Seeking Redress for Mis-sold IRHPs
In June 2012 the then FSA (now FCA) announced a review into the sale of Interest Rate Hedging Products (IRHPs or Interest Rate Swaps). IRHPs are derivative products which are used either to fix, or to limit fluctuations in, interest rates. These were sold to small and medium-sized businesses as protection from rising interest rates when taking out loans.
What is the current position regarding the FCA review?
A preliminary review carried out by the then FSA found that 90% of interest-rate swaps may have been mis-sold. This issue is now the responsibility of the FCA, who have agreed with 11 UK banks, that these banks will review all IRHP sales made after 1 December 2001, and provide redress where appropriate. However, only customers considered ‘non-sophisticated’ will be included in the review. Banks have now started writing to eligible customers, asking them if they would like the sale of their product to be reviewed.
So what is the problem with IRHPs?
IRHPs were sold to customers as an insurance policy against rising interest rates. In many cases this was made a condition of the loan. However, customers ended up being locked into long term contracts, with exorbitant break costs, and were not able to benefit from the collapse in interest rates. This was because they had not been made fully aware of the risks attached to these hedging products if interest rates fell. Swaps were often sold for periods far exceeding the term of the original loan, or were the only hedging solution made available. In some cases highly complex structures were put in place that were not suitable for SME customers. Indeed, some of these products have been described as ‘toxic’ by the FCA.
My client has received a letter from their bank informing them they have been categorised as a non-sophisticated customer. What does that mean and what should I advise them to do?
Only customers categorised as ‘non-sophisticated’, as defined by the FCA, will be included in the review. The banks have now started sending letters to customers informing them whether they have been categorised as ‘sophisticated’ or ‘non-sophisticated’ and if they will be included in the review. Customers who receive a letter saying they have been included in the review, should opt-in by returning the form included with the letter. In addition if you can show that your client is in financial difficulty, their case will be prioritised and their payments to the swap may be suspended pending the outcome, so the sooner this can happen the better for your client.
What are the criteria for deciding whether a customer is considered ‘sophisticated’ or ‘non-sophisticated’?
The sophistication test involves a number of objective measures based on turnover, net assets and number of employees, as well as a subjective test whereby the bank judges whether the customer had the relevant knowledge and experience to make an informed decision on the product. If the notional value of swap products held by a customer immediately after the sale in question was more than £10 million, the customer is automatically considered ‘sophisticated’.
My client has received a letter from their bank informing them that they have been categorised as a sophisticated customer and are not eligible to take part in the review. Are there any other options?
It is worth checking the assumptions made by the bank against the FCA criteria and challenging if appropriate. Even if your client has been correctly categorised as a sophisticated customer they may still have a valid mis-selling case. For example, it has recently been reported that Lord Sugar may be the highest profile victim of mis-selling. He is complaining to Lloyds Bank after paying £10 million in break fees on a swap product that would be excluded from the review. It is vital to take advice, to evaluate other options such as pursuing a negotiated settlement with the bank.
My client’s bank have asked me to attend a fact-finding meeting – what format do these meetings take and how should I advise my client?
When your client has opted in to the review, they will be invited to have a face-to-face meeting or teleconference in order to gather the facts of the case. This meeting will be recorded and will typically be two to three hours long. There will usually be two people representing the bank, who could be bank employees, consultants or lawyers. In addition there may be an independent reviewer who will observe the meeting.
Following the meeting the bank will assess the case and if appropriate, agree suitable redress which must be approved by the independent reviewer.
The bank’s line of questioning may be designed to elicit information that could undermine your client’s case. It is well worth asking in advance for copies of all paperwork they hold on the case, in order to be prepared for any issues where your client’s account differs from theirs – another reason to ensure the meeting is not rushed into.
Given that the bank will follow a pre-prepared line of questioning, it could be challenging for your client to ensure their points are heard. It is also worth bearing in mind that they do not have to attend the meeting at all – they could opt to be represented by a written statement alone.
These meetings have been described to us by those who have experienced them as formal, even intimidating. It is vital that your client understands the importance of this meeting and is fully prepared.
The letter my client received said the review should be simple, so do they really need advice? They still have active lines of credit with their bank and they don’t want to damage the relationship.
The banks appear keen to stress that this is a simple process, and customers do not need specialist advice. This could appear disingenuous, given that the basis of the review is the sale of highly complex derivative products to non-sophisticated small businesses. The banks are going into these meetings fully represented. We believe customers should ensure they are represented by experts in the sale of derivatives, who are fully aware of the regulatory framework governing these sales, and can negotiate from an informed position without creating an adversarial situation between the customer and the bank.
If my client’s bank agrees to pay redress, will they get back everything they have paid for the swap product?
If the bank agrees to pay redress, this will not necessarily mean the full return of all payments made on the product. The FCA have agreed that the banks can introduce substitute products when calculating redress, particularly if hedging was a condition of the original loan. The bank can argue that the award should be limited to the difference in cost between the product sold to your client, and a notional product they might otherwise have bought. Expert advice from someone with market knowledge and an understanding of hedging products could ensure that your client receives the maximum appropriate redress.
Will consequential losses be taken into account?
Businesses may experience losses over and above the direct costs of the swap product. For example, the cost of any further borrowing to service the swap product, or lost business opportunities.
Until recently, the banks have been treating consequential loss as an integral part of any redress made in mis-sold swap cases, and they would not pay out until consequential losses had been agreed. Some reports claim that no customer actually received an award until August 2013, when Santander paid a claimant the direct costs of the mis-sold swap, with consequential loss to be agreed later.
What is the current position with the legal cases that have come before the courts?
Two high profile cases, Grant Estates vs RBS and Green & Rowley vs RBS, both lost. There have been successes but these have come through the review process and not through the courts. At Veritas Treasury, we believe that litigation is not the answer at this point in time. The review will not focus on the legalities of the contract but on the compliance of the sale, so access to expertise in banking compliance is essential when supporting a client through the review process.
How does the IRHP review affect companies in administration?
Administrators will receive an invitation to review letter for companies that are included in the review and can opt-in as normal. At this point the administrator then has to investigate the extent of mis-selling and present an appropriate case to the bank. At this point IPs may wish to take expert advice from derivatives specialists.
What is your current advice to CAs about IHRPs?
We are concerned that victims of mis-selling will not be properly represented and therefore not properly compensated. The fact finding meetings are very important. Preparation and representation are vital. Each case is different, and an understanding of the product, sales process and regulatory framework is key. Consequently we would suggest that CAs advise their clients to seek specialist advice.
- Scott Cowan Director 07768 902 675 Email me