The UK Government’s decision to re-privatise Lloyds Banking Group just before general election has led to public discussion of one more in the series of mis-selling scandals. The restructuring move by the government follows the transfer of the Banking Group to public sector oversight in the wake of the global financial crisis of 2008.

The scandal surrounding default on liabilities by British banks, incurred from improper interest rate application to protection products altering the accountability to payouts on those swaps, is said to be approaching the magnitude of the PPI claims scandal; that latter of which has cost an approximate £22bn thus far. While exposure estimates connected to similar mis-selling by Lloyds’ is a reported £5bn, the risk has not yet reached that of other institutions. Still, the government fears that other UK banks could be similarly affected.

To present, estimates of extent of the scandal has been confined to interest-rate hedging products (IRHPs). IRHPS sold mostly to SME (small and medium-sized enterprises) in swaps said to be valued at more than £10m in aggregate have been threatened by faulty application of interest rates to those protection products.

High-value claims made on derivative contracts of this sort are now under investigation by the UK Financial Conduct Authority (FSA). Publication of results to the task force on mis-selling have turned up a potentially a larger problem for UK banking institutions than PPI. Banks were forced to payout an estimated £22bn in compensation. Profits from PPI partly offset this measure, yet swap derivatives are predicted to be greatly reduced in dividend payout due to the high settlement costs of the government enquiry.

The scale of the alleged mis-selling activities which remained undisclosed until this past year, has the potential to impact investor confidence in UK banking trust say some analysts. The UK Treasury and the FCA review have focused solely on businesses and institutional investors since the scandal broke.

The complexity of the financial products and their effects are still untold across the broad investor market. IRHPs, meant to offer predictability on loan interest repayments, have resulted in major losses for investors due to the fact that the size of the swaps were often higher than the loan guarantee of those products.

Lloyds, Barclay, RBS, and six other major depository and financial institutions are set to pay £3bn in mis-selling compensation in remedy to clients. According to the FCA, about 90 percent of those deals were identified by the financial administration as not in compliance with UK financial regulations.

 

At the moment, the Government holds a 25 percent interest in Lloyds. The return of the Banking Group to full private ownership is a strategic decision in response to the mis-selling enquiry. With the The closed-door deal between the FCA and the banking institutions following the IRHP review, excluded those institutions with a turnover of £6.5m annually or more, with swaps of £10m or more in worth.

This follows the FCA announcement of 29,490 new cases targeting swap deals. Of those cases, nearly 19,000 were evaluated as ‘non-sophisticated’ trades, and with 10,475 meeting ‘sophisticated’ trading criteria. Lloyds’ share of the 29,490 total is said to be more than 1,500, consistent in ratio of 2:1 of non-sophisticated to sophisticated investor clients.

Legal intervention brought on by Lloyds has been critical to the Banking Group’s 500 recognised claims connecting high-value swap mis-selling to the institution. Viewed as high exposure speculation on the part of investors, the number of ‘non-sophisticated’ investors has emphasised the Group’s responsibility to the complaint.

The argument that duty to a reasonable standard of professional care is the impetus to Lloyd’s partnership with well-known financial law firms in the case. The UK Government claim lodged against the Banking Group with the Royal Courts of Justice, examines the financial databases, and other sources close to those partner law firms for collusion. The notional average of each high-value swap is estimated to be a near £20m.

Exposure attached to Lloyds swap contracts in the case is estimated at 30 to 50 percent of this notional swap value; a potential £5bn. Financial analysts indicate that such a scale of proportional risk may affect the Group’s share price, casting doubts over what was publised as the imminent return of the Bank to private ownership.

The implications of law firm involvement in the case is elucidated in the claim filed by plaintiff clients, citing the sale of swaps of £10m to £200m at the advisory of those firms. The request for compensatory damages rests on number of years of payments evidenced, as well as the break costs and ‘consequential losses’ to the swap contracts, such as failed portfolios impacted by the mis-sold IRHPs. The cost of legal representation is also factored in those complaints.

The continued non-disclosure of IRHPs related filings by UK banks’ since the commencement of the FCA investigation, is consistent with Lloyds refusal to reveal the Group’s average claim value of those complaints lodged by investors deemed ‘sophisticated’. ( FCA Sophisticated Test )  A spokesman for the Banking Group has indicated that Lloyds maintains its position of strict liability, citing no obligation to a duty to a standard of care to customers beyond written disclosure.

Furthermore, suggest banking industry experts, in the absence of provision, UK banking customers not covered under the existing FCA agreement, may not have redress depending on their claim. Rules to monitoring and enactment of future provisions are not recognised as post facto, so that the banking institutions in question are not under full obligation to detriments suffered by clients in response to market exposure.

Some out-of-court settlements have been reached in conformance with UK Government recommendation. Policy reforms to the existing FCA scheme on lending is being examined in respect to protection products sold by large banking institutions. It is still unknown the full extent of the exposure banks could have on IRHP swaps.


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Tim Capper reports on Financial Mis-Selling for Maple Leaf Financial. Our aim is to ensure you get honest advice and proper guidance to ensure a suitable recommendation can be made to pursue a financial claim

 

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Tim Capper

Bringing you financial news and information in plain english for Maple Leaf Financial. My aim is to help readers understand these often complex financial instruments.