Conduct Risk - Lessons Learnt from Interest Rate Hedging Products
Anyone who watched the recent BBC Panorama programme - ‘Britain’s New Banking Scandal’ - about Interest Rate Hedging Product (“IRHP”) mis-selling, could probably not help but wonder “how could this have happened?” Could the “victims” have been as naïve and trusting as they appeared? Could the banks have been as malicious as they were portrayed? What lessons can financial services senior executives and those in product design, distribution, sales and those in second line oversight in banks do to avoid this type of scandal happening again?
A review conducted by the Financial Services Authority (“FSA”; now the Financial Conduct Authority, “FCA”) in 2012 found serious failings in the sale of IRHPs to small and medium sized businesses (“SMEs”). As a result, four banks, followed by a further seven, agreed to review their sales of around 40,000 IRHPs made to certain ‘non-sophisticated’ customers from 1 December 2001 onwards. The FSA first published an update in August 2012, followed by a report in January 2013 (based on pilots completed by Barclays, HSBC, Lloyds and RBS)explaining the banks’ failings and customers’ redress routes.
Between 2001 and 2008 the prevailing economic trends indicated continued global GDP growth, leading to a feeling of security, and scepticism regarding the possibility of a market crash. UK interest rates were very low and appeared stable; few predicted that they would fall to levels not seen since the 1930s. This stable interest rate environment and the desire amongst many to lock into the low rates fuelled the steady growth of IHRP sales. Traditionally offered to wholesale market participants, their distribution of IRHPs expanded to less experienced investors with varying risk profiles, including investors who subsequently were classified as ‘non-sophisticated’.