Our biggest banks have been battered by mis-selling claims and governance failures for over a decade. As PPI and interest rates swaps payouts tail off, Eduardo Reyes asks, are they finally managing to reduce their exposure?
The low down
Banking blunders generate long, expensive clean-ups, during which financial institutions that suffered systemic failings face costly litigation and regulatory enforcement. UK banks have now been able to reduce their provisions for two major mis-selling scandals – PPI and the more esoteric interest rate swaps. Their duties under ‘authorised push payment’ frauds were also clarified in their favour. Can UK banks, in the dog house since the global financial crisis, now turn the page? To a degree. But new sources of liability are emerging. And the conduct of their senior executives is under closer scrutiny than ever before.
For most of this century, hefty legal claims by customers of and investors in banks have come thick and fast, forcing the sector to set aside billions following mis-selling scandals and frauds. The UK’s retail banks found their own television advertisements, promoting partnership and trust, competing for airtime with claims management companies and the Financial Conduct Authority, which reminded anyone who took out payment protection insurance (PPI) that the product was widely mis-sold, and that customers may have a claim.
From 2010 onwards, one particular class of business finance was appearing in the press – ‘interest rate hedging products’ embedded in loan agreements. These complex financial instruments were pressed on small and medium-sized enterprises on an industrial scale. When interest rates failed to behave as envisioned, in particular due to the global financial crisis, SMEs faced enormous losses. The Financial Services Authority (FSA) intervened – first to investigate and then to set up a compensation scheme designed to steer claims away from litigation. Accountability for that scheme was assumed by the Financial Conduct Authority (FCA), which succeeded the FSA in 2013.
Journey’s end?
Earlier this month, the Supreme Court gave judgment in a PPI case, Smith and another v Royal Bank of Scotland plc. It was a setback for the banks, in that it reopened the way for claims for mis-sold PPI by those who failed to obtain complete redress under the FCA’s PPI mis-selling scheme, which closed on 29 August 2019.
The claimants, Ms Smith and Mr Burrell, had both terminated PPI policies (in 2006 and 2008 respectively). Smith’s credit card agreement (which the PPI policy had covered) continued until 2015 and Burrell’s till 2019. They became aware of the bank’s wrongdoing when they received partial compensation in late 2017 and early 2018. In 2019 they brought claims; although their PPI agreements had been terminated more than six years ago, this was less than six years after the credit card agreements had been terminated.
The headline raised fears of ‘stale claims’ continuing to haunt banks. But Mishcon de Reya partner Edwin Chik wrote the day after the judgment: ‘This position strikes a fair and sensible balance between consumers who were unable to obtain redress due to lack of knowledge, while making clear that the courts hearing these cases should not exercise their discretion to reward previous inaction over known claims.’
Banks’ own annual reports show a steady fall in claims liabilities. HSBC UK’s PPI provision was £128m in 2021 and £74m in 2022. NatWest’s consumer redress provision fell over the same period – from £800m to £700m. NatWest Group subsidiary RBS’s provision for ‘regulatory redress, litigation and other regulatory matters’ halved from £200m in 2021 to £100m in 2022.
Lloyds’ claims liability figures are skewed by the need to provide for the ‘HBOS Reading fraud’, perpetrated against customers of the Reading branch by bank staff; but its accounts note it has paid out £22m in PPI claims in total. Barclays’ provision is high at £1.6bn, reflecting claims it faces in the US (see below).
And what of mis-sold products that had interest rate hedging products embedded? This is a complex product class. Depending on specifics, they behaved very differently in the context of interest rate moves. Essentially, the FSA’s initial investigation in December 2012 concluded that ‘over 90% of sales across all four banks were non-compliant with our Principles, rules and guidance’. But while one consultancy estimated the value of credible claims at £16bn-£20bn, the bespoke scheme the FSA agreed the banks should administer – and bear the cost of – paid out just £2.2bn.
The scheme was criticised in terms that were in part upheld in an independent review commissioned by the FCA, which reported in 2021 (see box). Nevertheless, any exposure the banks face is down to a thin tail.
Another broad measure of bank exposure is cases dealt with by the Financial Ombudsman Service. Complaints received by the service peaked in 2013/14 at 512,167, falling to 165,263 in 2021/22.
Marking the assessors: the swift review
In 2019, the Financial Conduct Authority asked Jonathan Swift KC to review the novel compensation scheme established by its predecessor regulator, the Financial Services Authority. The scheme existed to review claims by ‘non-sophisticated’ bank customers who had been sold interest rate hedging products, and suffered a loss as a result.
The review was commissioned to learn lessons, reflecting concerns raised about the FSA’s design of the scheme, and the transparency of decisions made by independent assessors who were appointed and paid for by the four banks at the centre of mis-selling allegations: Barclays, HSBC, Lloyds and RBS.
Swift’s review, which reported in 2021, concluded that most customers eligible for the scheme in all likelihood obtained better outcomes than could have been achieved outside it.
Other more critical findings, which the FCA accepted in full, were that:
• The FSA/FCA should have carried out a more intensive investigation of the root causes of the mis-selling before concluding not to pursue enforcement action.
• There was a lack on consultation on the nature, terms and scope of the compensation scheme.
• The ‘sophistication’ test saw many changes, including changes that followed last-minute confidential consultations with the banks. Here FSA conduct ‘fell short’.
• The FSA should have provided for an independent appeal mechanism for decisions.
• 10,000 sales of interest rate hedging products to customers designated by the FSA/FCA’s rules as private customers/retail clients were excluded from the scheme, a third of the total, ‘leaving customers with no relief other than through the courts… an inadequate regulatory response as regards those customers’.
FCA chair Charles Randell said: ‘The FCA today is a very different organisation from the FSA as it existed when these products were sold and when it established the redress scheme. We would expect to act far sooner and more decisively today.
Fraud
Recent years have seen an exponential increase in fraud, and financial services institutions and their customers have been an obvious target. Office for National Statistics data released on 19 October, based on the Crime Survey for England and Wales, showed 3.5m fraud offences in the year to March 2023.
Bank and credit card fraud has fallen. But when it comes to litigation liability, ‘authorised push-payment’ (APP) fraud has been a particular issue for banks. Trade body UK Finance estimated that this reached £485m in 2022. The question, put simply, is when a customer directs the transfer of their own funds, having been duped into doing so, do banks have a duty to detect and prevent such a transfer?
The duty is known as ‘Quincecare’, after a 1992 case against Barclays, which established that banks have a duty of care. The question was again the subject of litigation in Philipp v Barclays Bank, which reached the Supreme Court this year.
On the facts of this case, the court decided that as the validity of the instruction was not in doubt, and no ‘agent’ of the bank was involved, the bank was under no duty of care to make enquiries to clarify or verify what it should do.
But while the banks may welcome the judgment, they are not entirely off the hook on APP liability. Gerard Heyes, partner at Farrer & Co, says: ‘The recent decision of the Supreme Court in Philipp v Barclays hasn’t had a material impact on the number of customers seeking redress from banks in the context of push payment fraud. The continued prevalence, and increasing sophistication, of push payment fraud means that activity in this area is something that is likely to continue.’
Heyes points out that since the events underlying the case took place, there have been other developments. These include the Payment Systems Regulator Scheme, a mandatory reimbursement mechanism in respect of APP fraud which is now set to come into force in 2024.
Reporting and governance
Failings in banks’ standards of reporting and governance have the potential to generate claims, and can also damage or lead to the ousting of senior leaders given the importance placed on such standards by regulators and investors.
And banks are ‘reporting’ on more than ever before, including statements on environmental, social and corporate governance standards (ESG). Increasingly, such reporting includes mandatory elements.
Laurence Winston, partner and co-head of Crowell & Moring London’s international disputes group, sees ESG claims as a ‘significant’ trend, ‘especially around corporate disclosures and the making of false statements, particularly in listing particulars’.
He adds: ‘This topic and “greenwashing” generally is likely to be a huge issue for businesses as we head into 2024 with the expected introduction by the FCA of climate-related reporting for listed companies… expect this to be a very fertile area of claims for 2024 and beyond.’
Where regulators establish a lack of candour, a hard line is taken. ‘I’m certainly seeing an uptick in FCA enforcement activity relating to firms and individuals,’ Heyes notes. ‘This comes off the back of a relatively quiet period, certainly in terms of the number of new investigations, and it will be interesting to see if that is reflected in the next set of data released by the FCA.’
On 12 October the FCA decided to fine former Barclays CEO James Staley £1.8m and ‘ban him from holding a senior management or significant influence function in the financial services industry’. It followed misleading statements on Staley’s relationship with disgraced and now deceased financier Jeffrey Epstein.
FCA enforcement head Therese Chambers said: ‘A CEO needs to exercise sound judgement and set an example to staff at their firm… We consider that he misled both the FCA and the Barclays Board about the nature of his relationship with Mr Epstein.’
Staley is contesting the decision and has said he will provide no further comment.
Products and pricing
Analysts continue to eye inappropriate and mis-sold products as potential claims areas. Despite the learning experience of interest rate hedging products claims, attention is still focused on products with a hedge and interest rate element.
Nikki Coles, managing director in the disputes and investigations team at industry consultants Alvarez & Marsal, is still watching ‘products offered as “hedges” to organisations and individuals which only perform in a boundary of interest rate levels’.
'Appropriate governance, fairness and rationale are areas of constant and considerable scrutiny'
Nikki Coles, Alvarez & Marsal
Interest rate changes have increased attention on this area, she explains: ‘Once they break out of these levels the economics are disadvantageous to the party concerned… Often these products are purely low interest rate plays which generate a return when rates are low, but cause outsize losses when rates are higher.’
Coles says institutional pricing decisions are also being looked at by customers and regulators. ‘Appropriate governance, fairness and rationale are areas of constant and considerable scrutiny,’ she says. Company-wide policies in areas such as loan and deposit rates, Coles says, ‘will continue to attract regulatory attention.
‘Treating customers fairly is a core principle of regulatory oversight of financial institutions, so pricing decisions will remain squarely in the crosshairs, with disputes likely to arise from any perceived shortcomings.’
Coles adds that interest rate fluctuations will also test the successor benchmarks that replaced LIBOR in contracts. These fluctuations ‘will almost certainly create winners and losers,’ she says, ‘increasing the potential for disputes’.
In the wake of the global financial crisis, banks increased their compliance departments internationally, beefed up controls and adapted to a more interventionist regulatory regime.
But regulatory fallout continues. The numbers remain big – and not just in the UK. In 2021 Barclays announced that since 2017 it had sold $15.2bn more in US investment products than it was permitted to. The over-issuance of securities resulted in £1.6bn in litigation and conduct charges over 2022. The bank settled with the US Securities and Exchange Commission for $361m.
In settling, the bank does not admit or deny the SEC’s findings. But the episode is a reminder that even as banks eye the diminution of major sources of liability, other sources of exposure are coming into view.
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