling: FX hedges in the spotlight
Mis-selling cases of foreign-exchange hedging products are on the rise with claimants inspired by the success of interest-rate swap mis-selling claims. Moreover, sharp volatility in currency markets has hit some businesses' hedges hard, leading them to question the suitability of FX products sold to them by their banks.
The interest-rate swap mis-selling scandal is drawing to a close, with £1.3 billion ($2 billion) already paid out in compensation under the Financial Conduct Authority's (FCA) redress scheme.
However, now businesses are turning their attention to foreign exchange – the largest market in the world – particularly in light of the $4.3 billion fines meted out to the banks for manipulation of key FX benchmark rates.
Complex world of options
Currency risk can erode an international business's bottom line, but can be legitimately hedged out using derivatives contracts. These range from simple forwards – whereby businesses buy or sell a foreign currency at today's prices – to structured options, which are inherently more risky, but offer a pay-out if a certain predetermined scenario is fulfilled.
Selling options is a lucrative business for the banks – certainly compared with straightforward spot FX, which commands more competitive pricing – but their complex nature means that, similarly to interest-rate swaps, they are not suitable for everyone.
Jackie Bowie, CEO,
Jackie Bowie, chief executive officer of consultancy firm JC Rathbone Associates, is seeing requests from businesses that need help with their FX hedges. "The banks are aggressive in selling structured products for FX hedging, with triggers and knock-out rates; ever-increasing levels of complexity," she says. "I suspect we will see more claims on the FX side – as interest-rate claims fall off, FX claims look likely to pick up."
Seneca Banking Consultants has successfully advised hundreds of businesses on interest-rate hedging product claims, and is now turning its sights to foreign exchange, says founding director Dan Fallows.
"At the moment, we are advising about eight different businesses at an early stage in relation to potential claims for mis-selling of currency swaps, which, in my opinion, have been mis-sold to the same extent as interest-rate swaps," he says.
"[Banks have] sold unsuitable products to very non-sophisticated businesses. We feel it's something the FCA should look into."
Volatility spikes interest
The recent spike in currency volatility highlights the perils of being stuck with a currency hedge that is not going your way. The decision by the Swiss National Bank to abandon its EUR/CHF 1.20 cap triggered a "whole series of enquiries" for Stevie Loughrey, partner at law firm Carter-Ruck. Big currency moves such as the Swiss franc can remove any protection offered by a hedge, by triggering what's known as the 'strike price'.
"The volatility in recent months has resulted in a marked increase in the number of enquiries," he says.
Law firm Collyer Bristow is representing claimants that typically have at least £100 million turnover a year and need to buy foreign currencies, but have come unstuck with their currency products.
We have seen clients … seduced into entering into some very speculative and complex outperformance derivatives
Abhishek Sachdev, Vedanta Hedging
Robin Henry, a partner in the firm's financial services team, argues that even a company's finance director cannot be expected to understand or calculate the consequences of complex foreign-exchange contracts, and losses can run into tens of millions.
"A company that might have required $30 million to $50 million a year on a normal basis can suddenly find themselves trapped by these contracts," he says. "Once exchange rates hit a certain level they trigger... [meaning] they have to buy huge quantities of the dollar at below market rate."
The dollar has rapidly strengthened since last year, with GBP/USD falling from approximately 1.68 a year ago to as little as 1.46 earlier this year. A company might only realize what is happening when the bank starts asking them for margin calls, says Abhishek Sachdev, chief executive officer of Vedanta Hedging.
"We have seen clients over a period of many months and years seduced into entering into some very speculative and complex outperformance derivatives, which meant that in fact the client became so leveraged they became a seller of dollars rather than a buyer."
Despite the touted merits of these mis-selling claims, lawyers predict they will not reach the same scale as the interest-rate swap scandal. Currency hedging contracts tend to be shorter, typically up to 18 months, whereas interest-rate swaps can run for decades. The pain is more manageable, although losses can still quickly rack up if currencies move significantly.
Separately, lawyers are increasingly being asked by potential claimants to investigate whether they can sue their bank over the FX benchmark manipulation. However, the jury is still out – the difficulty lies in proving the manipulation directly led to losses suffered by the claimants on their trades, say lawyers.
Nevertheless, it adds fire to mis-selling claims and is a good bargaining tool.
Collyer Bristow's Henry says: "We have used it in proceedings as an additional argument against those banks that were fined for forex manipulation. It has proved very useful."