Posted on Nov 15, 2012 by | 0 Comments
Interest Rate Swap Mis-selling: the role of the Financial Services Ombudsman (FSO) by Cat MacLean and Liina Tulk Interest rate swap mis-selling has been a hot topic in recent months, with many aggrieved customers coming forward to complain of having been mis-sold hedging products. To date, however, no SME has been able to bring a successful misselling claim in the UK Courts. In a recent test case, Grant Estates were unsuccessful in in the Edinburgh Commercial Court (Grant Estates Limited v Royal Bank of Scotland www.scotcourts.gov.uk/opinions/2012CSOH133.html):although the judgment came out after the FSA announcement this summer, Lord Hodge nevertheless decided that the Royal Bank of Scotland had not breached any statutory or common law duties when “selling” the swap to the small property business. The Commercial Court’s decision dampened the Scottish SMEs desire to go down the Court route and as the Financial Ombudsman route was lengthy and similarly did not appear to result in favourable decisions, aggrieved businesses turned towards the FSA review process. Unfortunately the FSA review process has not turned out to be what the SMEs had hoped. Five months have passed since the FSA announcement and to date no payments have been made by any of the major banks to the missold SMEs. Throughout this time and with no compensation payment date on the horizon, the banks have continued to demand high swap interest payments from cash-strapped SMEs. Against this background the England and Wales Financial Ombudsman Mr Tony Boorman’s two recent provisional decisions in favour of missold SMEs came as such a welcome surprise. One of the cases involved a missold collar, whereas the other involved a swap. In both cases the product was made a precondition of a loan, which has also been the case for most of MBM’s missold clients. So far both the Courts and the Financial Services Ombudsman (“FSO”) have taken the approach that the decision to make an interest rate hedging product or a security a precondition of a loan fell within the bank’s commercial discretion. Mr Boorman however departed from that approach in his decisions by saying that the question is whether making the interest rate hedging product a precondition of the loan made commercial sense in all the circumstances. If it did not, then the bank was not allowed to request it. In both cases, Mr Boorman decided that the swap should not have been a precondition of the loan. Mr Boorman thereafter considered the position if advice had and had not been given by the bank. The Ombudsman went further than simply relying on what was written in the contract and looked at what had actually happened. In both cases the bank haddirected the SME to the specific product, selected the term over which it was to operate, and actively encouraged (perhaps to the point of making it a requirement) the purchase of the swap. In those circumstances Mr Boorman concluded that the actions of the banks did amount to professional investment advice. As such the banks were obliged to offer suitable advice which paid sufficient amount of attention to the needs (short term and long term) of the SME. A long term hedge with the possibility of significant cancellation charges may not be suitable for the overall needs of a small business. Mr Boorman concluded that the banks in the two cases had been driven by an imperative to sell more of the interest rate hedging products to SMEs, rather than a thoughtful assessment of the clients’ interests and needs. For the sake of completeness the Ombudsman also considered the position if the bank had not given advice. This issue is particularly relevant to Scottish SMEs as most of them had contracts with banks, which expressly stated that no advice had been given or relied upon. Mr Boorman said that where no advice has been given the question was whether the bank providedthe SME withinformationthat was clear, fair and not misleading, in order that theSME could make an informed choice. In both cases the bank should have drawn the SME’s attention to the significant breakage costs. The SMEs, similarly to most of the missold SMEs in the UK, did not expect the breakage charges to be so onerous and at worst expected them to be a few months’ interest payments.Crucially, nowhere in the documentation made available to the SMEs (either before or immediately after the transaction) was there a clear statement of the possible scale of the fees involved in cancellation. The Ombudsman concluded that whether or not advice was given, the banks had encouraged a focus on short term rates whilst effectively hiding the potential impact of cancellation charges. That had the effect of tying the SMEs into long term arrangements that had not met their needs. Perhaps even more importantly,the Ombudsman went considerably further than previous FSO decisions when considering redress and damages. One of the reasons a lot of SMEs have not treated the FSO as a satisfactory route of redress is that the maximum award of damages the FSO can award is £150,000. Large amount of SMEs, however, have suffered (and in a lot of cases continue to suffer) significantly bigger losses. Mr Boorman recognised this, and made a recommendation to the banks involved in the two cases to settle in full the remaining amount above the FSO’s maximum award. While the Ombudsman’s recommendation is not binding, considering the press attention these claims are currently receiving, it would be foolhardy in the extreme for these banks, who have publicly said they are trying to put things right, to ignore the FSO’s recommendation. Although FSO’s decisions are not binding on Scottish courts, the two recent decisions do indicate that the attitude towards the liability of the banks is changing. Previously there had beena very blinkeredapproach to misselling claims,in the sense that the focus was on what was in the written contract, not what happened in reality. Thus as in Grant Estates, the banks have been able to hide behind “execution only” provisions to escape any liability for the giving of advice. With the advent of these two FSO decisions, the tide does finally appear to be turning. Even if the contract was one of execution only, the FSO has now confirmed (although provisionally) that the bank nevertheless had to provide the SME with sufficient information so that the business could made an informed decision. It is indisputable that the majority of SMEs who have misselling claims against banks were not provided with anything like enough information, and soalthough so far there havs been no successful misselling case decided in the UK Courts, if the Courts are now minded to follow the Ombudsman’s reasoning, then this may finally open the floodgates for missold SMEs.