It has been impossible for any of us to escape the flurry of recent news articles about banks’ mis-selling of interest rate swaps. In this article we consider the potential impact these recent developments may have on financial institutions and their insurers.
Barclays, HSBC, LBG and RBS mis-selling interest rate swap products
Interest rate swaps (swaps) allow customers (mainly small and medium sized companies) to fix their rate in order to protect them from increases in interest rates. Swaps were typically sold alongside commercial loans to provide comfort that, if interest rates were to increase, interest payments would remain the same. However, interest rates plummeted and customers found themselves paying higher interest rates than those generally available. They were therefore in a worse position than if they had not bought the product. Many customers found it increasingly difficult to meet the interest payments and also found it costly to bring their agreements to an end, due to substantial exit fees and charges.
The FSA has found “serious failings” on the part of Barclays, HSBC, Lloyds Banking Group and RBS in relation to the sale of swaps, particularly as regards disclosure of exit charges, failure to ascertain customers’ understanding of the risk and advise appropriately. Such failings will lead to claims by customers who bought these products.
What can we expect?
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. It perhaps makes sense to take control themselves rather than wait to see what the FSA might later compel them to do.
At the behest of the FSA, each of the banks are in the process of engaging an independent party to assess the sales of interest rate swap products. Each customer must 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.
Claims have already started to follow, as evidenced in the High Court “test case” (Guardian Care Homes v Barclays) where, during an initial hearing at the end of October, the court seemed very critical of the Bank’s conduct. Elsewhere, the Financial Ombudsman has recently reversed two of its earlier decisions which ordered banks to pay substantial amounts of compensation. Whilst it is unclear how many claims will arise, or what proportion will be successful, it is clear that the costs of investigating and fighting claims will be significant.
Considerations for insurers
Banks will need to notify their insurers of these problems. These are circumstances which may give rise to claims, and issues will arise regarding the timing of notifications; first awareness of the problem; and the extent to which, if at all, policy wordings will cover investigation costs incurred by their insureds.
Aside from third party claims, there may be shareholders who consider themselves prejudiced by the banks’ conduct, particularly if the announcements have any long term impact on share prices.
Check-list for notifications to insurers
Insurers 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 act quickly in order to prevent further harmful publicity whilst insurers may conclude that they have grounds to resist meeting investigation costs incurred without their consent. Insurers should also consider:
- Retroactive dates
- When banks first became aware of the problem
- Where banks have not as yet been “named and shamed”, whether those banks have been “put on notice” by the adverse publicity
- 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 wordings
- The possible application of policy exclusions, including those which relate to fees and commissions earned
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.