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Do Borrowers Have to Cover Lenders’ Hedging Costs?

Banks commonly enter into hedging arrangements to spread the risks they take on lending money and, in one important case, the High Court has considered whether the cost of doing that can legitimately be passed on to borrowers.

Building under constructionA bank lent more than £9.2 million to a syndicate which intended to use the money to acquire, develop and let a property. As part of the deal, the syndicate agreed to indemnify the bank against any costs or losses it might incur in the unwinding of funding transactions undertaken in connection with the loan facility.

The syndicate was considering paying off the loan. However, the bank argued that, as a condition of such redemption, the syndicate was obliged to cover the cost of terminating an internal interest rate swap by which it had hedged its position. That cost was quantified by the bank at almost £2.4 million.

In ruling in favour of the syndicate, the Court found that, on a true interpretation of the loan agreement, the swap was not a ‘funding transaction’. The internal hedging arrangement, viewed on its own, had also given rise to no loss or cost to the bank.