Interest-rate Swap Agreements

– in the Scottish Parliament on 13th June 2013.

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Photo of Elaine Smith Elaine Smith Labour

The next item of business today is a members’ business debate on motion S4M-06307, in the name of Roderick Campbell, on sales of interest-rate swap agreements. The debate will be concluded without any question being put.

Motion debated,

That the Parliament notes with concern that banks throughout the UK, including some banks in Fife and across Scotland, may have mis-sold interest rate swap agreements to small and medium-sized businesses; further notes the campaign by bullybanks.co.uk to further highlight this issue, and notes calls for banks to adequately compensate businesses that have been affected and for the Scottish Government to engage appropriately with stakeholders to ensure that customers throughout Scotland are offered appropriate redress.

Photo of Roderick Campbell Roderick Campbell Scottish National Party

I welcome members of the support group for customers of National Australia Bank, who are in the gallery, and I thank MSP colleagues who have stayed behind for the debate. I also acknowledge the contribution of Simon Bain of The Herald on this issue.

Following the payment protection insurance scandal and the manipulation of London interbank offered rates, perhaps we should not be surprised that the banks are again in the midst of another scandal—interest-rate swaps misselling. The banks certainly have a long way to go to restore their battered image, which is being further tarnished this week by the latest scandal highlighted by The Times.

The issue was first brought to my attention by a constituent back in 2011, and I have had a considerable amount of correspondence with the Clydesdale Bank on the matter.

It is clear that the product that my constituent was sold is not a straightforward financial product. In the past, many people placed a lot of trust in their long-term relationship with the banks, but the days of the friendly bank manager have long since gone. Sadly, banks today seem to many to be finance shops with substantial sales forces operating on commission, to the neglect of customers’ real interests.

Bully-banks has been at the forefront of the campaign to highlight the issue, and has illustrated just how it has affected small and medium-sized businesses across the United Kingdom. At Westminster, the all-party parliamentary group on interest-rate swap misselling has met often to discuss the issue, and I am grateful for the assistance of the Liberal Democrat MP for Ceredigion, Mark Williams, and his caseworker, Lisa Francis, and of the Labour MP, Clive Betts.

Some members may be asking what exactly interest-rate swaps are. At the basic level, banks would offer customers the right to fix the base rate on a loan at a certain level, to ensure that a rise in interest rates would not lead to companies’ borrowing costs rising to a level that they would be unable to pay. Customers were routinely advised that it was like a form of insurance or fixed-rate mortgage, but interest-rate swap agreements are highly complicated financial products that are difficult to get your head round if you do not have a degree in economics or finance.

The loans were originally devised for sophisticated investors, but the products were subsequently sold to small and medium-sized enterprises. Of course, although the rate swaps were designed to protect customers if interest rates rose, it also cost them dear when they fell, and as we all know we have been living in a low-interest environment for some while.

A frequent allegation is that banks failed to give proper advice on the break costs of exiting the swap when customers wished to terminate the agreement. It is clear that most customers were unaware of the complicated nature of the product when it was presented to them by their local banks.

Misselling of interest-rate swap agreements has had a devastating impact on the businesses affected, which include bed and breakfasts, hotels and restaurants, among many others. Bully-banks surveys have subsequently identified those businesses as being the key target for the sale of tailored business loans, to which I will refer later.

In April 2012, it emerged that the Financial Standards Authority had been told a year before by an industry whistleblower about swap misselling, but it ignored those warnings and the practices used in relation to what it now accepts were “unsophisticated clients”. That term lies at the heart of the matter.

A review by the FSA was agreed with a number of banks in June and July 2012, in relation to those unsophisticated clients. The FSA’s successor, the Financial Conduct Authority, has yet to confirm the date on which it will publish its findings, but I understand that it aims to do so in the next six to eight weeks. However, in an interim comment in January this year, the FSA accused Britain’s largest banks of selling “absurdly complex” products, having found that 90 per cent of firms in a pilot study with the big four banks were missold complex interest-rate swap agreements. Current best estimates are that the cost of compensation to be paid by banks may be up to £2 billion in the United Kingdom as a whole.

The FSA identified four broad categories of interest-rate hedging products:

“Swaps; which enable customers to ‘fix’ their interest rate ... Caps; which place a limit on any interest rate rises ... Collars; which enable customers to limit interest rate fluctuations to within a simple range ... Structured collars; which enable customers to limit interest rate fluctuations to within a specified range, but involves arrangements where, if the reference interest rate falls below the bottom of the range, the interest rate payable by the customer may increase above the bottom of the range.”

I said that it was complicated. The FSA emphasised:

“An interest rate swap is a separate contract to the underlying loan agreement. It is an agreement between two parties whereby one type of interest payment is swapped for another, such as exchanging a fixed interest rate payment for a floating payment.”

As I understand it, since 2001, approximately 38,000 IRHPs have been sold in the UK: approximately 2,000 structured collars, 28,000 swaps and simple collars and 8,000 caps, with approximately 32,000 customers affected.

In addition, although this was not part of the agreement with the FSA, in October 2012 Clydesdale Bank agreed that it would review the sale of some tailored business loans whose characteristics were comparable to stand-alone structured collars, simple collars and caps, but it excluded products that included a fixed-rate loan for any part of the loan period and which were deemed to be commercial loans.

The FSA and now the FCA’s position is that stand-alone IRHPs are regulated by the FCA pursuant to European legislation, but commercial loans in their own right, including those with embedded IRHPs, are not generally regulated by the FCA. Despite requests to change that position, such loans still do not form part of the review.

The FCA advised the all-party group at Westminster at its meeting on 15 May that it is in discussions about products that have similar features to complex IRHPs but which are embedded within commercial loan agreements. No final decision has been taken by the FCA and its position remains that the matter is for the Treasury.

The truth is, however, that a customer who has taken out a tailored business loan with an embedded IRSA may be faced with exactly the same potentially large break costs as they would have faced had they taken out a loan and a stand-alone IRHP. Why should tailored business loans be excluded on the grounds of a mere technicality? Loans with embedded or hidden swaps are just as toxic as stand-alone IRSAs, and if the bankers who sell the swaps need to be registered with the FCA to do so, why are the swaps not included in the review?

Such loans ought to be included in the review and the decision to exclude them means that fewer than 10 per cent of all tailored business loans—generally those with a structured collar, which Clydesdale Bank and Yorkshire Bank sold—are included in the review and 90 per cent are not. Derivatives experts such as Abhishek Sachdev believe that those tailored business loans should be included in the review and I agree. We need to put pressure on the Westminster Government to ensure that tailored business loans in particular are addressed.

I am aware that banking and the regulation of financial services are a reserved matter, but I hope that the Scottish Government can demonstrate its support for those affected by the current exclusion of tailored business loans in particular by making the appropriate representations to the UK Government and encouraging it to ensure that compensation is paid to those affected by missold interest-rate swaps in general.

Photo of Gavin Brown Gavin Brown Conservative

First of all, I congratulate Roderick Campbell on securing this debate and bringing to the chamber on behalf of some of his constituents a very important and, I think, deeply distressing subject for consideration. The subject is very complex and in his speech Mr Campbell dealt with it in a very fair and fairly straightforward manner.

Concerns about interest-rate swap agreements have been around for a year or two. Anecdotally, the original issues were about the inappropriateness of the products, the lack of explanation of the risks and, in particular, the pressure to buy that was put on various businesses; indeed, taking out the product was sometimes a firm condition of the loan. It was also suggested that in a number of cases businesses were given a very short timescale within which to make its decision, which made it even more difficult for it to get its head around the matter and to take independent advice.

Roderick Campbell said that it is difficult to get your head around this issue if you do not have a degree in economics or finance. That is true, but I also know plenty of people with degrees in both who say that it is equally difficult for them to get their heads around it. When the then FSA looked at this, its initial findings, which were published in June last year, almost entirely backed up everything that businesses had been telling MPs, MSPs and the FSA itself, highlighting the very poor disclosure of exit costs from the products; the failure in many cases to ascertain the customer’s understanding of risk; non-advised sales straying into advice; overhedging; rewards and incentives being a driver of practices; and—to cap it all—evidence of poor record-keeping. Among the biggest concerns was that there was no mention at all—or, at least, minimal mention—of the break costs of leaving the contract, nor of the fact that, in many cases, the length of the hedge contract was substantially longer than the length of the loan period. As a result, when the loan came to an end, perhaps after five years, the business might find that it had signed up to and would have to continue to pay for a 10-year contract for a hedging product for a loan that no longer existed; after all, when the crisis hit, the banks simply did not renew many of those loans.

The findings of the initial pilot review in January would have been of concern to many people. Of the 173 sales that were looked at in greater detail, more than 90 per cent did not comply with at least one regulatory requirement. That figure is staggering. It is fair to point out that all of the cases were complex and might not be wholly representative of the tens of thousands of other cases but, notwithstanding that, the fact that the figure in the pilot was so high should be a matter of concern to us all.

Most important, we need to decide where we go from here and, although it is absolutely critical for the timescale to be as swift as possible, we also need to take time to get this right. The banks that are looking at the customers who took out these products must prioritise the most vulnerable companies; many of them will be in great difficulty at the moment and must be processed quickest to ensure that they do not stray into administration in the interim period.

On top of that, the banks must go further than they need to go legally to resolve this issue. Roderick Campbell was quite right to talk about reputational issues. In this case, the banks simply cannot do just the bare minimum; they must do everything that they possibly can for their customers to ensure that the independent reviewers are not consistently sending them back.

The ultimate sting in the tail is that most of these problems have arisen because of our record low interest rates, which are due in quite some measure—although not exclusively—to the behaviour of the banks. That is why it is doubly important that they resolve the issues as quickly and as effectively as possible.

Photo of Chic Brodie Chic Brodie Scottish National Party

This chamber has been the centre of many emotions but none so great as the anger felt on this issue by myself, by my colleagues and by those affected, some of whom are with us in the public gallery today. Today, we highlight the dangers of the interest-rate swaps embedded in tailored business loans—the shark that lies just below the surface in bank lending to small and medium-sized businesses.

Much though it went beyond my entrepreneurial spirit, after 2008 I suggested that we should take those banks that are supported by public funds at least temporarily into public ownership, to ensure that the banks changed their casino culture, which existed particularly in the investment parts of some banks. We did not, and the banks have not.

Privilege does not extend to this Parliament so we cannot name or shame, but the banks concerned know who they are. The Financial Secretary to the Treasury confirmed to the Westminster Parliament that Yorkshire Bank and Clydesdale Bank have agreed to review at least one customer’s fixed-rate loan.

The interest-rate swap mechanism embedded in tailored business loans is a relatively simple finance mechanism. Where two parties have taken out loans of equal value, one at the prevailing fixed rate and the other at a floating rate, the parties swap the loans and, as the loan principal is the same, in effect only the interest rates are swapped. The problem is that one party, in this case the bank, demands a risk premium for its gambling from the other party, which in this case is a small business client. That premium on the floating interest rate was tied to the London interbank offered rate, which members will recall was the subject of daily manipulation by bank representation on the LIBOR committee. Here were bankers—or at least some of them—gambling with other people’s chips.

The interest-rate gambling embedded in tailored business loans means that such loans are not fixed-rate loans; but—as some of our friends in the public gallery today will confirm—the banks say that they are. The banks will even smooch people into thinking that such loans are better and more protected than fixed-rate loans, but that is not the case. The conditions inherent in those tailored business loans, particularly on exiting or breaking the loan, are penal. Banks will stay quiet about and/or surreptitiously write into the small print conditions on the loans without making it clear that their investment risk is being passed on to the client. The banks did not want people to know that exiting the loan might ultimately cost them 20, 30 or even 40 per cent of the loan value.

I could regale members with stories of what has happened so far. For example, although Mr and Mrs L have paid off most of their initial loan, they now owe more because of the exit or break fees. Mr and Mrs H were told that they would need to pay 30 per cent of their large loan for paying it off early. I could mention the experiences of Mr P, a tea shop owner; or Mr M, who himself was previously involved in banking; or Mr B, a successful small business man in Dundee; or Mr Mac; or the church that cannot now provide the community services for which it was renowned because it must repay expensive missold loans.

The UK Government and regulators are exploring whether to expand the compensation scheme to cover missold swaps on fixed loans, but they may be too late—the horse may have bolted. It is believed that, throughout the UK, there are 40,000 embedded interest-rate swaps as well as a further 60,000 fixed-rate loans that are subject to scrutiny. All of those affect good small businesses. As Rod Campbell said, £2 billion may need to be set aside to address the issue.

However, that will not be enough to compensate people for the loss of property and lifestyle, nor assuage the worry that has been created and the unnecessary anxiety that has been imposed on many good small business people. It will certainly not be enough to assuage the anger. I ask the Parliament to act by encouraging Westminster to move quickly in support of those small businesses.

The Deputy Presiding Officer:

Before I call the cabinet secretary to respond to the debate, I will clarify, for the record, the position on parliamentary privilege. Section 41 of the Scotland Act 1998 provides that:

“For the purposes of the law of defamation—

(a) any statement made in proceedings of the Parliament, and

(b) the publication under the authority of the Parliament of any statement, shall be absolutely privileged.”

That is to ensure that members are free to debate, and that the Parliament is free to report on, matters of public interest without the fear of a defamation action being raised.

Photo of John Swinney John Swinney Scottish National Party

I record my thanks to Roderick Campbell for lodging the motion on an important subject. He demonstrated in the argument that he presented to Parliament the depth of the analysis that he has undertaken in addressing on behalf of his constituents the issues that have come to him. That is exactly what members of the Parliament should do: face the real-life circumstances that affect the members of the public whom they have the privilege to represent and bring those issues to the Parliament to ensure that they are given full scrutiny and attention.

I thank Mr Campbell for setting out so clearly and in such depth the issues with which we are wrestling. They are significant. A number of members in their speeches set out their experience—I have my experience from my constituency case load—of the impact of interest-rate swap agreements on members of the public in the small business community. There are important implications for members of the public who have taken on such agreements. When we hear about such circumstances, we are all aware of the depth of difficulty that they cause for members of the public.

At the heart of the debate is the question of trust. That is the nub of the argument that Mr Campbell put forward. This is about individuals who seek to develop and grow their businesses, which is precisely what we all want them to do. We want to encourage business growth, and the Parliament has expressed on countless occasions its opinion on the extent to which business growth must emerge from the SME community.

It is essential that SMEs are able to access the financial support and assistance that they require to enable them to grow, so the people who have been affected by interest-rate swap agreements are not doing something unusual or at the high end of risk; they are simply trying to grow their local businesses in their local communities in the fashion that Parliament and politicians are encouraging them to do. They go to financial institutions in an atmosphere of trust—which they should be able to do—to obtain the necessary products, support and access to finance to enable that to happen. I am not sure how business growth happens without participating banks supporting expansion of the SME community and delivering such products.

The problem, however, is that people have been sold products that are not appropriate for their requirements. Mr Campbell made the point about them being sophisticated products for an unsophisticated market. If there was ever a statement that marshals the difficulties with which we are wrestling, it is that. At the heart of the debate is the fact that members of the public should be advised on and sold products that are appropriate for their needs and circumstances. That has clearly not been the case, and the individuals who are involved are now in some difficulty.

The first port of call in trying to resolve the issues must be the remedial actions that the banks themselves can take. All of the dispute resolution procedures over which the Parliament presides have a common theme, which is that disputes are best resolved at the closest point to decision making rather than being investigated and pursued over a longer period. Therefore, I encourage the banking sector to engage with those who are affected and to come to some form of resolution as quickly and as effectively as possible. If that is not done, we will get into the territory that Mr Brown was fair to identify, where the more protracted the inquiry into the arrangements in question, the more difficult the financial situation could be for the individuals who took out the products. Early resolution through those mechanisms is important.

As Mr Campbell said, and as Mr Brodie and Mr Brown mentioned, the Financial Conduct Authority has now secured agreement to hold an inquiry into these matters, and I encourage it to carry out that inquiry speedily and to ensure that the issues are properly addressed. Mr Campbell made a strong point about the need for the remit of the review to be expanded to take into account the issue of tailored business loans, and I commit to contacting the FCA to press his point.

We must also ensure that the review and the banks engage in a dialogue with those who are affected to resolve the issues speedily. There has been some dialogue between bully-banks, the FCA and the banks, and I encourage the continuation of that dialogue. The process of review, inquiry and dialogue with the individual banks on the individual cases will lie at the heart of resolution of the issue.

In general, we will resolve the issue by ensuring that the highest standards of banking advice, decision making and support are available to members of the public. In that respect, our banks have been in a difficult and poor position. Many thousands of people who work day and daily in our banks deliver good service and good support to members of the public, but in some circumstances members of the public have experienced an acute absence of high-quality service and of appropriate advice. It is in no one’s interests for that state of affairs to be prolonged; it is in everyone’s interests for it to be remedied as quickly as possible.

I thank Mr Campbell for raising an important issue that relates to members of the public who have been badly affected by decision making on the products in question, and I assure him that the Government will encourage the review process to resolve the issues as quickly as possible.

13:03 Meeting suspended.

14:30 On resuming—