Whilst not, strictly speaking, Professional Negligence, the rights of court action available in Mis-selling cases are so closely akin to Professional Negligence actions that they are dealt with by our Professional Negligence team.
Interest Rate Swap products were sold as a relatively low cost method of future-proofing businesses against escalating interest rates. For small businesses, they were marketed as a convenient solution to an obvious risk in the wake of the extremely high interest rates that were reached in the 1990’s – if interest rates increased to potentially unsustainable levels for the Customer, the interest rate swap would restrict the loss.
However, with financial products, benefit must always be weighed against risk and, in the case of Interest Rate Swaps, there were substantial risks to the Customer in the form of swinging interest rates if interest rates dropped. These risks materialised when the credit crunch began to bite, and interest rates dropped to just above 0%.
In addition Customers, who wanted an early exit from the arrangement, found that the breakage fees were so high that the Customer had no choice but to remain locked in to the Interest Rate Swap product for its whole term, and pay its very high interest rate charges. Some small to medium sized businesses, (SME’s) failed when the burden of repaying very high interest rates became more than their business could bear.
What is an Interest Rate Swap?
An ‘Interest Rate Swap’ is a financial instrument which derives its own value from the value of other assets but it has no value of its own. It is a kind of derivative, which in turn is actually a contract between two parties, (the Provider and the Customer), the terms of which set out certain conditions that create a formula under which one party must pay interest to the other, either at key points in time or at some future date. So, for example, it will specify the underlying asset from which its value is derived (stocks, bonds, interest rates etc); it will specify the conditions to be satisfied before interest becomes payable by the Customer, and will specify what that interest rate will be or how it will be calculated.
A ‘Hedge’ is an investment mechanism which offsets losses or gains against a linked investment and is used to reduce substantial losses or gains on the investment.
The Interest Rate Swap is not made directly between the Provider and the Customer, but through an intermediary – such as a retail bank, as an over the counter (OTC) product.
Buyers and Sellers
Interest Rate Swap products were sold by many of the most well known and trusted high street banks in the mid 2000’s, in most cases, in respect of very high value finance arrangements (in excess of £1million).
Some of these arrangements were genuinely sold to Customers on the basis of the positive aspects of certainty and managing risk. In other cases, they were the only arrangement for financing that the bank was prepared to offer, so that in many cases, the Customer did not have any choice but to accept the bank’s terms if it wanted to continue trading.
In a product market of well over 100 variations, some of the more common examples of Interest Rate Swap products are:
- The Cap: This is a straightforward product that, in return for the payment of a premium, simply ‘caps’ (at a specific percentage rate) the amount of interest that a Customer must pay under a finance arrangement with a variable interest rate, so that the Customer is not adversely affected by higher interest rates. If you think of the cap as a ceiling, it makes understanding the other forms of arrangement a little easier!
- The Swap: This is a product that allows for a hedge against interest rate fluctuations by enabling the Customer, (in return for the payment of a premium), to exchange a variable interest rate for fixed rate payments which are set at the start of the contract. Let’s say the interest rate is fixed at 5% when the base rate is 3.5%. The Customer wants to guard against a risk that the rate may rise above 5% so a swap arrangement looks attractive. However, the interest rates actually fall to 0.5% and stay that way throughout the life of the arrangement, but the Customer still pays 5%, having already paid a premium for the ‘benefit’ of this arrangement.
- The Collar: This product limits the interest rate charged so that it falls within an upper ceiling and a lower floor (the collar). Let’s say the ceiling is fixed at 4% and the floor is fixed at 2%. If the actual interest rate is regularly above 4% then the Customer will benefit, but if the actual interest rate falls to 1%, then the Customer will still have to pay the floor rate of 2%. Again, the Customer has paid a premium for the benefit of the arrangement.
- The Enhanced Collar: This product is a type of ‘collar’ arrangement but the ‘enhancement’ may be structured so that the Customer must pay an enhanced rate where the interest rate falls below the collar ‘floor’. Let’s say that the floor is set at 3%. As the actual interest rate falls, the interest payable by the Customer increases. The lower the rate, the more the Customer pays. In answer to the obvious question about why anyone would enter into such an arrangement, the banks argue that this allows them to set the floor lower for the benefit of the Customer.
- The Double Floor Collar: This ‘collar’ arrangement is similar to a cap and collar arrangement but applies a second floor which is set below the first collar floor. If the base interest rate falls below the first collar floor, the Customer must pay the difference between the base interest rate and the first collar floor, plus the first floor rate. The second floor rate of interest operates as a penalty. In a low interest economy, that can mean an excessively high interest rate.
When is a Swap not a Swap?
When it’s a Tailored Business Loan. Offered by a few banks, the bank and the Customer agreed to enter into a loan (fixed or variable rate, and in a variety of the ‘swap’ combinations explained above), based on the bank’s base rate or LIBOR rate.
However, the bank would enter into a separate underlying hedge agreement with a Provider, some of which were extremely complex.
The Customer would not be aware of this arrangement until he sought an early exit and found that the breakage fees were extremely high.
This is a product that allows the bank to terminate the swap arrangement (effectively, to call in the loan) at particular points in its life, without compensating the Customer, meaning it has a ‘get out of jail’ card if the interest rates rise to levels that become unprofitable for the bank. Given that this is a product that is sold to a Customer as a protection against spiralling interest rates, in reality it offers the Customer no genuine protection.
Swapping Swaps for more Swaps
It has been reported that some Customers have started the complaints procedure, in relation to one kind of swap arrangement, and as part of the bank’s internal complaints procedure, have been persuaded to replace their swap for a different product, which promises better repayments over shorter terms, but which does not compensate for the Customer’s past losses. There are concerns that such arrangements allow the banks to escape responsibility for the Customer’s substantial past losses, in respect of the previous product, whilst generating further profits from the replacement products.
Retail banks have a duty (in contract, and in the tort of negligence), to use reasonable skill and care when providing products and services to their customers. Retail banks are also regulated by the Financial Conduct Authority (FCA – formerly the Financial Services Authority, or FSA) and as such are subject to the FSA Conduct of Business Sourcebook (COBS) rules which set out minimum standards of conduct for banks as sellers.
Features such as the complexity of the product; the severity of the risks associated with it; and the sophistication (or otherwise) of the Customer, impose duties on the bank, as the seller of the product, to ensure that the Customer understands what the product does, what it will actually cost, and any potential risks associated with it.
Interest Rate Swap products were particularly complex, and particularly risky for the Customer. Even so, in many cases, the banks breached their duties to their customers in the following ways:
- By failing to advise their Customers about the risks associated with the product.
- By emphasising only the benefits of the product and not sufficiently explaining the risks.
- By failing to explain how the products worked and how the interest rates were calculated.
- By failing to take reasonable steps to ensure that the Customer understood the product they were buying.
- By failing to explain how much the break costs would be.
- By failing to consider whether the product being sold was actually suitable for the Customer, taking account of that Customer’s circumstances.
- By failing to explain provisions for early termination by the bank.
The examples given above also give rise to claims for negligent misstatement.
However, until recently, methods of redress for the Customers who bought these products have very much less than satisfactory.
There may be an alternative to court action
The FCA Review Process
The former FSA reached agreement with certain banks (Barclays, HSBC, Lloyds Banking Group, RBS, Allied Irish Bank, Bank of Ireland, Yorkshire Bank, Clydesdale Bank, Co-operative Bank and Santander (UK)) that they will provide appropriate redress where misselling has occurred. It has been agreed that theses banks will do the following:
(i) provide fair and reasonable redress to non-sophisticated* customers who were sold structured collars;
(ii) review sales of other interest rate hedging products (except caps or structured collars) for non sophisticated customers; and
(iii) review sales of caps if a complaint is made by a non sophisticated customer during the review.
This process will be scrutinised by an independent reviewer and overseen by the FCA.
* ‘sophisticated customer’ was defined by the FSA as those who: in the financial year during which the sale was concluded, met at least two of the following criteria: (i) a turnover of more than £6.5 million; or (ii) a balance sheet total of more than £3.26 million; or (iii) more than 50 employees. Alternatively, the firm is able to demonstrate that, at the time of the sale, the customer had the necessary experience and knowledge to understand the service to be provided and the type of product or transaction envisaged, including their complexity and the risks involved.
Customers who fall within the redress process can expect to receive a letter from the FCA about what is means for their case and the bank will also write to affected customers to explain how to engage in the review process and to provide details on the next steps. Banks should prioritise cases where customers are in financial difficulty and affected customers should make them aware of this as a matter of urgency.
Complain to your bank
Whether you need to complain depends on whether you are classed as a “non-sophisticated” customer and what type of product you were sold.
If you are a non-sophisticated customer and you were bought a cap on or after 1 December 2001 then you will only be included in the scope of a review if you make a complaint. If the independent review process has already been completed then your complaint will be dealt with under the banks normal complaints handling procedure.
If you were a sophisticated customer then you come outside the scope of the review process and you will need to make a complaint to the bank if you were not happy with the sale. Your complaint will then follow the bank’s normal complaints handling procedure.
As regulated financial advisers, all banks must have procedures in place to ensure that complaints about their services are considered carefully and that you receive a response within a reasonable time – up to a maximum of eight weeks from the date they receive your complaint.
If you are not satisfied with the redress offered by the bank, either through the review process or the complaints procedure, then if you are eligible you may be able to refer your complaint to the Financial Ombudsman Service.
The Financial Ombudsman Service (‘FOS’)
Only the following criteria of Customer (set out in the DISP Section of the FSA Handbook), may have their complaint considered by the FSO:
- A ‘consumer’ (an individual)
- A ‘micro-enterprise’ (one that employs fewer than 10 people and has a small turnover)
- A charity with an annual income of less that £1M at the time the complainant refers the complaint to the respondent (ie; the bank)
- A trustee of a trust which has a net asset value of less than £1M at the time the complainant refers the complaint to the respondent
Where a complaint cannot be resolved through the bank’s own complaints procedure, the FOS will determine complaints in accordance with a strict set of criteria, applying statutory provisions and any relevant Code of Practice in determining the complaint and making its recommendations.
Initial decisions are made by adjudicators, but they are subject to review by an Ombudsman before a final determination is made.
In terms of its powers, it can require a bank to pay up to £150,000 (plus interest and reasonable costs) as compensation, provided the Complainant accepts that decision.
It can also recommend that a bank pays more.
The question of whether a complainant who accepts the FOS decision may bring a court action for the balance has produced conflicting decisions and remains unsettled.
Time limits apply, but a complaint to the FOS will not stop time running for limitation purposes (see below).
Further, until recently, complainants to the FOS were often disappointed to find that their complaints were not upheld, in relation to Interest Rate Swap products, because the adjudicator would apply strict contractual principles to their decisions.
Then, in October 2012, one of the FOS’s,Tony Boorman, made two provisional decisions on cases that had been referred to him for review. One of these was a Swap arrangement, the other was a collar, but in both cases, purchase of the product was a precondition of the Customer receiving loan funding. In both cases, the adjudicator had determined that this precondition was within the bank’s commercial discretion. Mr Boorman disagreed and considered whether, from the Customer’s point of view, the product was a commercially sensible arrangement – if it was not, then the bank had no right to impose the precondition. He then went further and considered how the bank’s handled each matter, in terms of how the products were sold and what information was given to the Customer in these cases. He concluded that the banks were providing professional investment advice but that they had failed to consider the needs of the Customer and had given unsuitable advice. He also found that the products were put in place for the banks’ own commercial convenience and with little or no consideration for the needs and interests of the Customers.
In one of these claims, Mr Boorman’s recommendation was a compensation payment in excess of £500,000.
How we can help
Customers who believe they have suffered financial loss as a consequence of Interest Rate Swap Mis-selling, have a number of options open to them to resolve their dispute.
If your case is being considered by your bank, as part of your review process, we can help you to present your case during the review process to ensure that your receive appropriate redress from the bank.
If it is necessary for you to make a formal complaint to the bank, or to the FOS, we can formally act on your behalf through the whole process. Remember, the FOS has the power to order a bank to pay costs so you may be able to recover most if not all of your costs through the FOS scheme. We will not accept instructions on a claim for loss of less than £10,000.
For larger enterprises, not covered by the FOS scheme, and for Customers who are unable to obtain adequate compensation via the FSO scheme, or where there is a limitation issue, we can take whatever steps are necessary to protect your position, from sending a letter before claim, to bringing a claim to trial or to a suitable settlement by agreement.
We have a range of funding options that may help you to bring your claim without worrying about how much it will cost
Limitation – Why you may need to act quickly
For most types of claim, the law allows you a limited period of time within which a Claimant must bring their claim – this is called ‘Limitation’ and is of crucial importance to consider when a claim for Mis-selling is contemplated.
Claims for breach of contract and breach of a statutory duty, must be brought within 6 years of the date of the breach. Claims for negligence, (including Negligent misstatement and negligent advice) must be brought within 6 years of the date that the damage is suffered – unless the damage was not discovered until a later date in which case, it is three years from the date that the claimant first had enough knowledge of the material facts that gave rise to the damage to make him realise he may have a claim.
Limitation dates can be difficult to calculate, a position made more complicated by the fact that time may have already started to run to bring a claim, without the claimant being aware of it. Most Interest Rate Swap arrangements are ‘term’ products, with a distinct period of operation; say ten years. Others are of potentially indefinite duration; say those that are designed to back a flexible loan. The period running from 2005 and 2008 saw a proliferation of these products, but they were on the market long before that.
If you think you may have a claim – you should seek legal advice as soon as possible. Remember also that time will not stop running because a complaint is being taken through a complaints procedure or through the FOS, so it may be worth speaking to a solicitor anyway.
Call the Professional Negligence Team at Jackson Lees Solicitors in confidence on 0151 227 1429 to discuss how we can help you resolve your dispute.