the FSA finally takes action on interest rate swap
arrangements
Many years ago I prepared a complaint by a
business to the Financial Ombudsman Service (FOS) – which deals
with complaints against FSA authorised firms. The complaint arose
out of the bank's requirement for the business to enter into an
interest rate swap arrangement (IRSA) in support of a loan facility
the bank was offering. Interest rates subsequently dropped and the
client became liable for increasing large monthly payments. The
client questioned whether it had been miss-sold.
The key facts of the case are set out
below:
- the requirement to take the interest rate swap was raised at
the 11th hour – at which point the client's options were
limited as it was too late to find alternative funding
- the customer classification process was not compliant with the
bank's own internal procedures and also it was not compliant with
the FSA's rules in place at that time
- there was evidence (in the form of emails) which suggested that
the bank had in fact provided advice and as such a greater duty of
care should have been imposed
- a letter which purported to provide information relating to the
maximum exposure was misleading as the total final exposure was
200% greater than the potential maximum exposure which was
communicated to the client
- when explaining the product to the client, the bank said it was
essentially an insurance product to protect against the possibility
of rising interest rates. No explanation was provided in relation
to the downside of the product and as such, the client was not
aware of the potential risks of the product until interest rates
fell and liability under the terms of the IRSA significantly
increased
- correspondence from the bank provided misleading information as
to the cost of unwinding the arrangement on more than one
occasion.
As the business the client was intending to
buy, and hence the reason for the loan facility fell through, the
loan facility was never used. However, the IRSA remained in place
and the client was committed to increasing monthly payments.
Sadly, my tale did not have a happy ending, as
the FOS took a strict line when determining the complaint and found
against the client. At the time it felt like a huge injustice
had been done and I wondered whether other businesses had
encountered a similar experience to my client?
Roll the clock on a few years and the
spotlight is now being cast on these arrangements brought to the
forefront of business news by an investigation by the Sunday
Telegraph. As a result of increasing pressure, the FSA
undertook a review of the sales of this product to SME's. On Friday
29 June FSA announced that it had reached an agreement with
Barclays, HSBC, Lloyds and RBS to provide appropriate redress where
mis-selling has occurred which is likely to result in the banks
having to pay out significant sums of money in compensation. The
FSA reported that it had found serious failings in the sales
process and in particular:
- exit costs was not properly disclosed
- there was a failure to ascertain the
customer's understanding of risk
- where the sale was non-advised, there was
clear evidence that advice had been given
- the amounts and / or the term of the hedging
agreement did not match the underlying loan, and
- banks were offering financial incentives for
selling the product to customers.
The four banks have agreed to carry out past
business reviews of the sales of the interest rate hedging products
since December 2001 and pay compensation where it is found that the
product was mis-sold. The past business review will focus on the
sale of the more complex interest rate hedging agreements to
"non-sophisticated" customers. The past business review will be
scruntinised by an independent reviewer and overseen by the FSA
.
So why has it taken such a long time for the
FSA to sit up and take notice of the interest rate swap mis-selling
scandal? Apparently the FSA first looked into the issue two years
ago and banks were asked to ensure that they had in place tighter
controls in relation to the sales of these products. However,
nothing appears to have been done about products which had already
been sold. It is the historic sales where there is a higher
likelihood of mis-selling.
The fact that the entities which were mis-sold
were small and medium business enterprises (SME's) is an important
factor. SME's were likely to be classified as either Intermediate
(under the FSA's old Conduct of Business Rules) or Elective
Professional (under the FSA's new Conduct of Business Rules).
Accordingly, the banks did not have the same requirements to
provide information as it would have done if it were dealing with a
retail customer where there would have been an obligation on the
bank to explain the risks of the product. However, it is clear that
all large proportion of the SME's were not financially experienced
and were unlikely to have had an understanding of the hedging
product that they entered into and the banks failed to act
responsibly in ensuring that adequate information was provided to
customers even in circumstances where the sale was non-advised.
Whilst the FSA's current actions are somewhat
late in the day – it is good to that perhaps this story will have a
happy ending.
what is an IRSA?
An IRSA is a derivative financial product
being cash based on the underlying value of interest rates such as
LIBOR or the Bank of England base rate. It is a hedging product
often used to offset the potential risk of rising interest
rates.
Many banks required SME's to enter into an
IRSA in support of a loan facility to provide the business with
protection from rising interest rates. As such, it was not the
businesses decision to hedge the risk of rising interest rates, but
more often than not a requirement of the loan. Additionally, the
break costs are often a significant proportion of the loan or loan
facility and are not easily quantifiable. IRSA's were sold on the
basis that they would protect the business in the event that
interest rates rose, but no one explained the downside, ie what
would happen in the event that interest rates went
down.
what should you be looking for?
There are a number of questions that you
should ask yourself which will help you understand whether you may
have a case:
- Was the IRSA a condition of a loan facility? When was the
condition raised – early on in the discussions or at the last
minute? Were you a hostage to fortune, ie were you in a position
where you had no choice but to enter into the IRSA as it would have
been too late to seek alternative funding, and was the bank aware
that this was the case?
- Did the term of the IRSA match the term of the loan or did the
IRSA last longer? If the IRSA exceeded the term of the loan, was
the reason for this explained to you? It is difficult to find any
logic in having the term of the hedge longer than the term of the
loan.
- Was the amount of the IRSA for the same or a greater amount
than the loan you took out? If it is for a greater amount did the
bank explain the reason for this?
- What customer classification were you given? Did the bank
explain the basis of the customer classification and what the
customer classification meant?
- When did you enter into the IRSA? Was it pre or post November
2007? The customer classification process, particularly under the
old Conduct of Business Rules (where a customer could be classified
as Intermediate on the basis of a financial assessment rather than
any experience or understanding) enabled the banks to wriggle out
of providing detailed information about the potential risks of the
product. If you entered into the arrangement post November 2007 the
bank would have had a greater obligation to assess your
understanding before being able to categorise you as a professional
customer – indeed it is likely that an SME with no relevant
experience would be classified as a retail customer – but could
have been asked to consider electing up to professional.
- Does the IRSA documentation enable the bank to unwind the
arrangement at certain trigger points at no cost, eg where the IRSA
becomes particularly disadvantageous due to a significant increase
in interest rates?
- Were you informed that you had a right to unwind the
arrangement? Were you informed of how the cost of unwinding the
arrangement would be calculated?
- Were you advised by the bank to enter into the product? (see
below for more information on the relevance of whether you received
advice from the bank). The majority of the sales were non-advised
and as such the bank will say that it was not the responsibility of
the bank to provide information about the associated risks of the
product.
- If you were advised, did the bank explain the risks of the
product to you? Were you provided with any information / literature
which explained the nature and the risks of the product to
you?
- Did you have any relevant financial services experience at the
point you entered into the IRSA? Did you understand the IRSA and
the potential downside risks?
what can you do?
In the first instance you should contact the
business directly which sold you the IRSA and make a formal written
complaint. The business you are complaining to is required to deal
with any complaints it receives in accordance with the FSA's
rules.
To be able to make a complaint you will need
the following:
- a copy of the customer classification letter detailing the
customer classification you were given which should include the
reason for the classification
- a copy of any documentation making the IRSA is a condition
of a loan or loan facility – this could be in the form of an e mail
– preparing a timeline of the discussions / negotiations with the
bank will be useful
- a copy of any documentation which indicates the basis upon
which the IRSA was sold to you, ie did the bank advise you that it
was suitable, or as is most likely, did the bank state that it was
a non-advised sale?
- a copy of the IRSA and any associated documentation.
advised versus non-advised
The difference between an advised and a
non-advised sale is the extent to which the bank owed a duty of
care at the point the business entered into the arrangement. Where
the business has been advised, the bank will need to demonstrate
the basis upon which the product has been deemed to be suitable for
the client and will need to demonstrate that it has taken the
following into account:
a) the knowledge and experience of the client
in relation to interest rate swap products
b) the client's financial situation, and
c) the investment objectives of the client
and on the basis of the information obtained
the bank is satisfied that the product is suitable.
However, in reality, very few of these types
of arrangements are likely to be advised sales. Even where the
business believed it was being advised, there is likely to be a
clause buried in a document which states that the sale is
non-advised and as such, there is no obligation on the bank to
assess the customer's understanding of the product and whether it
is suitable for their needs.
Once a complaint has been submitted the bank
must provide you with a response to the complaint within 56 days
(or notify you in that time why it is unable to respond in full).
In the event, that the bank rejects your complaint you may have the
right to refer the matter to the Financial Ombudsman Service
(FOS).
the Financial Ombudsman Service
The FOS is an independent body set up to deal
with complaints, amongst other, about FSA authorised firms. It is
free to refer a complaint to the FOS and the FOS is designed to be
consumer friendly i.e you do not need to employ solicitors to
assist you in preparing the complaint. The firm being complained
about is required to respond to any requests for information by the
FOS and is not permitted to recoup any legal costs in defending a
FOS complaint.
To refer a complaint to the FOS the
complainant needs to be an eligible claimant within the FSA's
Rules. In summary, you must either be:
- an individual, or
- a micro-enterprise.
A micro-enterprise is defined as one which has
a turnover or annual balance sheet which does not exceed €2 million
and employs fewer than ten employees.
Additionally the term enterprise means any person engaged in an
economic activity, irrespective of legal form, ie it will include
self employed persons, partnerships and associations.
The FOS will consider the complaint and may
request further information from you and the business to enable it
to make its determination. The FOS is only able to enforce awards
of up to £150,000, although it may make higher awards if it
considers it appropriate to do so.
However, as a result of the decision by the
High Court in Andrews v SBJ Benefit Consultants [2010]
EWHC 2875 (Ch) you will precluded from bringing civil proceedings
to recover any amounts in excess of the £150,000 FOS limit.
Accordingly, the amount that you are seeking is a factor which
should be taken into account when determining whether the FOS or
the civil route is the best route for you.
the civil route
In the event that:
- the complainant is not an eligible claimant, or
- the FOS has determined the complaint and has rejected it,
or
- the FOS has determined the complaint but the amount being
claimed exceeds the £150,000 threshold and you have rejected the
FOS award,
it may be possible to bring a civil case to
try a recover any losses in circumstances where there has been:
- misrepresentation: you may be able to claim
misrepresentation if you believe that the bank misrepresented the
way the product worked or if the bank can be shown to have
failed to disclose material or important facts. You would also need
to establish that had all the relevant information been disclosed
to you, you would not have entered into the arrangement
- negligent misstatement: this is harder to establish than
misrepresentation. Negligent misstatement requires the bank to have
made a false statement (whether intentionally or recklessly) of
fact upon which you relied in entering into the IRSA
- breach of common law advisory duty: where you were advised by
the bank, or possibly where you believed that you were being
advised by the bank, and the standard of care owed by the bank fell
below a reasonable standard, then you may have a claim for a breach
of common law advisory duty.
The basis upon which proceedings could be
brought will depend on the individual circumstances of the case.
In each case, you would need to establish loss.
Alternatively, S.150 of the Financial Services
and Markets Act 2000 (FSMA) enables private persons to bring a
claim for breach of statutory duty. Broadly speaking, an entity in
the course of carrying on a business is unlikely to qualify as a
private person, Under s.150(3) of FSMA the FSA may prescribe
breaches of certain rules as actionable by anyone, but the current
exceptions are unlikely to be of any use in these circumstances.
Additionally, for an action to be successfully brought on this
basis it would need to be demonstrated that the bank had breached
the Conduct of Business Rules or the New Conduct of Business Rules
(COBS), eg relating to customer classification /suitability and
appropriateness.
The civil route should not be entertained
lightly. Whilst an unfavourable judgement could open the floodgates
to billions of pounds' worth of claims, banks are likely to
vigorously defend any actions in relation to the miss-selling of
IRSA's, at least in the early stages of an action. A number of
cases have been commenced against banks, but to date no judgement
has not been given on an IRSA case. It is understood that a number
of cases have settled on confidential terms; whilst the terms can
only be a matter of speculation, it is likely that the
confidentiality is at the insistence of banks wishing to resolve
claims out of the spotlight of public proceedings.
next steps
In the event that you decide to make a
complaint to the business and thereafter refer the matter to the
FOS you should not need to employ the services of a solicitor.
In the event that you are considering legal
action through the courts you should seek legal advice from a
solicitor who has experience of this type of product. Some firms
may not be able to act for you if they act for the banks. You could
also consider contacting one of the action groups e.g the Norton
Accord, which may be able to provide assistance with funding the
legal costs of civil action.
However, if you have an interest rate hedging
agreement with Barclays, HSBC, Lloyds or RBS then you should
shortly receive a letter from your bank explaining whether the sale
of your interest rate hedging product will be included within the
past business review.
notes
