Banks are expected to release reviews of interest rate swaps ordered by the Financial Services Authority (FSA) within 12 months, the FSA said in a statement. Each bank subject to the FSA order is expected to complete a pilot sample of their financial data before beginning a complete review.
The reviews will look at the sale of Interest Rate Hedging Products (IRHP) sold to small businesses since 2001. The studies will focus sharply on the sales of IRHPs to what the FSA is calling “non-sopisticated” customers. Non-sophisticated customers are defined as small businesses that lacked the financial sophistication to understand inherent risks in those financial instruments. These studies will determine whether or not these businesses are due redress by the banks.
Interest Rate Swap Review
The investigation of this matter began after the FSA had determined that there were “some serious failings” with the way banks had sold IRHPs to businesses, the FSA said in its statement. The information gleaned from the initial investigation led to the FSA to call for a review.
HSBC, Barclays, Lloyds and RBS embarked on the initial pilot reviews at the end of January. FSA also ordered these banks to begin paying redress based on specific FSA principles. This matter will be reviewed by independent sources, FSA said.
In mid-February, the results of the pilot reviews done by Clydesdale and Yorkshire Banks, Allied Irish Bank UK (AIB), Co-operative Bank, Bank of Ireland and Santander UK were released. Under FSA principles, those banks pledged to carry out further reviews of IRHP sales made to small businesses and grant redress to offended businesses. This places all the banks mentioned in this report on the same page.
The review will bring to the front of the line those businesses that are in dire financial stress, FSA said. Each review is likely to be different, and FSA said that it expects that customers will be treated “fairly and reasonably according to their own circumstances.”
Banks will be expected to assess whether each sale of interest rate hedge products followed established guidelines when sold, FSA said. The agency further stated that its analysis of the pilot reviews convinced the agency that a case-by-case review is necessary in order to determine that guidelines were followed. These reviews will find out whether redress is due, and each case must be considered individually, FSA stated.
To date, FSA has concluded that 90 percent of sales made by eight banks did not meet one or more regulatory dictates. FSA stated that a significant portion of the cases already reviewed will qualify for redress. However, FSA cautioned that this small sample may not be representative of all cases once the reviews are completed.
FSA used a “sophistication test” to judge the sales made at Bank of Ireland. The bank insisted to regulators that all its sales were made to customers that were judged by the bank to be sophisticated. FSA said that the pilot study at the bank revealed that some bank customers are eligible for individual case reviews.
FSA is classifying “non-sophisticated” customers as retail clients or private customers as defined under FSA rules. Those rules paint the non-sophisticated customer as, generally, a small business that likely lacks the the financial acumen to understand risks inherent in IRHP financial instruments.
FSA also announced that it is currently changing its sophistication test to be certain that reviews will focus on businesses that lack financial sophistication.
As the matter stands now according to news sources and government statements, more than 40,000 UK small businesses may have been mis-sold certain financial instruments. This mis-selling could cost UK banks as much as £10 billion pounds in redress.
Businesses that bought Interest Rate Swap Agreements have been hammered with hundreds of thousands of pounds in additional interest payments. Other businesses have been told that it would cost them large amounts of money, in some cases approaching £1 million pounds, to exit the swap contracts.
The big financial hits have resulted in some unknown number of businesses going under and throwing others on the ropes as they struggle to meet these unexpected expenses.
News reports have run stories about businesses claiming that they were never informed by the banks of the swap risks. Many business owners assert that these schemes were sold with the implied promise that these swaps were no-risk financial instruments. This claim will be at the heart of the dispute as businesses file claims, seek redress and run lawsuits through the courts.
Banks were thrown a temporary life preserver recently in Green & Rowley v RBS in a Manchester Mercantile Court. The court ruled that Green & Rowley failed to substantiate their claims of negligence and breach. The ruling also shot down their avenue to pursue claims under the FSMA section 150 act. The ruling is expected to be appealed to the Court of Appeal.
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