When the UK's Financial Services Authority (FSA) banned HSBC, Lloyds, Barclays and RBS from selling interest rate swap agreements (IRSA) to UK businesses, it opened a can of worms in terms of the sheer magnitude of the potential mis-selling of products that could cost the industry billions of pounds.
At the end of June, the FSA found that about 28,000 of these products had been sold to businesses and there were "serious failings" in the way they had been sold by banks.
The findings highlighted industry questions as to why many businesses, which had never purchased anything more complex than a simple fixed rate loan or mortgage, were sold these products in the first place.
Only two months later, Martin Wheatley, managing director at the FSA and CEO-designate of the Financial Conduct Authority (FCA), published a report on clamping down on banks sales rewards which he said led to mis-selling of many types of financial products - not just complex hedging derivatives.
While many people breathed a sigh of relief when the FSA released its findings this year, the results of an IBTimes UK investigation into the fallout of banks mis-selling complex derivatives have revealed that there is still a significantly long way to go to rectify the problems.
The Foundation for Problems
A decade ago, many SMEs, generally family-owned companies or private groups, were looking to expand.
In most cases, the companies were looking for mortgages or basic loans to purchase a warehouse or office space to accommodate the expansion of their home-grown businesses.
A relationship manager would liaise with the business and the bank to discuss the options available and bridge the two parties to close a deal. It is important to note that these relationship managers were not FSA-authorised and therefore only allowed to give general advice. They had to advise the client that before making any financial decisions they should first determine whether the information was appropriate by consulting a qualified financial adviser.
However, what has emerged through business complaints, an FSA review and the IBTimes UK investigation is that while the loan or mortgage was being arranged, these businesses were being sold complex hedging products - IRSAs.
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 are 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 in interest payments each year.
But wrapped into these types of agreements is a clause that if firms want to cancel the 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.
Abhishek Sachdev worked at the Treasury for a short time and then at Lloyds for nearly 10 years and one of his areas was the hedging department. That department would provide derivatives products for large and small businesses, which led to some businesses such as hotels buying £200m-£300m hedging products.
"When I sat around a table with the big accountancy firms, chartered surveyors and various other firms, I realised that most of them were clueless and had little idea as to the true nature of these products and how detrimental it could be if they made poor hedging decisions," said Sachdev, who is now managing director at Vedanta Hedging.
Businesses Locked Into Failing?
The situation described by Sachdev is reflective of the businesses the IBTimes UK has spoken to for this investigation.
Many of them are claiming that over the years, the banks mis-sold them IRSAs through unsolicited approaches, lack of communication, clear documentation to sign, and in some cases products that are longer than the life of the loan, when all they wanted in the first place was a simple mortgage.
"After working in this area for a long time, I realised, that there was almost nowhere for SMEs to turn to for truly impartial independent advice on hedging. Almost all banks write in their terms and conditions that the SME must seek their own independent advice," said Sachdev, who is also an expert witness in a number of ongoing mis-selling court cases and is therefore restricted from giving more details of specific examples.
"However, a solicitor or accountant is not FSA-authorised to advise on these products. Until recently, there were no companies authorised by the FSA to give derivative advice to SMEs, so where these businesses supposed to turn to? This led me to create Vedanta Hedging which is FSA-authorised, in order to provide more transparency when SMEs are seeking new or additional hedging," he added.
One business that was willing to go on record and is indicative of a number of businesses that wanted to remain anonymous for fear of jeopardising their negotiations is Barrel Resolve, a document management and archive company.
Greg Vinyard and his wife have been running their business from their home for 15 years and had been growing it with no problems.
In November 2005, Vinyard said they decided to buy a warehouse and contacted their business manager at Barclays. He referred them on to a relationship manager at the bank who went to their home and told them that they would be granted a £1,140,000 mortgage on the warehouse. It was arranged in March 2006.
However, what followed was representative of what many businesses who claim they were mis-sold ISRAs went through.
"In December , we got a confirmation letter for the mortgage, subject to final approval, and then they recommended life cover and for us to enter 'some kind of interest rate protection policy'," said Vinyard. "We were lambs to the slaughter.
"We just received the documents confirming the rate swap agreement. We were told this was normal procedure but we were not given any information or explanation in plain English about what the product was or what it meant for our business or that we would have to pay Barclays.
"We told Barclays repeatedly that we do not understand what the product is and what is happening and our relationship manager even admitted to us that he did not understand it either. We had one meeting with Barclays in Canary Wharf [after it had purchased the product] and we still left the meeting with no new information or explanation of what we were bound to," he added.
Vinyard's situation is troubling and he says that now they are "treading water" after already paying £170,000 over three years in swap payments to Barclays. The company's turnover is about £400,000, before taking into account tax, bills and mortgage payments.
"When we took out a loan with Barclays we honestly thought we were just purchasing a mortgage on a warehouse as we have never bought a 'financial product' in our entire lives. We have been slowly sinking for three years and we have cut back our resources to the bone. We simply cannot employ any more people," said Vinyard.
He added that the bank was still taking thousands of pounds out of the Vinyard account each month and felt that Barclays was "just ignoring us while hoping we slip into bankruptcy and the problem goes away".
"I hope that is not the case but with no contact and still taking payments out of our account, we feel like this is what they are hoping is going to happen," he added.
Barclays was contacted by the IBTimes UK about his case and sent the following statement:
"We are sorry to hear that Barrel Resolve is dissatisfied with the product they purchased from Barclays. Barrel Resolve entered into these products in 2006 and only recently raised a complaint to us. As part of the FSA independent review process, Barclays has informed the company as well as our other eligible customers about the next steps to be taken."
In a similar case, Adcock & Sons, a small privately owned electrical retailer in Norfolk, is trying to stay afloat. Coupled with the natural strain on the business in the recession, it is still making payments on a swap.
Despite UK interest rates being held at a record low of 0.5 percent, Adcock & Sons is paying an interest rate of 9 percent on a commercial mortgage, generating a bill of just under £80,000 a year.
Adcock said he did not know that the interest rate swap that came with the extra features would have triggered the deal swinging against him. He was sold, he said, a bet on the Bank of England's offered rate not falling below 4.7 percent.
Since rates have stood at 0.5 percent since May 2009, Adcock, like many others, has been paying unsustainable amounts on a product that bears little resemblance to the loan he thought he had taken out in the first place.
Adcock, like Vinyard, has had to lay off staff and said it was unlikely that the business would survive much longer. The Barclays Capital salesman who sold him the contracts had said that the protection would be "free", he claimed.
While any bank expert would be keen to point out the legal limitations of what the relationship manager or salesperson is allowed to talk about, businesses have questioned the sales tactics and non-full disclosure or scenario explanations by the salespeople.
"Of course, before the credit crisis, the product would technically be free," Adcock told IBTimes UK. "However, what in many cases happened was that it was not explained from the outset how it would 'cost' a company enormous amounts should rates reach a certain level."
In reply, Barclays said: "Barclays has an ongoing dialogue with Mr Adcock. We continue to work with the company, utilising the expertise of our business support team to respond to the challenging market conditions faced by the retailing sector."
Finding a Resolution
Businesses claiming to be mis-sold derivatives by the banks told IBTimes UK that clear and full information was not disclosed at the time of buying the product.
Sources close to the big UK banks confirmed that many of the businesses were given presentations by FSA-authorised employees to fully break down the components of these products. However, the sources added that many customers were only given these presentations after they were locked into swap agreements.
"I have been consistently shocked that banks have been selling these type of complicated products to small businesses and I have tried to alert the authorities several times over the last 18 months of the sheer magnitude of this situation," said Sachdev.
"I have seen several SMEs that had five-year loans, but 30-year complex swaps known as 'bermudans'.
"The situation is clearly a lot more complicated than anyone anticipated and while people relate this to PPI, the mis-selling of derivatives is far more complex and more damaging to British businesses industry than PPI ever can be," he added.
Other companies, such as Commercial Finance Solutions UK Limited (CFS, has also seen an influx of people being sold IRSAs and other complex derivatives products it believed had been mis-sold.
Andrew Craddock, director of CFS, is an ex-banker and now acts as a broker of dispute resolution. He said that just last year alone, the number of clients claiming to be mis-sold IRSAs took up 80 percent of his time.
"Despite trying to help resolve client disputes, I still have people coming to me with product proposals from banks that essentially have been throwing weird set-ups for small businesses," said Craddock.
"Seeing many clients' cases, it begs the question as to why many of these businesses were sold these products in the first place. For instance, I have a property developer client who was sold a 15-year swap which has essentially crippled their business and in other cases clients that have IRSAs or other swaps exceed the life of the loan."
Another business that IBTimes UK spoke to, but who wanted to remain anonymous because of ongoing negotiations with its bank, said that it was sold two swaps that were longer than the life of the loan. When it won a case against the bank through the financial ombudsman, the bank appealed. In the meantime the company is still making payments on the swap.
Is the FSA Ruling Enough?
In June, the FSA banned the UK's four largest banks from selling IRSAs and found that during the period 2001 to date, banks had sold about 28,000 interest rate protection products to customers.
"For many small businesses this has been a difficult and distressing experience with many people's livelihoods affected," said Wheatley. "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."
Despite the banks being found guilty of serious failings in the sale of interest rate hedging products to some SMEs, the banks are now in charge of leading investigations into all the potentially affected customers with the aid of independent reviewers. The independent reviewers are overseen by the FSA.
The FSA said that although not all businesses will be owed redress, 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.
The banks are also in-charge of the redress procedures for each customer.
"The June FSA agreement with the banks [which includes the them being banned from selling IRSAs], as well as August's findings and recommendations on banks' sales staff incentives, is a great step in the right direction but it is my strong view that these are still very limited," said Sachdev.
Sources close to the FSA said: "The FSA does not have the level of resources needed to look into these number of cases. Also it should be up to the banks to investigate as they have all the original documentation. The idea of an independent reviewer is to make sure the process more smoothly by an unaffiliated source."
The businesses themselves are finding ways to get their voices heard because they believe that since the FSA has allowed the banks to be in charge of investigations and compensation, the time delay and lack of action mean many businesses will not reach a resolution.
"I understand that it takes time and significant resources to look into all these cases but the reason why the business owners are now at the end of their tether is because we have been largely ignored for years," said Adcock.
"In some cases, like mine, we have been trying to get an answer for years and now with further investigations, it is going to take even longer. When the FSA investigation was published, we were all initially excited that the nightmare for many people may end, but all it did was add to the delay and denial tactic that the banks have been using."
Companies such as Barrel Resolve said that they had tried to complain and get an answer from the banks themselves but were directed instead to a complaints phone line.
Vinyard said: "We contacted the FSA after seeing a number of people on the news in situations that echoed our own. We had a half-hour interview with the FSA but after that they said that they wouldn't be drawn into the actual dispute and that we had to complain to Barclays."
Vinyard said that the only contact he has had with Barclays since then was a circular letter enclosing a leaflet from the FSA and a letter that said that Barclays and the independent reviewer were looking into his case.
"We have been fobbed off by the bank since June and they have refused to speak to us," he said. "Yesterday, our lawyer received a letter from the bank saying that we are intermediate customers and will not be reviewed by the FSA scheme. As the classification was entirely the banks' instigation this is very upsetting."
A representative at the FSA told the IBTimes UK: "The independent reviewers will be a key part of the process to make sure that this is resolved properly. There is a lot of information on our website about this. Discussions with the banks have been wholly focused on getting the right outcome for those people who bought these products and insuring that there is a thorough review of their sales."
HSBC said: "We are working with the FSA and an independent reviewer and we will be providing customers with further information about this process as soon as possible. We are committed to building long-term relationships with customers and will provide clear communication to all customers throughout the process."
RBS also responded to claims in this article and told us: "The RBS Group has reached agreement with the FSA on an approach to the issues surrounding interest rate swap products for SMEs. We believe that an independent review process will help to bring the clarity and certainty that customers and other stakeholders need.
"In the case of a small number of less sophisticated customers who entered into more complex swap products we have agreed to move directly to redress. We believe risk management products are an essential part of corporate banking and it is important we restore customer trust in this area. We are committed to the fair and timely treatment of our customers and will work closely with the FSA to achieve that end."
A spokesperson at Lloyds told IBTimes UK: "We are fully engaged and participating in the review of interest rate derivative products, which will provide redress to certain customers as set out by the FSA and we are taking this process very seriously.
"We have already written to those SME customers with structured collar products to notify them that they are party to the review and that their case will be reviewed by an independent assessor. In due course, we will also write to those with interest rate products deemed to be simpler in nature to notify them that if they would like their case to be reviewed that we will do so.
"Interest rate derivative products were not products that we sold widely to our SME customers with over 90 percent of our SME customers that wished to protect themselves against interest rate moves doing so through fixed rate loans."
Barclays added: "Barclays welcomes the clarity and certainty that the independent FSA review process will bring for customers. Barclays is finalising the detail of the review with the FSA after which Barclays shall be writing to all eligible customers to let them know the next steps to be taken for their particular case.
"Where there is evidence of failures in the way these products were sold, Barclays will work hard to make things right. We continue to believe that risk management products such as interest rate swaps remain an effective tool for some businesses wishing to hedge their exposure to interest rates and can be an appropriate product when sold properly."
Businesses Fighting Back
After years of disputes and companies teetering on the brink of collapse due to the swap payments exacerbating the already tough trading conditions, businesses have started to group together to find a solution.
Independent campaign group Bully-Banks, which has 700 members, has set up a new company called Ordinary People in Business Ltd (OPB) to help members to each separately start litigation proceedings against UK banks that they believe have mis-sold them complex derivative products.
The group, led by Jeremy Roe, who runs a chain of holiday cottages, set up Bully-Banks after he said he fell victim to mis-selling. The group has since managed to meet UK Treasury officials to discuss its concerns over the FSA's review and agreement with the UK banks' and how in turn the government can aid them.
"From January to June this year, Bully-Banks was speaking with senior officials at the FSA before it released its paper," said Roe. "We presented a survey from all our members, as well as our concerns about how we could get a resolution from the banks. We also outlined points that would enable us to get a succinct and independent review of our cases and how best to move forward with compensation on mis-sold products."
Roe added that they included a number of case studies, including their own and outlined how there should be a clear definition of what constitutes mis-selling, for example, if the swap is longer than the term of the loan.
"When the FSA delivered their verdict on the banks, the conclusion was astonishing," said Roe. "The FSA did a couple of things of principle, like the product selling ban, but it largely neglected to include key points that would resolve the situation more quickly. The banks that the FSA found to have engaged in serious failings in selling derivatives to businesses are now in charge of investigation and compensation. The FSA also failed to define what constitutes mis-selling so it has given the banks a blank canvas on what they would see as mis-sold product.
"Another couple of points that the FSA failed to do was to put a deadline on these investigations which spells disaster for many businesses that are already struggling to survive," he added.
Banking on a Deadline
The FSA agreement with the banks does not include a deadline, which Roe and many other UK businesses owners have voiced concerns about because coupled with other issues, a lack of time limit on resolving an issue could spell the end of a company.
Bully-Banks and its members, including Adcock, said that this, along with the lack of enforced suspension of payments from the businesses, was a major point that FSA ignored.
"The main serious concern when we first met the FSA was that there has to be some kind of immediate release for businesses while investigations are ongoing," said Adcock. "Some of us have been trying to resolve our situations for years but each month we pay a substantial amount out of our accounts.
"We appreciate it would take a degree of time to put in place but the lack of an enforced respite for companies, coupled with the lack of a deadline for the banks' investigations, means that businesses are dying. Some banks, such as HSBC, suspended some payments for customers while they investigate but not for all and it shouldn't be this way," said Adcock.
Only a few days before the FSA revealed its agreement with the big four, one company that wanted to remain nameless fell into administration.
The owner said that while business was going well, the swap payment forced it into bankruptcy and it was trying to stop the bank selling its assets because "it put us there in the first place".
Lack of Deadline and Legal Constraints
The lack of deadline may also lead to legal ramifications for the customer, not the bank.
The FSA said that banks had agreed to review all sales of interest rate hedging products to "non-sophisticated" customers made on or after 1 December, 2001.
However, the agreement does not affect the application of the Limitations Act to claims that are brought through court proceedings.
"Customers who are unsure about whether they are still able to bring about court proceedings or are concerned that they may run out of time should they decide to issue court proceedings, should consider seeking legal advice," it adds on its website.
The statute of limitation is six years. The risk of further delays could mean a customer not being left with much choice.
Roe said many claimants had had to wait six years already - for even a direct response from the bank. He said that Bully-Banks were making progress in talks with parliamentary officials and it was delivering another 14-point plan on resolving the mis-selling issues.
The plan also calls for banks to find ways of putting business swap payments "on ice" while disputes were being resolved.