Conduct and competition in SME lending - Treasury Contents

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.


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.


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


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.


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]


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]


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]


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]


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.


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]


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.


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]


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.


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.


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]


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.

  1. 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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Prepared 13 March 2015