The latest stage of the FSA’s investigation into the mis-selling of interest rate hedging products (IRHPs or “swaps”) has seen the regulator announce that 90 per cent of the sales reviewed in its pilot study did not comply with its requirements.
Swaps were typically sold to companies between 2004 and 2008, when interest rates were higher, but have performed poorly after interest rates fell to historic lows in 2008. As a result, companies found themselves tied into making repayments at much higher rates than would have been available on the open market and being quoted substantial charges if they wished to bring the agreement to an end. In addition to criticism for failing to explain fully the nature of the product, banks have also been criticised for not drawing the customers` attention to the charges that would apply if the agreement was terminated at an early stage.
Green & Rowley v RBS
So it is encouraging for financial institutions and their insurers to note from the recent victory for the defendant in Green & Rowley v RBS, heard in the Manchester Mercantile Court, that sales of these products can be defended. RBS sold a swap to Mr Rowley, a hotelier, and his business partner, Mr Green, in 2005, in order to hedge against movements in the interest rate on an underlying loan of £1.5 million. The swap was relatively straightforward and the claimants benefited from it until market conditions changed in 2008. They enquired in 2009 about terminating the swap, but were told this would cost them as much as £138,650, so they decided not to take any action.
Green and Rowley did not have sufficient evidence to substantiate their claims of negligence and breach of duty. By contrast, the bank had a helpful contemporaneous note of what was discussed at the initial meeting when the advice was given. Furthermore, the claimants were unable to pursue claims under section 150 of the Financial Services and Markets Act 2000 (FSMA) – which should have been their strongest line of argument – since claims under the FSMA were statute-barred.
This claim very much turned on its own facts and we do not expect it to apply across the board to the majority of claims that will arise from swaps. Green and Rowley have recently been granted permission to appeal on grounds of public interest, so it will provide the Court of Appeal with a valuable opportunity to give its considered view. It remains to be seen whether the judgment will be upheld.
The FSA ordered the four principal banks under investigation to review their sales and offer appropriate compensation to their clients where applicable. Seven other banks have also agreed to review their sales of IRHPs. The FSA has placed particular emphasis on a “sophistication test” to be incorporated into these reviews. This underlines the importance for banks to explain the product fully to customers and to have due regard to the customer’s profile and standing, from the smallest SME to the largest plc.
It is worth noting that banks may be able to raise causation defences if it can be proved that the customer would have gone ahead and purchased the swap anyway, even if the sale had been fully compliant. This possible defence is referred to in the FSA’s recent findings and harks back to the “insistent customer” defence recognised in previous FSA guidance on pension and endowment mis-selling.
It could take as long as 12 months before the banks have completed the review of their swap sales and this will have wide-ranging implications, from the strain on their resources to the need for accurate provisioning. The overall redress due from IRHP mis-selling, although very substantial, is not expected to be as high a figure as that which arose from PPI mis-selling.