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The FSA's pilot scheme on interest rate hedging products - a more sophisticated approach?


First, a little background into the interest rate swap mis selling situation is perhaps required. Interest rate swaps were initially marketed to protect against rising interest rates, and some companies are now arguing that they were not made aware of the implications of the rate going down, or having the risks properly explained by the lender. In some cases, these products were a condition of the loan, so the customer had no choice at all. With the interest rates slashed by the Bank of England in 2008 (and remaining low ever since), companies with an otherwise profitable business have found themselves crippled by massive fees and early exit costs.

In 2012, the FSA in conjunction with Barclays, HSBC, Lloyds and RBS ('the Big 4') announced the launch of a scheme to review and compensate customers who had been mis-sold hedging products. AIB, Bank of Ireland, Clydesdale and Yorkshire banks, Co-operative Bank, and Santander UK all subsequently agreed to be part of the scheme. A pilot version of the scheme has been in operation in order to allow the FSA the time to consider the banks' proposed approaches to reviewing sales and to ensure they would deliver the right outcome for customers.

The FSA's pilot scheme involving the Big 4 looked at 173 sales to 'non sophisticated' customers and found that over 90% of the sales did not comply with at least one or more regulatory requirement, i.e. customers had been mis-sold swaps.

As a result of the pilot, the FSA has also provided welcomed clarification of the 'sophistication test' so as to try and ensure that its scheme is focused on those small businesses that were unlikely to have understood the risks associated with these products.

The previous test, based on financial thresholds (turnover of more than £6.5m or a balance sheet total of more than £3.26m) and the number of employees (less than 50), was a crude method of gauging a customer's understanding of these complex products and the risks associated with them. It was unsurprising that such thresholds generated unfair outcomes. Some Special Purpose Vehicles and small subsidiaries of larger group structures were falling within the scheme, whereas farmers and bed and breakfast businesses (with a large balance sheet by virtue of owning property and machinery and a large seasonal workforce) were excluded.

Now, customers who meet only the balance sheet and employee number criteria will be included in the scheme where the total value of their swap product is equal to, or less than, £10m. Special Purpose Vehicles and subsidiaries forming part of a larger group, however, are likely to be excluded from the scheme.

The FSA has also helpfully clarified the nature of compensation affected customers might receive. The intention is to put the customer back in the position they would have been had the hedging product not been mis-sold. Customers successfully demonstrating that they would not have signed up to the hedging product if they had been able to make an informed choice about the product could: be allowed to exit from the hedging product free of charge; receive a refund of all payments made under it; and receive compensation for any proven 'consequential' (or associated) losses, such as additional borrowing charges.

If it is reasonable to conclude that a customer would have purchased a different hedging product had the sale complied with regulatory requirements, that customer will be offered an alternative product and will be refunded the difference in payments (including exit costs) between the product (mis)sold and the alternative one.

Now the pilot is over, the FSA has estimated that the Big 4 will complete their review of other claims within 6 to 12 months. The other banks involved in the overall scheme could take longer. The pilot was launched in June and the FSA originally indicated that it would be completed by the end of 2012, so customers should be mindful of potential delays.

The scheme applies to all hedging products sold to 'non-sophisticated' customers since December 2001, but if the scheme doesn't provide suitable compensation, customers only have 6 years from the date the hedging product was mis-sold to them in which to commence court proceedings.

The FSA maintain that customers do not need to seek advice from lawyers. Whilst that may be true in some cases, claimants should be mindful of the fact that all of the banks are legally represented. These are complex products and understanding how they have been mis-sold can often be highly fact sensitive. It is important to ascertain the customer's knowledge of these products, their interaction with the bank during the sales process, the complexity of the product (mis)sold, and the quality and extent of the advice given during the sales process. Customers also need advice on the compensation they can claim (particularly consequential losses) and the potential tax implications in the event that compensation is paid to them.

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