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Interest rate swap doing your head?

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The Six Year Rule

Note – nothing on this website is purported to provide legal advice. Readers must make their own minds up after reading referenced material, and should consult a solicitor if contemplating legal action.

A number of those who have been mis-sold swaps have now passed the six year point. My information is that this starts to run from when the ISDA contract was first discussed, and not when the contract was dated.

I understand that once the six year point is passed, an action can only be brought in common law. This means that it is not possible to use the COB (or, soon, COBS) rules to determine whether the bank was at fault when it sold you the contact.

At first sight, it may seem that the only way forward is to go into the FCA’s process, which covers sales subsequent to December 2001 – so the six year period is virtually doubled. However, this process has been seen to have a number of major disadvantages.  Many aspects of the process are kept secret, the bank is primarily the judge and jury of the process, and there is current controversy regarding the low levels of payments made to date, especially regarding consequential loss; so you may decide to follow the court route. Some points worth considering are as follows:

Firstly, the six year rule is not cast iron, in that Section 32 of the act allows for the period to run from a later date where there has been concealment of relevant information.

Secondly, banks’ behaviour both during the sale and in subsequent communications has been to deter purchasers from establishing any solid facts in connection with the sales process, and to give the impression that they alone were responsible for a speculative gamble. Many cases which have proceeded to court have been settled with comprehensive non-disclosure agreements, preventing information from reaching either the public domain or the court reports.

Thirdly, misleading marketing material and other communications are still available in documentary form (including presentations and telephone transcripts) in many cases. The purpose of the Limitation Act was to prevent actions where the memories of those involved had been dulled with time and therefore they could not reliably give oral evidence. The existence of these documents can, in many cases, present an adequately full picture.

Apart from this, what are the relevant events of universal application? Where could those who believed themselves mis-sold have received credible clarification?

I suggest the first event was Guto Bebb’s House of Commons Back Bench motion on 21 June 2012. Nearly 40 MP’s spoke over 2 ½ hours. I cannot do justice to this in my own words – it needs to be watched.

http://news.bbc.co.uk/democracylive/hi/house_of_commons/newsid_9730000/9730272.stm

Evidence in this forum appears to be in total contrast to the response to which any complainants were met with, which was, by all accounts, “You’re the only one to complain”.

The second event was the announcement on 31 January 2013 of the FSA (as it was then) of a review, the result of the discovery that, of 173 sales examined, over 90% had not complied with at least one regulatory requirement.  It was stated that a significant proportion of these 173 cases were likely to result in redress being due to the customer. The report also stated:

“We also found that sales rewards and incentive schemes could have exacerbated the risk of poor sales practice. “ (My italics)

This understatement limits the help offered in understanding the nature of any mis-sale. More importantly, the FSA does not mention its own eighth principle:

“Conflicts of Interest: A firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client.”

The review process that the FCA has put in place is governed by whether or not “your bank believes that you may not have understood fully what you were buying” according to its 11 April 2013 announcement.

How the review pans out will depend on the following:
· How your bank is allowed to argue ‘its belief’
· How ‘understood fully’ is to be determined, when assessed four years after most sales
· Whether ‘what you were buying’ relates simply to the mechanics of the product, or whether the phrase includes allowance for the economic environment, including future interest rate dealing prices, at the time of sale; and any misleading information provided by the bank, including feigning ignorance of those dealing rates and the link to bank profit by demonstrating only general information within presentations

“Independent Assessors” have been appointed by the FCA to oversee the process. Details of their experience or qualifications have not been published from the FCA, despite this being requested. I understand that the FCA have delegated this role to certain management consultancy firms.

Details of each bank’s review and redress process have to a large degree been kept secret.

The detailed announcement can be found at:

http://www.fsa.gov.uk/library/communication/pr/2013/010.shtml

The third event is the release of the FCA (as it now is) written submission to the Court of Appeal on 29 July 2013. The appeal itself was of little interest, as most informed commentators opined that it was likely to fail in short order - as indeed it did. The submission, however, reveals more to those claiming a mis-sale than any previous information provided by the FCA. Mr Nicholas Peacock QC and Ms Catherine Addy put a good deal of material into the public domain not previously acknowledged by the Regulator, and explained it lucidly. This is a further stepping-stone towards understanding.

The FCA submission can be found here.

Even after digesting all of the above, you might be forgiven for thinking that the banks’ only sin was a failure to disclose information.  There’s a lot more to it than that!

I suggest that the fourth event is an appreciation of the difference between what the bank said and showed, and what it saw and knew at the point of any sale in one’s own case.  Both the degree of difference, and how that difference may have misled a client, are key to understanding any ‘mis-selling for profit’, and how that might translate into possible legal action.

The key document in many of the sales being questioned is in the form of a PowerPoint summary. Most of the ones we have seen can be divided into three elements:
a) Generalised comments on the UK markets, mainly fixed interest, indicating uncertainty
b) Product details of one or a range of products
c) Caveats that the bank was never responsible for anything the client bought

The products we have seen were invariably structured so that the value of bank profit exceeded, often substantially, the value of any client benefit, when measured against the market specified above. The degree of bank profit broadly equated to the degree of client detriment. The values of both bank profit and client benefit could be determined precisely (apart from the issue of covenant value) on day one of the sale, with the same techniques used to subsequently determine break costs.

Those values were closely related to, and driven by, the level and shape of the forward curve on the day of sale. Investigating this curve over the period 2006 – 2008 shows unusual features.

The first nine months of 2006 showed a yield curve shape where after a period of sporadic rises over 3-4 years, the pattern over the subsequent twenty or so years is consistently falling. From the last quarter of 2006 to the end of 2008, (when Base Rate was reduced dramatically), the pattern, including the first 3-4 years of the term, was a consistently falling one.

Most economic theory confirms the view that a falling yield curve presages economic recession, if not depression. A consistent pattern over time is a particularly ominous sign. It is often called a ‘bear curve’.

However, the source of these yield curves was not the view of an individual, or even a group, of economists. It represents the levels at which deals were being carried out in the $250 trillion (value as at 2006) market.

Moreover, the yield curve (as described by Nicholas Peacock and Catherine Addy) represents the terms at which interest rate deals can be carried out in respect of money invested now, and invested for a particular term. This is referred to as the spot yield for a particular term. Accountants and IFAs would be expected to be familiar with this concept.

However, in order to carry out the pricing of contracts such as were sold to SMEs, a bank would have to make use of a different structure, known as the forward curve. This represents investment returns available for money invested in the future.

Accountants and IFAs would not be familiar with this structure, as they would generally have no use for it. Accountants would most likely first encounter SME-sold derivative products (with their contractual links to interest rates at points in the future) when they needed to identify it in a client’s balance sheet. The valuation of these instruments is currently (and was over the period in question) governed by accounting standard IAS39. The thrust of this is that such derivatives should be valued in a company’s balance sheet at market value at the date of the accounts. Such a quotation would in all practical terms, have to be obtained by the issuing bank. (Incidentally, for all the contracts we have seen, had the company accounting period ended the day after the derivative was sold, it would have shown up as a significant liability for the company.)

Nor would IFAs be any the wiser. They deal with client funds to be invested or switched now. The yield curve provides adequate answers to investing client funds for a period up to, say, their retirement. The rate that will be ruling at age 65 is less important that the combined effect of all the rates up until that age.

In order to design swap or cap/floor contracts, a bank would have needed to have an up-to-date and accurate view of the forward curve on that date. Any interest rate assertions it made in marketing material would need to be judged against that curve to see if the bank was representing its knowledge honestly.

The banks employed large sales forces to promote these products. Undoubtedly, the sales process in many cases can reasonably described as profiteering. The key question that presents itself is: at what point does profiteering become racketeering?

Communications from the bank after the sale should also be considered. There is clear evidence of banks continuing to mislead customers. One who complained was told:

“You took a bet and you lost. You Welsh people are all the same. You get together in your corners and you chatter.” (– said to Barclays client)

Apart from the obvious discourtesy, this shows the actual attitude of the banks to their victims.

How does this translate into action for you?

Any mis-selling victim who is outside or near the six year rule should immediately discuss the fourth event above with their solicitor, and consider carefully the likely strength of a legal challenge on the basis of negligence or fraud. We are happy to provide an initial review of swap contracts and sales material, and can provide detailed and fully researched point of sale report, covering the above areas. However, we will not generally do this unless a lawyer is involved, as unless there is a realistic prospect that the report can be beneficially utilised in legal action, its value may be limited.

Contact Windsor Actuarial at mail@windsorac.com to find out further details and how the above may apply to you.  


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