Interest Rate Swap Derivatives

Richard Fuller Excerpts

Thursday 24th October 2013 Commons Chamber

[Guto Bebb]

I agree that 16 months is a very long time. Even when cases are accepted into the redress scheme, they seem to be taking a long time. The banks would argue that businesses need to engage with them, but I believe we still need to look carefully at this matter. The sophistication test should be more flexible, and the discrepancies that I have described need to be acknowledged.

Another discrepancy involves the asset value. A business could be excluded from the scheme because of the asset value that it holds. In effect, it could be argued that a business that had been lucky enough to invest in property at the right time should be excluded from the redress scheme because of that piece of luck. If the asset value had increased to a certain level, that could result in the company being excluded from the scheme.

There is also a lack of consistency. In some cases, the banks are ignoring the sophistication test because they believe that a customer would fail it and therefore be eligible for the redress scheme. Instead, they are moving the customer straight into the assessment of redress. If they can ignore the sophistication test in some cases, where is the consistency? A member of the all-party parliamentary group argued strongly on behalf of a constituent who had a £12 million swap and, lo and behold, the constituent was subsequently allowed to become part of the redress scheme. That was an excellent result for that business, but again, where is the consistency? The FCA needs to look carefully at the sophistication test.

My final point on the sophistication test is that, if a business spends six months waiting to be assessed, those six months will be lost in regard to the statute of limitations for taking legal action. The FCA needs to recognise that, because it is potentially dangerous for the businesses concerned.

A further concern relates to the alternative products on offer. It has been said time and again that if these complex products are unsuitable, it cannot be right to introduce a redress scheme in which a swap can be substituted by a slightly less complicated swap. It is also important to note that a business will be offered an alternative product only if it has failed the sophistication test—that is, if it has been deemed to be unsophisticated. I find it difficult to understand how any alternative product other than a cap could possibly be suitable.

Another reason why the cap is the obvious alternative product is that if businesses had been told clearly of the cost of the products they were taking on board back in 2006-07, they would have seen that a cap would have offered them significantly better value for money. Why was the cap not offered? Probably because of the financial imperative of the banks to sell something more complex and more rewarding. It is thus important to highlight the fact that having a complex derivative rather than a cap as alternative product is a real concern. If businesses have been classified as unsophisticated, that issue should be recognised and we should try to ensure that we provide a cap as the only acceptable alternative product.

[Richard Fuller (Bedford) (Con)]

My hon. Friend mentions the omission of information from the sales process; does he also accept that the information needed was introduced late and that only opinions were offered? What was really going on was a sophisticated sales process to dupe people who may have been financially unsophisticated for the financial benefit of the banks. Does he believe that that should mean that the people in charge of that process should face criminal sanction, not just financial redress for their customers?

[Guto Bebb]

That is certainly a call that some of the organisations campaigning on this issue have made, and I am sure that other hon. Members and members of the all-party group will expand on that theme in their speeches.

We thus need to look carefully at the alternative product issues. It is fair to argue that businesses might have been looking for interest rate protection, but it is difficult to argue that they would have been tempted by an expensive product in 2006-07, when a cap offered such good value for money at that time. I am unpersuaded of the arguments for a complex derivative.

--- Later in debate ---

[Mark Garnier]

I will try to explain the issue as simply as I can now.

Imagine a second-hand-car dealer. He may buy a dodgy motor on his own books and try to make as big a turn as he can, but he risks not getting his money back. Now imagine a car dealer with a valuable vintage car who aligns a seller and buyer at exactly the same time. He takes a turn with no risk at all, and that is how a swap behaves. Now imagine that, having lined up that trade, he takes the money from the buyer, so has a contractual agreement with them, and agrees a sale with the seller. However, on the way to deliver the car, he writes it off in a crash and is not insured. He still has liabilities on both sides—he still has to deliver a car to the buyer and has to pay the seller. That is the mess that the banks are in. They have caused themselves a massive car crash and have to look after the other side of the trade.

We are fully aware of the losses to the banks on the financial redress scheme—plus, obviously, the consequential loss scheme as well. We have heard about how much has been put aside, and there will be debate about whether that is the right amount or not. However, we have heard nothing yet about the value of the liability on the other side of the swap—the liability to institutions, most likely to be pension funds, that still needs to be honoured. That has implications for the stability of the banks and shows why it is important for banks to keep the redress scheme running for as long as possible.

[Richard Fuller]

rose—

[Mark Garnier]

I see that my hon. Friend wants to intervene, but may I develop my point?

The financial redress scheme has a specific value, based on a number of factors—including, crucially, interest rates and time. Similarly, time to run is a key component of the value of the other side of the swap. With interest rates so low, the longer the time to run, the higher its value to the customer and the higher the liability to the bank. As a result, we get a built in incentive for the banks to delay settlement for as long as possible. With each day that goes by, the liability on the other side of the swap is reducing.

Harry Wilson, of The Daily Telegraph, has put in freedom of information requests to the Financial Conduct Authority to find out exactly what the loss on the other side of the trade will be. Amazingly, nobody seems to have the answer. It seems inconceivable that the banks would not have the information. Any derivatives trading room team, especially on a swaps desk, will have detailed information on the extent of the liabilities; they have to know that. Even if the swaps team does not, the risk or treasury department should know it—loads of people should know it. It is extraordinary that nobody is coming forward with the information.

The issue has been dragging on for far too long. Too many businesses have failed as a result of it and it is likely that too many more have fallen into that twilight zone of bad forbearance by banks, which sometimes keep otherwise dead institutions alive simply because it is in their interests.

I spent the best part of the last year on the Banking Commission considering the matter. It is worth noting that this crisis happened before the Banking Commission, the financial crisis and the rest of it. However, today the banks have to prove that they have moved on, that they should now be allowed to come into polite society and will do the right thing by the consumer.

--- Later in debate ---

[Richard Fuller]

My hon. Friend is a defender of a system of true free-market principles. He has identified the twin problem mentioned by my hon. Friend the Member for Wyre Forest, which is that, in addition to the unfunded liability cause, we have now booked the profits and paid the bankers for going through the process that duped the people. Those involved should face criminal sanction.

[Steve Baker]

My hon. Friend makes an interesting point. I want to live in a free society with a free and commercially successful banking system, but we have to ask ourselves whether the current system has incentivised behaviour that is fraudulent under the law as it stands. The last thing we must do is allow ourselves, in a frenzy of condemnation, to start criticising a system on which our civilisation depends, when that criticism is unjustified. We should be looking at the law as it stands and checking—carefully investigating—whether individuals have broken the law. I am particularly concerned about IFRS. I do not think it complies with UK company law and think it has incentivised behaviour that is probably fraudulent.

Banking ought to be simple. It ought to be about connecting depositors with those who wish to borrow in order to invest for productive purposes, such as buying a house or even going on holiday, but predominantly it should be about investing to create real resources and real wealth, and to increase productive capacity and the balance of capital invested per head, so that real wages increase and the cost of living goes down. Instead, we have ended up with a system in which poor state intervention from one end to the other has created so much moral hazard and so many perverse incentives that it has become abundantly clear that a small number of individuals—far fewer than 1% of the population—have captured the state in order to turn implicit and explicit taxpayer guarantees, or bail-out funds, into personal remuneration. It is a disgrace.

The banking system needs to be made honest, and quickly, and part of that is a system of compensation for people who have been treated extremely badly.

--- Later in debate ---

[Mr Robert Syms (Poole) (Con)]

I, too, pay tribute to my hon. Friend the Member for Aberconwy (Guto Bebb) for his leadership of the all-party group on interest rate swap mis-selling. The issue is important for all Members, which is why the Chamber is so full.

We all know of a number of cases in which people were switching banks or wanted loans for a project, and one of the last products slid across the table to them was an interest rate swap. Many felt that they did not have much choice but to take it. The British economy is showing welcome signs of starting to recover, and the Bank of England is pushing cheap credit into it to get the banks to lend, which is having an impact. However, we should all reflect on the fact that 30,000 to 40,000 businesses run by serial entrepreneurs could well go out of business before the process that we are discussing is finished, which would have a cataclysmic effect on the businesses with which they deal, the people who work for them and many of our local economies. The issue is not just mis-selling but whether we maintain stable economic growth and create jobs and prosperity in future.

[Richard Fuller]

Does not my hon. Friend find it sadly ironic that the victims of mis-selling were people who had shepherded their money and built their businesses carefully over many years, while the people who benefited were those who were in it for a fast buck?

[Mr Syms]

I do, and many of the people who have been affected have a lifetime’s work in their business—more than one lifetime in the case of many family businesses, which are the bedrock of our constituencies. Those people have been key members of the community and employed many people. Today’s debate is therefore important, as we need to give the FCA and the Government a strong message that the authorities must get the banks to get on with it. Things are going too slowly. As we heard earlier, the banks have put forward some billions of pounds for compensation, but they have dealt with only 0.2% of cases. Of the £3 billion that is potentially available for redress, only £2 million has been paid out to 32 businesses, which shows that we need to speed things up.

In many cases, first the capital was sucked out of businesses and then the break clauses were such that many people could not afford to get out of the contracts. With most normal capitalist activity, if someone felt they could not make a go of it, they would sell their business on. However, nobody will buy a business that has the poison pill of an interest rate hedging product because they know that it is a major drag on the business. It is not free enterprise as we know it, and I rather agree with Members who have suggested that the banking system has not done itself any favours.

What is so tragic about the products in question is that people have no way out. We need to get on with achieving compensation. Members have made some good contributions today, and behind every story they have told is tragedy and worry. People cannot sleep at night because they are not sure how to deal with the problem. I say to Ministers and the FCA that we need to get some speed up and get compensation paid. We need to deal with people fairly, and to support and cherish serial entrepreneurs, who should be playing a major role in the economy’s recovery, rather than being put in a position of not knowing what will happen in a week, six months or a year. We need to give them our support.