UK: "Hidden" Swaps And Zero LIBOR Floor Language - Not Yet Regulated

Last Updated: 20 April 2015
Article by Ekaterina Pavlycheva

The "FCA regulation" cloud is floating above the UK financial industry often bringing heavy thunderstorms, especially when it comes to fixing interest rates under various lending arrangements. However, there are certain financial arrangements which look like regulated products but are not (yet?) regulated.

The implication of this for lenders is that care needs to be taken in considering whether a particular financial product is regulated or not regulated and treat that financial product accordingly.

Set out below are two examples of traditional lending products which have evolved in the market in a manner which raises a question as to whether they should be "regulated" – these are break costs operating as "hidden" swaps and zero LIBOR1 floor.

1. "Hidden" swaps: loan arrangements with similar features to interest rate hedging products

It has been confirmed by the Financial Conduct Authority (FCA)2 and by the two leading silks, namely Mr Charles Flint QC and Jonathan Fisher QC3 that loans with similar features to interest rate hedging products fall outside of the FCA's regulatory remit.

Standalone interest rate hedging products are subject to the FCA's regulatory regime as contracts for difference ("CFD") under Article 85 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 ("RAO") because their purpose is to secure a profit or avoid a loss by reference to fluctuations in "an index or other factor designated for such purpose", such as interest rates. 

There is a similarity between such interest rate hedging products and more traditional lending arrangements arising from the fact that break costs typically applicable to loan agreements are linked to the cost to the bank of terminating a hedging arrangement the bank has entered into with a third party provider to mitigate its own interest rate risk. Such loans have been referred to as "embedded" or "hidden" swaps.

The FCA's view is that it is not entirely accurate to call such loan agreements "hidden" swaps because they do not have the CFD purpose; their primary purpose is for the customer to borrow and for the bank to lend. The customer is not a party to the hedging arrangement entered into by the bank with the interest rate hedging provider and the break costs arise only when a customer decides to terminate the loan agreement early and it does not operate to change the purpose of such loan agreement as a whole. Such a break cost clause in a loan agreement is, in substance, a liquidated damages clause under which the parties have agreed the basis on which damages will be assessed in the event of default or early termination. The customer may be exposed, under the loan agreement, to liability to pay the break costs incurred by the bank under its hedging arrangements; however that does not change the nature of the loan agreement as for it to be considered as CFD.

The FCA explained that such loan agreements are not "specified investments" under the current regulatory regime and accordingly entering into or terminating them does not constitute a regulated activity under Article 85 RAO. The effect of this is that under the current powers the FCA is unable to establish a redress in respect of any failings to properly disclose break costs in contracts for such loans, and the FCA conduct of business rules do not apply when the bank enters into such a loan agreement or terminates it.

2. Zero LIBOR floor

Zero LIBOR floor language is another recent trend in the loan market. It is included in loan agreements to avoid the potential effect, on the lending arrangements, of negative interest rate benchmarks. A negative LIBOR will reduce the margin payable by a borrower under a loan agreement unless the zero LIBOR floor wording is included.

The LMA (Loan Market Association) recommended definition for LIBOR includes an optional language that if either the applicable screen rate (LIBOR rate administered by ICE Benchmark Administration Limited for the relevant currency and period) or, if the screen rate is unavailable, any other base interest rate determined pursuant to a facility agreement, "is less than zero, LIBOR shall be deemed to be zero."

The question then arises - does zero LIBOR floor wording in a loan agreement constitute an "embedded" swap since a borrower is swapping the negative LIBOR rate for 0%?

Although one might argue that the purpose of the zero LIBOR floor language in a loan agreement is to avoid a loss for the lender by reference to fluctuations in the LIBOR rate which makes it look like a CFD under Article 85 RAO, it seems unlikely that the FCA will consider this as sufficient enough to change the overall objective of such loan agreements which are for the customer to borrow and for the bank to lend. The zero LIBOR floor wording in the definition of LIBOR will most likely be viewed as a mechanism for determining the overall rate of interest under the loan agreement contractually agreed between the parties. Technically, the zero LIBOR floor language means that if the LIBOR rate is negative then the borrower will not be paying the LIBOR rate at all until such time as the LIBOR rate increases above zero. It also protects the lender against a potentially negative margin and what seems like an impossible scenario when the lender will be required to pay the borrower if the overall interest rate itself, under the loan agreement, is negative.

Applying the same analysis as with the "hidden" swaps above, loan agreements with the zero LIBOR floor language are unlikely to be classified as specified investments under the FCA regulatory regime and entering into or terminating such loan agreements will not be subject to the FCA conduct of business rules.

A further question arises as to whether keeping LIBOR at 0% or higher could be considered as fixing it.

We consider that this would be unlikely. During the credit crunch the banks became concerned about lending to each other and the LIBOR rate rose significantly. The fixing LIBOR issue arose because certain banks were attempting to fix LIBOR at a lower rate without notifying their customers in order to show that that bank was in a better position than it actually was.  On the other hand, when two parties contractually agree to avoid the effect of a negative LIBOR in order to preserve the margin under their facility arrangements, the regulators and the court will be reluctant to intervene. 

3. Action plan

We suggest that, whilst the above is the better view broadly in considering the effects of the arrangements described above, when dealing with financial products that seem, in substance to have characteristics similar to a regulated product, it should not be assumed that these are not regulated under the FCA regulatory regime . It is important to consider each financial arrangement or product on a case by case basis taking into account the underlying purpose of such contract.


1 For the purposes of this article we talk about zero floors in the context of LIBOR but of course this can apply equally to any floating inter-bank offer rate or IBOR.

2 Letter dated 26 June 2014 from Sean Martin, General Counsel of the Financial Conduct Authority to Andrew Tyrie MP, Chairman of the Treasury Committee.

3 Legal Opinion submitted by Jonathan Fisher QC, 7 January 2015.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.