Mis-selling Derivatives: Barclays, RBS, HSBC and Lloyds Banned From Selling Interest Rate Hedging Products

UK lenders Barclays, RBS, HSBC and Lloyds Banking Group have agreed to stop selling interest rate hedging products to small-to-medium enterprises (SME) after regulator Financial Services Authority (FSA) found them guilty of mis-selling derivatives products.

"The FSA has found serious failings in the sale of interest rate hedging products to some SMEs," said an official statement. "We believe that this has resulted in a severe impact on a large number of these businesses. In order to provide as swift a solution to this problem as possible we have today confirmed that we have reached agreement with Barclays, HSBC, Lloyds and RBS to provide appropriate redress where mis-selling has occurred."

In a settlement with the FSA, the four banks agreed to stop marketing interest rate structured "collars" to retail customers, which have included fish-and-chip shops and family-owned electrical goods stores.

However, the during the period 2001 to date, banks sold around 28,000 interest rate protection products to customers.

Interest rate swap agreements, or IRSAs, are contracts between a bank and its customer where typically one side pays a floating, or variable, rate of interest and receives a fixed rate of interest payments in exchange. They're used to hedge against extreme movements in market interest rates over a given period. Companies that have seen the value of these products move against them as rates fell during the recession, now owe banks crippling sums of money in interest payments each year.

But if these businesses want to cancel these contracts, the cost of doing so would be even higher in a lump sum payment, as banks demand cash upfront in lieu of future revenue.

"For many small businesses this has been a difficult and distressing experience with many people's livelihoods affected," said Martin Wheatley, managing director of the Conduct Business Unit at the FSA. "Our work has focused on ensuring a swift outcome for these businesses that form such an important part of the economy. I am pleased that Barclays, HSBC, Lloyds and RBS have agreed to do the right thing by their customers and offer redress or a review of past sales. These firms have responded to the need to provide a fair deal for customers by working with us, and I welcome this outcome."

Over the past two months the FSA conducted a review of these 28,000 sales and reviewed a significant amount of documentation from the firms, including sales files, customer complaints and taped conversations.

After its investigation, the FSA said it found a range of poor sales practices including failure to ascertain the customers' understanding of risk, poor disclosure of exit costs, non advised sales straying into advice and the concept of "over-hedging" - where the amounts and/or duration did not match the underlying loans.

The FSA added though that not all businesses will be owed redress, but for those that are, the exact redress will vary from customer to customer and could include a mixture of cancelling or replacing existing products, together with partial or full refunds of the costs of those products.

History of Mis-Selling Derivatives

Over the past year, IBTimes UKreported that hundreds of small to medium enterprises (SMEs) are turning to specialist lawyers from overseas to help them wrangle their way out of what they believe are mis-sold complicated financial contracts, sold as loan protection products, that are now suffocating them financially.

The groundswell comes alongside Barclays' chief executive Bob Diamond's admission that the bank "made some mistakes" in the market for interest rate products during the bank's last annual general meeting.

Diamond, whose bank has now been found guilty of mis-selling interest rate swaps and had the most banking customer complaints in 2011 according to the FSA, said: "There was a worry about interest rates going higher in 2005, particularly in the property sector where consumers wanted to lock in interest rates. I can guarantee you we have made some mistakes, when we have a mistake we're going to own up and fix it."

The news from the FSA comes straight after the bank had been found guilty of also fixing Libor and Euribor rates.

Only recently, the FSA launched a probe into Britain's four largest banks after Britain's Parliamentary Treasury Select Committee asked the regulator to investigate the selling of complex derivatives products to customers.

The FSA said it was focusing on four of Britain's largest banks as the groups collectively account for 95 percent of interest rate swaps; the derivatives contracts that UK businesses bought to insure themselves against unexpected hikes in interest rates.

"We think there are a number of questions to answer," said Martin Wheatley, head of conduct at the FSA to the treasury committee on Wednesday.

Wheatley will be the head of the new Financial Conduct Authority from early 2013 with a specific remit to protect consumers in a bid to end Britain's history of mis-selling of financial products.

In previous reports from IBTimes UK, we heard from a German law firm that hundreds of firms believe they should never have been sold the products in the first place.

While the FSA had been investigating, customers had been moving towards taking banks to court to release them from contracts that they say they either did not fully understand, or were misrepresented as just "payment protection" against rising interest rates.

"Derivatives are a totally different kettle of fish and it is a dubious business to start, especially if you don't fully understand the products. If the client doesn't understand the contract, at best, they are gambling blind," says Professor Julian Roberts, partner at law firm Wolfsteiner Roberts. "Derivatives don't work like normal investments such as stocks, shares or savings accounts. As the German courts now recognise, they are more akin to bets. Unless customers clearly understand that, and all the consequences that follow, they are definitely not in a position to make an informed judgment about the bank's offer. Clearly the banks discovered a market opportunity by selling these types of instruments to individuals and SME's as a protection or loan enhancing method, but which are in fact excessive and risky for the individual who does not stand to gain a benefit from these massive bets."