As regular readers of our articles will be aware, following on from the agreement reached with the major banking institutions in the summer of 2012 to conduct a review of certain sales of Interest Rate Hedging Products, the FSA has required the relevant banks to carry out a pilot scheme first. This involves a selection of each bank’s affected customers to assess each bank’s approach and ensure that it is delivering the right outcomes for its customers.
On Wednesday 31 January 2013, the FSA released a report to set out its findings from the Pilot Scheme in relation to the four major UK banking institutions: Barclays Bank plc, HSBC Bank plc, Lloyds Banking Group and The Royal Bank of Scotland plc/National Westminster Bank plc. The findings in relation to the other banks which are part of the agreement will be released in due course.
Please follow the link below for the full report from the FSA.
FSA Pilot Scheme
In this article, we highlight the headlines from the Pilot Scheme and, where appropriate, provide our comments.
Over 90% of the Interest Rate Hedging Products were mis-sold
Perhaps the biggest headline grabber of all from the report of the Pilot Scheme was the FSA’s finding that, of the 173 sales to “non-sophisticated” customers of Interest Rate Hedging Products that were part of the Pilot Scheme, over 90% did not comply with “one or more of the regulatory requirements”.
The FSA has further confirmed that a significant proportion of these sales are likely to result in financial redress.
Our specialist team comments:
“A figure in excess of 90% in terms of the amount of sales which breached regulatory requirements seems remarkably high. It is startling evidence that the banks were not necessarily acting in their customers’ best interests when selling these products.
On the other hand, one must not forget that, when selecting which cases to pilot, the banks and the FSA deliberately selected typically more complex cases to review. Therefore, it is likely that, if and when all relevant sales are reviewed, the actual percentage of sales which breached regulatory requirements will change and likely reduce. However, of course any mis-selling by the banks is a serious matter.”
Changes to the “Sophistication Test”
As we previously reported, the FSA has confirmed that only “non-sophisticated” customers could be eligible to have the way in which they were sold the Interest Rate Hedging Product reviewed, if it was a type of product that fell within the review. This principle remains unchanged.
However, to determine whether a customer is “non-sophisticated” for the purposes of the review, the banks were previously required to apply the Companies Act 2006 tests which determine whether a company is “small”. There are three criteria for this: having a turnover of less than £6.5m, a balance sheet of less than £3.26m and less than 50 employees. Any customer that satisfied two of these tests, would not, under the previous sophistication test, be eligible to take part in the review.
Concerns were raised that a classification as determined above could prevent genuinely non-sophisticated customers from being eligible for the review. The primary example given is that of farming businesses which are typically balance sheet rich (due to land assets ordinarily owned) and, as a result of a large seasonal workforce, employ in excess of 50 employees. Categorisation based on the previous model would prevent those businesses taking part in the review.
To address these concerns, the FSA has amended the three criteria “sophistication” test and produced a flow chart to describe that test. Follow this link for a copy of that flow chart: http://www.fsa.gov.uk/static/pubs/other/irs-flowchart-2013.pdf.
To overcome concerns relating to the classification of certain customers eligible for the review, one amendment the FSA has implemented concerns customers who meet (only) the balance sheet and employee number criteria. These customers are now included in the review if the total value of their ‘live’ Interest Rate Hedging Products is equal to or less than £10m.
Our specialist team comments:
“Effectively, the FSA has introduced a cap of £10m in relation to the total value of a customer’s Interest Rate Hedging Products. In doing so, the FSA is opening the door for some customers but potentially slamming it shut to others.
Whilst this change could potentially be good news for certain customers such as farming, bed and breakfast, or care home businesses, and this is to be welcomed, it is theoretically possible for larger small or medium businesses to now be excluded from the review having previously been eligible to take part.
It is also a rather uncomfortable consequence of the FSA’s change that it automatically excludes the largest claims. These were inevitably going to be the costliest claims for the banks if redress had been found to be due.”
Principles of redress
The FSA had previously confirmed that the level of redress would be what is “fair and reasonable” but gave no clue as to what fair and reasonable redress would be or how this would be calculated.
The FSA has clarified matters a little further by confirming that all non-compliant sales will be considered for redress which, if applicable, “should aim to put customers back in the position they would have been in had the breach of regulatory requirements not occurred”.
The FSA has stated that there will be three potential outcomes, depending on the relevant circumstances of each sale reviewed:
- Full redress – this will mean repayment in full of all sums paid under the Interest Rate Hedging Product if it is deemed that the customer would not have purchased it at all but for the mis-selling.
- Alternative product redress – this will mean a refund of all sums paid under one product less those sums that would have been paid under an alternative product if it is deemed that the customer would have purchased an alternative Interest Rate Hedging Product had it not been mis-sold the product it did purchase.
- No redress – this will mean that no repayment will be made to the customer if it is determined that the customer would still have purchased the same Interest Rate Hedging Product notwithstanding a breach of regulatory requirements (i.e. had it not been mis-sold).
Finally in this regard, the FSA has confirmed that customers eligible for redress may be able to recover consequential losses in principle. However, the FSA has stated that the banks will determine this by using “an established legal approach…which will involve consideration of whether the loss was caused by the breach and whether the breach was reasonably foreseeable”.
Our specialist team comments:
“The FSA has confirmed that each case will be assessed subjectively. One of the problems is that the assessment will be made by the very bank which mis-sold the Interest Rate Hedging Product in the first place. This is likely to cause considerable unease in the minds of those subject to the review. Of course, the assessment will be reviewed by an “independent person” who should remain impartial throughout the process. However, allowing the banks to determine the level of redress is, in our opinion, opening up the potential for conflict from the outset.
It is definitely a positive thing that the FSA has confirmed that consequential losses, such as loss of profit, overdraft charges etc are recoverable in principle. However, the banks will likely offer robust opposition to including such claims to reduce payments they have to make. Consequential losses will not be recovered without a significant battle based on legal principles.”
The FSA had previously set no time limits to complete the review agreed with the banks.
However, the FSA has now confirmed that the reviews with the major four UK banks are to commence immediately. Further, the FSA has confirmed that it “expects” reviews to be completed within six months or, where the banks have a large portfolio of cases, within 12 months.
The extent of the mis-selling identified in the review is considerable, albeit this is tempered slightly by the fact that the pilot contained more complex cases to begin with.
Whilst there may be good news for some customers as a result of changes made to the sophistication test, it has the potential to exclude previously included customers and, worryingly, potentially enable the banks to avoid the largest of claims.
Although the time frames for the reviews to be completed are encouragingly short, those customers who purchased Interest Rate Hedging Products leading up to six years ago really should obtain legal advice as a matter of urgency with a view to preserving their right to bring a claim, should there be concerns over the way the review process is conducted.
Where limitation is less of a concern, we would encourage customers to be fully involved in the review process with their bank and, if they have any concerns about how the review is being conducted or require any assistance with their participation, we would encourage those customers to obtain professional legal advice.
If you do require any assistance, or wish to discuss the matters included in this article, please contact us.