It was reported in the Sunday Telegraph on 21 April 2013 that the Financial Conduct Authority (FCA) (formerly known as the ‘Financial Services Authority’ (FSA)) is facing a claim for judicial review of its Redress Scheme (“the Review”) which was intended to provide redress to individuals and businesses that were mis-sold interest rate hedging products. The FCA took over the Review of interest rate hedging products on 1 April 2013, as a consequence of the Financial Services Act 2012.
The FCA found serious failings in the way in which interest rate hedging products were sold in particular to small and medium sized business (SMEs) and poor practice on behalf of the Banks to an extent to justify the Review. Interest rate hedging products are designed to provide customers with protection against the risk of fluctuating interest rates but they are often very complex instruments and are therefore susceptible to mis-selling with many customers not really understanding the agreement they are entering into. It was estimated by the FCA that more than 40,000 interest rate swaps were sold to small and medium sized businesses in the last decade, with the greatest volume being sold in the period 2005 – 2008 before the base rate fell sharply to an historic low.
Interest rate hedging products are typically separate to a loan. There are broadly four types of products that have been sold to customers:
- swaps – enabling the customer to ‘fix’ their interest rate;
- caps – placing a limit on any interest rate rises;
- collars – enabling the customer to limit interest rate fluctuations to within a simple range; and
- structured collars – enabling a customer to limit interest rate fluctuations to within a specified range, but involving arrangements where, if the reference interest rate falls below the bottom of the range, the interest rate payable by the customer may increase above the bottom of the range.
Given the concerns highlighted in the Review regarding the inappropriate sale of these products, the FCA reached agreement with Barclays Bank Plc, HSBC Bank Plc, Lloyds Banking Group, The Royal Bank of Scotland Plc and National Westminster Bank Plc to provide appropriate redress where mis-selling has occurred, whereby the banks agreed to:
- provide fair and reasonable redress to non-sophisticated customers who were sold structured collars;
- review sales of other interest rate hedging products (except caps or structured collars) for non-sophisticated customers; and
- review the sale of caps if a complaint is made by a non-sophisticated customer during the review.
However, concerns have now been expressed in some quarters as to whether the criteria for inclusion in the Review is too restrictive, and insufficient provision is being made for medium-sized businesses which do not meet the criteria as ‘non-sophisticated’ customers. The allegedly unfair and changing nature of the criteria is the driving force behind the claim for judicial review of the FCA’s Review.
The rationale for the limited scope of the Review was that a ‘non-sophisticated’ customer would generally be a small business which was unlikely to have possessed the specific expertise to understand the risks associated with these products. Originally, a sophisticated customer was defined as a customer who satisfies at least two of the following:
- A turnover of more than £6.5m;
- A balance sheet of a total of more than £3.26m; or
- A company with over 50 employees.
This definition excluded many potential claimants from the Review, and so the FCA widened the scope of the Review by concluding that a non-sophisticated customer for the purposes of the Review will be a customer who meets only the balance sheet and employee number criteria where the total value of their ‘live’ interest rate hedging product is equal or less than £10m. Business with net assets of more than £5 million at the time the swap or hedging product was taken out will also be excluded from the Review as they do not qualify as a private customer. The concern is that this still excludes a number of medium size businesses, who could reasonably argue that they had did not possess any more expertise than the so-called non-sophisticated customer, simply by virtue of the fact that they had hedging products of more than £10 million. The arbitrary limits imposed on the Review mean that a lot of businesses will be excluded simply because of the size of their debt or a higher balance sheet.
It remains to be seen whether the judicial review proceedings will be successful but it is hoped that the FCA will respond to the threat of these proceedings by expanding the scope of the Review so that it better addresses the inappropriate sale of these products.
Customers who are excluded from the Review still have the option to issue Court proceedings or to refer a complaint to the Financial Ombudsman Service, but they will still have to meet the FOS’s eligibility criteria and if they have suffered a loss that is more than £150,000 then a Court action may be the only option.
Amidst all the confusion generated by the eligibility criteria for the Review, businesses should keep a close eye on the limitation period for bring a claim in the Courts (6 years from the date the cause of action arose). As a large number of interest rate hedging products were sold in the period from 2007, in many cases, this limitation period is fast approaching so any business in this situation should seek legal advice as soon as possible.