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Banks provide AFM with insight into scope of interest rate derivatives held by small and medium-sized enterprises

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Non-professional small and medium-sized enterprises currently hold approximately 17,000 interest rate derivatives. The underlying amount in financing to which these derivatives relate is approximately €26 billion. The current value of these outstanding derivatives was €2.7 billion negative in April 2014.

This is evident from an investigation performed by the Netherlands Authority for the Financial Markets (AFM) into the extent of possible problems involving interest rate derivatives held by non-professional small and medium-sized enterprises and the manner in which banks handle this. The AFM requested information for this purpose from the largest providers of interest rate derivatives to non-professional small and medium-sized enterprises.

Points for attention interest rate derivatives services

At the start of 2014, the AFM made several recommendations to the banks in order to improve interest rate derivatives services, on the basis of an investigation into the interest rate derivatives services provided to non-professional small and medium-sized enterprises. The investigation that formed the basis for the recommendations identified several points for attention that may in certain cases have led to unsuitable or negligent services to non-professional small and medium-sized enterprises. The AFM considers that insight into the extent to which unsuitable or negligent services were provided must be obtained soon. The banks have indicated that they will review their services with respect to interest rate derivatives concluded in the past on the basis of the existing statutory requirements within a reasonable term. The AFM will ensure that the correct aspects are included in this review and that priority is given to situations that constitute a greater risk to small and medium-sized enterprises.

Outstanding interest rate derivatives are mainly interest rate swaps

The number of companies that hold interest rate derivatives is lower than 17,000. This is caused by the fact that some companies have concluded several derivatives. The companies use derivatives to hedge (part of) the interest rate risk of financing, involving a total amount of €26 billion. This comes down to an average underlying amount of €1.5 million per derivative. Although it nearly always concerns financing involving an amount that exceeds €250,000, the average amount differs per derivative that has been concluded and per type of derivative per bank. More than 90% of the derivatives positions of small and medium-sized enterprises has been concluded by three banks. Nine out of every ten outstanding interest rate derivatives held by non-professional small and medium-sized enterprises are interest rate swaps, whereby an enterprise exchanges a variable interest rate for a fixed interest rate, and caps, whereby the market interest is maximised.

The total value of these outstanding derivatives held by non-professional small and medium-sized enterprises was €2.7 billion negative in April 2014. The fact that the current value of a derivative is negative does not automatically cause problems, as the value of a derivative moves towards zero as its term passes. A negative value of a derivative can cause problems in the event of premature additional repayment or termination of the underlying credit and/or the derivative. In such cases, the consequences are partly the same as those of premature termination of financing with a fixed interest rate and term. More than 70% of all current derivatives has a remaining term of less than 5 years. A small part has a term that exceeds ten years.

Insight into possibly acute problems

The AFM considers that insight must be obtained soon into the acute problems at those small and medium-sized enterprises which hold derivatives that do not or do no longer match their situation. Small and medium-sized enterprises can suffer financial losses in such cases, for example if derivatives are terminated prematurely or cover a higher underlying amount than the related financing (overhedging).

Solutions

The AFM expects that the relevant banks provide solutions in those cases in which services provided in the past were unsuitable and/or negligent. After all, it may be expected of banks that they give priority to the interests of their clients, and this applies equally when the client is a small or medium-sized enterprise. In addition, several enterprises have urgent continuity problems. The AFM expects banks to give priority to these cases when assessing the suitability of services and, if necessary, to finding suitable solutions. The AFM investigation shows that the number of non-professional small and medium-sized enterprises that holds an interest rate derivative and comes under a bank's so-called special management, is approximately 1400 (4% of the total number of non-professional small and medium-sized enterprises in special management).

Research population

The AFM investigation focused specifically on the services provided to small and medium-sized enterprises classified as non-professional. The majority of small and medium-sized enterprises are classified in this category. An entrepreneur can be deemed to be professional if he satisfies at least two of three following requirements: a balance sheet total of more than 20 million euros, sales exceeding 40 million euros, equity of 2 million or more. Within the context of transparent reporting, incidentally, the AFM expects small and medium-sized enterprises to provide insight into the principal sum and current value of current interest rate derivatives in their company financial statements.

The AFM is committed to promoting fair and transparent financial markets.

As an independent market conduct authority, we contribute to a sustainable financial system and prosperity in the Netherlands.

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