24 April 2015 by

A Captive Regulator

Anti-bank sentiment is an unfortunately prominent feature of the zeitgeist. We are barely given enough time to digest the current banking scandal before the next wave of wrongdoing crashes onto the front pages, flooding us with another round of jargon and statistics in an attempt to explain what the banks have done this time around. During the course of last year, further problems with PPI emerged (that banks have failed to follow the rules set down by the Financial Conduct Authority in providing compensation to those affected), money laundering in relation to the proceeds of organised crime was exposed, rigging of key interest and foreign exchange rates resulted in record-breaking fines being levied against the banks, and allegations concerning the predatory practices of their internal restructuring teams made headline news following the release of the Tomlinson Report, leading, we are told, to concerted action by a large group of affected companies against one bank in particular – RBS. We are only two months into 2015 and the banks are already reeling from revelations relating to their role in tax avoidance schemes.

But there is one scandal that continues to simmer: a scandal that first came to the boil, publically, almost 3 years ago – mis-sold interest rate hedging products. Tens of thousands of small and medium sized business have been affected, some so severely that they have ultimately lost the fight and fallen into insolvency. I have represented many such businesses over the course of the past three years and have observed a remarkable level of engagement, determination, and devotion to a cause in the face of extraordinary adversity and against the most challenging of opponents. But for those who are not directly affected, the technical and jargon-istic nature of the scandal means that it is difficult to grasp, difficult to empathise with, and the gravity of the Bank’s behaviour remains mis-understood.

But the events of the past few weeks have significantly altered the playing field. It would seem that the true nature of this scandal raises fundamental concerns not just about bad bankers, but also about the Financial Conduct Authority’s (FCA) relationship with the banks, its ability to protect consumers, its strength of conviction and, ultimately, its fitness for purpose. It is my view, shared by many, that these are issues that concern every bank customer, and every consumer that the FCA is mandated and purports to protect.

Basis of Scheme

Having carried out a pilot review of 173 cases throughout 2012, the FCA (then the Financial Services Authority) concluded that “mis-selling” occurred in over 90% of cases. The Pilot findings are enclosed at Appendix 1. Whilst mis-selling is not a technical legal term, it incorporates a number of legal principles, the combined thrust of which indicates that the banks were deemed to have breached a legal duty owed to their customers in some shape or form. The inescapable conclusion was that the FCA had a duty to establish a scheme by which the tens of thousands of small businesses affected could seek redress. At the core of the scandal is how the FCA did precisely that, the effects of the paths that it chose, and the inferences that can be drawn as a result.Under section 404 of Financial Services and Market Act 2000 (‘FSMA’) (statutory extracts are enclosed at Appendix 2), the FCA has the power to set up a mandatory scheme to compel banks to provide customers with redress if it can show that:

  • There has been a widespread or regular failure by the banks to comply with requirements applicable to the carrying on by them of any activity;
  •  A customer has suffered loss as a result of that failure and would have a remedy through the courts (which would be the case in most cases where “mis-selling” occurred); and
  •  The FCA considers it desirable to make rules for the purposes of securing redress (having regard to other ways in which the customer might obtain redress).

Any such scheme would compel the banks to review their sales practices against a publically known set of standards and principles, and would take place in a transparent and open way that would be open to customer, public, and parliamentary scrutiny, would ensure that the banks were not in charge of assessing their own wrong-doing, and would therefore significantly decrease the potential for the banks to stray.

However, despite the glaring suitability and applicability of the FCA’s section 404 powers to the IRHP scandal, the FCA appears to have considered it to be undesirable to invoke them. Instead, and to the dismay and confusion of victims and their advisors, the FCA chose to enter into “voluntary agreements” with the banks which ultimately provided the architecture for the scheme. The FCA has failed to adequately explain the basis for this decision, and indeed it remains unclear as to whether the various methods of analysis that the FCA was required to undertake as part of the consultation process were ever actually undertaken.

“So what?”, I hear you say. Well, for a start, in opting to pursue a voluntary approach, the rules of the scheme became the subject of intense negotiation between the FCA and the banks. This is a very important point – the FCA was not forcing the banks to deal with their wrongdoing in an open, fair, and transparent way (as it had the power to do). It was instead negotiating with them as to how remediation would occur, in effect asking them how they were going to resolve their own wrongdoing. On a conceptual level this is difficult to reconcile – the FCA had found that the Banks had mis-sold products in over 90% of cases, and yet from the outset it allowed the banks to have a say (and a significant say, as we shall see) in the way in which they would put matters right.

Further, and perhaps more alarmingly, by entering into negotiations and ultimately voluntary agreements with the banks (as opposed to invoking powers under section 404) had the consequence of cloaking the entire scheme in confidentiality. This is because the dialogue and resulting agreements are subject to section 348 of FSMA, which restricts the FCA’s ability to disclose to the public information concerning its dialogue with the banks.

On behalf of my clients I (along with countless other victims and advisors) tried repeatedly to obtain this information from the banks and the FCA (on the basis that it was inherently unfair to conduct a review in line with a framework that was unknown to the customer), but to no avail. Meanwhile the banks continued to hand down redress offers to their customers that, whilst appearing to have no basis in logic or law, would be justified (and finalised) in reference to the confidential agreements between the FCA and the banks.

However, on 10 February 2015 the Treasury Select Committee interrogated the Chairman (John Griffiths-Jones) and CEO (Martin Wheatley) of the FCA and the result is that finally, after nearly three years and countless deficient offers of redress, the “voluntary agreements” upon which the scheme is built have now been released for public consumption, it having been demonstrated that their being crucial to public interest was, in this case, more important than the confidentiality created by section 348. Together with Martin Wheatley’s comments to the Treasury Select Committee and subsequent letter of 9 March 2015, both shown at Appendix 3, they reveal an inexplicably soft touch in the negotiation of the agreements, ineffective/non-existent monitoring and policing of the scheme on the part of the FCA, and in some cases a complete disregard for the agreements by the banks bound to them.

The Agreements

The contracts and correspondence that have been released are enclosed with this paper at Appendix 4, and comprise of a main agreement, a template letter from Clive Adamson in the Conduct Business Unit at the (then) FSA, and a supplemental agreement.

The agreements are encouraging in some respects. They give very clear guidelines as to how the banks may incorporate alternative products as part of the redress process, including how those products are to be priced. They show that the CEO of each bank has personally undertaken to ensure that complaints are treated fairly and within the spirit of the scheme. They reveal that the standards against which the complaints are to be judged includes the relevant regulations contained in the FCA’s handbook (i.e. COB/COBS). Crucially, they show that the only source of impartiality rests in the appointment of the Independent Reviewer as the “Skilled Person”.

However, the final agreed terms of the scheme constitute an enormous victory for the banks. In particular: 

  • the introduction of a sophistication test based on the size of the customer, thereby immediately and arbitrarily precluding thousands of complainants from the review (reportedly the number of sophisticated customers is in excess of 10,000,m i.e. nearly a third of all of the businesses effected by mis-sold interest rate hedging products);
  •  A refusal to use the Financial Ombudsman Service as an appeal route for customers dissatisfied with their redress outcome, leaving customers with no impartial avenue to appeal the bank’s decision under the scheme except by appealing to the bank itself;
  •  No express obligation to ensure that there is a fair and frank sharing of the information upon which the review is based, and which is being presented to the Independent Reviewer;
  •  A reticent acceptance by the FCA that redress must be provided in respect of consequential loss , but a failure to (i) grasp the inherent complexity of such claims, (ii) provide any proper direction or requirement on the banks as to how to provide redress for consequential loss, and (iii) provide for customers to be able to take professional advice.
  •  No mandatory time frame within which the review must be concluded and no requirement for the banks the pause time in any legal proceedings, enabling the banks to delay and obfuscate the process. In many cases this would ultimately cause the statutory time limit on customers’ legal claims to expire (exacerbated by the FCA’s recommendation that victims of the scandal need not take legal advice).

By entering into the voluntary agreements as the FCA and banks did, the banks’ overall liability flowing from IRHP mis-selling was slashed. The confidential nature of the agreements also allowed the banks to carry out the reviews on their own terms without proper scrutiny, thereby further reducing the amount that they would ultimately have to pay.

The Scheme in Practice

Notwithstanding the soft touch taken by the FCA in negotiating the agreements, their release confirms the long and wide-held suspicion that in many cases the banks have broken the rules in any event. For example: 

1. One bank in particular has shown itself to have no regard to the FCA’s guidance regarding the imposition of an alternative product. The bank in question routinely justifies the imposition of alternative products (that are economically similar to the mis-sold product) by referring to contemporaneous statements made by the customer, such statements having been made on the basis of severely (and unlawfully) deficient information given by the bank at the point of sale – this directly contravenes the parameters set out by the FCA and seeks to reduce (if not eliminate altogether) the amount that the bank must pay the customer in redress. 

2. Whilst the FCA claims that £365m has been paid in respect of consequential loss, this is actually largely comprised of the 8% interest element provided by the scheme, which is paid in lieu of consequential loss. To date, we understand that less than 5 consequential loss claims have resulted in redress of any real substance. On behalf of clients I have prepared comprehensive legal documents, with the assistance of specialist counsel, demonstrating how the FCA’s tests (which are parallel to the legal tests) for consequential loss are met. The banks simply say “no”, and there is no further discussion on the topic. And the voluntary agreements facilitate this because there is no impartial avenue of appeal and there is no proper independent authority to assess the validity of the banks’ conclusions. As such there is nowhere for the customer to turn, effectively wiping out what is likely to be an enormous cumulative liability for the banks. In many cases consequential losses are the cause of the devastation of the underlying business but the redress scheme fails to grasp the issue. 

3. In many cases, the Skilled Person has been nothing more than a silent observer, and has conducted no meaningful supervision over the review. For example, I have attended numerous “post redress review meetings” which purport to allow the customer to interrogate the banks’ rationale after an offer has been made. David de Souza of the FCA has provided numerous written descriptions of the purported purpose and structure of such meetings, as shown at Appendix 5. In practice, the meetings have no constructive value, the banks do not listen to the challenges levied toward them, they openly breach the terms of the agreements that have now been revealed; all of this under the watchful eye of the Skilled Person. 

4. The role of the Skilled Person was explored by the Treasury Select Committee during the interrogation on 10 February 2015, and the responses of the FCA were, we would say, damaging to its credibility. The following passage is of particular relevance:

Andrew Tyrie: …I’m asking you to check whether the Skilled Person is doing the job. That is, are they contacting the [customer] in order to obtain the [customer’s] view?

Martin Wheatley: We – as I say – we would expect them to. We wouldn’t validate on every case but if we had complaints that they were not doing that, we would go back to the bank and the Skilled Person to check on that”.

In our experience, as a matter of procedure the customer is denied access to the Skilled Person. In fact, where the skilled person was contacted directly they responded by explicitly stating that their role is “to report directly to the FCA”, that they were “unable to enter into correspondence about cases with customers of [the bank+”, that correspondence should be addressed “directly to *the bank+” and that any other queries about the review process as a whole should be directed to the FCA. A redacted copy of the letter is available. When the FCA was approached, no action was taken and the FCA told the customer to speak directly to the bank concerned. An inevitable shortfall is left between what the FCA holds out as the role of the Skilled Person and what their actual involvement is. 

5. During many of my clients’ reviews, the Bank has failed to gather and consider all appropriate evidence, and it must be inferred that the banks have been selective with the evidence that has been passed to the Skilled Person. This concern was raised by Mark Garnier MP during the Treasury Select Committee’s interrogation, where reference was made to court disclosure of documents used in a review, which showed that “one paragraph out of 70 pages [of a relevant document]” made its way onto the case file that was ultimately presented to the Skilled Person. Further, many clients have come to me after they have gone through the relevant banks’ information gathering process and it is clear that the banks have been able to be selective about their information gathering where the customer does not have professional representation.

6. The banks have, time and time again, priced the alternative products unfairly. In this regard a report on the banks’ pricing practices was commissioned Bully Banks and was prepared by Nick Stoop of Warwick Risk Management, who has a wealth of experience and expertise in the area. The report (enclosed at Appendix 6) concludes that 4 banks subject to the scheme have been guilty of this practice: in some cases alternative interest rate caps have routinely been priced in excess of 1600% of the fair value. The net effect is to further reduce the amount payable in redress to the customer.

The FCA’s claims of success

Martin Wheatley and other representatives of the FCA continually refer to their statistics as evidence vindicating the success of the Scheme. In particular, Martin Wheatley stated to the treasury select committee that “14,000 of 17,000 eligible customers have got cash payments and £1.8billion has been paid out that would not have been paid out had we not entered into this scheme”.

It is quite clear that these numbers have no relevance unless they are compared to the amount that those 14,000 customers actually lost under the products. Based on Mr Wheatley’s statistics the average payout under the scheme has been £128,000, inclusive of Consequential loss.

But for argument’s sake, if the average customer actually lost £500,000, and the bank has been able to reduce that amount down to £128,000 by (i) mis-applying the principles of the review; (ii) basing the imposition of alternative products on unreliable evidence; and by (iii) aggressively pricing the alternative product, the statistics can hardly be said to vindicate success of a scheme that is supposed to deliver fair and reasonable results.

A further, perhaps more pressing concern over the conduct of the FCA is that no attempt has been made by the FCA to quantify the total amount paid by affected customers under the mis-sold products. As such, it must be the case that no real attempt has been made to measure the genuine success of the scheme.


The above demonstrates what many consider to be a failure of the IRHP scheme. It is true that in some cases the scheme has produced positive results for the customers in a timely and cost-effective manner. Indeed we have acted for clients who have achieved satisfactory redress through the scheme.

But its purpose was to provide a timely and cost effective process to achieve fair and reasonable redress for every customer affected by the mis-selling, and it is my view that it has failed in that pursuit. As a result of that failure, a proper impartial enquiry into the FCA and its role in the scheme must be undertaken. By opting to build the scheme on voluntary agreements (as opposed to invoking its statutory powers under section 404 FSMA), the FCA all but removed transparency and fairness. By narrowing access to the scheme to “non-sophisticated” customers, the FCA arbitrarily precluded from the scheme swathes of customers who have suffered loss as a result of the mis-selling. By narrowing and softening the rules of the scheme the FCA gave the banks free reign when conducting the review. By failing to properly empower and supervise the Skilled Person, the FCA all but handed over the last vestige of impartiality and fairness to the banks. By failing to establish a proper mechanism of appeal the Banks actions have almost entirely escaped scrutiny. By failing to address concerns levied directly at the FCA with regards to the banks’ handling of the scheme, it actively ignored those customers whom the scheme had failed. And finally, by way of Martin Wheatley’s comments to the Treasury Select Committee (and by way of numerous analogous correspondence received by Bolt Burdon on behalf of its clients, and many other bank customers beyond), the FCA has demonstrated a failure to grasp the manner in which the scheme has been conducted by the banks on the ground.

In the circumstances, it comes down to one question: upon concluding that the banks committed wrong-doing in over 90% of cases, why did the FCA establish and preside over a voluntary scheme that enabled the banks to be their own judge, jury, and executioner, when it had the statutory power to put something proper in place? In response, many commentators would say that the FCA is a Captive Regulator – a regulator whose mandate is to protect consumers, but who instead advances the commercial interests of the institutions it purports to regulate. This sentiment was echoed by Mr John Thurso MP, during the interrogation on 10 February 2015, when he said that he had “…a very distinct feeling that you, the FCA, have been captured by the banks…

On the basis of the above I agree, and so do many others. The release of these documents has finally put documentary meat on the bones of thousands of grievances levied against the banks and the FCA and shows that the FCA established a review scheme that has ultimately saved the banks a fortune. The possibility of a Judicial Review looms large. I, along with all others involved in or affected by IRHP mis-selling, will eagerly contribute and participate as much as possible.

But importantly – for those with an inadequate offer from the bank in the scheme: if you have preserved your right to litigate then pursuing the court process is likely to be the only way that you achieve the right result. If you have been affected by any of the issues raised above, or if you have an embedded interest rated derivative which falls outside the scheme (or indeed if you have been deemed to be sophisticated) and you would like to talk to someone, please contact a member of our team who would be happy to help explore your options.

Simon Bishop

A Captive Regulator PDF

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