Barclays, RBS Will Compensate Clients Mis-Sold Derivatives

Barclays to Repay Swaps Customers as RBS, Lloyds Join Settlement
Barclays was fined $451 million this week by the FSA, the U.S. Justice Department and the U.S. Commodity Futures Trading Commission after admitting it submitted false London and euro interbank offered rates to benefit its derivatives trades. Photographer: Simon Dawson/Bloomberg

Barclays Plc, Royal Bank of Scotland Group Plc and Britain’s two other biggest banks will compensate small and medium-sized businesses improperly sold interest-rate derivatives following a probe by the U.K. financial regulator.

The four lenders, including Lloyds Banking Group Plc and HSBC Holdings Plc, will also stop selling interest rate collars to retail customers as part of a settlement with the Financial Services Authority, the regulator said in a statement today. While the FSA found “serious failings” by the banks dating back to 2001, it stopped short of fining the firms.

The compensation plan is the second blow in a week to an industry already under investigation for attempting to rig global interest rates. Barclays was fined $451 million by the FSA, the U.S. Justice Department and the U.S. Commodity Futures Trading Commission after admitting it submitted false Libor rates to benefit derivatives trades, putting pressure on Chief Executive Officer Robert Diamond to resign.

“Banks have clearly been involved in some poor business practices prior to and during the credit crisis,” said Gary Greenwood, a banking analyst at Shore Capital. “It’s possible that not all of these practices have yet to be unearthed and it is the threat of civil litigation that is the main risk” to banks’ future share performance.


The FSA didn’t say how much the banks could have to spend to compensate customers. Sixteen financial firms paid 1.9 billion pounds ($3 billion) in 2011 after the FSA found they improperly sold clients payment-protection insurance. Hector Sants, the regulator’s chief executive officer, said in a speech last year that customers may receive as much as 9 billion pounds as a result of the PPI probe.

The swaps case is “not PPI two,” Deutsche Bank AG analysts Jason Napier and David Lock said in a report today. “We don’t expect this issue to produce costs which threaten bank solvency -- individually or in aggregate given the surprisingly modest numbers of products sold.” The outcome “is likely to be continued pressure on banks from a public policy and regulatory perspective,” they said.

Banks offered derivatives to small business and individual customers on concern that they might not be able to service loans if floating rates rose.

Rates Fall

Products included caps, where customers paid a premium to keep borrowing costs below a pre-defined maximum, swaps, where customers locked in a fixed rate, and more complex combinations of these products, among them collars, which kept payments within a fixed range. When interest rates fell, the market value of many swap and collar products plunged, leaving customers out of pocket. The banks sold 28,000 of the products since 2001, according to the FSA.

“We’re talking tens of thousands of customers potentially,” Martin Wheatley, the FSA’s managing director of its conduct unit, said in an interview.

The FSA decided that a compensation scheme, rather than civil penalties against the banks, was the preferable way to deal with the problem because it would get money to small business faster, Wheatley said.

Exit Costlier

“These products were often recommended to customers with no prior experience of derivatives together with documentation that failed properly to identify the risks involved,” said Andy McGregor, a banking litigation lawyer at Reynolds Porter Chamberlain LLP in London. “The complex nature of some of the swaps could lead to a customer being in a position where it would cost more to exit the swap than to stay in.”

The four banks gave customers poor information on what it would cost to exit the swaps deals and didn’t properly explain the risks. They also offered hedging products that didn’t match up to the underlying loans, the FSA said. Compensation could include partial or full refunds of products, or cancellation or replacing them, the regulator said.

Companies made around 605 complaints last year over banks’ bundling of interest-rate swaps with loans, FSA Chairman Adair Turner said in a letter to lawmakers last month. The London-based watchdog initially didn’t see any “widespread, underlying issues” with the practice and instructed firms to review their sales systems, Turner said.

Barclays and Lloyds said in separate statements that they cooperated with the FSA investigation. HSBC said it would “move rapidly to redress the few remaining small business customers with more complex interest rate products.’”

Effective Tool

“Risk management products such as interest rate swaps remain an effective tool for businesses wishing to hedge their exposure to interest rates,” Barclays said in an e-mailed statement. “Where we have made mistakes in the way we have provided these for clients we are committed to resolving them.”

RBS said it has “agreed to move directly” to redress “a small number of less sophisticated customers who entered into more complex swap products.” Risk-management products are “an essential part of corporate banking,” the bank said in an e-mailed statement.

Lloyds said in a statement it didn’t expect the costs of the settlement to be material.

While the FSA had gotten complaints about the products before, it wasn’t until this year that the regulator started to take action, Wheatley said.

“The wave started to build up in February, March this year, when we started to hear many many more issues and when we started going talking to the customers,” he said. “We found we were getting very common themes.”

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