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FSA Pilot Findings - Are you sophisticated?

Posted on Feb 01, 2013 by  | 0 Comments

Following their review of the pilot review scheme, the FSA have made some changes to the interest rate hedging products (IHRPs) review process.  It is worth taking a closer look at the changes to the ‘sophistication test’, which determines if a customer is eligible for the review.

The report notes that the review is aimed at helping ‘non-sophisticated’ customers, which were mainly “small businesses that are unlikely to have possessed the specific expertise to understand the risks associated with these products”. 

The Old Sophistication Test

Prior to the yesterday’s report a customer was deemed sophisticated, and therefore ineligible for the review, if they had at least two of the following:

-    a turnover of more than £6.5m; or

-    a balance sheet total of more than £3.26m; or

-    more than 50 employees.

Irrespective of the size of the business, the customer could also be deemed sophisticated if they had the necessary experience and knowledge to understand the product and the risks involved.

The FSA found that the above test sometimes produced unsatisfactory results. For example farmers or B&B businesses could be deemed sophisticated because they had a large balance sheet and a high number of employees, whereas small subsidiaries of large multinational corporations could pass the test and be deemed non-sophisticated.

The New Sophistication Test

To address this issue the FSA have amended the way the criteria can be applied so that:

- customers who meet (only) the balance sheet and   employee number criteria are included in the review where the total value of their ‘live’ IRHPs is equal to or less than £10m;

- subsidiaries of large groups and SPVs forming part of a large group are likely to be excluded from the review;

- company groups that are not able to take advantage of the lighter reporting requirements under the Companies Act 2006 for small groups are likely to be excluded from the review; and

-   SPV customers that are constituted in a way that falls outside the Companies Act 2006 definition of a group but are nevertheless connected entities are likely to be excluded from the review where the total value of their ‘live’ IRHPs is more than £10m.

 Under the new criteria the customer will still be deemed sophisticated if they had the necessary experience and knowledge at the time of the sale.

The FSA have produced a flow chart to provide more information on what is meant by groups or connected entities, which can be found at the link below.  Notwithstanding this, customers may require assistance to interpret the new criteria. Customers who hope to get redress from the review scheme should apply the new criteria to the time when the IRHP was sold to determine if they were sophisticated.  

Flow Chart: http://www.fsa.gov.uk/static/pubs/other/irs-flowchart-2013.pdf

Please feel free to get in touch or leave a comment.

Liana Park, Solicitor

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