Financial Products (Mis-selling)

Bill Wiggin Excerpts

Wednesday 12th June 2013 Westminster Hall

[Bill Wiggin (North Herefordshire) (Con)]

I thank you, Ms Dorries; as always, I refer the House to my entry in the Register of Members’ Financial Interests.

I want to discuss the limitations set by the Financial Services Authority, now called the Financial Conduct Authority or the FCA, in respect of its June 2012 review of the mis-selling of financial products to companies by UK banks in 2005 and 2006, which I shall refer to hereafter as “the FSA review”.

The FCA now holds the compensation fund contributed to by the banks that were guilty of such practices. The fund was set up to provide recompense to small and medium-sized enterprises—SMEs—that were mis-sold certain financial instruments. I seek the Government’s support in challenging the FCA’s definition of a SME as contained in the limitations of the FCA review, so that all businesses and not just the smaller ones may be permitted support and assistance from the FCA in claiming compensation for being mis-sold financial products.

I also wish to challenge the limitation placed on the types of financial products that were part of the FSA review. In 2007, the FSA implemented new conduct of business rules, which derived from the EU’s 2007 markets in financial instruments directive. Under those rules, customers are afforded different levels of protection according to the category into which they fit.

The three categories are retail, which includes private individuals and smaller businesses not regulated by the FSA; professional, which includes larger firms, some of which are regulated by the FSA; and eligible counterparties, which includes financial institutions such as investment banks and stockbrokers.

Before 2007, the boundaries between retail and professional customers were significantly lower than they are now. Today, as a direct result of the 2007 rule changes, the banks are prohibited from selling many products they used to sell to their customers. Recognising, however, that we had insufficient legislation and protection for our businesses against the banks’ mis-selling of financial products back in 2005-06, I question why the FSA review protected only some and not all of those affected.

I suggest that the limitations set by the FSA fly in the face of logic and reason, and wrongly exclude a number of organisations from deserved recompense. I therefore ask the Minister to require that the FCA increase the scope of the compensation fund. We should afford protection to all affected companies, regardless of their size and of which financial products they were mis-sold. Quite simply, if they were mis-sold anything, they should be entitled to the protection of the FSA review, and compensated accordingly by the FCA.

In June 2012, the FSA issued a statement regarding the banks’ mis-selling of financial products. The statement reads as follows:

“The FSA has today announced that it has found serious failings in the sale of interest rate hedging products to some small and medium sized businesses (SMEs). 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.

The banks will move to provide redress directly for those customers that bought the most complex products. They have also agreed to stop marketing interest rate structured collars to retail customers.

Interest rate hedging products can protect bank customers against the risk of interest rate movements and can be an appropriate product when properly sold in the right circumstances. During the period 2001 to date, banks sold around 28,000 interest rate protection products to customers.

These products range in complexity from comparatively simple ‘caps’ that fixed an upper limit to the interest rate on a loan, through to the more complex derivatives such as ‘structured collars’ which fixed interest rates within a band but introduced a degree of interest rate speculation.

Over the past two months the FSA has conducted a review of these sales. We have reviewed a significant amount of documentation from the firms (including sales files, customer complaints and taped conversations). We have also talked to over 100 customers who have come forward.”

In its investigations, the FSA found a number of poor sales practices by the banks, including poor disclosure of exit costs; failure to ascertain customers’ understanding of risk; non-advised sales straying into advice; over-hedging, which is where the amounts or the duration did not match the underlying loans; and rewards and incentives being a driver of the practices.

In its statement, the FSA concluded that

“not all businesses will be owed redress”,

which means that only SMEs, and only those SMEs that were sold interest rate hedging products, were entitled to redress. Those conditions left certain businesses, simply because of the number of employees they had or the amount of turnover they generated, being declared by the FSA as “sophisticated investors”, and not entitled to redress via the FSA, or the FCA in its new form.

For the FCA, a sophisticated investor is an organisation that is bigger than an SME, but I suggest that the term must surely apply to a person, firm or organisation that has a degree of sophisticated knowledge or understanding of financial products, and that the level of sophistication cannot be determined merely by size.

From information provided to me by a constituent, the FCA’s definition of an SME—a “non-sophisticated investor”—which has been agreed with the banks, is that it is an organisation with an annual turnover of less than £6.5 million, a head count of fewer than 50 and protected assets of less than £3.26 million. If a company cannot satisfy two or more of those criteria, it is considered outside the FCA’s scope for the compensation fund.

The definition hardly covers all SMEs, especially when we consider that they are differently defined by the Companies Act 2006. Under that Act, a medium-sized company is defined as having fewer than 250 employees—considerably more than 50—and a turnover of less than £12.9 million.

Furthermore, under European Commission guidelines adopted on 1 January 2005 with a view to harmonising the Europe-wide definition of an SME, there is a third definition whereby a medium-sized company is defined as having fewer than 250 employees and an annual turnover of less than €50 million, which is the equivalent of £42.5 million and therefore considerably larger than the figure in the FSA’s definition.

The FSA created its own definition of an SME with no public consultation and no logic or reason behind it, and in a way that seems to contradict legislation and EU guidelines. Perhaps it was influenced by the banks—perhaps not.

[Tessa Munt (Wells) (LD)]

We are talking about the very sector that has been hit hardest by the mis-selling of interest rate swap agreements. All we seek is growth, most of which will come from small and medium-sized businesses, so does the hon. Gentleman not agree that that group of companies and organisations should be given the best assistance possible, so that they can get out of these appalling agreements and carry on with their businesses?

[Bill Wiggin]

I partly agree, but I would like to see justice for all companies, irrespective of their number of employees or the size of their turnover. As a former banker, I know that the degree of sophistication needed to understand these complex products is extremely high. If companies were not properly educated into the deals they were doing, why should the FSA pick one particular group to protect? I agree with the emphasis on SMEs as a very important sector, but they are not the only sector.

We know that many businesses were mis-sold different types of financial product. In many cases, they were mis-sold products that were even more complicated than the interest rate hedging products covered by the review, but because they were mis-sold a different and more complex type of product, they, too, are not entitled to redress via the FCA compensation fund. Could it be that companies outside the FCA’s definition of an SME, such as my constituent, that were mis-sold complex financial products have suffered even greater financial losses than those that have redress available to them?

In the FSA statement of last June, Martin Wheatley, managing director of the conduct business unit, said:

“For many small businesses this has been a difficult and distressing experience with many people's livelihoods affected. Our work has focused on ensuring a swift outcome for these businesses that form such an important port of the economy.”

That was rather what my hon. Friend the Member for Wells (Tessa Munt) said.

Surely all businesses, large and small, form an important part of our economy. For my particular constituent, whose case I will cover in detail, the effects of the banks’ negligent malpractices were unquantifiable. It is almost impossible to predict how the company might have grown, how many more people it might have employed and how its development might have impacted on the local economy of Herefordshire had it not lost in excess of £2.25 million over just a few months, which it spent five years paying off. Because it had more than 50 employees at the relevant time and was doing well in turnover during the relevant period, it did not get access to the justice to which others were entitled from the compensation fund.

Despite my constituent’s company being clearly recognisable as a medium-sized enterprise under the Companies Act definition, it falls outside the FCA’s unique version of what constitutes an SME. I suggest that it is not alone, and that it is time that the floodgates were opened to provide redress to all organisations that have been the victim of bank malpractice, regardless of their size and of what they were mis-sold.

I think that we would all agree that the FSA review was necessary to bring order to the banks, to create accountability for past negligence and malpractices and to provide deserved recompense for those that had been misled and badly advised by the banks. However, it is now time to do more.

My constituent’s is a privately-owned, limited company, called allpay Ltd. Entrepreneur-led and owned, the company rapidly evolved from a groundbreaking idea in the 1990s—the owner re-mortgaged his house to get the business off the ground—and has now become one of Herefordshire’s biggest success stories. It was the first company to use magnetic swipe cards to collect payments for Departments, local authorities and registered social landlords cheaply, efficiently and safely. It now offers several bill payment solutions, and processes nearly £5 billion of central and local authority and RSL payments every year. The business deserves recognition and reward for its services to the public sector, its innovation and its creation of hundreds of jobs in the most rural county in England. The company is still growing.

In 2005-06, allpay was the victim of mis-selling by its bank, HSBC. Originally, allpay asked HSBC to advise it on the very type of product that was covered by the FSA review, but it was ultimately mis-sold something significantly more complex: three multi-callable range accrual interest rate swaps—products that, although speculative in nature, were sold as hedging by the bank.

The company had banked with HSBC for many years and felt that it could trust the bank to recognise its needs and understand which products were suitable. It was required to sign HSBC’s private customer terms and conditions, which confirmed that it did not rely on advice from the bank, but fully understood the risks as it was a sophisticated customer. The word “sophisticated” was not defined.

There is no evidence that allpay was made aware of the risks, yet HSBC continued to present more complex products for sale. The beauty of the bank’s sales pitch was to offer differing products—some suitable, but with a price attached, and some unsuitable, with a slight additional return and a purchase price of zero. The bank relied on an unsophisticated customer not to spot the unlimited risk associated with the free products should there be an adverse rate movement.

Under the terms of the agreement, allpay initially received from HSBC the difference between the interest rate that was first set and LIBOR on a notional sum, provided that LIBOR remained below 5.5%. We are all aware of the LIBOR manipulation scandal, and it is impossible to suggest that my constituent’s company was not one of its indirect victims.

The agreement was for five years. HSBC, not allpay, had an option to terminate the agreements at the end of each quarter; allpay had no documented exit route. It did not realise that at the time, because in no way was it ever a sophisticated investor with any degree of sophisticated financial knowledge about its entering into something akin to betting on a horse—in essence, gambling on LIBOR rates staying at a certain level. At the time, my constituent’s company entirely misunderstood the risks. Furthermore, even when it explicitly asked HSBC, allpay never received an explanation about the level of compensation that the company would have to pay if the bet was lost.

To go back to the FSA’s investigation of bank behaviour, there were several findings. It found poor disclosure of exit costs, and my constituent told me that allpay had no contractual right to exit and that no exit costs were stated. It found that there was a failure to ascertain customers’ understanding of risk, and I know that HSBC failed to explain the risks to allpay. It found that non-advised sales strayed into advice, and allpay told me that it asked for advice on hedging products but was ultimately sold something more risky. It found that rewards and incentives were a driver of such practices, and in this case the rewards for the employees who carried out the sale were significant. Therefore, despite ticking all the boxes looked into by the FSA review, my constituent still has no form of redress.

Ultimately, the horse did not win: my constituent’s company lost more than £2.25 million and overnight, with a change in the LIBOR rate, found itself haemorrhaging almost £5,000 a day—£35,000 a week or £455,000 a quarter—in interest. That was completely unsustainable, and would be for most businesses for any period. Worse still, those figures were the least amounts payable: if interest rates moved further from the agreed price, they could easily double, treble or more.

My constituent’s company was left in a very difficult position—completely over a barrel—facing certain insolvency and the probable loss of hundreds of jobs. The managing director attempted everything that he could: he threatened, begged, cajoled and applied to exit out of an agreement that had no exit clause. It cost the company dearly, not just in the interest payments made, but in additional costs of £1.5 million to cover the bank’s lost income. Ironically, HSBC provided the loan for the exit payment that it agreed to take.

My constituent’s company was advised to sue the bank for negligence, but by that time it did not have the resources to take on HSBC in expensive and lengthy High Court litigation. It asked the FSA to consider allpay in its review, but the request was refused due to its size at the relevant time and the type of product it was mis-sold.

The company asked HSBC for recompense. Appallingly, HSBC ignored it and responded to its correspondence only when I stepped in to offer my support. HSBC’s in-house lawyer finally engaged with my constituent’s company and entered into some dialogue, eventually inviting my constituent from Hereford to its offices in Canary Wharf on a “without prejudice” basis to discuss a settlement. The meeting was a waste of time: it lasted no more than 30 minutes, and it appears that HSBC dragged my constituent to London essentially to be told to get lost. The bank made it clear that it will discuss the matter further only if it is compelled to do so by the FCA, and if the case is brought within the review.

In March, the hon. Member for Dundee West (Jim McGovern) queried why other products were excluded from the FSA review. A constituent of his was mis-sold a fixed-rate tailored business loan and was excluded from the review. I understand that my right hon. Friend the Secretary of State for Business, Innovation and Skills is ready to press the FCA to extend the review’s remit, which I wholeheartedly support. An extension of the scope of the original FSA review is necessary.

The decision to limit the scope of the FSA review was perverse, because it did not take into account the categories into which companies fitted and what definition they met, nor the fact that companies, through no fault of their own but entirely due to a banking institution, were mis-sold a financial product and suffered significant financial loss. There is no logical explanation for the exclusion from redress of companies due to their size or to the type of product that they were mis-sold.

I appreciate that an extension might open the floodgates to a wave of new claims against other banks and trigger a significant increase in their provisions for mis-selling liabilities, which have already more than doubled to £2 billion, but the banks might just learn a lesson. I hope that the Government will support all affected businesses of whatever size, ensure that the banks are called on by the FCA to provide compensation for their malpractices and that the FCA is compelled to extend the scope of the review.

[The Economic Secretary to the Treasury (Sajid Javid)]

This is the first opportunity that I have had to serve under your chairmanship, Ms Dorries, and it is a real pleasure. I congratulate my hon. Friend the Member for North Herefordshire (Bill Wiggin) on securing this important debate. I acknowledge the strength of his feeling on this particular subject. He has put forward a considered and eloquent argument to the Chamber, and made a strong representation on behalf of his constituent.

I am sure that everyone present is keen to see a speedy conclusion to the Financial Conduct Authority review of the mis-selling of financial products. It is only right that businesses that have been mis-sold products are compensated accordingly.

The Government have been clear from the start that such practices are unacceptable. We take extremely seriously the abuse that has taken place, and we are determined that any wrongs that have been inflicted on businesses should be put right. My hon. Friend shared with us the example of allpay Ltd, which is a company in his constituency that was sold a hedging product but is not eligible for the FCA review. I am sure that my hon. Friend will understand if I do not go into the specifics of that particular case right now, but I am happy to look into any case, including the one that he has raised, in further detail.

I want to take this opportunity to address the key points that my hon. Friend has raised. First, he challenged the definition of an SME as used by the FCA in its review. He has argued instead that all businesses, not just the smaller ones, should be given support and assistance from the FCA in claiming compensation.

The FCA used the criteria for non-sophisticated customers, as set out in the UK Companies Act 2006, in its objective test. That is because those criteria are used for classifying companies that are subject to the small companies regime, and that have lighter reporting requirements. They are therefore the companies that are less likely to have staff or advisers with appropriate knowledge and skills to advise directors on the purchasing of financial instruments.

Moreover, I understand that the FCA review also changed the sophistication test in January to ensure that certain customers who were classified as sophisticated under the Companies Act test are instead classified as non-sophisticated and therefore brought into the scope of the review. I am sure that my hon. Friend will welcome that move, particularly as his constituency in Herefordshire, like mine in Bromsgrove, has many farmers. Had the change not happened, many farmers who typically have larger work forces and balance sheets than other SMEs could have been excluded.

The Government have been clear that where a business lacks the necessary skills and knowledge to understand fully the risks of such products, it should receive the appropriate redress. However, we do not agree that all businesses should have access to the FCA review. Instead, there needs to be a defined cut-off point where more sophisticated businesses are able to take responsibility for understanding the products or services they are entering into. There will be organisations that took one of these product with a full understanding of the risks involved if interest rates changed, and it is not for the Government to perform due diligence for such large, sophisticated organisations. Any such action would weaken incentives for businesses to act sensibly when purchasing financial instruments, and would potentially open the floodgates—a word my hon. Friend also used—to any businesses that have lost out from a financial transaction. I am therefore confident that the FCA has found the right balance to ensure that all non-sophisticated businesses fall inside the scheme.

My hon. Friend also mentioned the limitation placed on the type of financial products that are part of the FCA review. Given the widespread sale of the particular products included in the review to small businesses, it is reasonable that the FCA has established the parameters of its review on that basis. The FCA did that based on a full review of what products were sold to which businesses and by whom, and the full review includes all those products that were widely sold to small and unsophisticated businesses.

The FCA must also consider how to allocate its resources economically and efficiently, and it therefore seems reasonable that the review is focused on the products where the bulk of sales took place.

In closing, I reiterate that the Government take extremely seriously the abuse that has taken place in very many cases.

[Bill Wiggin]

I am most grateful to the Minister for taking the trouble to reply to this debate. He is right that there are some things in there, but will he agree to think about how a regulator such as the FCA should proceed in the future so that we get regulation across the board, and not just for specific groups of companies? It strikes me that it does not matter how many employees a company has or how big its balance sheet is, it should be behaving responsibly. In the case of larger companies, more jobs are put at risk if financial mis-selling takes place, and we rely on the FCA to be a regulator. I would be grateful if he bore that in mind.