UK banks and their insurers should be aware of two major developments in relation to interest rate hedging product (IRHP) mis-selling: first, the pending appeal in the Green v Royal Bank of Scotland case is to be heard by the Court of Appeal in late July; second, the publication by the Financial Conduct Authority (FCA) of its findings following a pilot review of a large sample of IRHP sales.
Green v RBS
The case concerns the alleged mis-selling of an IRHP to a pair of small business owners by Royal Bank of Scotland (RBS) and could be a sign post for similar cases in the pipeline. At the heart of the dispute were two claims brought by Paul Rowley and John Green, who claimed they were mis-sold an interest rate swap eight years ago. The claimants brought two categories of claim against RBS: the information claim and the advice claim.
The information claim alleged RBS was guilty of negligent mis-statement at or before a meeting on May 19, 2005 when the swap was arranged. The advice claim alleged RBS went further than purely giving information about the swap and advised the claimants to enter into it. The provision of advice meant a duty of care came into existence; RBS was allegedly in breach of this duty because the swap was not suitable for the claimants.
The dispute was heard before the High Court in 2012, when the judge ruled RBS was not in breach, dismissing the claim entirely. While this would have been welcomed by RBS and other banks that sold IRHPs (and their insurers), there will be many cases in which the banks’ contemporaneous documentary evidence of discussions will not be as comprehensive as in this case, which was clearly a deciding factor in the judge’s decision, as well as RBS’s decision to fight this at trial.
The Green case should be viewed against the background of the prevailing regulatory landscape relating to the sales of IRHPs in the UK. In 2012, the FCA (formerly the FSA) carried out a wide-ranging review finding serious failings in the sale of IRHPs to small and medium-sized enterprises (SMEs). The report, published on January 31, 2013, followed the FCA’s recent review of a sample of 173 sales of IRHPs to “non-sophisticated” customers from across eight banks. The FCA concluded more than 90% of these sales did not comply with one or more of its requirements.
This report was updated in March 2013, setting out guidelines for a full review of the mis-selling of IRHPs. Nine banks (Allied Irish Bank (UK), Bank of Ireland, Barclays, Clydesdale and Yorkshire, Co-operative Bank, HSBC, Lloyds, RBS and Santander) have agreed to conduct their own reviews in line with these guidelines. The reviews will focus on the sale of IRHPs to non-sophisticated customers.
One important aspect – the assessment of “consequential loss”, which can form part of the damages recovery – will be assessed using “an established legal approach” to determine the measure of damage, including the usual causation/foreseeability requirements; this is an encouraging sign for the banks and their insurers. The scale and labour-intensive nature of the FCA-driven review will inevitably involve a host of the banks’ professional advisers, creating extremely substantial costs expenditure giving rise to significant coverage issues under the banks’ financial lines insurance programmes.
The FCA has estimated more than 40,000 IRHPs have been sold by financial institutions to SMEs in the 10-year period covered by the review. The scale of the liability exposures where the sales practices fell short of the mark, giving rise to systemic liability, will therefore be very substantial, resulting in a significant damages and costs bill. One law firm acting for close to 100 claimants has indicated each of its clients has lost on average between £300,000 ($452,094) and £500,000 as a result of IRHPs mis-selling. The banks have been forced to revise their financial provisions upwards by substantial margins.
Barclays announced on February 5 it would double the provision it had set aside for redress on the mis-sale of IRHPs from £450m to £850m. RBS, in its annual results published on February 28, increased its provision by 14 times, from £50m to £700m. In March it emerged RBS’s total figure could possibly surpass £1bn. Meanwhile, HSBC has set aside £130m, while Lloyd’s Banking Group has yet to announce a provision, although this is thought to be in the region of £300m.
Taking RBS’s upper estimate of £1bn, these provisions would take the cost of IRHPs mis-selling of the big four banks to more than £2bn. Some analysts are suggesting the final cost could be more than the costs incurred for PPI mis-selling.
Barclays, RBS, HSBC and Lloyds Banking Group have agreed to suspend customer payment obligations under IRHP products on a case-by-case basis where customers can prove they are in “financial distress”. Greg Clark MP, the financial secretary to the Treasury, has asked the FCA to insist banks should relieve loss-making IRHP carriers from their liabilities under IRHP products until their cases have been resolved. The banks are likely to claim indemnity under their financial lines policies in respect of the losses sustained by reason of these voluntary suspensions. This will raise contentious issues of coverage.
Underwriters can take some comfort from the fact the redefining of non-sophisticated customers under the new FCA guidelines should narrow the class of claimants falling within the redress scheme. A further positive is the total redress bill for each bank could be reduced as a result of the FCA’s explicit adoption in its pilot review of the use of common law principles regarding foreseeability and loss causation to determine the measure of recoverable loss. This principle is stated in the FCA’s report in the context of consequential losses only.
However, in our view, it would make no sense to acknowledge these principles only in relation to consequential losses. Clearly, these principles should apply to the primary measure of damages, which would bring the assessment into the High Court territory rather than adopting the “fair and reasonable” principles, which the Financial Ombudsman Service would apply. This will have a significant impact on the overall quantification of recoverable losses.
The Green case is clearly an encouraging example of a successfully defended claim, which shows the English courts will uphold the bank’s position where the investor understood the risks. However, the outcome was entirely fact-dependent; the bank’s successful defence was only available because its file included well-documented evidence of risk warnings. Nevertheless, the judgment demonstrates the English courts will not necessarily take a pro-consumer stance where the evidence justifies this. Following intervention from the FCA, it has been reported the Court of Appeal has accelerated the appeal hearing date to late July.
Despite the successful defence of the first reported claim, the latest FCA sample review has identified a high proportion of claimants with valid mis-selling claims. The FCA’s criteria for “non-sophisticated” customers may be open to challenge but, as things stand, the banks involved have agreed to adopt these guidelines for their voluntary redress schemes, which they are aiming to complete before the end of this year. In such cases, it is likely to be in underwriters’ interests to be engaged in, or at least monitoring closely, this review process. The coverage response will raise a number of considerations, including the requirement to demonstrate an actual legal liability as recently affirmed by the Astra Zeneca v Ace and XL judgment.
First published in Insurance Day (www.insuranceday.com) on 30 May 2013