The City regulator failed in its duties when it excluded about 10,000 businesses from a compensation scheme for a major banking scandal, an official review has concluded.
John Swift QC said that the Financial Services Authority was “wrong” and avoided its responsibilities when it produced a sophistication test “at the stroke of a pen” for a redress scheme for small and medium-sized companies who were mis-sold toxic interest rate hedging products.
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In a damning report for the FSA and its successor body, the Financial Conduct Authority, Swift also highlighted evidence of political interference in the scheme by George Osborne, the chancellor at the time, over concerns that it was going to cost banks too much money. The sophistication test cut banks’ compensation bills by billions of pounds.
The redress scheme was set up after the discovery by the Financial Services Authority in 2012 of “serious failings” in the way banks sold interest rate hedging products to SMEs before the financial crisis.
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Wrongly sold as “protection” against the risk of rising interest rates, swaps left firms facing disastrous cost increases when rates fell during the crisis. Lenders failed to explain the risks associated with the products and mis-selling was found in 90 per cent of cases. Many people lost their livelihoods.
Banks paid out about £2.2 billion in redress but the compensation scheme was dogged by accusations of unfairness. In 2013 the regulator altered its plans for the compensation scheme, introducing an eligibility cap, which essentially meant that businesses deemed “sophisticated” were frozen out.
Records show that Osborne wanted redress costs to be reduced having been “lobbied hard” by the bosses of Royal Bank of Scotland and Lloyds Banking Group, Stephen Hester and Antonio Horta-Osorio.
The Treasury asked for FSA “proposals” on how the costs could be reduced because the “desire of ministers to limit the costs” of compensation overrode its public position of “supporting small businesses”, evidence showed.
Swift found “no explanation” of why the sophistication change was arrived at despite examining one million documents and interviewing FCA staff. This “stroke of the pen” resulted in the exclusion of about one in three mis-selling victims but Swift found “no consultation with customers or their representatives” about it.
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The scheme was restricted “after only the briefest consideration, and without sufficient involvement by the board” and there was “no clear evidence as to how the eligibility test was identified as appropriate”.
Swift found the scheme was unduly tilted in favour of the offending banks in certain respects. Changes to the sophistication test were “negotiated in last-minute confidential discussions with the banks” and the Treasury, with victims excluded. “The FSA’s conduct fell short of the level of transparency that would have been appropriate.”
FSA and FCA communications “did not provide a level playing field between the banks . . . and the potential beneficiaries of the scheme” Swift said. He called a case of FCA refusing to provide transparency to parliament a “low point”.
Swift’s report shows significant interference from the Treasury in the scheme, something the FCA and the government has previously denied.
In an internal email written in October 2013, Martin Wheatley, head of the FSA, recalled “pressure” from Sajid Javid, then a Treasury minister, to “go easy on the banks”. The previous month Wheatley had been asked by the Treasury select committee whether he had come under any pressure to “go easy on the banks”. He said he had not. Wheatley refused to co-operate with the review.
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There was some evidence of resistence to the interference from the FSA’s Clive Adamson, who told the Treasury its lobbying was “inappropriate” because the FSA was supposed to be an independent regulator.
Swift said that both regulators should have considered taking enforcement action against the banks beyond the redress scheme, which was voluntary, and the failure to do so meant possible serious misconduct escaped sanction.
The FCA said that it acknowledged “clear shortfalls in processes, governance and record keeping when decisions about the redress scheme were made, and a lack of transparency”. However, it rejected Swift’s conclusion that it was wrong to limit the scope of the redress and said that it would therefore “not be appropriate or proportionate to take further action”.
Charles Randell, chairman of the FCA, 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.”
He said that Swift had made “recommendations that will strengthen our regulation, our supervision of firms and our approach to redress”.
