Introduction

Prior to September 2008, numerous small and medium-sized enterprises (SMEs) entered into interest rate hedging products (IRHPs) to support borrowing with major financial institutions. In the wake of the collapse of Lehman Brothers and the ensuing financial crisis they found themselves paying for either swaps which they did not need or paying far more than was originally envisaged to terminate the products.

Typically, the purpose of IRHPs was to protect against fluctuations in interest rates. These can be broken down into:

1. •

   swaps—which fix interest at an agreed rate

2. •

   caps—which create a limit on any interest rate rises

3. •

   collars—which limit interest rate movements within a specified range, and

4. •

   structured collars—which limit interest rate movements within a specified range, but also involve arrangements where, if the reference interest rate falls below the bottom of the range, the interest rate payable by the customer may increase above the bottom of the range

Banks commonly made the purchase of IRHPs a condition to lending or strongly