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Interest rates hedging - how to tell if you are a 'sophisticated customer'

View profile for Jonathan Chadwick
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A sophisticated customer is a type of customer who is deemed to have sufficient investing experience and knowledge to weigh up the costs and benefits of an investment opportunity.

In relation to hedging, this means that the sophisticated customer will have had knowledge about the interest rate hedging, and what the risks and benefits of taking this product would be. Obviously this classification is important as a sophisticated customer will be excluded from the Financial Conduct Authority review into hedging products.
 
The FCA test initially stated that customers who met two out of the following three criteria will be considered sophisticated:

  • The turnover that exceeds £6.5 million; and/or
  • A balance sheet which exceeds £3.26 million; and/or
  • More than 50 employees

 
However, the criteria has subsequently been amended to provide that if the customer meets both the balance sheets and employee criteria above, making it a sophisticated client under the original test, but does not meet the turnover test, then it will nevertheless be treated as a non-sophisticated customer, providing that the total value of the hedging products are no more than £10 million.
 
If the customer is part of a group, and the group as a whole meets the test for sophistication, then the customer will be treated as sophisticated even though treated in isolation, it would have been deemed as non sophisticated.
 
Understanding the new £10 million test
 
This only applies in two specific situations, one being if you have a turnover of less that £6.5 million, but a balance sheet of more that £3.26 million and more than 50 employees, you will be classed as a non sophisticated client.
 
Or, on the other hand, if you are classed as non-sophisticated, as you only meet one of the three conditions, but you have interest rate swaps of more than £10 million, then you will be treated as a sophisticated client.

By Leanne Millhouse, commercial litigation solicitor

 

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