FCA unable to act on GRG behaviour

FCA unable to act on GRG behaviour

Michael Leslie JCRA August 2018

Our commentary on the release of the FCA report on the Royal Bank of Scotland’s GRG division was written in February 2018 (please see below), when the long-awaited report finally was put into the public domain under parliamentary privilege by the Treasury Select Committee. This week, the FCA has concluded that they are unable to take action in respect of the “fundamental failings” of the bank as commercial lending was, and remains, unregulated. However, the FCA takes comfort from the introduction of the Senior Managers Regime in March 2016 which applies to senior managers in financial institutions in relation to both regulated and unregulated activities. This regime cannot be applied retrospectively which is of little comfort to some of the SME and mid-market borrowers who found themselves in GRG between 2008 – 2013.

Last week was book-ended by news on RBS. On Friday the Group announced its first annual profit in 10 years; the first since its rescue by the UK taxpayer in October 2008. The headline figure may be positive but drill deeper and the bank’s results remain impacted by a legacy of unsettled litigation, restructuring charges and reorganisation costs. Earlier in the week, one such ghost from the bank’s recent past was finally laid bare as the Financial Conduct Authority’s (FCA) report into RBS’s treatment of SME customers was published under parliamentary privilege by House of Commons Treasury Select Committee. The much delayed report, stretching to 360 pages, was published in full by the Committee and makes for grim reading as an account of the governance, objectives, practices and processes of the bank’s Global Restructuring Group (GRG), the division of the bank responsible for the management of customer accounts in distress in the aftermath of the financial crisis.

The report points to “fundamental failings to ensure the effective oversight and governance of GRG” which was found to place its own objectives, notably the generation of income from these distressed accounts, over those of customers. Rather than supporting customers and pursue a primarily turnaround agenda focused on the long-term viability of these businesses, the bank’s actions were actually found to have caused material financial distress in one in six of the cases reviewed by the report’s authors. In the absence of a defined regulatory regime for lending to SME customers (see below), failures in communication and in the failure to adopt, or subsequently follow, appropriate internal policies and address potential conflicts of interest, the report identified inappropriate treatment of customers in 86% of the cases reviewed.

The report is particularly critical of the bank’s approach to Treating Customers Fairly (TCF) and GRG’s handling of complaints. It notes that “failure to adopt adequate procedures and to ensure fair treatment of customers gave rise to widespread inappropriate treatment of customers throughout the Relevant Period” and quotes example of antagonistic and inconsistent behaviours by case managers, including threats of insolvency.

Of course, whilst this will represent vindication for some, the findings are of little new comfort to the businesses adversely affected by GRG. As the report covers a review of cases from 2008 to 2013 many will by now be time-barred or already brought to a conclusion. There is no indication of additional redress/restitution; albeit that the report notes that “it is understandable there will be calls for RBS to compensate the customers affected” in cases where the actions of GRG have caused material financial distress to certain customers.

We must ask: what can we learn from this episode and how may it impact the way that banks interact with the SME sector and the treatment of loans and business in financial distress going forward? Some changes are already being felt in terms of increased disclosure by lenders and compliance which, although necessary, can delay funding processes and often places a greater emphasis on the customer’s understanding of the products being sold to the customer – shifting the risk profile. In addition, we have already seen a move on the part of some financial counterparties to restrict the products available to borrowers, especially in the case of interest rate risk management (commonly referred to as hedging). The report noted that “on the basis of our assessment, we concluded that almost 50% of our sample lacked financial sophistication” and the response of lenders may be to limit not just the sale of what have been shown to be unsuitable products but to restrict suitable products and, ultimately credit, to the sector.

What might be the approach of lenders in future restructuring situations? The report highlights the range (and cost) of fees charged to borrowers and is critical of the use of upside instruments, particularly those that resulted in the acquisition of property or equity by the bank or its subsidiaries. Approaches incorporating increased margins, fees and exit fees and some form of “debt for equity” have traditionally been used to improve lenders’ returns in high-risk positions and it remains to be seen whether such tactics will now be considered appropriate in the SME sector. If not, how will lenders manage high-risk accounts and, again, will this ultimately result in credit only being extended to the lowest risk businesses.

Finally, questions remain for the FCA in this case beyond just the historic level of oversight applied to the sale of loans and structured products to SME customers by the Authority. Firstly there is the issue of timing. It should be noted that the FCA had missed Parliament’s deadline to publish the report, leading to the Committee’s decision to publish on account of the “overwhelming public interest” of doing so. The report was instructed, under Section 166 of the Financial Services and Markets Act 2000, on 20 May 2014. It was presented to the FCA in September 2016 and took a further 16 months to reach the public domain. Secondly, as the report notes, the activities of GRG along with almost all features of bank lending to SME customers, were not regulated by the FCA at the time, nor are they at present. Therefore, there were limited regulatory rules or principles by which to assess the GRG’s treatment of customers and the report concludes that the FCA should work with government and other relevant parties to extend the protections available to SME customers.

One cannot dispute the Committee Chair’s summary that “the findings of the report are disgraceful” and the timetable to bring the report to the public was unacceptable. Customers in high-risk positions deserved better treatment and support from the bank, whose objectives created the potential for conflicts of interest in the face of inadequate controls and inconsistent case management. The report shines a light on unacceptable practice and makes specific recommendations as to how RBS should fundamentally rethink how it handles customers in financial distress.

Now we know what unacceptable looks like, what the industry needs to answer is what protections will be implemented across the wider SME banking market, to avoid a similar catalogue of distress and mismanagement in the next financial cycle.

All views expressed here are the Author’s own and are based on information available at the time of writing.


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