Since 2010 small companies have bought 60,000 such hedging instruments, which are considered part of a bank loan rather than a separate insurance product. Some borrowers claim that they were mis-sold, but the Financial Conduct Authority (FCA) has said it does not have the power to launch a redress scheme.

These products, also known as interest rate swaps, were meant to protect investors against rate increases. However, rates have fallen to record lows and borrowers have been forced to pay extra charges or face penalties for terminating the contracts.

The legal opinion from Jonathan Fisher for parliament's Treasury Select Committee has backed the FCA's position that as a watchdog it has no powers to force banks to review the products sold and consider compensation.

In so far as issues of consumer protection are concerned, there is a gap in the law, Fisher said in his opinion made available by the committee on Friday.

The announcement is likely to spark some relief among lenders that are already paying out compensation for other types of interest rate hedging products and for mis-sold loan insurance.

The Treasury Committee's chairman, Andrew Tyrie, said that lawmakers will look at whether more needs to be done to plug the gap in regulation.

"It is crucial to the UK economy that this market be restored to working order," he said.

Lawmakers are also worried about the effectiveness and transparency of the FCA's redress scheme for interest rate hedging products that are sold separately from the loans they protect, Tyrie added.

Britain's banks have paid out less than half of the 4.4 billion pounds ($6.72 billion) set aside to cover mis-selling of standalone interest rate hedging products.

The lawmakers will discuss swaps compensation with FCA Chief Executive Martin Wheatley, who faces his regular six-monthly grilling in front of the committee on Tuesday.

Parliament would have to change the law to give the FCA powers to set up a redress scheme for embedded swaps, though it is unlikely that even this could compensate businesses for products already sold.

(Editing by David Goodman)

By Huw Jones