The first hearings of Australia’s Banking Royal Commission began in March 2018 – only one month after the final conclusion of a long running UK review into the post-GFC handling of problem loans by UK’s Royal Bank of Scotland.
A so-called ‘Skilled Person’ report was commissioned by the UK Financial Conduct Authority in January 2014, and delivered in September 2016. But it was only released to the public in February 2018 when an apparently impatient Parliamentary Committee acted unilaterally by publishing the full report online here.
Whereas the Royal Commission hearings in June 2018 presented a small and carefully curated selection of customer complaints, the RBS review conducted an extremely detailed analysis of more than 200 cases – an unprecedented insight into the working of a workout team.
The background to the report is discussed in detail here.
The report concluded that there was ‘widespread inappropriate treatment of customers’ by GRG – RBS’ workout team. It included recommendations for RBS specifically, and also made recommendations ‘for the wider market.’ Both are reproduced in full below.
How does Australia measure up against the RBS report recommendations?
At a time when there appears to be fierce scrutiny of the treatment of small business borrowers by Australian banks, it is appropriate to measure the current Australian position against the four general recommendations contained in the RBS report:
1. Extension of Unfair Contract Terms protections to SMEs
The UK’s Unfair Contract Terms regime does not apply to SME businesses at all.
The Australian UCT regime does not completely align to the UK regime (for a careful comparison see here) but what is in place does apply to loans of less than $1 million to small business (defined as those with fewer than 20 FTE) made or varied after 12 November 2016.
The ASBFEO and others argue that the $1m limit is too low, but Australia at least has some coverage.
2. Greater access to the Financial Ombudsman Service
In the UK, ‘micro-enterprises’ (an EU definition: businesses with an annual turnover of up to two million euros and fewer than ten employees) can access their FOS scheme, with compensation awards limited to £150,000.
In Australia, the current FOS scheme compensation is limited to $323,500. At present then, the UK and Australian schemes provide broadly similar coverage, however from 1 November 2018 the new Australian Financial Complaints Authority will commence operations. AFCA will have power to award compensation of up to $1m in relation to business credit facilities up to $5m provided to businesses with less than 100 staff.
As of 1 November the Australian scheme will therefore be available to micro, small, and medium businesses, and it will provide significantly larger compensation. Australian businesses will clearly have better protection from 1 November than their UK counterparts.
3. Introduction of a Code for bank support of customers
There is a ‘Lending Code’ in the UK, but it provides limited guidance in the area of bank support, and in any event it only applies to micro-enterprises.
The Australian Code of Banking Practice – approved by ASIC last week, but to apply no later than 1 July 2019 – is available here.
The CoBP is stated to apply to ‘small businesses’ (yet another definition!): those with fewer than 100 staff and annual turnover of less than $10 million in the previous financial year, and less than $3 million total debt.
Part 6 of the CoBP sets out protections for small businesses. Perhaps the most significant development is a limitation on the recovery of loans based on the grounds of non-monetary default. That said, careful explanation is required because some non-monetary defaults will still apply if material: formal insolvency, lapsing of insurance, failure to provide correct and complete information, a loss of license or breach of law, or use of the loan funds for an unauthorised purpose. There also specific types of loans where ‘financial indicator’ non-monetary defaults are ‘ruled in’ : margin lending, SMSF loans, bailments, invoice finance, construction finance, foreign currency loans and tailored cash flow lending.
Other changes include:
- A minimum 30 days’ notice of enforcement action (albeit with some exceptions where special risks are evident).
- A minimum of 3 months’ notice where a bank decides not to extend a loan beyond its original term.
- A blanket prohibition against the use of ‘material adverse change’ clauses.
- Clarity around valuation processes: clear explanation around the purpose of the valuation, with copies of property valuations and valuer instructions to be provided to the borrower unless enforcement action has already commenced.
- An undertaking to ensure that valuers and investigating accountants are members of professional organisations with appropriate codes of conduct. Banks must apply additional internal oversight if investigating accountants are to be appointed as receivers.
ASBFEO argues that the $3m limit is too low and should be increased to $5m, but again, Australia is clearly ahead of the UK in relation to a formal code of practice.
4. Dealings with third-party providers, especially in relation to secondees.
The RBS report identified issues which it said gave rise to concerns that third-party service providers ‘may be too ready to see the bank’s point of view.’ Most would expect that a service provider would work hard to see things from a clients’ point of view however, so it is not clear at first reading what criticism was intended by the authors of the report.
More clearly, the report identifies the need for controls around distribution of sensitive information to advisers, and the potential for conflicts of interest where secondees are involved.
Most lenders would have their own controls around such issues, but there is no industry standard in either the UK or Australia.
Recommendations do not apply to non-bank lenders
The RBS recommendations refer specifically to ‘banks’ rather than ‘lenders.’
At least in Australia, the market share of non-banks is growing strongly in some sectors. Some part of that growth may be due to a customer preference for Fintech offerings, but it also reflects the lack of alternatives for borrowers who are excluded by the CoBP criteria (for example, those who are ‘asset rich’ but ‘income poor’), or seeking funds in areas where bank portfolio management issues translate to limited appetite (currently: property development).
Some critics of banks may argue that it is appropriate that banks are subject to a higher standard than other lenders. Leaving the merits of that argument to one side, it raises an interesting policy question: is there a need for non-bank borrowers to have a real understanding of which regime applies, or is it acceptable for that to be left to the ‘small print’ of the loan agreement?
Overall
It may not suit the narrative of some bank critics, but protection of small business bank customers is greater than that available to small business non-bank customers, and it is clear that both have significantly better regulatory protection in Australia than their UK counterparts.
Part 7 of RBS Group’s treatment of SME customers referred to the Global Restructuring Group (available online here) is reproduced in full below.
Part 7 – Recommendations
7.1 Throughout this report, we have Identified Issues relating specifically to RBS, but we also believe that there are wider lessons for RBS and for the industry as a whole. In this Part we draw together specific recommendations for RBS and draw out some wider observations in the light of our findings.
7.2 The FCA has instigated a review of its own approach to SMEs as users of financial services and we see our report and its recommendations as a contribution to that work. There are also Important Implications for other lenders, the professionals with whom they work, policy makers, and SME customers.
Recommendations for RBS
7.3 The conclusions we have reached in this report warrant a fundamental rethink by RBS of how it handles Its SME customers in financial distress.
7.4 We recognise that some change was already being made at the end of the Relevant Period. But the terms of reference for Phase One meant that we did not review whether or not the lessons from these events have been learnt by RBS, or whether the wide-ranging changes that we consider to be necessary have been made and are embedded. As we did not review changes made by RBS after the end of the Relevant Period we recognise that some of the recommendations set out below may already have been addressed or their relevance superseded by subsequent events but nonetheless they provide a framework within which future treatment of SME customers can be developed and provide an opportunity to address the weaknesses in governance and oversight, and indicators of poor culture in GRG that we have highlighted In this report.
7.5 We recommend that a review is carried out to ensure that our conclusions and recommendations that remain relevant to RBS have been implemented and in particular, to provide assurance to RBS, customers and the FCA that adequate governance and oversight arrangements are now in place to ensure that similar poor treatment of distressed SME customers could not happen in future.
7.6 Specifically we recommend that in carrying out that review RBS should, in the light of the observations and conclusions in this report:
- Improve its governance arrangements and in particular*:
- Review the objectives set for its turnaround division – the revised objectives should be agreed by the RBS Group Board;
- Review the governance of its turnaround division to ensure that it is subject to effective scrutiny, and establishes effective second and third lines of defence;
- Review the content and form of management Information to ensure that customer outcomes and experience are accurately reported:
- Review the staff objectives set for, and culture of, those In Its turnaround unit dealing with SME customers to ensure that these more closely align with the revised objectives the RBS Board has agreed;
- Improve the arrangements around transfer into and out of the turnaround unit:
- Revise the criteria for the consideration of referral to the turnaround unit In respect of SME customers;
- Review the governance of the transfer process for SME customers to ensure that It is acting both efficiently and fairly: specifically we recommend that the chair of the group considering transfers should be independent of both B&C and the turnaround division;
- Ensure that its arrangements for returning customers to mainstream banking are clearly signposted to SME customers and that where RTS is appropriate this can be expedited promptly;
- Provide a greater focus on turnaround options where these are viable:
- Review and Improve Its training and guidance for staff handling turnaround issues and ensure that staff have the necessary support and training to deliver good turnaround practice;
- Ensure in future that viability assessments are carried out on all cases following transfer and that where customers are potentially viable, a clear turnaround plan with milestones and targets should be produced and wherever possible shared and agreed with the SME customer;
- Review the role and purpose of the Strategy and Credit Committee (or its successors) to ensure the terms of reference contain a requirement that turnaround options and the fair treatment of customers are reviewed in addition to credit considerations;
- Rethink its approach to pricing in respect of distressed SME customers:
- Review the policy and practice of the turnaround unit on pricing to ensure that Relationship Manager pricing decisions and reasoning are fully documented and validated and that turnaround considerations are taken Into account;
- Review the range and form of fees and other charges for SME customers and set out for customers a clear and simple guide to when fees wiII be applied;
- Review the rationale for an additional administrative/management fee being routinely levied on distressed customers;
- Ensure any internal valuations are handled more carefully:
- Ensure that internal valuations and the reasoning behind them are fully documented and that this information is shared with the customer if the valuation is to be used in the development of strategy, or in decisions around the level of facilities or pricing;
- Where in-house resources are used to provide valuations upon which significant decisions are made In the context of a turnaround unit, RBS should ensure that there is a clear separation of functions and adequate safeguards to prevent conflicts of Interest;
- Review its policies and practices on dealing with customers and on complaints:
- Review its policy and procedures for Relationship Managers’ engagement with SME customers. In particular RBS should consider how Its engagement with SME customers takes appropriate account of the different circumstances of the diverse group of SMEs with which it deals;
- Review and revise its communications with customers to ensure that it is transparent, clear and informative,
- Revise its approach to complaint handling and provide SME customers with clearly signposted routes to escalate their complaint if necessary;
- Review its use of third-party firms and in particular the use of secondees’
RBS should ensure that appropriate guidelines and mechanisms are in place to guard against conflicts of interest in these areas;
- Fundamentally review its approach to the purchase of distressed assets:
Amend the governance, policies and practices and other arrangements relating to circumstances where it (West Register) acquires or considers the acquisition of assets owned by its distressed SME customers to address the shortcomings in arrangements that we have Identified and ensure effective separation of the function from any turnaround unit;
- Review the use of Upside Instruments in the context of SME customers:
- Review the Information provided to SME customers In relation to PPFAs to ensure that the agreements and the associated costs are transparent; and
- Review the role of EPAs In relation to SME customers, in so far as RBS Judges their continued use is justified and helpful to some customers it should further consider customer communication, minimum timescales and notification of buy-back terms, the governance around the arrangements and more widely the Interaction between SIG, the turnaround unit and SME customers
7.7 Addressing these recommendations will help ensure that similar problems to those experienced In RBS’s GRG during the Relevant Period do not occur in future. These recommendations do not, however, address the concerns and Issues of those SMEs that were handled by GRG. We make two recommendations that are intended to address specific unfairness that we observed during the course of our review. These are:
- Revisit the cases Identified in our review where it Is clear that GRG failed to respond to a complaint or where Its response was Inadequate, and
- Review the position of those SME customers who entered Into an EPA during the Relevant Pernod with a view to ensuring that where a West Register minority holding in their business remains in place that they have a fair means of resolving disputes about the value of that holding.
7.8 But those specific recommendations do not address the central findings of our review. We have identified a number of cases where we conclude that the actions of RBS are likely to have caused material financial distress to the customers affected and there are other cases where it seems clear that the customer will have suffered from some unfairness. It is understandable that there will be calls for RBS to compensate the customers affected.
7.9 As we have noted previously the extent and nature of financial distress vary considerably and are often hard to quantify with any precision. The circumstances of GRG customers often meant that the Bank had considerable discretion under the law, and those Individuals who suffered may not have a straightforward legal position. In any case, for example because the company was the Bank’s customer, and they may no longer be the owners, or the company may have ceased to exist. The inappropriate actions we identify and their wide ranging consequences for customers were not caused by breaches of regulatory rules or principles so the scope for regulatory action is limited
7 10 Responsibility for responding to these Issues and the distress GRG caused many of its customers rests with the Board of the RBS Group. We do not underestimate the challenges of any redress scheme it would likely require independent, lengthy and complex mediation, operating outside the strict legal framework.
7.11 Nevertheless we recommend that RBS should consider the practicalities of providing redress to GRG customers who are likely to have experienced financial distress as a result of its actions.
7.12 There are also some wider Issues for RBS to consider. First the extent to which the Issues we report here In respect of GRG were or In particular remain features of other units handling SME customers. We recommend that RBS reviews the relevance of these findings more widely to its handling of SME customers.
7.13 Second the terms of the Requirement Notice meant that we did not review the extent to which those in RBS outside GRG were aware of the Issues. In any event it appears to us that there are wider lessons for RBS to consider in terms of how the events in GRG could have continued for so long apparently either unnoticed or unchallenged by others in the wider RBS Group.
Lessons for the wider market
7.14 The FCA has, as noted above, Instigated a review of its own approach to SMEs as users of Manual services. Our report and its recommendations can be viewed as a contribution to that work. Our findings highlight the diversity of SMEs and the Inequality of bargaining power between less sophisticated SMEs and banks. They also underline the lack of protection available more widely to SMEs.
7.15 The case for standards – established either by regulation or by agreement – In relation to lending to SMEs Is derived from the special features of the market, as described In the CMA/FCA Market Study and the wider CMA Retail Banking – SME market Investigation: a sector with high concentration in lending, the lack of understanding of many SMEs as to the pricing of banking products Including loans, and the paradox of Simultaneous low levels of satisfaction and of switching among SME bank customers. As our work has shown, SME customers facing hardship may have even more limited choices. They will often have little realistic prospect of changing their banking arrangements – whatever their level of satisfaction or dissatisfaction with the services provided, and whatever the price of those services. This Is particularly the case during periods of economic uncertainty
7.16 The SMEs In our sample illustrate the variety of SMEs that banks have to deal with. They included some SMEs with a reasonable level of financial sophistication who had available to them expert advice; but they also included SMEs without access to Independent advice, and with little financial experience. Even when a SME had some reasonable understanding of financial Issues, this was not necessarily sufficient for the increased complexity of the Issues which often arose once the SME was transferred to GRG, where the situation could be complicated both by general legal issues such as the different protections and treatments offered to limited companies and to sole traders, and by the complexity of the solutions which GRG on occasion brought forward. There were other important differences some were In effect sole traders or owner managers where the sickness of a key individual could have catastrophic consequences for the business for some smaller customers the lending was closely intertwined with personal financial arrangements, so that when things went wrong in the business the consequences were personal as well as professional.
7.17 We have noted that GRG had few arrangements for drawing such distinctions in its customer base and for shaping its services and communications with an eye to these differing levels of capability. Indeed, it is not clear that RBS now accepts the need for this.
7.18 We believe that policies and practices for the SME sector need to be based at least In part on an appreciation of differing customer capabilities, if the SME customer is to be treated fairly. This is not readily defined by arbitrary limits such as amounts of debt or even turnover. But it will be relevant to take account of the stage in the banking relationship reached by the customer, to ensure that products, services and communications are appropriate for the needs of the SME customer.
7.19 The present regulatory protections for SME-related conduct are limited. Given the widespread inappropriate actions Identified in this report in relation to lending activities, we consider that the FCA should work with the government and other relevant parties to extend the protections available to SME customers.
7.20 One option would be to extend the regulatory perimeter to bring SMEs within the scope of FCA’s regulated activities, to ensure that regulatory action can be taken to guard against unfair treatment of customers and that the principles for business and standards of good governance and personal respon5ibility apply to this sector as they do to other parts of retail banking However a higher priority may be to give SMEs avenues to challenge banks where they are treated unfairly For example consideration should be given to extending the unfair contract terms protections to SMEs, and giving them greater access to the F0S.
7.21 Contracts with SMEs for the provision of credit facilities and other services can be markedly more complex than their retail market equivalents. In part this reflects limited protections for SMEs – in particular the Unfair Terms in Consumer Contracts Regulations (UTCCRs).
7 22 As a result, SME contracts can give banks wide discretionary rights to vary terms that would not be compliant with unfair contract terms provisions in a retail setting. The lack of unfair contract terms protections, taken together with the restricted access to redress/dispute mediation for SMEs, can give rise to a risk of unfair treatment of customers. Whilst some discretion may be inevitable given the nature of the products involved, the ability of banks to change lending criteria, or to treat many loans as well as overdrafts as ‘on demand’, means that banks have a wide discretion that SMEs cannot readily plan against or challenge.
7.23 The Law Commission’s recommendation” that Unfair Terms in Consumer Contracts provisions should be extended to at least some SME customers has not been progressed. Coupled with the restrictions on access to dispute resolution services, this can place SMEs at a material disadvantage
7 24 A concern raised by many SME customers in our sample related to the absence of any serious consideration of their complaints while RBS had a policy to respond to complaints in line with its requirements under regulatory rules, many SME customers were not micro-enterprises and as such complaints from them were not covered by DISP. That meant the Bank had no regulatory obligations to handle complaints promptly, to investigate them fairly or to consider the root causes of such complaints. And there was no obligation to record and report on those complaints or to publish information about them.
7.25 For customers other than micro-enterprises there is no access to the F0S. The ability, alternatively, to litigate for most of these customers will be limited, litigation is notoriously slow and costly and detracts from the running of the business. FCA is committed to reviewing the scope of FOS following the report of the Banking Standards Commission. But the micro-enterprise definition is not the only barrier facing SMEs in their dealings with FOS. Even for micro-enterprises, the F0S award limit (£150,000), coupled with the inability to litigate for any additional compensation Following a FOS decision, limits the relevance of FOS as a redress option
7.26 We encourage the FCA to work with the government to ensure that there are adequate protections for the less sophisticated SMEs. This could include the extension of the unfair contract terms protections to SMEs and greater access to the F0S.
7.27 An alternative (or supplementary) approach would be to develop professional standards governing banks’ lending to SMEs. The Lending Code applies to some SMEs, but only micro-enterprises. It includes some provisions on helping micro-enterprises who are experiencing financial difficulties and complaints handling. The Lending Code is monitored by the Lending Standards Board.
7.28 In relation to turnaround divisions the need for additional protection for SME customers is more acute. At present there are no generally recognised professional standards for turnaround or restructuring units in the UK, although various guides and codes exist which are seen as relevant. These include for restructuring the IMF Restructuring Guidelines, the ‘London approach’ and the INSOL Principles. Both the Insolvency Practitioners Association and the Institute for Turnaround publish codes of ethics, and the latter has recently published a ‘Statement of Principles for the UK ‘ Business Support Units’ of Banks’.
7.29 The principles cover Issues we identified as part of our review, including provisions on treating customers sympathetically, communication, appropriate pricing and complaints handling. They have been endorsed by several banks. However, there is little transparency about what banks have done to ensure that they meet the principles, and it seems no independent monitoring of compliance with the principles it is unlikely, therefore, to give customers confidence that this will make a difference to their treatment in future.
7.30 Both the Lending Code and the Institute for Turnaround Statement may have a useful role here. What is Important is that any self-regulatory action has the confidence of both banks and customers and has demonstrably effective independent oversight and monitoring.
7 31 We encourage the industry and customer groups to develop a code on how banks can best support customers in need of business support. Such a code should be subject to independent oversight and monitoring.
7.32 The situation In RBS and GRG was particular to that organisation at that time. Nevertheless the themes raised in this report may have wider resonance as banks consider how they should further develop turnaround units. For example, a concern that was raised with us by some stakeholders was the nature of the relationship between lenders and various professional firms that support the turnaround or Insolvency process.
7.33 Inevitably banks are a major user of accounting/Insolvency, valuation and legal services. Given their scale and scope providers of these services will understandably wish to have strong and constructive relationships with banks. A complex pattern has emerged of links between Individual suppliers and banks which, It Is argued, includes frequent use of secondees from professional firms, complex and sometimes non-transparent fee and revenue agreements between advisers and individual banks, and questions around the control of sensitive information between the banks and their advisers
7.34 Such Issues can give rise to concerns about the availability of qualified third-party support with the relevant experience to support customers (given that most with experience will have extensive conflicts with the banks serving those customers) There is also a perception that customer perspectives will be Ignored because of the commercial significance of meeting wider bank requirements where a bank Is a major client of a specific adviser and that the professionals may be too ready to see the bank’s point of view.
7.35 In the case of GRG we identified weaknesses in the management of potential conflicts of interest, in particular around the use of secondees. It was not surprising that many customers were left with the Impression that third-party providers were too close to the Bank. But a more general comment is that, whether or not such behaviours take place, the absence of agreed standards can create a suspicion of inappropriate practice, particularly where clients are facing economic distress, even If this may not In fact exist.
7.36 We suggest that banks should review how they interact with third-party providers, especially in relation to secondees.
7.37 More generally we suggest that banks should review their own turnaround units with a view to ensuring that the lessons from this report in so far as they are relevant to other institutions are applied more widely.
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Australian Loan Restructuring Issues 