Interest Rate Swap Derivatives

Mark Lazarowicz Excerpts

Thursday 24th October 2013 Commons Chamber

[Guto Bebb]

I could not agree more with my hon. Friend. The expectations back in 2007 were that interest rates would go down, yet there were numerous examples of bank sales teams informing businesses that they needed to protect themselves against a rising interest rate scenario—contrary to the information that the banks themselves had.

Another key call is why there is no appeal process within the redress scheme. There would be much more confidence in that scheme if there were an appeals process. I understand that the Financial Ombudsman Service offered to provide an appeals service, but the offer was rejected by the FCA. It would give some comfort without complicating issues too much if, for example, assessors working for one bank in the redress scheme were able to provide an appeals process for another bank in it. That may not be perfect, but it would help to avoid over-complicating what is already a complicated redress process and it would give businesses the confidence that there is an appeal process and that they can turn to somebody else to argue their case. We should be very concerned about having a redress scheme without any appeal process, as it goes against the principle of natural justice, while opening up the door to litigation, when the whole point of the redress scheme was supposed to be to avoid litigation.

Embedded or hidden swaps, which are currently excluded from the redress scheme, are another key issue to highlight and a matter of huge concern. If we think about it, a hidden swap is quite possibly worse because businesses were not even aware that they were also taking out with their fixed-rate loan an interest rate derivative product. The American author, James Riley once said:

“If it walks like a duck, and swims like a duck and quacks like a duck, then it must be a duck.”

The same point needs to be made about these hedging products. If the impact of an embedded swap is the same as the impact of a separate hedging product taken out with it, it is difficult to argue that the small businesses that were sold those products should be excluded because of a technicality relating to whether they are subject to the FCA regulations. I ask the Minister to respond on that specific issue.

A publican from Aberystwyth, Mansel Beechey, was sold one of these embedded products. I know Mansel very well because when I was a student in Aberystwyth, I was financially illiterate and used to cash cheques in the pub. I used to do that on a Wednesday evening and pay 50p for the privilege. On a Saturday evening, I would want to cash a cheque again, and Mansel would say, “Well, make it one for £30, and I will give you back what you gave me on Wednesday, only charging you the 50p once.” Mansel Beechey thus showed me more respect and consideration, in behaving properly towards me, than the bank that sold him the hidden swap showed to him. That business had been built up over a long period. If Mansel Beechey could show to me a degree of responsibility that had not been shown to him, there is clearly something wrong with our banking sector.

[Mark Lazarowicz (Edinburgh North and Leith) (Lab/Co-op)]

Will the hon. Gentleman give way?

[Guto Bebb]

I am afraid that I cannot take another intervention.

The issue of hidden swaps is important and needs to be addressed. We need to know why businesses to which they were mis-sold have been excluded from the redress scheme. Thousands of businesses have been mis-sold these products, banks have admitted that the products were mis-sold, and yet the redress scheme is not, as yet, performing as it should. I am not looking for a new scheme, but I am looking for changes, and much greater speed, in the scheme that we currently have; and I think that we need to address some of the exclusions, which are clearly unfair.

I became involved in this issue when a constituent of mine, Mr Colin Jones, came to see me. He claimed that he had been sold a complex product and that, as a result, his business had gone under. The last news I heard of Mr Jones was that he was homeless and living with his mother. He has lost absolutely everything, and because his business was a limited company, it is highly unlikely that even if the redress scheme highlights the fact that he was mis-sold the product and is in need of compensation, he will not benefit from that compensation personally. I think it wholly wrong for someone to lose his business not because he was a poor business man, not because he made a mistake, but because he was taken advantage of by his bank. Having listened to the trade calls, I am quite happy to say that publicly.

I am delighted to note the interest in the issue that is being expressed in the Chamber today, because I believe that businesses all over the country are looking to us to give a lead. I hope that the FCA and the banks will listen to what is being said, and I sincerely hope that the redress scheme will start to perform in the way in which it was expected to perform in January, rather than in the slow and bureaucratic way in which it has performed so far.

--- Later in debate ---

[Mark Garnier]

My hon. Friend is absolutely right in what he says. The banks made an incredibly cynical effort to persuade people to enter into these contracts where, in many instances, they should not have done so. Sometimes it was the right thing to do, and I think that many businesses will agree that they just got it wrong, but we need to look after the smaller businesses that were simply mis-sold these products.

[Mark Lazarowicz]

Do not the banks, or at least some of them, also have to be much more proactive in identifying the people who been the business victims of this practice? As we all know, whenever we have a debate such as this, more people come forward who were frightened to come forward before or who did not even realise that they were victims of these schemes. It is up to the banks to be much more proactive in identifying the cases and then trying to resolve them.

[Mark Garnier]

That is absolutely right. Part of the problem, however, is that the banks have an incentive not to get in touch with people, for obvious reasons. That relates to the second point I wish to develop. It is a technical point, but it is incredibly important in terms of why it is incentivising banks to delay technical redress for as long as they can, and it has implications for the financial stability of the banks.

We should not think of these things as stand-alone products, but should recognise them for what they are. They are not stand-alone products; there is another side of this trade. They are swaps for a reason, and it is important to understand what a swap is. Any one of our victims will have been persuaded to take out a contract with the bank that has the beneficial effect of capping interest rate payments at a certain level. That is a virtuous thing and we are all familiar with the financial planning behind the thought process, through things such as fixed-rate mortgages. But these are not fixed-rate mortgages; they are stand-alone products that relate to a loan, but are not part of that loan. Importantly, many people have paid off the loan but still have the outstanding liability on the swap. The quid pro quo of having a fixed cap on interest payments is the collar that has caused so many problems for our victims, whereby they have to pay a relatively high rate of interest in today’s terms. What is not fully understood is that this is not a simple contract with the bank, as it first appears. The bank is not taking a naked bet with its customers that, in the environment of falling interest rates, it has won. It is not receiving as profit the penalty in the increased premiums being paid in interest rates by the victim, because for a swap to actually be a swap, there is a matching trade with a third party on the other side. What the banks receive in higher interest rate payments they are paying to an opposing and third-party counterpart on the other side.

I shall now go into a bit more detail. Businesses may want to make sure that they do not pay too high an interest rate; that is why they are persuaded, rightly or wrongly, to take the swaps. However, an organisation such as a pension fund needs to guarantee its income should a severe drop in interest rates, such as we have seen, occur. It would want to take a position opposite that of the businesses, which are the victims.

The pension fund will forgo a rise in rates while winning the guaranteed floor rate that it will receive. For a business to have a rate cap at, say, 7%, it will guarantee to pay no less than 5%. For a pension fund to be guaranteed to receive a minimum payment of 5%, it would agree to receive no more than 7%. In that way, the business’s and pension fund’s interests are perfectly aligned in opposition.

As both the pension fund and business are clients of the bank, the bank does two simultaneous trades—one with the business, to cap and collar the rate payments, and the other with the pension fund, to collar and cap the interest rate receipts. The bank makes a small margin, but essentially its liability, if everything stands up, is perfectly and oppositely aligned. That is the symmetry of liability and the basis of the swap market.