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New City Agenda Event, Tuesday 10th July 2018, Committee Room 14, House of Commons
A well-attended New City Agenda event heard from Anthony Stansfeld, the Thames Valley Police and Crime Commissioner, on the HBOS banking fraud and the lessons from this scandal. Stansfeld strongly rebuked the actions of senior board members of the Banks, their ongoing complicity in attempting to cover-up large- scale frauds, their mis-treatment of SMEs and proposed reforms to the current financial regulatory system, which clearly is not and will not work whilst the Banks can continue to exert control without transparent checks and balances.
Victims of banking misconduct from HBOS, Lloyds and RBS were present along with MPs representing many constituents who have suffered due to large-scale fraud, members of the House of Lords, members from the APPG on Fair Business Banking, the SME Alliance and members of the financial services litigation team at LEXLAW were all present to hear Anthony Stansfeld’s rebuke of endemic large-scale financial fraud, which spreads much further than the conviction of middle-management in one regional office in Reading.
Thames Valley Police and Crime Commissioner Anthony Stansfeld speaking in Committee Room 14, House of Commons, on large-scale banking fraud. Credit: Steve Baker MP
Anthony Stansfeld rebukes endemic financial fraud
The powerful message coming from the most senior figure in British policing and an integral figure in tackling large scale financial fraud is that Lloyds and other UK banks have been guilty of corrupt practices and:
reports such as Project Lord Turnbull, leaked onto the APPG website, highlight in “devastating detail” the dishonest and “disgraceful” actions of senior banking figures and the continuing cover-up by Lloyds of major fraud and the hole in HBOS’ accounts;
many frauds across Banks have not been properly investigated, especially Lloyds Bristol, which maybe larger than the HBOS scandal;
victims of financial fraud are common-place, as was highlighted in the Parliamentary debate, Stansfeld noted that victims of “business support” “profit-churning centres” of Lloyds’ BSU, RBS’s GRG and NAB Clydesdale, have still yet to be fully compensated (if at all);
over £200 billion is the quantum of fraud in the UK, less than 1% of serious organised crime is investigated and only the one office of HBOS Reading has been successfully prosecuted.
The next steps in tackling large scale banking fraud
Anthony Stansfeld rebuked the Treasury’s ignoring of the “destitution” of SMEs from the offices of Gordon Brown to Phillip Hammond. SMEs contribute more to the UK economy than large multinationals and he criticised the Treasury for taken the interests of the Banks’ more into account (especially when many civil servants end up in Bank employ further into their careers). Large scale fraud in HBOS Reading was only uncovered after a 10 year and £7 million investigation by the Thames Valley Police instigated by Paul and Nikki Turner. Clearly, as Stansfeld suggested, a better system is needed to uncover fraud:
A US-style Chapter 11 system may go some way to prevent predatory business support units stripping SMEs of their assets, by allowing debtor businesses time to restructure and pay its creditors over time.
Chairmen of Banks and its senior Board members must not be placeholders, but must be qualified bankers that understand the rules and not salesmen.
Fraudulent bankers must be arrested and prosecuted like in the US, who have a much cleaner system.
The SFO and the FCA must be properly independent to the Treasury.
Civil servants should not be able to move effortlessly into Bank jobs.
More funding is required for financial fraud investigations for the Serious Fraud Office (SFO) and specialist regional fraud police units are required.
A system of recompense for victims of banking fraud is required: Stansfeld advocated for a removal of the 6 year statutory limit; restrict the use of personal guarantees; stop Banks using large amounts of shareholder money on expensive London lawyers to protect themselves.
LEXLAW Banking Litigation & Dispute Resolution
It is an absolute must that victims of Lloyds BSU, RBS GRG or other bank BSUs protect their legal rights. This is the only sensible course of action when a business is facing a high value dispute with a major bank, such as the Royal Bank of Scotland or National Westminster Bank. Otherwise, if there is no redress scheme, or if the bank refuses to offer reasonable redress, customers may well find they are time-barred from commencing legal action and their high value claim is now worthless. Legal rights can be protected by taking urgent legal advice and by instructing specialist financial services litigation solicitors to issue a protective claim form or by instructing us to prepare and agree a carefully written standstill agreement.
Our Financial Services Litigation team of Solicitors and Barristers in London are highly experienced in banking litigation and specialise in representing SMEs in banking disputes. Our high profile and high value cases regularly appear in the national and international media. Our banking litigators advise on the protection of borrower legal rights in the face of predatory bank practices. We have successfully managed and settled court litigation against all major UK banks. Call us on 02071830529 or complete our online contact form.
Rt Hon Nicky Morgan MP
Treasury Select Committee
House of Commons
30 January 2018
Re: FCA powers and perimeter
I am writing to you following our appearance at the Committee on 31 October. During the session Mr Mann asked if I could write to you regarding the powers we do not have that it might be useful for the Committee to consider whether we should have. The question was framed around RBS Global Restructuring Group (RBS GRG) but also more broadly. Mr Mann also asked me to set out what we have been doing on areas outside our regulatory perimeter.
This letter sets out an overview of what the FCA regulates, the aim of regulation, the powers available to us, and specific examples of areas where issues have arisen about the nature and extent of the FCA’s role. I hope this will provide helpful context for some of the questions we have grappled with in the past. I also set out the steps we have taken to explain our understanding of the FCA’s remit where there is less clarity about the role we should play.
What the FCA regulates
Certain types of financial services activity require a license or “permission” before they can be carried on. The definition of these activities, and the “specified investments” to which the activity relates, is at the heart of FCA regulation.
The activities are described at a high-level in the Financial Services and Markets Act 2000 (FSMA), and in more detail in the Financial Services and Markets Act 2000 (Regulated Activities) Order (the RAO). We usually refer to such activities simply as “regulated activity” or as being within the “FCA’s perimeter”.
Much of the regulatory framework set out in FSMA, and most of the FCA’s powers, are targeted at regulating the conduct of this activity. Persons licensed to perform such activities are “authorised persons”. Obvious examples of regulated activity are giving advice on whether to invest in particular securities or, since 2014, providing consumer credit. Performing such activities without an FCA permission is a criminal offence.
The regime set out in FSMA and in the RAO governing “regulated activity” is not, however, the only basis for the FCA’s regulatory responsibilities. The FCA performs the role of the UK’s listing authority. The listing regime applies to firms whether they are authorised under FSMA to conduct regulated activities or not; and in fact the majority of listed companies are not FCA authorised firms. Another example is the market abuse regime which applies to behaviour conducted by any person irrespective of whether they are authorised by the FCA.
We are also responsible for regulating some entities or conduct under standalone legislation outside the FSMA framework altogether. The Payment Services Regulations, for example, set out a separate regime for registering or authorising payment service providers, and give the FCA a different set of responsibilities and powers. Similarly, the Money Laundering Regulations 2017 specify responsibilities for the FCA which extend beyond those for authorised firms conducting regulated activities.
Finally, as of 1 April 2015 the FCA became a competition regulator. The FCA has a specific objective to promote competition in the interests of consumers (I cover this in more detail later), and has also been given what are usually referred to as “concurrent competition powers” available to the Competition and Markets Authority (CMA) and other sectoral regulators. Such powers may be exercised in respect of “financial services activity” rather than being tied to the more specific and narrower concept of “regulated activity” from the RAO.
The decision as to what or whom should be regulated by the FCA is of course one for Government and Parliament. Often the choice will be made for domestic policy reasons, such as the transfer of consumer credit from the Office of Fair Trading (OFT) to the FCA in 2014. At other times EU legislation has shaped whether and how a financial service should be regulated; it then falls to Member States to decide which body within their jurisdiction should be the national competent authority for the activity in question. The Payment Services Directive and the Benchmark Regulation are two examples of recent EU legislation which have resulted in additional responsibilities being given to the FCA.
Why we regulate
The FCA’s aim and purpose is set out in FSMA. We have a single strategic objective – to ensure that relevant markets function well. The strategic objective is underpinned by three statutory “operational objectives”:
to secure an appropriate degree of protection for consumers;
to protect and enhance the integrity of the UK’s financial system; and
to promote effective competition in the interest of consumers.
Many of the FCA’s core powers, especially the rule-making power, require that action by the FCA should be to advance one of these three operational objectives. A key concept is the meaning of “consumer” for these purposes. The definition in FSMA is broad, but it does not extend to all consumers of all products. Rather, the emphasis is upon persons who use, may use, or have used, regulated financial services or have invested, or may invest, in relation to financial investments. This is something we have to consider both when making rules and if we contemplate firm-specific action to further our consumer protection objective.
In pursuing the aims set out in the statutory objectives, we are concerned not only with the behaviour of the firms we regulate, but also – at least for the firms authorised only by the FCA- their financial health. In this sense, we are both a conduct regulator for 56,000 firms and a prudential regulator for 18,000 firms. The FCA prudentially regulates those firms for which such regulation apples that are not regulated by the Prudential Regulation Authority (PRA).
How we regulate
The FCA’s powers are extensive, but the availability of the powers, and how we use them, will depend on who and what it is we are dealing with. In particular, it will depend upon whether the person in question is an authorised firm (that is, a person given permission to carry on regulated activity), an individual at such a firm, or a person subject to our criminal prosecution powers or our competition law jurisdiction.
To carry on regulated activity at all, a person must satisfy us that they meet the “threshold conditions” set out in FSMA. This provides us with the opportunity to assess their suitability at the “gateway”, and impose requirements or restrictions upon how they carry on the relevant activity. Among other things, we look at whether a firm’s business model is viable and the firm is suitable to carry on regulated activity.
These threshold conditions also apply on a continuing basis to authorised firms, and therefore are the minimum standards a firm is required to satisfy. The unregulated activities of a firm may be relevant to whether that firm continues to meet the threshold condition on suitability which requires that the firm must be fit and proper. Whether this is the case or not will depend very much on the particulars of the firm’s conduct. The conduct in question would need to be sufficiently serious before it called into question the firm’s ability to meet this condition.
Once a firm is authorised, we can:
write rules governing their conduct;
impose requirements on individual firms that they do or do not do specific things;
investigate them if circumstances suggest that that they have broken our rules, and impose financial or other penalties if we conclude that they have done so;
require that “skilled persons” report on aspects of the firm’s business.
We can make rules only if they advance our operational objectives. Importantly, the power allows us to make rules governing unregulated activity by authorised persons. This means that we have some regulatory oversight of activities which do not themselves require authorisation. As explained above, one of the constraints on the exercise of the power in the context of consumer protection has been the need to consider whether “consumers”, in the sense defined in FSMA,, are the object of any intended protection.
The FCA’s Principles for Businesses are 11 high level rules which apply to all FCA regulated firms. They include requirements that firms must conduct their business with integrity, exercise reasonable skill and care, treat their customers fairly, and observe proper standards of market conduct. With three exceptions, the Principles are directed at firms’ conduct in respect of regulated activity. The exceptions relate to:
the adequacy of a firm’s financial resources (Principle four);
the adequacy of the firm’s systems and controls – to the extent that these are likely to have a negative effect on the firm’s ability to satisfy the threshold conditions or the integrity of the UK financial system (Principle three); and
the duty to deal with the FCA in an open and co-operative way (Principle 11).
The fact that these three Principles extend to all of a firm’s activities provides the FCA with some regulatory grip over everything that a firm does; but the breadth of the rules is not intended to dissuade the FCA from its focus on the regulated activities of a firm and the detailed rules governing such conduct. We do nonetheless look to the Principles when we are concerned about how firms behave “outside the perimeter”. This was the case, for example, when we took action in respect of the LIBOR (London Interbank Offered Rate) manipulation and in respect of firms’ foreign exchange practices.
FSMA requires that individuals performing “controlled functions” within authorised firms must be approved by the regulator. The FCA’s (and PRA’s) role has been to designate these functions, assess whether individuals are fit and proper to perform the functions, and take disciplinary action against individuals who break the regulators’ rules.
For the most part, the FCA’s ability to take action against individual “approved persons” has been limited to conduct within the scope of the particular function for which they were approved (unless the individual was “knowingly concerned” in the breach of rules by a firm). With the introduction of the Senior Managers and Certification regime (SMCR), this is changing.
The SMCR asks that the regulators concentrate on the assessment of the suitability of senior managers at the gateway; but allows the regulators to extend rules governing individuals’ conduct beyond those who have been vetted by the FCA (or PRA). The FCA’s conduct rules for banks apply to senior managers, certified persons and other non-ancillary staff. Once the SMCR is extended beyond banks to all firms, we propose to adopt a similar approach.
One of the key differences under the SMCR is that the conduct rules are not limited to an individual’s behaviour only in relation to the regulated activity carried on by the firm. They can also apply to conduct in relation to the firm’s unregulated activity. The rules require, among other things, that individuals act with integrity, that they have due regard to the interest of consumers, and that they observe proper standards of market conduct.
Senior managers are also required to comply with four additional conduct rules:
take reasonable steps to ensure that the business of the firm is controlled effectively;
take reasonable steps to ensure that the business of the firm complies with the relevant requirements and standards of the regulatory system;
take reasonable steps to ensure that any delegation of responsibilities is to an appropriate person and that this is overseen effectively; and
disclose appropriately any information of which the FCA or PRA would reasonably expect notice.
Under the SMCR’s’ overall responsibility’ requirement, firms need to ensure they assign overall responsibility for all business areas to a senior manager, including those in unregulated markets. They must then operate their business in line with our rules, including putting in place governance, systems and controls to ensure this.
Setting the boundary: where the perimeter lies
I set out below some of the areas where there have been calls for the FCA to intervene, questions asked about the extent of FCA involvement or action, or where uncertainty has arisen. These are not intended to be exhaustive examples, but rather to illustrate how questions have arisen about the scope of FCA regulation.
Bank activities outside the perimeter – GRG and “embedded swaps”
In contrast to mortgage lending and consumer credit activity, commercial lending is not a regulated activity. In other words, a person lending money commercially does not need to be authorised by the FCA (unless the lending constitutes “consumer credit’). So some lenders are therefore completely outside the scope of FCA regulation. Banks, on the other hand, are regulated by the FCA (because they are deposit-takers), but the FCA’s interest is primarily in the extent which the banks’ activity outside “the perimeter’ is relevant to the banks’ standing as a deposit taker. This is consistent with the scope of the FCA’s Principles, and the fact that the FCA will look at a firm’s financial resources, its systems and controls (to the extent that they reflect on the fitness of the firm itself or adversely impact the wider financial system), and the firm’s relationship with its regulators, even where concerns might arise from unregulated activity.
The extent of the FCA’s responsibility for the unregulated activity of banks has nonetheless been the subject of public debate and scrutiny.
During my appearance at the Committee in October, I explained some of the complexities around GRG and our perimeter. Engaging in the sort of restructuring activity conducted by GRG is not of itself regulated activity. Our detailed conduct rules on the design and governance of products and services do not apply. The initial allegations about the conduct at GRG were, however, sufficiently serious to raise questions about RBS beyond the immediate business area. We took the view therefore that – despite the fact that the conduct in issue was unregulated – the test for the appointment of a ‘skilled person’ under section 166 FSMA was met.
As I explain above, the SMCR will promote greater accountability within regulated firms in future, even in respect of unregulated activity. The SMCR cannot be applied retrospectively, but we would expect the new framework to assist with a GRG type scenario in the future.
Commercial loans with marked to market break costs, sometimes known as embedded swaps or “tailored business loans”, provide another illustration of the issue. Again, these are not regulated products, but they do have similar characteristics to interest rate hedging products (IRHPs). After the FSA agreed the IRHP redress scheme with the banks, there were calls for the banks to extend the scheme to commercial loans of this type.
Crypto-currencies are not ‘specified investments’ for the purposes of the RAO. This means that typically the issuing of, or trading in, a cryptocurrency itself will not involve regulated activity. However, derivatives which reference a cryptocurrency (such as a future, or a contract for difference based on a particular cryptocurrency) are capable of being regulated investments. So trading, arranging or advising activities related to cryptocurrency derivatives can amount to regulated activities.
Since the increased public awareness of certain cryptocurrencies, including Bitcoin, there has been discussion about whether the FCA should regulate this sector. I have spoken publicly of my concerns regarding cryptocurrencies, and that investors should be prepared to lose their money if they invest. Cryptocurrencies are not a secure investment given the volatility in the pricing of the asset and the limited nature of its liquidity.
Spot FX transactions where the exchange of currencies takes place within two trading days are not regulated investments for the purposes of the RAO.
The serious concerns about conduct in the foreign exchange (FX) markets were, however, one of the drivers for setting up the Fair and Effective Markets Review (FEMR). The FEMR recommendations published in June 2015, and the subsequent work of industry and central banks under the auspices of the Global FX Committee, led to publication of the FX Global Code in May 2017. This is a new industry code that sets out global principles of best practice for the Wholesale FX Market.
The FCA contributed to the preparation of the Code, drawing in particular on deficient practices identified as part of our supervisory work. I will set out later how our proposals on industry codes of conduct could support similar initiatives in the future.
Generally the regulation of pre-paid funeral plans, as opposed to regulated insurance products, also falls outside the FCA’s remit. While the authorisation and registration of funeral plans is a regulated activity under the RAO, there are exclusions that apply if certain conditions are met.
Broadly speaking, the exemption applies if the funeral plan is set up under a trust, or if the funeral plan provider applies the sums paid under the plan to a whole of life insurance policy with a regulated provider for the purposes of providing the funeral. Funeral plan providers that meet these criteria are subject to a self-regulatory regime under the Funeral Planning Authority (FPA).
We understand that all relevant funeral plan providers use these exclusions. No funeral plan provider is authorised and regulated by the FCA. We liaise with the FPA on perimeter matters as appropriate.
Investment consultancy services provide another example of a concern arising from the delineation of the perimeter. In June 2017 we published the findings from our Asset Management Market Study, which identified weak competition in the market. The Final Report is available on our website: https://www.fca.org.uk/publication/market-studies/ms15-2-3.pdf
In particular, we found that pension trustees have limited ability to assess the quality of the advice they receive from consultants. There are also relatively high levels of market concentration and barriers to expansion which restrict smaller or newer consultants from developing their business. We also found that vertically integrated business models were creating conflicts of interest.
Investment consultants play a significant role advising pension fund trustees when they are procuring asset management services. There are areas of investment consulting that are not regulated by us but still have a significant impact on returns for investors, such as strategic asset allocation advice. Therefore, to allow a complete assessment, and to enable any remedies to cover the whole market, we referred the sector to the CMA for a market investigation.
Subject to the findings of the market investigation, we have recommended HM Treasury bring the provision of investment consulting and employee benefit consulting asset allocation advice within the FCA’s regulatory perimeter.
Unregulated mortgage purchasers
There are three regulatory activities relating to mortgage lending: “entering into”, “administering”, and advising on a regulated mortgage contract. Mortgage lenders who “enter into” a regulated mortgage contract are able to transfer the ownership of those contracts or the rights under them to other entities, often as a funding source. The regulatory framework does not require the purchasing entity to be regulated, as long as they employ an authorised third party to “administer” the mortgage contracts. However, the administering activity is narrowly drawn, essentially amounting to notifying the consumer of interest or payment changes, or taking necessary steps to collect or recover payments due.
This potentially exposes consumers to harm if, for example, an unregulated entity were to charge higher interest rates to captive borrowers, not reduce rates in a falling market, or treat customers in arrears unfairly. As you may recall, the Public Accounts Committee raised this area as a point of concern in the recent asset sale undertaken by UK Asset Resolution (UKAR) to Cerberus. Depending on the regulated status of the purchaser of the book, there is the potential for consumers to be exposed to greater harm. There is also a risk that this harm might not be apparent to us because when mortgages are sold to an unauthorised entity, the new owners are not subject to our reporting requirements and so we have no way of knowing how these loans are performing in terms of arrears and repossession levels.
Perimeter complexities – British Steel Pension Scheme (BSPS)
Recently we have seen the complexities of navigating the regulatory perimeter brought into the spotlight due to BSPS, along with restrictions on the action we can take.
The regulation of pensions falls to a number of different bodies – the FCA regulates primarily defined contribution pensions, whereas the Pensions Regulator (TPR) regulates defined benefit pensions. There are also other schemes that fall within the Government’s direct remit, but the FCA and TPR are responsible for the majority of the pensions market.
The BSPS is a defined benefit pension scheme and is regulated by TPR. The FCA has no role or oversight of BSPS, or any..
Mr Justice Andrew Baker determined this claim for breach of statutory duty under s.138D(2) of the Financial Services and Markets Act 2000 (FSMA) by the bank in advising the Claimants to invest in three structured capital at risk products (SCARPs) sold under an advisory agreement that were unsuitable because it should have known that the Claimants were “low-risk investors unwilling to contemplate anything more than minimal risk of loss of capital”. The Claimants were judged to be entitled to damages to reflect the position they would have been in had they not purchased one of the complex structured products.
Abdullah v Credit Suisse: Summary of the Facts
The Claimants are a wealthy Kuwaiti family who held a joint private banking account with Credit Suisse. During 2008, following the advice of the bank, they invested in three SCARP Notes net of borrowing for approximately USD $26 million:
Note 18 (the first Note mis-sold by the bank) was a USD $20 million 3-year equity barrier SCARP bet on major stock indices (referenced to the Eurostoxx 50, S&P 500 and Nikkei 225 indices as well as the Swiss Market Index) purchased in May 2008.
Note 19 (the second Note) was a USD $2.4 million 1-year bet on the stock prices of three major international banks.
Note 20 (the final Note) was bought during the fiscal turmoil following the collapse of Lehman Brothers in October 2008. The contemporary market volatility caused the in-built barriers of some of the Claimant’s other Notes with the bank to be breached and as such Note 20 was issued as a “switch” trade where their existing portfolio was subject to “jumbo” restructuring into a consolidated Note.
Immediately after the final Note settled in October 2008, the Claimants decided not to meet a margin call issued by Credit Suisse and refused to deposit further securities to cover potential losses (they were assured that the switch would not require additional funds) resulting in the liquidation of their USD $30 million investment and leaving them overdrawn by over USD $300,000.
Credit Suisse Breached Statutory Duties Owed under FSMA
The Claimants sought damages under s.138D of FSMA 2000 which provides that a private person who suffers financial loss as a result of breach of the regulatory rules may bring a statutory claim for compensation.
“contravention by an authorised person of a rule made by the FCA is actionable at the suit of a private person who suffers loss as a result of the contravention”
[Credit Suisse] did not take reasonable steps to ensure that any personal recommendation was suitable for the client (in breach of COBS 9.2.1R).
[Credit Suisse] did not have a reasonable basis for believing that the transaction recommended met the client’s investment objectives nor that the client had the necessary experience and knowledge to understand the risks involved (in breach of COBS 9.2.2R); and
The Claimants were mislead
[Credit Suisse] did not ensure that a communication or financial promotion was fair, clear and not misleading (in breach of COBS 4.2.1R).
Overall, they alleged that the bank did not ensure that the communication or financial promotion was “fair, clear and not misleading”.The Claimants argued that they were “low risk investors” and it was clear from their long relationship with the bank that they were only willing to invest on the basis of very limited risk of loss of capital. They alleged that Credit Suisse gave “bad positive advice” and the bank failed to take reasonable steps to ensure the personal recommendation of a high-risk product was suitable for the clients. This advice neither met their “investment objectives” nor did they ascertain whether their clients had the necessary knowledge to understand the risks involved. The crux of their claim- like many customers who have been mis-sold derivatives- was that the bank “under-estimated the magnitude of risks” involved to them and as such the bank’s bad advice created an ill-conceived willingness in the Claimants to run those risks.
When is a Bank Considered to have Breached its Statutory Duties?
Note 18: This product was unsuitable for their “low risk appetite” and the sale of the product was misleading
It was misleading for the bank to convey to the Claimants that the structured product was a low risk investment and that it was very unlikely that the Note barriers would be breached.
Their advisor at the bank told them that there was “only a small chance of loss” and “pushed them” into investing. He wrongly assured them that the product was suitable for their “conservative risk appetite”.
The advisor coerced them into purchasing by assuring them that his own family had invested on the same terms presented and moreover the judge worryingly found that the Claimants were most likely not even shown an indicative term sheet at their meeting.
In fact, the judge agreed with expert evidence that Note 18 was taking a “50:50 bet” on having no capital protection and therefore leaving the Claimants exposed: that is not what the Claimants thought they were buying and not what the bank could reasonably have believed they wanted to buy.
Note 19: The product was not unsuitable as the Claimants knew they were “making a bold, risky investment” and the bank did not mislead them into believing it to be a safe investment
Unlike for Note 18, the reason why the bank was not in breach of its duties here was because the Claimant chose on an “informed basis” to take a real risk on what was a relatively small investment of USD $2.4 million for potentially high returns in a volatile market.
On this occasion, Credit Suisse did make it very clear that it would be a bold and hazardous investment with a view to a very high return.
Therefore, the crux of whether the bank is in breach of its duties comparing the two findings on the Notes is that the “nature of the recommendation” was different. The bank is at fault if it recommends a risky product to a conservative client and misleads them as to the nature of the risk. The bank is not at fault if it recommends a risky product to a client that is well aware of that risk.
Note 20: The product was not unsuitable as the Claimants knew about the risk but the bank did make misleading assurances to induce the purchase of the switch trade
The claim for suitability breaches under COBS Rules 9.2.1R and 9.2.2R failed as it was obvious that the investment was highly risky whilst the markets were in turmoil following the collapse of Lehman Brothers. The bank was not in breach as it was reasonable for Credit Suisse to have believed that Note 20 met the clients’ objectives at that particular time.
The judge found that the Claimants were well aware of the risk as Note 20 “was obviously not a Note to be buying if you had only a conservative appetite for risk.” The difference with Note 18 and the reason why the Claimants could not demonstrate that they were misled was quite simply that they were aware of the risks.
However, Credit Suisse did breach COBS 4.2.1 by asserting that the switch trade would not require further funds. Although the bank was correct in claiming that the switch trade would not require a net purchase price payable for the trade (to buy Note 20 in return for giving up their previous Notes)- due to the different basis for the mark-to-market pricing used for Note 20 and its lower LTV ratio- as soon as the Note was issued the bank assessed the account to suffer from a large collateral shortfall with the margin call that followed leading to the closing of the account.
Therefore, there was a breach of COBS 4.2.1 because the assurances given by the bank that the switch trade would not result in needing further investment from them was inaccurate and misleading. This reading of the COBS rule demonstrates that the court applies subtlety in determining whether a Claimant has been induced to buy in a misleading way by taking a wide interpretation. This is promising for future Claimants.
Click to Download Haider Abdullah v Credit Suisse – Commercial Court Judgment
Resounding Rejection of Credit Suisse’s Defence
Credit Suisse attempted to persuade the court that the family were “aggressive investors” looking for high returns who accepted the significant risk of loss of capital and as such were not badly advised. In addition, the bank argued that the losses were not caused by their breach of duty but resulted from the financial crash. The bank also tried to pin the blame on the Claimants by claiming they had committed “financial suicide” when they chose to close their investments after Note 20, which it alleged was so unreasonable a decision that is was the exclusive cause of their loss. The three main arguments in the Bank’s defence were:
(1) Credit Suisse loses their defence that the Claimants committed “financial suicide” which broke the chain of causation
The court did not accept that the Claimant’s refusal to meet the margin call was so unreasonable as to amount to a failure to mitigate loss/was the sole cause of the loss. The judge stated that the family’s decision to close their portfolio was not “irrational” but out of concern that the worst may not be over and “they also felt let down and misled” by the bank.
The court robustly rebuked the “financial suicide” defence and therefore provided welcome reassurance to customers that a bank will not be permitted to pin the blame on them for leaving an investment early if the decision is not irrational.
(2) Credit Suisse loses their defence that the loss was too remote as it was caused by the severity of the financial crash
The court did not accept the bank’s contention that the losses were not caused by any breach of duty on its part as they resulted from the extreme nature and severity of the 2008 crash. The essence of the duty of a financial advisor is precisely to protect clients from major market falls by assessing with “due care” that any capital protection barriers were highly unlikely to be breached.
Although the loss was exacerbated by the market crash, the resulting loss was still within the scope of the duty broken.
Banks will not be permitted to completely abdicate their duties owed to customers by blaming resulting losses solely on extreme fluctuations in the financial market.
(3) Credit Suisse loses their defence that the Claimants were contributory negligent
The court rejected the bank’s weak defence claiming that the investors failed to read the terms and conditions; failed to take adequate steps to understand the investments and failed to complete a customer profile form (to ensure Credit Suisse had no doubt as to their investment objectives).
Judge Davis said: “[The investors took] adequate steps to understand their investments given that they were relying on [Credit Suisse] for risk evaluation. They were simply let down… in respect of that evaluation”.
Unsophisticated customers will not be penalised for a lack of due diligence when agreeing to purchase a complex structured product.
Relevance to those Mis-sold Complex Derivative Products?
This is one of very few cases that consider the practical meaning and effect of the FCA’s Conduct of Business Sourcebook rules governing the sale of complex derivatives and the extent of duties owed by banks to their customers. It elucidates the rules concerning the suitability of structured product sales and provides a useful barometer of the court’s future reasoning on when a product is considered to have been sold in a misleading way and how suitability issues will be interpreted under the COBS rules.
“This judgment should go some way in encouraging smaller claimants considering or facing litigation against major banks not to abandon their cause of action under s.138D FSMA 2000. It demonstrates that litigation for private persons is a potentially meritorious option with an arguable chance of success either at trial or via alternative dispute resolution settlement. A successful outcome is of course dependent on the facts of any individual case.”
Our Financial Services Litigation team of Solicitors and Barristers in London are highly experienced in banking litigation. Our high profile and high value cases regularly appear in the national and international media. Our banking litigators advise on the protection of borrower legal rights in the face of predatory bank practices. We have successfully managed and settled court litigation against all major UK banks. Call us on 02071830529 or complete our online contact form.
RBS’s Chief Executive Ross McEwan, divulged the expansion of its current GRG appeal process to introduce an “independent appeals procedure” in a letter to John Glen MP (City Minister) to fill a “gap in our previous position”. Former customers of GRG can currently claim compensation for consequential losses, but this has proved inadequate because (unlike for direct loss claims) if a customer’s claim is rejected, there is no right of appeal to the independent third party (Sir William Blackburne). RBS’s announcement represents a U-turn on their previous position that it was not practicable to build a third-party assurance and appeals process to provide oversight of the decisions reached by the bank on consequential loss.
It has been reported that RBS will finalise the details of widening the remit of the Independent Third Party Appeals Process to include a consequential loss appeals process with Sir William Blackburne (a former High Court Judge) in the next few weeks. RBS has received just one consequential loss claim thus far but it is expected that the Bank will receive many claims with high value for consequential losses in the near future. However, doubts remain over the effectiveness of the redress on offer.
Ex-GRG customers have the right to refer complaints to the Financial Ombudsman Service and pursue claims for consequential losses through the courts with the benefits of independent judicial oversight, expert evidence and established judicial principles. RBS’s announcement to expand the GRG complaints process ensures, to some extent at least, that third- party assurance and independent oversight of the decisions the bank reaches on consequential loss will be in place.
It is essential to seek early legal advice from LEXLAW to advise you on all the potential options to secure compensation, through articulating consequential loss claims in the GRG complaints scheme to High Court litigation.
What is GRG?
GRG is shorthand for Global Restructuring Group, which was NatWest/RBS’s turnaround or business support unit (BSU) for troubled businesses.
What did GRG do wrong?
The bank recovery team were tasked to recover debt owed to the bank but were purposefully mis-described as providing “business support”. In fact these departments managed RBS’s distressed and impaired customers that had lending secured by property based assets. The members of these teams prepared and submitted exit strategies and liaised with LPA Receivers and Administrators and the bank’s solicitors to recover debt owed to the bank.
Like other recovery units such as Barclays’ BSR and Lloyds’ BSU, RBS’s GRG behaved in an aggressive and arguably dishonest and unfair way designed to maximise profit for the bank. Bank recovery departments were often highly incentivised to overstate the bank’s write-down provisions in order to obtain bonuses for recovering more than the bank expected to recover. This included for example moving lending rates to rigged rates (LIBOR); setting up pre-pack administration deals without the customer’s knowledge; and pressurising customers into Profit or Property Participation Fee Agreements (PPFA) whereby associated parts of the bank (West Register) would take up free shares in a business or gain a percentage of sale proceeds.
Instead of SMEs getting the help they needed in a weak economy, GRG targeted the unregulated SME sector and became a profit churning processing unit to exacerbate the demise of SMEs and squeeze capital to improve RBS’s own post- credit crunch balance sheet.
What is the current GRG redress scheme?
RBS announced the implementation of a £400million GRG complaints process in November 2016 (and updated in May 2017) to process complaints by SME customers for losses incurred as a result of GRG’s misconduct.
RBS will review a complaint from eligible ex-GRG customers (see below) and if the complaint is upheld, redress for direct losses and/or automatic complex fee refunds may be offered. In order to make a claim for consequential loss, the customers’ complaint must first have been upheld. LEXLAW have helped many small businesses in analysing consequential loss and whether it is the type of loss that can be adequately evidenced. RBS has agreed to meet the customers’ reasonable costs of meeting with a professional loss assessor or solicitor in establishing a consequential loss claim.
RBS’s redress scheme is overseen by Sir William Blackburne (the Independent Third Party), whose “assurance and appeal” role is to oversee the process and to run an Independent Third Party Appeals Process (ITP Appeals Process) to consider appeals against decisions made in the RBS complaints process for direct losses but not consequential losses. The remit of the ITP Appeals Process will be expanded to include consequential loss in the near future.
The GRG complaints process is different to the FCA Interest Rate Hedging Products Review scheme (IRHP Review Scheme), the failings of which have previously been highlighted by LEXLAW. In some respects, the GRG complaints process suffers from the same defects as the IRHP review scheme in that they are both essentially voluntary reviews undertaken by the banks themselves with- in essence- limited independent oversight.
What is the new consequential loss compensation appeal process?
The current GRG Complaints Process has been heavily criticised for its lack of adequate compensation for businesses that have suffered consequential losses. The loss of potential profits by an SME forced to close due to GRG misconduct is often the largest head of loss in a claim against a Bank. The current complaints process has been restricted to appealing claims only for direct losses whilst at GRG, whereas now businesses will able to appeal for indirect consequential losses.
Under the RBS complaints process, if a direct loss complaint is upheld, then a customer can apply to have consequential losses assessed. The reformed appeal process for companies harmed by GRG will now allow those customers to appeal to the independent third party, mirroring the current process for direct loss complaints.
Ross McEwan’s letter to John Glen MP stated that the new consequential loss appeals process will be finalised in the upcoming weeks. The independent third party, Sir William Blackburne, will be consulted on how the process should work and whether he will take on the role of hearing consequential loss appeals.
It is expected that once the RBS complaints scheme appeal process for consequential losses gets underway, many ex-GRG customers will be entitled to claim compensation with the assurance that third-party independent oversight is built into the process to ensure the bank’s decisions on consequential loss compensation are reasonable.
Are customers likely to receive adequate compensation through the GRG redress scheme?
RBS earmarked a £400million pot in November 2016 and despite thousands of businesses suffering loss due to the misconduct of GRG, the pay-outs have been relatively small (on average around £30,000). Approximately £115million has been paid out as an automatic refund of complex fees. Of the remaining £285million which is available in the GRG complaints process, only £3.6million has been offered in compensation and only £2.2million has been paid out.
Liberal Democrat leader Sir Vince Cable has criticised the scheme:
“to see that RBS is processing this compensation, which is almost certainly too little anyway, so slowly is another disgrace in this scandal and suggests that the current leadership of RBS has not learned from the many failure of its predecessors”
Clearly adequate compensation for SMEs has not yet been forthcoming through the GRG complaints process. The direct loss compensation scheme appeals system has received independent oversight and the damning indictments of the levels of redress offered leads to assumptions that independent oversight of consequential loss appeals will not ensure effective redress for ex-GRG customers.
Which customers are eligible for redress in the GRG review scheme?
and a small or medium-sized enterpyrise (SME) customer;
under the control of GRG; and
during the period 2008-2013.
Customers are excluded from the definition of an SME if they are:
an entity with listed securities
an entity with debt syndicated across a number of banks
registered offshore or the majority of its shareholders are offshore
private equity backed
a Special Purpose Vehicle (SPV), or
a sizeable business based on financial metrics (e.g. debt facilities and/or turnover higher than £20m).
Eligible customers have the right to enter the automatic fee refund process and automatically receive the refund of complex fees. RBS believe that this refund process is substantially complete. GRG utilised a number of different terms to describe fees charged, and the following fees during 2008-2013 are included in the automatic fee refund:
asset sales fee;
late management information (MI) fee.
What is the GRG redress scheme process for direct loss claims?
increased interest payments made to RBS by a customer;
costs and expenditure incurred in connection with an independent business review, valuation report, security review or other actions required by RBS; or
costs and expenditure incurred by a customer for the appointment of a third party to the customer at the request of RBS.
The RBS complaints process initially involves the bank itself assessing the complaint and deciding whether to award compensation for direct losses to a customer. Direct losses include sums paid by a customer to RBS and out of pocket costs of meeting RBS’s requirements.
RBS will self-investigate the complaint based on documentary evidence held by the bank and provided by the customer. LEXLAW are experienced in identifying the causes of action, the evidence required and formulating the complaint on behalf of SMEs and submitting this to Bank’s review team. Unlike a truly independent Court process, no detailed written arguments or oral evidence is considered. LEXLAW have pursued all avenues in the pursuit of justice for SME customers and have managed cases in the courts and complaints to the Financial Ombudsman Service (FOS) which offer a more detailed assessment of misconduct claims.
The basis of assessment is NOT a test of legality. The GRG complaints team assess customer complaints on standards of reasonableness (whether RBS’s actions were justifiable), transparency (timeliness and clarity of communication) and compliance (with their own internal procedures). In the event that the complaint is upheld by RBS, the bank assesses what it considers to be fair and reasonable compensation. In addition, at its sole discretion without an appeal to the Independent Third Party, the bank may award a “goodwill payment” in respect of disruption that was caused to the business.
Following the Outcome letter, the customer has 28 days to either accept or appeal against RBS’s offer of redress for direct losses. If accepted, this is taken a full and final settlement of the claim and no further action is permitted to recover further sums for direct loss. If compensation is not forthcoming or inadequate, the customer has 56 days to appeal the decision to the Independent Third Party Appeals Process (ITP Appeals Process) overseen by Sir William Blackburne.
The customer is required to complete an appeal form explaining the reasons why RBS’s decision was wrong. The Independent Third Party will reach their own conclusion on whether the complaint should be upheld or not and on what basis. The decision will be based on contemporaneous documents gathered by RBS, evidence submitted by the customer and materials created during the initial RBS complaints process. The Independent Third Party will record their decision, including any award for direct loss only, and a brief summary of the reasons will be provided to RBS and the customer. Subject to the customer accepting the Independent Third Party’s decision, the decision of the Independent Third Party will be binding on the bank.
What is the current GRG redress scheme process for consequential loss claims?
RBS will assess a claim for consequential losses based on evidence and information submitted by a customer. The claim is assessed using the bank’s sole discretion. The bank self-determines whether the consequential loss is factually and legally attributable to it. Crucially, “this will be considered by the same team in RBS that conducted the RBS Complaints Process but, for the avoidance of doubt, this process will not be overseen by the ITP and there will be no right appeal to the ITP”.
Although RBS apply a self-described “fairness test” in their complaints process, an upheld complaint does not relate to a breach of legal obligations. Nevertheless, the bank does assess consequential loss complaints by reference to established legal principles. Therefore, it is important to seek legal advice if considering a consequential loss claim. The bank will apply the following legal tests which LEXLAW are adept at presenting on behalf of businesses:
the consequential losses would not have happened but for the misconduct of GRG and/or the direct loss. In other words, it must be shown that the bank caused the loss. Often a counterfactual scenario is conducted to ascertain whether the losses would have incurred if the actions of the bank were fair and reasonable.
The consequential loss must have been reasonably foreseeable at the time GRG’s unfair actions caused the direct loss.
Only claims supported by contemporaneous evidence will be considered.
The burden is on the customer to demonstrate on a balance of probabilities that a loss has been incurred and would not have occurred but for the actions of RBS.
RBS will send a final letter to the customer setting out the findings and any offer for compensation for consequential loss. If this is accepted, the customer is required to enter into a full and final settlement of any consequential loss claim with RBS.
However, a major criticism of the current redress scheme for consequential losses is that if a customer chooses to reject RBS’s compensation, the decision of the bank is final and the Independent Third Party has no power to review the decision. This has meant there is a lacuna in the GRG complaints process, whereby the Independent Third Party can review a compensation redress offer for relatively small direct loss claims but has no power to review compensation (or lack of) for the much larger consequential loss claims.
Which consequential losses can a former GRG customer make a claim for?
Consequential losses (or indirect losses) are lost potential profits as result of a business being forced to close due to GRG’s misconduct. Compensation for consequential loss covers the knock-on effect of RBS’s mistreatment of small businesses. RBS already to a limited extent will consider claims for consequential loss involving quantifiable financial loss. Claims involving non-financial loss, for example stress, illness or inconvenience caused by GRG’s misconduct, is not recoverable through the complaints process.
RBS have stated that it will meet the costs of an initial meeting with a professional loss assessor to “assist you in establishing whether you may have suffered a Consequential Loss”.
In the current complaints scheme, RBS refund direct losses and in some cases have additionally compensated for the cost of being deprived of direct loss funds by adding 8% simple interest annually to all payments. RBS considers that in the majority of cases this 8% is enough to compensate customers for consequential loss claims. For the majority of ex-GRG customers, this will not be the case and they are encouraged to make a separate consequential loss claim.
Consequential losses include the following:
Loss of profits in relation to a lost new business opportunity
A claim for consequential loss will be unsuccessful if the lost profit was less than the 8% simple interest received from the direct losses claimed in the initial stage of the complaints process. An ex-GRG customer would need to demonstrate that there was a specific opportunity available contemporaneously which had to be forgone due to the unfair actions of GRG, for which a complaint must have previously been upheld and/or direct losses been attributed. It is important to demonstrate that the lost profits were caused and occasioned by the misconduct of GRG rather than extraneous factors, such as the depressed economic climate in 2008-2013. It is essential to gather supporting documentary evidence such as:
evidence of the concrete opportunity at the time (e.g. planning permission granted, architect drawings, builder quotes);
correspondence which documents that the opportunity was foregone (letters, emails);
evidence of a causal link between the bank’s unfair actions and the failure to pursue the new opportunity (e.g. revised cash flow statements);
evidence that the same or similar opportunity has been undertaken when funds became available (e.g. details of actual costs incurred);
evidence of additional profits forgone at the time (e.g. increased demand, evidence that the new opportunity has led to increased profits).
Loss of profits in relation to lost opportunity for the grossing up of business profits
A claim would be successful if it can be demonstrated that but for the unfair actions of GRG, additional stock would have been purchased AND the additional demand for said stock existed at the time. It is essential to gather and submit supporting documentary evidence such as documented above. A claim will be unsuccessful if the lost profit was below 8% and if the evidence only demonstrates a “speculative or generic opportunity”.
Loss of profits in relation to lost opportunity for acquiring assets
A SME that was not able to acquire new assets as a result of GRG’s misconduct and/or direct loss can then go on to make a consequential loss claim. The associated losses due to not purchasing property assets can include: lost capital appreciation, lost rental income and lost development opportunity. It is essential to gather supporting evidence of a specific opportunity at the time and evidence of a causal link between the unfair actions of the bank and the failure to pursue the asset acquisition.
Loss of profits due to asset disposal
Ex-GRG customers that were forced to dispose of assets due to the unfair actions of the bank are entitled to make a consequential loss claim.
Increased cost of borrowing
This head of consequential loss is incurred by businesses that have had to borrow money to meet payment of a direct loss (defined above) or refinance externally with another lender at an increased cost due to GRG’s actions. A claim has a higher chance of success if evidence can be gathered to demonstrate a causal link, for example revised cash flow showing the business would have had sufficient..
The Court of Appeal dismissed the £30 million appeal brought by Property Alliance Group (PAG) on the sale of interest rate hedging products and the bank’s exercise of its contractual facility rights. Although the Court dismissed all four of PAG’s claims on the facts, two legal principles have been decided that may pave the way for future claims against banks.
Court of Appeal decides two legal principles to protect customers from banks
The good news for potential Claimants against banks was two-fold. Firstly, the Court of Appeal found that there was certainly an implied representation that the Royal Bank of Scotland (RBS) was not manipulating and did not intend to manipulate LIBOR when it entered into a Swaps agreement. Although the scope of this representation failed on the facts, the re-formulation of this legal principle by the judiciary in banking law provides welcome encouragement for potential litigants that have been mis-sold LIBOR-linked derivatives and are suing banks that have been at fault for manipulating this key benchmark.
Secondly, it was held that RBS’s (through GRG) contractual facility rights to call for valuations of a customer’s assets was not unfettered but subject to an implied term that it could only be exercised for a purpose related to the bank’s “legitimate commercial interests”. This paves the way for stronger arguments against GRG, especially given the publication of the section 166 skilled person’s report. Future Claimants may be able to rely on this implied term and the evidence in the section 166 report and the “Just Hit Budget” memo to decisively to a Court that GRG did indeed exercise its facility rights not for “legitimate commercial interests”.
PAG v RBS : Summary of the facts
PAG is in the business of property investment and development and has a portfolio of industrial sites, offices, retail and leisure properties. RBS was PAG’s primary source of commercial banking facilities and entered into 11 transactions in derivatives between 2003 and 2014. PAG employed banking specialists and took advice from a leading derivatives advisory firm to consult on strategies including interest rate hedging.
The proceedings focus on four Swaps sold to PAG between 2004 and 2008. The first Swap was a cancellable “Multi Callable Libor Value Collar” for a notional amount of £10 million referenced to 3 month LIBOR. In simple terms, no matter how high the 3 month LIBOR rate went up, PAG would pay interest at no more than 6.25% and if the 3 month LIBOR rate fell below 3.30%, PAG would pay interest at 5.25% and would be liable to pay a break cost. The second Swap was a “Libor Cancellable Discount Swap (Bank)” for a notional amount of £15million for 4 years and then £30million for a further 6 years, referenced to LIBOR. The third Swap was a cancellable “Libor Collar” for a notional amount of 20 years for up to five years. The fourth Swap was a cancellable “Switchable LIBOR to base rate callable Swap” for a notional amount of £15million up to a five year term.
In 2010, RBS transferred PAG to the auspices of its Global Restructuring Group (GRG). GRG proceeded to demand valuations of PAG’s properties over which RBS held security. In 2011, PAG terminated the Swaps and incurred a break cost of over £8 million. In 2014, PAG sought funding elsewhere, securing a facility with HSBC, and completed repayment of all outstanding indebtedness to RBS by July 2014.
PAG v RBS : Summary of the proceedings
In 2013, PAG issued proceedings against RBS and sought rescission of the Swaps and/or damages. In 2016, PAG alleged to the High Court it had been mis-sold four interest rate Swaps referable to GBP 3 month LIBOR. PAG asserted that they were entitled to rescind the Swaps due to the implied representations made by RBS on the authenticity and integrity of LIBOR. PAG alleged that RBS’s representations were both false and fraudulent due to the manipulation of LIBOR, which had been proved by the regulatory findings against RBS. In addition, PAG alleged that GRG breached implied terms in their facility agreement and thereby abused its discretion and acted in bad faith. The Hon. Mrs Justice Asplin dismissed the Swaps, LIBOR and GRG claims in their entirety.
PAG appealed the High Court decision. Lord Justice Patten when granting PAG permission to appeal, described the case as a “vehicle” to determine important issues in banking law. PAG relied on certain points in the Court of Appeal, namely:
Negligent Misstatement Claim: A claim that RBS is liable in tort for negligent misstatement as a result of its failure to provide PAG with information about potential break costs;
Misrepresentation Claim: A claim that RBS falsely represented to PAG that each of the Swaps was a “hedge” and, hence, that they would reduce PAG’s interest rate risk;
LIBOR Claims:A claim that RBS fraudulently made implied representations about LIBOR and how it was set; and
Valuation Claim:A claim that RBS was wrong to have PAG’s portfolio revalued in August 2013.
Although the Court of Appeal unanimously dismissed PAG’s appeal, the points of law formulated in the LIBOR claims and Valuation claim may pave the way for future claims against banks accused of manipulating LIBOR and who have sold LIBOR-linked derivatives.
Claimants can rely on a banks’ implied representation that it was not and will not manipulate LIBOR when selling a Swap
The question answered by the Court of Appeal on whether the bank’s LIBOR representations could be implied was described by RBS as “the most important legal issue in the case”. RBS lost this legal issue as the Court found that there was enough conduct on RBS’s part for such a representation about LIBOR to be implied. An important principle in banking law has been elucidated at the highest level thus far: a bank which sells a LIBOR referenced derivative will be taken to impliedly represent that it has not and will not manipulate LIBOR. If a Claimant can show that that a bank manipulated LIBOR for the particular currency to which the Swap is referenced, then there are potentially grounds to rescind the contract.
RBS’s “deeply shocking” misconduct undermined the integrity of LIBOR
The FSA concluded that RBS’s misconduct undermined the integrity of LIBOR- in particular with the manipulation of rates that formed part of the calculation of Japanese yen and Swiss franc LIBOR. The Court did strongly chastise RBS for its LIBOR manipulation and noted that the admitted manipulation of Japanese yen LIBOR and Swiss franc LIBOR was “deeply shocking”. However, crucially for PAG’s case, no specific findings were made in relation to GBP LIBOR and as such there have been no regulatory findings of misconduct on the part of RBS in connection with GBP LIBOR.
When a bank says nothing about LIBOR there is an implied representation that their role in the setting of LIBOR was an honest one
PAG’s claim was that, if it had realised LIBOR was manipulated, it would never have agreed to enter into the Swaps in the first place and as such, the Swaps should be rescinded. No such representation was expressly made by RBS, so therefore the question was whether this representation could be implied. PAG alleged that 4 representations should be implied from RBS’s conduct in proposing the Swap contracts; however, the Court proceeded on the simpler formulation that “RBS was representing that, at the date of the Swaps, RBS was not itself seeking to manipulate LIBOR and did not intend to do so in the future”.
There has not been a substantial amount of authority on the material required for the making of an implied representation for a banking transaction, The Court considered the interlocutory observations in Graiseley Properties Ltd v Barclays Bank plc  EWCA Civ 1372 and determined that to some extent, these comments should represent the law. In Graiseley, Longmore LJ strongly disagreed with the submission that when nothing was said by a bank in connection with LIBOR, there was no obligation to disclose its own dishonesty:
“In the present case, however, the banks did propose the use of LIBOR and it must be arguable that, at the very least, they were representing that their own participation in the setting of the rate was an honest one. It is, to my mind, surprising that the banks do not appear to be prepared to accept that even that limited proposition is arguable. It was also submitted that doing nothing cannot amount to an implied representation. But it is (arguably) the case that the banks did not do nothing in that they proposed transactions which were to be governed by LIBOR. That is conduct just as much as a customer’s conduct in sitting down in a restaurant amounts to a representation that he is able to pay for his meal, see DPP v Ray  AC 370, 379D per Lord Reid.”
Graiseley Properties Ltd v Barclays Bank plc  at para 27- 28
The Court assented to Longmore LJ’s reasoning that when a bank says nothing about LIBOR, there is an implied representation that “their own participation in the setting of the rate was an honest one”. Therefore, there was sufficient conduct on the bank’s part for such a representation to be duly implied. The Court rejected RBS’s submission that it would be wrong to hold that any representation should be implied as it “covered ground which would normally be covered by an implied term”. The Court found that a counterparty should be able to rely on misrepresentation:
“We do not accept this submission since the law relating to misrepresentation fulfils a different function from the law relating to implied terms. The former deals with the present not the future and gives potential remedies which may be more appropriate than a claim for damages. A party to a contract containing a Swap needs to be certain of the counterparty’s honesty at the beginning of the deal not just in the future but throughout its course. If a Claimant has suffered no loss, that may be relevant to remedy but should not exclude a right to rely on misrepresentation if any misrepresentation has occurred.”
Property Alliance Group Ltd v The Royal Bank of Scotland Plc  at para 125
Court re-formulated Colman J’s “helpful test” on the existence of an implied representation
As well as accepting the reasoning of Longmore LJ in Graiseley, the Court also considered Geest plc v Fyffes plc  1 All ER (Comm) 672 and endorsed Colman J’s “helpful test”:
“In evaluating the effect of the beneficiary’s conduct a helpful test is whether, having regard to the beneficiary’s conduct in such circumstances, a reasonable potential surety would naturally assume that the true state of facts did not exist and that, had it existed, he would in all the circumstances necessarily have been informed of it.”
Geest plc v Fyffes plc  at p683
Therefore, the Court endorsed the test that the existence of an implied representation can be found if a reasonable potential surety would naturally assume that the true state of facts did not exist and that if it did, he would necessarily be informed of it. This is the first occasion where this “helpful test” has been considered at this level and may now pave the way for future misrepresentation claims. The approval of the dicta of Colman J is an important win for potential Claimants on this essential point of law, but it must be noted that there must be clear words and/or conduct from a bank from which the representation can be implied.
“RBS did make some representation to the effect that RBS itself was not manipulating and did not intend to manipulate LIBOR”
Having reformulated the implied representation test, the Court did find that RBS had indeed made an implied representation to PAG that it was not manipulating LIBOR:
“In the present case there were lengthy discussions between PAG and RBS before the Swaps were concluded as set out by the Judge in the earlier part of her judgment….RBS was undoubtedly proposing the Swap transactions with their reference to LIBOR as transactions which PAG could and should consider as fulfilment of the obligations contained in the loan contracts. In these circumstances we are satisfied that RBS did make some representation to the effect that RBS itself was not manipulating and did not intend to manipulate LIBOR.”
Property Alliance Group Ltd v The Royal Bank of Scotland Plc  at para 133
Therefore, the Court disagreed with Asplin J’s judgment that the proffering of Swaps was “not in the context of this case conduct from which any representation could be inferred”. There was an implied representation by RBS that it was not manipulating LIBOR when it sold PAG the Swaps. The door has been opened for misrepresentation claims to be brought by a counter-party to derivative which is linked to LIBOR, where the Swap is with a LIBOR panel bank which has been found to have engaged in the manipulation of LIBOR.
Implied representation cannot extend further than particular transactions induced by representations
PAG’s LIBOR claim failed on the facts because, although the Court found that there was an implied representation that RBS was not manipulating and did not intend to manipulate LIBOR, the manipulation was limited to Swiss franc LIBOR and Japanese yen LIBOR and crucially there was no factual finding that GBP LIBOR had been manipulated and the Swaps in PAG’s case were specifically referenced to the latter.
Representation extends to all tenors of GBP LIBOR but not to LIBOR in other currencies
The Court was unwilling to extend the scope of the representation to a currency to which the Swaps were not referenced. PAG contended that RBS should be held to have made general representations about “LIBOR encompassing every tenor and every currency”, whereas RBS claimed that any such representation should be confined solely to 3 month GBP LIBOR. The Court did not go as far as either contention. It was found that RBS during its discussions with PAG had made an implied representation and this representation extended to all tenors of GBP LIBOR, but not to LIBOR in other currencies.
The approach of Flaux J in Graiseley was raised by PAG, Flaux J having noted that:
“it is a wholly artificial exercise to seek effectively to divide up the various LIBOR fixings or manipulations into separate currencies. It is quite clear that there was fixing not only of sterling LIBOR but also of dollar LIBOR and of EURIBOR, and that, as I said during the course of argument, there is inevitably scope for cross-infection here.”
Graiseley Properties Ltd v Barclays Bank plc  at para 19
The court recognised the issue of “cross infection” but distinguished RBS because the main sterling submitter for RBS was a different person to other currency submitters.
The Court did strongly chastise RBS for its LIBOR manipulation and noted that the admitted manipulation of Japanese yen LIBOR and Swiss franc LIBOR was “deeply shocking”. But decisively, “that is not, of itself, a reason for holding that representations made to PAG should go further than representations about the sterling LIBOR rate.” Although the Court were clear that “any implied representation cannot legitimately extend further than the particular transactions allegedly induced by the representations”, the door was left open to extending the scope of implied representation if the facts of a case so dictate. Future cases may test the boundaries of the scope of implied representation. One such example of when the “cross-infection” argument may become relevant was raised by the court: “If, of course, a submitter in yen or Swiss francs had also made sterling submissions, that might render false the representation about sterling LIBOR”.
The Court’s reformulation of Colman J’s helpful implied representation test failed on the facts of this case because although there was an implied representation, due to the particular derivative sold, this was not misrepresentation. Nevertheless, future Claimants will be assured that the Court left open the possibility of future cases extending the scope of implied representation beyond the particular transactions induced in this case.
RBS’s contractual facility right to call for valuations of security is not unfettered but subject to an implied term that it can only exercise its’ right for “legitimate commercial aims”
Under the provisions of one of the facility agreements with the bank, RBS had the right to require a valuation at PAG’s cost of all of the assets over which it held security. Clause 21.5.1 of the 2011 facility provided as follows:
“The Lender [i.e. RBS] may, at any time, require the Valuer to prepare a Valuation of each Property [i.e. each of the properties over which RBS held security]. The Borrower [i.e. PAG] shall be liable to bear the cost of that valuation once in every 12 month period from the date of this Agreement or where a default is continuing.”
“reasonably, in a commercially acceptable or rational way, in good faith, for a proper purpose (i.e. the purpose for which such power or discretion was conferred), not capriciously or arbitrarily and not in a way that no reasonable lender, acting reasonably, would do” (to quote from the Particulars of Claim).
Property Alliance Group Ltd v The Royal Bank of Scotland Plc  at para 162
PAG argued that GRG’s request for valuation was arbitrary and pointless because, according to a witness statement from an RBS manager, RBS had decided by May 2013 against refinancing PAG and clause 21.5.1 was exercised without rational reason after this time in August 2013. Moreover, the convincing argument was advanced that if clause 21.5.1 was not constrained by a Socimer-type implied term, then “there would have been nothing to stop RBS requiring a valuation every week or even every day.”
On the other hand, Mrs Justice Asplin in the High Court agreed with RBS’s submission that a Socimer-type implied term did not arise as clause 21.5.1 had been inserted primarily for RBS’s benefit and RBS was (in her view) not obliged to take account of PAG’s interests when deciding to invoke the provision.
Socimer-type implied terms accepted to limit a bank’s exercise of contractual rights
The Court of Appeal examined the Socimer line of authorities and looked favourably upon the previous authorities submissions on implied terms. Rix LJ in Socimer held:
“It is plain from these authorities that a decision-maker’s discretion will be limited, as a matter of necessary implication, by concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality. The concern is that the discretion should not be abused.”
Socimer International Bank Ltd v. Standard Bank London Ltd  at para 66
Moreover, in Paragon Finance plc v Nash  EWCA Civ 1466, Dyson LJ submitted that power was not completely unfettered and an “implied term is necessary in order to give effect to the reasonable expectations of the parties.” Jackson LJ agreed in Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd EWCA Civ 200 that, where there was a one-sided contract under which only one party is permitted to exercise discretion (such as RBS’s right to demand a valuation pursuant to the 2011 facility agreement), there is an implied term “that the relevant party will not exercise its discretion in an arbitrary, capricious or irrational manner”, which is “extremely difficult to exclude”.
The Court of Appeal adapted the Socimer-type implied term. In accepting PAG’s appeal on this point of law, the power conferred by clause 21.5.1 “was not wholly unfettered” and:
“In the circumstances, it seems to us that RBS must have been free to act in its own interests and that it was under no duty to attempt to balance its interests against those of PAG. It can, however, be inferred that the..