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Review of interest rate swaps could consider eligibility to refer complaints to ombudsman, FSA says

The City watchdog could reconsider the grounds on which small businesses can refer claims to the Financial Ombudsman Service (FOS) as part of its review into the potential mis-selling of complex interest rate swaps, it has suggested.24 May 2012

In a letter (4-page / 181KB PDF) to Andrew Tyrie, chair of the Treasury Select Committee, Financial Services Authority (FSA) chair Lord Turner said that MPs "may also wish to consider" whether the balance sheet threshold below which small businesses were eligible to refer complaints, and the compensation limits, remained "appropriate".

The FSA confirmed that it was considering whether some large banks promoted the products to customers for whom they were unsuitable, in breach of their regulatory obligations, earlier this month.

Tyrie wrote to the FSA and the FOS, the independent body which was set up to handle complaints between consumers and financial services companies without recourse to the courts, expressing his concerns about the practice in March. His letters followed allegations from "a number of small businesses" that they had been mis-sold the products. The Committee heard evidence earlier this week on the practice as part of the "broader prevailing culture" within UK banks.

"The alleged mis-selling has been of concern to the Committee for some time," he said. "I am pleased the FSA is now investigating it. As [former Morgan Stanley chair] Sir David Walker said in evidence to us, products such as these are unlikely to be appropriate for the retail market... It is now up to the FSA to get to the truth. We will do what we can to ensure that they do."

He added that further allegations by some businesses that they were forced to purchase the products in order to obtain other bank services, such as loans, were "wholly unacceptable" and potentially anti-competitive.

Swaps provide borrowers with protection against changes in interest rates by locking in net cash outflow to a fixed interest rate. The product is designed so that the swap provider - usually a bank which has also provided the underlying loan – covers the cost of increased payments if the interest rate rises while customers have to pay the bank if rates fall. In addition to the risk of having to make higher payments if the market does not perform as anticipated, customers who wish to abandon a swap arrangement may be liable for substantial exit fees.

The FSA Conduct of Business Sourcebook (COBS), which sets out the conduct of business requirements the watchdog applies to regulated firms, prevents them from recommending products to retail customers which are unsuitable or inappropriate for the customer in question. In addition, firms must ensure that any communications or promotions to retail customers are "fair, clear and not misleading".

"In 2010 and 2011, we became aware of a small number of complaints from SMEs about the sale of interest rate products," Turner said in his letter. "We did not at that time see any widespread, underlying problems. We are now doing more work to understand in more detail the types of products that have been sold."

In a separate letter (4-page / 170KB PDF) to Tyrie, FOS chairman Sir Nicholas Montagu said that the service had received only a "modest" number of complaints from small businesses. However, he noted that the service's remit with regards to such complaints was "constrained".

The FOS primarily handles complaints from consumers, intended as a means of addressing the significant imbalance in resources and bargaining power" between them and large banks. Although it does deal with a small number of complaints from business customers, representing 1% of its workload according to Montagu's letter, its remit is limited to those firms defined as "micro enterprises" with an annual turnover of no more than €2 million and a maximum of 10 employees. In addition, compensatory awards are limited to £150,000 – increased from a limit of £100,000 at the start of this year.

"Practically therefore our remit seldom encompasses the larger business loans that I believe are at the heart of the reported concerns," he wrote.

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