Barclays, HSBC, LBG and RBS mis-selling interest rate swap products

Interest rate swap products allow customers (mainly small and medium sized businesses) to fix their rate in order to protect them from increases in interest rates. These products were typically sold alongside commercial loans to provide comfort that if interest rates increased, interest payments on the loan would remain the same. The problem was that interest rates plummeted to an even lower level and customers found themselves paying higher interest rates than those which came to prevail in the market. They were therefore in a worse position than if they had not bought the product. The problem has arisen due to interest rates remaining so low for such a long period of time, which has meant that many customers have found it increasingly difficult to service the payments on these products. Customers have also found it costly to bring their agreements to an end, since the standard terms provide for substantial exit fees and charges.

The FSA has found that there were “serious failings” on the part of Barclays, HSBC, Lloyds Banking Group and RBS in relation to the sale of interest rate swaps.

The FSA has found failings on behalf of the above four banks as regards disclosure of exit charges, failure to ascertain their customers’ understanding of the risk and to give appropriate advice. Such failings will almost certainly lead to claims by customers who had bought these products.

The same old story?

This criticism of the banks in interest rate swaps mis-selling has some parallels with that which arose from the mis-selling of PPI insurance, which has dominated the headlines over the past few years. It also harks back to the failure, several years ago, to disclose MEAFs (Mortgage Exit Administration Fees) when mortgage terms came to an end or customers changed their mortgage providers. The difference between PPI insurance and interest rate swaps is one of scale. Whilst PPI insurance was sold as part of hundreds of thousands of products nationwide, the FSA has estimated that around 44,000 interest rate swaps were mis-sold since 2001. In contrast, PPI involved far smaller payments from customers than those for interest rate swap products, which were directed more at the wealthier clients of the banks, including small and medium sized businesses. For example, it has been reported that RBS settled a claim brought by a single businessman by writing off around €30 million worth of swaps and loans. It seems that the costs of compensating past customers for mis-selling could be substantial with Barclays, HSBC and RBS reportedly putting aside a total of £630 million to cover the costs of compensating customers for mis-sold interest rate swaps.

What can we expect?

As with PPI and other previous mis-selling, the FSA has ordered each of those banks named to conduct internal reviews of every product sold in order to determine how many customers were affected. Seven other banks (Santander, Co-operative, Allied Irish, Bank of Ireland, Clydesdale, Yorkshire Bank and Northern Bank) have volunteered to conduct similar reviews of their interest rate swap sales, despite the fact that the FSA has not yet ordered them to do so. Better perhaps for them to be seen to take steps to put their houses in order first, rather than waiting to be compelled to do so by the FSA.

In terms of the format of the review, the FSA has directed each of the banks to engage an independent party to assess the sales of interest rate swap products. It has directed that each customer be given the right to have an independent reviewer present during any meetings or calls with the banks, and the independent assessor must be approved by the FSA.

While it is certain that claims will follow on from these reviews, it is by no means clear how many claims will arise, even less how many of the claims brought will be successful. It is by no means a foregone conclusion that all interest rate swaps were mis-sold, as is evident from the recent Scottish case brought by a small property developer (Grant Estates Limited), which was successfully defended by RBS. But the costs of investigating and fighting claims are likely to be significant.

Considerations for insurers

Whil the banks have little option but to notify their insurers of these problems, as circumstances which may give rise to claims, issues will arise in relation to the timing of notifications, the bank’s awareness of the problem and the extent to which, if at all, typical policy wordings will cover the costs of the investigations, whether ordered by the regulators or being carried out voluntarily. It is difficult to say at this stage whether and to what extent insurers will have to foot the bill. As discussed above, claims by customers will undoubtedly arise from the mis-selling of interest rate swaps. Class actions are expected in the US and other jurisdictions.

Aside from third party claims, there will almost certainly be shareholders who consider themselves prejudiced by the banks’ conduct, particularly when the impact the announcements have had on the share prices of the banks involved is taken into account.

Check-list for notifications to insurers

Insurers will need to consider carefully how they respond to notifications and what guidance, if any, they give to their insureds. Banks may feel under pressure to deal with this situation quickly, in order to prevent further harmful publicity and insurers may be able to resist meeting investigation costs incurred by banks if incurred at an early stage and without insurers’ consent. Insurers should also consider:

  1. Retroactive dates
  2. When the banks themselves first became aware of the problem
  3. Where banks have not as yet been “named and shamed”, careful consideration should be given as to whether those banks have been “put on notice” by the press furore
  4. As with PPI insurance, banks should not be indemnified for any element of redress which relates to reimbursement of fees or charges; this type of “claim” will not usually be covered under typical policy wordings
  5. The possible application of policy exclusions such as those which relate to fees and commissions earned

The most recent press coverage has confirmed that the FSA is coming under political pressure to start the compensation process for small businesses' potentially mis-sold swaps following complaints that the regulator has not acted quickly enough. Watch out for further releases from the FSA in response in the near future.