FSA confirms review of Interest Rate Swap mis-selling opening up potentially huge bank compensation bill

1 February 2013

UK regulator the Financial Services Authority (FSA) said that the country’s ‘big four’ high street banks - Barclays, HSBC, Lloyds and Royal Bank of Scotland (RBS) - will undertake a full review of their sales of interest rate hedging products (IRHPs) to small and medium-sized enterprises (SMEs). The furore threatens to develop into yet another costly mis-selling scandal following the payment protection insurance (PPI) debacle which has also cost British banks tens of billions of pounds in compensation.

In June 2012 an FSA report entitled ‘Interest rate hedging products - Information about our work and findings’, revealed serious failings in the sale of IRHPs and poor sales practices across a number of products. They included poor disclosure of exit costs; failure to ascertain the customers’ understanding of risk; non-advised sales straying into advice; ‘over-hedging’ where the amounts and/or duration did not match the underlying loans; and rewards and incentives being a driver of sales practices.

The latest announcement confirmed that the four banks had agreed to work on reviewing individual sales and providing redress to customers based on principles outlined in the watchdog’s report and overseen by independent reviewers.

The FSA reported that a subsequent pilot exercise had confirmed initial findings of mis-selling of IRHPs. The watchdog reviewed 173 sales by banks to ‘non-sophisticated’ corporate customers and found that over 90% of the sales did not comply with at least one or more regulatory requirement. A significant proportion of the 173 cases are likely to result in redress being due to the customer. However, the FSA stressed that the small number of typically more complex cases in the sample was not necessarily representative of all IRHP sales.

“This marks significant progress in our review of these products,” said Martin Wheatley, chief executive officer (CEO) of the Financial Conduct Authority (FCA) which, together with the Prudential Regulation Authority (PRA), is due to take over the FSA’s powers later this year. “We believe that our work will ensure a fair and reasonable outcome for small and unsophisticated businesses.

“Small businesses will now see the result of the review as the banks look at their individual cases. Where redress is due, businesses will be put back into the position they should have been without the mis-sale. But it is important to remember that this review is firmly focused on the particular circumstances of each process and, if so, whether redress is due.”

This latest mis-selling episode to affect the UK’s banks is estimated by the FSA to involve over 40,000 IRHPs have been sold to businesses which, according to some reports, could end up costing the industry more than £10bn. However the FSA said that some businesses, such as small subsidiaries of multinational corporations (MNCs) and special purpose vehicles (SPVs) - deemed to be sophisticated enough to have understood the terms of the product or to have sufficient resources to obtain advice prior to buying - will not be eligible for compensation.

In a commentary issued by Fitch Ratings, the credit ratings agency (CRA) said that the costs for redress of the mis-selling of IRHP should be manageable for UK banks but will dent their net earnings prospects in the short- to medium-term. It added that although difficult to quantify the redress costs for the whole industry, they are unlikely to be as large as other misconduct costs, such as the payment protection insurance (PPI) compensation and London Interbank Offered Rate (Libor) fines although Fitch expects conduct risks to remain high.

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