Treasury Committee reports on Conduct in SME lending (FCA IRHP Mis-selling Review, TBLs, Hidden Swaps and GRG)

The House of Commons Treasury Committee has today (10 March) published its report on Conduct and competition in SME lending. This report covers bank mis-sold interest rate derivatives, regulation of loans embedded with swaps (hidden swaps such as TBLs), criticisms of the FCA Review process, challenging banks through litigation at the courts, or via the Financial Ombudsman Service and issues regarding RBS Global Restructuring Group (GRG). We set out below some of the key conclusions and recommendations.

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Mis-sale of Interest Rate Hedging Products and the FCA’s IRHP review

Much of what the Treasury Committee has today reported on, in 2015, was warned and notified to the FCA by LEXLAW in a letter dated 10 October 2013 which we wrote to Martin Wheatley of the FCA to warn him and give the regulator NOTICE OF FAILINGS IN AND ABUSES OF THE IRHP REVIEW.  He defended the review scheme in his response and the FCA denied the scheme was flawed.  However, the Treasury Committee has now indicated the process is flawed and the FCA should investigate to establish whether there are systematic failures in the review scheme. 

The FCA’s IRHP redress process is guided by the principle that “redress must be fair and reasonable”, and that “redress should aim to put customers back in the position they would have been in had the breach of regulatory requirements not occurred.” This is a statement of principles, and is open to interpretation by banks conducting the review. The outcome in each customer’s review therefore relies primarily on the judgement of the bank, on a case by case basis, subject to approval from an independent reviewer. In addition different banks came to different conclusions with inconsistency between different independent reviewers. (paragraph 91)

The arbitrary sophistication test may have been necessary to obtain agreement to a voluntary scheme from banks, but it is clear that not all non-sophisticated customers have been included in the review. (paragraph 92)

The FCA has acknowledged that the introduction of a £10 million cap on the size of an IRHP has excluded approximately one third of the largest IRHP review participants. The FCA should write to the Committee to explain its decision-making on this cap. This explanation must state whether, in its view, it represented a concession to bank lobbying, and if not, why not. (paragraph 99)

The FCA has consistently maintained that the redress process has worked as intended. But there have been complaints that the process of the IRHP review falls short of delivering fair and reasonable redress. It has been difficult for this Committee to determine, however, whether these complaints are examples of isolated exceptions to an adequate process, or are signs of a wider, systemic problem with the review. (paragraph 114)

This in itself is indicative of a flaw in the process which the FCA should address. In particular, the FCA should collect the information necessary to establish whether there are systemic failures in the review. The FCA should publish its findings, a summary of the complaints it has examined, and take any action it decides is appropriate to ensure that all customers receive fair and reasonable redress. (paragraph 115)

Chairman of the Treasury Committee, Andrew Tyrie MP:
“Many small businesses have been badly hit by the complex terms of the IRHPs offered by their bank. A significant number of those firms who were mis-sold these hedging products feel that, having been ripped off in the first place, they have now been treated unfairly again by the FCA’s IRHP redress scheme.

“It is far from clear that the FCA’s scheme has delivered fair and reasonable redress to all the businesses affected. The FCA needs to do much more to demonstrate that this process is credible and has not unduly favoured the banks.

“As part of this work, the FCA should collect the information necessary to establish whether there are systemic failures in the review. This would benefit from independent oversight. It should publish its findings. Greater transparency is crucial in order to ensure that those SMEs mis-sold these products receive – and are seen to receive – appropriate redress. The Financial Services Act provides for the Treasury to require for this type of work to be done. But hopefully this won’t be necessary.” 

Tailored Business Loans and Clydesdale Bank

Over 60,000 fixed rate or tailored business loans containing embedded derivatives or ‘hidden swaps’ have been sold to SMEs by major banks and building societies including Clydesdale and Yorkshire Banks. These ‘loan contracts’ are in fact regulated ‘contracts for difference’ and are open to legal challenge as they were thereby often mis-sold, for example, due to inadequate warning of break costs. We have litigated more cases than any other law firm in the UK and are settling cases constantly including cases involving ‘hidden swaps’.

We have received evidence suggesting that Clydesdale Bank mis-sold Tailored Business Loans. Clydesdale has itself admitted that its terms and conditions letters would not pass a plain English test, and that its TBL customers could not reasonably have anticipated the high levels of potential break costs to which they had exposed themselves. Many small businesses indeed did not grasp their exposure to such high break costs, nor could they reasonably have been expected to do so. (paragraph 147)

It appears that the bank did not explain the potential scale of break costs in a low interest rate environment because the bank itself had not taken into account this potential risk. Banks, however, should be the experts in assessing the potential risk of products they sell, and explain those risks to their customers. The sale of TBLs has led to considerable consumer detriment. The bank’s failure adequately to assess the potential risk of its product may explain the detriment that the bank has caused to its customers, but does not excuse it. (paragraph 148)

From the point of view of the customer, the services provided by the hedging element of a loan with an embedded interest rate hedging facility—such as a Tailored Business Loan—and a stand-alone IRHP are extremely similar, if not identical. But stand-alone IRHPs are regulated, while loans with embedded interest rate hedging facilities are not. It is a logically inconsistent result of the perimeter of regulation that products whose effects may be identical fall on both sides of the perimeter. (paragraph 149)

Clydesdale understood that TBLs were unregulated. It created TBLs to avoid requirements imposed by the regulator on the sale of a regulated product, IRHPs. It claims that this was to simplify the associated documentation, and to make the product easier for customers to understand. The use of TBLs has left regulators powerless to enforce compensation for customers to whom products were mis-sold, as they have done with IRHPs. Clydesdale created a product that retained the risks and complexities of the regulated product, but had none of the safeguards. (paragraph 150)

The Treasury should publish an assessment of the feasibility, benefits and costs of adjusting the perimeter of regulation to cover loans with features of interest rate hedging products. This assessment will need to take into account the possibility that other products may inadvertently be included in the perimeter as a by-product, and the negative consequences that this could entail. (paragraph 151)

The lack of public oversight, minimal transparency and limited coverage of the scheme mean that the Committee cannot be confident that Clydesdale’s separate internal review will deliver outcomes equivalent to the FCA review upon which it is intended to be based. If Clydesdale’s aim is to build public trust in its actions, it should address all three of these problems. (paragraph 161)

Chairman of the Treasury Committee, Andrew Tyrie MP:
“The hedging element of Tailored Business Loans fell outside the scope of regulation, despite sharing – for all practical purposes – the features of regulated products.

“This gap in the regulatory perimeter meant that the product created by Clydesdale Bank was not covered by the usual safeguards. Many of its customers did not understand the product and could not reasonably have been expected to do so. Some were probably unaware that the product fell outside the scope of FSMA. Regulators have been powerless to provide redress to those affected by wrongdoing.

“Furthermore, Clydesdale’s own internal review of potential mis-selling appears to have serious shortcomings. It lacks public oversight, transparency and is limited in scope. All three of these problems need to be addressed by Clydesdale.

“The Treasury should, for the future, undertake a thorough analysis to consider the merits of bringing these products within the scope of regulation.”

The role of the regulators

Regulation can be an impediment to effective competition in banking. Regulators appear to have an instinctive resistance to new entrants: in the recent past, prudential requirements had been applied in a way that unnecessarily hindered new entrants, the authorisation process had been difficult for new entrants, and small banks had to reach an agreement with a larger one to have access to the payments system. The FCA now has a statutory objective to promote competition in the interests of consumers. The FCA must continue to transform its regulatory approach in order to fulfil this new objective. It is essential that the FCA’s approach to meeting this objective is not siloed within an individual department of the regulator, but instead permeates through the entire culture and approach of the organisation. (paragraph 250)

The FCA’s competition objective is new. The regulator is in the process of learning a new set of skills. The evidence suggests that this is a work in progress. The Committee recommends that the FCA, with oversight from the CMA, produce an annual report on the implementation of its pro-competition activities. In particular, the CMA should be invited to form a judgement on the effectiveness of the FCA’s competition regime. The FCA and CMA have concurrent competition objectives. They both remain active in the competition field. The danger is that the CMA retreats, and the FCA does not vigorously fill in the space left. The CMA should report publicly if it believes the FCA is not fulfilling its competition duties.(paragraph 251)

Chairman of the Treasury Committee, Andrew Tyrie MP:
“Regulation alone is not the answer. After persistent pressure from the Treasury Committee, the FCA is now required by law to promote competition in the interests of consumers.

“The FCA’s efforts to fulfil this objective and transform its culture are still work in progress. Much more needs to be done to put competition at the core of decision-making across the organisation. The CMA should assume responsibility for reaching an annual judgement as to whether the FCA is fulfilling its statutory duty to promote competition in the interests of consumers. It should ensure that its findings are published.”


In a blow for RBS, a bank which has in recent times obtained judgment by fraud in the High Court, the Treasury Committee has described testimony from senior RBS witnesses as “incorrect and therefore misleading” in respect of RBS attempts to deny that GRG generated profits for the bank.

In his report on RBS, Sir Andrew Large said that GRG was run as an “internal profit centre”. However, in written and oral evidence to the Committee, RBS disputed that description—even though it had had the opportunity to contest that point when it saw Sir Andrew’s report in draft. Mr Sullivan and Mr Sach told the Committee, on behalf of RBS, that GRG was not a profit centre. The Committee, having received further written evidence from Sir Andrew Large, the Chairman of RBS, Mr Sach and Mr Sullivan, has concluded that Mr Sullivan and Mr Sach’s original statements to the Committee on this point were wrong. It is now agreed by all that Sir Andrew was correct in his description of GRG as an internal profit centre. (paragraph 80)

The evidence that Mr Sach and Mr Sullivan gave was incorrect and therefore misleading, whether intentionally or not. RBS has apologised to the Committee and corrected its evidence. However, given the seniority of the original RBS witnesses, it should not have required intervention by this Committee with the Chairman of RBS to obtain that apology and a full statement of RBS’s position. (paragraph 81)

This misunderstanding of the bank’s position by two senior executives is indicative of a systemic weakness of standards and culture. It is understandable, indeed right, that banks should seek to support businesses in difficulty with special measures but how that is done and whether the institution or the customer is the main beneficiary needs much greater clarity. (paragraph 82)

The Clifford Chance review of RBS’s treatment of distressed customers, principally by the Global Restructuring Group, was welcomed by RBS as finding “no evidence of systematic defrauding of business customers”. However, the review—overseen by a bank executive rather than an non-executive director—was not independent, was based on narrow terms of reference, and left a number of questions unanswered, such as why GRG could not explain the size of fees it had charged, and the accuracy of its asset valuations.(paragraph 68)

The FCA is conducting its own review into GRG. It is important that this review comprehensively address the allegations against GRG, so that the public can be confident that any wrongdoing is identified and resolved. (paragraph 69)

Chairman of the Treasury Committee, Andrew Tyrie MP:
“Two senior RBS managers gave evidence to the Committee that was materially incorrect on a key point. RBS has subsequently but belatedly apologised.

“The Clifford Chance review of RBS’s treatment of distressed customers should not be considered a clean bill of health. A thorough investigation by the FCA already underway is crucial to the restoration of confidence in RBS as a bank. This investigation needs to demonstrate that RBS serves its customers’ interests rather than its own.”

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