In June 2012 the Financial Services Authority (FSA) published its review of interest rate hedging products, finding evidence of widespread mis-selling by the major banks to small businesses as far back as 2001. Typically, these products were sold alongside business loans and the customer was frequently left with the impression that the bank required a hedging product to be bought as a condition of the loan. In theory the hedging products made good business sense for many customers by reducing their vulnerability to rises or fluctuations in the interest rates they were paying on their borrowing. However, as many of our clients have reported to us, they were not adequately informed of the substantial exit costs associated with terminating the hedging arrangements early or of the fact that they were effectively engaged in interest rate speculation with inherent risks if base rates were to fall significantly.
Even more concerning, the FSA also found that hedging products were often inappropriate for customers' circumstances with a mismatch between the hedging product sold and the amount and duration of the customer’s loan. For example, one client found themselves owing the bank a monthly payment of £9,000 despite having repaid all their borrowing! When they complained to the bank that the hedging product served no purpose whatsoever they were quoted a cancellation fee of approximately £350,000.
The key finding of the FSA’s review was that it was inappropriate and in breach of FSA rules for such complicated financial products to be sold to inexperienced customers (termed 'non-sophisticated customers' by the FSA), given that the banks provided little or no explanation of the true nature of the products being sold. In a recent set of instructions, the only explanation of the potential costs was a note contained in the small print on page 3 of a pre-contractual letter stating: 'if any proposed transaction involves you cancelling an existing contract, then such a cancellation may result in a cost to you'.
In a case for another client, they would not have agreed to a hedge had a clear explanation been given (as it should have been) of the basis on which the cost of early termination would be calculated. In that case, the cost of terminating the hedge early was in excess of £600,000, which came as something of a surprise!
The FSA also found that sales incentive and reward schemes for staff exacerbated the poor sales practices which led to inadequate explanations and the banks’ failure to take account of their customers’ circumstances. The objective appears to have been the protection of the bank against falling interest rates rather than protecting customers against the risk of paying more for their borrowing. Whilst a collar on interest rates may be appropriate for a business with a fixed or stable cash flow which is looking to achieve certainty within a narrow margin, it may not have been at all appropriate for a business which is very sensitive to changes in the general economy. For example, a business which is heavily dependent on the construction industry, where cashflow is likely to reduce at times of slow or negative growth in the economy, would need to take advantage of the likely falling interest rates which accompany slow growth periods. However, the banks still required these customers to enter into hedging arrangements despite their clear unsuitability for the business concerned.
This aggressive sales behaviour by the banks seems indefensible, particularly in the current climate. However, prior to the FSA’s review the banks had been taking a very tough line pointing out that customers only sought to evade the terms of hedging arrangements when interest rates reduced and a payment was due from the customer to the bank rather than vice versa. They also contended that the cost of terminating a hedging arrangement was a fair and reasonable estimate of the cost to the bank of replacing the contract. The banks’ position was largely supported by the Financial Ombudsman Service (the FOS) which supported the bank in over three-quarters of cases before them prior to the review. Therefore from small businesses’ point of view the review has been a long time coming.
What redress may be available?
As a direct result of the FSA’s review, four of the major banks (Barclays, HSBC, Lloyds and RBS) have agreed to offer automatic redress to non-sophisticated customers who were sold structured collar products since 1 December 2001. In order to be a ‘non-sophisticated’ customer, the business needs to have met two of the following criteria in the year the hedging product was bought:
- a turnover of less than £6.5 million;
- a balance sheet total of less than £3.26 million; or
- less than 50 employees
A structured collar product is one which limits interest rate fluctuations to within a range. It also includes provisions that if the rate falls below the floor limit, the monthly payment owing from the customer to the bank increases by proportionately more than the payment from the bank to the customer if the rate had exceeded the cap limit.
Whilst the outcome of the review is to be welcomed, this is not a total victory for small businesses, and significant hurdles lie ahead. As stated above, automatic remedies are only available to customers in certain limited defined categories and not to all types of hedging products. There may well be businesses outside the strict definition of non-sophisticated customer who nonetheless feel that the bank failed to explain the potential risks. Further, the banks have merely indicated that they will provide ‘fair and reasonable’ redress. It is fair to say that the banks definition of fair and reasonable redress are not likely to live up to expectations.
Further review of hedging products
If your business was sold a swap (fixed interest rate) or a collar (interest rates limited to a simple range), you may also receive a letter from your bank offering redress. The same four major banks have agreed to review the sales of swaps and collars to non-sophisticated customers and offer redress if the bank believes that you did not understand what you were buying. In July 2012, seven further banks also agreed to participate in the review and compensate any small businesses for any mis-selling which they believe has occurred. The seven banks are Santander, Co-op, Allied Irish, Bank of Ireland, Clydesdale and Yorkshire Banks and Northern Bank.
The FOS and other remedies
If your business does not fall within any of the categories mentioned above, and/or you feel that you have been mis-sold a hedging product, then you still have the option to make a formal complaint to the FOS once you have exhausted the bank’s complaint procedure and failed to get sufficient redress. The FOS will consider complaints by businesses with a turnover or annual balance sheet not exceeding €2 million and fewer than ten employees. The FOS can award binding remedies against the bank up to a limit of £150,000. Our experience tells us that this route can be very effective notwithstanding the £150,000 binding limit when a genuine case of mis-selling has occurred. We have recent experience of obtaining an award for full redress from the FOS, namely a cost free exit from the hedging product, refund of all net monies paid under the contract and the refund of 75% of legal fees. The bank complied in full with the award despite it being well in excess of the £150,000 FOS limit.
If you are outside the scope of the FSA review and the FOS criteria, then it is still open to you to follow the bank’s normal complaint handling procedure and to take action through the courts if you fail to obtain adequate redress.
Next steps and how we can help
If you are a customer of Barclays, HSBC, Lloyds or RBS and consider that your business has been the victim of mis-selling and if you are:
- a non-sophisticated customer with a structured collar product - redress should be automatic. You should shortly receive a letter from your bank offering fair and reasonable redress. We are able to assist you with your negotiations with the bank as to what constitutes ‘fair and reasonable’ redress.
- a non-sophisticated customer with a swap or collar product - your bank is carrying out a review and will write to you if it believes mis-selling has occurred. If you fail to receive a letter offering sufficient redress, we are able to assist you with making representations to your bank and escalating the claim to the FOS if necessary.
- a non-sophisticated customer with another derivative or hedging product - you need to follow your bank’s normal complaint procedure. If this fails, you need to consider whether your business is eligible to make a complaint to the FOS. We are experienced in dealing with the FOS and are able to assist you through the process.
- a sophisticated customer - you are outside the scope of the FSA’s review and will not meet the FOS criteria for considering complaints. Please contact us to consider whether a claim should be pursued through the courts.
If you are a customer of Santander, Co-op, Allied Irish, Bank of Ireland, Clydesdale and Yorkshire Banks or Northern Bank - your bank is carrying out a review and will write to you if it believes mis-selling has occurred. If you fail to receive a letter offering sufficient redress, we are able to assist you with making representations to your bank and escalating the claim to the FOS if necessary.
If you are a customer of another bank - the FSA is contacting these banks and considering whether they should be included in the review. This process may take some time, so you may wish to utilise your bank’s complaint procedure and then consider whether you are eligible to make a complaint to the FOS.
If you are considering taking action in relation to any mis-selling, please bear in mind that it is possible to claim for mis-selling as long as six years ago. However this means that if the mis-selling occurred in 2006, the limitation date will necessitate taking action as soon as possible.