Interest Rate Swap Products

George Eustice Excerpts

Thursday 21st June 2012 Commons Chamber

[Mark Garnier]

That is an incredibly important point. We live in an ever-increasingly complex world, and banks are competing against each other to come up with more and more sophisticated products that appear to be user-friendly, such as simple fixed rate mortgages. But as products become more complex there are more hidden elements in the contracts that people sign, such as in the one under discussion, whereby in a completely unforeseen period of super-low interest rates, business owners have to pay what amounts to a fee to buy themselves out of the contract’s residual value.

People then get into very complex calculations to try to understand what is going on, and the economic value of, and internal rate of return on, the contract. That is when things go way above the pay grade of most people, apart from those specialists sitting in dealing rooms in Canary Wharf who really understand such stuff. So, as part of the banking review and the Financial Services Bill that is passing through Parliament, we need to look very carefully at the classification of customers and of salespersons in order to get back to the fundamental point that we have to match products to a customer’s ability to deal with them.

[George Eustice (Camborne and Redruth) (Con)]

I have seen cases in which, through a process of legal discovery, a very clear e-mail trail has shown banks wilfully deciding not to explain the disadvantages of such products and, sometimes, a complete mismatch between the length of their loans and the length of the product they were selling. Does my hon. Friend agree that this is not just about people not understanding the situation, but about an intention in many cases by people not to inform customers because they wanted the business for their own bank?

[Mark Garnier]

The hon. Member—

--- Later in debate ---

[Peter Aldous (Waveney) (Con)]

I am grateful to my hon. Friend the Member for Aberconwy (Guto Bebb) for raising this important issue and for campaigning on it with such determination.

I wish to draw attention to a case study concerning a medium-sized business in my constituency, setting out its experiences and seeking to draw some lessons from them. At this stage, the business wants to remain anonymous, as it is seeking to resolve the matter with its bank without recourse to legal action and it does not wish to prejudice those negotiations.

In 2005 the business entered an interest rate hedging transaction that ran for five years. At the outset, taking into account the immediate outlook for the economy and for interest rates, there was some logic to such an arrangement. In May 2008 the bank contacted the business, recommending and urging it to renew the arrangement for another five years, even though the agreement was not due to expire until 2010, more than two years away. During the ensuing three to four months, the customer continued to receive correspondence and telephone calls from the bank encouraging renewal.

At a meeting on 15 August 2008, the matter was discussed more fully. Subsequently, on 29 October, more than two months later, my constituent sent an e-mail to the bank advising it that he did not wish to renew the agreement. On 4 November he received a contract from the bank for signature. The bank told him it was confirmation of the verbal agreement reached on 15 August. Under pressure, not wishing to upset a business arrangement with his bank that had been in place for many years and at a time when the economic outlook was uncertain and the customer was keen to keep on good terms with the bank, he signed the agreement.

Earlier this year, my constituent decided, having sold a property, to bring the agreement to an end, so he contacted the bank to establish the cost of doing so. He was advised that that would cost more than £72,000. Up to today, the whole arrangement has cost him £162,000 in interest charges, which are predicted to have risen to £200,000—40% of the value of the loan—by the end of the arrangement in September 2015.

I have three observations on that chain of events. First, in whose interests was the bank acting? Its own or its customer’s? Why did it put pressure on him to renew the agreement when there was no need to do so for another two years, until 2010? In 2008, taking into account the outlook for interest rates and their likely future movements, there was no incentive or reason for the customer to rush to renew. It would have been much better to see what would happen over the following two years. Any independent adviser acting in the company’s best interest would have advised it to do that. In my view, the bank’s actions were dictated purely by its own self-interest rather than the best interests of its customer.

Secondly, the bank appears to have been incompetent at best, and at worst to have adopted underhand tactics in putting pressure on the customer to renew the agreement. Obviously what happened at the meeting on 15 August is subject to disagreement, but I personally accept my constituent’s version of events. Surely the best practice for the bank to have pursued would have been to take its customer through the arrangement step by step at that meeting and, if there was a verbal agreement, to produce a contract immediately and not two months later. A further meeting should have taken place, to go through the contract line by line, until the customer was fully aware of the implications before signing. The fact that the bank did not send the contract for two months, and only did so because it received an e-mail from its customer indicating that he did not wish to proceed, shows it in a very poor light.

Thirdly, there is a clear failure by the bank to provide full, independent and impartial advice that sets out the pros and cons of the transaction, in particular the cost of breaking early. If my constituent had been aware of all those factors, he would not have renewed the arrangement.

I am keen to give other hon. Members the opportunity to state their case, so I will conclude with two points. First, this whole matter needs to be addressed straightaway and given high priority by the FSA, and a framework should be put in place for cases to be investigated quickly with proven claims settled immediately. We do not want this scandal to drag on for years, because that could undermine the very businesses on which the economic recovery needs to be built.

Secondly, we need a banking system that is regulated and run in a way that prevents such conflicts of interest. In the case I have described, the bank was clearly acting in its own interest rather than that of its customer.

[George Eustice]

Does my hon. Friend agree that if banks encourage their customers to take up such products, they should not then be allowed to provide them through one of their subsidiary companies? That would be one way of creating a division.

[Peter Aldous]

I agree entirely with my hon. Friend—a dog cannot serve two masters. The two acts of advising a customer and selling a financial product must be completely separate and provided by organisations that are independent of each other and not related parties.

I support the motion and look forward to hearing from the Minister about the Government’s proposals for achieving a prompt resolution to yet another bank selling scandal.

--- Later in debate ---

[Chris Heaton-Harris (Daventry) (Con)]

Thank you for calling me to speak in the debate, Mr Deputy Speaker. I appreciate the opportunity as I did arrive late. I have come directly from the Defamation Bill Committee, but I hope that I shall not defame the banks too much as I talk about this scandal that they have been perpetrating. I shall test the Enoch Powell theory of public speaking today; if it is true, this is going to be a blinder of a speech.

I congratulate my hon. Friend the Member for Aberconwy (Guto Bebb) on securing the debate. The quality of all the contributions, raising constituency cases as I intend to do, has shown me that this scam, which has been taking place for a long time, is a massive one of ginormous scale that requires firm action as soon as possible. I also congratulate the Backbench Business Committee, which has yet again come up trumps in calling a debate that our constituents would like to hear, and that probably would not have been heard in normal circumstances under previous mandates.

I will try not to repeat the points that other Members have made, but I want to give some details about a couple of cases in my constituency. I also want to press the Minister on the matter and issue a call for action. My hon. Friend the Member for Staffordshire Moorlands (Karen Bradley) gave the House a description of the swaps. I was a small business man before I entered politics, and I can understand how those businesses were caught by this scam. The relationship that they have with their bank manager—and perhaps with their relationship manager, as we have heard—is all important, or it certainly was until these products started to be sold. It was a relationship based on friendship and trust. It was understood that products were being bought and used, but it was always felt that independent advice was being offered and that the bank would put you right all the time. That has been completely lost with the sale of these interest rate swap agreements. Something really bad happened back in 2003-04 when all this started to happen.

Two of my constituency cases are happy to be named and others are not. My constituency is full of vibrant small businesses. In one case, Mr Benyon has two companies: Oastlodge Ltd and Hallway Estates Ltd. Oastlodge had been with Lloyds bank for over 35 years, and Hallway for just over 10. In 2004, Oastlodge was taking out a large loan and was advised to take out a swap. This would have increased overall borrowing costs—the right questions were asked of the person trying to sell the product—so the company requested not to enter. In 2005, Lloyds came back with an offer for a swap where the bank would halve interest margins on all existing loans. The offer was in writing. A business man confronted with having interest loan costs halved is likely to be interested in taking up the offer. In 2006, the company was sold a further swap, on the basis of reducing the overall cost of borrowing and saving even more money.

In 2008, Oastlodge and Hallway were offered several more swaps, and one in particular was highlighted. All the benefits were listed in great detail, but none of the downsides; neither was any information provided on potential breakdown costs. It was also explained in writing that

“there would be no risk to borrowing costs trailing higher”.

The previous swap had been for 10 years; the new ones were for 20 years—far longer than the duration of the loans at the time. The swap was signed up to, with the companies knowing full well—or, at least, thinking they did—that there was a ceiling on the borrowing costs.

In 2009, the companies were informed, when their loans were up for renewal, that their lending margin was going to double. They complained that the bank was reneging on a deal, but were told that there was nothing formally agreed. The bank could, however, sell them another swap to reduce borrowing costs until 2013. They now had no choice but to enter the new swap at a cost of about £200,000 a year.

While they were making their complaint, the companies discovered that the swap was not a relationship with the bank they thought they were dealing with, as it had been sold on in the financial markets. Other Members have highlighted this. The companies took legal and financial advice but, despite having a good case, were wary of risking the extra costs of taking the bank to court. In fact, my hon. Friend the Member for Aberconwy is their last best hope, and I suspect that that is so in many other cases, too.

[George Eustice]

One problem many businesses have is that when they decide they want to take legal action against a bank, they often find that many of the law firms that might appear to be the natural ones to turn to have effectively been bought off by the banks through things called permanent retainers and through the approved panels. Some of the best litigators in the country are thus often barred from acting against the banks.

[Chris Heaton-Harris]

I did not know that, and I thank my hon. Friend for raising it.

Lloyds bank has denied any wrongdoing whatever, claiming that the margin reduction was not necessary for the duration of the swap, and it hides behind the small print that says, as we heard earlier, that any advice given was not, in fact, “advice”.