The recent decision by the court in the claim brought by Guardian Care Homes against Barclays (see story 30 October 2012), allowing the claimant to bring the manipulation of LIBOR into a case on hedge mis-selling, highlights the storm clouds that still gather around the banking sector and may indicate a lack of trust of banks in the Courts.
I believe the mis-selling of hedge instruments is an on-going issue, waiting to hit the banking sector, especially the question of break costs and their calculation.
The potential cost implications to the banks are huge.
When I was a banker (before becoming a solicitor some 10 years ago), where a fixed rate was referred to in loan documents, specific hedge instruments were not put in place unless it was a large transaction.
The “fixed rate” would be identified within the loan documentation but not hedged as such. No doubt at some point a global hedge would be put in place by the bank covering a series of historic loans with a similar “fixed rate” and repayment profile, but this was not loan specific. The Bank would rely on standard indemnity wording in its loan documentation in order to recover, for example, break costs but their calculation was done on a notional rather than an actual basis.
More recently, I have noticed that more banks prefer to put individual hedges in place on a transaction by transaction basis, often using the International Swaps and Derivatives Association (ISDA) documentation.
This documentation is, in my view, impenetrable and difficult for an ordinary customer to understand. I feel it is really intended for bank to bank use so is full of banking jargon.
It is difficult to see how anybody, other than certain specialist institutions, could advise a layman borrower on ISDA documentation. Unlike other finance documents, I don’t really believe that most lawyers are qualified to do so.
Ironically, ISDA documentation gives a borrower more protection than less. It certainly provides for break profits to be paid to a borrower whereas loan indemnities generally do not. However, most hedges based on ISDA documentation use LIBOR as their benchmark to calculate the difference between the rate applied and the rate hedged.
Therefore, the increased use of these kinds of instruments has left the banks open to the risk that consideration of the question of mis-selling of hedges may extend to the manipulation of LIBOR, as demonstrated by the Guardian Care Homes case.
As for the customers, why should they care about how the bank benchmarks its interest rate?
The reality is that if a customer has a fixed rate in place the customer would be paying interest at a rate calculated using the fixed rate specified in any confirmation letter issued on completion.
The loser here would be the bank, as the hedge counterparties would be either paying too much or too little to itself depending on the calculation of LIBOR. This may not be the case if a different form of hedge instrument were in place, for example a cap and/or collar, where LIBOR may be used.
It’s easy to argue that where a customer has a fixed rate in place, LIBOR and it’s manipulation should not really have any bearing on what interest a customer physically pays on an on-going basis.
However, the decision of Mr Justice Flaux in this case indicates to me that the Court is concerned that the manipulation of LIBOR, although not maybe having a direct consequence on a fixed rate, is indicative of how the banks treat interest rates generally.
As LIBOR was a rate set within the banking industry itself, with no involvement of or reference to any external agency (other than the BBA), the decision seems to reflect the lack of trust that exists in respect of the
internal mechanisms of banks and their ability to set their own checks and balances. The steady flow of these decisions proves that banks should expect both more involvement in their affairs from agencies outside the direct banking sector and customers taking opportunities to mount legal claims against them, which may be treated more sympathetically against this backdrop of distrust.
The real difficulty for litigants seems to me to be in firstly linking the misquotation of any particular bank to have caused an artificial LIBOR (or other rate); and, secondly, showing that artificial rate caused a loss which would be recoverable from that particular bank, it’s all a question of causation.
As I said, the storm clouds are gathering and I see no sign of them abating in the short to medium term. How this will leave the banking industry when the blue skies return is difficult to predict but I suspect it will be a much changed (and chastened) animal to the one that existed in the past.
Howard Kennedy partner Steve Clinning