The Financial Services Authority (FSA) announced last summer that it had found "serious failings" in the way these products, which are very complex hedging products, had been marketed and sold to small and medium-sized companies.
Interest rate hedges include a variety of different products, which are sold to customers to help protect them against upward shifts in interest rates - these include products called Swaps, Caps and Collars. Many small business owners were sold these products on the promise that they would be protected from market turmoil and would be safe if there was a sudden hike in interest rates.
However, these products, which were supposed to protect businesses, are highly-complex and in many cases were explained poorly by the banks with very little reference to the downside risks including the potential costs to businesses if interest rates fell and the significant "break costs" they would face if they wanted to exit the particular hedging product.
Businesses without the resources to afford sophisticated advice on these hedging products financial advisers, didn't fully understand what they were signing up for and when interest rates plunged after the 2008 financial crisis, many were left facing significantly high rates of interest, with some products costing business owners hundreds of thousands pounds.
The FSA's current estimate of the number of firms affected is somewhere in excess of 40,000 - and as the scale of the problem has emerged, so have its consequences. A picture of small businesses struggling to pay the ruinously high interest rates and unable to get out of these hedging products because of punishing exit fees - which in many cases were not adequately disclosed - has become apparent.
Eleven high street banks, including Barclays, Lloyds Banking Group, HSBC, the Royal Bank of Scotland, the Co-Operative Bank, Santander UK, and the Yorkshire and Clydesdale banks have now agreed to compensate businesses which are the victims of mis-selling.
Estimates of the eventual cost of the scandal to the banking sector vary greatly, however some experts believe the scandal could end up costing the banks more than £10 billion, potentially making it more costly than the payment protection insurance (PPI) mis-selling scandal.
Directors affected by the scandal can be reluctant to speak up about being a victim of mis-selling because they feel they have been duped by the bank into accepting what was in reality an inappropriate product sold by a highly incentivised banker.
However, support for victims is beginning to burgeon, and Guto Bebb, the Conservative MP, is leading an all-party Parliamentary campaign to get redress for businesses. The group is campaigning to ensure that businesses which are struggling as a result of mis-selling are compensated properly and in a timely fashion.
Some businesses have already begun to file complaints with the Financial Ombudsman Service. In October, two banks identified only as 'Bank E' and 'Bank S', were accused of putting their own profits ahead of the customers' interests in selling them the hedging products that ended up crippling the businesses due to the high interest payments.
The unnamed banks were urged to pay hundreds of thousands of pounds in compensation to two customers who were mis-sold hedging products.
In one judgement, Tony Boorman of the Financial Ombudsman Service said 'Bank E' had sold the hedges "primarily for the bank's commercial convenience and with little or no attention to the needs of its clients."
The criteria the FSA uses to decide whether a business is fit to make a claim is based around the level of knowledge and experience the company had when deciding whether to take out one of the products on offer.
The FSA's view is that most small businesses would be unlikely to possess the specific expertise to understand all of the risks associated with these products - these businesses would be categorised as 'unsophisticated'.
These findings raise the prospect of a flood of new claims from small businesses sold interest rate hedging products. The processes around these claims are highly complex and it's important that businesses which, think they may have been sold these interest rate-protection products check their finances and take specialist advice immediately.
