LAST May The Herald revealed the plight of thousands of Scottish businesses, locked into shocking interest payments on complex hedging products sold alongside business loans.
They had been encouraged to purchase them by the major banks as an insurance against rises in interest rates. But when interest rates were slashed to historically low levels by the Bank of England, these businesses found their interest payments rising rather than falling. And if they tried to extricate themselves from such arrangements, they came up against huge break clauses.
Yesterday, the Financial Services Authority (FSA) finally recognised that many interest rate swap agreements (IRSAs) and similar products had been mis-sold, opening the door to compensation payments for the victims. The report covers the four main banks, with a further report on six others due shortly.
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The FSA agreed with this newspaper that many of the small businesses that took them out – including some that were obliged to do so as a condition of the loan – were unlikely to understand the risks of such "absurdly complex products".
This is a significant victory. It sends a warning to the banking industry that it cannot hide the serious downside of a financial product in small print or use a statement that it does not give advice, when that is exactly what customers believe they are receiving.
There is still a lack of clarity as to how the compensation scheme will operate, the level of payments and who will qualify. Some less complex hedging products will fall outwith the scheme and some clients will be deemed experienced enough to have known better than to take them on. This seems like a fair compromise. Banks must now work speedily to identify victims of mis-selling and compensate them appropriately. Also, the FSA needs to clarify issues such as the appeals process. Meanwhile, companies applying for compensation should have their repayments suspended during the review process.
This process will be an interesting test for Martin Wheatley, chief executive designate of the new Financial Conduct Authority, soon to replace the FSA.
The same applies to annuities, the annual pensions people buy with their pension pots when they retire. The FSA announced yesterday that it is to launch an investigation into the way annuities are sold, amid concern that those buying them are still not being given enough encouragement to shop around, despite recent changes to working practices. While this is to be welcomed, this investigation is too narrow. The purchase of an annuity is one of the most important financial decisions an individual ever makes and getting it wrong has lifelong consequences.
The Bank of England's quantitative easing scheme has forced up the prices of government bonds (gilts) and lowered their interest rates, with a profound knock-on effect on annuities. A pension pot that would have bought an £8000 pension in 2009 would yield less than £6000 by last year. Yet those who defer buying annuities in the hope that interest rates on gilts will rise in future, can face stiff penalties. Annuities are too inflexible.
What characterises both these issues is that some financial products disadvantage not only customers but the economy as a whole. Small businessmen trapped in IRSAs are spending on interest payments funds that should be going into employing staff and expanding their businesses (or simply keeping afloat). Meanwhile, poor-value annuities mean those approaching retirement hoard money they would otherwise spend, helping to kickstart the economy.