Bank lenders and internal swaps

Bank lenders and internal swaps

Is an internal swap a ‘funding transaction’ for the purposes of a loan agreement?

Original news

Barnett Waddington Trustees (1980) Ltd and another v Royal Bank of Scotland [2015] EWHC 2435 (Ch), [2015] All ER (D) 82 (Aug)

The key issue in the case was whether an internal swap qualified as a ‘funding transaction’ under a loan agreement and the costs of unwinding it would therefore be payable if the borrowers prepaid the loan. The court held that an internal swap between divisions of the lending bank was not a transaction as a transaction involved two different legal entities. The bank was therefore not entitled to claim the costs from the borrower. The case highlights the importance of ensuring provisions in the loan agreement reflect the ways in which fund and hedge fixed rate loans in practice.

What were the key issues in this case?

This case concerned a situation which very often arises in commercial bank lending—the bank, in this case RBS, advanced a long-term fixed rate loan to a group of borrowers to finance the purchase of a property and funded the loan and hedged its interest rate exposure by a four-step process.

Step one was to obtain funding from external sources, presumably by a mix of borrowing in the interbank and capital markets and taking deposits from customers. For the bank’s accounting purposes, funds so obtained where treated as being held by its group treasury, an internal division of the bank and not a separate legal entity.

Step two was a floating rate loan from group treasury to the bank’s corporate banking division, also an internal division of the bank. In this way the corporate banking division obtained floating rate funding for its fixed rate loan to the borrowers.

Step three was a fixed to floating rate ‘internal swap’ between the bank’s corporate banking division and the bank’s interest rates desk, another internal division of the bank. In this way the corporate banking division hedged

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About the author:
Before joining LexisNexis Tony was a partner for many years in the financial markets department of Simmons & Simmons, where he covered structured products, derivatives, debt capital markets, structured trade finance, emerging markets and many other types of financial transactions. He has extensive experience of transactions in Russia, Spain and Latin America and a number of other jurisdictions.