Banks have been handed a free pass allowing them to get out of paying compensation on the biggest interest-rate swap mis-selling claims, The Independent has learnt.
The controversial products were pushed aggressively by banks on to small and medium-sized companies when they were sold loans. They were sold as a way of protecting against rising interest rates. But they left firms facing huge bills that sent some to the wall during the financial crisis, when interest rates unexpectedly plummeted.
Banks will now be allowed to throw out the biggest compensation claims.
The Financial Services Authority ordered banks on Thursday to review all sales, after a survey found that more than 90 per cent included in the review breached at least one of its rules.
But it has emerged that swaps of £10m and above will be excluded, exempting the banks from compensating companies that took them out.
There was no mention of the figure in the watchdog’s press releases or in a detailed larger document. It was accessible only through study of a complicated flow chart. While the £10m figure looks substantial, experts said it was conceivable that some relatively small enterprises, and many medium-sized firms, could be excluded from the process as a result.
City analysts suggest that banks’ compensation claims related to swaps mis-selling could reach £1.5bn – a large sum but only a fraction of the more than £10bn set aside to cover the mis-selling of payment protection insurance policies. Excluding the bigger claims will help keep the that figure down, amid mounting concerns about banks’ financial health.
Rich Eldridge, head of finance at the law firm Manches, described the “cap” on the review as “startling”.
Mr Eldridge, who contacted The Independent after spotting the get-out, clause said: “The FSA report just contains an oblique reference to customers who meet a balance-sheet and employee test being included in the review where their swap does not exceed £10m. In fact all swaps over £10m have been unexpectedly excluded, irrespective of balance-sheet or turnover figures.”
Mr Eldridge continued: “Many people suspected the potential exposure of the banks was too large for taxpayer-owned banks. It seems the FSA has bowed to the pressure from the banks by agreeing to exclude the largest claims.
“I have lost all faith in the process. A process in which the FSA bows to the strength of the banks will not deliver a fair result for borrowers. It is particularly concerning that the FSA has not been upfront about changing the review to exclude the larger claims.”
As a result, shares in the banks have hardly moved. Barclays shares finished down just 2p at 300p following the announcement; Lloyds shares have lost only 0.62p to 51.64p, and HSBC has given up 4.5p to 719.6p. Royal Bank of Scotland, the only bank to warn of increased provisions as a result of the review, has lost 6.7p to 340.5p. That indicates the City is relatively relaxed about the review and the potential costs from it.
Watchdogs are privately extremely concerned about the potential cost of legal claims relating to the Libor interest-rate fixing scandal. None of the big banks has yet made any provision to cover these.
Critics have complained that, because the banks will be conducting the review, this leaves them in the position of being “judge and jury”, although the FSA will be closely watching how they carry it out.
A spokesman for the FSA defended the imposition of the £10m cap and said it was aimed at bringing more firms into the review process. Under the Companies Act, a number of tests are set for a company to be considered “small”. They are having a turnover of less than £6.5m, a balance sheet of less than £3.26m and less than 50 employees. A breach of any two means a company is no longer defined as small.
But critics said that could easily exclude many farms, which often employ more than 50 people, and whose land holdings push their balance sheet above £3.26m.
As a result the FSA abandoned the tests and simply set a £10m cap.
A spokesman for the regulator, soon to be replaced by the Financial Conduct Authority, said: “We introduced the £10m notional hedge limit to bring businesses such as farms, B&Bs and small care homes into the review. Without this change they might otherwise have been excluded due to the size of their fixed assets and numbers of seasonal [or] part-time workers.”
Q&A: Swap with a sting in its tail
Q. What is an interest rate swap?
A. It’s a financial product that was sold to a number of businesses alongside loans to protect them against rising interest rates.
Q. Why has there been problems with them?
A. Swaps have been described as similar to insurance, but they are actually complicated derivative products which often carry a sting in the tail. They left many companies facing high costs when the recession hit and rates unexpectedly tumbled.
Q. Why is there a mis-selling review?
A. The sophistication of interest rate swaps meant many firms weren’t clear about what they were buying into and the potential risks.
Q. Why does the Financial Services Authority want to impose a cap on claims?
A. It argues that the larger firms should have been able to seek advice from lawyers and accountants, although it is a matter of debate as to whether a small provincial lawyer or accountant would have had any more knowledge of the way some of the more complex swaps work than the companies they were advising.