On 29 June 2012, the FSA (as it was then; it became the FCA on 1 April 2013) announced the findings of its initial 2 month long review into widespread complaints that UK banks had mis-sold complex interest rate hedging products such as Swaps and Structured Collars to small and medium sized businesses (SMEs) in the U.K. [30,000 of these products were sold, with the vast majority entered into between 2005 – 2008.]
The FSA declared it had found evidence of “serious failings” in the banks’ sales processes. It went on to set out the “poor sales practices” it views as evidence of a non-compliant sale (i.e. a sale which does not comply with the FSA Conduct of Business Rules applicable at the time). These include:
- Poor disclosure of exit costs;
- Failure to ascertain the customers’ understanding of risk;
- Non advised sales straying into advice;
- Over-hedging’ (i.e. where the amounts and/or duration did
not match the underlying loans); and
- Rewards and incentives being a driver of these practices.
The FSA stated that in order to provide “a swift solution for customers”, it had reached agreement with Barclays, HSBC, Lloyds and RBS/Natwest that each would carry out its own Past Business Review (to be overseen by an “Independent Reviewer”) and provide appropriate redress where mis-selling had occurred. [On 23 July 2012, the Review was widened to include Allied Irish Bank (UK), Bank of Ireland, Clydesdale and Yorkshire banks (part of the National Australia Group (Europe)), Co-operative Bank, Northern Bank and Santander UK.]
While many raised concerns that the FSA had decided to allow the banks to determine themselves whether they had breached the FSA’s rules (noting this was akin to asking the accused to perform the role of investigator, judge and jury) the announcement was generally welcomed, particularly as it was billed as a quick and inexpensive method of obtaining redress. Further, those affected were reassured by claims that the banks would adopt a “customer centric approach”. The customers affected were also encouraged by the announcement that the banks had agreed to suspend payments for those in “financial distress” pending the outcome of the Review process.
Before launching the Review Scheme proper the FSA ordered that a Pilot Scheme be carried out in order to determine the principles, procedure and redress calculation methodology. On 31 January 2013, the FSA announced the results of that Pilot Scheme. It stated it had reviewed 173 cases and determined that a headline-grabbing 90% had failed to comply with one or more of its regulatory requirements. However, and perhaps more importantly (though buried away at the bottom of the statement and in an appendix to it), the FSA revealed it had fundamentally altered the eligibility requirements for the Review.
When the FSA made its first statement on this issue back on 29 June 2012, the test as to who could and could not participate in the Review was a relatively straightforward one. The FSA provided the following explanation for what it considered a “sophisticated customer” and hence one which should be excluded from the Review:
For these purposes we have defined ‘sophisticated customer’ as: in the financial year during which the sale was concluded, a customer who met at least two of the following:
- a turnover of more than £6.5 million; or
- more than 50 employees.
- a balance sheet total of more than £3.26 million; or
Alternatively, the firm (i.e. the Bank) is able to demonstrate that, at the time of the sale, the customer had the necessary experience and knowledge to understand the service to be provided and the type of product or transaction envisaged, including their complexity and the risks involved.
The first part of the above is the Companies Act 2006 definition of a “small company”. It is clear and easy to understand. The second part is also easy to follow and is designed, understandably and perfectly reasonably, to exclude from the Review those customers with sufficient knowledge and expertise to understand the products sold to them.
However, by the time of the FSA’s second statement, 7 months later on 31 January 2013, the eligibility test had been significantly altered.
The FSA, no doubt under significant pressure from the banks and their lawyers, introduced a new procedure for determining eligibility to participate in the Review. It printed a flow-chart which the banks now use to determine which customers are “sophisticated” (and hence outside the scope of the Review) and which are “non-sophisticated customers” (and hence eligible to participate in the Review).
One of the new criteria introduced by the FSA was the imposition of a £10m threshold, which means that any customer with aggregate notional hedging in excess of £10m at the time of sale now finds themselves excluded from the scope of the Review. It is not clear exactly what link the FSA considers exists between level of borrowing/hedging and financial sophistication. The variance/discrepancy between the two concepts is particularly pronounced in the South East of the country where relatively small property investors/developers, particularly in the period 2005 – 2008, regularly entered into finance arrangements considerably in excess of £10m and consequently found themselves being sold highly complex derivatives with an initial notional value in excess of £10m. Very often they did not need or want the products in the first place (they only entered into them because they were made a condition of sanction of the underlying lending, or were told, by their bank, that it would look more favourably upon them and future finance applications if they had some form of hedging in place.) It is frequently the case that the businesses who entered into these arrangements did not understand them or the potential consequences of entering into them. It is simply illogical to suggest that because they were able to borrow large sums of money at that time, based on the value of the portfolio in which they were investing, they are more able to understand a complex derivative than a business with a smaller hedge.
What is clear is that this new test has been of considerable assistance to the banks in excluding thousands of customers from the Review on the basis that they are “sophisticated”. The effect of this is to very considerably reduce the banks’ potential liabilities (at least under the FCA Review).
Current Position under FCA Review
When the FSA issued its second statement on 31 January 2013 it stated “we expect the banks to aim to complete their review within 6 months, although we accept that for banks with larger review populations that this may take up to 12 months”.
It is now over 9 months since that statement, so now seems as good a time as any to take stock of the progress of the FCA Review.
Total provisions to cover the cost of compensating customers mis-sold interest rate hedging products are currently understood to be around £3bn. Barclays alone has made a provision of £1.5bn. RBS has so far put aside £750m. Lloyds’ provision currently stands at £400m. HSBC has put aside £385m.
Despite this, we know from the FCA’s update on 30 October 2013 that only 1,162 “redress outcome decisions” have been communicated to customers and only 125 offers have been accepted, totalling just £15.3m, or 0.5% of the total provision.
Given that the FCA wanted the Review to have been completed by now, this represents painfully slow progress. It also, I believe, demonstrates that the FCA’s targets were hopelessly misjudged and the banks are not progressing the Review cases with anything like the alacrity and efficiency they ought to be. As it happens, Carter-Ruck has a number of clients that fall within the 125 – however we have many more where the bank has not even got round to telling the customer whether they can participate in the Review.
Interestingly, we now know just how effective (at least for the banks) the change to the eligibility criteria has been. From a review population of just under 30,000, the banks have managed to exclude 10,500 customers on the basis that they are “sophisticated” and hence outside the scope of the Review.
So what do you do if you are one of the 10,500 businesses told by your bank that it considers you a “sophisticated customer” and hence not eligible to participate in the Review?
The banks often tell their customers that they can pursue their complaint via the Financial Ombudsman Service. However the FOS is not a viable option for the vast majority of these businesses. The reason being that the FOS compensation limit is only £150,000 – a tiny fraction of the average claim value.
So if the FOS is not an option – what else can you do? There are, in essence, two options (although they are not necessarily mutually exclusive):
- The first option is to instruct a solicitor to challenge your categorisation as a “sophisticated customer” by, so far as the facts permit, making a positive case for inclusion in the Review with reference to the FCA’s eligibility criteria. [We have successfully challenged several incorrect categorisations, resulting in customers who were told they were outside the scope of the Review now being able to participate in it.]
- The second option is to consult a solicitor on the merits of bringing a legal claim against the bank. However, time is of the essence as there is, ordinarily, a 6 year limitation period within which you must issue proceedings at Court. While the 6 years normally runs from the date the product was entered into, this is not always the case. As the majority of products were sold in the period 2005- 2008, those claims that are still within time do not have long left. If you are up against the limitation period you should consult a solicitor immediately so that they can either issue a protective claim form at court (allowing you four months to decide whether you wish to serve proceedings on the bank) or seek the bank’s agreement to enter into a standstill agreement on limitation while your solicitor investigates the claim and decides whether the facts warrant you incurring the cost of preparing a detailed letter of claim.
For further information please contact Stevie Loughrey.