4 Mis-sale of Hedging Products
Box 1: Interest rate hedging products and Tailored
Business Loans
Variable interest rates on loans rise or fall in
line with the base rate or benchmark on which they are based.
Adverse movements in variable rates are a risk to the business
with the loan and to the bank through the business's diminished
interest rate cover.
Businesses can protect themselves from this interest
rate risk by purchasing a stand-alone interest rate protection
product, called an Interest Rate Hedging Product (IRHP), or by
taking out a loan with the hedging features embedded within the
contract itself.
Standalone Interest Rate Hedging Products (IRHP)
are a type of derivative contract sold by banks. They are a separate
contract to that of the underlying loan or portfolio of loans.
Businesses with IRHPs typically pay for their loan separately
from the IRHP. The IRHPs can then provide interest rate protection
to a business by creating a separate set of payments to and from
the business that offset the variability of the interest rate
paid on the underlying loan. IRHPs are regulated by the FCA as
Contracts for Difference. These products are sometimes referred
to as "swaps".
Loans with embedded interest rate hedging features
are individual loan products that contain
interest rate hedging features embedded within the contact of
the loan itself. When paying off the loan, the business typically
makes only a single payment that accounts for both loan interest
and interest rate protection. These loans are also referred to
as "loans with embedded swaps" and "loans with
embedded IRHPs". Clydesdale sold such loans under its Tailored
Business Loan (TBL) brand. Such loans are not regulated by
the FCA as they are classified as commercial lending.
Both methods of interest rate hedging can come in
a variety of types, with each type offering different types of
interest rate protection. There are three key types of protection
available: caps, swaps and collars. Standalone IRHPs and loans
with embedded IRHPs can both contain cap, swap or collar features.
Each type can perform the same economic function whether they
are sold as standalone IRHPs or as an embedded interest rate hedging
feature within a loan.
Caps can set a maximum
interest rate to be paid by the business for the underlying loan,
but do not set a floor. This means that, over time, the interest
paid on the underlying loan cannot exceed a certain amount, but
is allowed to fall freely when interest rates fall.
Collars can set both maximum
and minimum interest rates to be paid by the business for the
underlying loan. This means that, over time, the interest paid
on the underlying loan can both rise and fall, but only to a pre-determined
maximum or minimum level. Collars can vary in complexity, with
structured collars offering more complex interest rate
ceilings and floors.
Swaps can be used to
fix the interest rate to be paid by the business for the underlying
loan—over time, the interest paid for the underlying loan
can vary, but the total amount paid by the business remains unchanged.
The term 'swap' is also frequently used to describe an interest
rate hedging product. Used in this context, the term does not
exclusively refer to fixed rate products.
FCA Interest Rate Hedging Product
review
83. Stand-alone interest rate hedging products (IRHPs)
are sold by banks to help businesses to manage the interest rate
they pay on loans. In June 2012 the Financial Services Authority
(FSA) announced that it had found "serious failings in the
sale of IRHPs to some small and medium sized businesses".[131]
The FSA identified a range of poor sales practices including:
· 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.[132]
84. On 29 June and 23 July 2012, the FSA announced
that a number of UK banks had entered into voluntary agreements
to conduct a redress exercise in relation to their sales of IRHPs.
This review covers only stand-alone IRHPs. Initially, a pilot
study of "a small sample of the typically more complex cases"
was undertaken. The FSA said that "the pilot was vital to
ensuring that each bank's approach to reviewing their sales would
deliver fair and reasonable outcomes for customers".[133]
85. The full review of IRHPs started in May 2013
and involved a total of nine banks: Allied Irish Bank (UK), Bank
of Ireland, Barclays, Clydesdale & Yorkshire Banks, Co-operative
Bank, HSBC, Lloyds Banking Group, Royal Bank of Scotland and Santander
UK. The FCA has recently said that "all nine banks have now
completed their sales reviews and have delivered redress letters
to all but a handful of these customers":[134]
· The review population covered 29,568 sales
of IRHPs.
· As at 31 December 2014, 19,185 customers
were found eligible for review, 10,372 customers were classified
as "sophisticated" and subsequently excluded from the
review, and 10 sophistication assessments remained in progress.
· Of the 19,185 customers eligible for review.
14,119 had been given redress offers. Of the remainder, around
2,000 had opted out, around 1,500 had been assessed as requiring
no redress, and around 100 assessments remained in progress.
· 11,200 redress offers by banks had been
accepted, paying out a total of £1.79 billion.[135]
86. The definition of a sophisticated customer was
deemed to be those with an aggregate annual turnover of "over
£6.5 million net (or £7.8 million gross)", along
with either an aggregate balance sheet total of "more than
£3.26 million net (or £3.9 million gross)", or
more than 50 employees. Customers were also deemed to be sophisticated
if the aggregate notional value of "all live (i.e. not matured)
IRHPs" held by the customer immediately after the IRHP sale
exceeded £10 million. This was a definition agreed between
the FCA and the banks that is not based on the legal definition
of sophistication.
OPERATION OF THE SCHEME
87. The IRHP review is being conducted by the nine
banks involved. The FCA states that the core tenet of the review
is to pay "fair and reasonable redress to customers where
appropriate" and that "fair and reasonable redress requires
that the customer be put back into the position they would have
been in if there had not been such a breach of the Regulatory
Requirements".[136]
In a case where mis-selling is identified, three outcomes for
redress are possible:
· Full redress—where the product is
refunded in full;
· Alternative product redress—where
an alternative product to the purchased IRHP is offered as part
of a firm's redress package. The cash redress paid to the customer
is the notional full redress sum, minus the notional cost to the
customer of the alternative product; or
· No redress.[137]
88. The FSA has noted that banks had been concerned
that the principles of the review were "too high level and
hence open to interpretation". In response, the FSA said
that "general guidance will not assist banks when carrying
out this review, because a case by case assessment is necessary".
It also said that the redress process requires "an objective
assessment of the facts to determine whether, in [each] customer's
circumstances, the firm has complied with the Regulatory Requirements
[…], and in particular, whether the Customer was provided
with sufficient information to enable the Customer to understand
the features and risks of the product".[138]
89. The redress scheme itself has been conducted
on a voluntary basis between banks and the FCA. Discussing the
rationale for the voluntary nature of the scheme, John Griffiths-Jones,
Chairman of the FCA, said:
I think that if we, as a regulator, are to do
mass redress schemes, of which this is classically one, we have
two ways of doing it. Either we go through the law courts, which
takes a very great length of time and costs a very great deal
of money, or, as a proactive regulator, we go out on the front
foot and say, "This is how we are going to do it", and
the necessary part of "this is how we are going to do it"
is coming to an arrangement with the banks that is "voluntary",
or at least contractually voluntary, to do it that way. If they
refuse, we end up in the law court and we get into a PPI-type
situation.[139]
Discussing the benefits of a voluntary scheme, the
Mr Griffiths-Jones said:
[…] on the back of the knowledge of the
PPI unsatisfactory outcome, Martin [Wheatley] and his team took
the proactive decision to do it on an arranged basis. The upside
to that was that people would get their money quicker and it would
be much cheaper for the consumers who we were trying to protect.
The downside would be that it was potentially subject to legal
challenge thereafter, which would unravel the scheme because we
are subject to judicial review, and we could be unravelled.[140]
90. Oversight of the process is primarily through
an 'independent reviewer'. The FCA said:
The independent reviewer will review all aspects
of the proactive redress exercise and past business review. This
will include the methodology and review of each individual case.[141]
Independent reviewers are professional services firms
hired by banks as 'skilled persons' under section 166 of the Financial
Services and Markets Act. Independent reviewers are approved by
the FCA with the aim of ensuring that they have "appropriate
skills, knowledge and expertise to scrutinise the bank's review
and that there are no conflicts of interest".[142]
91. The FCA's IRHP redress process is guided by
the principle that "redress must be fair and reasonable",
and that "redress should aim to put customers back in the
position they would have been in had the breach of regulatory
requirements not occurred." This is a statement of principles,
and is open to interpretation by banks conducting the review.
The outcome in each customer's review therefore relies primarily
on the judgement of the bank, on a case by case basis, subject
to approval from an independent reviewer. In
addition different banks came to different conclusions with inconsistency
between different independent reviewers.
92. The arbitrary
sophistication test may have been necessary to obtain agreement
to a voluntary scheme from banks, but it is clear that not all
non-sophisticated customers have been included in the review.
ALTERNATIVE PRODUCT REDRESS
93. The FCA sets out the circumstances in which alternative
redress should be offered by the Bank to the SME as follows:
If it is reasonable to conclude that, had the
sale complied with the regulatory requirements, the customer would
have purchased a different IRHP, fair and reasonable redress will
be the alternative product and the refund of any difference in
payments between the alternative product and the product actually
purchased, including, where appropriate, the difference in any
break costs previously paid.[143]
The FCA states that, in cases where fair and reasonable
redress is an alternative product, two principles will apply to
the alternative redress offered:
The alternative product will be simple—this
is because we believe that, if the original sale had complied
with our regulatory requirements, customers would only have purchased
simple products (e.g. a cap, vanilla swap or vanilla collar).
The alternative product would not have had potential
break costs in excess of 7.5%, in a pessimistic but plausible
scenario, of the amount hedged at the point of sale—this
is because we believe that, if the original sale had complied
with our regulatory requirements, customers would have not entered
into a product with potentially sizeable break costs.[144]
According to FCA published statistics to December
2013, just over 40 per cent of cases where redress has been due
have involved alternative products.[145]
94. Alternative product redress means a business
is given a different IRHP as part of its redress, and therefore
less cash than would have been the case with a full tear-up. The
more expensive such an alternative product is deemed to be, the
less cash redress will be offered.[146]
Some customers have been dissatisfied by such offers, and have
challenged their validity as redress.[147]
Fox Williams said:
On occasion an entirely different product has
been proposed as an Alternative IRHP, such as an interest rate
cap. […] it is unclear on what basis a Participating Bank
can assume that an interest rate cap would have been purchased
by a customer in circumstances where it is clear that no such
product other than the transacted IRHP was ever discussed with
the customer.[148]
AHV Associates, a corporate finance advisory firm,
said that "often, there is no evidence that the company would
have bought such a cap since such a product was not discussed
or it could not have afforded the premium."[149]
Martin Berkeley of Vedanta Hedging, a derivatives consultancy,
said "the replacements are quite expensively priced and are
often not particularly suitable or perhaps what a client would
have chosen".[150]
95. Particular concern has been expressed regarding
long dated caps offered as alternative products, and whether customers
would have bought them. Guto Bebb MP, chair of the All Party Parliamentary
Group on Interest Rate Mis-Selling, said that "experts in
the field of derivatives and interest rate protection tell me
that there is no demand in the marketplace for a 10-year cap".[151]
However, he said banks offered such products as alternative redress:
Yet, time and again when businesses are offered
a cap as an alternative product, the cap is for 10 years. It will
not surprise hon. Members to learn that a 10-year cap is significantly
more expensive than a five-year one.[152]
When asked by the Committee whether "it is typical
for a 15-year loan to be covered by a 15-year cap", Mr Wheatley
said:
Yes, I have looked at it. In these products it
is not in itself unusual for the protection to be the same period
as the loan.[153]
96. Alternative product redress is determined
by the bank and the independent reviewer, who retrospectively
determine what a business would have bought had a sale been compliant.
This is a matter of judgement, and one not necessarily easily
made, by the bank and the independent reviewer.
Criticisms of the FCA IRHP review
DRAFTING OF THE VOLUNTARY AGREEMENTS
97. In addition to the agreements between the FSA
and banks disclosed by the FCA, the Committee has seen an earlier
draft of the letter from Mr Adamson to banks dated 17 January
2013.[154] This draft
letter contains some material differences to the final version
of the letter sent on the 29 January 2013. Some of the important
differences are:
· The first letter does not contain the
£10 million cap on the customer's aggregate nominal IRHP
hedge value that the review applies;[155]
· There are 17 instances where reference
to involvement of the skilled person in the decision making process
of the review was removed from the document. With reference to
the second letter, the relevant paragraphs are 6, 17, 20, 22 (ii),
24, 26, 30, 36, 38, 39, 40, 41, 43, 44, 46, 47, 49, 50, and 51.[156]
· The decision not to proceed with a special
Financial Ombudsman Service scheme for the IRHP review is mentioned
in the second letter but not the first;[157]
· A requirement for banks to "presume"
that certain facts are correct or that the customer would have
behaved in a certain way, in the absence of evidence to the contrary,
is included in the final letter.[158]
· The test applied to check whether a sale
was compliant was altered from the first letter to the second.
Specifically, the test was changed from whether the customer "understood
the features and risks of the product",[159]
to whether the customer "was provided with sufficient information
to enable the Customer to understand the features and risks of
the product".[160]
98. The Committee raised some of these differences
with the FCA in oral evidence on 10 February 2015. Martin Wheatley,
CEO of the FCA, acknowledged that the £10 million cap on
the aggregate notional hedge value of an IRHP added to the final
letter "took out about a third of the total of the products
that were sold".[161]
He also acknowledged that the value of the products removed by
this cap would be higher than a third, as the removed caps were
"typically the larger customers".[162]
On the removal of references to the independent reviewer between
drafts, Mr Wheatley subsequently wrote:
[…] the Committee raised concerns that the
role of the independent reviewers had in some way been 'watered
down' when it came to assessing the legitimacy of the banks' conditions
of lending. Please be assured that on this point, the final drafting
of the IRHP agreement clarified the fact that the parties to the
agreement were the FCA and the banks but did not change the requirement
of the independent reviewers to look at every case and assess
whether the revised methodology was applied appropriately by the
banks, including on the condition of lending. The independent
reviewers specifically report to us on this particular point.[163]
99. The FCA has acknowledged that the introduction
of a £10 million cap on the size of an IRHP has excluded
approximately one third of the largest IRHP review participants.
The FCA should write to the Committee to explain its decision-making
on this cap. This explanation must state whether, in its view,
it represented a concession to bank lobbying, and if not, why
not.
POSSIBLE CONFLICTS OF INTEREST
100. Fox Williams, a law firm, submitted evidence
raising potential conflicts of interest in the independent reviewers
hired by each bank:
We are […] aware of a case where an Independent
Reviewer for a Participating Bank was implicated in mis-selling
IRHPs whilst employed at another bank. This clearly in breach
of the role of the reviewer envisaged by the FSA.[164]
In response, the FCA said that banks had been asked
to identify potential conflicts of interest, including the "nature
and value of previous work undertaken by the independent reviewer"
and their possible "involvement in the design of the products
and sales processes being reviewed". The FCA said that "to
the best of our knowledge there are no former bank employees who
were involved in the sale of IRHPs within the independent review
teams".[165]
101. Fox Williams also said that that conflicts of
interest could arise in bank's own internal review teams:
We have found evidence that the Participating
Banks are employing individuals as case reviewers who themselves
have been implicated in mis-selling IRHPs either at the same bank
or during their previous employment at another bank.[166]
The FCA said that "some staff who were connected
to the sale of IRHPs may be involved in some basic processing
roles on the banks' IRHP review teams". However, the FCA
said that "they are unable to influence customer outcomes".[167]
The FCA also said:
We understand concerns about bank employees who
were involved in the sale of IRHPs having even a limited role
in the banks' review teams—however, more than 3,000 people
have been involved in the banks' IRHP reviews and it would be
impractical for us to try and remove every one.[168]
COMPLAINANT ACCESS TO THE INDEPENDENT
REVIEWER
102. When asked by the Committee whether the FCA
would expect independent reviewers to be "contacting the
firms in order to obtain the firms' views", Mr Wheatley told
the Committee that he would "expect them to". However,
he said that the FCA would not check whether this was happening
on every case but "if we had complaints that they were not
doing that we would go back to the bank and the skilled person
to check on that".[169]
103. Evidence received by the Committee suggested
that in some cases independent reviewers had not been contacting
firms seeking their views and that firms had in some cases been
barred from contacting the independent reviewer altogether. Larry
Berkovitz, on behalf of a business participating in the IRHP review,
said:
We have not heard from nor been allowed or given
any access to the independent reviewer ("skilled person")
whatsoever; we do not even know who that person is; nor, crucially,
what that person has been shown.
We have been told by RBS that—
a) We are not able / entitled to have any contact
with the independent reviewer ("skilled person")
b) They will not be providing copies of any document
or transcript upon which they have relied in arriving at their
decision.[170]
Chris Mounsor, who owns a business participating
in the IRHP review, told us that "There has been no clarity
in the appeal process whatsoever and I have never had any direct
contact with the [independent reviewer]. I don't know his name
and I have never spoken to him (despite requesting to do so)".
He also said that "RBS have specifically denied me access
to the [independent reviewer]" and that "the only information
that our [independent reviewer] has had from us is 3rd hand and
sanctioned by RBS—despite our requests".[171]
COMPLAINANT ACCESS TO CASE INFORMATION
104. Banks are required by the FCA to explain the
rationale for redress on a case by case basis. The FCA said that
"for customers to make an informed decision as to whether
to accept a redress offer, banks are required to clearly explain
how they have reached their determination, including what facts
they have relied on".[172]
It also said:
Redress offer letters must at a minimum set out
the basis of banks' decisions. In addition to the letter, all
customers are also offered a face to face meeting. All letters
are reviewed by independent reviewers, and they also oversee the
meetings.[173]
Regarding the quality of disclosures by banks, the
FCA said that, overall, it believed "banks are explaining
their decisions to a reasonable and consistent standard."
However, it did acknowledge that "in a number of cases, the
explanations provided by the banks in redress meeting have been
judged to be insufficient by the independent reviewers. In these
cases, the banks have had to hold the meeting again or provide
a more comprehensive written explanation".[174]
105. Regarding disclosure of information about a
businesses' IRHP case, the FCA said that it expects "banks
to carefully consider customer requests for copies of documents
in line with their usual policies and legal obligations".[175]
However, the Committee has received complaints about the willingness
of banks to provide information used to form the basis of redress
determinations to complainants. Fox Williams said:
Participating banks have refused to engage in
dialogue as to the basis of the assumptions they have relied up
and to provide documentary evidence for the conclusions drawn.
In each case, we have been informed that the Participating Bank
is not required to do so in accordance with the rules agreed between
the bank and the FCA.[176]
Berg said that, for one case, Barclays was "not
prepared to disclose the internal documents upon which they relied
when determining their offer of redress".[177]
Bully banks said that "banks refuse to disclose key documentation
upon which the review decision and the redress decision are made".[178]
AHV Associates, a corporate finance advice firm, said that "certain
information about the IRHP transaction is often not made available,
e.g. telephone transcripts, e-mails, etc".[179]
AHV Associates also wrote that there appeared to be inconsistency
between banks regarding the provision of information:
[Bank B] in particular has not provided telephone
transcripts for customers incorporated as companies stating that
it is not in a position to provide copies of voice recording or
transcripts of any recorded call. However, other banks such as
HSBC have provided such voice recording and transcripts.[180]
Banks have, we are told, been unwilling to provide
information as to how the pricing of alternative products has
been arrived at. Seneca Banking Consultants, a claims management
firm, said that banks "fail to provide any indication as
to how they arrived at the cap rate (for example) or the value
of the premium being charged".[181]
AN APPEALS PROCESS?
106. The FCA states that the IRHP review scheme has
"an in-built appeal mechanism". This is described as
"a face to face meeting, during which they can […],
if appropriate, challenge the outcome. The banks and independent
reviewers will carefully consider any points raised by customers
and, if necessary, will review their decision".[182]
The FCA said that the circumstances where an appeal can be considered
were:
After hearing the bank's explanations, the customer
considers that the bank has clearly relied on erroneous information,
such that the bank's rationale is based on faulty evidence; or
The customer believes that the bank has clearly
missed an important piece of information, such that the bank's
explanation is based on incomplete evidence.[183]
Regarding the appeals process, the FCA also said:
It is important to understand that whilst we
expect banks to explain their decisions, we do not expect them
to present their evidence and debate their judgments in the same
way that perhaps you might expect in a courtroom—the review
does not replicate litigation. If customers wish to put all the
evidence and facts on the table and then let experts argue over
how to interpret it in an adversarial way, then the IRHP review
simply won't deliver this.[184]
Complainants are limited in what information they
are allowed to present during the appeals process. The FCA wrote
that certain "expert reports" and "written submissions"
are "unlikely to be viewed as new evidence and are therefore
unlikely to change the outcome".[185]
Banks' refusal to provide businesses with information about their
case may also limit a customer's ability to appeal. Berg wrote:
Barclays […] confirmed that they were not
prepared to disclose the internal documents upon which they relied
when determining their offer of redress and so Berg and Vogue
Jewels were unable to review the justification behind their decision.[186]
Berg also wrote:
Businesses do not have full information and documentation.
The Banks refuse to provide this. The Banks are seeking to limit
the number of challenges (or appeals) to one, with requests for
information and documents being treated as that 'one challenge'.
This means that businesses are having to appeal before they are
in a credible position to do so, due to this lack of information
and documentation and the Banks "have the upper hand ".
It is not a level playing field.[187]
107. The Committee has received one report of an
appeal meeting where the independent reviewer had no knowledge
at all of the customer's case. Mr Mounsor said:
At the appeal process in August with the bank
an IR from KPMG did attend—but at the outset of the meeting
this IR read out a statement that "he was not the IR who
oversaw my case, he had no knowledge of our case, that he was
an observer and that he would ask no questions nor answer any"—which
is what happened during a four hour meeting.[188]
108. Businesses who are eligible to take complaints
to the FOS can still do so if dissatisfied with the outcome of
their review.[189]
While considered by the regulator, a special FOS scheme for the
IRHP review was not created:
In our announcement in June 2012 we said we would
approach the FOS to ask if it would consider offering a specific
Scheme for dealing with the outcome of the review and related
matters. We have decided not to proceed with a FOS Scheme for
customers dissatisfied with the determination of their case. We
accept that a FOS Scheme will lengthen the review process. However,
this means it is extremely important that the Skilled Persons
are effective in their role, providing independent oversight and
ensuring that the banks follow the FSA's position and provide
fair outcomes for consumers.[190]
109. Mr Bebb has argued for a stronger appeals process
within the IRHP review. He said:
There would be much more confidence in that scheme
if there were an appeals process. […] It would give some
comfort without complicating issues too much if, for example,
assessors working for one bank in the redress scheme were able
to provide an appeals process for another bank in it. That may
not be perfect, but it would help to avoid over-complicating what
is already a complicated redress process and it would give businesses
the confidence that there is an appeal process and that they can
turn to somebody else to argue their case. We should be very concerned
about having a redress scheme without any appeal process, as it
goes against the principle of natural justice, while opening up
the door to litigation, when the whole point of the redress scheme
was supposed to be to avoid litigation.[191]
110. The FCA does not know how many redress determinations
have been altered as a result of the appeals process.[192]
THE SCALE OF THE PROBLEM
111. 29,568 IRHP sales were considered by the IRHP
review.[193] In total,
1,223 complaints have been received by the FCA about the redress
scheme, representing 602 unique correspondents. Of these, 116
unique correspondents have complained about their redress offer,
while 45 have complained about the conduct of their bank.[194]
112. The FCA has maintained that the IRHP review
has worked as it intended. Mr Wheatley said:
To say that there were complaints—there
absolutely have been complaints and some of the small businesses
have felt it was unfair or unbalanced against them. We have looked
into the process and we consider the process to have been reasonable
and fair.[195]
113. Members of the House of Commons have raised
a number of concerns about the IRHP review. Primarily, complaints
raised were regarding a lack of consistency in the application
of the scheme between banks,[196]
a lack of transparency about how the scheme was being run,[197]
a lack of appeals process,[198]
and the inappropriate nature of some alternative redress offered
to businesses.[199]
114. The FCA has consistently maintained that
the redress process has worked as intended. But there have been
complaints that the process of the IRHP review falls short of
delivering fair and reasonable redress. It has been difficult
for this Committee to determine, however, whether these complaints
are examples of isolated exceptions to an adequate process, or
are signs of a wider, systemic problem with the review.
115. This in
itself is indicative of a flaw in the process which the FCA should
address. In particular, the FCA should collect the information
necessary to establish whether there are systemic failures in
the review. The FCA should publish its findings, a summary of
the complaints it has examined, and take any action it decides
is appropriate to ensure that all customers receive fair and reasonable
redress.
TRANSPARENCY OF THE VOLUNTARY AGREEMENTS
116. The agreement between the FSA and banks itself
was not published at the time the IRHP review commenced. Following
a request from the Committee for copies of the agreements, the
FCA responded on 26 June 2014, stating that it was unable to disclose
the agreements without permission from the banks themselves. The
FCA stated that it had sought guidance from external legal counsel
that found that "a request from a select committee does not
of itself allow the FCA to disclose confidential information",[200]
and that:
The FSA has been able to provide materials protected
by section 348 to the select committee and the Parliamentary Commission
on Banking Standards when the relevant firms have consented to
disclosure of the information. This is not the position in this
case.
We have considered whether we could provide the
Committee with an anonymised version of the agreement. However,
given that the agreement reached with all the banks was almost
identical, this would still result in disclosing information which
is confidential under section 348.[201]
Section 348 of the Financial Services and Markets
Act states:
(1) Confidential information must not be disclosed
by a primary recipient, or by any person obtaining the information
directly or indirectly from a primary recipient, without the consent
of—
(a) the person from whom the primary recipient
obtained the information; and
(b) if different, the person to whom it relates.[202]
117. The Committee was not satisfied with the FCA's
response and raised the matter with the FCA publicly on three
separate occasions: 1 July 2014, 9 September 2014 and 10 February
2014.[203] On 12 February
2015, following its eventual disclosure to the Committee by the
FCA, a generic copy of the agreements between the FCA and banks
was published by the Committee.[204]
This was following the FCA obtaining permission for publication
from all banks participating in the IRHP review.
118. Section 348 of the Financial Services and
Markets Act 2000 (FSMA) prevents the FCA from disclosing confidential
information to third parties without the permission of the regulated
entity to which that information relates. The FCA cited this provision
as the reason for its reluctance to provide the Committee with
the agreement it had reached with banks about the IRHP review.
At no stage did the FCA suggest that the Committee's request was
unreasonable. The FCA did eventually provide the agreement, but
only after considerable delay. The FCA should come forward with
suggestions as to how such difficulties could be prevented in
future.
Tailored Business Loans
119. Over the course of the review of standalone
IRHPs, the FCA identified, as a potential problem, loans with
the features of interest rate hedging facilities written into
the contract.[205]
Martin Wheatley, Chief Executive of the FCA, wrote in a letter
to the Financial Secretary of the Treasury:
[…] the size of the issue is potentially
significant. Data collected from Barclays, HSBC, Lloyds, National
Australia Bank Group and RBS shows that more than 60,000 of fixed
rate loans with mark to market break costs have been sold since
2001, significantly more than the 40,000 standalone IRHP's covered
by our review.[206]
120. The campaign group Bully Banks identified at
least ten banks whose customers had complained to the Financial
Ombudsman Service about the sale of commercial loans with 'embedded'
interest rate hedging facilities.[207]
This Committee has received a large number of written submissions,
in particular from customers of Clydesdale Bank.
121. Clydesdale Bank plc, through both its own branches
and through those under its trading name Yorkshire Bank, sold
both standalone IRHPs and loans with embedded swaps. These loans
were sold under its 'Tailored Business Loan' (TBL) brand. Clydesdale's
target market for TBLs was "a very broad range of SMEs".[208]
Clydesdale wrote that it sold 11,271 loans across all of its Tailored
Business Loan variants between September 2002 and July 2012. This
included both fixed-rate products and more complex arrangements.
Between December 2001 and July 2012, the firm states that it provided
8,372 fixed-rate Tailored Business Loans to 6,153 customers.[209]
BREAK COSTS AND SIMILARITIES WITH
STANDALONE IRHPS
122. The hedging element of a TBL and a standalone
IHRP have very similar features and economic functions. David
Thorburn, Chief Executive of Clydesdale and Yorkshire banks, described
TBLs as having "many of the effects of a swap".[210]
The FCA said that TBLs "have a very similar economic impact
to an IRHP coupled with a variable rate loan".[211]
Mr Wheatley wrote to the Government:
A customer who has taken out a loan with an 'embedded'
IRHP may be faced with exactly the same repayment features and
exactly the same (potentially large) break cost that the customer
would have faced had the customers taken out a loan and a standalone
IRHP.[212]
123. Like standalone IHRPs, TBLs can incur break
costs when a customer exits the loan early. Debbie Crosbie, Executive
Director of National Australia Group Europe, Clydesdale Bank's
parent company, explained how mark to market TBL break costs were
calculated:
[…] we look at […] the difference between
the interest rate that is prevailing at the moment and when the
interest rate was set, and for the remaining period of time, the
customer is charged the difference effectively of those interest
rates.[213]
This break cost calculation process for a TBL appears
to be the same as for a standalone IRHP delivering the same hedging
function. Mr Thorburn said:
As long as it is for the same loan for the same
duration broken at the same point in time and entered into at
the same point in time [the break cost] should be the same.[214]
124. Break costs on TBLs can be substantial. The
costs reported to the Committee that customers have experienced
have been as high as 40 per cent of the principal value of the
original loan.[215]
For example, Michael Neeld, who purchased a TBL, said that he
faced a break cost of "up to £200,000" on a loan
of £1,000,000 of which £600,000 was fixed for 22 years.[216]
Lawrence Beere, who also purchased a TBL, said that he faced a
"breakage cost in excess of £1.1 million" on a
£3.9 million facility.[217]
125. TBL break costs therefore appear to be significantly
higher than the "1 per cent to 3 per cent of the capital
loan" that Mr Thorburn estimated the standard break cost
of a residential mortgage to be.[218]
Part of the reason for these higher break costs may be the long
duration of interest rate fix in many TBLs. Mr Thorburn said:
Although someone may have a 25-year mortgage,
they would tend to fix the term for two, three, maybe five years
maximum, whereas some of these business loans were fixed for up
to 20 years, so you have a huge difference in the break costs
because of the different term of them. The other one is that the
standard practice in this country is to have a cap on mortgages
for domestic customers and, therefore, there is a limit beyond
which the customer's break costs cannot go. For a business mortgage,
that was not the case.[219]
126. To protect themselves against the risk of providing
a TBL's hedging function, banks need to hedge the risk themselves.
The FCA said that "the bank will have entered into a separate
IRHP with a third party in order to manage its financial risk
of entering into the loan".[220]
Mr Thorburn confirmed that this was the case for Clydesdale Bank.[221]
Break costs therefore partially reflect the cost to the bank of
their own underlying hedge.
DISCLOSURE
127. A number of Clydesdale's customers wrote to
the Committee stating they did not and could not fully understand
certain features of the product they were sold, in particular
break costs.[222] Anthony
Maher wrote that "at the point of sale of the loan we were
never given any information about break costs and were certainly
not warned of the possible magnitude of the break costs".[223]
Gael Properties wrote that they "would definitely not have
taken on" a TBL had they been given "a clear indication
of the likely break cost", which did not happen "due
to the lack of documentation provided and explanations given".[224]
Laurence Beere, the owner of a small business who had purchased
a TBL, said:
[…] the information that we were given was
sorely lacking and I can sum that up simply by saying if in the
process of completing our loan they had turned around and said
to me, "Do you understand that on day one, you will have
a breakage cost in excess of £1 million relative to this
£3.9 million loan?" do you honestly think that I would
have said, "That is perfectly acceptable"? For the bank
to say, "Well, we told you there were breakage costs, so
you should have understood" that is to me where trust breaks
down. The bank understood what it was selling and it relied upon
the fact that I did not.[225]
128. In particular, it appears that the size of potential
break costs was often not set out in detail in the terms and conditions
of the loan document. For example, Mr Neeld said that his product
literature said that break costs "could be substantial"
and that this explanation of risks "is wholly inadequate
and provides no quantum of potential cost or the cost relative
to the value of the loan".[226]
Clydesdale said that some break cost information was provided
in the form of a flyer.[227]
However, this information was not contained within the offer letter
itself, and was provided late in the sales process.[228]
Patrick Walton, a former Managing Partner of Clydesdale's Financial
Solutions Centre in Leeds, said:
My review of customer files found no clear evidence
that any bespoke TBL presentation was made to customers to explain
the complexity of the TBL product. Features, risks and benefits
explanation were simply conveyed by the general statement that
the product would be "marked to market" if terminated
early. The treasury experts may have sought to explain this at
the meeting, however, I suspect that given the nature of the [Clydesdale
and Yorkshire Bank] customer base they would not have appreciated
the full ramifications of the contract into which they were entering.[229]
He also said that Clydesdale's "documentation
was inferior to that used at other banks to explain the products
held by the customer".[230]
Furthermore, Mr Walton said that without "detailed explanation"
it would be "unusual that SME customers would consider this
key risk".[231]
Tim Murphy of Seneca Banking Consultants told the Committee:
On the TBLs, I think, with a standalone bank
facility letter, it is difficult for a non-financially-aware person
to understand all the nuances of that facility letter and it is
skewed towards the bank. It is in the bank's favour.[232]
129. Some customers believed that break costs would
be comparable to regulated residential mortgages. The proprietors
of the Muker Village Store wrote to the Committee saying that
their "understanding was that we were taking out a Fixed
Rate Loan much like the Fixed Rate Mortgages we had had in the
past".[233] Similarly,
NAB Customer Support Group told the Committee:
Most affected customers perceived that any break
cost would be in the region of between 1% or 2% of the amount
of the loan, consistent with those of domestic mortgages.[234]
130. When asked whether it was possible that customers
of Clydesdale could have misunderstood the break costs of a TBL
by thinking they were similar to a residential mortgage, Mr Thorburn
said it was "possible" because "customers do not
always read what you give them".[235]
However, when asked by the Committee whether "the terms and
conditions letter […] issued with the loans […] would
not pass a plain English test", Mr Thorburn replied "yes".[236]
He said:
I think the standard terms and conditions were
unfortunately the usual bank terms and conditions, which customers
do not find very easy to understand. There were other documents
that were used in this process, such as the flyer that accompanied
the facility letter, which I think is pretty plain English. The
terms and conditions themselves, no, they were not. That is one
of the things we have learned, that that kind of language is unhelpful
to customers.[237]
131. Discussing whether the level of break costs
could have been anticipated by customers, Mr Thorburn conceded
that he did "not think that customers could reasonably have
anticipated" the high level of break costs.[238]
He agreed that many SME customers have very limited financial
sophistication,[239]
and that "with the benefit of hindsight it was clear we were
selling [TBLs] to customers who did not always understand what
they were getting into in a falling interest rate environment.[240]
He acknowledged that "there is always that issue that the
bank has a lot more information and sophistication compared with
the customer", that the sales process "should be designed
to close that gap and help the customer understand what they are
getting into", and said that Clydesdale operated with "an
honest endeavour to do just that".[241]
132. Mr Thorburn also admitted that the bank itself
did not anticipate the high level of break costs:
[…] we did not foresee potentially the scale
of break costs […] in a situation where interest rates fell
sharply from a relative high to a historic low and stayed there
for a long period of time. That exaggerates the break costs required
for customers caught at that moment in time.[242]
He also said:
The shortcoming on that product was when we illustrated
the break costs we did not foresee the interest rate circumstances
that took place between 2008, 2009 and today. I think the product
actually works but we didn't see that scenario playing out.[243]
SALES PRACTICES
133. Some of Clydesdale's customers reported the
use of pressure sales tactics by the bank in selling TBLs. Andrew
Dykes of Crusoe Hotel wrote that, prior to the sale of their TBL,
Clydesdale "bombarded us with phone calls".[244]
GW & M Singleton & Sons said that, following their relationship
manager's move to Clydesdale, they "put pressure" on
the business to transfer their loans to Clydesdale.[245]
Ballantyne Property Services described being "exposed to
extreme pressure to the point of bullying and intimidation"
in 2008 when Clydesdale attempted to increase the interest rate
of their TBL agreed just over a year before.[246]
134. Patrick Walton, a former Managing Partner of
Clydesdale's 'Financial Solutions Centre' in Leeds, wrote negatively
about Clydesdale's sales process. Mr Walton said that "there
was immense pressure to sell TBLs." He said that the bank
had a culture in which there was a "pressure to sell at all
costs that was driven from the top of the organisation."
Staff who did not meet targets faced "disciplinary action".
Mr Walton described Clydesdale's culture "to be the most
corrosive and threatening [he had] ever encountered".[247]
135. Mr Thorburn admitted that Clydesdale was undergoing
rapid growth pre-crisis and that, sometimes, "staff overstepped
the mark".[248]
He told the Committee:
There was a lot of organisational focus on doing
more business with existing customers, attracting new customers
[…]. It was an environment of growth and in the tailored
business-loan product we felt that we had something that, because
of its relative simplicity, was a bit different from some of the
other banks. Therefore we put quite a lot of emphasis on introducing
this service to customers. It should not have gone beyond that
to anything associated with a pressurised sales environment. Sometimes
staff overstepped the mark and when we find evidence of that,
we will fix it for the customer. That is kind of a long answer
but I just want to be open with you. It was a time of growth and
we did focus on the product but it should never have crossed the
line into being a pressurised sale from a customer perspective.[249]
136. However, Clydesdale also defended its practices.
Mr Thorburn told the Committee that the bank's treasury representatives
involved in the transaction "were regulated" and "trained
to sell" TBLs.[250]
However, the FCA challenged the relevance of this statement. Chris
Woolard, Director of Policy, Risk and Research at the FCA, said
that while these individuals were "financial advisers who
were regulated", this was only for "the sale of products
that were within our regulatory boundary."[251]
According to Mr Woolard:
What you can't do is simply say here is someone
who is qualified to sell regulated products and they are going
to take what is effectively an unregulated product and somehow
they are regulated while they are selling that. There is a bit
of a misnomer in terms of what was said on the record there.[252]
137. These are not the first allegations of poor
incentives and sales cultures to be made against the banking sector.
As the Parliamentary Commission on Banking Standards concluded,
poorly designed incentive schemes and cultures within banks have
distorted behaviour and encouraged mis-selling and poor conduct:
Though they have been much less generous than
in investment banking, poorly constructed incentive schemes in
retail banking have also hugely distorted behaviour. They are
likely to have encouraged mis-selling and misconduct. Senior management
set incentive schemes for front-line staff which provided high
rewards for selling products and left staff who did not sell facing
pressure, performance management and the risk of dismissal. It
shows a disregard for their customers and front-line staff that
some senior executives were not even aware of the strong incentives
for mis-selling caused by their own bank's schemes. These remuneration
practices are ultimately not in the interests of banks themselves,
still less of the customers they serve.[253]
Regulation of TBLs
138. The Financial Conduct Authority's (FCA) remit,
or regulatory perimeter, is determined by the Financial Services
and Markets Act 2000 (Regulated Activities Order) 2001 (RAO).
In written evidence to the Committee, the FCA said that standalone
IRHPs were covered by the perimeter of regulation, but that TBLs
were not. They said:
Standalone IRHPs are contracts for differences
(CFDs) for the purposes
of Article 85 of the Regulated Activities Order. A
CFD includes rights under a contract the
purpose of which is to secure a profit or avoid a loss by reference
to fluctuations in, for example, interest rates. Where interest
rate contracts are purchased separately to a variable rate loan
which the client
wishes to hedge, they are a form of CFD.
In contrast, [Tailored
Business Loans] are not CFDs because the purpose of the loan is
not to secure a profit or avoid a loss by reference to fluctuations
in interest rates. Rather, the purpose of the loan from the customer's
perspective is to borrow money on the specified terms in the loan,
for example, relating to the interest rate payable on the loan.[254]
The Committee sought a legal opinion from its specialist
advisor, Jonathan Fisher QC, who agreed with the FCA on this matter.[255]
Commercial loans are not listed as a regulated activity in the
Regulated Activities Order 2001.[256]
As a result of this, the FCA has extremely limited powers to investigate
or bring enforcement action in respect of the sale of loans with
embedded interest rate hedging features. The existing FCA IRHP
review does not extend to TBLs or other loans with embedded interest
rate hedging features.[257]
139. However, as discussed previously, the hedging
features of TBLs are extremely similar, if not identical, to those
of standalone IRHPs. Mr Woolard summarised the contrast between
the legal treatment of TBLs and their economic impact on customers:
[…] in many ways you could say they walk
like a duck and quack like a duck but, legally, they are a very
different product.[258]
140. Indeed, Clydesdale told the Committee that avoiding
regulation was one of the reasons they created TBLs. In particular,
Clydesdale wished to avoid the complex documentation that the
sale of regulated products required. In explaining the design
of TBLs, Mr Thorburn said:
The difference was simplicity essentially. A
standalone interest rate hedging product will have a separate
ISDA agreement quite separate to the loan. The documentation associated
with it is really complex and really extensive. A tailored business
loan provides potentially a similar outcome to an interest rate
hedging product but without the complexity so the documentation
is much, much simpler. It was modelled on a domestic mortgage
product to try to make it more understandable. In a nutshell that
is the difference between the two.[259]
Mr Thorburn also said:
[…] because the standalone [IRHP] is a regulated
product you are required to go through a certain process, uses
the documentation, which is very complex. That was something we
did not need to put our smaller business customers through. If
they wanted a loan that was fixed for a period of time we didn't
need to put them through all that.[260]
141. The Committee explored the issue of the regulatory
perimeter on multiple occasions, particularly in relation to commercial
loans with 'embedded' interest rate hedging products, such as
Tailored Business Loans. The FCA, when asked about problems illustrated
by the possible mis-sale of certain TBLs by Clydesdale Bank, said:
I think we are of the view that this is a product
that appears to be so close to one where we have had significant
regulatory questions it would be better if we had the ability
to regulate it.[261]
142. However, banks expressed concerns about the
consequences of a widening of the regulatory perimeter. Shawbrook
Bank told the Committee that they supported "proportionate"
regulation that created "good customer outcomes", but
that there was a risk that overzealous change "could inhibit
supply of credit for business lending".[262]
Similarly, Lloyds Banking Group said that the current perimeter
of regulation was sufficient. It told the Committee that "the
distinctive needs of SMEs" needed to be "considered
so that there are not unintended consequences from applying a
one-size fits all solution." It also believed that "increasing
prescriptive and standardised rules" could "limit the
flexibility and efficiency" of small business support.[263]
RBS questioned "whether extending the perimeter of regulation
to include commercial lending would help the supply of finance
to SMEs", as to do so would "increase the operating
costs of providers of SME lending, further depressing the weak
returns on such lending." It also warned that increased "costs
of compliance, which include a significant fixed cost element,
would also disproportionally affect smaller, challenger banks".[264]
143. Other witnesses told the Committee that banks
would not change without some form of intervention. Mr Tomlinson
told the Committee that "nothing" would "happen
by leaving the banks to do it themselves."[265]
Others were critical of the regulators' ability to create effective
change, but believed that a change in regulation could lead to
better outcomes for SMEs. Mr Roe, of the campaign group Bully
Banks, said cultural change within the regulator to become "much
more assertive" was required.[266]
Professor Mark Watson-Gandy, of Thirteen Old Square Chambers,
described the current regulatory framework as combining "the
two unattractive qualities of being leviathan in its volume and
at the same time strikingly patchy in the protection it affords."
However, he appreciated that "when it does work, it works
well."[267] Professor
Watson-Gandy called for the regulatory perimeter to "be expanded
to include more lending and selling of financial products to SMEs",
as businesses can misunderstand the regulatory protection afforded
to them.[268] Jonathan
Fisher QC said, "In so far as issues of consumer protection
are concerned, there is a lacuna in the law".[269]
144. Small businesses' understanding of financial
products and the current regulatory perimeter has been highlighted
as problematic, in that larger SMEs are not afforded the same
protections of smaller businesses. Frances Coulson, Head of Insolvency
and Litigation at Moon Beever Solicitors and former President
of R3, the insolvency trade body, thought that an "SME at
the smaller end of the SME market is slightly akin to a consumer"
in their understanding of financial transactions.[270]
This is corroborated by the CBI, who have found that SMEs "find
it difficult to access the skills necessary" to understand
financial transactions. According to the CBI, "25% of SMEs
have a formally qualified financial manager". As a result,
they state that "the resource and skills to do deals is often
not held internally" and that only 16% of SMEs "consult
external advisers before making finance decisions".[271]
145. The Government, however, believes the regulatory
perimeter should not be extended to business lending. The Economic
Secretary to the Treasury said:
There is this fundamental principle that business
lending itself is not regulated. It is provided normally by regulated
entities but business loans themselves have not traditionally
been regulated and I think according to the industry, there is
not an appetite for general business lending to come under regulation.[272]
146. The FCA has written twice to the Treasury to
raise concerns about the sale of loans with embedded interest
rate hedging features and the FCA's inability to address the problem
under the current perimeter of regulation.[273]
However, the Treasury appears not to have responded formally to
the FCA on the matter:
I am not aware—and this is just from memory—if
we replied to Martin's letter as such. Certainly, he would have
had frequent meetings with the then FST, so it would have been
discussed there in the context of TBL.[274]
In oral evidence, the Committee suggested to the
Economic Secretary to the Treasury that the Government's Small
Business, Enterprise and Employment Bill could be used to change
the FCA's perimeter of regulation.[275]
However, the Government has published no plans to alter the regulatory
perimeter to include loans with embedded interest rate hedging
features.
147. We have received evidence suggesting that
Clydesdale Bank mis-sold Tailored Business Loans. Clydesdale has
itself admitted that its terms and conditions letters would not
pass a plain English test, and that its TBL customers could not
reasonably have anticipated the high levels of potential break
costs to which they had exposed themselves. Many small businesses
indeed did not grasp their exposure to such high break costs,
nor could they reasonably have been expected to do so.
148. It appears that the bank did not explain
the potential scale of break costs in a low interest rate environment
because the bank itself had not taken into account this potential
risk. Banks, however, should be the experts in assessing the potential
risk of products they sell, and explain those risks to their customers.
The sale of TBLs has led to considerable consumer detriment. The
bank's failure adequately to assess the potential risk of its
product may explain the detriment that the bank has caused to
its customers, but does not excuse it.
149. From the point of view of the customer, the
services provided by the hedging element of a loan with an embedded
interest rate hedging facility—such as a Tailored Business
Loan—and a stand-alone IRHP are extremely similar, if not
identical. But stand-alone IRHPs are regulated, while loans with
embedded interest rate hedging facilities are not. It is a logically
inconsistent result of the perimeter of regulation that products
whose effects may be identical fall on both sides of the perimeter.
150. Clydesdale understood that TBLs were unregulated.
It created TBLs to avoid requirements imposed by the regulator
on the sale of a regulated product, IRHPs. It claims that this
was to simplify the associated documentation, and to make the
product easier for customers to understand. The use of TBLs has
left regulators powerless to enforce compensation for customers
to whom products were mis-sold, as they have done with IRHPs.
Clydesdale created a product that retained the risks and complexities
of the regulated product, but had none of the safeguards.
151. The Treasury should publish an assessment
of the feasibility, benefits and costs of adjusting the perimeter
of regulation to cover loans with features of interest rate hedging
products. This assessment will need to take into account the possibility
that other products may inadvertently be included in the perimeter
as a by-product, and the negative consequences that this could
entail.
CLYDESDALE'S REVIEW OF TBLS
152. Clydesdale has taken some action to address
allegations that it mis-sold TBLs. Mr Thorburn told the Committee
that in 2012, Clydesdale made adjustments to the TBL products
they sold due to "difficulties surrounding their sale",
noting that the type of product Clydesdale now sold was a "straightforward
fixed-rate loan."[276]
He said:
[…] we further simplified the products so
we still offer a fixed-rate business loan, a simpler fixed-rate
business loan, to our customers today but the more complex ones—the
category A and B products, as the FCA describes them—have
been off sale since this situation arose.[277]
153. As well as its FCA-mandated review of standalone
IRHPs, Clydesdale has also been voluntarily reviewing past sales
of some TBL products. However, not all TBL products are eligible
to be part of Clydesdale's voluntary review. TBLs where "the
interest rate was fixed for the period of the loan or any part
of it", are excluded.[278]
Mr Thorburn said:
What we excluded from it were variable-rate tailored
business loans and fixed-rate tailored business loans that do
not have the same characteristics as the more complex interest-rate
hedging products […].[279]
In written evidence, Clydesdale said that its voluntary
TBL review did not apply to 8,372 fixed rate loans—81 per
cent of its TBL portfolio.[280]
154. Clydesdale have justified the exclusion of fixed-rate
TBLs from their review of TBLs on the basis that they are not
equivalent in complexity to standalone fixed-rate IRHPs. Ms Crosbie
of Clydesdale Bank told the Committee:
The FCA standalone review detailed a set of products
and they refer to them as category A, B and C. We accepted that
a number of our tailored business loans had very similar characteristics,
in that they would also be categorised as A, B and C. Where we
found that to be the case we have opted all of those products
in […] Any products that have been excluded from that review
are fixed-rate products and we believe they are different, simpler
to understand because the customer gets a fixed payment for a
fixed period of time and that payment will never change as long
as the customer does not want to terminate the agreement early.[281]
155. Standalone interest rate hedging products which
exchange or "swap" two interest rate payments are used
to fix the interest rate that a customer pays.[282]
Such products are included in the in the FCA review as Category
B.[283] Fixed rate
TBLs also fix the interest rate that a customer pays. Functionally,
these two products are therefore very similar. Furthermore, the
Financial Ombudsman Service has been determining TBL cases in
a similar way to standalone IRHP cases. Tony Boorman, then Interim
Chief Executive and Chief Ombudsman of the Financial Ombudsman
Service, said:
The analysis that my ombudsmen have done suggests
that our outcomes for the tailored business loans will be very
similar to the analysis that we are undertaking in relation to
the swaps cases.[284]
156. Clydesdale states that its own review uses "the
same internal and external governance for the review of its in-scope
Tailored Business Loans, including the same Independent Reviewer
(Berwin Leighton Paisner), as it has used for the formal FCA review
of stand-alone IRHPs".[285]
However, aside from information submitted by Clydesdale to this
Committee in in June 2014, and Clydesdale's publication Information
relating to Clydesdale and Yorkshire Banks' Review of Interest
Rate Hedging Products (IRHPs), dated 9 April 2013,
publicly available information on the operation and progress of
Clydesdale's voluntary review remains limited.[286]
For example, Clydesdale has not published statistics on the progress
of its review.
157. Customers with Fixed Rate Loans—which
are all outside Clydesdale Bank's voluntary TBL review—can
complain to the bank directly through its normal complaints process.
Ms Crosbie told the Committee that Clydesdale had sold "just
over 8,300" fixed-rate TBLs and by June 2014 had "received
550 complaints about the sales process".[287]
158. Ms Crosbie told the Committee that offers following
reviews of past complaints are "informed by any adjudications
[Clydesdale] have had from FOS".[288]
She said that, of these complaints, Clydesdale project that somewhere
"in the order of 60%" of customers will receive "some
form of redress". The main reason for redress were problems
"around break cost".[289]
When comparing findings of the FCA review of sales of standalone
IRHPs to the sale of TBLs, Ms Crosbie said she did not see "the
lack of understanding through the sales process that was evident
in standalone review […] mirrored" in the sale of TBLs.[290]
159. In the absence of an FCA review of Tailored
Business Loan sales, Clydesdale has created its own review to
assess potential mis-selling of such products. It has employed
the same independent reviewer as for its FCA review of IRHPs.[291]
160. However, Clydesdale's review excluded fixed
rate products.[292]
This represents 80 per cent of all TBL sales.[293]
Customers with fixed rate products can complain to the bank through
its usual internal complaints process.[294]
Clydesdale told us that this exclusion was on the grounds that
there was no equivalent product within the FCA review.[295]
161. The lack of public oversight, minimal transparency
and limited coverage of the scheme mean that the Committee cannot
be confident that Clydesdale's separate internal review will deliver
outcomes equivalent to the FCA review upon which it is intended
to be based. If Clydesdale's aim is to build public trust in its
actions, it should address all three of these problems.
CHALLENGING BANKS THROUGH THE COURTS
162. SMEs which are not covered by the FOS can challenge
decisions by their banks through the courts. Bully Banks wrote:
"the regulation of the banks in a free market economy is
traditionally left to the courts and on many occasions the SME
is advised to look to the courts for a remedy if they have a complaint
which the bank refuses to recognize".[296]
163. However, many who wrote to the Committee complained
that the cost of taking a bank to court would often be prohibitive.
Bully Banks wrote:
The banks conduct litigation with a strategic
aim of increasing the costs of litigation as a deterrent to the
customer to take or pursue legal proceedings. The costs of proceedings
are huge. Just one current example will suffice to illustrate
the point: one of our members with an IRHP to the value of £3.5
million is litigating against a bank for what appears to be an
obvious mis-sale where the costs of both parties are currently
estimated to be of the order of £700K. This level of costs
is beyond the reach of the vast majority of SMEs […][297]
Minotaur, a claims management company, gave examples
to the Committee that "highlight the plight of directors/owners
who having appealed to the authorities available to them, realise
their only real option for redress is court action that they are
unable to finance".[298]
Leander Joseph Difford, a care home owner, wrote to the Committee
about his legal case against Clydesdale:
We had already paid out approximately £40,000
in legal fees. On the 29th January our lawyers asked for another
£10,000 to appear in court the next day. We could not afford
it and later that day we decided as a family that we could no
longer fight […][299]
164. Bully Banks also noted that the continuing relationship
between an SME and its bank made legal action difficult, saying
that "the practical reality is that, given the dependence
of the SME on its bank, it is an incredibly difficult decision
for an SME to decide to sue its bank.[300]
FINANCIAL OMBUDSMAN SERVICE
165. The Financial Ombudsman Service (FOS) currently
provides a dispute resolution service to consumers and some SME
businesses. The FOS describes itself as an "independent service
for settling complaints fairly, reasonably, quickly and informally".[301]
Customers who are dissatisfied with the outcome of a bank's internal
complaints procedure have the option to raise their case with
the FOS, which can re-assess the case on a "fair and reasonable
basis".[302] For
a complaining customer, access to the FOS is free. The FOS is
paid for by businesses through individual case fees, and an annual
levy.[303]
166. The FOS may be of benefit to both banks and
the customer. Walter Merricks, then Chief Ombudsman, said of the
benefits to banks in 2001: "for the industry it has obvious
side benefits: the financial contributions to the scheme are probably
less than the legal fees it would pay if cases went to court,
and there is probably a saving in management time." On the
benefits to consumers, he said: "the person who has a complaint
can approach the ombudsman, without fear of having to pay more,
or of forfeiting any legal rights—a real "no lose"
situation".[304]
The Treasury Committee said in 2004 that: "The Financial
Ombudsman Service currently commands wide support among the industry
and consumers as an inexpensive and speedy way of resolving disputes
and achieving redress where redress is due."[305]
More recently, the CBI said that "the FOS framework helps
the efficiency of the complaints process and avoids the need on
either side for lengthy and costly court battles".[306]
167. Existing FOS rules restrict the SME complaints
it can take up. As Mr Boorman explained:
I am limited to looking at small businesses,
the microenterprise definition, which obviously cuts out a lot
of the people that often are talked about.[307]
This microenterprise definition limits FOS coverage
to businesses with an annual turnover of less than €2 million
and fewer than ten employees. The FOS also has an award limit
of £150,000.[308]
Mr Boorman told the Committee the current limit did not give the
FOS "award powers that cover most of these swap and swap-related
cases." When referring to the lead decision on these cases
Mr Boorman explained that the redress offer cost the "bank
concerned about £3 million".[309]
He said that the bank "did not technically have to follow"
the ombudsman's decision.[310]
168. The Committee asked witnesses whether the remit
of the FOS should be expanded. Laurence Beere, who had purchased
a TBL, expressed the frustration some small businesses experience
when they fall outside the FOS remit.[311]
HSBC wrote that they were in favour of a consultation to consider
the extension of the FOS's remit to "include more SMEs".[312]
Tim Murphy, of Seneca Banking Consultants, said that he had "no
faith in [bank's] internal procedures".[313]
He suggested that a wider FOS remit, possibly delivered by a "FOS
Mark 2," which extended to businesses of around "£25
million turnover", would "hopefully keep banks' internal
procedures on their toes".[314]
Mr Roe of Bully Banks called for the enhanced "publication
by each bank" of "what is happening within its complaint
processes" and to ensure that the Ombudsman service had "appropriate
jurisdiction" to permit a greater number of SMEs to access
the FOS.[315]
169. The ACCA said in its written evidence that the
current remit of the FOS was not proportionate to the level of
financial sophistication of SME businesses:
Indicatively, businesses with more than £1.7m
in turnover cannot generally take cases to the Financial Ombudsman—even
though at least a third of these do not have financially trained
staff, another third don't have a written business plan, and one
in six do not produce regular management accounts. A £5m
turnover threshold would be much more sensible, ensuring that
most businesses above the threshold have appropriate financial
capabilities in place. But ideally, sophistication should be considered
in terms of the adequacy of businesses' resources and expertise
in relation to the complexity and significance of the financial
decisions they are required to make.[316]
170. Any expansion to the FOS remit would, according
to Mr Boorman, need to be met with an increase in the FOS's award
limit. Mr Boorman also challenged the capacity of the Ombudsman
to be a suitable substitute for litigation:
[…] from my perspective a business-to-business
dispute is one that is better resolved in court with court procedures
rather than through an ombudsman service that is invited by Parliament
to be informal and to make decisions on the basis of what is fair
and reasonable.[317]
Overall, Mr Boorman believed there was some "nervousness"
on the board of the FOS about extending its "powers of resolving
matters on a fair and reasonable basis, into very sizeable financial
disputes".[318]
171. The jurisdiction of the FOS is determined by
FCA rules.[319] In
response to a recommendation of the Parliamentary Commission on
Banking Standards (PCBS)[320]
the FCA committed to consult on an expansion of the FOS.[321]
172. Regulation has, in many cases, failed to
prevent mis-selling. Dispute resolution services—such as
the Financial Ombudsman Service (FOS)—can provide a means
of redress to bank customers when things go wrong. The existence
of the FOS has, overall, been positive for both banks and their
customers. It provides a means of independent, affordable and
effective dispute resolution through which to challenge a bank's
decision making.
173. There is
a risk that a wider remit and the greater complexity of SME cases
could greatly increase the workload of the FOS and overburden
it. This could be detrimental to existing users of the FOS. However,
it is clear that there is a group of small businesses which are
too large to be covered by the FOS but too small to be able to
afford to challenge their bank in court effectively. Such businesses
are often unable to challenge poor decision making by banks or
to seek redress when their banks treat them badly, even when their
case is valid. It is not acceptable that these businesses should
be denied adequate redress or that banks should, as it appears,
be permitted to game the system to avoid responsibility for their
actions.
- Bearing in mind the risk identified
above, the FCA consultation on the scope of the FOS, prompted
by the Parliamentary Commission on Banking Standards, should also
consider how this gap in coverage can be closed, and, as a matter
of urgency, report to Parliament their conclusions.
131 Financial Services Authority, FSA agrees settlement
with four banks over interest rate hedging products, 29 June 2012 Back
132
Financial Services Authority, FSA agrees settlement with four
banks over interest rate hedging products, 29 June 2012 Back
133
Financial Services Authority, Interest rate hedging products pilot
findings, March 2013, p 5-6 Back
134
FCA, Interest rate hedging products, 26 February 2015 Back
135
Progress of sales through stages of the review as at 31 December
2014, Financial Conduct Authority, 28 January 2015 Back
136
Letter from Clive Adamson to banks, 29 January 2013 Back
137
Financial Services Authority, Interest Rate Hedging Products Pilot
Findings, March 2013, p 14 Back
138
Letter from Clive Adamson to banks, 29 January 2013 Back
139
Oral evidence by John Griffiths-Jones to the Treasury Committee,
9 September 2014, q 168 Back
140
Oral evidence by John Griffiths-Jones to the Treasury Committee,
9 September 2014, q 168 Back
141
FCA, Interest rate hedging product review-FAQs, as at 24 February
2015 Back
142
Financial Services Authority, Interest Rate Hedging Products Pilot
Findings, March 2013, p 6 Back
143
Interest Rate Hedging Products Pilot Findings, FSA, March 2013,
p 14 Back
144
Interest Rate Hedging Products Pilot Findings, FSA, March 2013,
p 14 Back
145
Progress of sales through stages of the review as at 31 December
2014, Financial Conduct Authority, 28 January 2015 Back
146
Berg, Backbench business debate on Financial Conduct Authority
Redress Scheme House of Commons, Main Chamber-4 December 2014,
Case study evidence examples,3 December 2014; Warwick Risk Management,
Replacement Caps Valuation Report, 18 February 2015 Back
147
Berg, Backbench business debate on Financial Conduct Authority
Redress Scheme House of Commons, Main Chamber-4 December 2014,
Case study evidence examples," 3 December 2014 Back
148
SME0163 Back
149
SME0174 Back
150
Vendanta Hedging, Martin Berkeley interviewed by IB Times about
hidden problems of FCA IRHP Redress offers, 10 February 2014 Back
151
HC Deb, 4 December 2014, Col 481 Back
152
HC Deb, 4 December 2014, Col 480-481 Back
153
Oral evidence by Martin Wheatley to the Treasury Committee, 10
February 2015, q 8 Back
154
Letter from Clive Adamson to banks, 17 January 2013 Back
155
Letter from Clive Adamson to banks, 29 January 2013, p 5, Annex
1, para 9 (iv) Back
156
Letter from Clive Adamson to banks; 17 January 2013, 29 January
2013 Back
157
Letter from Clive Adamson to banks, 29 January 2013, p 5, para
9 (iv) Back
158
Letter from Clive Adamson to banks, 29 January 2013, Annex 3,
paras 11-13; 16, 22 (i), (ii), 52 Back
159
Letter from Clive Adamson to banks, 17 January 2013, Annex 2,
para 9 Back
160
Letter from Clive Adamson to banks, 29 January 2013, Annex 2,
para 2 Back
161
Oral evidence by Martin Wheatley to the Treasury Committee, 10
February 2015, q 20 Back
162
Oral evidence by Martin Wheatley to the Treasury Committee, 10
February 2015, q 22 Back
163
Letter from Martin Wheatley to Andrew Tyrie MP, 16 February 2015 Back
164
SME0163 Back
165
Letter from Martin Wheatley to Andrew Tyrie MP, 16 February 2015 Back
166
SME0163 Back
167
Letter from Martin Wheatley to Andrew Tyrie MP, 16 February 2015 Back
168
Letter from Martin Wheatley to Andrew Tyrie MP, 16 February 2015 Back
169
Oral evidence by Martin Wheatley to the Treasury Committee, 10
February 2015, q 17 Back
170
SME0173 Back
171
SME0169 Back
172
FCA, Interest rate hedging product review-FAQs, as at 24 February
2015 Back
173
Letter from Martin Wheatley to Andrew Tyrie MP, 16 February 2015 Back
174
Letter from Martin Wheatley to Andrew Tyrie MP, 16 February 2015 Back
175
SME0171 Back
176
SME0163 Back
177
Berg, Backbench business debate on Financial Conduct Authority
Redress Scheme House of Commons, Main Chamber - 4 December 2014,
Case study evidence examples, 3 December 2014 Back
178
Letter from Bully Banks to Vince Cable MP, 7 July 2014 Back
179
SME0174 Back
180
SME0174 Back
181
SME0148 Back
182
"Interest rate hedging product review-FAQs," FCA website,
as at 24 February 2015 Back
183
SME0172 Back
184
SME0172 Back
185
SME0172 Back
186
Berg, Backbench business debate on Financial Conduct Authority
Redress Scheme House of Commons, Main Chamber-4 December 2014,
Case study evidence examples," 3 December 2014 Back
187
Berg, Summary note of issues regarding the sale of interest rate
hedging products (IRHP), 3 December 2014 Back
188
SME0169 Back
189
Oral evidence from Martin Wheatley to the Treasury Committee,
10 February 2015, q 23 Back
190
Letter from Clive Adamson to banks, 29 January 2013 Back
191
HC Deb, 24 Oct 2013, Col 462 Back
192
Letter from Martin Wheatley to Andrew Tyrie MP, 16 February 2015 Back
193
Progress of sales through stages of the review as at 31 December
2014, Financial Conduct Authority, 28 January 2015 Back
194
Letter from Martin Wheatley to Andrew Tyrie MP, 16 February 2015 Back
195
Oral evidence from Martin Wheatley to the Treasury Committee,
10 February 2015, q 18 Back
196
HC Deb, 4 Dec 2014, Col 479-480 Back
197
HC Deb, 4 Dec 2014, Col 484 Back
198
HC Deb, 4 Dec 2014, Col 482-484 Back
199
HC Deb, 4 Dec 2014, Col 489, 492-493 Back
200
Letter from Sean Martin to Andrew Tyrie MP, 26 June 2014 Back
201
Letter from Sean Martin to Andrew Tyrie MP, 26 June 2014 Back
202
Financial Services and Markets Act 2000 Back
203
Qq 728-730; Oral evidence by John Griffiths-Jones to the Treasury
Committee, 9 September 2014, Qq 168-169; Oral Evidence by John
Griffiths-Jones to the Treasury Committee, 10 February 2015, Qq
2-6 Back
204
Letter from Clive Adamson to banks, 29 January 2013; FCA and banks,
Agreement relating to past sales of interest rate hedging products,
June 2012; FCA and banks, Supplemental agreement relating to past
sales of interest rate hedging products, January 2013 Back
205
Letter from Martin Wheatley to Rt Hon Greg Clark MP, 9 May 2013 Back
206
Letter from Martin Wheatley to Rt Hon Greg Clark MP, 9 May 2013 Back
207
SME0116 Back
208
Q 409 Back
209
SME0142 Back
210
Q 425 Back
211
SME0140 Back
212
Letter from Martin Wheatley to Rt Hon Greg Clark MP, 9 May 2013 Back
213
Q 431 Back
214
Q 437 Back
215
SME0083 Back
216
SME0099 Back
217
SME0023 Back
218
Q 452 Back
219
Q 451 Back
220
SME0140 Back
221
Q 402 Back
222
SME0010; SME0094; SME0070 Back
223
SME0069 Back
224
SME0042 Back
225
Q 205 Back
226
SME0099 Back
227
SME0165 Back
228
Q 411 Back
229
SME0155 Back
230
SME0155 Back
231
SME0155 Back
232
Q 233 Back
233
SME0022 Back
234
SME0128 Back
235
Q 455 Back
236
Q 450 Back
237
Q 449 Back
238
Q 432 Back
239
Q 410 Back
240
Q 396 Back
241
Q 463 Back
242
Q 440 Back
243
Q 465 Back
244
SME0087 Back
245
SME0066 Back
246
SME0037 Back
247
SME0155 Back
248
Q 416 Back
249
Q 416 Back
250
Q 412 Back
251
Q 703 Back
252
Q 703 Back
253
Parliamentary Commission on Banking Standards, Changing Banking
for Good, First Report of Session 2013-14, HC 175-II, June 2013,
p 131, para 119 Back
254
SME0140 Back
255
SME0162 Back
256
Regulated Activities Order 2001 Back
257
SME0162 Back
258
Q 678 Back
259
Q 392 Back
260
Q 486 Back
261
Q 701 Back
262
SME0123 Back
263
SME0118 Back
264
SME0093 Back
265
Oral evidence by Lawrence Tomlinson to the Treasury Committee,
29 January 2014, q 107 Back
266
Q 256 Back
267
SME0061 Back
268
SME0061 Back
269
SME0162 Back
270
Q 339 Back
271
SME0080 Back
272
Q 741 Back
273
Letter from Martin Wheatley to the Financial Secretary to the
Treasury, 9 May 2013; Letter from Martin Wheatley to the Financial
Secretary to the Treasury, 23 February 2013 Back
274
Q 769 Back
275
Qq 781-782 Back
276
Qq 396, 405 Back
277
Q 396 Back
278
Clydesdale Bank, Information relating to Clydesdale and Yorkshire
Banks' Review of Interest Rate Hedging Products (IRHPs), April
2013 Back
279
Q 458 Back
280
SME0142 Back
281
Q 472 Back
282
Financial Conduct Authority, Interest rate hedging product review - FAQs,
11 August 2014 Back
283
Financial Conduct Authority, Interest rate hedging product review - FAQs ,
11 August 2014 Back
284
Q 711 Back
285
SME0142 Back
286
Clydesdale Bank, Information relating to Clydesdale and Yorkshire
Banks' Review of Interest Rate Hedging Products (IRHPs), 9 April
2013 Back
287
Q 415 Back
288
Q 443 Back
289
Q 501 Back
290
Q 470 Back
291
Clydesdale Bank, Information relating to Clydesdale and Yorkshire
Banks' Review of Interest Rate Hedging Products (IRHPs), 9 April
2013 Back
292
Clydesdale Bank, Information relating to Clydesdale and Yorkshire
Banks' Review of Interest Rate Hedging Products (IRHPs), 9 April
2013 Back
293
SME0142 Back
294
Clydesdale Bank, Information relating to Clydesdale and Yorkshire
Banks' Review of Interest Rate Hedging Products (IRHPs), 9 April
2013 Back
295
Q 472 Back
296
SME0116 Back
297
SME0124 Back
298
SME0102 Back
299
SME0054 Back
300
SME0124 Back
301
Financial Ombudsman Service, Alternative dispute resolution for
consumers: implementing the alternative dispute resolution directive
and online dispute resolution regulation, 3 June 2014 Back
302
Financial Ombudsman Service, information for businesses covered
by the ombudsman service, 5 March 2015 Back
303
Financial Ombudsman Service, Funding and case fees, April 2014 Back
304
Speech by Walter Merricks, Chief Ombudsman of the Financial Ombudsman
Service, to the Chantrey Vellacott DFK Annual Reception, 6 June
2001 Back
305
Treasury Committee, Restoring confidence in long-term savings,
Eighth Report of Session 2003-04, HC 71-1, 19 July 2004, p 44,
para 86 Back
306
Confederation of British Industry, The Financial Conduct Authority:
Approach to Regulation, CBI response, September 2011 Back
307
Q 679 Back
308
Financial Ombudsman Service, "The Ombudsman and Smaller Businesses,"
1 June 2014 Back
309
Q 714 Back
310
Q 714 Back
311
Q 258 Back
312
SME0115 Back
313
Q 250 Back
314
Q 251 Back
315
Q 254 Back
316
SME0011 Back
317
Q 714 Back
318
Q 721 Back
319
FCA Handbook, Jurisdiction of the Financial Ombudsman Service
(DISP 2), 6 March 2015 Back
320
Parliamentary Commission on Banking Standards, Changing Banking
for Good, First Report of Session 2013-14, HC 175-II, 11 March
2014, p 278, para 523 Back
321
SME0140 Back
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