Bad news for banks, but good news for businesses on Thursday - The Financial Services Authority (FSA) has said it will investigate the mis-selling of interest rate swaps after finding 90% of the processes it looked at were flawed.
Four banks will see their practices put under the spotlight for the complex financial instruments initially; Barclays, HSBC, Lloyds and the Royal Bank of Scotland. These banks have already agreed to work on reviewing individual sales and providing redress to customers based on principles outlined by the FSA.
The FSA looked at 173 sales to non-sophisticated customers and found that more than 90% of the sales did not comply with at least one or more regulatory requirement. Many of the 173 cases are likely to result in money being returned to the customer, but a small number of cases were judged as not being representative of all of the sales.
In response, the regulator has re-focussed the eligibility criteria, to ensure the review is focused on those small businesses that were unlikely to understand the risks associated with those products.
This might include, for example, bed and breakfast businesses which would previously have been ineligible due to their large numbers of seasonal workers.
Some businesses that fell under the criteria published last June will be excluded. These include, for example, small subsidiaries of multi-national corporations, or Special Purpose Vehicles that are sophisticated enough to have understood the terms of the product or have sufficient resources to obtain advice.
John Walker, national chairman for the Federation of Small Businesses, said the news would come as a relief to thousands of small firms.
"However... we are concerned that the FSA has not mandated that all payments are suspended when a firm enters into the scheme – we would like the banks to do this for their customers. There is also a lack of clarity on what full redress looks like, with banks determining what constitutes consequential losses, and how an appeals process will work," he added.
"What is clear is firms will need expert support when they enter the scheme to ensure they receive the redress they deserve. Now the pressure is on the banks to contact its customers. They must do so quickly and decisively to draw a line under this matter and bring the situation to a close."
What is an interest rate swap?
Also known as interest rate hedging products (IRHPs), interest rate swaps are financial instruments developed by banks to help limit a company's exposure to interest rate rises, or to get access to a marginally lower interest rate than it would have otherwise been able to get.
Many businesses who were struggling under debts were encouraged to use the transaction to help limit their debts' exposure to rising interest rates - essentially they swapped their debt obligations (which could go up with interest rates and the London Inter Bank Offer Rate (Libor)) for a fixed rate loan instead, helping them to manage their cashflows.
They are typically sold alongside a business loan from banks, but can vary in complexity and can, therefore, be mis-sold.
The swaps also became attractive to other fixed-income traders because swaps reflect the market's expectations for interest rates in the future.
The British Bankers' Association said banks had been working proactively with the FSA since the problem was uncovered in order to resolve the issue "as swiftly as possible".
Chief executive Anthony Browne said in a statement: "The announcement today will give clarity to businesses and will enable the banks to put in place the steps needed to resolve each case for customers. Where customers have suffered unfairly the banks have all agreed that they will put it right.
"Banks will be contacting those companies affected shortly, prioritising those with the greatest need. Any business which is currently facing financial distress and is seeking a suspension of payments should get in touch with their bank immediately."
Alison Loveday of Manchester-based law firm Berg is currently working on 50 mis-selling cases to do with interest rate swaps. She said she was disappointed at how long it had taken the FSA to get on top of the issue.
"Since the FSA's initial findings, thousands of businesses have been pushed to the wall and others have been effectively turned into 'zombies', which can barely survive because of huge interest rate swap payments," she said.
"Our advice remains the same – businesses which believe they have been mis-sold swaps should seek professional advice, but remember this is not a payment protection insurance style free-for-all, and there is no one size fits all for each case.
"In many cases the consequential loses suffered by a business will be every substantial and so the compensation the customer may be entitled to will need to be carefully assessed in each case."
The FSA has also been reviewing sales of IRHPs by Allied Irish Bank (UK), Bank of Ireland, Clydesdale and Yorkshire banks, Co-Operative Bank, and Santander UK. The FSA aims to be able to confirm that these banks can launch their reviews by 14 February.
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