Vol 21 (2024) - Issue 1

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The Risks of Mis-Sold Derivatives in a Changing Rates Environment and How to Mitigate Them

Synopsis
Companies regularly use derivative products to hedge financial risks. Among products that are commonly used are interest rate swaps and foreign exchange derivatives. Interest rate swaps are typically used to hedge against interest risk from floating rate loans, effectively converting the floating interest rate into a fixed interest payment. Foreign exchange derivatives, on the other hand, are typically used by companies with operations in multiple countries to hedge their currency exposures.
When used appropriately, these products can provide an effective hedge against the financial risks faced by companies. However, these products are complex in nature, and business managers buying them on the recommendation of financial intermediaries may not fully understand the risks they are taking on. This could leave companies exposed to significant losses in the event of market volatility.
The mis-selling of derivative products was a key issue for businesses, particularly small and medium enterprises, in the aftermath of the global financial crisis.
Recent news, market reports and our own experiences with clients suggest that the practice remains a problem even now.