Hedge Your Bets

Tuesday 3 July 2012

In a previous blog post I reported on how High Street banks had been mis-selling interest protection products to many small businesses. Following a two month review, the Financial Services Authority (FSA) has found that there have been “serious failings” at Barclays, HSBC, Royal Bank of Scotland and Lloyds in the way they have sold interest rate hedging products to small and medium size businesses.

“The FSA has found serious failings in the sale of interest rate hedging products to some SMEs” [small to medium-sized enterprises] it said in an official statement. “We believe that this has resulted in a severe impact on a large number of these businesses. In order to provide as swift a solution to this problem as possible we have today confirmed that we have reached agreement with Barclays, HSBC, Lloyds and RBS to provide appropriate redress when mis-selling has occurred”.

Interest rate swap agreements are contracts between a bank and its customers where typically one side pays a variable rate of interest and receives a fixed rate of interest payments in exchange.

They are used to “hedge” against extreme movements in market interest rates over a period of time and can protect customers against this risk. They can be an appropriate product when properly sold in the right circumstances.

These products range in complexity from comparatively simple “caps” that fix an upper limit to the interest rate on the loan through to more complex products known as “structured collars” which fix interest rates within a band but introduce a degree of interest rate speculation to the transaction. However, many customers that have seen the value of these products move against them as rates fell during the recession, now owe their banks crippling sums of money in interest payments each year and are unable to exit the arrangement without paying an exorbitant fee.

Around 28,000 interest rate protection products were sold to thousands of small businesses since 2001 though, the FSA found, most were sold between 2005 and 2008. The FSA focused on four of Britain’s largest banks as they collectively account for 95% of these products which have been sold to SMEs.

During its investigation, the FSA found a range of poor sales practices from the banks including failure to ascertain the customers’ understanding of the risks involved, poor disclosure of exit costs, “over-hedging” i.e. where the amount or duration of the arrangement was disproportionate to the underlying loan and the sale of these products being incentive-driven.

As part of an agreement with the FSA, the four banks have agreed to provide redress to customers that were sold inappropriate interest products and to stop marketing certain of these highly complicated products to particular groups of customers. The businesses affected should now be contacted by their banks to instruct them on whether they are included in a review of the sales.

Those which were found to have been victims of mis-selling will eventually be offered compensation by their banks.   The FSA say that not all businesses will be owed redress but for those that are, the exact redress will vary from customer to customer and could include a mixture of cancelling or replacing existing products, together with partial or full refunds of the cost of those products.

Whilst the FSA has been investigating, many customers have been taking the banks to Court to release them from the contracts which they say they either did not fully understand or were misrepresented as just “payment protection” against rising interest rates. We are already assisting a number of clients who are pursuing such actions against their banks.

The findings of the FSA come at a time when the reputation of British banks is at an all time low in light of the scandals concerning the mis-selling of payment protection insurance (PPI) to customers and more recently the manipulation of lending rates by Barclays.