Britain’s biggest banks may have thought they had put the scandal involving misleading sales of complex interest rate derivatives to rest after they paid out over £2.4 billion ($US3.7 billion) incompensationto small businesses.
But the LIBOR interest rate scandal — a seemingly separate issue — may have the potential to undo those settlements, sources tell Business Insider, if it can be shown that banks’ manipulation of interest rates affected the derivatives they sold to small businesses.
The derivatives in question are financial products that were sold as “insurance” to businesses who wanted to be protected against high interest rates prior to 2008. However, the products were not insurance policies. They were interest rate swaps, a type of derivative deal that usually only occurs between investment banks or other large, sophisticated financial entities. In an interest rate swap, two parties bet that rates will either go up or down, and the parties must pay each other changing streams of payments on the result.
When interest rates dropped after the 2008 financial crisis, hitting historic lows, businesses found themselves on the wrong side of their swaps deals and ended up paying the banks thousands of pounds a month in interest, the reverse of what would have happened if rates were high. Many businesses fell into financial hardship and some even went bankrupt.
It’s not just a case of sour grapes on a bet gone wrong. The Financial Conduct Authority (FCA) declared in 2012 that these products were sold misleadingly. Many businesses did not understand, or were not fully told, what type of contract they were entering into. Many didn’t even need these products in the first place.
To date, 17,000 businesses — from family run shops to owners of a chain of hotels and care homes — have received redress. The redress can include everything from cash compensation to the cancellation of the swaps product without a fee.
But now Lloyds, RBS, HSBC, and Barclays face the prospect of the bulk of those financial settlements being torn up because many of the banks have since been fined or settled with a range of US and UK authorities over their manipulation of LIBOR.
LIBOR — the “London Interbank Offered Rate” — is a measure of the average interest rate banks are willing to lend to each other at. It is used internally to set the price of financial products worth billions of pounds. Between that and foreign currency exchange-fixing allegations, Britain’s small businesses are claiming that their initial agreements with the banks were created under fraudulent circumstances. If the banks were manipulating LIBOR, and the swaps were based in some part on LIBOR, then the price of the damage the swaps caused must be wrong, these businesses argue.
That is how one of Britain’s most prominent specialists in the area, Abhishek Sachdev, sees the situation. Sachdev has worked as a consultant to politicians investigating the scandal, while also working with a range of businesses with debts of £1.5 million ($US2.33 million) to £1 billion ($US1.6 billion) that need to be hedged. (Hedging is when a business buys a financial product to reduce any potential losses stemming from market volatility.)
“We are beginning to see high net-worth clients and corporates who have entered into confidential settlements with banks in the last three to four years look to try and challenge and unwind those settlement agreements on the basis of new and more detailed regulatory findings and notices that are coming out from different global regulators, different banks, and at different points in time,” said Sachdev, managing director of the FCA authorised Vedanta Hedging and former Lloyds banker, to Business Insider.
“This is a bolshie move because it’s very difficult to unwind a legal settlement. But we are increasingly seeing a lot of people alleging fraud against the bank they settled with. Fraud in legal terms is a very serious matter and the burden of proof is very high. However we are seeing a number of barristers, solicitors, and high level QCs supporting these claims.
“Also, with the allegation of fraud, the statute of limitations — the six-year deadline after a financial product was sold to file a claim — goes out the window. Also the settlement and damages is a whole other ball game.”
Sachdev did not cite the clients or the banks that have started the process of tearing up their agreements.
Business Insider contacted Britain’s biggest four banks, which sold the bulk of the misleading derivatives, and asked for comment. Barclays and RBS declined to comment. HSBC said “we are evaluating each swap trade on the basis of the agreed FCA methodology and reaching agreement with each customer based on the facts of each case.” And Lloyds said it would “vigorously” defend itself against any business tearing up their agreement with the bank.
The banks’ fines and settlements over market manipulation
A number of Britain’s biggest banks, as well as global lenders, have been fined or settled with a range of US and UK authorities over LIBOR since the separate settlement over the interest swaps was reached. For example, the FCA fined Lloyds £105 million for Libor fixing in 2014.
Barclays was also the first British bank to settle with the US Department of Justice and the FCA’s predecessor, the Financial Services Authority (FSA), over Libor fixing with a combined £290 million ($US450 million) penalty. In May this year, it was also fined a total of £1.5 billion ($US2.4 billion), including £284 million ($US441 million) by the UK’s Financial Conduct Authority (FCA) in connection with the LIBOR currency market and interest rate rigging scandal.
The British bank is among five banks that have agreed to pay a combined $US5.8 billion (£3.7 billion) in connection with the scandal, which peaked in 2008. Barclays, as well as Citicorp, JPMorgan, and RBS, are pleading guilty to criminal charges tied to forex manipulation.
Businesses allege that now there is evidence, as uncovered by financial regulators and government authorities looking into LIBOR, that banks were manipulating markets during the period they bought a swap.
The swaps scandal
The financial products in question were mainly interest rate swap agreements (IRSA).
IRSAs were touted by banks as a simple form of “insurance” for small- and medium-sized businesses taking out the kind of loans that would have funded a new shop or bought new equipment. Banks said these IRSAs would protect them from rising interest rates.
Effectively, if interest rates went up, the bank would pay them a sum of money. However, if interest rates went down, they would owe the bank thousands of pounds in cash. These products are appropriate for larger businesses that look to hedge their interest rate exposure on large amounts of debt. But small and medium-sized business were sold this product because they thought it was insurance.
Many businesses claimed to have not known about the downside of the deal, when interest rates started to fall following the 2008 credit crisis.
From 2012 to date, £1.9 billion ($US2.9 billion) has been paid in redress. This payout number is already considered small by politicians and lobby groups because many businesses have either lost their companies, downsized to the extent where they have even lost their family homes or had to axe staff to make ends meet. This number does not include private lawsuits that were made by businesses through the courts.
While many settled through the FCA scheme, Sachdev said hundreds of businesses have gone through the courts. Since this is a costly move, it is usually only the high-net worth individuals with businesses that have been able to afford to do this.
One of the highest profile cases is at the moment is Gary Hartland, the owner of a Wolverhampton-based property company Wingate Associates, which took Lloyds to court. He is alleging in London’s High Court that a 2011 undisclosed settlement with Lloyds should be overturned and he should be given more generous compensation because Lloyds was found to have manipulated LIBOR during this time.
“The Hartland case is a huge one but even if hundreds of smaller businesses successfully tore up smaller settlements in the £200,000 to £300,000 ($US310,589 to $US465,884) range, this could run in a lot of money for the banks,” said Sachdev.
In response to any business looking to tear up its agreements or settlement, Lloyds told Business Insider in an email that “where a customer has previously agreed a full and final settlement with the Group, these agreements make clear that it discharges both parties from all claims. As such, we would view any new claim as not having any merit and we would contest it vigorously.”
Hartland already won £40 million ($US62 million) from Barclays after he took the bank to the High Court over the mis-selling of swaps between 2007 and 2008 to his Graiseley Properties business, which owns Guardian Care Homes.
Sachdev emphasised to Business Insider that is it not just compensation settlements that could be torn up and revised, it is also a range of other costly writedowns that the banks have already taken.
He said, as an example, businesses that saw 60% of their losses paid back in compensation could see upwards of 75% returned if companies tore up their agreements. This could be absolutely massive in a case-by-case basis.
“The largest settlement we’ve been party to has been a combination of a debt write-off and restructure of a swap, which came up to just under £18 million ($US28 million),” said Sachdev, who is also a Conservative party councillor for the Potters Bar Parkfield constituency.
While that illustrates just one business, Sachdev said added: “This could be really worrying for the banks if all the settlement agreements they entered into over the last few years were challenged. It’s not guaranteed that it will produce a more favourable outcome for the business but many are trying it following the range of financial scandals that have emerged during the settlement process.”
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